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

                                    FORM 10-K

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

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

                   For the fiscal year ended December 31, 1998
                                       OR
[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934 

           For the transition period from ___________ to ____________

                         Commission file number 0-22332

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

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

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

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

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

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

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

                          Common Stock, $.01 Par Value

        Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

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

        The aggregate market value of Common Stock, $.01 par value, held by
non-affiliates of the registrant as of March 26, 1999: $15,008,759 (based upon
the closing sale price of the Common Stock on March 26, 1999). Number of shares
of Common Stock, $.01 par value, outstanding as of March 26, 1999: 18,781,528.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the Common Stock have been excluded from such calculation as
such persons may be deemed affiliates. This determination of affiliate status is
not necessarily a conclusive determination for other purposes.

                       DOCUMENTS INCORPORATED BY REFERENCE

        Designated portions of the following document are incorporated by
reference into this Report on Form 10-K where indicated: portions of the Proxy
Statement for the registrant's 1999 Annual Meeting of Stockholders which is
estimated to be held on or about June 7, 1999 are incorporated by reference into
Part III.

<PAGE>   2

                           ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                TABLE OF CONTENTS


<TABLE>
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                                                                                          Page
                                                                                          ----
<S>              <C>                                                                      <C>
PART I
        Item 1.  Business.................................................................  1
        Item 2.  Properties............................................................... 20
        Item 3.  Legal Proceedings........................................................ 20
        Item 4.  Submission of Matters to a Vote of Security Holders...................... 20

PART II
        Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters.... 20
        Item 6.  Selected Financial Data.................................................. 22
        Item 7.  Management's Discussion and Analysis of Financial Condition and Results
                 of Operations............................................................ 23
        Item 7a. Qualitative and Quantitative Disclosures About Market Risk............... 26
        Item 8.  Financial Statements and Supplementary Data.............................. 27
        Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial
                 Disclosure............................................................... 40

PART III
        Item 10  Directors and Executive Officers of the Registrant....................... 40
        Item 11. Executive Compensation................................................... 40
        Item 12. Security Ownership of Certain Beneficial Owners and Management........... 40
        Item 13. Certain Relationships and Related Transactions........................... 40

PART IV
        Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......... 40
</TABLE>

<PAGE>   3

                                     PART I

ITEM 1.  BUSINESS

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


                                   THE COMPANY

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

        Glaucoma Genetics. The Company's glaucoma genetics program, which is
being carried out in collaboration with academic researchers, is focused on
discovering genes that are associated with glaucoma, and the mutations on these
genes that cause the disease. This genetic information then may be applied to
develop new glaucoma diagnostic, prognostic and management tools. To date, the
Company's academic collaborators have identified genes associated with primary
open-angle glaucoma (the most prevalent form of the disease in adults), juvenile
glaucoma and primary congenital glaucoma. A prototype diagnostic/prognostic
technology, ISV-900, which is capable of identifying multiple glaucoma genetic
markers from a single sample, has been developed and the Company is discussing
its commercialization with several potential partners. The Company's academic
collaborators for its glaucoma genetics program are at the University of
California, San Francisco ("UCSF"), the University of Connecticut Health Center
("UCHC") and other institutions in North America and Europe.

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

        The first product utilizing the DuraSite technology, AquaSite(R) dry eye
treatment, was launched as an over-the-counter ("OTC") medication in 1992 by
CIBA Vision Ophthalmics ("CIBA Vision"), to which the Company has licensed
certain co-exclusive rights. In connection with its DuraSite development
efforts, the Company has established collaborations with Pharmacia & Upjohn,
Inc. ("P&U") and British Biotechnology Pharmaceuticals, Inc. ("British
Biotech"), among others and has licensed marketing rights to certain
DuraSite-based product candidates to P&U, CIBA Vision and Bausch & Lomb
Incorporated ("B&L").

        In January 1999, the Company entered into a license agreement and stock
purchase agreement with P&U for the exclusive worldwide rights to ISV-205 for
glaucoma. (See "--Collaborative and Licensing Agreements" for additional
information on the agreements.) In an effort to expedite the development of
ISV-205, and meet certain milestones in the agreement, the Company is currently
focusing its DuraSite related research on the development of ISV-205 which is in
Phase II testing.



                                       1
<PAGE>   4

       Due to the continued development of the glaucoma genetics and treatment
programs, during 1998 the Company elected to utilize additional resources in
this area rather than to continue the internal development of its other
DuraSite-based product candidates and its retinal drug delivery system at this
time. Accordingly, the Company has deferred further development of its ISV-120
product candidate. Additionally, the Company has determined it will not continue
to pursue ISV-611, its product candidate for allergic conjunctivitis at this
time.

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


OPHTHALMIC PHARMACEUTICAL MARKET

        In 1998, the market for ophthalmic prescription pharmaceuticals in the
U.S. was approximately $1.4 billion. The principal categories of ophthalmic
drugs are glaucoma treatments ($566 million), anti-biotics ($237 million),
anti-allergic ($203 million), and anti-viral ($186 million) products. However
many eye conditions, including those that involve damage to the retina, are
untreated at present. For example, macular degeneration, which affects 10
million or more people in the U.S., and diabetic retinopathy, a frequent
complication of diabetes, have no effective drug treatments and surgical
interventions for these diseases carry risks of significant side effects.

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

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

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



                                       2
<PAGE>   5

PRODUCTS AND PRODUCT CANDIDATES

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

                         PRODUCTS AND PRODUCT CANDIDATES

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
                                                     ANTICIPATED
        PRODUCT               INDICATIONS              BENEFITS               STATUS(1)
    GLAUCOMA GENETICS
<S>                        <C>                 <C>                       <C>
       ISV - 900               Glaucoma             Detect disease       Pre-commercialization(2)
                              prognostic/           susceptibility               
                              diagnostic

    GLAUCOMA PRODUCT
       CANDIDATES

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

       ISV - 208               Glaucoma        Once daily product with      Phase I/II(3)
                                                   improved comfort

 OTHER TOPICAL PRODUCT
 AND PRODUCT CANDIDATES

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

       ISV - 120               Pterygium           No satisfactory           Phase II(3)
                              recurrence           existing therapy
                              prevention

       ISV - 205           Inflammation and    Reduced dosing frequency      Preclinical
                               analgesia

   RETINAL DEVICE AND
        PRODUCT

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

------------------------------------------------------------------------------------------------
</TABLE>

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

(2) A prototype diagnostic/prognostic technology has been developed and the
    Company is discussing its commercialization with several potential partners.

(3) Current research and development and clinical activities on these products
    are being deferred as resources are focused on ISV-900 and ISV-205.



                                       3
<PAGE>   6

GLAUCOMA GENETICS

        Glaucoma is the leading cause of preventable blindness in the U.S.,
affecting an estimated two to three million people. Glaucoma-related
pharmaceutical sales were approximately $560 million in the U.S. in 1998. The
most prevalent form of glaucoma in adults is primary open-angle glaucoma. Other
forms of the disease include primary congenital glaucoma, a leading cause of
blindness in infants, and juvenile glaucoma that effects children and young
adults.

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

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

        Current glaucoma tests are generally unable to detect the disease before
substantial damage to the optic nerve has occurred. Gene-based tests may make it
possible to identify patients at risk and initiate treatment before permanent
optic nerve damage and vision loss occurs. The Company's ISV-900 program is
intended to discover the appropriate genetic markers for certain forms of
glaucoma and to incorporate those markers into prognostic, diagnostic and
management tools.

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

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

GLAUCOMA CANDIDATES

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

        A Phase II clinical study was started in 1998 to evaluate the efficacy
of two concentrations of diclofenac. Results of this study are currently
anticipated to be released by the third quarter of 1999. The initial indication
being studied is the prevention of IOP elevation following steroid use. Other
potential indications may include glaucoma prevention, analgesia and other
anti-inflammatory indications. Co-exclusive rights, in the U.S., to develop,
manufacture, use and sell ISV-205 to treat inflammation and infection or
analgesia, were licensed to CIBA Vision in May 1996.



                                       4
<PAGE>   7
        In January 1999, the Company entered into an exclusive worldwide
royalty-bearing license agreement with P&U for ISV-205 for glaucoma. The license
provides for research and development payments to be made to the Company by P&U
and for P&U to assume responsibility for the development of the product upon
completion of the Phase II study currently being conducted by the Company. P&U
also made an equity investment in the Company and may make additional future
equity investments if certain project milestones are achieved. See
"--Collaborative and Licensing Agreements" for additional information on the
agreement.

        ISV-208. During 1996, the Company entered into an agreement with B&L to
develop a DuraSite-based formulation of an ophthalmic beta-blocker for the
once-daily treatment of elevated IOP associated with glaucoma and ocular
hypertension. Under the terms of the agreement, B&L obtained worldwide exclusive
rights to manufacture, use and sell the new formulation. During 1998 a Phase
I/II clinical study was completed with positive results. Current activity on
this project is being deferred as resources are focused on ISV-900 and ISV-205.


