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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K/A

(Amendment No. 2)



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, 2003



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



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INSITE VISION INCORPORATED

(Exact name of registrant as specified in its charter)



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 94-3015807                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification 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:



|                              |  |                                          
|----------------------------- |  | -----------------------------------------
|Title of each class           |  | Name of each exchange on which registered
|Common Stock, $0.01 Par Value |  | American Stock Exchange                  



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



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes ̈No  x



The aggregate market value of registrants Common Stock, $0.01 par
value, held by non-affiliates of the Registrant as of June 30, 2004: was approximately $12,742,170 (based upon the closing sale price of the Common Stock on the last business day of the registrants most recently completed second fiscal
quarter). 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. Number of shares of Common Stock, $0.01 par value, outstanding as of March 26, 2004: 33,138,778.



DOCUMENTS INCORPORATED BY REFERENCE



None.

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EXPLANATORY NOTE



This Amendment No. 2 on Form 10-K/A (this Amendment) amends and restates in its entirety the Annual Report of
InSite Vision Incorporated on Form 10-K for the fiscal year ended December 31, 2003, originally filed on March 30, 2004 (the Original Filing), including Amendment No. 1 on Form 10-K/A originally filed on April 29, 2004 (the Prior
Amendment). This Amendment is being filed to revise language contained in the Original Filing under the following Items:



| | · | Item 1: Businessin order to identify the accredited investor to whom we sold shares in a private placement in December 2003; to add additional disclosure regarding our
ISV-401 product candidate, our collaborative, licensing and service agreements, and our patent portfolio; and to reorder and make clarifying changes to certain of the risk factors;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | Item 3: Legal Proceedingsin order to identify the party who filed a claim against us in October 2003;
| | - | -----------------------------------------------------------------------------------------------------



| | · | Item 5: Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Securities in order to provide additional disclosure regarding the
parties to whom we have recently issued unregistered securities;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | Item 7: Managements Discussion and Analysis of Financial Condition and Results of Operationsin order to clarify the disclosure regarding our critical accounting
policies and use of estimates, our results of operations, and our liquidity and capital resources;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | Item 8: Financial Statements and Supplementary Data in order to clarify line item descriptions in the Consolidated Balance Sheets and Consolidated Statements of Cash Flows,
and to clarify and add disclosure to Notes 1, 2 and 10 to our Consolidated Financial Statements.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition, Item 10 of the Prior Amendment has been revised in this Amendment to correct a typographical error in the biography of director Jon S. Saxe.
In connection with the filing of this Amendment and pursuant to the rules of the Securities and Exchange Commission, the Company is including with this Amendment certain currently dated certifications as Exhibits 31.1, 31.2, and 32.1 and, due to the
changes in the Notes to the Consolidated Financial Statements, the Company is including with this Amendment a new consent of Burr, Pilger & Mayer LLP as Exhibit 23.1. As no changes have been made in this Amendment to the Companys
Consolidated Financial Statements or the Notes thereto for the two fiscal years ended December 31, 2002, the consent of Ernst & Young LLP contained in Exhibit 23.2 is incorporated by reference to the consent filed as an exhibit to the Original
Filing.



Except as described above, no other changes have
been made to the Original Filing or the Prior Amendment, however for the convenience of the reader the Company has restated the entire Original Filing and Prior Amendment, as amended pursuant to the description above, in this Amendment. This
Amendment continues to speak as of the date of the Original Filing, and the registrant has not updated the disclosures contained therein to reflect any events which occurred at a date subsequent to the filing of the Original Filing.



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ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003



TABLE OF CONTENTS



|           |  |                                                                                                       |  |     
|---------- |  | ----------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                       |  | Page
|           |  |                                                                                                      
|PART I     |  |                                                                                                       |  |     
|           |  |                                                                                                      
|Item 1.    |  | Business                                                                                              |  | 1   
|           |  |                                                                                                      
|Item 2.    |  | Properties                                                                                            |  | 34  
|           |  |                                                                                                      
|Item 3.    |  | Legal Proceedings                                                                                     |  | 34  
|           |  |                                                                                                      
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                   |  | 34  
|           |  |                                                                                                      
|PART II    |  |                                                                                                       |  |     
|           |  |                                                                                                      
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Securities |  | 35  
|           |  |                                                                                                      
|Item 6.    |  | Selected Financial Data                                                                               |  | 38  
|           |  |                                                                                                      
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 39  
|           |  |                                                                                                      
|Item 7A.   |  | Qualitative and Quantitative Disclosures About Market Risk                                            |  | 48  
|           |  |                                                                                                      
|Item 8.    |  | Financial Statements and Supplementary Data                                                           |  | 48  
|           |  |                                                                                                      
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                  |  | 71  
|           |  |                                                                                                      
|Item 9A.   |  | Controls and Procedures                                                                               |  | 71  
|           |  |                                                                                                      
|PART III   |  |                                                                                                       |  |     
|           |  |                                                                                                      
|Item 10.   |  | Directors and Executive Officers of the Registrant                                                    |  | 72  
|           |  |                                                                                                      
|Item 11.   |  | Executive Compensation                                                                                |  | 75  
|           |  |                                                                                                      
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters        |  | 79  
|           |  |                                                                                                      
|Item 13.   |  | Certain Relationships and Related Transactions                                                        |  | 81  
|           |  |                                                                                                      
|Item 14.   |  | Principal Accountant Fees and Services                                                                |  | 82  
|           |  |                                                                                                      
|PART IV    |  |                                                                                                       |  |     
|           |  |                                                                                                      
|Item 15.   |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                      |  | 84  
|           | 
|Signatures |  | 85                                                                                                   



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Cautionary Statement for purposes of the Safe Harbor provisions of Private Securities Litigation Reform
Act of 1995:



Except for the historical information
contained herein, the discussion in this Annual Report on Form 10-K contains certain forward-looking statements that involve risks and uncertainties, such as statements of our plans, beliefs, 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 only 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.



PART I



Item 1.    
Business



THE COMPANY



We are an ophthalmic product development company focused
on developing genetically-based technology, for the diagnosis, prognosis and management of glaucoma, as well as ophthalmic pharmaceutical products based on our proprietary DuraSite® eyedrop-based drug delivery technology. In addition, we have a retinal program that includes both a therapeutic agent
and a retinal drug delivery technology.



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



| |  |  | ISV-401, a DuraSite formulation of azithromycin, an antibiotic not currently used in ophthalmology;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | targeted market introduction of our OcuGene® 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-014, a retinal drug delivery device; and
| | - |  | --------------------------------------------



| |  |  | treatments for diabetic retinopathy and macular degeneration.
| | - |  | -------------------------------------------------------------



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 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. In contrast, conventional eyedrops typically only last a few minutes in the eye and 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 provide protection until 2016.



The first product utilizing our DuraSite technology, AquaSite® 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



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Japan. (See Collaborative and Licensing Agreements for additional information on these 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.



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 and regulate the severity of 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, our genetic test to determine if an individual has a higher risk of developing a more aggressive form of glaucoma, is focused on targeted market introduction and was
first introduced to the medical community at the end of 2001.



In June 2003, a peer-reviewed study was published inClinical Genetics titled Association of the Myocilin mt.1 Promoter Variant with the Worsening of Glaucomatous Disease Over Time, (2003: 64: 18-27). The study is based
on information gathered at Philadelphia-based Wills Eye Hospital from 147 patients with primary open-angle glaucoma (POAG) who were followed for an average of approximately 15 years. Investigators conducted analyses that were controlled for various
relevant disease-related baseline risk factors, including age, family history, initial drug treatment, initial surgical treatment, diabetes, gender, myopia and initial disease severity.



The results of this study indicate substantial evidence that the TIGR/MYOC mt.1(+) variant provides a strong marker
for accelerated worsening of both optic disc and visual field measures of glaucoma progression above and beyond other baseline risk factors, stated one of the authors of the study, Jon Polansky, M.D., University of California, San Francisco.
Dr. Polansky also acts as our advisor. Our OcuGene glaucoma genetic test screens for the TIGR/MYOC mt.1(+) variant.



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.



To date, our academic collaborators have identified genes associated with POAG (the most prevalent form of glaucoma in
adults), normal tension glaucoma, juvenile glaucoma and primary congenital glaucoma, or PCG. Our academic collaborators for our glaucoma genetics program include: 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.



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.



Corporate Information.    Our principle executive offices are located at 965 Atlantic Avenue, Alameda, California 94501. Our
telephone number is (510) 865-8800. We make our periodic and current reports available, free of charge, through our website (http:///www.insitevision.com) under Investor RelationsSEC Filings as soon as reasonably practicable after
such material is electronically filed with the Securities and Exchange Commission.



Ophthalmic Pharmaceutical Market



According to Vision Problems in the U.S. by Prevent Blindness America, the number of Americans with age-related eye disease and the vision impairment that results is expected to double within the next 30 years.



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The U.S. Census Bureau projects that the U.S. population over age 65 will increase from 35 million in 1999 to approximately 70 million by the year 2030. We
believe that this aging of the U.S. population and similar trends in other developed countries 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.



According to the Glaucoma Research Foundation, glaucoma is the leading
cause of preventable blindness, affecting over three million people in the U.S., and 65 million people worldwide. The prevalence of the disease in first-degree relatives of affected patients has been documented to be as high as four to nine times
that of those without glaucoma in their family. Glaucoma also may occur as a complication of conditions such as diabetes, or as a result of extended steroid use.



The worldwide ophthalmic antibiotic market was anticipated to reach approximately $956 million in 2002, according to a
study by Frost and Sullivan. The market has been, and we believe 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.



Also, approximately 18 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.



Recent Developments



On December 16, 2003, we sold 142,857 shares of our common stock in a private placement to Eli Jacobson, an accredited investor. We received $50,000
in proceeds from this private placement. On March 26, 2004, we received approximately $1.8 million, net of placement fees, from the initial closing of a private placement to 133 accredited investors that will yield aggregate gross proceeds
of $16.5 million if the final closing occurs. At the initial closing we sold 3,880,000 shares of our common stock at a price of $0.50 per share and warrants to purchase 1,940,000 shares of our common stock at an exercise price of $0.75 per share.
The final closing is contingent upon our receiving stockholder approval for the financing and for an amendment to our Certificate of Incorporation increasing the authorized shares of our common stock by an amount sufficient to enable us to issue the
shares and warrants contemplated in the final closing and other standard closing conditions. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of SecuritiesRecent Sales of
Unregistered Securities for a further description of these transactions.



On December 31, 2003, we entered into a settlement agreement with Xmark Funds, L.P. et al, or Xmark, related to a complaint filed against us by Xmark. As part of the settlement we paid Xmark $10,000 and issued
warrants to purchase 250,000 shares of our Common Stock at an exercise price of $0.58 per share that expire on December 31, 2006. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of SecuritiesRecent Sales of Unregistered Securities for a further description of this transaction.



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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



|                                             |  |                                                                                                       |  |                                                                                                  |  |                                               
|-------------------------------------------- |  | ----------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------ |  | ----------------------------------------------
|Product                                      |  | Indications                                                                                           |  | Anticipated Benefits                                                                             |  | Status(1)                                     
|Glaucoma Genetics                            |  |                                                                                                       |  |                                                                                                  |  |                                               
|                                             |  |                                                                                                       | 
|OcuGene  GlaucomaGenetic Test               |  | Glaucoma severity(TIGR gene)                                                                          |  | Determine disease severity among glaucoma patients                                               |  | Marketed                                      
|                                             |  |                                                                                                       | 
|PCG  Primary Congenital Glaucoma Test       |  | Glaucoma detection ininfants                                                                          |  | Patient identification to allow early treatment before complications and irreversiblevision loss |  | Pre-commercialization (2)                     
|                                             |  |                                                                                                       | 
|ISV-900                                      |  | Glaucoma prognostic/ diagnostic                                                                       |  | Identify new genetic markers to detect disease susceptibility and determine disease severity     |  | Research                                      
|                                             |  |                                                                                                       | 
|Glaucoma Product Candidates                  |  |                                                                                                       |  |                                                                                                  |  |                                               
|                                             |  |                                                                                                       | 
|ISV-205                                      |  | Steroid-induced intraocular pressure elevation, glaucoma                                              |  | Treat/prevent disease progression                                                                |  | Phase 2(b)completed                           
|                                             |  |                                                                                                       | 
|Other Topical Product Candidates and Product |  |                                                                                                       |  |                                                                                                  |  |                                               
|                                             |  |                                                                                                       | 
|ISV-401                                      |  | Bacterial infection including ophthalmia neonatorum                                                   |  | Broad spectrum antibiotic with reduced dosing frequency                                          |  | Phase 3 (3)                                   
|                                             |  |                                                                                                       | 
|ISV-403                                      |  | Bacterial infection                                                                                   |  | Fourth generation fluoroquinolone antibiotic with reduced dosing frequency                       |  | Phase 1 (4) Sold to Bausch & Lomb Incorporated
|                                             |  |                                                                                                       | 
|ISV-205                                      |  | Inflammation and analgesia                                                                            |  | Reduced dosing frequency                                                                         |  | Preclinical                                   
|                                             |  |                                                                                                       | 
|AquaSite                                     |  | Dry eye                                                                                               |  | Reduced dosing frequency and extended duration of action                                         |  | Marketed (OTC)                                
|                                             |  |                                                                                                       | 
|Retinal Device                               |  |                                                                                                       |  |                                                                                                  |  |                                               
|                                             |  |                                                                                                       | 
|ISV-014                                      |  | Retinal drug delivery device for potential treatment of diabetic retinopathy and macular degeneration |  | Non-surgical delivery of drugs to the retina                                                     |  | Research                                      

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|1) |  | All products except OcuGene, ISV-900, AquaSite and ISV-014 are expected to be prescription pharmaceuticals. As denoted in the table, Preclinical follows the research
stage and 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 1, Phase 2 and Phase 3 clinical trials
and New Drug Application, or NDA, see Government Regulation.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2) |  | A prognostic technology has been developed and plans for use in screening a limited population prior to being available for a broader market will be dependent upon available
funding.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3) |  | Phase 2 testing is completed for ISV-401 and Phase 3 clinical trials are anticipated to begin in the second quarter of 2004.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------

|4) |  | The Phase 1 testing is completed and the program was sold to Bausch & Lomb in December 2003. Further clinical development will be conducted by Bausch & Lomb.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



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Glaucoma Genetics



According the Glaucoma Research Foundation, 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.
However, 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 a 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 these patients usually incur visual field loss before
they are diagnosed.



ISV-900.    There is accumulating evidence that genetic predisposition is a major factor in the development of several forms of glaucoma. According to the Glaucoma Research Foundation, a family history of POAG
increases the risk of developing glaucoma by 4 to 9 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 disease-causing, or modifying, genes related to POAG including TIGR/MYOC, OPTN, OCLM and
APOE. Additional research has revealed mutations in the CYP1B1 gene that are related to PCG. We have obtained exclusive worldwide licenses for the rights to commercialize certain 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 and APOE, as it interacts with TIGR, from INSERM.



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. However, development of additional clinical data will be necessary to support the market utility of this product. We anticipate that as further research identifies new genes, and additional
mutations, we will bring these to market as additional tests.



In December 2002, we entered into an agreement with Società Industria Farmaceutica Italiana (SIFI) that grants them the exclusive right to manufacture/perform, distribute and market OcuGene in Italy for eight years. SIFI introduced
the OcuGene test at two Italian ophthalmic meetings in late 2003, and is currently evaluating the market opportunity and feasability to support a product launch in the second half of 2004.



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



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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. Our ISV-205 product candidate delivers concentrations of diclofenac that have been shown in cell culture systems to inhibit the production of the TIGR protein.



We successfully completed a Phase 2a clinical study in 1999 that evaluated 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.



In 2001 we completed a Phase 2b clinical study that 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, a 0.1% formulation of our ISV-205 product candidate 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. However, we cannot assure you that similar clinical results will be achieved. Also, initiation of such studies will require us to obtain additional funding either from a strategic
partner or from investors.



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.    We
have developed a topical formulation of the antibiotic, azithromycin to treat bacterial conjunctivitis and other infections of the outer eye. Azithromycin has a broad spectrum of antibiotic activity and is widely used to treat respiratory and other
infection in its oral and parenteral forms. The eye drop of 1% azithromycin (ISV-401) is formulated to deliver sufficient tissue concentrations over a 5-day dosing period using our proprietary DuraSite technology that enables superior bactericidal
activity against most common ocular pathogens and pseudomonas. The key advantages of ISV-401 include a significantly reduced dosing regimen (6 doses vs. 36 doses for comparable products), the high and persistent levels of azithromycin achieved
in the tissues of the eye and its wide spectrum of activity. Phase 1 and 2 studies have shown that ISV-401 is well tolerated and effective. The Phase 2 study statistically measured an ISV-401 formulation containing 1% azithromycin against a placebo.
The results of this study showed that the ISV-401 formulation was statistically significantly more effective than placebo in bacterial eradication and clinical cure, which includes reduction in inflammation and redness. ISV-401 also has broad patent
protection (see Risk FactorsOur business depends upon our proprietary rights, and we may not be able to adequately protect, enforce or secure our intellectual property rights).



ISV-401 has been formulated to meet the regulatory requirements for both a
United States and a global product. Our marketing emphasis will focus on pediatricians, general practitioners, and ophthalmologists. Pediatricians and general practice physicians write more than 65% of total prescriptions for ophthalmic antibiotics.
We expect that if and when it is released, use of ISV-401 by ophthalmologists will grow steadily as the product, in our estimation, will be positioned to compete favorably with the newer 4thgeneration fluoroquinolones for antibacterial coverage. Further, ISV-401 possesses the advantage of reduced dosing frequency that we believe may ultimately
increase patient compliance and reduce the likelihood of the development of bacterial resistance. Additionally, we believe ISV-401 may be used in additional indications, including surgery, opthalmia neonatorium and blepharitis. Marketing of ISV-401
will require us first to obtain additional funding either from a strategic partner or from investors.



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Product safety and efficacy have been demonstrated, respectively, in Phase 1 and Phase 2 clinical trials.
As a result of our End of Phase 2 Meeting with the FDA, we intend to execute two pivotal Phase 3 clinical trials, the first of which is planned to begin in the second quarter of 2004. We anticipate conducting the trials in both the
United States and internationally to permit aggressive enrollment of the subjects, including both children and adults, necessary to complete the studies. We further anticipate that the primary endpoints of both trials will be microbial eradication
and clinical cure.



We have secured a source for the active
ingredient and have a contract-manufacturing site for production of clinical trial supplies and registration batches. The supplies are being manufactured under the supervision of our personnel. We are planning to begin the manufacture of the
registration batches needed to support the filing of the NDA at this contract facility in the second quarter of 2004. We anticipate that our contract manufacturing facility will be ready for inspection by the FDA at the time of our NDA submission.
It should be noted that manufacturing plans are subject to delays and unanticipated interruptions.



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, it was determined that 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 allow for reduced
dosing frequency compared to other fluoroquinolone formulations currently on the market. In February 2003 we filed an Investigational New Drug Application, or IND, with the FDA and in April 2003 we began a Phase 1 clinical trial of ISV-403. In June
2003 the dosing for the study was completed. In December 2003 we sold the ISV-403 product candidate to Bausch & Lomb, who had licensed the product candidate from us in August 2002. Bausch & Lomb is responsible for the further clinical
development of the product.



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 AquaSite 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 royalty-bearing license with SSP for the sales and distribution of AquaSite in Japan.



Retinal Device



Ophthalmic conditions that involve retinal damage include macular degeneration, which according to the American Macular Degeneration Foundation affects 10
million or more people in the U.S., and diabetic retinopathy, a common side effect of diabetes. According to the National Diabetes Education Foundation, approximately 16 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 and photo-dynamic therapies, 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 2002, 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 viral or small molecule 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



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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 pursing the licensing of this technology to third parties.



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.



Bausch and Lomb Incorporated.    On December 30,
2003, we completed the sale of our drug candidate ISV-403 for the treatment of ocular infections to Bausch & Lomb Incorporated or Bausch & Lomb, pursuant to an ISV-403 Purchase Agreement dated December 19, 2003 (the Purchase
Agreement) and a License Agreement dated December 30, 2003 (the License Agreement, and collectively, the Asset Sale).



Under the terms of the Purchase Agreement, we received a cash payment from Bausch & Lomb in the amount of $1,500,000 and reimbursement of certain
ISV-403 product development expenses as well as budgeted expenses in furtherance of ISV-403 product development actually incurred between November 1, 2003 and the closing of the Asset Sale, as well as reimbursement for development support
obligations for a period of time subsequent to closing. We will also receive a percentage of future ISV-403 net product sales, if any, in all licensed countries, ending upon the later of the expiration of the patent rights underlying ISV-403 in
April 2021 or ten years from the date of the first ISV-403 product sale by Bausch & Lomb. Bausch & Lomb has assumed all future ISV-403 development and commercialization expenses and, following a transfer period, will be responsible for all
development activities, with our assistance as appropriate. In addition, the August 2002 ISV-403 licensing agreement and the related Series A-1 Preferred Stock purchase agreement between Bausch & Lomb and us has been terminated and Bausch &
Lomb has returned to us for cancellation all shares of our Series A-1 Preferred Stock we previously issued to Bausch & Lomb. Under the Purchase Agreement, we also have certain potential indemnification obligations to Bausch & Lomb in
connection with the Asset Sale.



The License Agreement
provides Bausch & Lomb a royalty free license under certain of our patents related to our DuraSite delivery system for use with ISV-403 and under other non-patent intellectual property used in ISV-403. The License Agreement provides for Bausch
& Lomb to complete development of the SS734 fluoroquinolone products that combine certain compounds, we licensed from SSP, Co., Ltd., or SSP, with the DuraSite delivery system and to commercialize any such products. The patent license is
exclusive (even as to us) in the particular field of developing, testing, manufacturing, obtaining regulatory approval of, marketing, selling and otherwise disposing of such products. The license of non-patent intellectual property granted to Bausch
& Lomb is nonexclusive.



In connection with the
Asset Sale, we also assigned to Bausch & Lomb a certain agreement between SSP and us under which we were licensed to commercialize SSPs SS734 fluoroquinolone. Because that agreement also included a license from us to SSP under certain
patents relating to DuraSite that we did not sell to Bausch & Lomb, the assignment of the agreement to Bausch & Lomb excluded the assignment of our obligations and rights as the licensor of such patents. Instead, we entered into a new
royalty free license agreement with SSP reflecting our original rights and obligations as the licensor of the DuraSite patents to SSP.



Societa Industria Farmaceutica ItalianaS.P.A. (SIFI)    In December 2002, we entered into a exclusive distribution
agreement with SIFI for OcuGene in Italy. The distribution agreement grants SIFI the right to manufacture, directly or indirectly, distribute, perform, market, sell and promote our OcuGene glaucoma genetic test in Italy. We are obligated to provide
SIFI with access to technical information related to OcuGene and



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provide them access to any marketing materials we develop with respect to OcuGene to aid them in their sales and distribution efforts. Over the initial
eight-year term of the agreement SIFI will pay us a fee for each test conducted. The agreement may be extended by SIFI for additional two year periods if certain sales targets are met during such periods, and may be terminated earlier due to a
material breach of the agreement. To date, no fees have been earned or received by us under this agreement.



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, in the U.S. and Canada: fluorometholone and tear replenishment products (AquaSite) utilizing the DuraSite technology, ISV-205
for non-glaucoma indications, and ToPreSite®, a
product candidate for ocular inflammation/infection. (The development of the fluorometholone and ToPreSite product candidates are not being pursued by us or CIBA Vision and there is no obligation to do so). We receive royalty payments until the
expiration of the last patent rights, July 2010. To date, we have received approximately $342,000 of royalties from the sales of AquaSite by CIBA Vision. The agreement terminates at the end of the royalty obligation period and may be terminated
early due to a material breach of the agreement.



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 are obligated to use reasonable commercial efforts to proceed with the research, development and commercialization of a product that incorporates the licensed technology. Additionally,
we are obligated to pay the cost of patent prosecution and maintenance. For the years ended 2003, 2002 and 2001 we incurred approximately $5,000, $12,000 and $22,000, respectively, in patent costs related to this agreement. We paid a licensing fee
of $10,000 when we licensed the technology and will make royalty payments on future product sales, if any, until the later of the expiration of the last patent rights, or December 2015. To date, we have made no royalty payments under this agreement.
The agreement terminates at the end of the royalty obligation period or it may be terminated early due to a material breach of the agreement, or by us, upon written notice to INSERM, or by INSERM if we have failed to commercialize a product
incorporating the licensed technology within seven years. If we terminate the agreement, we are obligated to pay INSERM any earned royalties as of the effective date of the termination, no other fees are due under the early termination provisions.



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. We are obligated to
use reasonable commercial efforts to proceed with the research, development and commercialization of a product that incorporates the licensed technology. Additionally, we are obligated to pay the cost of patent prosecution and maintenance. For the
years ended 2003, 2002 and 2001 we incurred approximately $11,000, $33,000 and $31,000, respectively, in patent costs related to this agreement. Under the agreement, we paid a licensing fee of $10,000 and will make royalty payments on future product
sales, if any, until the later of the expiration of the last patent rights, May 2019, or July 2011. Additionally, we owe annual minimum royalties of $15,000 from 2004 through 2011 until the first commercial sale. For first three years of commercial
sales the annual minimum royalties increase to $25,000 per year and increases to $40,000 through the remaining life of the agreement. To date, we have made no royalty payments under this agreement. The agreement terminates at the end of the royalty
obligation period or it may be terminated early due to a material breach of the agreement, or by us, upon written notice to UCHC, or by UCHC if we have failed to commercialize a product incorporating the licensed technology within six years. If we
terminate the agreement, we are obligated to pay UCHC any earned royalties as of the effective date of the termination and if the product has not yet been commercialized a fee equal to six months of the applicable minimum royalty. No other fees are
due under the early termination provisions.



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



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associated with glaucoma. . We are obligated to use reasonable commercial efforts to proceed with the research, development and commercialization of a
product that incorporates the licensed technology. Additionally, we are obligated to pay the cost of patent prosecution and maintenance. For the years ended 2003, 2002 and 2001 we incurred approximately $95,000, $239,000 and $289,000, respectively,
in patent costs related to this agreement. Under both agreements, we paid initial licensing fees, of $40,000, share sub-licensing fees we receive, if any, and will make royalty payments to the UC Regents on future product sales, if any, until the
later of the expiration of the latest patent rights, October 2014, for the March 1993 agreement and January 2017, for the August 1994 agreement. To date we have made no royalty payments under the March 1993 agreement and approximately $2,000 of
royalty payments under the August 1994 agreement. The agreements terminate at the end of the royalty obligation period or it may be terminated early due to a material breach of the agreement, or by us, upon written notice to UC Regents. If we
terminate the agreement, we are obligated to pay UC Regents any earned royalties as of the effective date of the termination. No other fees are due under the early termination provisions.



Columbia Laboratories, Inc.    In February
1992, we entered into a royalty free 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 due to a material breach of the agreement, the Columbia Agreement continues in effect until the expiration of all patents covered by the DuraSite technology, in July 2010, to which
Columbia has certain rights.



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. We are obligated to supply Kukje with the polymer necessary for
production of AquaSite. The agreement terminates after ten years, may be extended by increments of one year, may be terminated by a material breach of the contract or by written notice. Upon termination Global Damon has the obligation to pay any
royalties due as of the date the termination is effective. To date, we have received approximately $14,000 under these agreements.





Other.    As part of our basic strategy,
we continually pursue 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 as well as collaborative agreements for the further development and marketing of our current products and product candidates. We intend to continue exploring licensing and collaborative opportunities, though there is no certainty that we
can successfully enter into, or maintain, 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



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applications, including three 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. Of these applications, six U.S. patents have been issued. Of the patent applications we have licensed from the UC Regents, twelve U.S. patents have issued.
Of the patent applications licensed from UCHC covering the diagnosis of PCG, five U.S. patents have been issued. We have three patent applications on file for our retinal programs and four U.S. patents on our retinal drug delivery device have been
issued. Three patent applications have been filed related to our antibiotic programs, and four U.S. patents have been 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. Foreign counterparts of the InSite patents as well as the licensed patents of certain of these applications exist in many countries.