OTHER TOPICAL PRODUCT AND PRODUCT CANDIDATES

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

        ISV-120 is a DuraSite-based ophthalmic formulation of batimastat that
the Company is evaluating for its potential in preventing the recurrence of
pterygium, a vascular overgrowth that occurs on the front of the eye and may
impair vision. The Company obtains batimastat, the active ingredient of ISV-120,
through a 1992 agreement with British Biotech, which in December 1996 advised
the Company that it had discontinued development and manufacturing of this
product. See "Risk Factors - Dependence on Third Parties." Current activity on
this project is being deferred as resources are focused on ISV-900 and ISV-205.


RETINAL DEVICE AND PRODUCT

        Retinal Delivery System. Another technology platform is comprised of a
device, ISV-014, for the controlled, non-surgical delivery of ophthalmic drugs
to the retina and surrounding tissues. During 1998 the Company conducted reviews
of the device by ophthalmic surgeons which resulted in the development of a
revised device which no longer uses a cannular delivery system licensed from the
University of Rochester ("U. Roch.") in 1997. The combination of this revised
device technology with polymer-based drug platforms may permit long term
delivery of therapeutic agents to treat several retinal diseases, most of which
cannot be effectively treated at the present time.

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

        ISV-014 is a device for the controlled, non-surgical delivery of
ophthalmic drugs to the back of the globe. The device consists of a handle with
a distal platform that is placed against the surface of the eye. A small needle
connected to a drug reservoir is extended from the platform into the tissues of
the eye. Once in place, a metering mechanism controls the amount and rate that
the drug is injected into the tissue. This produces a highly localized depot of
drug inside the ocular tissues. By controlling both the distance and



                                       5
<PAGE>   8

direction that the needle protrudes, the device greatly reduces the chance that
the needle will penetrate through the sclera of the eye into the underlying
tissues, which are easily damaged. The Company has filed for two patents related
to the device and its use. The Company is currently investigating licensing this
technology to a third party.


COLLABORATIVE AND LICENSING AGREEMENTS

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

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

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

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

        British Biotech. In November 1992, InSite entered into a collaboration
agreement with British Biotech (the "ISV-120 Agreement"), pursuant to which
British Biotech has granted InSite the right to conduct, at InSite's own
expense, preclinical and clinical trials on British Biotech's batimastat
compound and the exclusive option to initiate negotiations with British Biotech
to pursue further development of ISV-120. In December 1996 British Biotech
advised the Company that it had discontinued its development and manufacturing
of this product. Subject to certain rights of early termination, the ISV-120
Agreement will continue until the earlier of a specified period following
completion of InSite's last human clinical trial on the compound or June 30,
1998. The Company is currently in negotiations with British Biotech to extend
the ISV-120 Agreement.

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

        University of Connecticut Health Center ("UCHC"). In August 1997 the
Company exercised its option to obtain an exclusive worldwide license from UCHC
for diagnostic uses of the newly discovered



                                       6
<PAGE>   9

gene for primary congenital glaucoma. The Company also has an option for a
worldwide exclusive license to commercialize technologies related to certain
research UCHC is conducting in the area of Adult-Onset Primary Open Angle
Glaucoma. Under the agreements, the Company will pay a licensing fee and will
make royalty payments on future product sales, if any.

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

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

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


PATENTS AND PROPRIETARY RIGHTS

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

        The patent positions of pharmaceutical companies, including InSite, are
uncertain and involve complex legal and factual questions. In addition, the
coverage claimed in a patent application can be significantly reduced before a
patent is issued. Consequently, the Company does not know whether any of its
pending patent applications will result in the issuance of patents or if any of
its patents will provide



                                       7
<PAGE>   10

significant proprietary protection. Since patent applications are maintained in
secrecy until patents issue in the U.S., or such patents are published by
foreign regulatory authorities, the Company cannot be certain that it or any
licensor was the first to file patent applications for such inventions.
Moreover, the Company might have to participate in interference proceedings
declared by the U.S. Patent and Trademark Office to determine priority of
invention, which could result in substantial cost to the Company, even if the
eventual outcome were favorable. There can be no assurance that the Company's
patents will be held valid or enforceable by a court or that a competitor's
technology or product would be found to infringe such patents.

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

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


ACCESS TO PROPRIETARY COMPOUNDS

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


RESEARCH AND DEVELOPMENT

        The Company's research and development staff at December 31, 1998
numbered 22 people, of whom 8 have Ph.D's. Research and development expenses
sponsored by the Company during 1998 were $6.2 million, which is net of $361,000
funded by (i) B&L, as part of the 1996 ISV-208 joint development agreement, and
(ii) P&U as part of a letter of intent to license ISV-205. During 1997 and 1996,
research and development expenses were $7.2 million and $5.5 million, which is
net of $534,000 and $366,000, respectively, funded by B&L. See "Business -
Collaborative and Licensing Agreements" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."


MANUFACTURING

        The Company has no experience or facilities for the manufacture of
products for commercial processes. Moreover, the Company currently has no
intention of developing such experience or implementing such facilities. The
Company has a pilot facility, licensed by the State of California, to produce
potential products for Phase I and certain Phase II clinical trials. However, as
stated above, the Company has no large-scale manufacturing capacity and relies
on third parties, such as B&L, for supplies and materials necessary for all of
its Phase III clinical trials. For example, the Company and B&L have entered
into an agreement to establish facilities capable of manufacturing and supplying
certain Phase III clinical supplies and commercial products at the B&L site in
Tampa, Florida. If the Company should encounter delays or difficulties in
establishing and maintaining its relationship with B&L or other qualified



                                       8
<PAGE>   11

manufacturers to produce, package and distribute its finished products, then
clinical trials, regulatory filings, market introduction and subsequent sales of
such products would be adversely affected. See "Risk Factors - No Commercial
Manufacturing Experience."


MARKETING AND SALES

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

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

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

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

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

COMPETITION

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

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



                                       9
<PAGE>   12

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


GOVERNMENT REGULATION

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

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

        The steps required before a pharmaceutical agent may be marketed in the
U.S. include (i) preclinical laboratory and animal tests, (ii) the submission to
the FDA of an Investigational New Drug application ("IND"), (iii) adequate and
well-controlled human clinical trials to establish the safety and efficacy of
the drug, (iv) the submission of an NDA or Product License Application ("PLA")
to the FDA and (v) the FDA approval of the NDA or PLA prior to any commercial
sale or shipment of the drug. In addition to obtaining FDA approval for each
product, each domestic drug manufacturing establishment must be registered with,
and approved by, the FDA. Drug product manufacturing establishments located in
California also must be licensed by the State of California in compliance with
separate regulatory requirements.

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

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

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



                                       10
<PAGE>   13

clinical plans and the results of the trials and may discontinue the trials at
any time if there are significant safety issues.

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

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

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


SCIENTIFIC AND BUSINESS ADVISORS

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

        The Company's advisors are as follows:

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



                                       11
<PAGE>   14

EMPLOYEES

        As of December 31, 1998, the Company employed 32 persons, including 28
full time employees. None of the Company's employees are covered by a collective
bargaining agreement. The Company considers its employee relations to be good.
The Company also utilizes independent consultants to advise the Company in
certain areas of its scientific and business operations.


                                  RISK FACTORS


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

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

-       will be found to be unsafe or ineffective;

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

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

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

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

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


WE REQUIRE SIGNIFICANT FUNDING FOR OUR CAPITAL REQUIREMENTS

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

-       the progress of our research and development programs;

-       the progress of preclinical and clinical testing;

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

-       the time and cost involved in obtaining regulatory approvals;

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

-       competing technological and market developments;

-       changes in our existing collaborative and licensing relationships; and

-       the purchase of additional capital equipment.

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



                                       12
<PAGE>   15

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

        We believe our cash and cash equivalents are sufficient to finance our
working capital and capital expenditure requirements through December 31, 1999.

WE EXPECT TO CONTINUE TO SUFFER LOSSES

        We have incurred significant operating losses since our inception in
1986. As of December 31, 1998, our accumulated deficit was approximately $85.9
million. We have not achieved profitability and we expect to continue to incur
net losses for the foreseeable future.

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

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

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

-   provide for Phase III clinical testing;

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

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

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

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

        To date, we have entered into agreements with CIBA Vision for
co-exclusive rights with us in North America to manufacture and market AquaSite,
ToPreSite and ISV-205 for certain non-glaucoma-related indications. Of these,
only AquaSite, an OTC product for which regulatory approval is not required, has
been marketed. CIBA Vision assumed all subsequent product development, clinical
and regulatory responsibility for ToPreSite, but has no obligation to fund the
further development of ISV-205.

        In January 1999, we entered into a license agreement with Pharmacia &
Upjohn AB, or P&U, pursuant to which:

-   P&U will develop, manufacture, process and use ISV-205; and

-   P&U will finish, market, distribute, detail and sell the products
    developed from the active ingredient in ISV-205.

    In July 1996, we entered into agreements with B&L pursuant to which:

-   B&L has agreed to manufacture our product candidates at B&L's facility
    in Tampa, Florida using equipment owned by us; we agreed with B&L to
    share the cost of certain leasehold improvements in connection with the
    installation and operation of the equipment;

-   B&L received, for a license fee of $500,000, an exclusive worldwide
    royalty-bearing license to manufacture and market PilaSite(R);

-   We agreed with B&L to collaborate to develop and sell a new DuraSite
    based eyedrop formulation.



                                       13
<PAGE>   16
        We have determined we will not proceed with PilaSite at this time.

        We are dependent upon British Biotechnology Pharmaceuticals, Inc., or
British Biotech, for the supply of batimastat, the active drugs incorporated
into the Company's ISV-120 product candidate. British Biotech has discontinued
clinical testing of batimastat and informed us that it will no longer
manufacture the product. We may have no source of ongoing raw materials for
ISV-120. If this turns out to be true, our business may be harmed.

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

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

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

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

        A number of pharmaceutical and biotechnology companies and research and
academic institutions have developed technologies, filed patent applications or
received patents on various technologies that may be related to our business.
Some of these technologies, applications or patents may conflict with our
technologies or patent applications. Such conflicts could limit the scope of the
patents, if any, we may be able to obtain or result in the denial of our patent
applications. In addition, if patents that cover our activities have been or are
issued to other companies, there can be no assurance that we will be able to
obtain licenses to these patents, at all, or at a reasonable cost, or be able to
develop or obtain alternative technology. If we do not obtain such licenses, we
could encounter delays or be precluded from introducing products to the market.

        Litigation may be necessary to defend against or assert claims of
infringement, to enforce patents issued to us or to protect trade secrets or
know-how owned or licensed by us. Such litigation could result in substantial
cost to and diversion of effort by the Company, all of which may harm our
business. We have also agreed to indemnify our licensees, including P&U, against
infringement claims by third parties related to our technology, which could
result in additional litigation costs and liability, which could harm our



                                       14
<PAGE>   17

business. In addition, we cannot be certain our efforts to protect or defend our
proprietary rights will be successful or, even if successful, will not result in
substantial cost to us.

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

ACQUISITIONS MAY PRESENT RISKS TO OUR BUSINESS

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

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

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

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

-   potentially losing key employees from the acquired companies.

WE HAVE NO EXPERIENCE IN COMMERCIAL MANUFACTURING

        We have no experience in the manufacture of products for commercial
purposes. We have a pilot facility licensed by the State of California to
manufacture certain of our products for Phase I and Phase II clinical trials. In
July 1996, we entered into an alliance under which B&L agreed to manufacture our
products. Should we encounter delays or difficulties in establishing and
maintaining our relationship with B&L or other 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 harmed.

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

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

-   will be subject to the regulatory requirements described above,

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

-   will require substantial additional capital.

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

OUR PRODUCTS ARE SUBJECT TO GOVERNMENT REGULATIONS AND APPROVAL



                                       15
<PAGE>   18

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

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

WE COMPETE IN HIGHLY COMPETITIVE MARKETS

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

WE RELY ON THIRD PARTIES TO MARKET AND SELL OUR PRODUCTS

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



                                       16
<PAGE>   19

WE ARE DEPENDENT UPON KEY EMPLOYEES

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

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

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

WE FACE RISKS FROM THE UNCERTAINTIES OF PRICING AND OTHER REGULATION

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

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

WE USE HAZARDOUS MATERIALS WHICH MAY POSE ENVIRONMENTAL RISKS

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



                                       17
<PAGE>   20

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

        As of December 31, 1998, our management and principal stockholders
together beneficially owned approximately 18% of our outstanding shares of
common stock. As a result, these stockholders, acting together, may be able to
effectively control all matters requiring approval by our stockholders,
including the election of a majority of our directors and the approval of
business combinations.

THE PRICE OF OUR COMMON STOCK MAY BE VOLATILE

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

WE HAVE ADOPTED CERTAIN ANTI-TAKEOVER PROVISIONS

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

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

        Sales of a substantial number of shares of common stock issuable upon
conversion of our Series A Convertible Redeemable Preferred Stock could
adversely affect the market value of the common stock, depending upon the timing
of such sales, and may effect a substantial dilution of the book value per share
of our common stock.

        As of December 31, 1998, 1,170 shares of Series A Convertible Redeemable
Preferred Stock were issued and outstanding. The actual number of shares of
common stock issuable upon conversion of the outstanding Series A Convertible
Redeemable Preferred Stock will equal:

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

               (ii) a conversion price equal to the lower of $2.127 or the
        product of the average of the lowest closing bid prices for our common
        stock for any 5 trading days during the 22 consecutive trading day
        period immediately preceding the date of conversion, subject to
        adjustment in accordance with the terms of the Certificate of
        Designations, Preferences



                                       18
<PAGE>   21

        and Rights for the Series A Convertible Redeemable Preferred Stock,
        multiplied by a conversion percentage equal to 82.5%.

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

        In addition, in the event our common stock is delisted from the American
Stock Exchange, or the AMEX, any or all of the holders of Series A Convertible
Redeemable Preferred Stock may cause us to redeem such shares. If we fail to so
redeem those shares, the holders are entitled to additional remedies as set
forth in the Certificate of Designations, Preferences and Rights. In view of our
current financial condition, we cannot be certain our shares will not be
delisted from the AMEX.



        EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT OF THE REGISTRANT

        As of March 26, 1999, the executive officers and other senior 
management of the Company were as follows:

<TABLE>
<CAPTION>
            NAME                     AGE                        TITLE
            ----                     ---                        -----
<S>                                  <C>    <C>
S. Kumar Chandrasekaran, Ph.D.        55    Chairman of the Board, President, Chief
                                            Executive Officer and Chief Financial Officer

Lyle M. Bowman, Ph.D.                 50    Vice President, Development and Operations

Cheryl E. Chen                        39    Senior Director, Clinical Operations

T. Raymond Chen, Ph.D.                48    Senior Director, Regulatory, Quality
                                            Assurance and Quality Control

Sandra C. Heine                       37    Controller

Samir D. Roy, Ph.D.                   40    Senior Director, Formulation Development
</TABLE>


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

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

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

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

        Sandra C. Heine joined the Company in March 1997, as Controller. Before 
joining the Company, Ms. Heine served as General Accounting Manager of Software 
Logistics Corporation from 1995 to 1997; Systems Engineer for Platinum Software 
Corporation from 1994 to 1995; General Audit Manager for Genentech, Inc. from 
1991 to 1994 and was an Audit Manager at Deloitte & Touche from 1989 to 1991. 
Ms. Heine holds a B.S. in Business Administration from Colorado State 
University.

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

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

ITEM 2.  PROPERTIES



                                       19
<PAGE>   22

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


ITEM 3.  LEGAL PROCEEDINGS.

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

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


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

        No matters were submitted to a vote of the Company's stockholders during
the quarter ended December 31, 1998.



PART II

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

        (a) Market Information

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

<TABLE>
<CAPTION>
        1998                                   HIGH              LOW
        ----                                   ----              ---
<S>                                            <C>              <C>  
        First Quarter                          $3.56            $2.44
        Second Quarter                         $4.00            $3.13
        Third Quarter                          $4.44            $1.63
        Fourth Quarter                         $2.44            $0.94
</TABLE>

<TABLE>
<CAPTION>
        1997                                   HIGH              LOW
        ----                                   ----              ---
<S>                                            <C>              <C>  
        First Quarter                          $6.75            $3.63
        Second Quarter                         $6.23            $3.44
        Third Quarter                          $5.50            $4.06
        Fourth Quarter                         $5.06            $2.00
</TABLE>

        (b) Holders

        As of December 31, 1998, the Company had approximately 7,000
stockholders. On March 26, 1999, the last sale price reported on The American
Stock Exchange for the Company's common stock was $1.00 per share.

        (c) Dividends



                                       20
<PAGE>   23

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

        (d) Recent Sales of Unregistered Securities

        As part of a January 28, 1999 transaction to license the exclusive
worldwide rights to ISV-205 for glaucoma to P&U, the Company sold a total of
1,095,506 shares of Common Stock to P&U for $2,000,000. The Common Stock in this
transaction was issued to a single, sophisticated foreign investor and in
reliance on the private placement exemption under Section 4(2) of the
Securities Act of 1933, as amended. The transaction also provides for future
equity purchases by P&U at an average of prevailing market prices, if the
Company achieves certain milestones.