The table below lists the six U.S. patents we currently hold, the patent
number and subject of the patent, the date of grant and the date of expiration. The same information is provided for each of our in-licensed U.S. patents, including the identity of the licensor:



|             |  |                                                                                                                                   |  |            |  |                |  |                      
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------- |  | ---------- |  | -------------- |  | ---------------------
|PatentNumber |  | Patent Subject                                                                                                                    |  | Grant Date |  | ExpirationDate |  | Licensor             
|             |  |                                                                                                                                   |  |           
|6,239,113    |  | Topical Treatment Or Prevention Of Ocular Infections                                                                              |  | 5/29/2001  |  | 3/31/2019      |  |                      
|             |  |                                                                                                                                   |  |           
|6,569,443    |  | Topical Treatment Or Prevention Of Ocular Infections                                                                              |  | 5/29/2001  |  | 3/31/2019      |  |                      
|             |  |                                                                                                                                   |  |           
|5,192,535    |  | Ophthalmic Suspensions                                                                                                            |  | 3/09/1993  |  | 3/09/2010      |  |                      
|             |  |                                                                                                                                   |  |           
|5,188,826    |  | Topical Ophthalmic Suspensions                                                                                                    |  | 2/23/1993  |  | 2/23/2010      |  |                      
|             |  |                                                                                                                                   |  |           
|6,378,526    |  | Methods Of Ophthalmic Administration                                                                                              |  | 4/30/2002  |  | 8/03/2002      |  |                      
|             |  |                                                                                                                                   |  |           
|6,309,374    |  | Injection Apparatus & Method Of Using The Same                                                                                    |  | 10/30/2001 |  | 8/03/2018      |  |                      
|             |  |                                                                                                                                   |  |           
|4,795,436    |  | Bioadhesive Compositions and Treatment Therewith                                                                                  |  | 01/03/1989 |  | 1/03/2006      |  | Columbia Laboratories
|             |  |                                                                                                                                   |  |           
|4,983,392    |  | Bioadhesive Compositions and Treatment Therewith                                                                                  |  | 01/08/1991 |  | 1/08/2008      |  | Columbia Laboratories
|             |  |                                                                                                                                   |  |           
|5,225,196    |  | Bioadhesive Compositions and Treatment Therewith                                                                                  |  | 7/06/1993  |  | 7/06/2010      |  | Columbia Laboratories
|             |  |                                                                                                                                   |  |           
|5,474,985    |  | Preventing And Treating Elevated Intraocular Pressure With Administered Or Endogenous Steroids Using Non-Steroidal
Cyclooxygenase |  | 12/12/1995 |  | 12/12/2012     |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,599,535    |  | Methods for the Cytoprotection of the Trabecular Meshwork                                                                         |  | 2/4/1997   |  | 2/4/2014       |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,674,888    |  | Methods for the Treatment of a Trabecular Meshwork Whose Cells are Subject to Inhibition of Cell Division                         |  | 10/7/1997  |  | 10/7/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,606,043    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 2/25/1997  |  | 2/25/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,789,169    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 8/4/1998   |  | 8/04/2015      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,849,879    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 12/15/1998 |  | 12/15/2015     |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,854,415    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 12/29/1998 |  | 2/25/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|5,861,497    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 6/19/1999  |  | 2/25/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|6,150,161    |  | Methods for the Diagnosis of Glaucoma                                                                                             |  | 11/21/2001 |  | 2/25/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|6,248,867    |  | Trabecular Meshwork Induced Glucocorticoid Response Fusion Protein                                                                |  | 6/19/2001  |  | 2/25/2014      |  | UC Regents           
|             |  |                                                                                                                                   |  |           
|6,171,788    |  | Methods for the Diagnosis, Prognosis and Treatment of Glaucoma and Related Disorders                                              |  | 1/09/2001  |  | 1/26/2017      |  | UC Regents           



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|             |  |                                                                                      |  |            |  |                |  |           
|------------ |  | ------------------------------------------------------------------------------------ |  | ---------- |  | -------------- |  | ----------
|PatentNumber |  | Patent Subject                                                                       |  | Grant Date |  | ExpirationDate |  | Licensor  
|             |  |                                                                                      |  |           
|6,475,724    |  | Methods for the Diagnosis, Prognosis and Treatment of Glaucoma and Related Disorders |  | 11/05/2002 |  | 1/26/2017      |  | UC Regents
|             |  |                                                                                      |  |           
|5,830,661    |  | Diagnosis and Treatment of Glaucoma                                                  |  | 11/03/1998 |  | 2/13/2017      |  | UCHC      
|             |  |                                                                                      |  |           
|5,962,230    |  | Diagnosis and Treatment of Glaucoma                                                  |  | 10/05/1999 |  | 2/13/2017      |  | UCHC      
|             |  |                                                                                      |  |           
|6,046,009    |  | Diagnosis and Treatment of Glaucoma                                                  |  | 4/04/2000  |  | 2/13/2017      |  | UCHC      
|             |  |                                                                                      |  |           
|6,127,128    |  | Diagnosis of Primary Congenital Glaucoma                                             |  | 10/02/2000 |  | 5/7/2019       |  | UCHC      
|             |  |                                                                                      |  |           
|6,207,394    |  | Diagnosis of Primary Congenital Glaucoma                                             |  | 5/27/2001  |  | 5/7/2019       |  | UCHC      



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 or that patents issued to our competitors will not block or limit
our ability to exploit our technology. 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.



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, 2003, our research and development staff numbered 14 people,
of whom 6 have Ph.D.s. In 2003, our research and development expenses were $4.4 million, including the expenses related to contract research activities for which we received $128,000 from Bausch & Lomb. In 2002, our research and development
expenses, including third party research we sponsored, were $7.1 million, of which $166,000 was funded by third parties. 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.



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Manufacturing



We have no experience or facilities for the manufacture of products for commercial purposes 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 1 and some of our Phase 2 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 3 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 targeted introduction of OcuGene and we are
primarily using external marketing and sales resources that include:



| |  |  | marketing consultants;
| | - |  | ----------------------



| |  |  | a network of key ophthalmic clinicians; and
| | - |  | -------------------------------------------



| |  |  | other resources with ophthalmic expertise.
| | - |  | ------------------------------------------



We are evaluating expansion of our external marketing and sales resources to support our continuing OcuGene efforts. Potential resources being evaluated
include:



| |  |  | contract sales forces;
| | - |  | ----------------------



| |  |  | co-marketing and co-promotion arrangements in the U.S.; and
| | - |  | -----------------------------------------------------------



| |  |  | licensing arrangements with companies outside of the U.S.
| | - |  | ---------------------------------------------------------



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



We have also entered into corporate collaborations, and we plan to enter into
additional collaborations 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.



Our current collaborators include:



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.



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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 ISV-403. We have exclusive marketing rights for the world except for Japan, which SSP retained, and shared rights with SSP in the rest of Asia. In December 2003
we assigned our rights under this agreement to the compound incorporated into ISV-403 to Bausch & Lomb. 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.



Bausch & Lomb.    In December 2003, we sold our ISV-403 product candidate to Bausch & Lomb. Bausch & Lomb has the
exclusive marketing rights for the world except for Japan, which were retained by SSP, and shared rights in the rest of Asia with SSP. Bausch & Lomb also has also assumed the development and manufacturing responsibilities for the ISV-403
formulation for their sales and distribution.



SIFI.    In December 2002, we entered into an exclusive licensing agreement with SIFI for OcuGene. SIFI has the exclusive right to manufacture/perform, distribute and market OcuGene in Italy. We provide SIFI with
access to technical information related to OcuGene and provide them access to any marketing materials we develop with respect to OcuGene to aid them in their sales and distribution efforts.



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 may obtain regulatory approval for the commercialization of their products more rapidly
or effectively than we do. 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 Pfizer, Inc. It is very difficult for smaller companies, such as ours, that do not have large and well-developed research and development,
and 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 patents 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 U.S. and foreign governmental approvals on a timely basis, attract and retain key personnel and enter into effective collaborations for the manufacture
and marketing of our products.



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 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



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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:



| |  |  | preclinical laboratory and animal tests;
| | - |  | ----------------------------------------



| |  |  | submission to the FDA of an IND;
| | - |  | --------------------------------



| |  |  | adequate and well-controlled human clinical trials to establish the safety and efficacy of the drug;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | the submission of an NDA or Product License Application (PLA) to the FDA; 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 manufacturer and facility 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. Before any clinical trial can commence, 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.



Clinical trials are typically conducted in three sequential phases, but the phases may involve multiple studies and may overlap. In Phase 1, 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 2 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 2 evaluations, Phase 3 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 requires 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



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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.



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                                                           
|Henri-Jean Garchon, M.D., Ph.D. |  | Director, INSERM, France                                                                                                                           
|David G. Hwang, M.D.            |  | Professor of Clinical Ophthalmology, Co-Director, Cornea and Refractive Surgery Service, University of California, San Francisco School of Medicine
|Kazuhide Kawase, M.D.           |  | Associate Professor, Gifu University, Japan                                                                                                        
|Roy Karnovsky                   |  | Advisor and Consultant in Business Development and Marketing                                                                                       
|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.          |  | Adjunct Professor of Ophthalmology, University of California, San Francisco                                                                        
|Roger Vogel, M. D.              |  | Medical Director                                                                                                                                   
|Claes Wadelius, M.D., Ph.D.     |  | Professor, Uppsala University, Sweden                                                                                                              



Employees



As of December 31, 2003, we had 22 employees, 17 of which were full time.
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.



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RISK FACTORS



We Require Immediate Significant Additional Funding to Continue our Operations and If We Are Unable to Complete the Final Closing Related
to a Private Placement Agreement We Have Entered Into, of If We Do Not Receive Additional Funding From Other Sources, We Will Cease Operations and Liquidate our Assets



Our independent auditors included an explanatory paragraph in their audit report referring to our recurring operating losses
and a substantial doubt about our ability to continue as a going concern. On March 26, 2004, we raised gross proceeds of $1.9 million (before transaction fees and expenses) through the initial closing of a private placement of our common stock and
warrants to purchase common stock which we believe will provide us the funds to operate for an additional 60 to 90 days after the initial closing. During this period we will be seeking the stockholder approval necessary to complete the final closing
related to this private placement, which if it occurs will yield additional proceeds of approximately $14.6 million (before transaction fees and expenses). We will be unable to complete the final closing if we are unable to obtain the required
stockholder approval, if we suffer a material adverse change (as such term is defined in the Subscription Agreement related to the private placement) which is not waived by investors in the private placement or if any other condition to
the final closing is not met and not waived by the Subscribers if capable of being waived. Also, pursuant to the terms of the private placement we are generally prohibited from raising additional financing through the issuance of securities during
the period from the initial closing through the earlier to occur of the final closing and June 30, 2004 (subject to extension at our sole discretion), which could significantly harm our ability to continue operations if the final closing does not
occur. If we are unable to complete the final closing or obtain additional funding from private or public equity or debt financings, collaborative or other partnering arrangements, asset sales or other sources, management will be required to cease
all operations and liquidate our remaining assets. If this occurs, our stockholders would likely lose their entire investment in us.



We are seeking longer term additional funding through the final closing of the private placement we entered into in March 2004 and through potential
public or private equity or debt financings, collaborative or other partnering arrangements, asset sales and from other sources. However, our current financial situation may harm our ability to obtain additional funding and could make the terms of
any such funding, if available, significantly less favorable than would otherwise be the case. 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 and could result in substantial
dilution and could adversely affect the market price for our common stock. If we raise funds through the issuance of debt securities, such debt will likely be secured by a security interest or pledge of all of our assets, will require us to make
principal and interest payments, would likely include the issuance of warrants, and may subject us to restrictive covenants. If we do not obtain such long term financing either through the final closing of the private placement or otherwise, we
would have to cease operations and liquidate our assets. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of SecuritiesRecent Sales of Unregistered Securities for a further
description of the March 2004 private placement.



We Will Need Stockholder
Approval to Amend Our Certificate of Incorporation and to Comply with Regulations of The American Stock Exchange in Order to Conduct the Final Closing of the March 2004 Private Placement and If We Do Not Receive such Stockholder Approval, We Will
Not Be Able to Hold the Final Closing, We Will Be Required to Pay Certain Penalties, and We May be Required to Cease Operations and Liquidate our Assets



We do not currently have enough authorized shares of common stock to issue the shares of our common stock and warrants to purchase common stock in the
final closing of the March 2004 private placement. Prior to and as a condition of the final closing of such private placement, the holders of a majority of the shares of our common stock will need to approve an amendment to our certificate of
incorporation to increase the number of shares of common stock we are authorized to issue in an amount sufficient to enable us to issue the common stock and related warrants to be issued in the final closing of the private placement and we will need
to file this



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amendment with the Secretary of State of the State of Delaware. In addition, since our stock is listed on The American Stock Exchange, or AMEX, under
applicable AMEX regulations prior to and as a condition of the final closing of the private placement, the holders of a majority of our common stock present at the meeting by proxy or in person must approve the issuance of the securities to be
issued in the final closing since such issuance will constitute an issuance of 20% or more of our outstanding common stock immediately prior to the initial closing at a price per share below the fair market value of our common stock at the initial
closing.



Our stockholders will incur substantial dilution if
the final closing of the March 2004 private placement occurs, and this might negatively affect our chances of receiving stockholder approval. However, if we do not receive the requisite stockholder approval within the required period, we will be
required to pay certain cash penalties to the investors in the private placement and even if we subsequently receive stockholder approval the investors in the private placement can refuse to invest in the final closing, either of which would
significantly harm our business and our financial condition. In addition, if we are unable to complete the final closing, we will likely not have sufficient funds to continue our business, and we will have to attempt to conduct another round of
financing, if available, or go out of business, in which case our stockholders will likely be significantly diluted or lose their entire investment. Furthermore, in between the initial closing and final closing of the March 2004 private placement,
provisions in the subscription agreements for that private placement impose significant restrictions on our ability to raise capital through the sale of additional securities other than those contemplated by the private placement.



Even if the Final Closing of the Private Placement Occurs, or We Are Able to Secure
Alternative Long Term Financing in the Event the Final Closing Does Not Occur, the Proceeds From Such Financings Will Not Fund Our Business Indefinitely. We Will Eventually Need to Seek Additional Funding or Partnering Arrangements that Could Be
Dilutive to Our Stockholders and Could Negatively Affect Us and Our Stock Price.



Assuming we are able to raise additional funding to continue our operations beyond the next 60 to 90 days, either through the final closing of the private placement or an alternative financing arrangement if the final
closing does not occur, we only expect the proceeds to us expected from the private placement to enable us to continue our operations as currently planned until approximately the third quarter of 2005. At that point, or earlier if circumstances
change from our current expectations, we will require additional funding. The terms of any securities issued to future investors may be superior to the rights of our then current stockholders, and could result in substantial dilution and could
adversely affect the market price for our common stock. If we raise funds through the issuance of debt securities, such debt will likely be secured by a security interest or pledge of all of our assets, will require us to make principal and interest
payments, would likely include the issuance of warrants, and may subject us to restrictive covenants. If we do not obtain such additional financing when required, we would likely have to cease operations and liquidate our assets.



In addition, we expect to enter into partnering and collaborative
arrangements in the future as part of our business plan, regardless of whether we require additional funding to continue our operations. Such arrangements could include the licensing or sale of certain assets or the issuance of securities, which may
adversely affect the market price of our Common Stock. It is difficult to know our future capital requirements precisely and such requirements depend upon many factors, including:



| |  |  | the progress of preclinical and clinical testing;
| | - |  | -------------------------------------------------



| |  |  | the progress of our research and development programs;
| | - |  | ------------------------------------------------------



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



| |  |  | the cost of maintaining or expanding a marketing organization for OcuGene and the related promotional activities;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | changes in, or termination of, our existing collaboration or licensing arrangements;
| | - |  | ------------------------------------------------------------------------------------



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| |  |  | whether we manufacture and market any of our other products ourselves;
| | - |  | ----------------------------------------------------------------------



| |  |  | the time and cost involved in obtaining regulatory approvals;
| | - |  | -------------------------------------------------------------



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



| |  |  | competing technological and market developments; and
| | - |  | ----------------------------------------------------



| |  |  | the purchase of additional capital equipment.
| | - |  | ---------------------------------------------



If We Do Not Receive Additional Funding When Needed to Continue Our Operations, Whether Before or After the Final Closing of the March 2004 Private Placement, We Will
Likely Cease Operations and Liquidate Our Assets, Which are Secured by Notes Payable to Our Chief Executive Officer



In the event that we are unable to secure additional funding when required to continue our operations, we will likely be forced to wind down our
operations, either through liquidation, voluntary or involuntary bankruptcy or a sale of our assets, regardless of whether such event occurred before or after the final closing of the March 2004 private placement. Our chief executive officer has
outstanding loans to us in an aggregate principal amount of $503,000, $400,000 of which is secured by a lien on substantially all of our assets including our intellectual property. The notes issued by us in connection with these loans are due on the
earlier to occur of March 31, 2007 and 30 days subsequent to the successful completion of a pivotal Phase III clinical trial with ISV 401. In the event that we wind down operations, whether voluntarily or involuntarily, while these secured loans are
outstanding, this security interest enables our chief executive officer to control the disposition of these assets. If we are unable to repay the amounts due under the secured notes when due, our chief executive officer could cause us to enter into
involuntary liquidation proceedings in the event we default on our obligations. If we wind down our operations for any reason, it is likely that our stockholders will lose their entire investment in us.



Our Management has Undertaken a Number of Measures to Reduce our Operating Expenses, but
These Measures Will Not Alone be Sufficient to Enable us To Continue Operations Beyond the Middle of June 2004 and May Have Other Negative Consequences



Our management has implemented plans designed to reduce our cash requirements through reductions in operating expenditures. The actions we have
taken include laying-off approximately 42% of our employees, voluntary salary reductions by our senior management team, ceasing work on all non-critical external projects, extending payment terms on our trade payables, working with our landlord to
restructure our lease obligations, and other cost containment measures. Of the 16 employees laid-off, 3 were general and administrative personnel and 13 were across the various research and development departments. These lay-offs resulted in savings
of approximately $530,000 in compensation and benefit costs. The voluntary salary reductions agreed upon between senior management and the Company resulted in approximately $720,000 of savings in compensation and benefit costs. The Company scaled
back its marketing and sales activities related to the OcuGene product, which resulted in approximately $950,000 of savings. Additionally, the Company placed development of its ISV-014 retinal device, its ISV-900 genetic research and ISV-205
glaucoma product candidate on hold, which resulted in expense reductions of approximately $1,040,000. The Company also minimized its operating expenses by reducing its travel and entertainment, renegotiated or terminated facility and equipment
support contracts where possible, limiting expenditures for equipment and taking other similar expense reduction actions. Although it is not possible to anticipate all potential effects the implementation of these expense control measures will have
on us or our development, these activities have and could continue to delay the initiation of Phase 3 clinical trials on ISV-401 and have and could continue to impact our ability to promote OcuGene. The extent and ramifications of these delays will
be dependent upon our ability to raise additional financing, the timing of the receipt of financing and the amount of such financing, if any. However, even with these expense reductions, the funds from the initial closing of the private placement,
our current cash on hand, anticipated cash flow from operations and current cash commitments to us are only sufficient to fund our operations through approximately the middle of June 2004. If we are unable to complete the final closing of the
private placement or another financing transaction, collaborative arrangement or asset sale prior to that time, we will cease operations and liquidate our



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assets. In addition, there is no assurance that these expense reduction efforts will enable us to continue operations or that if we do survive we have not
significantly harmed our business or prospects.



Questions
Concerning Our Financial Condition May Cause Customers and Current and Potential Partners to Reduce or Not Conduct Business with Us



Due to our present financial condition and concerns regarding our ability to continue operations, customers and current and potential partners may decide
not to conduct business with us, may reduce or terminate the business they conduct with us, or may conduct business with us on terms that are less favorable than those customarily offered by them. In that event, our sales would likely decrease, our
product development efforts would suffer and our business will be significantly harmed.



The Initial Closing of the March 2004 Private Placement Triggered Anti-Dilution Adjustments Under the Terms of Certain Outstanding Securities Convertible into or Exercisable for Shares of Our Common Stock and
Additional Anti-Dilution Adjustments Could Be Triggered by the Final Closing of the Private Placement, Which Would Be Dilutive to Our Stockholders.



Immediately prior to the initial closing of the March 2004 private placement there was an aggregate of approximately $18,000 in principal amount and
accrued interest outstanding under our convertible debentures held by HEM. Pursuant to anti-dilution adjustments contained in the debentures, following the initial closing of the private placement these debentures are now convertible into
unrestricted shares of our common stock at a conversion price that is the lower of $0.35394 or the average of the three lowest closing per share bid prices for our common stock during the 40 trading days prior to conversion. If these debentures
remain outstanding on the final closing of the March 2004 private placement, the conversion price of the debentures will be further adjusted downward on such closing date if the market price of our common stock on such closing date is below $0.50,
the per share sale price of our common stock that would be sold at such final closing. Pursuant to the terms of the debentures, if the anti-dilution adjustment is triggered at the final closing, the new conversion price of the debentures will be
calculated by multiplying the then current conversion price by a fraction, the numerator of which will be the number of shares of our common stock (excluding treasury shares, if any) outstanding on the date of the final closing plus the number of
shares which the aggregate price paid for the shares issued at such closing (assuming the exercise of warrants issued at such closing) would have purchased at the then current market price of the common stock, and the denominator of which will be
the number of shares of our common stock (excluding treasury shares, if any) outstanding on the date of the final closing plus the number of additional shares of common stock to be issued in such closing (including any shares issuable upon the
exercise of warrants issued in such closing). The amount of this adjustment will be dependent upon the market price of our common stock at the time of the final closing of the March 2004 private placement. Such anti-dilution adjustments would be
dilutive to our then current stockholders.



Immediately prior
to the initial closing of the March 2004 private placement, warrants we issued to Xmark were exercisable for 250,000 shares of our Common Stock at a price of $0.58 per share. Pursuant to anti-dilution provisions contained in these warrants,
following the initial closing of the private placement these warrants became exercisable for 254,386 shares of our common stock at a price of $0.57 per share. If any of these warrants are outstanding on the date of the final closing, the exercise
price of the warrants will be adjusted downwards at such closing as follows:



Adjusted Warrant Price = (A x B) + D

A+C



where:



|A |  | =     the number of shares of common stock outstanding immediately preceding the final closing
|- |  | ----------------------------------------------------------------------------------------------



|B |  | =     the exercise price of the warrant in effect immediately preceding the final closing
|- |  | -----------------------------------------------------------------------------------------



|C |  | =      the number of additional shares of common stock outstanding as a result of the final closing
|- |  | ---------------------------------------------------------------------------------------------------



|D |  | =     the aggregate consideration received by us upon the final closing
|- |  | -----------------------------------------------------------------------



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Additionally, upon each adjustment in the exercise price of the Xmark warrants, the number of shares
purchasable under these warrants is adjusted, to the nearest whole share, to the product obtained by multiplying the number of shares purchasable immediately prior to such adjustment by a fraction, the numerator of which is the exercise price
immediately prior to such adjustment, and the denominator of which is the exercise price immediately thereafter.



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, and in 2002 we began to receive a small amount of revenues from the sale of our OcuGene glaucoma genetic test. Before regulatory
authorities grant us marketing approval for additional products, 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:



| |  |  | are found to be unsafe or ineffective;
| | - |  | --------------------------------------



| |  |  | fail to receive necessary marketing clearance from regulatory authorities;
| | - |  | --------------------------------------------------------------------------



| |  |  | even if safe and effective, are too difficult or expensive to manufacture or market;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | are unmarketable due to the proprietary rights of third parties; or
| | - |  | -------------------------------------------------------------------



| |  |  | 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 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, 2003, our accumulated deficit was approximately $115.7 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. In addition, we recognize revenue when all services have been performed and collectibility is reasonably assured,
accordingly, revenue for the sales of OcuGene may be recognized in a later period than the associated recognition of costs of the services provided, especially during the initial launch of the product. In addition, due to this delay in revenue
recognition, our revenues recognized in any given period may not be indicative of our then current viability and market acceptance of our OcuGene product.



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 May Not Successfully Manage Our Growth



Our success will depend upon the expansion of our operations and the
effective management of our growth, which will place a significant strain on our management and on our administrative, operational and financial resources. To manage this growth, we must expand our facilities, augment our operational, financial and
management systems and hire and train additional qualified personnel. If we are unable to manage our growth effectively, our business would be harmed.



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We Are Dependent Upon Key Employees and We May Not Be Able to Retain or Attract Key Employees, and Our Ability to
Attract and Retain Key Employees is Likely to be Harmed by Our Current Financial Situation



We are highly dependent on Dr. Chandrasekaran, who is our chief executive officer, president and chief financial officer, and Dr. Lyle Bowman, our
vice president, development and operations. The loss of services from either of these key personnel might significantly delay or prevent the achievement of planned development objectives. We carry a $1 million life insurance policy on Dr.
Chandrasekaran under which we are the sole beneficiary, however in the event of the death of Dr. Chandrasekaran such policy would be unlikely to fully compensate us for the hardship such a loss would cause us. Furthermore, a critical factor to our
success will be 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. Our ability to attract and retain such individuals is likely to be significantly reduced by our current financial situation and our past reductions in force. For example, we have recently laid-off approximately 42% of our employees and
our senior management has agreed to accept reduced salaries. Although we are not aware of any plans of our management or scientific personnel to leave us, these measures and other cost reduction measures we have undertaken make it more likely that
such individuals will seek other employment opportunities and may leave our company permanently. The loss of key personnel or the failure to recruit additional personnel or to develop needed expertise could harm our business.



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, or at all. Moreover, our
current financial condition may make us a less attractive partner to potential collaborators. 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 future 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



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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 or block our rights to exploit our technology. 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. For example, we are aware that the European Patent Office has indicated that it intends to grant a patent to Pfizer covering the use of azithromycin once a day in a topical
formulation to treat bacterial infections in the eye. We may conclude that we require a license under this patent to develop or sell ISV-401 in Europe, which may not be available on reasonable commercial terms if at all.



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 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.



Our Current Financial Situation May Impede Our Ability to Adequately Protect or Enforce Our Legal Rights Under Agreements and to Our Intellectual Property



We currently do not have sufficient funds, anticipated cash flow from
operations and current cash commitments to us to continue our operations beyond approximately the middle of June 2004. Our current financial situation may impede our ability to enforce our legal rights under various agreements we are currently a
party to or may become a party to due to our inability to incur the costs associated with such enforcement. Similarly, our lack of financial resources makes it more difficult for us to enforce our intellectual property rights, through the filing or
maintenance of patents, taking legal action against those that may infringe on our proprietary rights, defending infringement claims against us, or otherwise. Our inability to adequately protect our legal and intellectual property rights may make us
more vulnerable to infringement and could harm our business.



If We Infringe
the Rights of Third Parties We Could Be Prevented From Selling Products, Forced to Pay Damages, and Defend Against Litigation



If our products, methods, processes and other technologies infringe the proprietary rights of other parties, we could incur substantial costs and we may
have to:



| |  |  | obtain licenses, which may not be available on commercially reasonable terms, if at all;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | redesign our products or processes to avoid infringement;
| | - |  | ---------------------------------------------------------



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| |  |  | stop using the subject matter claimed in the patents held by others;
| | - |  | --------------------------------------------------------------------



| |  |  | pay damages; or
| | - |  | ---------------



| |  |  | defend litigation or administrative proceedings which may be costly whether we win or lose, and which could result in a substantial diversion of our valuable management resources.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 licensing agreement we had entered into with them in January 1999, 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:



| |  |  | provide for Phase 2 and/or Phase 3 clinical testing;
| | - |  | ----------------------------------------------------



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



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



In December 2003, we completed the sale of our drug candidate ISV-403 for the treatment of ocular infections to Bausch & Lomb Incorporated. Bausch
& Lomb has assumed all future ISV-403 development and commercialization expenses and, following a transfer period, will be responsible for all development activities, with our assistance, as appropriate. The Bausch & Lomb Purchase Agreement
and License Agreement grants Bausch & Lomb rights to develop and market ISV-403, subject to payment of royalties, in all geographies except Japan (which were retained by SSP, in connection with a separate license agreement between us and SSP),
with such rights being shared with SSP in Asia (except Japan) and exclusive elsewhere. This sale resulted in the termination of the August 2002 license agreement we entered into with Bausch & Lomb related to ISV-403. Our ability to generate
royalties from this agreement will be dependent upon Bausch & Lombs ability to complete the development of ISV-403, obtain regulatory approval for the product and successfully market it. In addition, under the Bausch & Lomb Purchase
Agreement, we also have certain potential indemnification obligations to Bausch & Lomb in connection with the Asset Sale which, if triggered, could significantly harm our business and our financial position.