                                       21
<PAGE>   24

ITEM 6.  SELECTED FINANCIAL DATA

The following table sets forth selected consolidated financial data for the
Company for the five years ended December 31, 1998:

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                            1998          1997          1996          1995          1994
                                          --------      --------      --------      --------      --------
<S>                                       <C>           <C>           <C>           <C>           <C>     
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA

Revenues                                  $     16      $     50      $    544      $     65      $    112

Operating expenses:
     Research and development                6,227         7,224         5,458         8,079         9,944
     General and administrative              2,656         3,034         2,902         3,801         4,961
     Loss on vacated facility                   --            --         1,412            --            --
     Restructuring                              --            --            --         1,031            --
                                          ----------------------------------------------------------------
         Total expenses                      8,883        10,258         9,772        12,911        14,905

Net interest and other income                  299           390           466           224           845
                                          ----------------------------------------------------------------

Net loss                                    (8,568)       (9,818)       (8,762)      (12,622)      (13,948)

Non cash preferred dividend                    514         1,326            --            --            --
                                          ----------------------------------------------------------------

Net loss applicable to common
stockholders                              $ (9,082)     $(11,144)     $ (8,762)     $(12,622)     $(13,948)
                                          ================================================================

Net loss per share applicable to
common stockholders basic and
diluted                                   $  (0.60)     $  (0.85)     $  (0.72)     $  (1.38)     $  (1.55)


Shares used to calculate net loss
per share basic and diluted                 15,079        13,053        12,131         9,160         8,998

<CAPTION>
                                                                   DECEMBER 31,
                                           1998          1997          1996          1995          1994
                                         --------      --------      --------      --------      --------
<S>                                      <C>           <C>           <C>           <C>           <C>     
CONSOLIDATED BALANCE SHEET DATA

Cash and cash equivalents and
short-term investments                   $  1,037      $  8,660      $ 10,518      $  3,867      $ 17,546

Working capital                               544         7,983         9,512         2,376        16,269

Total assets                                2,086        10,546        12,820         7,643        21,266

Long term notes payable                        --            --            --            92         1,256

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

Accumulated deficit                       (85,882)      (76,800)      (65,656)      (56,894)      (44,272)

Total stockholders' equity (deficit)     $   (108)     $  2,031      $ 11,619      $  5,847      $ 17,953
</TABLE>

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



                                       22
<PAGE>   25

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

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

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


OVERVIEW

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

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

          The Company has international and national collaborations with
academic institutions for the identification and clinical evaluation of genetic
markers for glaucoma. To date, the Company's academic collaborators at UCSF and
UCHC have identified genes associated with primary open-angle glaucoma (the most
prevalent form of the disease in adults), juvenile glaucoma and primary
congenital glaucoma. A prototype diagnostic/prognostic technology, ISV-900,
which is capable of identifying multiple glaucoma genetic markers from a single
sample, has been developed and the Company is discussing its commercialization
with several potential partners.

          Another result of the glaucoma genetics research has been the
development of the ISV-205 product candidate. This DuraSite formulation contains
a drug that has been shown in cell and organ culture systems to inhibit the
production of a protein that appears to cause glaucoma. In 1998, the Company
began a Phase II trial of ISV-205 and anticipates releasing results by the third
quarter of 1999. In January 1999, the Company entered into a transaction that
granted P&U an exclusive worldwide license for ISV-205 for the treatment of
glaucoma. See "Collaborative and Licensing Agreements" for additional discussion
of the transaction.

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



                                       23
<PAGE>   26

adverse side effects.

          The Company is focusing its research and development on ISV-900 for
prognosis, diagnosis and management of glaucoma and ISV-205 for the treatment of
inflammation and the prevention and treatment of glaucoma.

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

          In May 1996, InSite entered into an agreement with CIBA Vision whereby
CIBA Vision received royalty-bearing, co-exclusive U.S. marketing rights to
InSite's ToPreSite product candidate for ocular inflammation/infection. CIBA
Vision assumed all subsequent product development, clinical and regulatory
responsibility for ToPreSite. In addition, CIBA Vision received royalty-bearing,
co-exclusive U.S. marketing rights to InSite Vision's ISV-205 product candidate
for certain non-glaucoma-related indications.

          In July 1996, the Company entered into agreements with B&L pursuant to
which: (i) B&L agreed to manufacture InSite product candidates at B&L's facility
in Tampa, Florida using equipment owned by InSite; B&L and InSite agreed to
share the cost of certain leasehold improvements in connection with the
installation and operation of the equipment; (ii) B&L received, for a license
fee of $500,000, an exclusive worldwide royalty-bearing license to manufacture
and market PilaSite; (iii) B&L and InSite agreed to collaborate to develop and
sell a new DuraSite based eyedrop formulation; and (iv) B&L made a $2 million
equity investment in the Company.

          As a result of these agreements, the Company elected to vacate its
co-tenancy of a manufacturing clean room at another manufacturer's plant and in
June 1996 wrote-off the amounts it had previously capitalized related to that
facility. This one-time write-off resulted in a non-cash charge to the Company's
results of operations of $1.4 million which is reported as a loss on vacated
facility in the accompanying financial statements.

          On January 28, 1999, the Company entered into a license agreement and
stock purchase agreement pursuant to which InSite granted P&U an exclusive
worldwide license to ISV-205 for the treatment of glaucoma. The license calls
for (i) P&U to assume responsibility for the development of the product upon
completion by InSite of, among other activities, Phase II studies currently
being conducted by the Company, (ii) P&U to reimburse InSite for certain
research and development expenses and make payments to InSite for on-going
technical support, and (iii) the payment by P&U to InSite of royalties on
product sales should ISV-205 be successfully commercialized. InSite will
continue to bear responsibility for the prosecution and maintenance of the
patents subject to the license, among other things. The transaction also called
for an equity investment from P&U of $2,000,000 for which they received
1,095,506 shares of common stock, with the potential for future equity
investments based on achievement of certain milestones.

          As of December 31, 1998, the Company's accumulated deficit was
approximately $85.9 million. There can be no assurance that InSite Vision will
ever achieve either significant revenues from product sales or profitable
operations.


RESULTS OF OPERATIONS



                                       24
<PAGE>   27

          The Company had total revenues of $16,000, $50,000 and $544,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. The decrease
from 1996 to 1997 was attributable to the license fee received from B&L in 1996.
The Company earned royalty income of $16,000 $50,000 and $44,000 for the years
ended December 31, 1998, 1997 and 1996, respectively, from sales of AquaSite by
CIBA Vision. To date, the Company has not relied on royalty revenues to fund its
activities, nor has it received revenues from the sale of products.

          Research and development expenses decreased 14% in 1998 to $6.2
million from $7.2 million in 1997 and increased 31% in 1997 from $5.5 million in
1996. The decrease in 1998 was primarily due to lower expenditures for outside
services, consultants and compensation related costs due to a reduction in R&D
headcount. The reduction in outside service costs mainly reflects the completion
of development activities for ISV-208 and transfer of the project to B&L, the
Company's joint development partner on this project. The increase in 1997 was
primarily due to expenditures related to the development of ISV-208 and ISV-900
and the acquisition of the retinal drug delivery device from the University of
Rochester. The Company presently anticipates that research and development
expenses net of third party reimbursements will be lower in 1999 than in 1998.

          General and administrative expenses decreased 10% during 1998 to $2.7
million from $3.0 million in 1997 and increased 4% in 1997 from $2.9 million in
1996. The decrease in 1998 was primarily related to the reduced cost of
directors and officers' insurance, lower consulting expenses and lower costs
related to the hiring of full time personnel in the area of accounting and
finance. The increase in 1997 was primarily due to the cost of hiring employees
in the area of accounting and finance to replace outside contractors.

          Net interest and other income was $299,000, $390,000 and $466,000 in
1998, 1997 and 1996, respectively. These fluctuations are due principally to
changes in average cash balances. Interest earned in the future will be
dependent on the Company's funding cycles and prevailing interest rates.
Interest expense related to notes payable which were paid off during the first
quarter of 1997.

          The Company incurred net losses of $8.6 million, $9.8 million and $8.8
million for the years ended December 31, 1998, 1997 and 1996, respectively.


LIQUIDITY AND CAPITAL RESOURCES

          Through 1995, InSite Vision financed its operations primarily through
private placements of preferred stock totaling approximately $32 million and an
October 1993 initial public offering of Common Stock, which resulted in net
proceeds of approximately $30 million. After 1995, the Company financed its
operations primarily through a January 1996 private placement of Common Stock
and warrants resulting in net proceeds of approximately $4.7 million and an
April 1996 public offering which raised net proceeds of approximately $8.1
million. In accordance with a July 1996 agreement between the Company and B&L,
the Company received a total of $2.0 million from the sale of Common Stock in
August 1996 and 1997. In September 1997, the Company completed a $7.0 million
private placement of 7,000 shares of redeemable convertible Series A Preferred
Stock resulting in net proceeds of approximately $6.5 million. At December 31,
1998, the Company had cash and cash equivalents totaling $1.0 million. It is the
Company's policy to invest these funds in highly liquid securities, such as
interest bearing money market funds, Treasury and federal agency notes and
corporate debt.

          For the years ended December 31, 1998, 1997 and 1996, cash used for
operating activities and additions to capital equipment was $7.8 million, $9.4
million and $7.6 million, respectively. Of those amounts, $25,000, $709,000 and
$91,000 were for additions to laboratory and other property and equipment in
1998, 1997 and 1996, respectively. In 1997, $645,000 of the additional
expenditures related to the Company's portion of improvements at B&L's
facilities in Tampa, Florida. In 1998, the Company recognized an impairment in
the value of its equipment located at B&L's facilities of $87,000. This also
resulted in a decrease in both laboratory and other equipment and accumulated
depreciation of $764,000. The timing of future expenditures will depend on the
timing of additional product development. Starting in



                                       25
<PAGE>   28

1997 the Company wrote-off its fully depreciated assets. This resulted in a
decrease in both property and equipment and accumulated depreciation of $1.3 and
$3.4 million in 1998 and 1997, respectively, with no change in net property and 
equipment.

          The Company's future capital expenditures and requirements will depend
on numerous factors, including the progress of its research and development
programs and preclinical and clinical testing, the time and costs involved in
obtaining regulatory approvals, the cost of filing, prosecuting, defending and
enforcing patent claims and other intellectual property rights, competing
technological and market developments, changes in the Company's existing
collaborative and licensing relationships, the ability of the Company to
establish additional collaborative arrangements, acquisition of new businesses,
products and technologies, the completion of commercialization activities and
arrangements, and the purchase of additional property and equipment.

          The Company anticipates no material capital expenditures to be
incurred for environmental compliance in fiscal year 1999. Based on the
Company's good environmental compliance record to date, and its current
compliance with applicable environmental laws and regulations, environmental
compliance is not expected to have a material adverse effect on the Company's
operations.

          The Company believes that its cash and cash equivalents, in
combination with the cash the Company has received and will receive during 1999
as part of the ISV-205 licensing transaction with P&U, will be sufficient to
meet its operating expenses and cash requirements through 1999. InSite Vision
will require substantial additional funds prior to reaching profitability and
the Company may seek private or public equity investments, future collaborative
agreements, and possibly research funding to meet such needs. Even if the
Company does not have an immediate need for additional cash, it may seek access
to the private or public equity markets if and when it believes conditions are
favorable. There is no assurance that such additional funds will be available
for the Company to finance its operations on acceptable terms, or at all.

YEAR 2000

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

          The Company has implemented a program to assess its exposure from Y2K
related failures in its internal systems. The Company has determined that the
majority of the Company's significant operating and accounting systems are Y2K
compliant. The systems that are not currently Y2K compliant are in the process
of being upgraded or replaced. The anticipated cost of these upgrades will be
expensed as incurred and are anticipated to be less than $25,000. However, there
can be no assurance that costs will not exceed the Company's estimate. While the
Company does not have a comprehensive program for monitoring whether its
suppliers' and vendors' systems are Y2K compliant, it does not believe that
non-compliance by any single source provider would have a material impact on its
operations. The Company does not expect its financial condition or results of
operations to be materially adversely affected by Y2K issues.


ITEM 7A.  QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

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

          The Company invests its excess cash in investment grade,
interest-bearing securities. At December 31, 1998, the Company 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, 1998 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.



                                       26
<PAGE>   29

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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

<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                       <C>  
Report of Independent Auditors                                               28

Consolidated Statements of Operations                                        29
Years Ended December 31, 1998, 1997 and 1996

Consolidated Balance Sheets - December 31, 1998 and 1997                     30

Consolidated Statements of Stockholders' Equity (Deficit)                    31
Years ended December 31, 1998, 1997 and 1996

Consolidated Statements of Cash Flows                                        32
Years Ended December 31, 1998, 1997 and 1996

Notes to Consolidated Financial Statements                                33-39
</TABLE>



                                       27
<PAGE>   30

REPORT OF INDEPENDENT AUDITORS


The Board of Directors and Stockholders
InSite Vision Incorporated

We have audited the accompanying consolidated balance sheets of InSite Vision
Incorporated as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

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


                                             /s/  Ernst & Young LLP

Walnut Creek, California
January 29, 1999



                                       28
<PAGE>   31

                                INSITE VISION INCORPORATED

                          CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                             Year Ended December 31,
(in thousands, except per share amounts)                  1998          1997          1996
--------------------------------------------------------------------------------------------
<S>                                                     <C>           <C>           <C>     
Revenues:
     License fee                                        $     --      $     --      $    500
     Royalties                                                16            50            44
                                                        --------      --------      --------
         Total                                                16            50           544

Operating expenses:
     Research and development                              6,227         7,224         5,458
     General and administrative                            2,656         3,034         2,902
     Loss on vacated facilities                               --            --         1,412
                                                        --------      --------      --------
         Total                                             8,883        10,258         9,772

Loss from operations                                      (8,867)      (10,208)       (9,228)

Interest and other income                                    299           399           509

Interest expense                                              --            (9)          (43)
                                                        --------      --------      --------
Net loss                                                  (8,568)       (9,818)       (8,762)

Non-cash preferred dividend                                  514         1,326            --
                                                        --------      --------      --------
Net loss applicable to common stockholders              $ (9,082)     $(11,144)     $ (8,762)
                                                        ========      ========      ========

Basic and diluted net loss per share applicable to
common stockholders                                     $  (0.60)     $  (0.85)     $  (0.72)


Shares used to calculate basic and diluted net loss
per share                                                 15,079        13,053        12,131
</TABLE>


See accompanying notes to consolidated financial statements.



                                       29
<PAGE>   32

                           INSITE VISION INCORPORATED

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                          December 31,
(in thousands, except share and per share amounts)                     1998          1997
                                                                     --------      --------
<S>                                                                  <C>           <C>     
ASSETS
Current assets:
    Cash and cash equivalents                                        $  1,037      $  8,660
    Prepaid expenses and other current assets                             190           303
                                                                     --------      --------
Total current assets                                                    1,227         8,963

Property and equipment, at cost:
     Laboratory and other equipment                                     1,062         2,731
     Leasehold improvements                                                49           163
     Furniture and fixtures                                                28           390
                                                                     --------      --------
                                                                        1,139         3,284
Accumulated depreciation                                                  280         1,701
                                                                     --------      --------
                                                                          859         1,583
                                                                     --------      --------
Total assets                                                         $  2,086      $ 10,546
                                                                     ========      ========

LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
     Accounts payable                                                $     86      $    109
     Accrued liabilities                                                  341           428
     Accrued compensation and related expense                             256           445
                                                                     --------      --------
Total current liabilities                                                 683           982

Commitments (Note 4)

Redeemable preferred stock, $.01 par value, 5,000,000
   shares authorized; 1,170 issued and outstanding at
   December 31, 1998; 6,700 issued and outstanding at
   December 31, 1997; redemption value $1,986,000                       1,511         7,533

Common stockholders' equity (deficit):
     Common stock, $.01 par value, 30,000,000 shares authorized;
        16,852,015 issued and outstanding at December 31, 1998;
        13,279,153 issued and outstanding at December 31, 1997;           169           133
     Additional paid-in capital                                        85,605        78,698
     Accumulated deficit                                              (85,882)      (76,800)
                                                                     --------      --------
Common stockholders' equity (deficit)                                    (108)        2,031
                                                                     --------      --------

Total liabilities, redeemable preferred stock and
stockholders' equity (deficit)                                       $  2,086      $ 10,546
                                                                     ========      ========
</TABLE>


See accompanying notes to consolidated financial statements.



                                       30
<PAGE>   33

                           INSITE VISION INCORPORATED

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                                                        ADDITIONAL                                   TOTAL
                                                              COMMON      PAID IN                  ACCUMULATED    STOCKHOLDERS'
 (dollars in thousands)                                        STOCK      CAPITAL       OTHER        DEFICIT    EQUITY (DEFICIT)
--------------------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>        <C>            <C>         <C>           <C>     
Balance, January 1, 1996                                     $     93     $ 62,651     $     (3)     $(56,894)     $  5,847

Issuance of 1,469,232 shares of common stock
   and warrants to purchase 367,308 shares of
   common stock in private placement                               15        4,671           --            --         4,686
Issuance of 254,032 shares of common stock
   from exercise of options and employee stock purchases            2          768           --            --           770
Issuance of 1,750,000 shares of common stock
   in public offering                                              17        8,062           --            --         8,079
Issuance of 210,527 shares of common stock
   to Bausch & Lomb in private placement                            2          994           --            --           996
Other                                                              --           --            3            --             3
Net loss                                                           --           --           --        (8,762)       (8,762)
                                                             --------------------------------------------------------------
Balance, December 31, 1996                                        129       77,146           --       (65,656)       11,619

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

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


See accompanying notes to consolidated financial statements.



                                       31
<PAGE>   34

                           INSITE VISION INCORPORATED

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                   Year Ended December 31
(in thousands)                                               1998          1997          1996
-----------------------------------------------------------------------------------------------
<S>                                                        <C>           <C>           <C>      
OPERATING ACTIVITIES:
Net loss                                                   $ (8,568)     $ (9,818)     $ (8,762)
Adjustments to reconcile net loss to net cash used
by operating activities:
      Loss on vacated facilities                                 --            --         1,412
      Depreciation and amortization                             904           851           696
      Changes in:
          Prepaid expenses and other current assets             113          (108)          (44)
          Accounts payable and accrued liabilities             (260)          373          (794)
                                                           --------      --------      --------
Net cash used by operating activities                        (7,811)       (8,702)       (7,492)

INVESTING ACTIVITIES:
Maturity of short-term investments                               --            --         3,000
Purchases of property and equipment                             (25)         (709)          (91)
                                                           --------      --------      --------
Net cash (used in) provided by investing activities             (25)         (709)        2,909

FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease
   obligations                                                   --           (92)         (301)
Issuance of redeemable preferred stock, net                      --         6,516            --
Issuance of common stock, net                                   213         1,129        14,531
                                                           --------      --------      --------
Net cash provided by financing activities                       213         7,553        14,230

Net (decrease) increase in cash and cash equivalents         (7,623)       (1,858)        9,647
Cash and cash equivalents, beginning of period                8,660        10,518           871
                                                           --------      --------      --------

Cash and cash equivalents, end of period                   $  1,037      $  8,660      $ 10,518
                                                           ========      ========      ========

Supplemental disclosures:
     Non-cash preferred dividends                          $    514      $  1,326      $     --
                                                           ========      ========      ========
     Non-cash conversion of redeemable preferred stock
        to common stock                                    $  6,575            --            --
                                                           ========      ========      ========
     Interest paid in cash                                 $     --      $      9      $     43
                                                           ========      ========      ========
</TABLE>


See accompanying notes to consolidated financial statements.