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



| |  |  | marketing consultants;
| | - |  | ----------------------



| |  |  | a network of key ophthalmic clinicians; and
| | - |  | -------------------------------------------



| |  |  | 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



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



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 and May Not Have the Financial Resources to Do So



We have no experience manufacturing products for Phase 3 and commercial
purposes. We have a pilot facility licensed by the State of California to manufacture a number of our products for Phase 1 and Phase 2 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 the FDAs 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:



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



| |  |  | will be subject to the regulatory requirements described above;
| | - |  | ---------------------------------------------------------------



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



| |  |  | will require substantial additional capital than we otherwise may require.
| | - |  | --------------------------------------------------------------------------



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



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



SSP is
the sole source for the active drug incorporated into the ISV-403 product candidate we sold to Bausch & Lomb for further development and commercialization. SSP has submitted a Drug Master File on the compound with the FDA and is subject to the
FDAs review and oversight. If SSP is unable to obtain and maintain FDA approval for their production of the drug or is otherwise unable to supply Bausch & Lomb with



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sufficient quantities of the drug, Bausch & Lombs ability to continue with the development, and potentially the commercial sale if the product is
approved, would be interrupted or impeded, our royalties from commercial sales of the ISV-403 product could be delayed or reduced and our business could be harmed.



We currently have a single supplier for azithromycin, the active drug incorporated into our ISV-401 product candidate.
The supplier has submitted a Drug Master File on the compound with the FDA and is subject to the FDAs review and oversight. If the FDA were to identify issues in the production of the drug that the supplier was unable to quickly resolve, or
other issues were to arise that impact production, our ability to continue with the development, and potentially the commercial sale if the product is approved, would be interrupted and could harm our business. Additional suppliers for this drug
exist, but qualification of an alternative source could be time consuming, expensive and could result in a delay that could harm our business and there is no guarantee that these additional suppliers can supply sufficient quantities at a reasonable
price, or at all. In addition, we do not have currently have contractual agreement with this supplier of azithromycin and consequently this supplier is not obligated to provide us any particular quantities of the drug.



In addition, certain of the raw materials we use in formulating our
DuraSite drug delivery system are available only from Goodrich Corporation. Although we do not have a current supply agreement with the Goodrich Corporation, to date we have not encountered any difficulties obtaining necessary materials from them.
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.



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 and May Not Have the Financial Resources to Do So



We have no experience in the analytical procedures related to genetic testing. We have entered into an agreement with Quest Diagnostics Incorporated under
which Quest exclusively performs 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 the FDAs facilities inspection program. Should we be required to perform the analytical procedures for genetic testing ourselves, we:



| |  |  | will be required to expend significant amounts of capital to install an analytical capability;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | will be subject to the regulatory requirements described above; and
| | - |  | -------------------------------------------------------------------



| |  |  | will require substantial additional capital than we otherwise may require.
| | - |  | --------------------------------------------------------------------------



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 Compete in Highly Competitive Markets and Our Competitors Financial, Technical, Marketing, Manufacturing and Human Resources May Surpass Ours and 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,



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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, particularly in light of our current financial condition. In
addition, they may 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.



If We Cannot Compete Successfully
for Market Share Against Other Drug Companies, We May Not Achieve Sufficient Product Revenues and Our Business Will Suffer



The market for our product candidates is characterized by intense competition and rapid technological advances. If our product candidates receive FDA
approval, they will compete with a number of existing and future drugs and therapies developed, manufactured and marketed by others. Existing or future competing products may provide greater therapeutic convenience or clinical or other benefits for
a specific indication than our products, or may offer comparable performance at a lower cost. If our products fail to capture and maintain market share, we may not achieve sufficient product revenues and our business will suffer.



We will compete against fully integrated pharmaceutical companies and
smaller companies that are collaborating with larger pharmaceutical companies, academic institutions, government agencies and other public and private research organizations. Many of these competitors have compounds competitive with ours already
approved or in development including Zymar and Ocuflux by Allergan, Vigamox and Ciloxan by Alcon, Quixin by Santen and Chibroxin by Merck. In addition, many of these competitors, either alone or together with their collaborative partners, operate
larger research and development programs and have substantially greater financial resources than we do, as well as significantly greater experience in:



| |  |  | developing drugs;
| | - |  | -----------------



| |  |  | undertaking pre-clinical testing and human clinical trials;
| | - |  | -----------------------------------------------------------



| |  |  | obtaining FDA and other regulatory approvals of drugs;
| | - |  | ------------------------------------------------------



| |  |  | formulating and manufacturing drugs;
| | - |  | ------------------------------------



| |  |  | launching, marketing and selling drugs; and
| | - |  | -------------------------------------------



| |  |  | attracting qualified personnel, parties for acquisitions, joint ventures or other collaborations.
| | - |  | -------------------------------------------------------------------------------------------------



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Clinical Trials Are Very Expensive, Time-Consuming and Difficult to Design and Implement



Human clinical trials are very expensive and difficult to design and
implement, in part because they are subject to rigorous regulatory requirements. The clinical trial process is also time consuming. We estimate that clinical trials of our product candidates will take at least several years to complete once
initiated. Furthermore, failure can occur at any stage of the trials, and we could encounter problems that cause us to abandon or repeat clinical trials, further delaying or preventing the completion of such trials. The commencement and completion
of clinical trials may be delayed by several factors, including:



| |  |  | unforeseen safety issues;
| | - |  | -------------------------



| |  |  | determination of dosing issues;
| | - |  | -------------------------------



| |  |  | lack of effectiveness during clinical trials;
| | - |  | ---------------------------------------------



| |  |  | slower than expected rates of patient recruitment;
| | - |  | --------------------------------------------------



| |  |  | inability to monitor patients adequately during or after treatment; and
| | - |  | -----------------------------------------------------------------------



| |  |  | inability or unwillingness of medical investigators to follow our clinical protocols.
| | - |  | -------------------------------------------------------------------------------------



In addition, we or the FDA may suspend our clinical trials at any time if it appears that we are exposing participants
to unacceptable health risks or if the FDA finds deficiencies in our submissions or the conduct of these trials.



The Results of Our Clinical Trials May Not Support Our Product Candidate Claims



Even if our clinical trials are completed as planned, we cannot be certain that their results will support our product
candidate claims. Success in pre-clinical testing and early clinical trials does not ensure that later clinical trials will be successful, and we cannot be sure that the results of later clinical trials will replicate the results of prior clinical
trials and pre-clinical testing. The clinical trial process may fail to demonstrate that our product candidates are safe for humans and effective for indicated uses. This failure would cause us to abandon a product candidate and may delay
development of other product candidates. Any delay in, or termination of, our clinical trials will delay the filing of our NDAs with the FDA and, ultimately, our ability to commercialize our product candidates and generate product revenues. In
addition, our clinical trials involve a small patient population. Because of the small sample size, the results of these clinical trials may not be indicative of future results.



Physicians and Patients May Not Accept and Use Our Drugs



Even if the FDA approves our product candidates, physicians and patients may not accept and use them. Acceptance and use
of our product will depend upon a number of factors including:



| |  |  | perceptions by members of the health care community, including physicians, about the safety and effectiveness of our drugs;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | cost-effectiveness of our product relative to competing products;
| | - |  | -----------------------------------------------------------------



| |  |  | availability of reimbursement for our products from government or other healthcare payers; and
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | effectiveness of marketing and distribution efforts by us and our licensees and distributors, if any.
| | - |  | -----------------------------------------------------------------------------------------------------



Because we expect sales of our current product candidates, if approved,
to generate substantially all of our product revenues for the foreseeable future, the failure of any of these drugs to find market acceptance would harm our business and could require us to seek additional financing.



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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 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. Additionally, the
FDA recently issued an advisory that microarrays used for diagnostic and prognostic testing may need regulatory approval. The need for regulatory approval of multiple gene analysis is uncertain at this time. 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.



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.



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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. Although we believe our current insurance coverage is adequate to cover likely
claims we may encounter given our current stage of development and activities, our present product liability insurance coverage may not be adequate to cover all potential claims we may encounter. In addition, our existing coverage will not be
adequate as we further develop, manufacture and market our products, and we may not be able to obtain or afford adequate insurance coverage against potential claims in sufficient amounts or at a reasonable cost.



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 hazardous solvents used in pharmaceutical development and manufacturing including acetic acid, acetone, acrylic acid, calcium chloride, chloroform, dimethyl
sulfoxide, ethyl alcohol, hydrogen chloride, nitric acid, phosphoric acid and other similar solvents. We retain a licensed outside contractor that specializes in the disposal of hazardous materials used in the biotechnology industry to properly
dispose of these materials, but we cannot completely eliminate the risk of accidental contamination or injury from these materials. Our cost for the disposal services rendered by our outside contractor have been approximately, $6,000, $17,000 and
$7,000 for the years ended 2003, 2002 and 2001, respectively. In the event of such an accident involving these materials, we could be held liable for any damages that result, and any such liability could exceed our resources. Moreover, as our
business develops we may be required to incur significant costs to comply with federal, state and local environmental laws, regulations and policies, especially to the extent that we manufacture our own products.



If We Engage in Acquisitions, We Will Incur a Variety of Costs, and the Anticipated
Benefits of the Acquisition May Never be Realized



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:



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



| |  |  | diverting our managements attention from day-to-day operation of our business;
| | - |  | -------------------------------------------------------------------------------



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



| |  |  | potentially losing key employees from the acquired companies.
| | - |  | -------------------------------------------------------------



Management and Principal Stockholders May Be Able to Exert Significant Control On Matters Requiring Approval by Our Stockholders and Security Interests in Our Assets
Held by Management May Enable Them to Control the Disposition of Such Assets



As of March 26, 2004, our management and principal stockholders together beneficially owned approximately 20% 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.



In July 2003, we issued a $400,000 short-term senior secured note payable to Dr. Chandrasekaran, our chief executive
officer, chief financial officer and a member our board of directors, for cash. This note bears interest at a rate of five and one-half percent (5.5%) and is due on the earlier to occur of March 31, 2007 and 30 days



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subsequent to the successful completion of a pivotal Phase III clinical trial with ISV 401 and is secured by a lien on substantially all of our assets
including our intellectual property and certain other equipment secured by the lessor of such equipment.



This security interest enables this member of our board of directors and management to control the disposition of these assets in the event of our
liquidation. If we are unable to repay the amounts due under this note, this director and officer could, or cause us to, enter into involuntary liquidation proceedings in the event we default on our obligation.



In addition, investors in our March 2004 private placement, as a group, own
approximately 17% of our outstanding shares of common stock. If the final closing occurs, we anticipate that such investors would own approximately 63% of our then 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 approval of business combinations.



The Market Prices For Securities of Biopharmaceutical and Biotechnology Companies such as Ours Have Been and Are Likely to Continue to 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 and circumstances, such as our current financial condition, the audit report
included in this filing that includes an explanatory paragraph referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern, our ability to obtain new financing, 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, conversions of convertible securities and the sale of the shares of
our Common Stock underlying those convertible securities, such as the debentures issued to HEM and the warrants issued to Xmark and others, could cause a significant decline in the market price for our common stock. Additionally, both the debentures
issued to HEM and the warrants issued to Xmark contain anti-dilution provisions that would decrease the conversion or exercise price of these instruments and, in the case of the Xmark warrants, result in an increase in the number of shares of our
common stock issuable under them. We have not paid any cash dividends on our common stock, and we do not anticipate paying any dividends on our common stock in the foreseeable future.



In addition, the terrorist attacks in the U.S. and abroad, the U.S. retaliation for these attacks, the war in Iraq and
continued worldwide economic weakness and the related decline in consumer confidence have had, and may continue to have, an adverse impact on the U.S. and world economy. These and similar 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 and Could Prevent or Make it More Difficult to Replace or Remove Current Management



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. In addition, such provisions could also prevent or



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make it more difficult, for our stockholder to replace or remove current management and could adversely affect the price of our common stock if they are
viewed as discouraging takeover attempts, business combinations or management changes that stockholders consider in their best interest. Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock, 15,000 of which
have been designated as Series A-1 Preferred Stock. Our board of directors has the authority to determine the price, rights, preferences, privileges and restrictions, including voting rights, 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 financings, 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, even if the transaction might be desired by our stockholders. 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. The issuance of preferred stock or Section 203 of the Delaware General Corporate Law could also be deemed to benefit incumbent management to the extent these provision deter offers by persons who would wish to make changes in management or
exercise control over management. Other provision of our certificate of incorporation and bylaws may also have the effect of delaying, deferring or preventing a takeover attempt or management changes that our stockholders might consider in their
best interest. For example, our bylaws limit the ability of stockholders to remove directors and fill vacancies on our board of directors. Our bylaws also impose advance notice requirements for stockholder proposals and nominations of directors and
prohibit stockholders from calling special meetings or acting by written consent.



We Have Convertible, Redeemable Securities That Have and May Continue To Result in Dilution for Common Stockholders, and May Be Convertible Into Common Stock or Debt



As a result of our merger with Ophthalmic Solutions Inc. on September 22,
2003, we assumed the rights and obligations in connection with $1,000,000 in principal amount of convertible debentures issued by Ophthalmic Solutions to HEM, including the gross proceeds raised through the sale of the debentures and Ophthalmic
Solutions obligations under the debentures and the related debenture purchase agreement. The debentures are convertible into shares of our Common Stock, accrue interest at the rate of 1% per year, payable in cash or shares of our Common Stock,
and have a maturity date of September 21, 2008. As of the date of this filing, an aggregate of $982,329 in principal amount of these debentures, along with the associated interest, had been converted into an aggregate of 3,763,651 unrestricted
shares of our Common Stock. As of the date of this filing, the remaining $17,724 in principal amount and accrued interest of the debentures is convertible into unrestricted shares of our Common Stock at a conversion price that is the lower of
$0.35394 or the average of the three lowest closing per share bid prices for our Common Stock during the 40 trading days prior to conversion. The conversion price reflects anti-dilution adjustments that were triggered by the initial closing of the
private placement. Additional anti-dilution adjustments are likely to be triggered by the final closing of the private placement, if such debentures are outstanding at that time.



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EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT OF THE REGISTRANT



As of March 30, 2004, our executive officers and other senior management were
as follows:



|                               |  |     |  |                                                                                      
|------------------------------ |  | --- |  | -------------------------------------------------------------------------------------
|Name                           |  | Age |  | Title                                                                                
|S. Kumar Chandrasekaran, Ph.D. |  | 61  |  | Chairman of the Board, President, Chief Executive Officer and Chief Financial Officer
|                               |  |    
|Lyle M. Bowman, Ph.D.          |  | 55  |  | Vice President, Development and Operations                                           
|                               |  |    
|David F. Heniges               |  | 60  |  | Vice President and General Manager, Commercial Opportunities                         
|                               |  |    
|Cheryl E. Chen                 |  | 44  |  | Senior Director, Clinical Operations                                                 
|                               |  |    
|Sandra C. Heine                |  | 42  |  | Senior Director, Finance and Administration                                          
|                               |  |    
|Erwin C. Si, Ph.D.             |  | 50  |  | Senior Director, Preclinical Research                                                



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.



David Heniges joined us in July 2002 as Vice President and General Manager, Commercial Opportunities. From 1998 to 2001, Mr. Heniges served as General
Manager-Europe/Africa/Middle East for Kera Vision, Inc., a manufacturer of implantable ophthalmic devices and equipment. From 1996 to 1998 he was Vice President, Global Marketing for the cardiovascular group at Baxter Healthcare Corporation. From
1982 to 1995 he served in various managerial positions, including Director, Product Management and International Marketing, Vice President, Marketing, and Vice President, Worldwide Business Development, at IOLAB Corporation, a Johnson & Johnson
company, which manufactured ophthalmic devices, equipment and pharmaceuticals. Mr. Heniges holds a B.S. in Sociology with a minor in science from Oregon State University.



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.



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



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 Preclinical 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.



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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 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.



On June 23,
2003, Xmark Funds, L.P. etal, or Xmark, filed a complaint in the United States District Court, Southern District of New York against us alleging that we breached the terms of the term sheet signed between Xmark and us in May 2003. On December 31,
2003 we settled the suit with Xmark. As part of the settlement, we paid Xmark $10,000 and issued Xmark warrants to purchase 250,000 shares of our common stock at an exercise price of $0.58 per share. Pursuant to certain anti-dilution adjustments set
forth in the warrants, our March 2004 private placement triggered an adjustment to the Xmark warrants such that the warrants are now exercisable for the purchase of 254,386 shares of our common stock at an exercise price of $0.57 per share. In
addition, the warrants issued to Xmark include piggyback registration rights which entitle Xmark to require us to include the shares issuable upon exercise of the warrants in the registration statement to be filed by us in connection with our March
2004 private placement. If the shares issuable upon exercise of the warrants issued to Xmark are not registered prior to June 30, 2004, the expiration date of such warrants is extended to December 31, 2008.



On or about October 8, 2003, Thai Nguyen, a former consultant to the
Company filed a complaint in the Superior Court of California, County of San Francisco against us, our chief executive officer, Kumar Chandrasekaran, the Regents of the University of California, or Regents, and two individuals associated
with Regents. In essence, Mr. Nguyen alleges that we breached an obligation to continue supporting his research; he has also made a variety of other related claims and allegations against us and the other defendants. He filed a motion to enjoin us,
during the pendency of the litigation, from alienating the license rights held by us relating to the subject of his research, and this motion was denied. We and Dr. Chandrasekaran filed a demurrer challenging certain aspects of the complaint which
was heard on January 28, 2004. The Court has not yet issued a ruling on the demurrer, and until that ruling issues we do not expect any further response to the complaint to be filed by either us or by Dr. Chandrasekaran.



While the amount of monetary relief is not specifically quantified in the
complaint, in general Mr. Nguyen seeks to enforce a claimed agreement which states that we would pay him between $100,000 and $200,000 in annual laboratory support for the life of patent, which corresponds to the certain TIGR
patents licensed from the University of California for the diagnosis of glaucoma, and bonus payments of approximately $60,000. Mr. Nguyen also seeks relief in connection with 30,000 shares of our Common Stock provided to him by us but which he
gave back to us at the direction of Regents. The complaint also seeks unspecified punitive damages, attorneys fees and other damages and relief (including an exclusive, royalty free license to certain patents relating to the glaucoma genetics
program).



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



On December 12, 2003, we held our Annual Meeting of Stockholders at which the stockholders approved:



(1) The election of S. Kumar Chandrasekaran, Ph.D., Mitchell H. Friedlaender, M.D., John L. Mattana, Jon S. Saxe and Anders P. Wiklund to the board of
Directors to serve until the next annual meeting or until their successors are elected and qualified. The following directors received the number of votes set opposite their respective names:



|                               |  |              |  |          
|------------------------------ |  | ------------ |  | ---------
|                               |  | For Election |  | Withheld 
|S. Kumar Chandrasekaran, Ph.D. |  | 21,289,528   |  | 842,975  
|Mitchell H. Friedlaender, M.D. |  | 21,902,753   |  | 229,750  
|John L. Mattana                |  | 20,702,058   |  | 1,430,445
|Jon S. Saxe                    |  | 21,495,488   |  | 637,015  
|Anders P. Wiklund              |  | 21,456,188   |  | 676,315  



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PART II



Item 5.    
Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Securities



Market Information



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.



|               |  |      |      |     |   |     
|-------------- |  | ---- | ---- | --- | - | ----
|2003           |  | High |      | Low
|First Quarter  |  | $    | 1.00 |     | $ | 0.63
|Second Quarter |  | $    | 0.70 |     | $ | 0.53
|Third Quarter  |  | $    | 0.66 |     | $ | 0.45
|Fourth Quarter |  | $    | 0.69 |     | $ | 0.33
|               |  |     
|2002           |  | High |      | Low
|First Quarter  |  | $    | 2.50 |     | $ | 1.74
|Second Quarter |  | $    | 2.17 |     | $ | 1.40
|Third Quarter  |  | $    | 1.55 |     | $ | 0.89
|Fourth Quarter |  | $    | 1.19 |     | $ | 0.62



Holders



As of March 25, 2004, we had approximately 300 stockholders of record. On
March 25, 2004, the last sale price reported on The American Stock Exchange for our common stock was $0.94 per share.



Dividends



We have never declared or paid dividends on our common stock and do not anticipate paying any cash 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.



Equity Compensation Plan Information



Information regarding our equity compensation plans is set forth in the section entitled Equity Compensation Plan Information in our Proxy Statement for our Annual Meeting of Stockholders which is expected
to be held on June 1, 2004 which information is incorporated herein by reference.



Recent Sales of Unregistered Securities



On September 22, 2003, we issued warrants to purchase 81,967 shares of common stock for $0.61 until September 2008 to TP Turner & Company, LLC as partial compensation for its services as a financial advisor in connection with the
initial placement of convertible notes payable. On November 2003, we issued additional warrants to purchase 125,000 shares of common stock for $0.40 that expire in November 12, 2008 to TP Turner & Company, LLC as part of the
placement of convertible notes payable. These securities were sold pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933, as amended, based on the limited nature of the offering and the financial advisors status as an
accredited investor.



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On December 16, 2003, we sold 142,857 shares of our common stock in a private placement to Eli
Jacobson, an accredited investor, and received $50,000 in proceeds. These securities were sold pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933, as amended, based on the limited nature of the offering and the
purchasers status as an accredited investor.



On
December 31, 2003, we entered into a settlement agreement with Xmark Funds, L.P. et al, or Xmark, related to a complaint filed against us by Xmark. As part of the settlement we paid Xmark $10,000 and issued warrants to purchase 250,000 shares of our
Common Stock at an exercise price of $0.58 per share that expire on December 31, 2006. These securities were sold pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933, as amended, based on the limited nature of the
offering and the purchasers status as an accredited investor. Pursuant to certain anti-dilution adjustments set forth in the warrants, our March 2004 private placement triggered an adjustment to the Xmark warrants such that the warrants are
now exercisable for the purchase of 254,386 shares of our common stock at an exercise price of $0.57 per share. In addition, the warrants issued to Xmark include piggyback registration rights which entitle Xmark to require us to include the shares
issuable upon exercise of the warrants in the registration statement to be filed by us in connection with our March 2004 private placement. If the shares issuable upon exercise of the warrants issued to Xmark are not registered prior to June 30,
2004, the expiration date of such warrants is extended to December 31, 2008.



On March 26, 2004, we completed the initial closing of a private placement to 133 accredited investors of shares of our common stock and warrants to purchase shares of common stock pursuant to subscription agreements
entered into between us and such investors. These securities were sold pursuant to Rule 506 promulgated under the Securities Act of 1933, as amended and pursuant to an exemption provided by Section 4(2) of the Securities Act of 1933, as amended.
Pursuant to the terms of the subscription agreements the subscribers agreed to purchase from us an aggregate of 1,650 units, of which 194 units, consisting of an aggregate of 3,880,000 shares of our common stock and warrants to purchase 1,940,000
shares of our common stock were sold at the initial closing and the remaining 1,456 units, consisting of an aggregate of 29,120,000 shares of our common stock and warrants to purchase 14,560,000 shares of our common stock, will be sold at the final
closing. The final closing is subject to and conditioned upon approval of such closing and the transactions contemplated thereby by our stockholders and certain other conditions set forth in the subscription agreements.



Each unit consists of 20,000 shares of common stock at $0.50 per share,
redeemable Class A warrants exercisable for 5,000 shares at an exercise price of $0.75 per share and redeemable Class B warrants exercisable for 5,000 shares at an exercise price of $0.75 per share. The Class A Warrants and
Class B Warrants may be exercised at any time prior to the earlier of the date on which they are redeemed and the fifth anniversary of their issuance. Outstanding Class A Warrants may be redeemed by us upon 30 days advanced written notice to the
holder at a per warrant share redemption price of $0.75 if the average closing price of the common stock on the American Stock Exchange for any 20 consecutive trading days is at least $1.50. Outstanding Class B Warrants may be redeemed by us upon 30
days advanced written notice to the holder at a per warrant share redemption price of $1.75 if the average closing price of the common stock on the American Stock Exchange for any 20 consecutive trading days is at least $2.50. The Class A Warrants
and Class B Warrants are referred to as the Warrants, the shares of common stock issuable upon exercise of the Warrants are referred to as the Warrant Shares and the term Securities means collectively the shares
of Common stock included in the units, the Warrants and the Warrant Shares.



Paramount BioCapital, Inc. acted as the placement agent for the private placement and will received approximately $120,000 in fees for such services in the initial closing. In addition, if the final closing occurs,
the placement agent will receive a non-redeemable five year warrant exercisable for 750,000 shares of common stock at an exercise price of $0.55 per share and will receive additional fees for services. As long as the placement agent and its
affiliates beneficially own at least 33% of the Securities issued to them in the private placement, the placement agent will be entitled to designate a nonvoting observer who may attend all meetings of our Board of Directors.



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The final closing will not occur, and we will not issue any common stock or Warrants at the final closing
or receive any proceeds therefore, unless we receive approval from our stockholders to:



| |  |  | issue the subscribers the balance of the common stock and Warrants (including any shares of common stock issuable upon exercise thereof) included in the units subscribed for by the
subscribers and not issued at the initial closing;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | issue to the placement agent the placement warrants (including any shares of common stock issuable upon exercise of the placement warrants) and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | amend our Certificate of Incorporation to increase the authorized number of shares of common stock in an amount sufficient to issue the shares of common stock to be sold at the
final closing and the shares of common stock issuable upon the exercise of the Warrants and the placement warrants.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



If we do not receive stockholder approval within 90 days of the initial closing, subject to certain limited extensions (the Termination Date),
the obligation of each subscriber to purchase the balance of the Securities in the final closing will be terminable at the option of the subscriber. In addition, if stockholder approval is not obtained by the Termination Date, we are required to pay
the subscribers liquidated damages equal in the aggregate to 2% of the gross proceeds received at the initial closing, for each week beyond the Termination Date that stockholder approval is not obtained, up to a maximum of 8% in the aggregate of the
gross proceeds received at the initial closing.



In addition,
not later than 15 days after the final closing, we are required to file a registration statement with the Securities and Exchange Commission, or the SEC, with respect to the resale of the shares of Common stock (i) included in the units; (ii)
issuable upon exercise of the Warrants included in the units; (iii) issuable upon exercise of the placement warrants, and issuable pursuant to any penalties under the subscription agreements (collectively, the Registrable Shares). If we
fail to file the registration statement within such period, we are required to issue to the subscribers (on a pro-rata basis) additional Class B Warrants to purchase a number of shares of common stock equal to 1% of the shares of common stock, on a
fully diluted basis, issued to subscribers in the private placement for each 15 day period the registration statement remains unfiled, up to a maximum of Class B Warrants in the aggregate (on a pro-rata basis) to purchase an additional 4% of the
common stock, on a fully diluted basis, issued to subscribers in the private placement.



If we do not receive stockholder approval by 15 days after the Termination Date, we must file a registration statement with the SEC with respect to the resale of the shares of common stock (i) included in the units
sold in the initial closing and (ii) issuable upon exercise of the Warrants included in the units sold in the initial closing. If we fail to file the registration statement within such period then it is required to pay to subscribers (on a pro-rata
basis) a cash payment equal to 1% of the gross proceeds raised in the initial closing for each 15 day period the registration statement remains unfiled, up to a maximum (on a pro-rata basis) of 4% of the initial closing gross proceeds.



Issuer Purchases of Securities



None.



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##### Table of Contents

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 following 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,
2003 (in thousands except per share amounts):



|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|---------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                                                                 |  | Year Ended December 31, |       
|                                                                                                                 |  | 2003                    |        |   | 2002 |   |         | 2001 |  |   | 2000   |   |  | 1999 |       
|Consolidated Statements of Operations Data                                                                       |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |       
|Revenues, net                                                                                                    |  | $                       | 134    |   |      | $ | 36      |      |  | $ | 5      |   |  | $    | 4,513  |   |  | $ | 4,760  |  
|Cost of goods                                                                                                    |  |                         | 20     |   |      |   | 114     |      |  |   |       |   |  |      |       |   |  |   |       |  
|Operating expenses:                                                                                              |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Research and development, net                                                                                    |  |                         | 4,436  |   |      |   | 6,911   |      |  |   | 6,610  |   |  |      | 1,674  |   |  |   | 1,397  |  
|Selling, general and administrative                                                                              |  |                         | 3,021  |   |      |   | 4,022   |      |  |   | 3,523  |   |  |      | 2,584  |   |  |   | 2,293  |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total expenses                                                                                                   |  |                         | 7,457  |   |      |   | 10,933  |      |  |   | 10,133 |   |  |      | 4,258  |   |  |   | 3,690  |  
|Gain on sale of assets                                                                                           |  |                         | 1,153  |   |      |   |        |      |  |   |       |   |  |      |       |   |  |   |       |  
|Interest and other income (expense), net                                                                         |  |                         | (561   | ) |      |   | 62      |      |  |   | 572    |   |  |      | 791    |   |  |   | 85     |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) before taxes                                                                                   |  |                         | (6,751 | ) |      |   | (10,949 | )    |  |   | (9,556 | ) |  |      | 1,046  |   |  |   | 1,155  |  
|Income tax provision                                                                                             |  |                         |       |   |      |   |        |      |  |   |       |   |  |      |       |   |  |   | 5      |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) before cumulative effect of accounting change                                                  |  |                         | (6,751 | ) |      |   | (10,949 | )    |  |   | (9,556 | ) |  |      | 1,046  |   |  |   | 1,150  |  
|Cumulative effect of accounting change(1)                                                                        |  |                         |       |   |      |   |        |      |  |   |       |   |  |      | (4,486 | ) |  |   |       |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss)                                                                                                |  |                         | (6,751 | ) |      |   | (10,949 | )    |  |   | (9,556 | ) |  |      | (3,440 | ) |  |   | 1,150  |  
|Non cash preferred dividend                                                                                      |  |                         | 221    |   |      |   | 48      |      |  |   |       |   |  |      | 3      |   |  |   | 22     |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) applicable to common stockholders                                                              |  | $                       | (6,972 | ) |      |   | (10,997 | )    |  | $ | (9,556 | ) |  | $    | (3,443 | ) |  | $ | 1,128  |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Basic earnings (loss) per share:                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) per share applicable to common stockholders before cumulative effect of accounting change      |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | ) |  | $    | 0.04   |   |  | $ | 0.06   |  
|Cumulative effect of accounting change(1)                                                                        |  |                         |       |   |      |   |        |      |  |   |       |   |  |      | (0.19  | ) |  |   |       |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) per share applicable to common stockholders                                                    |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | ) |  | $    | (0.15  | ) |  | $ | 0.06   |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Diluted earnings (loss) per share:                                                                               |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) per share applicable to common stockholders before cumulative effect of accounting change      |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | ) |  | $    | 0.04   |   |  | $ | 0.06   |  
|Cumulative effect of accounting change(1)                                                                        |  |                         |       |   |      |   |        |      |  |   |       |   |  |      | (0.18  | ) |  |   |       |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Net income (loss) per share applicable to common stockholders                                                    |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | ) |  | $    | (0.14  | ) |  | $ | 0.06   |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Pro-forma net income (loss) assuming the accounting change is applied retroactively                              |  | $                       | (6,972 | ) |      | $ | (10,997 | )    |  | $ | (9,556 | ) |  | $    | 1,043  |   |  | $ | (3,358 | )
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Pro-forma net income (loss) per share assuming the accounting change is applied retroactively, basic and diluted |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | ) |  | $    | 0.04   |   |  | $ | (0.17  | )
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used to calculate basic net income (loss) per share                                                       |  |                         | 25,767 |   |      |   | 24,997  |      |  |   | 24,897 |   |  |      | 23,574 |   |  |   | 19,285 |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used to calculate diluted net income (loss) per share                                                     |  |                         | 25,767 |   |      |   | 24,997  |      |  |   | 24,897 |   |  |      | 24,483 |   |  |   | 19,856 |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used to calculate pro-forma basic net income (loss) per share                                             |  |                         | 25,767 |   |      |   | 24,997  |      |  |   | 24,897 |   |  |      | 23,574 |   |  |   | 19,285 |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  
|Shares used to calculate pro-forma diluted net income (loss) per share                                           |  |                         | 25,767 |   |      |   | 24,997  |      |  |   | 24,897 |   |  |      | 24,483 |   |  |   | 19,285 |  
|                                                                                                                 |  |                         |        |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   |        |  

---

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



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|                                     |  |              |          |   |      |   |          |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------ |  | ------------ | -------- | - | ---- | - | -------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                     |  | December 31, |         
|                                     |  | 2003         |          |   | 2002 |   |          | 2001 |  |   | 2000    |   |  | 1999 |        
|Consolidated Balance Sheet Data      |  |              |          |   |      |   |          |      |  |   |         |   |  |      |        
|Cash and cash equivalents            |  | $            | 1,045    |   |      | $ | 1,179    |      |  | $ | 10,095  |   |  | $    | 18,904  |   |  | $ | 6,746   |  
|Working capital                      |  |              | (6,434   | ) |      |   | 353      |      |  |   | 8,747   |   |  |      | 18,305  |   |  |   | 6,167   |  
|Total assets                         |  |              | 1,405    |   |      |   | 1,866    |      |  |   | 11,051  |   |  |      | 20,000  |   |  |   | 7,463   |  
|Long term notes payable              |  |              |         |   |      |   | 10       |      |  |   | 45      |   |  |      | 26      |   |  |   |        |  
|Redeemable preferred stock           |  |              |         |   |      |   |         |      |  |   |        |   |  |      |        |   |  |   | 30      |  
|Convertible preferred stock          |  |              |         |   |      |   | 2,048    |      |  |   |        |   |  |      |        |   |  |   |        |  
|Accumulated deficit                  |  |              | (115,722 | ) |      |   | (108,750 | )    |  |   | (97,753 | ) |  |      | (88,197 | ) |  |   | (84,754 | )
|Total stockholders equity (deficit) |  |              | (6,200   | ) |      |   | 887      |      |  |   | 9,485   |   |  |      | 18,770  |   |  |   | 6,256   |  



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



Except for the historical information contained herein, the discussion in this Annual Report on Form 10-K contains 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 only 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 following discussion should be read in conjunction with the financial statements and notes thereto included in Item 8 of this Form 10-K.



Overview



As of December 31, 2003, our accumulated deficit was approximately $115.7 million. Absent additional funding from final closing of the private placement
we entered into in March 2004 or other private or public equity or debt financings, collaborative or other partnering arrangements, or other sources, as of March 26, 2004 we expect that our cash on hand, anticipated cash flow from operations and
current cash commitments to us will only be sufficient to fund our operations until approximately the middle of June 2004. If we are unable to complete the final closing related to the March 2004 private placement, there is no assurance that such
additional funds will be available for us to finance our operations on acceptable terms, if at all. If such funds are not available, management will be required to cease all operations and liquidate our remaining assets, most of which is secured by
a note to an officer who is also a board member. 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 our inability to obtain funding and resultant ceasing of operations. 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 are an ophthalmic product development company focused on ophthalmic
pharmaceutical products based on our proprietary DuraSite® eyedrop-based drug delivery technology, as well as developing genetically-based technology, for the diagnosis, prognosis and management of glaucoma. In addition, we have a retinal program that includes both a
therapeutic agent and a retinal drug delivery technology.



In
2003 we faced significant challenges related to our lack of financial resources. To continue our operations we took actions to reduce our cash usage including:



| |  |  | laying-off approximately 42% of our personnel;
| | - |  | ----------------------------------------------



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| |  |  | our senior management voluntarily reduced their salaries;
| | - |  | ---------------------------------------------------------



| |  |  | we placed several development programs on hold including expansion of our ISV-900 technology, ISV-014 our retinal delivery device, and treatments for retinal diseases;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | slowed our clinical activities related to ISV-401; and
| | - |  | ------------------------------------------------------



| |  |  | we instituted other cash saving actions including extending the payment of our liabilities.
| | - |  | -------------------------------------------------------------------------------------------



With our limited resources we focused our research and development and commercial efforts on the following:



| |  |  | ISV-403, a DuraSite formulation of a fourth generation fluoroquinolone;
| | - |  | -----------------------------------------------------------------------



| |  |  | ISV-401, a DuraSite formulation of azithromycin, an antibiotic not currently used in ophthalmology; and
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | targeted activities to support the market introduction of our OcuGene glaucoma genetic test based on our ISV-900 technology.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



ISV-403.    In February 2003 we filed an IND for
our ophthalmic antibiotic product candidate ISV-403, which was the first milestone under the August 2002 license agreement with Bausch & Lomb and resulted in the receipt $2.0 million from the sale of Series A-1 Preferred Stock. In April 2003 we
began a Phase 1 clinical trial of ISV-403 and in June 2003 the dosing for the study was completed. In December 2003 we sold the ISV-403 product candidate to Bausch & Lomb, which resulted in the receipt of $1.5 million in cash, the return of the
$4.0 million of Series A-1 Preferred Stock, and the related dividends, to us for cancellation, and provides for royalties on future product sales, if any. While we will be providing contract research services into the second quarter of 2004, due to
the sale Bausch & Lomb is responsible for the further clinical development of the product and we will be able to focus our development efforts on our ISV-401 product candidate.



ISV-401.    We have developed a topical formulation of the antibiotic, azithromycin, a broad
spectrum of antibiotic activity and is widely used to treat respiratory and other infection in its oral and parenteral forms, to treat bacterial conjunctivitis and other infections of the outer eye. The key advantages of ISV-401 include a
significantly reduced dosing regimen (6 doses vs. 36 doses for comparable products), the high and persistent levels of azithromycin achieved in the tissues of the eye and its wide spectrum of activity. Product safety and efficacy have been
demonstrated, respectively, in Phase 1 and Phase 2 clinical trials. As a result of our End of Phase 2 Meeting with the FDA early in 2003, we intended to initiate two pivotal Phase 3 clinical trials. Due to our financial constraints the
initiation of the trials was delayed and currently is planned for the second quarter of 2004. We anticipate conducting the trials in both the United States and internationally to permit aggressive enrollment of the subjects, including both children
and adults, necessary to complete the studies. We further anticipate that the primary endpoints of both trials will be microbial eradication and clinical cure. Our ability to execute on these clinical plans will be dependent upon the receipt of
funds from the final closing related to our March 2004 private placement.



In 2003 we secured a new source for the active ingredient in ISV-401 and have a contract-manufacturing site for production of clinical trial supplies and registration batches. The supplies are being manufactured under
the supervision of our personnel. We are planning to begin manufacture the registration batches needed to support the filing of the NDA at this contract facility in the second quarter of 2004. We anticipate that our contract manufacturing facility
will be ready for inspection by the FDA at the time of our NDA submission.



OcuGene.    Our OcuGene glaucoma genetic test is based on our glaucoma genetics program, which has been pursued in collaboration with academic researchers, is focused on discovering
genes that are associated with glaucoma, and the mutations on these genes that cause and regulate the severity of the disease. In June 2003, a peer-reviewed study was published inClinical Genetics titled Association of the Myocilin
mt.1 Promoter Variant with the Worsening of Glaucomatous Disease Over Time, (2003: 64: 18-27). The results of this study



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indicate substantial evidence that the TIGR/MYOC mt.1(+) variant provides a strong marker for accelerated worsening of both optic disc and visual field
measures of glaucoma progression above and beyond other baseline risk factors, stated one of the authors of the study, Jon Polansky, M.D., University of California, San Francisco, who also serves on our Scientific Advisory Board.



In 2003, the information from this article and previous publications was
used to target specific thought leaders and ophthalmic centers in an effort to support the focused introduction of the OcuGene glaucoma genetic test. Expanded marketing efforts were curtailed as we contained our cash use.



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 our AquaSite product by CIBA Vision and Global Damon. In the fourth quarter of 2001, we commercially launched our OcuGene glaucoma genetic test and
early in 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 on an annual basis 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, issuance of
convertible debentures and, to a lesser extent, from collaborative agreements and bridge loans.



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.



We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make significant estimates, assumptions and judgments about
matters that are uncertain:



Revenue
Recognition.    Our revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has standalone value to the customer and
whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria
are applied to each of the separate units.



We
recognize up-front fees over the expected term of the related 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 if it is based on a substantive element in a multi-element agreement or if it reflects substantive progress toward the completion of the activities contemplated in a long-term
contract, and the payment reflects the milestone achieved.



Revenue related to contract research services is recognized when persuasive evidence of an arrangement exists, the services have been rendered, the fee is fixed or determinable and collectibility is reasonably
assured. During the year ended 2003, we recognized payments received under the December 2003 Bausch & Lomb agreement of $128,000 as contract and other revenue in accordance with EITF 01-14, Income Statement Characterization of Reimbursement
for Out of Pocket Expenses Incurred. We incurred approximately $310,000 of costs related to the research and development activities under the related contract.



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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.



Revenue related to the sales of our product, the OcuGene glaucoma genetic test, is recognized when all related services have been rendered and
collectibility is reasonably assured. Accordingly, revenue for the sales of OcuGene may be recognized in a later period than the associated recognition of costs of the services provided, especially during the initial launch of the product. The
revenue in connection with the asset purchase agreement with Bausch & Lomb will be recognized over the contract period.



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 our 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. We directly reduced expenses for amounts reimbursed due to cost sharing agreements during the year ended December 31, 2002 and 2001, of $166,000 and $713,000, respectively, as the agreements provided for the direct
reimbursement of costs incurred.



Cost of
goods.    We recognize the cost of inventory shipped and other costs related to our OcuGene glaucoma genetic test when they are incurred.



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, 2003, our inventories solely consisted of OcuGene
kits.



Results of Operations



Revenues.



We had total net revenues of $134,000, $36,000, and $5,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. In 2003 95% of net revenues was from contract research activities. Sales of OcuGene represented 5% and 77% of the net revenues in 2003 and 2000, respectively. Sales of AquaSite® by CIBA Vision and Kukje Pharma Ind. Co., Ltd., our
AquaSite manufacturing partner in Korea represented 23% and 100% of the net revenues in 2002 and 2001, respectively. The increase in revenue is due to contract research activities conducted for Bausch & Lomb in 2003 under the ISV-403 Asset
Purchase Agreement. We recognize revenue when all services have been performed and collectibility is reasonably assured. Accordingly, revenue for the sales of OcuGene may be recognized in a later period than the associated recognition of costs of
the services provided, especially during the initial launch of the product.



Cost of goods.



Cost of
goods of $20,000 and $114,000 for 2003 and 2002 respectively, reflect the cost of OcuGene tests performed as well as the cost of sample collection kits distributed for use. In 2002 a large number of OcuGene test kits were distributed, as the product
was made initially available to interested parties. A significantly lower number of units were shipped in 2003.



Research and development.



Research and development expenses decreased to $4.4 million from $7.1 million in 2003 compared to 2002. This 38% decrease reflects the personnel cost
containment actions taken in the second quarter of 2003 and the reduction in support for external research which was begun in the first quarter of 2003. Additionally, costs incurred in 2002 for the license of the Optineuron gene from UCHC and the
related cost of new patent filings, were not incurred in 2003 as the majority of the initial filings were completed in 2002. R&D expenses in 2002



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decreased 3% to $7.1 million from $7.3 million in 2001. This decrease mainly reflected a reduction in support for external research for our ISV-900 and
ISV-014 programs as we focused our resources on the targeted launch of OcuGene and on our antibiotic programs.



In 2003, we received no R&D cost reimbursements. In 2002, our R&D cost reimbursements decreased 77% to $0.2 million from $0.7 million in 2001. The
decrease reflected the termination of the ISV-205 license by Pharmacia in 2001. Cost reimbursement in 2002 related to joint development programs to evaluate compounds for ophthalmic use.



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 2003, 2002 and 2001 (in thousands):



|                               |  |      |       |      |   |       |  |   |      
|------------------------------ |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                               |  | 2003 |       | 2002 |   | 2001 
|Research                       |  | $    | 2,707 |      | $ | 4,860 |  | $ | 5,050
|Clinical development           |  |      | 1,729 |      |   | 2,217 |  |   | 2,273
|                               |  |      |       |      |   |       |  |   |      
|Total research and development |  | $    | 4,436 |      | $ | 7,077 |  | $ | 7,323
|                               |  |      |       |      |   |       |  |   |      



Due to our limited
personnel and the 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 decrease in research activities in 2003 compared to 2002 reflects the cost containment efforts initiated in the second quarter of 2003. In May 2003,
we instituted a one-month furlough, which included 80% of our research personnel. In June 2003, approximately 75% of the furloughed research personnel were laid-off. In 2003 we also continued to reduce our financial support of the research related
to our genetics programs by not renewing certain research contracts pending the receipt of additional funding. In a further effort to reduce expenses, we have reviewed, and will continue to review, our patent filings and will discontinue maintenance
of patents and patent applications related to programs that we have determined not to pursue. The decrease in research activities in 2002 compared to 2001 mainly represents the conversion of a portion of the ISV-900 research into the OcuGene
glaucoma genetic test, which is in the initial marketing launch phase. Research is being conducted on other genes and genetic markers but at a lower rate as our limited resources are used to support the commercialized technology. As much of this
research is conducted at external academic centers, we were able to scale back this research without incurring termination costs.



The 22% decrease in Clinical development expenses from $2.2 million in 2002 to $1.7 million in 2003 reflects the cost containment efforts initiated across
the company in the second quarter of 2003. In May 2003, we instituted a one-month furlough, which included 50% of our clinical development personnel. In June 2003, approximately 83% of the furloughed clinical development personnel were laid-off.
Additionally, clinical development costs related to the OcuGene glaucoma genetic test were reduced as the studies were completed in 2002 and no new studies were begun in 2003. Clinical development expenses remained consistent between 2002 and 2001,
as the clinical trial activity was comparable between the two years. We shifted the resources used to file the IND for ISV-401 in 2001 to similar activities on the ISV-403 program in 2002.



Most of our projects are in the early stages of the product development cycle
and may not result in commercial products. 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 trials it may be found
to be ineffective or there may be harmful side effects. Additionally, during the development cycle, other



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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. If we are unable to enter into collaborative arrangements for any product candidate, our ability to commercialize the product may be slowed or we may decide not to proceed with that
candidate. These collaborative arrangements may either speed the development or they may extend the anticipated time to market. 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.



Selling,
general and administrative.



Selling, general and
administrative expenses decreased to $3.0 million in 2003 from $4.0 million in 2002. This reflects the approximately 79% decrease in selling expenses related to the initial market introduction of OcuGene, such as advertising and our limited initial
contract sales force. The remaining decrease includes a 47% decrease in personnel-related costs due to the impact of the employee furloughs, lay-offs and voluntary salary reductions. While our legal costs related to our fund raising efforts and the
cost of our insurance coverage, including directors and officers insurance increased approximately 56% in 2003 compared to 2002, these costs were more than offset by the other expense containment measures.



Selling, general and administrative expenses increased 14% in 2002 to $4.0
million from $3.5 million in 2001. The increase in 2002 reflects the additional costs incurred to support the ongoing launch of the OcuGene glaucoma genetic test. These costs included the addition of a V.P. of Commercial Development, expanded
promotional advertising and outreach activities into ophthalmic and optometric practices.



Our 2004 expenses will be dependent upon the final closing of the March 26, 2004 private placement. If the final closing occurs, we anticipate that our R&D expenses will increase by approximately 50% from the 2003
levels. This increase will mainly reflect the anticipated initiation of two Phase 3 clinical trials for our ISV-401 product candidate. We anticipate that we will continue the suspension of activity on our other product candidates absent additional
funding. Also, we anticipate that if the final closing of the March 2004 private placement occurs, our selling, general and administrative costs will remain consistent with 2003 levels. We anticipate that the expense reductions related to the
scale-back of marketing activities related to OcuGene will continue in 2004 and selective additions may be made to headcount but any such increases will be minimized. We also anticipate that salaries voluntarily reduced for the members of senior
management will be increased to their previous levels. If we are unable to complete the final closing of the March 2004 private placement, there is no assurance that additional funds will be available for us to finance our operations on acceptable
terms, if at all. If such funds are not available, management will likely be required to cease all operations and liquidate our remaining assets, most of which is secured by a note to an officer who is also a board member.



Gain on sale of assets.



The gain on sale of assets reflects the sale of the ISV-403 product
candidate to Bausch & Lomb in December 2003. We received $1.5 million in cash and Bausch & Lomb surrendered the $4.0 million of Series A-1 Preferred Stock, plus accumulated dividends, we had issued to them under the August 2002 License and
Preferred Stock Purchase Agreements. The total gain will be recognized over the five-month period that we have an obligation to provide contract research support for ISV-403, which began in December 2003.



Interest, other income and expenses.



Net interest, other income and expense was an expense of $561,000 in 2003
compared to income of $62,000 in 2002. This change principally reflects the $545,000 of interest expense related to the debt discount of the convertible debentures, interest expense related to the short-term notes payable and to lower average cash



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balances. As of December 31, 2003 $1,000 of the debt discount remained and will be amortized over the life of the notes. Net interest, other income and
expense was income of $62,000 in 2002 compared to income of $572,000 in 2001. This decrease is due principally to lower average cash balances and decreased interest rates. Any interest earned or paid in the future will be dependent on our ability to
raise additional funding and prevailing interest rates.



Liquidity and
Capital Resources



We have financed our operations since
inception primarily through private placements and public offerings of debt and equity securities, equipment and leasehold improvement financing, other debt financing and payments under corporate collaborations. At December 31, 2003, our cash and
cash equivalents balance was $1.0 million. It is our policy to invest our cash and cash equivalents in highly liquid securities, such as interest bearing money market funds, Treasury and federal agency notes and corporate debt.



In March 2004, we received approximately $1.8 million, net of placement fees,
from the initial closing of a total private placement that will yield aggregate gross proceeds of $16.5 million. Our ability to receive the remainder of the funds at the final closing will be subject to receipt of stockholder approval of the final
closing of the placement and of the increase in our authorized shares necessary to issue both the Common Stock to be issued in the final closing of the placement and the Common Stock issuable upon the exercise of the warrants issued as part of the
final closing of the placement, and satisfaction of other standard conditions contained in the subscription agreements. We will be seeking the necessary stockholder approval at our annual meeting of stockholders, which is scheduled to take place on
June 1, 2004.



Our auditors have included an explanatory
paragraph in their audit report referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern. Absent additional funding from the final closing related to the March 2004 private placement, other
private or public equity or debt financings, collaborative or other partnering arrangements, asset sales, or other sources, we expect that our cash on hand, anticipated cash flow from operations and current cash commitments to us will only be
adequate to fund our operations until approximately the middle of June 2004. Also, pursuant to the terms of the private placement we are generally prohibited from raising additional financing through the issuance of securities during the period from
the initial closing through the earlier to occur of the final closing and June 30, 2004 (subject to extension at our sole discretion), which could significantly harm our ability to continue operations of the final closing does not occur. If we are
unable to complete the final closing of the March 2004 private placement or secure sufficient additional funding prior to the middle of June 2004, we will need to cease operations and liquidate our assets, most of which is secured by a note to an
officer who is also a board member. Our financial statements were prepared on the assumption that we will continue as a going concern and do not include any adjustments that might result should we be unable to continue as a going concern.



Even if we are able to complete the final closing of the March
2004 private placement, in order to continue long-term operations beyond approximately the third quarter of 2005, we will require and are seeking additional funding through collaborative or other partnering arrangements, public or private equity or
debt financings, asset sales and from other sources. However, there can be no assurance that we will obtain interim or longer-term financing or that such funding, if obtained, will be sufficient to continue our operations as currently conducted or
in a manner necessary for the long-term success of our company. If we raise funds through the issuance of debt securities, such debt will be secured by a security interest or pledge of all of our assets, will require us to make principal and
interest payments, would likely include the issuance of warrants and may subject us to restrictive covenants. In addition, our stockholders may suffer substantial dilution if we raise additional funds by issuing equity securities.



For the years ended December 31, 2003, 2002 and 2001, cash used for
operating activities was $5.6 million, $11.0 million and $8.4 million, respectively. Cash used in operating activities in 2003 resulted primarily from the net loss of $6.7 million and gain on sale of the ISV-403 product candidate of $1.2 million.
Partially offsetting



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these cash uses in 2003 were a $1.0 million increase in accounts payable, accrued liabilities, accrued compensation and deferred rent, a $33,000 decrease in
inventories, prepaid expenses and other current assets and $1.3 million of non-cash expenses primarily reflecting the amortization of beneficial conversion feature of the convertible notes payable, depreciation and amortization of our property and
equipment and the amortization of stock-based compensation. Cash from (used in) investing activities were $1,477,000, ($61,000) and ($474,000) primarily related to proceeds received from the sale of assets in 2003 and cash outlays for additions to
laboratory and other equipment made during 2003, 2002 and 2001, respectively.



Cash provided by financing activities was $4.0 million, $2.1 million and $0.1 million for the years ending December 31, 2003, 2002 and 2001, respectively. We received $2.0 million in the first quarter of 2003 from the
issuance of 2,000 shares of our Series A-1 preferred stock to Bausch & Lomb under the ISV-403 license agreement. We issued $1.0 million of short-term notes payable in 2003 to directors, members of senior management and other stockholders. These
notes bear interest at rates from 2% to 12% and are due from January 15, 2003 through March 31, 2007. We received $845,000, net of debt issuance costs of approximately $154,000, from the issuance of convertible debentures in 2003. These debentures
bear interest at a rate of 1% and are due on September 21, 2008. In 2003 we received $3,000 from the issuance of our common stock from the exercise of stock options by employees compared to $125,000 in 2002 and $71,000 in 2001. During 2003, we also
received $134,000 in connection with private placements of our common stock. We received payments on a note to a stockholder of $23,000 and $26,000 in 2003 and 2002, respectively. We also made $18,000 of payments on capital leases for certain
laboratory equipment in 2003 compared to $31,000 in 2002 and $7,000 in 2001.



Assuming we are able to obtain additional financing and continue our operations, our future capital expenditures and requirements will depend on numerous factors, including the progress of our clinical testing,
research and development programs and preclinical testing, the time and costs involved in obtaining regulatory approvals, our ability to successfully commercialize OcuGene and any other products that we may launch in the future, our ability to
establish collaborative arrangements, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, competing technological and market developments, changes in our existing collaborative and licensing
relationships, acquisition of new businesses, products and technologies, the completion of commercialization activities and arrangements, and the purchase of additional property and equipment.



We anticipate no material capital expenditures to be incurred for
environmental compliance in fiscal year 2004. Based on our environmental compliance record to date, and our belief that we are current in compliance with applicable environmental laws and regulations, environmental compliance is not expected to have
a material adverse effect on our operations.



46



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##### Table of Contents

Contractual Obligations



The following table summarizes our significant contractual obligations as of December 31, 2003 and the effect such obligations are expected to have on
our liquidity and cash flows in the future periods. This table excludes amounts already recorded on our balance sheet as current liabilities.



|                                   |  |                                       |       |                  |   |             |  |                   |       |  |   |   
|---------------------------------- |  | ------------------------------------- | ----- | ---------------- | - | ----------- |  | ----------------- | ----- |  | - | --
|                                   |  | Payments due by period (in thousands)
|                                   |  | Total                                 |       | Less than 1 year |   | 1 - 3 years |  | More than 5 years
|Operating lease obligations(1)     |  | $                                     | 2,230 |                  | $ | 718         |  | $                 | 1,512 |  | $ |  
|Licensing agreement obligations(2) |  |                                       | 120   |                  |   | 15          |  |                   | 45    |  |   | 60
|                                   |  |                                       |       |                  |   |             |  |                   |       |  |   |   
|Total commitments                  |  | $                                     | 2,350 |                  | $ | 733         |  | $                 | 1,557 |  | $ | 60
|                                   |  |                                       |       |                  |   |             |  |                   |       |  |   |   

---

|(1) |  | We lease our facilities under a non-cancelable operating lease that expires in 2006.
|--- |  | ------------------------------------------------------------------------------------

|(2) |  | We have entered into certain license agreements that require us to make minimum royalty payments for the life of the licensed patents. The life of the patents which may be issued
and covered by the license agreements cannot be determined at this time, but the minimum royalties due under such agreements are as noted for 2004 through 2011 and are approximately $15,000 per year until the first commercial sale, increase to
$25,000 per year in the first three years of sales, and then increase to $40,000 per year until the expiration of the related patents.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Recent Accounting Pronouncements



In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics
of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest
entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. We
will adopt FIN 46 effective January 1, 2004. The adoption of FIN 46 is not expected to have a material impact on our financial position, results of operation or cash flows.