                                       32
<PAGE>   35

                           INSITE VISION INCORPORATED

                   Notes to Consolidated Financial Statements
                                December 31, 1998


1.      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        Basis of Presentation. The accompanying consolidated financial
statements include the accounts of InSite Vision and its wholly-owned United
Kingdom subsidiary, InSite Vision Limited. InSite Vision Incorporated (the
"Company" or "InSite Vision") operated in one segment and is focused on
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 has incurred losses since its inception and expects to incur
substantial additional development costs prior to reaching profitability,
including costs related to clinical trials and manufacturing expenses. As a
result, the Company will require substantial additional funds, and the Company
may seek collaborative agreements, research funding, and private or public
equity or debt investments to meet such needs. If such funds are not available,
management may need to reassess its plans. Even if the Company does not have an
immediate need for additional cash, it may seek access to the private or public
equity markets if and when conditions are favorable. There is no assurance that
such additional funds will be available for the Company to finance its
operations on acceptable terms, if at all.

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

        Cash and Cash Equivalents. The Company invests its excess cash in
investment grade, interest-bearing securities. As of December 31, 1998 and 1997,
cash equivalents consisted of money market and mutual funds. All cash and cash
equivalents are stated at fair market value. The Company considers highly liquid
investments with original maturities of three months or less as cash
equivalents.

        Property and Equipment. Property and equipment is stated at cost, less
accumulated depreciation. Depreciation of property and equipment is provided
over the estimated useful lives of the respective assets, which range from three
to five years, using the straight-line method. Leasehold improvements are
amortized over the lives of the related leases or their estimated useful lives,
whichever is shorter, using the straight-line method. It is the Company's policy
to write-off its fully depreciated assets. This resulted in a decrease in both
property and equipment and accumulated depreciation in 1998 and 1997 of $1.3
million and $3.4 million, respectively, with no change in net property and 
equipment.

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



                                       33
<PAGE>   36

        Pro Forma Net Loss Per Share. The Company adopted Statement of 
Financial Accounting Standards Statement No. 128, "Earnings Per Share" 
("FAS 128"), which is effective for fiscal years ending after December 15, 1997.
FAS 128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities (including the potential shares to be issued upon
conversion of preferred stock.) Dilutive earnings per share is very similar to
the previously reported fully diluted earnings per share.

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

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

        Accounting for Cost Sharing Agreements. The Company directly reduces
expenses for amounts reimbursed pursuant to cost sharing agreements. During 1998
and 1997, research and development expenses were reduced by $361,000 and
$534,000, respectively, for costs reimbursed by Pharmacia & Upjohn (P&U) and
Bausch and Lomb Pharmaceuticals, Inc. (B&L) under the terms of the
collaborations described in Note 3.

        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.


2.      LOSS ON VACATED FACILITIES

        In 1996, as a result of a new manufacturing agreement with B&L, the
Company ended its relationship with its previous contract manufacturer and
wrote-off its share of equipment and leasehold improvements installed at the
previous manufacturer's plant. This act resulted in a one-time non-cash charge
of $1.4 million for fiscal year 1996 which is reported separately in the
accompanying statement of operations.


3.      LICENSES

        On January 28, 1999, the Company entered into a license agreement and
stock purchase agreement pursuant to which InSite granted P&U an exclusive
worldwide license to ISV-205 for the treatment of glaucoma. The license calls
for (i) P&U to assume responsibility for the development of the product upon
completion by the Company of, among other activities, Phase II studies currently
being conducted by the Company, of (ii) P&U to reimburse InSite for certain
research and development expenses and make payments to InSite for on-going
technical support, and (iii) the payment by P&U to InSite of royalties on
product sales should ISV-205 be successfully commercialized. InSite will
continue to bear responsibility for the prosecution and maintenance of the
patents subject to the license, among other things. The transaction also calls
for an equity investment from P&U of $2,000,000 for which they received
1,095,506 shares of common stock, with the potential for future equity
investments based on achievement of certain milestones.



                                       34
<PAGE>   37

        In July 1996, the Company entered into agreements with B&L which provide
for (i) B&L to receive, for a one-time license fee of $500,000, an exclusive
worldwide royalty-bearing license to manufacture and market PilaSite and (ii) a
collaboration between the Company and B&L to develop and sell a new DuraSite
based eye-drop formulation for which, after development, the Company will issue
an exclusive, worldwide, royalty bearing license to B&L.

        The Company has a license agreement with CIBA Vision Ophthalmics ("CIBA
Vision"), an ophthalmic company which is an affiliate of CIBA-GEIGY Limited.
Under the terms of the agreement, CIBA Vision has co-exclusive rights to
manufacture and market AquaSite and ToPreSite in the U.S. and AquaSite in
Canada. The license agreement requires CIBA Vision to pay royalties on net sales
of the licensed products. The Company recognized $16,000, $50,000 and $44,000 of
royalty revenue for sales of AquaSite in 1998, 1997 and 1996, respectively.


4.      LEASE COMMITMENTS

        The Company leases its facilities under noncancelable operating lease
agreements which expire in 2001. Rent expense was $514,000, $497,000 and
$605,000 for 1998, 1997 and 1996, respectively. As of December 31, 1998, the
aggregate future minimum payments under noncancelable leases are:

<TABLE>
<S>                                             <C>       
                 1999                           $  485,828
                 2000                              499,941
                 2001                              514,054
                                                ----------
                 Total                          $1,499,823
                                                ==========
</TABLE>


5.      INCOME TAXES

        Significant components of the Company's deferred tax assets for federal
and state income taxes as of December 31, 1998 and 1997 are as follows (in
thousands):

<TABLE>
<CAPTION>
----------------------------------------------------------------------------
                                                         1998         1997
----------------------------------------------------------------------------
<S>                                                    <C>          <C>     
Deferred tax assets:
     Net operating loss carryforwards                   $26,226     $ 25,042
     Research and development credit carryforwards        2,916        2,646
     Capitalized research and development                 5,824        3,880
     Depreciation                                           572          580
     Other                                                   90          148
                                                       --------     --------
     Total                                               35,629       32,296
Valuation allowance                                     -35,629      -32,296

Net deferred tax assets                                $     --     $     --
                                                       ========     ========

----------------------------------------------------------------------------
</TABLE>

        The valuation allowance increased by $3.3 million and $4.2 million
during the years ended December 31, 1998 and 1997 respectively.

        At December 31, 1998, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $72.0 million, which expire in
the years 2001 through 2018 and net operating loss carryforwards for state
income tax purposes of approximately $28.9 million which expire in the years
1999 through 2003. The



                                       35
<PAGE>   38

Company also has federal and state research and development credit carryforwards
of approximately $1.1 million and $2.0 million, respectively, which expire in
the years 2001 through 2013.

        Utilization of the Company's federal and state net operating loss
carryforwards and research and development tax credits are subject to an annual
limitation against taxable income in future periods due to the ownership change
limitations provided by the Internal Revenue Code of 1986. As a result of this
annual limitation, a significant portion of these carry forwards 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.


6.      REDEEMABLE PREFERRED STOCK

        In September 1997, the Company received net proceeds of approximately
$6.5 million from a private placement of 7,000 shares of Series A Convertible
Preferred Stock with a $.01 par value ("Series A Preferred"). The number of
shares of Common Stock issuable upon conversion of the Series A Preferred will
be equal to the face value of each share of Series A Preferred divided by the
lower of the fixed conversion price of $2.127 or a variable conversion price.
The variable conversion price is determined by applying a discount, which ranged
from 10% for shares converted prior to June 10, 1998, to 17.5% for shares
converted after December 7, 1998, to an average of closing bid prices of the
Company's common stock at the time of conversion. Such conversion prices are
subject to adjustment in accordance with the terms of the Certificate of
Designations, Preferences and Rights of the Series A Preferred. The value of the
Series A Preferred shares to be converted will also include a 6% per annum
premium which accrues from the date of issuance until the date of conversion.
Three years after issuance, any remaining unconverted preferred shares will
automatically be converted into common stock. As of December 31, 1998, 3,589,797
shares of common stock have been issued as a result of conversions of Series A
Preferred. Subsequent to December 31, 1998, 834,007 shares of common stock were
issued as a result of conversions of Series A Preferred. The holders of the
Series A Preferred have no voting rights, except as required by applicable
Delaware law. The Company also issued a warrant to purchase 70 shares of Series
A Preferred which is subject to the same conversion terms and premium as
described above. The Company has authorized 5,000,000 shares of Preferred Stock,
7,070 of which have been designated Series A Preferred. Pursuant to the
agreement, 6,000,000 shares of common stock have been reserved for issuance to
the holders of the Series A Preferred of which 2,410,203 shares remain reserved 
at December 31, 1998.

        For the years ended December 31, 1998 and 1997, in accordance with SEC
Rules and Regulations, the Company reported non-cash preferred dividends of $0.5
million and $1.3 million, respectively. The dividends are related to the
discount at which Series A Preferred could be converted to common stock and the
6% per annum premium, payable in additional common stock, earned on the
outstanding Series A Preferred Stock. The dividends are used to determine the
net loss per share applicable to common stockholders.