In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (SFAS 150), Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.
It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in certain circumstances). Many of these instruments were previously classified as equity. Although some of the provisions of this
statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, the remainder is consistent with FASBs intention to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own shares. This statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. There was no impact to the consolidated financial statements related to SFAS 150 for the year ended December 31, 2003.



In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, (SAB 104) which
supersedes SAB 101, Revenue Recognition in Financial Statements (SAB 101). SAB 104s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as
a result of the issuance of Emerging Issues Task Force (EITF) 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under
which it will perform multiple revenue-generating activities.



47



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##### Table of Contents

Specifically, EITF 00-21 addresses whether an arrangement contains more than one unit of accounting and the measurement and allocation to the separate units
of accounting in the arrangement. Additionally, SAB 104 rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked Question and Answers issued with SAB 101 that had been codified in SEC Topic 13. The revenue recognition
principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 and EITF 00-21 did not have a material effect on our financial condition 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, 2003, we had $1.0 million invested in money market mutual funds. While a hypothetical decrease in market interest rates by 10 percent from the December 31, 2003 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:



|                                                                                             |  |        
|-------------------------------------------------------------------------------------------- |  | -------
|                                                                                             |  | Page   
|                                                                                             | 
|Report of Independent Auditors                                                               |  | 49 - 50
|                                                                                             | 
|Consolidated Balance Sheets December 31, 2003 and 2002                                      |  | 51     
|                                                                                             | 
|Consolidated Statements of Operations Years Ended December 31, 2003, 2002 and 2001           |  | 52     
|                                                                                             | 
|Consolidated Statements of Stockholders Equity Years ended December 31, 2003, 2002 and 2001 |  | 53     
|                                                                                             | 
|Consolidated Statements of Cash Flows Years Ended December 31, 2003, 2002 and 2001           |  | 54     
|                                                                                             | 
|Notes to Consolidated Financial Statements                                                   |  | 55 - 70



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##### Table of Contents

Report of Burr, Pilger & Mayer LLP, Independent Auditors



The Board of Directors and Stockholders

InSite Vision Incorporated



We have audited the accompanying consolidated balance sheet of InSite Vision Incorporated as of December 31, 2003, and the related consolidated statements
of operations, stockholders equity (deficit) and cash flows for the year then ended. The 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 audit.



We
conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides 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, 2003, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 1 to the financial statements, the Companys
recurring losses from operations raise substantial doubt about its ability to continue as a going concern. Managements plans as to these matters are also described in Note 1. The 2003 financial statements do not include any adjustments that
might result from the outcome of this uncertainty.



/s/    BURR, PILGER & MAYER LLP



Palo Alto, California

March 12, 2004



49



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##### Table of Contents

Report of Ernst & Young LLP, Independent Auditors



The Board of Directors and Stockholders

InSite Vision Incorporated



We have audited the accompanying consolidated balance sheet of InSite Vision Incorporated as of December 31, 2002, and the related consolidated statements
of operations, stockholders equity and cash flows for each of the two years in the period ended December 31, 2002. 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, 2002, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States.



The
accompanying consolidated financial statements have been prepared assuming InSite Vision Incorporated will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses, has an accumulated
deficit as of December 31, 2002 of $108.8 million and does not currently have available sufficient funds to sustain its operations through fiscal year 2003. These conditions raise substantial doubt about the Companys ability to continue as a
going concern. Managements plans in regard to these matters are also described in Note 1. 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.



/s/    ERNST & YOUNG LLP



Palo Alto, California

January 30, 2003



50



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##### Table of Contents

InSite Vision Incorporated



Consolidated Balance Sheets



|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                          |  | December 31,                                      |         
|                                                                                                                                                                          |  | 2003                                              |          |   | 2002 |  
|                                                                                                                                                                          |  | (in thousands, except shareand per share amounts) |         
|Assets                                                                                                                                                                    |  |                                                   |          |   |      |   |          |  
|Current assets:                                                                                                                                                           |  |                                                   |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                                 |  | $                                                 | 1,045    |   |      | $ | 1,179    |  
|Inventory                                                                                                                                                                 |  |                                                   | 19       |   |      |   | 19       |  
|Prepaid expenses and other current assets                                                                                                                                 |  |                                                   | 91       |   |      |   | 124      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total current assets                                                                                                                                                      |  |                                                   | 1,155    |   |      |   | 1,322    |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Property and equipment, at cost:                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Laboratory and other equipment                                                                                                                                            |  |                                                   | 837      |   |      |   | 1,087    |  
|Leasehold improvements                                                                                                                                                    |  |                                                   | 73       |   |      |   | 73       |  
|Furniture and fixtures                                                                                                                                                    |  |                                                   | 3        |   |      |   | 3        |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|                                                                                                                                                                          |  |                                                   | 913      |   |      |   | 1,163    |  
|Accumulated depreciation                                                                                                                                                  |  |                                                   | 664      |   |      |   | 619      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|                                                                                                                                                                          |  |                                                   | 249      |   |      |   | 544      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Deferred debt issuance cost                                                                                                                                               |  |                                                   | 1        |   |      |   |         |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total assets                                                                                                                                                              |  | $                                                 | 1,405    |   |      | $ | 1,866    |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Liabilities and stockholders equity (deficit)                                                                                                                            |  |                                                   |          |  
|Current liabilities:                                                                                                                                                      |  |                                                   |          |   |      |   |          |  
|Short-term notes payable to related parties, unsecured                                                                                                                    |  | $                                                 | 326      |   |      | $ |         |  
|Short-term notes payable to related parties, secured                                                                                                                      |  |                                                   | 682      |   |      |   |         |  
|Accounts payable                                                                                                                                                          |  |                                                   | 972      |   |      |   | 373      |  
|Accrued liabilities                                                                                                                                                       |  |                                                   | 650      |   |      |   | 307      |  
|Accrued compensation and related expense                                                                                                                                  |  |                                                   | 160      |   |      |   | 289      |  
|Deferred gain on sale of assets                                                                                                                                           |  |                                                   | 4,616    |   |      |   |         |  
|Deferred rent                                                                                                                                                             |  |                                                   | 183      |   |      |   |         |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                 |  |                                                   | 7,589    |   |      |   | 969      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Capital lease obligation, less current portion                                                                                                                            |  |                                                   |         |   |      |   | 10       |  
|Convertible note payable (net of beneficial conversion feature of $1)                                                                                                     |  |                                                   | 16       |   |      |   |         |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total liabilities                                                                                                                                                         |  |                                                   | 7,605    |   |      |   | 979      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Commitments (Note 4)                                                                                                                                                      |  |                                                   |          |   |      |   |          |  
|Stockholders equity (deficit)                                                                                                                                             |  |                                                   |          |   |      |   |          |  
|Preferred stock, $0.01 par value, 5,000,000 shares authorized; none issued and outstanding at December 31, 2003; 2,000 issued and outstanding
at December 31, 2002        |  |                                                   |         |   |      |   | 2,048    |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Common stockholders equity:                                                                                                                                              |  |                                                   |          |   |      |   |          |  
|Common stock, $0.01 par value, 60,000,000 shares authorized;29,253,294 issued and outstanding at December 31, 2003;25,131,786 issued and outstanding at
December 31, 2002 |  |                                                   | 293      |   |      |   | 251      |  
|Additional paid-in capital                                                                                                                                                |  |                                                   | 109,437  |   |      |   | 107,569  |  
|Notes receivable from stockholder                                                                                                                                         |  |                                                   | (208     | ) |      |   | (231     | )
|Accumulated deficit                                                                                                                                                       |  |                                                   | (115,722 | ) |      |   | (108,750 | )
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Common stockholders deficit                                                                                                                                              |  |                                                   | (6,200   | ) |      |   | (1,161   | )
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total stockholders (deficit) equity                                                                                                                                      |  |                                                   | (6,200   | ) |      |   | 887      |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  
|Total liabilities and stockholders (deficit) equity                                                                                                                      |  | $                                                 | 1,405    |   |      | $ | 1,866    |  
|                                                                                                                                                                          |  |                                                   |          |   |      |   |          |  



See accompanying
notes to consolidated financial statements.



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InSite Vision Incorporated



Consolidated Statements of Operations



|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------- |  | --------------------------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                |  | Year Ended December 31,                 |       
|                                                                                                |  | 2003                                    |        |   | 2002 |   |         | 2001 | 
|                                                                                                |  | (in thousands, except per shareamounts) |       
|Contract and other revenues                                                                     |  | $                                       | 134    |   |      | $ | 36      |      |  | $ | 5       |  
|Cost of goods                                                                                   |  |                                         | 20     |   |      |   | 114     |      |  |   |        |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Gross profit                                                                                    |  |                                         | 114    |   |      |   | (78     | )    |  |   | 5       |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Operating expenses:                                                                             |  |                                         |        |   |      |   |         |      |  |   |         |  
|Research and development                                                                        |  |                                         | 4,436  |   |      |   | 7,077   |      |  |   | 7,323   |  
|Cost reimbursement                                                                              |  |                                         |       |   |      |   | 166     |      |  |   | 713     |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Research and development, net                                                                   |  |                                         | 4,436  |   |      |   | 6,911   |      |  |   | 6,610   |  
|Selling, general and administrative                                                             |  |                                         | 3,021  |   |      |   | 4,022   |      |  |   | 3,523   |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Total                                                                                           |  |                                         | 7,457  |   |      |   | 10,933  |      |  |   | 10,133  |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Loss from operations                                                                            |  |                                         | (7,343 | ) |      |   | (11,011 | )    |  |   | (10,128 | )
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Gain on sale of assets                                                                          |  |                                         | 1,153  |   |      |   |        |      |  |   |        |  
|Interest (expense) and other income, net                                                        |  |                                         | (561   | ) |      |   | 62      |      |  |   | 572     |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Net loss                                                                                        |  |                                         | (6,751 | ) |      |   | (10,949 | )    |  |   | (9,556  | )
|Non-cash preferred stock dividend                                                               |  |                                         | 221    |   |      |   | 48      |      |  |   |        |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders                                                      |  | $                                       | (6,972 | ) |      | $ | (10,997 | )    |  | $ | (9,556  | )
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Net loss per share applicable to common stockholders, basic and diluted                         |  | $                                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38   | )
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  
|Shares used to calculate basic and diluted net loss per share applicable to common stockholders |  |                                         | 25,767 |   |      |   | 24,997  |      |  |   | 24,897  |  
|                                                                                                |  |                                         |        |   |      |   |         |      |  |   |         |  



See accompanying notes
to consolidated financial statements.



52



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InSite Vision Incorporated



Consolidated Statements of Stockholders Equity (deficit)



|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  
|---------------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | - | ----------- | - | ------------------------ |  | ----------------------------- | ------- |  | ------------------ | ---- | - | --------------------------------- | - | -------- | - |  | - | ------- | -
|                                                                                                     |  | PreferredStock         |        |   | CommonStock |   | AdditionalPaid InCapital |  | NoteReceivableFromStockholder |         |  | AccumulatedDeficit |      |   | TotalStockholdersEquity(deficit) |  
|                                                                                                     |  | (dollars in thousands) |       
|Balances, January 1, 2001                                                                            |  | $                      |       |   |             | $ | 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   |  
|Issuance of 201,436 shares of common stock from exercise of options and employee stock purchase plan |  |                        |       |   |             |   | 2                        |  |                               | 123     |  |                    |     |   |                                   |   |         |   |  |   | 125     |  
|Issuance of 2,000 shares of Series A-1 preferred stock                                               |  |                        | 2,000  |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   |         |   |  |   | 2,000   |  
|Loan payment from stockholder                                                                        |  |                        |       |   |             |   |                         |  |                               |        |  |                    | 26   |   |                                   |   |         |   |  |   | 26      |  
|Non-employee stock option and warrant compensation                                                   |  |                        |       |   |             |   |                         |  |                               | 200     |  |                    |     |   |                                   |   |         |   |  |   | 200     |  
|Net loss and comprehensive loss                                                                      |  |                        |       |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (10,949  | ) |  |   | (10,949 | )
|Non-cash preferred dividend                                                                          |  |                        | 48     |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (48      | ) |  |   |        |  
|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  
|Net loss applicable to common stockholders                                                           |  |                        | 48     |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (10,997  | ) |  |   | (10,949 | )
|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  
|Balances, December 31, 2002                                                                          |  | $                      | 2,048  |   |             | $ | 251                      |  | $                             | 107,569 |  | $                  | (231 | ) |                                   | $ | (108,750 | ) |  | $ | 887     |  
|Issuance of 5,000 shares of common stock from exercise of options                                    |  |                        |       |   |             |   |                         |  |                               | 3       |  |                    |     |   |                                   |   |         |   |  |   | 3       |  
|Issuance of 2,000 shares of Series A-1 preferred stock                                               |  |                        | 2,000  |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   |         |   |  |   | 2,000   |  
|Issuance of 352,857 shares of common stock from private placements                                   |  |                        |       |   |             |   | 4                        |  |                               | 130     |  |                    |     |   |                                   |   |         |   |  |   | 134     |  
|Issuance of convertible notes payable with beneficial conversion feature                             |  |                        |       |   |             |   |                         |  |                               | 547     |  |                    |     |   |                                   |   |         |   |  |   | 547     |  
|Issuance of 3,763,651 share of common stock from conversion of debentures                            |  |                        |       |   |             |   | 38                       |  |                               | 946     |  |                    |     |   |                                   |   |         |   |  |   | 984     |  
|Surrender of Series A-1 preferred stock as part of sale of assets                                    |  |                        | (4,269 | ) |             |   |                         |  |                               |        |  |                    |     |   |                                   |   |         |   |  |   | (4,269  | )
|Loan payment from stockholder                                                                        |  |                        |       |   |             |   |                         |  |                               |        |  |                    | 23   |   |                                   |   |         |   |  |   | 23      |  
|Non-employee stock option and warrant compensation                                                   |  |                        |       |   |             |   |                         |  |                               | 242     |  |                    |     |   |                                   |   |         |   |  |   | 242     |  
|Net loss and comprehensive loss                                                                      |  |                        |       |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (6,751   | ) |  |   | (6,751  | )
|Non-cash preferred dividend                                                                          |  |                        | 221    |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (221     | ) |  |   |        |  
|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  
|Net loss applicable to common stockholders                                                           |  |                        | 221    |   |             |   |                         |  |                               |        |  |                    |     |   |                                   |   | (6,972   | ) |  |   | (6,751  | )
|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  
|Balances, December 31, 2003                                                                          |  | $                      |       |   |             | $ | 293                      |  | $                             | 109,437 |  | $                  | (208 | ) |                                   | $ | (115,722 | ) |  | $ | (6,200  | )
|                                                                                                     |  |                        |        |   |             |   |                          |  |                               |         |  |                    |      |   |                                   |   |          |   |  |   |         |  



See accompanying notes
to consolidated financial statements.



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InSite Vision Incorporated



Consolidated Statements of Cash Flows



|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|-------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                                   |  | Year Ended December 31, |       
|                                                                                                   |  | 2003                    |        |   | 2002 |   |         | 2001 | 
|                                                                                                   |  | (in thousands)          |       
|Operating activities:                                                                              |  |                         |        |   |      |   |         |      |  |   |        |  
|Net loss                                                                                           |  | $                       | (6,751 | ) |      | $ | (10,949 | )    |  | $ | (9,556 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                        |  |                         |        |   |      |   |         |      |  |   |        |  
|Depreciation and amortization                                                                      |  |                         | 275    |   |      |   | 300     |      |  |   | 233    |  
|Stock-based compensation                                                                           |  |                         | 242    |   |      |   | 200     |      |  |   | 200    |  
|Loss on disposal of capital lease asset                                                            |  |                         | 27     |   |      |   |        |      |  |   |       |  
|Gain on sale of asset                                                                              |  |                         | (1,153 | ) |      |   |        |      |  |   |       |  
|Amortization of beneficial conversion feature                                                      |  |                         | 546    |   |      |   |        |      |  |   |       |  
|Debt issuance cost amortization                                                                    |  |                         | 153    |   |      |   |        |      |  |   |       |  
|Accrued interest on convertible notes payable                                                      |  |                         | 2      |   |      |   |        |      |  |   |       |  
|Changes in:                                                                                        |  |                         |        |   |      |   |         |      |  |   |        |  
|Inventories, prepaid expenses and other current assets                                             |  |                         | 33     |   |      |   | 30      |      |  |   | 432    |  
|Accounts payable, accrued liabilities, accrued compensation and related expense, and deferred rent |  |                         | 1,031  |   |      |   | (556    | )    |  |   | 292    |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Net cash used in operating activities                                                              |  |                         | (5,595 | ) |      |   | (10,975 | )    |  |   | (8,399 | )
|Investing activities:                                                                              |  |                         |        |   |      |   |         |      |  |   |        |  
|Purchases of property and equipment                                                                |  |                         | (23    | ) |      |   | (61     | )    |  |   | (474   | )
|Proceeds from sale of asset                                                                        |  |                         | 1,500  |   |      |   |        |      |  |   |       |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Net cash provided by (used in) investing activities                                                |  |                         | 1,477  |   |      |   | (61     | )    |  |   | (474   | )
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Financing activities:                                                                              |  |                         |        |   |      |   |         |      |  |   |        |  
|Payment of capital lease obligation                                                                |  |                         | (18    | ) |      |   | (31     | )    |  |   | (7     | )
|Note payment received from stockholder                                                             |  |                         | 23     |   |      |   | 26      |      |  |   |       |  
|Issuance of short-term notes payable to related parties                                            |  |                         | 997    |   |      |   |        |      |  |   |       |  
|Issuance of convertible notes payable, net of issuance costs                                       |  |                         | 845    |   |      |   |        |      |  |   |       |  
|Issuance of preferred stock                                                                        |  |                         | 2,000  |   |      |   | 2,000   |      |  |   |       |  
|Issuance of common stock, net                                                                      |  |                         | 137    |   |      |   | 125     |      |  |   | 71     |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Net cash provided by financing activities                                                          |  |                         | 3,984  |   |      |   | 2,120   |      |  |   | 64     |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Net decrease in cash and cash equivalents                                                          |  |                         | (134   | ) |      |   | (8,916  | )    |  |   | (8,809 | )
|Cash and cash equivalents, beginning of year                                                       |  |                         | 1,179  |   |      |   | 10,095  |      |  |   | 18,904 |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Cash and cash equivalents, end of year                                                             |  | $                       | 1,045  |   |      | $ | 1,179   |      |  | $ | 10,095 |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Supplemental disclosures:                                                                          |  |                         |        |   |      |   |         |      |  |   |        |  
|Surrender of preferred stock in connection with sale of asset                                      |  | $                       | 4,269  |   |      | $ |        |      |  | $ |       |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Preferred stock dividends                                                                          |  | $                       | 221    |   |      | $ | 48      |      |  | $ |       |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Conversion of debentures to common stock                                                           |  | $                       | 984    |   |      | $ |        |      |  | $ |       |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Beneficial conversion feature on convertible notes payable                                         |  | $                       | 547    |   |      | $ |        |      |  | $ |       |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  
|Capital lease obligation incurred                                                                  |  | $                       |       |   |      | $ |        |      |  | $ | 51     |  
|                                                                                                   |  |                         |        |   |      |   |         |      |  |   |        |  



See accompanying
notes to consolidated financial statements.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements

December 31, 2003



1.    Summary of Significant Accounting Policies



Basis of Presentation.    The accompanying consolidated financial statements include the accounts of InSite Vision, Ophthalmic Solutions, Inc., its wholly-owned subsidiary 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 and assumes the Company will continue as a going concern. Except for 1999, the Company has incurred losses since its inception,
including a net loss of $7.0 million for the year ended December 31, 2003, and the Company expects to incur substantial additional development costs, including costs related to clinical trials and manufacturing expenses. The Company has incurred
negative cash flows from operations since inception, including net cash used in operations of $4.1 million for the year ended December 31, 2003. As of December 31, 2003, the Company had an accumulated deficit of $115.7 million and a cash and cash
equivalents balance of $1.0 million. In these circumstances the Company believes it may not have enough cash to meet its various cash needs for fiscal 2004 unless the Company is able to obtain stockholder approval for the issuance of additional
shares related to the private placement it entered into in March 2004 (see Note 12 Subsequent Events). The Companys plans in this regard, include active pursuit of stockholder approval for the final closing of the private placement it entered
into in March 2004 and active pursuit of other sources of additional funds, including new license and collaboration agreements. There is no assurance that stockholder approval will be obtained or additional funds or license or collaborative
agreements 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
development programs and may cease operations altogether. 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.



The Company has continued a number of measures it took in 2003 to reduce
its short term operating expenses to allow it to continue operations without additional financing through approximately the beginning of June 2004. The measures taken in 2003 included: laying-off approximately 42% of its employees, voluntary salary
reductions by its senior management team, ceasing work on all non-critical external activities, extending payment terms on its trade payables, and other cost containment measures. Of the 16 employees laid-off, 3 were general and administrative
personnel and 13 were across the various research and development departments. The laid-off employees were not provided a financial termination package. These lay-offs resulted in savings of approximately $530,000 in compensation and benefit costs.
The voluntary salary reductions agreed upon between senior management and the Company resulted in approximately $720,000 of savings in compensation and benefit costs. The Company scaled back its marketing and sales activities related to the OcuGene
product, which resulted in approximately $950,000 of savings. Additionally, the Company placed development of its ISV-014 retinal device, its ISV-900 genetic research and ISV-205 glaucoma product candidate on hold, which resulted in expense
reductions of approximately $1,040,000. The Company also minimized its operating expenses by reducing its travel and entertainment, renegotiated or terminated facility and equipment support contracts where possible, limiting expenditures for
equipment and taking other similar expense reduction actions. There is no assurance that these expense reduction efforts will enable the Company to continue operations or that if the Company does survive it has not significantly harmed its business
or prospects.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



Any person considering an investment in the Companys securities is urged to consider both the
risk that the Company will cease operations at or around the middle of June 2004 if stockholder approval is not obtained related to the proposed financing transaction or an alternative source of funds is not obtained. All of the statements set forth
in this report are qualified by reference to those facts.



Accounting
Policies and Use of Estimates



The preparation of
financial statements in conformity with generally accepted accounting principles in the United States of America 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, 2003, our inventories solely consisted of OcuGene kits.



Property and Equipment.    Property and
equipment is stated at cost, less accumulated depreciation and amortization. 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.    Our revenue
arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has standalone value to the customer and whether there is objective and reliable evidence of the
fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units.



We recognize up-front fees over the expected term of the related
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 if it is based on a substantive element in a multi-element agreement or if it reflects substantive progress toward the completion of the activities contemplated in a long-term contract, and the payment reflects the milestone
achieved.



Revenue related to contract
research services is recognized when persuasive evidence of an arrangement exists, the services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured. During the year ended 2003, we recognized payments
received under the December 2003 Bausch & Lomb agreement of $128,000 as contract and other revenue in accordance with EITF 01-14, Income



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



Statement Characterization of Reimbursement for Out of Pocket Expenses Incurred. We incurred approximately $310,000 of costs related to
the research and development activities under the related contract.



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.



Revenue related to the sales of our
product, the OcuGene glaucoma genetic test, is recognized when all related services have been rendered and collectibility is reasonably assured. The revenue in connection with the asset purchase agreement with Bausch & Lomb will
be recognized over the contract period.



Cost of
goods.    We recognize the cost of inventory shipped and other costs related to our OcuGene glaucoma genetic test when they are incurred.



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 our 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. We directly reduced expenses for amounts reimbursed due to cost sharing agreements during the year ended December 31, 2002 and 2001, of $166,000 and $713,000, respectively, as the
agreements provided for the direct reimbursement of costs incurred.



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



Stock-Based Compensation.    We have elected to continue to follow the intrinsic value method of
accounting as prescribed by Accounting Principles Board Opinion No. 25 (or APB 25), Accounting for Stock Issued to Employees, to account for employee and director stock options. Accordingly, we do 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.



Pro forma information regarding net loss and loss per share is required by Statement of Financial Accounting Standards (SFAS) No. 123, Accounting
for Stock Based Compensation, as amended by SFAS No. 148, and has been determined as if we had accounted for our 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 2003, 2002 and 2001, respectively: risk-free interest rates ranging from 0.89% to 5.57%; volatility factors for the expected market price of our
common stock of 1.06, 1.07 and 1.09; and a weighted-average expected life for the options of 4 years.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



The following table illustrates the effect on net loss and net loss per share as if the Company had
applied the fair value recognition provisions of SFAS 123 as amended by SFAS 148 to stock based employee compensation (in thousands, except per share amounts):



|                                                                                                          |  |                         |        |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                          |  | Year Ended December 31, |       
|                                                                                                          |  | 2003                    |        |   | 2002 |   |         | 2001 | 
|Net loss applicable to common stockholders-as reported                                                    |  | $                       | (6,972 | ) |      | $ | (10,997 | )    |  | $ | (9,556  | )
|Deduct: Total stock-based employee compensation expense determined under fair value method for all awards |  |                         | (473   | ) |      |   | (184    | )    |  |   | (644    | )
|                                                                                                          |  |                         |        |   |      |   |         |      |  |   |         |  
|Net loss applicable to common stockholders-pro forma                                                      |  | $                       | (7,445 | ) |      | $ | (11,181 | )    |  | $ | (10,200 | )
|                                                                                                          |  |                         |        |   |      |   |         |      |  |   |         |  
|Loss applicable to common stockholders per share:                                                         |  |                         |        |   |      |   |         |      |  |   |         |  
|Basic and diluted-as reported                                                                             |  | $                       | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38   | )
|                                                                                                          |  |                         |        |   |      |   |         |      |  |   |         |  
|Basic and diluted-pro forma                                                                               |  | $                       | (0.29  | ) |      | $ | (0.45   | )    |  | $ | (0.41   | )
|                                                                                                          |  |                         |        |   |      |   |         |      |  |   |         |  



For purposes of
pro forma disclosures pursuant to SFAS 123 as amended by SFAS 148, the estimated fair value of options is amortized to expense over the options vesting period.



The pro forma impact of options on the net loss for 2003, 2002 and 2001 is not necessarily representative of the effects on
net income (loss) for future years, as future years will include the effects of additional stock grants.



Accounting for Stock Options and Warrants Exchanged for Services.    The Company issues stock options and warrants to
consultants of the Company in exchange for services. The Company has valued these options and warrants using the Black-Scholes option pricing model in accordance with the Emerging Issues Task Force (EITF) Consensus No. 96-18, Accounting for
Equity Investments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods, or Services, at each reporting period and has recorded charges to operations over the vesting periods of the individual stock
options or warrant. Such charges amounted to approximately $242,000, $200,000 and $200,000 in 2003, 2002 and 2001, respectively.