        In certain circumstances, the Series A Preferred Stockholders have the
right to redeem their outstanding shares. The redemption amount is equal to the
number of shares of common stock issuable upon conversion multiplied by the
closing bid price of the Company's common stock as of the date of redemption
($2.0 million as of December 31, 1998).



                                       36
<PAGE>   39

7.     COMMON STOCKHOLDERS' EQUITY

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

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

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

        In January 1996, the Company received net proceeds of approximately 
$4.7 million from a private placement of 1,469,232 shares of its common stock 
and 367,308 warrants. Each warrant entitles its holder to purchase one share of 
the Company's common stock for $3.25 per share until January 2001. In April 
1996, the Company received net proceeds of approximately $8.1 million from a 
public offering of 1,750,000 shares of its common stock.

Stock Option Plan.

        At December 31, 1998, a total of 2,217,815 shares of common stock were
reserved under the 1994 Stock Plan for issuance upon the exercise of options or
by direct sale to employees, including officers, directors and consultants.
Options granted under the plan expire 10 years from the date of grant and become
exercisable at such times and under such conditions as determined by the
Company's Board of Directors (generally ratably over four years). Activity under
the 1994 Stock Plan has been as follows:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
                                               Shares
--------------------------------------------------------------------------------------------------
                                                                                     Weighted
                                                                                      Average
                                   Options                                         Exercise Price
                                  Available          Options                         of Shares
                                  for Grant        Outstanding      Option Price     Under Plan
                                 -----------      -------------    --------------  ---------------
<S>                              <C>              <C>              <C>              <C>
Balance at January 1, 1996           402,057         1,323,980        $0.60-9.25       $2.29
Granted                             (277,250)          277,250         4.25-6.38        5.67
Exercised                                             (243,145)        0.60-5.00        3.01
Forfeited                             85,219           (85,219)        0.60-7.25        3.74
                                  ----------       -----------
Balance at December 31, 1996         210,026         1,272,866         0.60-9.25        2.79
Additional Shares reserved           500,000                --                --          --
Granted                             (628,500)          628,500         2.81-6.25        4.07
Exercised                                 --           (30,598)        0.60-4.38        2.86
Forfeited                            204,927          (204,927)        0.60-6.75        4.07
                                  ----------       -----------
Balance at December 31, 1997         286,453         1,665,841         0.60-9.25        3.12
Additional Shares reserved           265,521                --                --          --
Granted                              (70,000)           70,000         1.31-3.53        2.26
Forfeited                            102,709          (102,709)        2.75-6.38        3.93
                                  ----------       -----------
Balance at December 31, 1998         584,683         1,633,132        $0.60-9.25       $3.03
                                  ==========       ===========

----------------------------------------------------------------------------------------------------
</TABLE>



                                       37
<PAGE>   40

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

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                            Options Outstanding                      Options Exercisable
                                                       Weighted Average                              Weighted
                                 Number         Contractual                         Number           Average
Range of Exercise Prices       Outstanding         Life         Exercise Price    Exercisable    Exercise Price
------------------------      -------------    -------------   ----------------  -------------  ----------------
<S>                           <C>              <C>             <C>               <C>            <C>
    $0.60 - $3.00                  874,952             5.11        $   1.74           438,294         $   0.86
    $3.53 - $5.88                  599,751             8.53            4.03           232,423             4.23
    $6.23 - $9.25                  158,427             7.77            6.35           111,797             6.38
                                 ---------        ---------        --------         ---------         --------
                                 1,633,130             6.62        $   3.03           782,514         $   2.65
                                 =========        =========        ========         =========         ========

----------------------------------------------------------------------------------------------------------------
</TABLE>

        The weighted average grant date fair value of options granted during
1998, 1997 and 1996 were $2.26, $3.58 and $5.26, 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 receives an annual grant of an option to
purchase 10,000 shares. Such options vest one year after the grant date.

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

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

        Pro forma information regarding net loss and loss per share is required
by Statement 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates
ranging from 4.64% to 6.58%; volatility factors for the expected market price of
the Company's common stock of 1.08, 0.8946 and 1.1494; and a weighted-average
expected life for the options of 4 years.



                                       38
<PAGE>   41

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

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------
                                                                          1998               1997               1996
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>                <C>                <C>        
Net loss applicable to common stockholders - as presented                $(9,082)          $(11,144)          $(8,762)
Net loss applicable to common stockholders - pro forma                    (9,681)           (11,652)           (9,240)
Loss per share applicable to common stockholders - as presented
 basic and diluted                                                         (0.60)             (0.85)            (0.72)
Loss per share applicable to common stockholders - pro forma
 basic and diluted                                                         (0.64)             (0.89)            (0.76)
-----------------------------------------------------------------------------------------------------------------------
</TABLE>

Employee Stock Purchase Plan.

        On April 1, 1994, employees of the Company began participating in an
Employee Stock Purchase Plan which provides the opportunity to purchase common
stock at prices not less than 85% of market value at the time of purchase.
During the years ended December 31, 1998, 1997 and 1996, respectively, 27,195,
13,370 and 10,887 shares of common stock were issued pursuant to this plan. At
December 31, 1998, an additional 37,930 shares are reserved for issuance under
this plan. The effects of the Stock Purchase Plan on the pro forma disclosures
above are not material.



                                       39
<PAGE>   42

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

        None.


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        The information required by this item with respect to the identification
of Directors is hereby incorporated by reference from the information under the
caption "Proposal One-Election of Directors" in the Company's Proxy Statement
for its Annual Meeting of Stockholders which is estimated to be held on or about
June 8, 1999 (the "Proxy Statement").

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

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


ITEM 11.  EXECUTIVE COMPENSATION

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


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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



                                     PART IV

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

(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.



                                       40
<PAGE>   43

    (2) Financial Statement Schedules

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

    (3) Exhibits

        The following exhibits are referenced or included in this report.


              Number        Exhibit Table
              ------        -------------

                3.1(1)      Restated Certificate of Incorporation.

                3.2(7)      Amended and Restated Bylaws.

                4.1(4)      Registration Rights Agreement, dated January 24,
                            1996 (the "Registration Rights Agreement"), between
                            the Registrant and the investors listed on Schedule
                            1 thereto.

                4.2(4)      Form of Warrant to Purchase Shares of Common Stock
                            between the Registrant and each of the investors
                            listed on Schedule 1 to the Registration Rights
                            Agreement.

                4.3(10)     Certificate of Designations, Preferences and Rights
                            of Series A Convertible Preferred Stock as filed
                            with the Delaware Secretary of State on September
                            11, 1997.

                4.4(10)     Certificate of Correction of the Certificate of
                            Designations, Preferences and Rights of Series A
                            Convertible Preferred Stock as filed with the
                            Delaware Secretary of State on September 26, 1997.

               10.5(2)      InSite Vision Incorporated Employee Stock Purchase
                            Plan.

               10.6(2)      Form of Indemnity Agreement Between the Registrant
                            and its directors and officers.

               10.7(2)      Form of Employee's Proprietary Information and
                            Inventions Agreement.

               10.13(3)(H)  License Agreement dated as of October 9, 1991 by and
                            between the Company and CIBA Vision Corporation, as
                            amended October 9, 1991.

               10.14(3)(H)  Letter Agreement dated February 27, 1992 by and
                            among the Company, Columbia Laboratories, Inc. and
                            Joseph R. Robinson, as amended October 23, 1992.

               10.15(2)(H)  Collaboration Agreement dated as of November 24,
                            1992 by and between the Company and British
                            Bio-technology Limited.

               10.16(2)(H)  Collaboration Agreement dated as of April 30, 1993
                            by and between the Company and British
                            Bio-technology Limited.

               10.17(8)     Facilities Lease, dated September 1, 1996, between
                            the Registrant and Alameda Real Estate Investments.

               10.18(1)(H)  Agreement dated as of February 15, 1994 by and
                            between the Company and Timm A. Carpenter.

               10.19(9)(HH) InSite Vision Incorporated 1994 Stock Option Plan
                            (Amended and Restated as of March 17, 1997).

               10.20(1)(HH) Form of InSite Vision Incorporated Notice of Grant
                            of Stock Option and Stock Option Agreement, with
                            Addenda.

               10.21(9)(HH) Form of InSite Vision Incorporated Notice of
                            Automatic Option Grant and Non-Employee Director
                            Option Agreement.

               10.22(1)     InSite Vision Incorporated 1994 Employee Stock
                            Purchase Plan.

               10.23(1)     Form of InSite Vision Incorporated Stock Purchase
                            Agreement.

               10.24(1)     Form of InSite Vision Incorporated Employee Stock
                            Purchase Plan Enrollment/Change Form.

               10.25(4)     Letter Agreement dated February 3, 1995 between the
                            Company and David G. Harper.



                                       41
<PAGE>   44

               10.26(4)     Settlement Agreement and General Release dated March
                            3, 1995 between the Company and Clifford Orent.

               10.27(5)     Common Stock Purchase Agreement dated January 19,
                            1996 between the Registrant and the Investors listed
                            on Schedule 1 thereto.

               10.28(6)(H)  ISV-205 License Agreement dated May 28, 1996 by and
                            between the Company and CIBA Vision Ophthalmics.

               10.29(6)(H)  ToPreSite License Agreement dated May 28, 1996 by
                            and between the Company and CIBA Vision Ophthalmics.

               10.30(6)(H)  BetaSite Contract Manufacturing Agreement dated July
                            18, 1996 by and between the Company and Bausch &
                            Lomb Pharmaceuticals, Inc.

               10.31(6)(H)  PilaSite License Agreement dated July 18, 1996 by
                            and between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.32(6)(H)  Timolol Development Agreement dated July 18, 1996 by
                            and between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.33(6)(H)  Stock Purchase Agreement dated July 18, 1996 by and
                            between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.34(10)    Engagement Agreement, dated April 1, 1997, by and
                            between the Company and William Blair & Company LLC.

               10.35(10)(H) License Agreement, dated July 1, 1997, by and
                            between the University of Connecticut Health Center
                            and the Company.

               10.36(10)(H) License Agreement, dated August 19, 1997, by and
                            between the University of Rochester and the Company.

               10.37(10)    Form of Securities Purchase Agreement, dated
                            September 12, 1997, by and among the Company and the
                            Selling Stockholders thereunder.

               10.38(10)    Form of Registration Rights Agreement, dated
                            September 12, 1997, by and among the Company and the
                            Selling Stockholders thereunder.

               10.39(10)    Form of Warrant, dated September 12, 1997, to
                            William Blair & Company LLC.

               10.40(11)    License Agreement, dated January 28, 1999, by and 
                            between the Company and Pharmacia & Upjohn AB.

               10.41(11)    Stock Purchase Agreement, dated January 28, 1999, 
                            by and between the Company and Pharmacia & Upjohn AB
                            and Pharmacia & Upjohn, SA.

               23.1         Consent of Ernst & Young LLP, Independent Auditors.

               24.1         Power of Attorney (included in Part IV of this
                            Annual Report on Form 10-K under the caption
                            "Signatures").

               27           Financial Data Schedule.

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

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

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

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

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

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

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



                                       42
<PAGE>   45

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

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

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

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

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

(HH)    Management contract or compensatory plan.

(b)     Reports on Form 8-K

        The Registrant did not file any reports on Form 8-K during the fourth
        quarter of fiscal 1998.

(c)     Exhibits

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

(d)     Financial Statement Schedules

        See (a)(2) above.



                                   SIGNATURES


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

Dated: March 30, 1999
                                            INSITE VISION INCORPORATED


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



                                       43
<PAGE>   46

                                POWER OF ATTORNEY

        KNOW ALL PERSONS BY THESE PRESENTS:

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

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

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


<TABLE>
<CAPTION>
      Name                                       Capacity                             Date           
      ----                                       --------                             ----           
<S>                                        <C>                                    <C> 
/s/ S. Kumar Chandrasekaran                Chairman of the Board, President,      March 30, 1999
--------------------------------------     Chief Executive Officer and
    S. Kumar Chandrasekaran, Ph.D.         Chief Financial Officer


/s/ Mitchell H. Friedlaender               Director                               March 30, 1999
--------------------------------------
    Mitchell H. Friedlaender, M. D.


/s/ John E. Lucas                          Director                               March 30, 1999
--------------------------------------
    John E. Lucas


/s/ John L. Mattana                        Director                               March 30, 1999
--------------------------------------
    John L. Mattana


/s/ Anders P. Wiklund                      Director                               March 30, 1999
--------------------------------------
    Anders P. Wiklund
</TABLE>



                                       44
<PAGE>   47
                                 EXHIBIT INDEX


              Number        Exhibit Table
              ------        -------------

                3.1(1)      Restated Certificate of Incorporation.

                3.2(7)      Amended and Restated Bylaws.

                4.1(4)      Registration Rights Agreement, dated January 24,
                            1996 (the "Registration Rights Agreement"), between
                            the Registrant and the investors listed on Schedule
                            1 thereto.

                4.2(4)      Form of Warrant to Purchase Shares of Common Stock
                            between the Registrant and each of the investors
                            listed on Schedule 1 to the Registration Rights
                            Agreement.

                4.3(10)     Certificate of Designations, Preferences and Rights
                            of Series A Convertible Preferred Stock as filed
                            with the Delaware Secretary of State on September
                            11, 1997.

                4.4(10)     Certificate of Correction of the Certificate of
                            Designations, Preferences and Rights of Series A
                            Convertible Preferred Stock as filed with the
                            Delaware Secretary of State on September 26, 1997.

               10.5(2)      InSite Vision Incorporated Employee Stock Purchase
                            Plan.

               10.6(2)      Form of Indemnity Agreement Between the Registrant
                            and its directors and officers.

               10.7(2)      Form of Employee's Proprietary Information and
                            Inventions Agreement.

               10.13(3)(H)  License Agreement dated as of October 9, 1991 by and
                            between the Company and CIBA Vision Corporation, as
                            amended October 9, 1991.

               10.14(3)(H)  Letter Agreement dated February 27, 1992 by and
                            among the Company, Columbia Laboratories, Inc. and
                            Joseph R. Robinson, as amended October 23, 1992.

               10.15(2)(H)  Collaboration Agreement dated as of November 24,
                            1992 by and between the Company and British
                            Bio-technology Limited.

               10.16(2)(H)  Collaboration Agreement dated as of April 30, 1993
                            by and between the Company and British
                            Bio-technology Limited.

               10.17(8)     Facilities Lease, dated September 1, 1996, between
                            the Registrant and Alameda Real Estate Investments.

               10.18(1)(H)  Agreement dated as of February 15, 1994 by and
                            between the Company and Timm A. Carpenter.

               10.19(9)(HH) InSite Vision Incorporated 1994 Stock Option Plan
                            (Amended and Restated as of June 8, 1998).

               10.20(1)(HH) Form of InSite Vision Incorporated Notice of Grant
                            of Stock Option and Stock Option Agreement, with
                            Addenda.

               10.21(9)(HH) Form of InSite Vision Incorporated Notice of
                            Automatic Option Grant and Non-Employee Director
                            Option Agreement.

               10.22(1)     InSite Vision Incorporated 1994 Employee Stock
                            Purchase Plan.

               10.23(1)     Form of InSite Vision Incorporated Stock Purchase
                            Agreement.

               10.24(1)     Form of InSite Vision Incorporated Employee Stock
                            Purchase Plan Enrollment/Change Form.

               10.25(4)     Letter Agreement dated February 3, 1995 between the
                            Company and David G. Harper.



<PAGE>   48
               10.26(4)     Settlement Agreement and General Release dated March
                            3, 1995 between the Company and Clifford Orent.

               10.27(5)     Common Stock Purchase Agreement dated January 19,
                            1996 between the Registrant and the Investors listed
                            on Schedule 1 thereto.

               10.28(6)(H)  ISV-205 License Agreement dated May 28, 1996 by and
                            between the Company and CIBA Vision Ophthalmics.

               10.29(6)(H)  ToPreSite License Agreement dated May 28, 1996 by
                            and between the Company and CIBA Vision Ophthalmics.

               10.30(6)(H)  BetaSite Contract Manufacturing Agreement dated July
                            18, 1996 by and between the Company and Bausch &
                            Lomb Pharmaceuticals, Inc.

               10.31(6)(H)  PilaSite License Agreement dated July 18, 1996 by
                            and between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.32(6)(H)  Timolol Development Agreement dated July 18, 1996 by
                            and between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.33(6)(H)  Stock Purchase Agreement dated July 18, 1996 by and
                            between the Company and Bausch & Lomb
                            Pharmaceuticals, Inc.

               10.34(10)    Engagement Agreement, dated April 1, 1997, by and
                            between the Company and William Blair & Company LLC.

               10.35(10)(H) License Agreement, dated July 1, 1997, by and
                            between the University of Connecticut Health Center
                            and the Company.

               10.36(10)(H) License Agreement, dated August 19, 1997, by and
                            between the University of Rochester and the Company.

               10.37(10)    Form of Securities Purchase Agreement, dated
                            September 12, 1997, by and among the Company and the
                            Selling Stockholders thereunder.

               10.38(10)    Form of Registration Rights Agreement, dated
                            September 12, 1997, by and among the Company and the
                            Selling Stockholders thereunder.

               10.39(10)    Form of Warrant, dated September 12, 1997, to
                            William Blair & Company LLC.
               
               10.40(11)    License Agreement, dated January 28, 1999, by and
                            between the Company and Pharmacia & Upjohn AB.

               10.41(11)    Stock Purchase Agreement, dated January 28, 1999,
                            by and between the Company and Pharmacia & Upjohn
                            AB and Pharmacia Upjohn, SA.

               23.1         Consent of Ernst & Young LLP, Independent Auditors.

               24.1         Power of Attorney (included in Part IV of this
                            Annual Report on Form 10-K under the caption
                            "Signatures").

               27           Financial Data Schedule.

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

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

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

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

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

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

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



<PAGE>   49

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

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

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


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

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

(HH)    Management contract or compensatory plan.

(b)     Reports on Form 8-K

        The Registrant did not file any reports on Form 8-K during the fourth
        quarter of fiscal 1998.

(c)     Exhibits

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

(d)     Financial Statement Schedules

        See (a)(2) above.