Income (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. Dilutive earnings per share is computed using the sum of the
weighted-average number of common shares outstanding and the potential number of dilutive common shares outstanding during the period. Potential common shares consist of the shares issuable upon exercise of stock options, warrants and convertible
securities. Potentially dilutive securities have been excluded from the computation of diluted net loss per share in 2003, 2002 and 2001 as their inclusion would be antidilutive.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



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



|                                                                                              |  |                                          |        |   |      |   |         |      |  |   |        |  
|--------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ------- | ---- |  | - | ------ | -
|                                                                                              |  | 2003                                     |        |   | 2002 |   |         | 2001 | 
|                                                                                              |  | (in thousands, except per share amounts) |       
|Numerator:                                                                                    |  |                                          |        |   |      |   |         |      |  |   |        |  
|Net loss                                                                                      |  | $                                        | (6,751 | ) |      | $ | (10,949 | )    |  | $ | (9,556 | )
|Non-cash preferred stock dividend                                                             |  |                                          | (221   | ) |      |   | (48     | )    |  |   |       |  
|                                                                                              |  |                                          |        |   |      |   |         |      |  |   |        |  
|Net loss applicable to common stockholders                                                    |  | $                                        | (6,972 | ) |      | $ | (10,997 | )    |  | $ | (9,556 | )
|                                                                                              |  |                                          |        |   |      |   |         |      |  |   |        |  
|Denominator:                                                                                  |  |                                          |        |   |      |   |         |      |  |   |        |  
|Denominator for basic and diluted loss per share - weighted-average common shares outstanding |  |                                          | 25,767 |   |      |   | 24,997  |      |  |   | 24,897 |  
|                                                                                              |  |                                          |        |   |      |   |         |      |  |   |        |  
|Basic and diluted net loss per share                                                          |  | $                                        | (0.27  | ) |      | $ | (0.44   | )    |  | $ | (0.38  | )
|                                                                                              |  |                                          |        |   |      |   |         |      |  |   |        |  



Due to the loss
applicable to common stockholders, loss per share for 2003, 2002 and 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 been impacted by the dilutive effect of the convertible notes payable in 2003, and the Series A-1 Preferred Shares in 2002, but would not have been effected by the minimal number
of outstanding stock options and warrants priced below the market price of the common shares at December 31, 2003. At December 31, 2003, 2002 and 2001, 156,000, 0 and 737,000 options and warrants were excluded from the calculation of diluted
earnings per share because the effect was anti-dilutive.



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.



Income Taxes.    We account for income taxes under an asset and liability approach that requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or our tax returns. In estimating future tax consequences, we generally consider all expected future events other
than enactments and changes in the tax law or rates. A deferred tax valuation allowance is provided for deferred tax assets when it is determined that it is more likely than not that amounts will not be recovered.



Concentration of Risk.    Financial instruments
that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents. Our cash and cash equivalents are primarily deposited in demand accounts with one financial institution.



Recent Accounting Pronouncements.    In January
2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied
for the first interim or annual period beginning after December 15, 2003. We will adopt FIN 46 effective January 1, 2004. The adoption of FIN 46 is not expected to have a material impact on our financial position, results of operation or cash flows.



In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 (SFAS 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in certain circumstances). Many of these instruments were previously
classified as equity. Although some of the provisions of this statement are consistent with the current definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, the remainder is consistent with
FASBs intention to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own shares. This statement is effective for financial instruments entered into or modified after May 31, 2003
and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. There was no impact to the consolidated financial statements related to SFAS 150 for the year ended December 31, 2003.



In December 2003, the SEC issued Staff Accounting Bulletin
(SAB) No. 104, Revenue Recognition, (SAB 104) which supersedes SAB 101, Revenue Recognition in Financial Statements (SAB 101). SAB 104s primary purpose is to rescind accounting
guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of Emerging Issues Task Force (EITF) 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses whether an arrangement contains more than
one unit of accounting and the measurement and allocation to the separate units of accounting in the arrangement. Additionally, SAB 104 rescinds the SECs Revenue Recognition in Financial Statements Frequently Asked Question and Answers issued
with SAB 101 that had been codified in SEC Topic 13. The revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 and EITF 00-21 did not have a material effect on our financial condition
or results of operations.



2.    Sale of Assets and
Licenses



In December 2003, the Company entered into
agreements with Bausch & Lomb Incorporated, or Bausch & Lomb, in which the Company sold the assets related to its ISV-403 product candidate, for the treatment of ocular bacterial infections, and licensed certain DuraSite patents for use in
the ISV-403 product candidate. Bausch & Lomb made a payment to the Company of $1.5 million, surrendered 4,000 shares of Series A-1 Preferred Stock (See Note 7) and the related accumulated dividends, and will pay the Company royalties on future
sales, if any. The Company had no carrying value related to the ISV-403 assets as all costs of development were expensed as incurred. Additionally, the Company agreed to provide certain contracted services to Bausch & Lomb for a period beginning
in November 2003 through April 2004, for which the Company would be paid an additional amount. The license and stock purchase agreements the Company entered into with Bausch & Lomb related to the ISV-403 product candidate in August 2002 were
terminated.



In accordance with Staff Accounting Bulletin
No. 104, Revenue Recognition in Financial Statements, the Company is recognizing the $5.8 million of gain on sale of assets, representing the cash received of $1.5 million and the fair value on the date of the agreement of the Series A-1
Preferred Stock and the related accumulated dividends surrendered of $4.3 million, on a straight-line basis over the period for which contract services will be provided. Correspondingly, as of December 31, 2003 the Company recognized $1.2 million of
gain on sale of assets from the sale of assets and recorded deferred gain on sale of assets of $4.6 million.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



In December 2002, the Company entered into an eight year distribution agreement with Societa
Industria Farmaceutica ItalianaS.p.A. of Italy (SIFI), in which InSite granted SIFI the exclusive right in Italy to perform, market and sell the OcuGene glaucoma genetic test and to manufacture and distribute the
related patient sampling kits. SIFI will pay the Company a royalty on each OcuGene test performed by them or on their behalf, if any.



In November 2002, the Company extended its November 2001 agreement with Quest Diagnostics Incorporated to provide laboratory services in the U.S. for the
Companys recently introduced OcuGene genetic test for the early prognosis and diagnosis of glaucoma. The Company will pay Quest a fee for each test performed and royalties on product sales.



In August 2002, the Company entered into a license agreement and preferred
stock purchase agreement with Bausch & Lomb, in which InSite granted Bausch & Lomb a royalty-bearing license to the Companys product candidate ISV-403 for the treatment of ocular bacterial infections. Bausch & Lomb obtained the
right to market ISV-403 in all geographies except Japan, with such rights being shared in Asia (except Japan) and exclusive elsewhere. The Company is responsible for the clinical development of ISV-403 through New Drug Application, or NDA, approval
from the U.S. Food and Drug Administration, or FDA, with Bausch & Lomb responsible for subsequent commercial manufacturing and marketing. Bausch & Lomb made an initial investment in preferred stock of $2.0 million in August 2002. Bausch
& Lomb made a second investment in preferred stock of $2.0 million in February 2003 when the Company reached the first milestone contemplated in the agreement. Upon the sale of these assets to Bausch & Lomb in December 2003, the license
agreement and preferred stock purchase agreement were terminated and no future milestone payments by Bausch & Lomb are required. (See Note 7.)



In January 2002, the Company entered into an exclusive worldwide license agreement with the University of Connecticut Health Center for the diagnostic,
prognostic and therapeutic uses of a gene and its mutations for normal tension glaucoma. The Company paid a licensing fee and will make a milestone and royalty payments on future product sales, if any.



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.



3.    Short-term Notes Payable



In August, September and November 2003, the Company issued a total of
$188,000 in a series of short-term unsecured notes payable to members of the Board of Directors, senior management and other employees of the Company for cash. These notes bear interest at a rate of two percent (2%) and are due March 31, 2004.



In July and August 2003, the Company issued $500,000 in
short-term Senior Secured Notes payable to an officer who is also a member of the Board of Directors and an affiliate of a member of senior management for cash. In November 2003 the Company increased one of the short-term Senior Secured Notes by
$20,000 after receipt of cash. These notes bear interest at a rate of between five and one-half percent (5.5%) and twelve percent (12%), were due between September 30, 2003 and October 15, 2003 and are secured by a lien on substantially all of the
assets of the Company, including the Companys intellectual property, other than the equipment secured under the Senior Secured Notes issued in May 2003, described below, and certain other equipment secured by the lessor of such equipment.
Prior to September 30, 2003 the due dates of these notes were extended to between November 15, 2003 and December 31, 2003. Subsequently, the due dates were further extended to January 15,



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



2004 and March 31, 2004. In January 2004, the Company repaid $120,000 of these Senior Secured Notes and the related accrued interest. The Company had
$682,000 of short-term secured notes payable to related parties outstanding at December 31, 2003.



In May and June 2003, the Company issued a series of short-term notes payable totaling $288,500 to members of the Board of Directors, senior management
and other stockholders for cash. $100,000 of these notes are Senior Secured Notes, bear a two percent (2%) annual interest rate, were due September 28, 2003 and are secured by a lien on certain pieces of laboratory and other equipment. Prior to
September 28, 2003 the due date on these notes was extended to December 31, 2003. Subsequently, the due dates were further extended to January 15, 2004. In January 2004, these Senior Secured Notes and the related accrued interest were repaid by the
Company. The remainder of these notes are unsecured, bear interest rates between two percent (2%) and twelve percent (12%) and were due August 15, 2003. On August 15, 2003, the due date on these notes was extended to November 15, 2003. Prior to
November 15, 2003 the due date on these notes was extended to December 15, 2003. Subsequently, the due date on these notes was extended to March 31, 2004. The Company had $326,000 of unsecured notes payable to related parties outstanding at December
31, 2003.



4.    Lease Commitments



The Company leases its facilities under non-cancelable operating lease
agreements that expire in 2006. Rent expense was $697,000, $659,000, and $445,000 for 2003, 2002 and 2001, respectively. The 2002 and 2001 rent expense reflects $13,000 and $74,000, respectively, received by the Company related to the January 1999
sublease of a portion of the Companys facility. The sublease ended in February 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 are $39,900 and $39,900, respectively, at December 31, 2003 and $103,600 and $44,500, respectively, at December 31, 2002.



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



|                                                 |  |                |  |                  |          
|------------------------------------------------ |  | -------------- |  | ---------------- | ---------
|Year ending December 31,                         |  | Capital Leases |  | Operating Leases
|2004                                             |  | 9,528          |  |                  | 718,113  
|2005                                             |  |               |  |                  | 743,253  
|2006                                             |  |               |  |                  | 769,245  
|                                                 |  |                |  |                  |          
|Total minimum lease payments                     |  | 9,528          |  | $                | 2,230,611
|                                                 |  |                |  |                  |          
|Amount representing interest                     |  | 524            |  |                  |          
|                                                 |  |                |  |                  |          
|Present value of net minimum lease payments      |  | 9,004          |  |                  |          
|Current portion, included in accrued liabilities |  | 9,004          |  |                  |          
|                                                 |  |                |  |                  |          
|Long-term portion                                |  | 0              |  |                  |          
|                                                 |  |                |  |                  |          



5.    Convertible Notes Payable



On September 22, 2003, the Company, Arrow Acquisition, Inc., a wholly-owned subsidiary of the Company, and Ophthalmic Solutions, Inc., (Ophthalmic Solutions) entered into an Agreement and Plan of Merger (the Merger
Agreement). The merger contemplated by the Merger Agreement (the Merger) was also completed on September 22, 2003. As a result of the Merger, Ophthalmic Solutions became a wholly-owned



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



subsidiary of the Company and all outstanding shares of Ophthalmic Solutions capital stock held by its sole stockholder were converted into 100 shares
of the Companys common stock. Ophthalmic Solutions is a private, development stage company with a business plan to pursue opportunities for over-the-counter products in the area of ophthalmology and had immaterial assets and liabilities as of
September 22, 2003, other than its obligations under and the proceeds from the debentures described below.



Immediately prior to the Merger, Ophthalmic Solutions entered into a Convertible Debenture Purchase Agreement (the Purchase Agreement), dated
as of September 22, 2003, with HEM Mutual Assurance LLC, pursuant to which it sold and issued convertible debentures to HEM in an aggregate principal amount of up to $1,000,000 in a private placement pursuant to Rule 504 of Regulation D under the
Securities Act of 1933, as amended. Two debentures in the aggregate principal amount of $500,000 were issued for gross proceeds of $500,000 in cash (the Initial Debentures) and an additional debenture in the aggregate principal amount of
$500,000 (the Contingent Debenture and collectively with the Initial Debentures, the Debentures) was issued in exchange for a promissory note from HEM in the principal amount of $500,000 (the Note). Each of the
Debentures had a maturity date of September 21, 2008, subject to earlier conversion or redemption pursuant to its terms, and bears interest at the rate of 1% per year, payable in cash or shares of common stock at the option of the holder of the
Debentures. As a result of the Merger, the Company has assumed the rights and obligations of Ophthalmic Solutions in the private placement, including the gross proceeds raised through the sale of the Debentures, the Note issued by HEM to Ophthalmic
Solutions, and Ophthalmic Solutions obligations under the Debentures and the Purchase Agreement.



As a result of the Merger at September 22, 2003, $492,750 and $3,625 in principal amount of the Initial Debentures was convertible into unrestricted
shares of the Companys common stock at a conversion price that is the lower of $0.30 or the average of the three lowest closing per share bid prices for the common stock during the 40 trading days prior to conversion and $0.01 per share,
respectively. On November 12, 2003 the $500,000 Contingent Debenture and an additional $3,625 of Initial Debentures became convertible and subject to repayment when the related Note from HEM was paid in full to the Company in cash. The Contingent
Debenture is convertible into unrestricted shares of the Companys common stock at a conversion price that is the lower of $0.375 or the average of the three lowest closing per share bid prices for the common stock during the 40 trading days
prior to conversion and the additional Initial Debentures have a conversion price of $0.01 per share.



The merger has been accounted for as an acquisition of assets. The assets acquired and liabilities assumed include: convertible debentures, cash and the
related promissory note(s). Ophthalmic Solutions had no other assets or liabilities at the time of the merger. This asset acquisition has been, in substance, reflected as a financing transaction in the accompanying financial statements, including
the receipt of cash and the issuance of debentures.



The
Initial Debenture conversion prices of $0.30 and $0.01 per share, respectively were lower than the per share price of the Companys common stock on the issuance date of September 22, 2003. The conversion prices of the Contingent Debenture and
remaining Initial Debentures of $0.375 and $0.01 per share, respectively were lower than the per share price of the Companys common stock on November 12, 2003 when the related Note from HEM was paid in full to the Company in cash. In
accordance with the provisions of EITF 00-27, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios to Certain Convertible Instruments, the Company recorded a beneficial
conversion feature of $547,000 related to the debentures. The Company accretes the $547,000 discount recorded from the beneficial conversion feature from the dates the debentures became convertible, September 22, 2003 and November 12, 2003, to the
stated redemption date of September 21, 2008. The accretion has been reported as interest expense with a corresponding increase to convertible debentures. Further, as amounts are converted into common stock, prior to the redemption date, all of the
remaining unamortized discount associated with those shares will be immediately recognized as interest expense. As of December 31, 2003 approximately $546,000 of the beneficial



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



conversion feature had been expensed as interest. As of December 31, 2003, the $16,000 convertible debentures reported on the face of the balance sheet are
net of related unamortized debt discount of $1,000. In connection with the convertible debt financing, the Company capitalized approximately $154,000 of debt issuance costs, which are included in prepaid expenses and other current assets and other
assets. These costs are being amortized over the life of the convertible debentures. As of December 31, 2003, $1,000 of the debt financing costs remain and $153,000 has been amortized.



On December 19, 2003, $482,329 in debenture principal and the related interest was converted into 1,393,011 shares of the
Companys common stock. On December 11, 2003, $3,625 in debenture principal and the related interest was converted into 363,284 shares of the Companys common stock. On November 26, 2003, $92,750 in debenture principal and the related
interest was converted into 309,717 shares of the Companys common stock. On November 10, 2003, $200,000 in debenture principal and the related interest was converted into 667,561 shares of the Companys common stock. On October 30, 2003,
$200,000 in debenture principal and the related interest was converted into 667,360 shares of the Companys common stock. On October 15, 2003, $3,625 debenture principal and the related interest was converted into 362,718 shares of the
Companys common stock.



The conversion price and number
of shares of common stock issuable upon conversion of the Debentures is subject to adjustment for stock splits and combinations and other dilutive events. To satisfy its conversion obligations under the Debentures, the Company placed 5,000,000
shares of its common stock into escrow for potential issuance to HEM upon conversion of the Debentures. As of December 31, 2003, 1,236,348 shares of common stock remain in escrow. Unless and until the debentures are converted, HEM has no voting or
other ownership rights in any of the shares of our common stock held in escrow and the shares in escrow are not treated by the Company as being issued and outstanding.



The Debentures may never be converted into an aggregate of more than 5,000,000 shares of the Companys common stock
unless the Company elects to increase the number of shares held in escrow in accordance with and subject to any applicable rules or regulations of The American Stock Exchange or such other exchange, market or system on which the Companys
common stock is then listed requiring stockholder approval prior to such additional issuance. In the event that the conversion rate of the Debentures would require the Company to issue more than an aggregate of 5,000,000 shares of the Companys
common stock upon conversion of the Debentures and the Company elects not to increase the number of shares held in escrow (or the Company fails to obtain any required stockholder approval for such proposed increase), the Company will be required to
redeem the unconverted amount of the Debentures for 140% of the principal amount thereof, plus accrued and unpaid interest.



In addition to the foregoing, the Debentures may not be converted if and to the extent that after such conversion the holder would beneficially own more
than 5% of the Companys then outstanding common stock, unless the holder waives this limitation by providing the Company 75 days prior notice of the waiver.



The Company has the right to redeem the Debentures, in whole or in part, at any time on 30 days advanced notice for 140% of
the principal amount of the outstanding Debentures being redeemed, plus accrued and unpaid interest. In addition, if at any time any of the Debentures are outstanding, the Company receives debt or equity financing in an amount equal to or exceeding
Five Million dollars ($5,000,000) in a single transaction or series of related transactions (excluding any portion of such financing consisting of forgiveness of debt or other obligations), the Company is required to redeem the Debentures for 150%
of the amount of the then outstanding Debentures. If trading in our common stock is suspended (other than suspensions of trading on such market or exchange generally or temporary suspensions pending the release of material information) for more than
ten trading days, or if our common stock is delisted from the exchange, market or system on which it is then traded



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



and not relisted on another exchange, market or the Over the Counter Bulletin Board within 10 trading days, HEM may elect to require us to redeem all then
outstanding Debentures and any shares of our common stock held by HEM through prior conversions at a price equal to the sum of the aggregate market value of the common stock then held by HEM through prior conversions plus the value of all
unconverted Debentures then held by HEM, calculated in each case in the manner set forth in the Purchase Agreement. The Company would owe an interest penalty of 8% per year on any payments not made within 7 business days of a redemption request made
pursuant to the preceding sentence.



Pursuant to the Purchase
Agreement, until December 22, 2003, the Company was prohibited from offering or issuing any floorless convertible security or any equity line of credit, although the Company could have entered into any other debt or equity financing during such
period. In addition, HEM had the right to participate in any debt or equity financing offered by us during the 30-day period following December 22, 2003.



Until such time as it no longer holds any Debentures, neither HEM nor its affiliates may engage in any short sales of the Companys common stock if
there is no offsetting long position in the Companys common stock then held by HEM or such affiliates.



6.    Income Taxes



Due to the companys history of net operating losses, there is no provision for income taxes for the years ended December 31, 2003, 2002 and 2001.



Significant components of the Companys deferred tax assets for federal and state income taxes as of December 31, 2003
and 2002 are as follows (in thousands):



|                                     |  |      |         |   |      |   |         |  
|------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                     |  | 2003 |         |   | 2002 |  
|Deferred tax assets:                 |  |      |         |   |      |   |         |  
|Net operating loss carryforwards     |  | $    | 32,054  |   |      | $ | 30,732  |  
|Tax credit carryforwards             |  |      | 5,970   |   |      |   | 5,378   |  
|Capitalized research and development |  |      | 7,549   |   |      |   | 9,166   |  
|Deferred revenue                     |  |      | 1,846   |   |      |   |        |  
|Depreciation                         |  |      | 434     |   |      |   | 440     |  
|Other                                |  |      | 58      |   |      |   | 127     |  
|                                     |  |      |         |   |      |   |         |  
|Total deferred tax assets            |  |      | 47,911  |   |      |   | 45,843  |  
|Valuation allowance                  |  |      | (47,911 | ) |      |   | (45,843 | )
|                                     |  |      |         |   |      |   |         |  
|Net deferred tax assets              |  | $    |        |   |      | $ |        |  
|                                     |  |      |         |   |      |   |         |  



The valuation
allowance increased by $2.1 million, $4.2 million and $4.2 million during the years ended December 31, 2003, 2002 and 2001, respectively.



At December 31, 2003, the Company has net operating loss carryforwards for federal income tax purposes of approximately $85.5 million, which expire in the
years 2004 through 2023 and federal tax credits of approximately $3.3 million, which expire in the years 2004 through 2023. The Company also has net operating loss carryforwards for state income tax purposes of approximately $49.6 million which
expire in the years 2004 through 2015, and state research and development tax credits of approximately and $2.5 million which carryforward indefinitely.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



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.



7.    Preferred Stock



Series A-1 Preferred Stock



In August 2002, the Company entered into a Preferred Stock Purchase
Agreement with Bausch & Lomb contemporaneously with the execution of the Bausch & Lomb License Agreement for the ISV-403 product candidate. The Stock Purchase Agreement provides for Bausch & Lomb to purchase up to 15,000 shares of Series
A-1 Preferred Stock for a purchase price equal to $1,000 per share for an aggregate investment of up to $15.0 million. The initial investment, which was made in August 2002, was for 2,000 shares of Series A-1 Preferred Stock, for a total investment
equal to $2.0 million. In February 2003, the first milestone was reached and Bausch & Lomb invested an additional $2.0 million and received 2,000 more shares of Series A-1 Preferred Stock. In December 2003, the ISV-403 product candidate was sold
to Bausch & Lomb and the Preferred Stock Purchase Agreement was terminated and the 4,000 outstanding shares, and the related accumulated dividends, were surrendered to the Company. The Series A-1 Preferred Stock did not contain voting rights,
except as otherwise provided by the Delaware General Corporation law and each share of Series A-1 Preferred Stock was entitled to a 6% per annum cumulative dividend.



For the year ended December 31, 2003 and 2002, the Company reported non-cash preferred dividends of $221,000 and $48,000,
respectively. The dividends are related to the 6% per annum premium earned on the outstanding Series A-1 Preferred Stock and are taken into consideration to determine the net loss per share applicable to common stockholders.



8.    Common Stockholders Equity (Deficit)



On December 16, 2003, the Company entered into a private placement of
142,857 shares of its common stock to an accredited investor and received $50,000 in net proceeds. On October 20, 2003, the Company entered into a private placement of 210,000 shares of its common stock to two accredited investors and received
$84,000 in net proceeds. During 2003 the Company received $3,000 from the exercise of stock options.



In December 2003, the Company issued warrants to purchase 250,000 shares of common stock for $0.58 per share that expire in December 2006 to Xmark as part
of the settlement of a legal suit which were expensed during the year (See Note 10). In November 2003, the Company issued warrants to purchase 125,000 shares of common stock for $0.40 that expire in November 2008 to a financial advisor as part of
the placement of convertible notes payable. In September 2003, the Company issued warrants to purchase 81,967 shares of common stock for $0.61 until September 2008 to a financial advisor as part of the initial placement of convertible notes payable.
In August 2003, the company issued warrants to a financial advisor to purchase 50,000 shares of common stock for $0.50 per share that expire in August 2006. These warrants were valued using a Black-Scholes option pricing model, assuming no dividend
yield, with the following assumptions: risk-free interest rate of 4.44%, volatility of 1.0616 and an expected life of 5, 3 and 3 years, respectively, resulting in the recording of an expense of $180,000 for the year ended December 31, 2003. As of
December 31, 2003, all of these warrants were outstanding.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



In April 2002, the Company issued warrants to purchase 20,000 shares of common stock for $2.33 per
share that expire in April 2006 to a financial advisor. In February 2002, the Company issued warrants to purchase 38,000 shares of Common Stock for $2.20 per share that expire in February 2005 to a financial advisor. These warrants were valued using
a Black-Scholes option pricing model, assuming no dividend yield, with the following assumptions: risk-free interest rate of 4.76%, volatility of 1.1361 and an expected life of 4 and 3 years, respectively, resulting in the recording of an expense of
$85,000 for the year ended December 31, 2002. As of December 31, 2003, all of these warrants were outstanding.



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, 2003 no shares had been issued under this shelf registration and it was not available due to the market
capitalization of the Company.



Stock Option Plan



At December 31, 2003, a total of 3,974,653 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). Under the terms of the 1994 Stock Plan on automatic
share increase feature pursuant to which the number of shares available for issuance is automatically increased on the first trading day in January each calendar year, beginning with calendar year 2002 and continuing over the term of the Plan by an
amount equal to 0.2% of the total number of shares of common stock outstanding on the last trading day in December in the immediately proceeding calendar year. Activity under the 1994 Stock Plan is as follows:



|                              |  |                           |   |  |                    |   |  |              |  |                                                   
|----------------------------- |  | ------------------------- | - |  | ------------------ | - |  | ------------ |  | --------------------------------------------------
|                              |  | Shares                   
|                              |  | OptionsAvailablefor Grant |   |  | OptionsOutstanding |   |  | Option Price |  | Weighted AverageExercise Price ofShares Under Plan
|Balances at January 1, 2001   |  | 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                                              
|Additional shares reserved    |  | 498,545                   |   |  |                    |   |  |              |  |                                                   
|Granted                       |  | (395,250                  | ) |  | 395,250            |   |  | 0.701.97    |  | 0.93                                              
|Exercised                     |  |                          |   |  | (184,173           | ) |  | 0.731.80    |  | 0.96                                              
|Forfeited                     |  | 20,616                    |   |  | (20,616            | ) |  | 0.604.81    |  | 1.44                                              
|                              |  |                           |   |  |                    |   |  |              |  |                                                   
|Balances at December 31, 2002 |  | 999,864                   |   |  | 2,477,215          |   |  | 0.609.25    |  | 2.26                                              
|Additional shares reserved    |  | 502,574                   |   |  |                    |   |  |              |  |                                                   
|Granted                       |  | (925,500                  | ) |  | 925,500            |   |  | 0.410.85    |  | 0.60                                              
|Exercised                     |  |                          |   |  | (5,000             | ) |  | 0.700.70    |  | 0.70                                              
|Forfeited                     |  | 346,384                   |   |  | (346,384           | ) |  | 0.419.25    |  | 1.48                                              
|                              |  |                           |   |  |                    |   |  |              |  |                                                   
|Balances at December 31, 2003 |  | 923,322                   |   |  | 3,051,331          |   |  | $0.416.38   |  | $1.85                                             
|                              |  |                           |   |  |                    |   |  |              |  |                                                   



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



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



|                         |  |                     |  |                     |  |                    |      |                                 |           |  |   |     
|------------------------ |  | ------------------- |  | ------------------- |  | ------------------ | ---- | ------------------------------- | --------- |  | - | ----
|                         |  | Options Outstanding |  | Options Exercisable
|                         |  |                     |  | Weighted Average    |  | Number Exercisable |      | Weighted Average Exercise Price
|Range of Exercise Prices |  | Number Outstanding  |  | Contractual Life    |  | Exercise Price     |      |                                
|$0.41$0.85              |  | 820,500             |  | 9.54                |  | $                  | 0.60 |                                 | 405,488   |  | $ | 0.71
|$0.93$1.13              |  | 782,382             |  | 6.66                |  |                    | 1.04 |                                 | 581,556   |  |   | 1.08
|$1.20$2.75              |  | 833,700             |  | 4.44                |  |                    | 2.10 |                                 | 743,053   |  |   | 2.17
|$2.81$6.38              |  | 614,749             |  | 4.00                |  |                    | 4.19 |                                 | 610,773   |  |   | 4.18
|                         |  |                     |  |                     |  |                    |      |                                 |           |  |   |     
|                         |  | 3,051,331           |  | 6.30                |  | $                  | 1.85 |                                 | 2,340,870 |  | $ | 2.17
|                         |  |                     |  |                     |  |                    |      |                                 |           |  |   |     



The weighted average
grant date fair value of options granted during 2003, 2002 and 2001 was $0.56, $0.86 and $1.42 per share, respectively.



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



In June 2002,
the Companys stockholders approved a series of amendments to the Companys 1994 Stock Option Plan, or the 1994 Plan, including (i) increasing the maximum number of shares of common stock issuable to any one person under the 1994 Plan over
the term of the 1994 Plan by 400,000 shares so that the limit is increased from 850,000 shares to 1,250,000 shares and (ii) extending the term of the 1994 Plan by an additional 5 years so that the expiration date is extended from July 27, 2003 to
July 27, 2008.



The Company granted stock options to
non-employees which resulted in compensation expense of $62,000, $116,000 and $200,000 in 2003, 2002 and 2001, respectively.



Employee Stock Purchase Plan



On April 1, 1994, employees of the Company began participating in the 1994 Employee Stock Purchase Plan, or the 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 stockholders approved an additional 85,000 shares of common stock be reserved for issuance under the Purchase
Plan. In June 2002, the Companys stockholders approved a series of amendments to the Companys Purchase Plan, including (i) increasing by 100,000 the total number of shares of the Companys common stock authorized for issuance under
the Purchase Plan, (ii) extending the term of the Purchase Plan by an additional 5 years so that the expiration date is extended from December 31, 2003 to December 31, 2008, and (iii) implementing an automatic share increase feature pursuant to
which the number of shares available for issuance under the Purchase Plan is automatically increased on the first trading day in January each calendar year, beginning with calendar year 2003 and continuing over the remaining term of the Purchase
Plan, as extended, by an amount equal to 0.5% of the total number of shares of common stock outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 125,000
shares.



During the years ended December 31, 2003, 2002 and
2001, respectively, none, 37,122, and 45,759 shares of common stock were issued pursuant to this plan. At December 31, 2003, 225,007 additional shares were



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



reserved for issuance under this plan. The effects of this plan on the pro forma disclosures described in Note 1 are not material.



The weighted average grant date fair value of the Purchase Plan shares issued
during 2002 and 2001 was $1.14 and $1.43 per share, respectively.



9.    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. In 2003 and 2002, Dr. Chandrasekaran made principal and interest payments of $38,500 and $83,000, respectively. 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.



10.    Legal Proceedings



On June 23, 2003 Xmark Funds, L.P. et al, or Xmark, filed a complaint in the
United States District Court, Southern District of New York against the Company alleging that the Company breached the terms of the term sheet signed between Xmark Funds and the Company in May 2003. On December 31, 2003 the Company settled the suit
with Xmark. As part of the settlement, the Company paid Xmark $10,000 and issued Xmark fully vested warrants to purchase 250,000 shares of the Companys common stock at an exercise price of $0.58 per share. The warrants expire on December 31,
2006 subject to certain possible extensions. Legal fees related to this litigation were expensed as incurred.



On or about October 8, 2003, Thai Nguyen, a former consultant to the Company filed a complaint in the Superior Court of California, County of San
Francisco, against the Company, our chief executive officer, Kumar Chandrasekaran, the Regents of the University of California or Regents, and two individuals associated with Regents. Mr. Nguyen alleges that the Company breached an
obligation to continue supporting his research; he has also made a variety of other related claims and allegations against the Company and the other defendants. The complaint seeks both monetary and injunctive relief. Mr. Nguyen has filed a motion
to enjoin the Company during the pendency of the litigation from alienating the license rights held by the Company relating to the subject of his research, which was denied. The Company and Dr. Chandrasekaran filed a demurrer challenging certain
aspects of the complaint, which was heard on January 28, 2004. The Court has not yet issued a ruling on the demurrer, and until that ruling issues, the Company does not expect any further response to the complaint to be filed by either the Company
or by Dr. Chandrasekaran. The outcome of this matter cannot be determined at this time and therefore no contingent liabilities have been recorded.



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 other 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.



11.    Related Party



Included in accounts payable on the balance sheet is $116,000 due to related parties for expenses incurred on behalf of the Company.



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InSite Vision Incorporated



Notes to Consolidated Financial Statements(Continued)



12.    Subsequent Event



On March 26, 2004, the Company received approximately $1.8 million from the initial closing of a private placement totaling
$16.5 million. At the initial closing the Company issued 3,880,000 shares of Common Stock and warrants to purchase 1,940,000 shares of Common Stock at an exercise price of $0.75 per share. The final closing is contingent upon the Company receiving
stockholder approval for the financing and for an amendment to the Certificate of Incorporation increasing the authorized shares of Common Stock by 49,500,000, and other standard closing conditions. The Company will seek stockholder approval at its
June 1, 2004 Annual Meeting.



13.    Quarterly Results
(Unaudited)



The following table is a summary of the
quarterly results of operations for the years ended December 31, 2003 and 2002. 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.



|                                                                                                |  |                                          |        |   |               |   |        |              |  |   |                |   |  |            |        |   |  |   |         |  
|----------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | - | ------------- | - | ------ | ------------ |  | - | -------------- | - |  | ---------- | ------ | - |  | - | ------- | -
|                                                                                                |  | 2003                                     |       
|                                                                                                |  | FirstQuarter                             |        |   | SecondQuarter |   |        | ThirdQuarter |  |   | Fourth Quarter |   |  | Total Year |       
|                                                                                                |  | (in thousands, except per share amounts) |       
|Revenues                                                                                        |  | $                                        | 4      |   |               | $ | 1      |              |  | $ | 4              |   |  | $          | 125    |   |  | $ | 134     |  
|Cost of goods                                                                                   |  |                                          | 8      |   |               |   | 4      |              |  |   | 5              |   |  |            | 3      |   |  |   | 20      |  
|Loss from operations                                                                            |  |                                          | (2,276 | ) |               |   | (1,826 | )            |  |   | (1,393         | ) |  |            | (1,848 | ) |  |   | (7,343  | )
|Net loss applicable to common stockholders                                                      |  |                                          | (2,314 | ) |               |   | (1,886 | )            |  |   | (1,462         | ) |  |            | (1,310 | ) |  |   | (6,972  | )
|Basic and diluted net loss per share applicable to common stockholders                          |  | $                                        | (0.09  | ) |               | $ | (0.08  | )            |  | $ | (0.06          | ) |  | $          | (0.05  | ) |  | $ | (0.27   | )
|Shares used to calculate basic and diluted net loss per share applicable to common stockholders |  |                                          | 25,133 |   |               |   | 25,137 |              |  |   | 25,137         |   |  |            | 27,661 |   |  |   | 25,767  |  
|                                                                                                | 
|                                                                                                |  | 2002                                     |       
|                                                                                                |  | FirstQuarter                             |        |   | SecondQuarter |   |        | ThirdQuarter |  |   | Fourth Quarter |   |  | Total Year |       
|Revenues                                                                                        |  | $                                        | 9      |   |               | $ | 8      |              |  | $ | 9              |   |  | $          | 10     |   |  | $ | 36      |  
|Cost of goods                                                                                   |  |                                          | 17     |   |               |   | 14     |              |  |   | 25             |   |  |            | 58     |   |  |   | 114     |  
|Loss from operations                                                                            |  |                                          | (2,985 | ) |               |   | (2,646 | )            |  |   | (3,100         | ) |  |            | (2,280 | ) |  |   | (11,011 | )
|Net loss                                                                                        |  |                                          | (2,957 | ) |               |   | (2,631 | )            |  |   | (3,108         | ) |  |            | (2,301 | ) |  |   | (10,997 | )
|Basic and diluted net loss per share                                                            |  | $                                        | (0.12  | ) |               | $ | (0.11  | )            |  | $ | (0.12          | ) |  | $          | (0.09  | ) |  | $ | (0.44   | )
|Shares used to calculate basic and diluted net loss per share                                   |  |                                          | 24,930 |   |               |   | 24,941 |              |  |   | 25,007         |   |  |            | 25,109 |   |  |   | 24,997  |  



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



On October 21, 2003, Ernst & Young LLP notified us that it would resign as our independent public accountants following the completion of its review
of the Registrants Form 10-Q for the Quarter ended September 30, 2003. Our Audit Committee was informed of, but did not recommend or approve, Ernst & Youngs resignation.



Ernst & Youngs reports on the financial statements for the past two fiscal years contained no adverse opinion or
disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principle, except that Ernst & Youngs report on the financial statements for the year ended December 31, 2002 contained an explanatory
paragraph expressing substantial doubt about our ability to continue as a going concern.



During our two most recent fiscal years ended December 31, 2002 and the subsequent interim periods up to and including their resignation, there were no disagreements between us and Ernst on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Ernst & Youngs satisfaction, would have caused them to make reference to the subject matter of the
disagreement in connection with their reports; and there were no reportable events as described in Item 304(a)(1)(v) of Regulation S-K.



Ernst provided us a letter addressed to the SEC stating whether it agrees with the statements made above by us. A copy of Ernst & Youngs letter
dated October 28, 2003, has been filed with the SEC.



On
February 19, 2004, we engaged Burr, Pilger & Mayer LLP as our new independent accountant. The decision to engage Burr, Pilger & Mayer LLP was recommended and approved by our Audit Committee.



During the two most recent fiscal years ended December 31, 2002 and December
31, 2003 and during the current fiscal year through the engagement of Burr, Pilger & Mayer LLP on February 19, 2004, we had not consulted with Burr, Pilger & Mayer LLP regarding either the application of accounting principles to a specified
transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements; nor on any matter that was either the subject of a disagreement or a reportable event.



Item 9A.    
Controls and Procedures



Under
the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of the end of the period covered by this report (the Evaluation Date). Based upon the
evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we
file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including
our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.



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PART III



Item 10.    
Directors and Executive Officers of the Registrant



Set forth below is information regarding the members of our board of directors, including information furnished by them as to their principal occupation at present and for at least last five years, certain other
directorships held by them, the year in which each became a director of the Company, and their ages as of April 2, 2004:



|                               |  |                                                                                      |  |     |  |              
|------------------------------ |  | ------------------------------------------------------------------------------------ |  | --- |  | -------------
|Director                       |  | Position(s) with the Company                                                         |  | Age |  | DirectorSince
|S. Kumar Chandrasekaran, Ph.D. |  | Chairman of the Board, President, Chief Executive Officer andChief Financial Officer |  | 61  |  | 1989         
|Mitchell H. Friedlaender, M.D. |  | Director                                                                             |  | 58  |  | 1996         
|John L. Mattana                |  | Director                                                                             |  | 74  |  | 1997         
|Jon S. Saxe, Esq.              |  | Director                                                                             |  | 67  |  | 2000         
|Anders P. Wiklund              |  | Director                                                                             |  | 64  |  | 1996         



S. Kumar
Chandrasekaran, Ph.D. has been a Director of the Company since 1989. Dr. Chandrasekaran joined the Company in September 1987 as Vice President, Development. From 1988 to 1989, Dr. Chandrasekaran served as Vice President, Research and
Development. From 1989 to 1993, Dr. Chandrasekaran served as President and Chief Operating Officer. Since August 1993, he has served as Chairman of the Board of Directors, President and Chief Executive Officer, and since January 1999, he has
served 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 at Berkeley.



Mitchell H. Friedlaender, M.D. has been a Director of the Company
since May 1996. He has served as an ophthalmologist at Scripps Clinic and Research Foundation (Scripps) since 1986 and currently serves as Head of Division of Ophthalmology and Director, LaserVision Center, Scripps Clinic. Prior to
joining Scripps, Dr. Friedlaender served as a full-time faculty member at the University of California, San Francisco for 10 years. He is the founder of the Aspen Corneal Society and the Pacific Ophthalmic Forum, co-editor in chief of
International Ophthalmology Clinics, a member of four scientific editorial boards, a member of the Sjogrens Syndrome Foundation Medical Advisory Board, and former president of the Ocular Microbiology and Immunology Group. He also serves as a
consultant for several pharmaceutical companies and performs clinical studies on new ophthalmic drugs. Dr. Friedlaender holds an M.B.A. from the University of Phoenix and an M.D. from the University of Michigan.



John L. Mattana has been a Director of the Company since September
1997. From 1992 to 1997, Mr. Mattana served as an Investment Vice President at New York Life Insurance Company, where he was a Director of Venture Capital Investments. From October 1997 through February 2004 he served as a Vice President at
Ceptor Corporation. Mr. Mattana holds an M.B.A. from New York University.



Jon S. Saxe, Esq. has been a Director of the Company since December 1999. Mr. Saxe was a Director of the Company from 1992 through 1997, when he resigned as a member of the Board of Directors and became
Director Emeritus until December 1999. Mr. Saxe is a Director of Protein Design Labs, Inc., a biotechnology company for which he served as President from January 1995 to May 1999. Mr. Saxe served as President of Saxe Associates, a biotechnology
consulting firm, from May 1993 to December 1994, President, Chief Executive Officer and a Director of Synergen, Inc., from October 1989 to April 1993, and Vice President, Licensing & Corporate Development for Hoffmann-LaRoche from August
1984 through September 1989. Mr. Saxe serves on the board of directors of Questocor Pharmaceuticals, Inc., Incyte Inc., First Horizon Pharmaceutical Corporation, Protein Design Labs, Inc., SciClone Pharmaceuticals, Inc., ID Biomedical Corporation
and Durect, Inc. Mr. Saxe



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also serves on the board of directors of several private companies. Mr. Saxe holds a B.S. in Chemical Engineering from Carnegie-Mellon University, a J.D.
from George Washington University School of Law, and an L.L.M. from New York University School of Law.



Anders P. Wiklund has been a Director of the Company since November 1996. Since January 1997 he has served as Principal at Wiklund International
Inc., an advisory firm to the biotechnology and pharmaceutical industries, and from 1997 through 2001 served as Senior Vice President at Biacore Holding Inc., a life science technology company. He served as Vice President, Corporate Business
Development of Pharmacia & Upjohn from January 1996 to December 1996, as Executive Vice President of Pharmacia U.S. Inc. from 1994 to 1996 and as President and Director of Pharmacia Development Corp. from 1993 to 1994. Mr. Wiklund served as
Chief Executive Officer, President and Director of KABI Pharmacia Inc. from 1990 to 1993. Mr. Wiklund serves on the board of directors of Medivir AB. Mr. Wiklund also serves on the board of directors of three private companies. Mr. Wiklund holds a
Master of Pharmacy from the Pharmaceutical Institute, Stockholm, Sweden.



The information required by this item with respect to the identification of Executive Officers is contained in Item 1 of Part I of the Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2003, filed on March 30, 2004 under the heading Executive Officers and Other Senior Management of the Registrant.



Audit Committee



During the 2003 fiscal year, the Audit Committee was initially composed of four non-employee directors: Mitchell H. Friedlaender, John L. Mattana,
Jon S. Saxe and Anders P. Wiklund. In March 2003, due to Dr. Friedlaenders other commitments outside the Company and his other responsibilities on the board and various committees of the board, it was determined that Dr. Friedlaender would no
longer serve on the audit committee and the committee would be comprised of Messrs. Mattana, Saxe and Wiklund for the remainder of the 2003 fiscal year. There were no disagreements between Dr. Friedlaender, the Audit Committee, or the Board of
Directors.



The Audit Committee appoints the
Companys independent accountants; approves all audit and non-audit services to be provided to the Company by the independent accountants; oversees the independence of the independent accountants; evaluates the independent accountants
performance; receives and considers the independent accountants comments as to accounting and financial controls; monitors the effectiveness of the internal and external audit controls, oversees the Companys financial and accounting
organization and financial reporting, discusses with management and the independent auditors the results of the annual audit and the Companys annual financial statements; and discusses with management and the independent auditors, as
applicable, the results of the independent auditors interim review of the Companys quarterly financial statements, as well as the Companys earnings press releases. The Audit Committee met six times in 2003. The Board of Directors
adopted and approved a revised written charter for the Audit Committee in April 2004, a copy of which is available on the Companys website located at www.InSiteVision.com under Investor Relations.



Among other things, under the revised charter of the Audit Committee, the
Audit Committee is responsible for reviewing and approving all related party transactions, approving and monitoring the Companys code of ethics for senior finance personnel and code of conduct for all employees and directors (including
approving any waivers of such codes for directors, executive officers and senior financial personnel), and establishing procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal
accounting controls, or auditing matters, and the confidential, anonymous submission by Company employees of concerns regarding questionable accounting, auditing or legal matters.



The Board of Directors has determined that each of the members of the Audit Committee is independent as that
term is defined in Section 121(A) of the American Stock Exchanges listing standards and also meets the additional criteria for independence of Audit Committee members set forth in Rule 10A-3(b)(1) under the Securities Exchange Act of 1934, as
amended. In addition, the Board of Directors has determined that each



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member of its Audit committee meets the requirement under the rules of American Stock Exchange that at least one member of the audit committee be
financially sophisticated. Although the Board of Directors does not believe any member of the Audit Committee currently qualifies as an audit committee financial expert as defined by the Securities and Exchange Commission,
the Company believes that the experience and financial acumen of the members of its Audit Committee is sufficient given the Companys current needs and financial position. The Board of Directors will continue to assess the qualifications of the
members of its Audit Committee, including the need to appoint a financial expert, in light of the Companys financial complexity, position and requirements in order to serve the best interests of the Company and its stockholders.



Section 16(a) Beneficial Ownership Reporting Compliance



Section 16(a) of the Securities Exchange Act of 1934, requires the
Companys directors and executive officers, and persons who beneficially own more than 10% of a registered class of the Companys equity securities, to file with the United States Securities and Exchange Commission initial reports of
beneficial ownership and reports of changes in beneficial ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% stockholders are required by the Securities Exchange Act of 1934, as amended, to
furnish the Company with copies of all Section 16(a) reports they file.



Based solely upon review of the copies of such reports furnished to the Company and written representations that no other reports were required, the Company believes that during the fiscal year ended December 31,
2003, its officers, directors and holders of more than 10% of the Common Stock complied with all Section 16(a) filing requirements.



Codes of Conduct and Ethics



The Company has adopted a Code of Business Conduct applicable to all employees and directors as well as a Code of Ethics for its Financial
Executives. Copies of these codes can be found on the Companys website located at www.InSiteVision.com under Investor Relations. The Company will disclose any waivers or material amendments under its Code of Conduct or Code
of Ethics granted to its directors or executive officers in a current report on Form 8-K filed with the Securities and Exchange Commission within 5 days of any such waiver or material amendment.



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Item 11.    
Executive Compensation



Summary of
Cash and Certain Other Compensation



The
following table sets forth the compensation earned by the Companys Chief Executive Officer, and each of the Companys other executive officers whose salary and bonus for fiscal year 2003 was in excess of $100,000, for services rendered in
all capacities to the Company for the 2003, 2002 and 2001 fiscal years (the Named Executive Officers). No executive officer who would have otherwise been included in such table on the basis of salary and bonus earned for the 2003 fiscal
year resigned or terminated employment during that fiscal year.



SUMMARY COMPENSATION TABLE



|                                                                                                                     |  |              |              |                       |             |                             |                                |                             |                                 |                     |  |          
|-------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------------ | --------------------- | ----------- | --------------------------- | ------------------------------ | --------------------------- | ------------------------------- | ------------------- |  | ---------
|                                                                                                                     |  | Year         |              | Annual Compensation   |             | Long-TermCompensationAwards |                                | All OtherCompensation($)(5)
|Name and Principal Position(1)                                                                                       |  |              | Salary($)(2) |                       | Bonus($)(3) |                             | Other AnnualCompensation($)(4) |                             | SecuritiesUnderlyingOptions (#) |                    
|S. Kumar Chandrasekaran, Ph.D. Chairman of the Board, President, Chief Executive Officer and Chief Financial Officer |  | 200320022001 |              | 104,085350,000350,000 |             | 70,000                    |                                | 7302,7721,806               |                                 | 295,00065,00050,000 |  | 127,318
|                                                                                                                     |  |              |              |                       |             |                            
|Lyle M. Bowman, Ph. D. Vice President, Development and Operations                                                    |  | 200320022001 |              | 103,443200,700192,000 |             | 5,000                     |                                | 491944908                   |                                 | 65,00015,00015,000  |  | 35,789 
|                                                                                                                     |  |              |              |                       |             |                            
|David Heniges Vice President and General Manager, Commercial Opportunities                                           |  | 20032002     |              | 69,32988,068          |             |                           |                                | 730753                      |                                 | 40,00075,000        |  | 10,000  

---

|(1) |  | Principal Position determined as of December 31, 2003.
|--- |  | ------------------------------------------------------



|(2) |  | During 2003, in agreement with the Company the executive officers reduced their salaries by the following amounts: Dr. Chandrasekaran $245,915, Dr. Bowman $97,257 and Mr. Heniges
$145,671.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | The amounts shown under the Bonus column include cash bonuses earned for the indicated fiscal years.
|--- |  | ----------------------------------------------------------------------------------------------------



|(4) |  | Represents amounts for excess life insurance coverage.
|--- |  | ------------------------------------------------------



|(5) |  | Amounts for 2002 for Dr. Chandrasekaran and Dr. Bowman represent payout of unused vacation. In 2002 Mr. Heniges received consulting fees for activities he conducted before he was
employed in July 2002.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Option Grants in Last Fiscal Year



The following table sets forth information concerning the stock options granted during the 2003 fiscal year to the
executive officers named in the Summary Compensation Table. Except for the limited right described in footnote (1), no stock appreciation rights were granted to those individuals during such fiscal year.



|                               |                |                                                    |      |                                                        |   |        |                                   |         |                |         |                                                                                            |        |        |   |         |        
|------------------------------ | -------------- | -------------------------------------------------- | ---- | ------------------------------------------------------ | - | ------ | --------------------------------- | ------- | -------------- | ------- | ------------------------------------------------------------------------------------------ | ------ | ------ | - | ------- | -------
|                               |                | Individual Grants                                  |      |                                                        |   |       
|Name                           |                | Number ofSecuritiesUnderlyingOptionsGranted (#)(1) |      | % of TotalOptionsGranted toEmployeesin Fiscal Year (2) |   |        | Exercise orBase Price($/Share)(3) |         | ExpirationDate |         | Potential RealizableValue at AssumedAnnual Rates of StockPrice Appreciation forOption Term
|                               |                |                                                    |      |                                                        |   | 5% (4) |                                   | 10% (4)
|S. Kumar Chandrasekaran, Ph.D. |                | (1a)   75,000                                      |      | 8.1                                                    | % |        | $                                 | 0.85    |                | 2/14/13 |                                                                                            | $      | 40,092 |   | $       | 101,601
|                               | (1b) 100,000   |                                                    | 10.8 | %                                                      |   | $      | 0.63                              |         | 9/23/13        |         | $                                                                                          | 39,620 |        | $ | 100,406
|                               | (1d) 120,000   |                                                    | 13.0 | %                                                      |   | $      | 0.41                              |         | 12/12/13       |         | $                                                                                          | 30,942 |        | $ | 78,412 
|Lyle M. Bowman                 |                | (1a)   25,000                                      |      | 2.7                                                    | % |        | $                                 | 0.85    |                | 2/14/13 |                                                                                            | $      | 13,364 |   | $       | 33,867 
|                               | (1b)   15,000  |                                                    | 1.6  | %                                                      |   | $      | 0.63                              |         | 9/23/13        |         | $                                                                                          | 5,943  |        | $ | 15,061 
|                               | (1b)   25,000  |                                                    | 2.7  | %                                                      |   | $      | 0.41                              |         | 12/12/13       |         | $                                                                                          | 6,446  |        | $ | 16,336 
|David Heniges                  |                | (1a)   25,000                                      |      | 2.7                                                    | % |        | $                                 | 0.85    |                | 2/14/13 |                                                                                            | $      | 13,364 |   | $       | 33,867 
|                               | (1b)     5,000 |                                                    | 0.5  | %                                                      |   | $      | 0.63                              |         | 9/23/13        |         | $                                                                                          | 1,981  |        | $ | 5,020  
|                               | (1c)   10,000  |                                                    | 1.1  | %                                                      |   | $      | 0.41                              |         | 12/12/13       |         | $                                                                                          | 2,578  |        | $ | 6,534  

---

|(1) |  | Each option has a maximum term of 10 years, subject to earlier termination in the event of the optionees cessation of service with the Company. The option granted will become
exercisable:
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



(a)
immediately upon grant; or



(b) on a
daily basis over the next year of service; or



(c) for twenty five percent (25%) of the option shares upon the completion of one (1) year of service measured from the grant date and will become exercisable for the balance of the option shares on a daily basis over the next three years
of service thereafter (the Normal Vesting Schedule); or



(d) the Normal Vesting Schedule; provided, however, the exercise period for such option shall accelerate upon the occurrence of certain milestones while Dr. Chandrasekaran is providing service to the Company as
follows: (A) 20% of the option shares shall become exercisable upon the closing of the Asset Sale with B&L (the B&L Milestone), (B) 40% of the option shares shall become exercisable upon the closing of a partnering transaction
relating to ISV-401 that yields immediate gross proceeds to the Company of at least $3,000,000 at the closing of such transaction (the ISV-401 Milestone), and (C) with respect to any accelerated exercise period pursuant to the B&L
Milestone or the ISV-401 Milestone, the option shares whose exercisability is accelerated pursuant to those milestones shall be the option shares that are at that time last to vest under the Normal Vesting Schedule at the time such milestone is met,
such that the length of the Normal Vesting Schedule will be shortened to the extent either (or both) the B&L Milestone or the ISV-401 Milestone is met.



However, each option will become immediately exercisable for all the option shares upon an acquisition of the Company by merger or asset sale,
unless the option is assumed by the successor entity. The option, to the extent so assumed, will subsequently vest in full should the optionees employment be terminated (whether involuntarily or through a resignation following a material
change in the optionees duties and responsibilities, level of compensation or principal place of employment) within twelve (12) months following the acquisition in which that option does not otherwise vest on an accelerated basis. The option
includes a limited stock appreciation right which will result in the cancellation of that option, to the extent exercisable for vested shares, upon the successful completion of a hostile tender offer for securities possessing more than 50% of the
combined voting power of the Companys outstanding voting securities. In return for the cancelled option, the optionee will receive a cash distribution per cancelled option share equal to the excess of (i) the highest price paid per share of



76



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the Companys Common Stock in such hostile tender offer over (ii) the exercise price payable per share under the cancelled option. The exercise price
may be paid in cash or in shares of Common Stock (valued at fair market value on the exercise date) or through a cashless exercise procedure involving a same-day sale of the purchased shares. For additional information on option acceleration
provisions, please see Employment Contracts, Termination of Employment Arrangements and Change in Control Arrangements below.



|(2) |  | Represents the individuals percentage (%) of the total options granted to all employees in the 2003 Fiscal Year as determined by combining all the options granted in the 2003
Fiscal Year to the particular individual.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | The exercise price may be paid in cash, in shares of the Companys common stock valued at the fair market value on the exercise date or through a cashless exercise procedure
involving the same-day sale of the purchased shares.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) |  | There is no assurance provided to any executive officer or any other holder of the Companys securities that the actual stock price appreciation over the 10-year option term
will be at the five percent (5%) or ten percent (10%) assumed annual rates of compounded stock price appreciation or at any other defined level. Unless the market price of the Common Stock appreciates over the option term, no value will be realized
from the option grants made to the executive officers.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Aggregate Option Exercises and Fiscal Year-End Holdings



The following table sets forth information concerning the exercise of options during the 2003 fiscal year by the Companys Chief Executive Officer and each of the Companys other Named Executive Officers and
the unexercised options held by such individuals at the end of such fiscal year. Except for the limited rights described in footnote (1) to the Summary Option Grant Table above, no stock appreciation rights were exercised by such individuals during
the 2003 fiscal year, and no outstanding stock appreciation rights outstanding at the end of such fiscal year.



AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR

AND FISCAL YEAR-END OPTION VALUES



|                               |  |                                       |  |                           |   |                                                                           |         |                                                                  |         |               |   |       |  |   |       
|------------------------------ |  | ------------------------------------- |  | ------------------------- | - | ------------------------------------------------------------------------- | ------- | ---------------------------------------------------------------- | ------- | ------------- | - | ----- |  | - | ------
|                               |  | Number ofSharesAcquiredOn Exercise(#) |  | AggregateValueRealized(1) |   | Number ofSecurities UnderlyingUnexercised Options atDecember 31, 2003 (#) |         | Value of UnexercisedIn-the-Money Options atDecember 31, 2003 (2)
|Name                           |  |                                       |  | Exercisable               |   | Unexercisable                                                             |         | Exercisable                                                      |         | Unexercisable
|S. Kumar Chandrasekaran, Ph.D. |  | None                                  |  | $                         | 0 |                                                                           | 903,529 |                                                                  | 231,471 |               | $ | 3,840 |  | $ | 15,360
|Lyle M. Bowman                 |  | None                                  |  | $                         | 0 |                                                                           | 144,658 |                                                                  | 50,342  |               | $ | 208   |  | $ | 3,792 
|David Heniges                  |  | None                                  |  | $                         | 0 |                                                                           | 53,216  |                                                                  | 61,784  |               | $ | 83    |  | $ | 1,517 

---

|(1) |  | Based on the market value of the shares on the date of exercise less the exercise price paid for those shares.
|--- |  | --------------------------------------------------------------------------------------------------------------

|(2) |  | Calculated on the basis of the closing sale price per share of the Common Stock on the American Stock Exchange of $0.57 on December 31, 2003 less the exercise price.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



Compensation of Directors



During the 2003 fiscal year, each non-employee Board member was entitled
to receive:



| |  |  | $2,000 for each Board meeting attended in person or by telephone, up to a maximum of $8,000 per year;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | an additional $2,500 for attending in person the annual strategic planning meeting between the Board of Directors and management;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | an additional $500 for each Audit Committee Meeting attended in person or by telephone, up to a maximum of $3,500 per year;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



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| |  |  | an additional $500 for each Compensation Committee Meeting attended in person or by telephone, up to a maximum of $2,000 per year;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | an additional $12,000 per year for serving on each of the Financing Committee, the Mergers and Acquisitions Committee, or the New Ophthalmic Opportunities Committee; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reimbursement of reasonable expenses for attending any Board or committee meetings.
| | - |  | -----------------------------------------------------------------------------------



In light of the financial position of the Company, the Board of Directors unanimously determined to defer the payment of
the cash compensation owed to the directors for their services to the Board during the 2003 fiscal year until the Final Closing of the March 26, 2004 Private Placement.



Under the Automatic Option Grant Program in effect under the 1994 Plan, each individual who first joins the Board as a
non-employee Board member will receive, at the time of his or her initial election or appointment to the Board, an option grant to purchase 10,000 shares of Common Stock at an exercise price per share equal to the fair market value per share of
Common Stock on the grant date. Each such option will have a maximum term of 10 years measured from the grant date, subject to earlier termination following the optionees cessation of Board service, and will become exercisable for all of the
option shares upon the optionees completion of one year of Board service measured from the grant date. However, the option will immediately become exercisable for all the option shares upon certain changes in control of the Company.



Continuing non-employee Board members will each
receive an automatic option grant for an additional 10,000 shares of Common Stock on the date of the first Board meeting held in December each year. In the event there is no December Board meeting in any year, then the annual option grant for that
year will be made on December 15thor if December 15this not a day on which the New York Stock Exchange is open for business such grant will be made on the immediately succeeding trading day. The option will have
an exercise price per share equal to the fair market value per share of Common Stock on the grant date and will have a maximum term of 10 years measured from the grant date, subject to earlier termination following the optionees cessation of
Board service. The option will become exercisable for all the option shares upon the optionees completion of one year of Board service measured from the grant date. However, the option will immediately vest and become exercisable upon certain
changes in control of the Company.



Accordingly, on
December 12, 2003, the date of the Companys first December Board meeting in 2003, each of the following non-employee Board members received an automatic option grant to purchase 10,000 shares of Common Stock at an exercise price of $0.41 per
share, the fair market value per share of Common Stock on such grant date: Messrs. Friedlaender, Mattana, Saxe and Wiklund. In addition, on December 12, 2003, each of these non-employee Board members received an additional option grant in
recognition of their service to the Company on the Board of Directors to purchase 20,000 shares of Common Stock at an exercise price of $0.41 per share, the fair market value per share of Common Stock on such grant date.





Compensation Committee Interlocks and Insider Participation



During the 2003 fiscal year, the Compensation Committee consisted of John L. Mattana and Anders P. Wiklund. No member of the Compensation Committee was at any time during the 2003 fiscal year, or at any other
time, an officer or employee of the Company.



During
the 2003 fiscal year, no executive officer of the Company served as a member of the board of directors or compensation committee of any entity which has one or more executive officers serving as a member of the Companys Board of Directors or
Compensation Committee.



Other Information



There are no family relationships among any of our directors or
executive officers.



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Employment Contracts, Termination of Employment Arrangements and Change of Control Arrangements



On May 30, 1995, the Company amended the 1994 Plan to implement
a special change in control feature designed to protect the economic benefit of the outstanding options in the event the Company were to be acquired. As a result of this special feature, should any optionees service be involuntarily terminated
within twelve (12) months following a Corporate Transaction in which his or her options are assumed by the successor corporation and do not otherwise accelerate at that time, then those options will accelerate and become fully exercisable for all of
the option shares as fully-vested shares of Common Stock upon such involuntary termination. A Corporate Transaction under the 1994 Plan is defined as a merger or consolidation in which securities possessing more than 50% of the total
combined voting power of the Companys outstanding securities are transferred to a person or persons different from those who held those securities immediately prior to such transaction, or the sale, transfer or other disposition of all or
substantially all of the Companys assets in complete liquidation of the Company.



|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- |  | ----------------------------------------------------------------------------------------------



The following table sets forth certain information known to the Company regarding beneficial ownership of the Companys Common Stock, as of April 2,
2004, unless otherwise noted by (i) each person who is known by the Company to beneficially own more than five percent of the Companys Common Stock, (ii) the Chief Executive Officer and each of the other executive officers of the Company named
in the Summary Compensation Table, (iii) each director and nominee for director at our 2004 Annual Meeting, and (iv) all current executive officers and directors as a group. Unless otherwise indicated, the principal address of each of the
stockholders below is: c/o InSite Vision Incorporated, 965 Atlantic Avenue, Alameda, California 94501. Except as otherwise indicated, the Company believes that each of the beneficial owners of the Common Stock listed below has sole voting and
investment power with respect to such shares, subject to community property laws, where applicable. Information for Eli Jacobsen and Pfizer Inc. is based upon the most recent 13G or 13G/A filed by such stockholder with the Securities and Exchange
Commission.



The percentage of beneficial ownership is
calculated based on the 33,138,778 shares of Common Stock that were outstanding on April 2, 2004. This percentage also includes Common Stock of which such individual or entity had the right to acquire beneficial ownership of as of April 2, 2004 or
within 60 days after April 2, 2004, including but not limited to upon the exercise of options; however, such Common Stock shall not be deemed outstanding for the purpose of computing the percentage owned by any other individual or entity.



|                                                                    |  |                    |      |  |                  |  
|------------------------------------------------------------------- |  | ------------------ | ---- |  | ---------------- | -
|                                                                    |  | Beneficially Owned |     
|Name of Beneficial Owner                                            |  | Number of Shares   |      |  | Percent of Class |  
|Pfizer Inc. 235 East 42nd StreetNew York, NY 10017                  |  | 2,665,614          | (1)  |  | 8.04             | %
|Eli Jacobson 125 Broad Street, 32nd FloorNew York, NY 10004         |  | 2,207,966          | (2)  |  | 6.66             | %
|S. Kumar Chandrasekaran, Ph.D.                                      |  | 1,282,398          | (3)  |  | 3.76             | %
|Lyle M. Bowman, Ph.D.                                               |  | 229,408            | (4)  |  | *                |  
|David F. Heniges.                                                   |  | 67,339             | (5)  |  | *                |  
|Mitchell H. Friedlaender, M.D.                                      |  | 104,398            | (6)  |  | *                |  
|John L. Mattana                                                     |  | 129,398            | (7)  |  | *                |  
|Jon S. Saxe                                                         |  | 101,645            | (8)  |  | *                |  
|Anders P. Wiklund                                                   |  | 104,398            | (9)  |  | *                |  
|All current executive officers and directors as a group (7 persons) |  | 2,018,984          | (10) |  | 5.83             | %

---

|* |  | Less than one percent of the outstanding Common Stock.
|- |  | ------------------------------------------------------



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|(1) |  | Pursuant to a Form 3 dated and filed with the Securities and Exchange Commission on June 19, 2003, Pfizer Inc. reported that as of April 16, 2003 it had sole voting power and sole
dispositive power of all 2,665,614 shares. No filing has been made subsequent to that date, so the Company assumes that the holdings of Pfizer Inc. remain the same as stated in the June 19, 2003 Form 3.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Pursuant to a Schedule 13G dated and filed with the Securities and Exchange Commission on February 13, 2004, Eli Jacobson reported that as of February 13, 2004 he had sole voting
power and sole dispositive power of 2,106,557 shares. The amount noted above also includes 67,606 shares, and 33,803 shares issuable upon the exercise of warrants, purchased in the March 26, 2004 private placement.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | Includes 957,373 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------



|(4) |  | Includes 164,520 shares issuable upon the exercise of stock options exercisable on April 2, 2003 or within 60 days thereafter.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------



|(5) |  | Comprised of 67,339 shares issuable upon the exercise of stock options exercisable on April 2, 2003 or within 60 days thereafter.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------



|(6) |  | Includes 84,398 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------



|(7) |  | Includes 79,398 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------



|(8) |  | Includes 79,645 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------



|(9) |  | Includes 84,398 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------



|(10) |  | Includes 1,517,071 shares issuable upon the exercise of stock options exercisable on April 2, 2004 or within 60 days thereafter.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------



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EQUITY COMPENSATION PLAN INFORMATION



The Company currently maintains the following compensation plans under
which the Companys equity securities are authorized for issuance:



| |  |  | InSite Vision Incorporated 1994 Stock Option Plan (the Option Plan)
| | - |  | ---------------------------------------------------------------------



| |  |  | InSite Vision Incorporated 1994 Employee Stock Purchase Plan (the ESPP)
| | - |  | -------------------------------------------------------------------------



Each of these plans has been approved by the Companys stockholders. The following table sets forth the number of
shares of the Companys Common Stock subject to outstanding options, warrants, and rights, the weighted-average exercise price of outstanding options, warrants, and rights, and the number of shares remaining available for future award grants
under these plans as of December 31, 2003.



|                                                       |  |                                                                                                                  |  |                                                                          |  |                                                                                                                                                             
|------------------------------------------------------ |  | ---------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                       |  | A                                                                                                                |  | B                                                                        |  | C                                                                                                                                                           
|Plan Category                                          |  | Number of Shares of theCompanys CommonStock to be Issued UponExercise of OutstandingOptions, Warrants
andRights |  | Weighted-AverageExercise Price ofOutstanding Options,Warrants and Rights |  | Number of Shares of theCompanys CommonStock RemainingAvailable for FutureIssuance Under EquityCompensation Plans(Excluding
SecuritiesReflected in Column A)
|Equity Compensation Plans Approved by Stockholders     |  | 3,051,329                                                                                                        |  | $1.85                                                                    |  | 1,148,329(1)                                                                                                                                                
|Equity Compensation Plans Not Approved by Stockholders |  | 0                                                                                                                |  | 0                                                                        |  | 0                                                                                                                                                           
|Total                                                  |  | 3,051,329                                                                                                        |  | $1.85                                                                    |  | 1,148,329                                                                                                                                                   

---

|(1) |  | Of the total number of shares available, 923,322 were available for additional stock option grants under the Option Plan and 225,007 were available for purchases under our ESPP. In
addition, the number of shares of the Companys Common Stock available for issuance under the Option Plan will automatically increase on the first day of January each year during the term of the Option Plan (which is currently scheduled to
expire in 2008) by an amount equal to two percent (2%) of the total number of shares of the Companys Common Stock issued and outstanding on the last day of December in the immediately preceding year. In addition, the number of shares of the
Companys Common Stock available for issuance under the ESPP will automatically increase on the first trading day in January each year during the term of the ESPP (which is currently scheduled to expire in 2008) by an amount equal to one-half
percent (0.5%) of the total number of shares of the Companys Common Stock issued and outstanding as of the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 125,000
shares.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 13.    
Certain Relationships and Related Transactions



The Companys Restated Certificate of Incorporation (the Certificate) provides for indemnification of directors and officers of the Company to the fullest extent permitted by the Delaware General
Corporation Law. Each of the current directors and executive officers of the Company has entered into separate indemnification agreements with the Company. In addition, the Certificate limits the liability of directors to the Company or its
stockholders to the fullest extent permitted by the Delaware General Corporation Law.



During 2003, S. Kumar Chandrasekaran, Ph.D., the Companys Chief Executive Officer, President, Chief Financial Officer and the chairman of the Companys Board of Directors loaned the Company an aggregate of
$543,000 which loans are evidenced by certain promissory notes and security agreements issued by the Company to Dr. Chandrasekaran, as described in greater detail below. On May 28, 2003, Dr. Chandrasekaran loaned the Company $40,000 pursuant to a
secured promissory note. This loan bears interest at the rate of 2% per annum, was due January 15, 2004 was repaid in full and was secured by a lien on certain equipment of the Company. On



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June 13, 2003, Dr. Chandrasekaran loaned the Company an additional $50,000 pursuant to an unsecured promissory note. This loan bears interest at the rate of
2% per annum. On July 14, 2003 Dr. Chandrasekaran loaned the Company an additional $400,000 pursuant to a secured promissory note. This loan bears interest at the rate of 5.5% per annum, and is secured by a lien on substantially all of the assets of
the Company, including the Companys intellectual property, other than equipment secured pursuant to the May 28, 2003 promissory note and certain other equipment secured by the lessor of such equipment. On August 29, 2003, Dr. Chandrasekaran
loaned the Company an additional $20,000 pursuant to an unsecured promissory note. This loan bears interest at the rate of 2% per annum. On September 3, 2003, Dr. Chandrasekaran loaned the Company an additional $18,000 pursuant to an unsecured
promissory note. This loan bears interest at the rate of 2% per annum. On September 15, 2003, Dr. Chandrasekaran loaned the Company an additional $15,000 pursuant to an unsecured promissory note. This loan bears interest at the rate of 2% per annum.
All of the outstanding loans are due on the earlier to occur of March 31, 2007 and the date that is 10 business days subsequent to the successful completion of a pivotal Phase III clinical trial with ISV 401.



In May 2003, the Company issued $80,000 (including $40,000 to Dr.
Chandrasekaran and $10,000 to Dr. Friedlaender) of Senior Secured Notes to members of the Board of Directors and Named Executive Officers for cash, which bear a two percent (2%) annual interest rate, were due January 15, 2004 and were secured by a
lien on certain pieces of laboratory and other equipment. In January 2004, these notes and the related accrued interest were repaid by the Company.



In addition to the notes issued to Dr. Chandrasekaran referenced above, from June 2003 through November 2003, the Company issued a series of unsecured
short term notes payable with a total principal amount of $113,500 in respect of loans made to the Company by other members of the Board of Directors and Named Executive Officers, including $55,000 to Dr. Friedlaender. As of March 31, 2004, an
aggregate principal amount of $103,500 plus accrued interest remains outstanding under such notes. These notes bear an interest rate of 2% and are due on the earlier to occur of March 31, 2007 and the date that is 10 business days subsequent to
successful completion of a pivotal Phase III clinical trial with ISV 401.



In May 2000, the Company issued loans to Dr. Chandrasekaran 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. In 2003 and
2002, Dr. Chandrasekaran made principal and interest payments of $38,500 and $83,000, respectively. 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.



Each of the transactions set forth above were approved by the Board of Directors and the Company believes that each such transaction was made on terms no
less favorable to the Company than could have been obtained from unaffiliated third parties. Pursuant to recently adopted American Stock Exchange regulations, the Companys corporate governance policies and its revised Audit Committee charter,
all future related-party transactions will be reviewed and approved by the Audit Committee.



Item 14.    Principal Accountant Fees and Services



Fees billed to the Company by Ernst & Young LLP and Burr, Pilger & Mayer LLP during fiscal year 2003 and 2002



Audit Fees



Audit fees billed to the Company by Ernst & Young LLP and Burr, Pilger & Mayer LLP for review of the Companys annual financial statements
and those financial statements included in the Companys quarterly reports on Form 10-Q for the fiscal year ended December 31, 2003 totaled $63,897 and $65,000, respectively. Audit fees billed to the Company by Ernst & Young LLP for review
of the Companys annual financial statements and those financial statements included in the Companys quarterly reports on Form 10-Q for the fiscal year ended December 31, 2002 totaled $149,746.



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Audit-Related Fees



Ernst & Young LLP did not bill the Company any amounts during the 2003 or 2002 fiscal year for audit-related
services.



Tax Fees



Ernst & Young LLP did not bill the Company any amounts during the
2003 or 2002 fiscal year for tax compliance, tax advice and tax planning.



All Other Fees



Ernst & Young LLP did not bill the Company any amounts during the 2003 or 2002 fiscal year for any other products or services rendered to the Company by Ernst & Young LLP.



All of the audit fees, audit-related fees and tax fees, and all other
fees, were approved by the Audit Committee of the Companys Board of Directors. The Audit Committee has delegated to Mr. Jon Saxe the ability to approve audit-related fees and services on behalf of the Audit Committee in accordance with
Rule 10A-3 under the Securities Exchange Act of 1934.



The Audit Committee considered whether the provision of audit-related services, tax services and other non-audit services is compatible with the principal accountants independence.



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PART IV



Item 15.    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/A. See index to
consolidated financial statements at Item 8 of this Annual Report on Form 10-K/A.



(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/A. See index to consolidated financial statements at Item 8 of this Annual Report on Form 10-K/A.



(3)    Exhibits



See Exhibit Index on page 86 of this Annual Report on Form 10-K/A.



(b)    Reports on Form 8-K



On October 28, 2003, we filed a Current Report on Form 8-K reporting under
Item 4 the resignation of our certifying accountant subsequent to the filing of our quarterly report on Form 10-Q for the quarter ended September 30, 2003.



On November 21, 2003, we filed an Amendment No. 1 to Current Report on Form 8-K/A reporting under Item 4 that the resignation of our certifying accountant
was effective as of November 19, 2003.



(c)    Exhibits



See
Exhibit Index on page 86 of this Annual Report on Form 10-K/A.



(d)    Financial Statement Schedules



See (a)(2) above.



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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:    May 6, 2004



INSITE VISION INCORPORATEDBy:

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




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.





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EXHIBIT INDEX



|          |  |                                                                                                                                                                                                                                        
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number    |  | Exhibit Table                                                                                                                                                                                                                          
|          | 
|2.1(17)   |  | Agreement and Plan of Merger, dated as of September 22, 2003, by and among InSite Vision Incorporated, a Delaware corporation, Arrow
Acquisition, Inc., a Delaware corporation, and Ophthalmic Solutions, Inc., a Delaware corporation.
|          | 
|3.1(1)    |  | Restated Certificate of Incorporation.                                                                                                                                                                                                 
|          | 
|3.2(9)    |  | Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock as filed with the Delaware Secretary of State
on September 11, 1997.                                                                       
|          | 
|3.3(9)    |  | 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.                                      
|          | 
|3.4(15)   |  | Certificate of Designations, Preferences and Rights of Series A-1 Preferred Stock as filed with the Delaware Secretary of State on July 3,
2002.                                                                                       
|          | 
|3.5(6)    |  | Amended and Restated Bylaws.                                                                                                                                                                                                           
|          | 
|4.1       |  | Reference is made to Exhibits 3.1, 3.2, 3.3 and 3.4.                                                                                                                                                                                   
|          | 
|4.2(17)   |  | Convertible Debenture Purchase Agreement, dated as of September 22, 2003, by and between Ophthalmic Solutions, Inc. and HEM Mutual
Assurance LLC.                                                                                      
|          | 
|4.3(17)   |  | $492,750 1% Convertible Debenture Due September 21, 2008, originally issued by Ophthalmic Solutions, Inc., a Delaware corporation to HEM
Mutual Assurance LLC on September 22, 3003.                                                   
|          | 
|4.4(17)   |  | $7,250 1% Convertible Debenture Due September 21, 2008, originally issued by Ophthalmic Solutions, Inc., a Delaware corporation to HEM
Mutual Assurance LLC on September 22, 3003.                                                     
|          | 
|4.5(17)   |  | $500,000 1% Convertible Debenture Due September 21, 2008, originally issued by Ophthalmic Solutions, Inc., a Delaware corporation to HEM
Mutual Assurance LLC on September 22, 3003.                                                   
|          | 
|10.1(10)  |  | InSite Vision Incorporated 1994 Employee Stock Purchase Plan (As amended and restated through April 17, 2000).                                                                                                                         
|          | 
|10.2(8HH) |  | InSite Vision Incorporated 1994 Stock Option Plan (Amended and Restated as of June 8, 1998).                                                                                                                                           
|          | 
|10.3(1HH) |  | Form of InSite Vision Incorporated Notice of Grant of Stock Option and Stock Option Agreement, with Addenda.                                                                                                                           
|          | 
|10.4(8HH) |  | Form of InSite Vision Incorporated Notice of Automatic Option Grant and Non-Employee Director Option Agreement.                                                                                                                        
|          | 
|10.5(1)   |  | InSite Vision Incorporated 1994 Employee Stock Purchase Plan.                                                                                                                                                                          
|          | 
|10.6(1)   |  | Form of InSite Vision Incorporated Stock Purchase Agreement.                                                                                                                                                                           
|          | 
|10.7(1)   |  | Form of InSite Vision Incorporated Employee Stock Purchase Plan Enrollment/Change Form.                                                                                                                                                
|          | 
|10.8(2)   |  | Form of Indemnity Agreement Between the Registrant and its directors and officers.                                                                                                                                                     
|          | 
|10.9(2)   |  | Form of Employees Proprietary Information and Inventions Agreement.                                                                                                                                                                   
|          | 
|10.10(3H) |  | License Agreement dated as of October 9, 1991 by and between the Company and CIBA Vision Corporation, as amended October 9,
1991.                                                                                                      
|          | 
|10.11(3H) |  | Letter Agreement dated February 27, 1992 by and among the Company, Columbia Laboratories, Inc. and Joseph R. Robinson, as amended October
23, 1992.                                                                                    
|          | 
|10.12(7)  |  | Facilities Lease, dated September 1, 1996, between the Registrant and Alameda Real Estate Investments.                                                                                                                                 



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##### Table of Contents

|           |  |                                                                                                                                                                                                                                          
|---------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number     |  | Exhibit Table                                                                                                                                                                                                                            
|           | 
|10.13(4)   |  | Common Stock Purchase Agreement dated January 19, 1996 between the Registrant and the Investors listed on Schedule 1
thereto.                                                                                                            
|           | 
|10.14(5H)  |  | ISV-205 License Agreement dated May 28, 1996 by and between the Company and CIBA Vision Ophthalmics.                                                                                                                                     
|           | 
|10.15(5H)  |  | To PreSite License Agreement dated May 28, 1996 by and between the Company and CIBA Vision Ophthalmics.                                                                                                                                  
|           | 
|10.16(5H)  |  | Timolol Development Agreement dated July 18, 1996 by and between the Company and Bausch & Lomb Pharmaceuticals,
Inc.                                                                                                                     
|           | 
|10.17(5H)  |  | Stock Purchase Agreement dated July 18, 1996 by and between the Company and Bausch & Lomb Pharmaceuticals, Inc.                                                                                                                          
|           | 
|10.18(9H)  |  | License Agreement, dated July 1, 1997, by and between the University of Connecticut Health Center and the Company.                                                                                                                       
|           | 
|10.19(9H)  |  | License Agreement, dated August 19, 1997, by and between the University of Rochester and the Company.                                                                                                                                    
|           | 
|10.20(11)  |  | Form of Stock and Warrant Purchase Agreement, dated May 1, 2000 by and among the Company and the purchasers thereto.                                                                                                                     
|           | 
|10.21(12)  |  | Placement Agent Agreement with Ladenburg Thalmann & Co., Inc. dated January 9, 2001.                                                                                                                                                     
|           | 
|10.22(13)  |  | Amendment No. 1 to Marina Village Office Tech Lease, dated July 20, 2001 and effective January 1, 2002.                                                                                                                                  
|           | 
|10.23(14H) |  | License Agreement, dated December 21, 2001 by and between the Company and The University of Connecticut Health Center.                                                                                                                   
|           | 
|10.24(16)  |  | Form of Senior Secured Notes in the aggregate principal amount of $100,000, each dated May 28, 2003, issued by the Company to the holders
listed on the signature pages to the Equipment Lien Agreement included as Exhibit 10.25 hereto.
|           | 
|10.25(16)  |  | Form of Equipment Lien Agreement, dated as of May 28, 2003, between the Company and the holders listed on the signature pages
thereto.                                                                                                   
|           | 
|10.26(16)  |  | Form of Promissory Notes in the aggregate principal amount of $188,500, dated between June 13, 2003 and June 30, 2003, issued by the
Company to certain members of the Companys Board of Directors, senior management, and stockholders.
|           | 
|10.27(16)  |  | Form of Waiver and Amendment to Promissory Notes to Promissory Notes by and between the Company and the holders of the promissory Notes
included as Exhibit 10.26 hereto.                                                                
|           | 
|10.28(16)  |  | Form of Senior Secured Note in the principal amount of $400,000, dated July 15, 2003, issued by the Company to S. Kumar Chandrasekaran,
Ph.D.                                                                                            
|           | 
|10.29(16)  |  | Form of Senior Secured Note in the principal amount of $50,000, dated July 30, 2003, issued by the Company to MHU Ventures,
Inc.                                                                                                         
|           | 
|10.30(16)  |  | Form of Security Agreement, dated as of July 15, 2003, between the Company and the holders listed on the signature pages
thereto.                                                                                                        
|           | 
|10.31(16)  |  | Form of Amendment to July 15, 2003 Security Agreement, dated as of July 30, 2003, by and among the Company and the parties listed on the
signature page thereto.                                                                         
|           | 
|10.32(19H) |  | ISV-403 Asset Purchase Agreement, dated December 19, 2003, between the Company and Bausch & Lomb, Inc.                                                                                                                                   
|           | 
|16.1(18)   |  | Letter of Ernst & Young, LLP regarding change in certifying account, dated October 28, 2003.                                                                                                                                             
|           | 
|23.1       |  | Consent of Burr, Pilger & Mayer LLP, Independent Auditors.                                                                                                                                                                               



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##### Table of Contents

|         |  |                                                                                                                                                                               
|-------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number   |  | Exhibit Table                                                                                                                                                                 
|         | 
|23.2(20) |  | Consent of Ernst & Young LLP, Independent Auditors.                                                                                                                           
|         | 
|31.1     |  | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934,
as amended.                         
|         | 
|31.2     |  | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934,
as amended.                         
|         | 
|32.1     |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.

---

|(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 Annual Report on Form 10-K for the year ended December 31, 1995.
|--- |  | -------------------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference to an exhibit in the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference to an exhibit in the Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------

|(7) |  | Incorporated by reference to an exhibit in the Companys Annual Report on Form 10-K for the year ended December 31, 1996.
|--- |  | -------------------------------------------------------------------------------------------------------------------------

|(8) |  | 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.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(9) |  | 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.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) |  | 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.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(11) |  | 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.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(12) |  | 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.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(13) |  | Incorporated by reference to an exhibit to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2001.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------

|(14) |  | Incorporated by reference to an exhibit to the Companys Annual Report of Form 10-K for the year ended December 31, 2001.
|---- |  | -------------------------------------------------------------------------------------------------------------------------

|(15) |  | Incorporated by reference to an exhibit to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2002.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------

|(16) |  | Incorporated by reference to an exhibit to the Companys Quarterly Report on Form 10-Q/A for the quarter ended June 30, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

|(17) |  | Incorporated by reference to an exhibit to the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on September 23, 2003.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|(18) |  | Incorporated by reference to an exhibit to the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on October 28, 2003.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|(19) |  | Incorporated by reference to an exhibit to the Companys Current Report on Form 8-K filed with the Securities and Exchange Commission on January 14, 2004.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

|(20) |  | Incorporated by reference to an exhibit to the Companys Annual Report on Form 10-K for year ended December 31, 2003.
|---- |  | ---------------------------------------------------------------------------------------------------------------------

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

|(HH) |  | Management contract or compensatory plan.
|---- |  | -----------------------------------------



88