<PAGE>



                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                            ------------------------

                                    FORM 10-K

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

(Mark One)

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

     For the fiscal year ended December 31, 2001
                               -----------------

                                      OR

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

     For the transition period from_______to_______.

                          Commission File No. 000-31135

                          INSPIRE PHARMACEUTICALS, INC.
             (Exact name of Registrant as Specified in Its Charter)

                            ------------------------

          Delaware                                        04-3209022
          --------                                        ----------
   (State or Other Jurisdiction of          (I.R.S. Employer Identification No.)
   Incorporation or Organization)

4222 Emperor Boulevard, Suite 470, Durham, North Carolina           27703-8466
---------------------------------------------------------           ----------
        (Address of Principal Executive Offices)                    (Zip Code)

                                 (919) 941-9777
                                 --------------
              (Registrant's telephone number, including area code)

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

         Title of Each Class           Name of Each Exchange on Which Registered
         -------------------           -----------------------------------------
                 None                                   None

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

                          Common Stock, $.001 par value
                          -----------------------------
                                (Title of Class)

     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 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. [ ]

     State the aggregate market value of the equity stock held by
non-affiliates of the Registrant: $52,760,995 at February 15, 2002 based on the
last sales price on that date.

     Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of March 1, 2002.

               Class                               Number of Shares
               -----                               ----------------
     Common Stock, $.001 par value                    25,792,721

Documents incorporated by reference
-----------------------------------

     The Proxy Statement to be filed with respect to the Annual Meeting of
Stockholders to be held on June 4, 2002 is incorporated by reference into Part
III of the Annual Report on Form 10-K.

<PAGE>


Item 1.   Business.

Overview

     We discover and develop drugs to treat diseases characterized by
deficiencies in the body's innate defense mechanisms of mucosal hydration and
mucociliary clearance as well as other non-mucosal disorders. Our product
candidates in clinical trials are based on proprietary technology relating to
P2Y receptors. Studies indicate that a subtype of this family, the P2Y2
receptor, coordinates the mechanisms of mucosal hydration and mucociliary
clearance. These complex mechanisms, which involve movement of salt and water,
a protein substance made in specialized cells that act to lubricate surfaces,
called mucin, and the movement of cilia, or hairlike projections on the surface
of cells that move together in a sweeping motion to move liquid and particles
forward, can be regulated therapeutically through the stimulation of this
receptor. Our lead products target respiratory and ophthalmic diseases with
inadequate current treatments. We have also begun to apply our expertise in
this field to other applications of other P2Y receptor subtypes as well as
advancing several non-P2Y programs. We currently have six product candidates in
clinical development:

     .    INS365 Ophthalmic for the treatment of dry eye disease;

     .    INS316 Diagnostic to aid in the diagnosis of lung cancer and lung
          infection;

     .    INS37217 Respiratory for the treatment of cystic fibrosis;

     .    INS365 Respiratory for the treatment of chronic bronchitis;

     .    INS37217 Intranasal for upper respiratory disorders; and

     .    INS37217 Ophthalmic for the treatment of retinal disease.

     We have entered into development and commercialization alliances with
Allergan Inc. ("Allergan"), Kissei Pharmaceuticals Co., Ltd., ("Kissei"),
Santen Pharmaceutical Co., Ltd. ("Santen") and Kirin Brewery Co., Ltd.
Pharmaceutical Division ("Kirin").

     We commenced operations in March 1995. At that time, we acquired a license
to our initial technology, including patents relating to P2Y receptors and on
method of use for P2Y2 receptor agonists in the respiratory area, from The
University of North Carolina at Chapel Hill. We initially focused on the
clinical development of INS316 for the treatment of respiratory diseases such
as cystic fibrosis and chronic bronchitis. In early 1996, we initiated a
research program to develop an improved P2Y2 agonist compound, INS365. A joint
patent for this compound was granted to us and The University of North Carolina
at Chapel Hill relating to the respiratory therapeutic uses. We began
preclinical studies of INS365 for respiratory uses in 1997, and clinical
testing of INS365 for respiratory uses in early 1998. We filed an
investigational new drug application ("IND") in the United States in the spring
of 1998. We acquired an exclusive license to use INS365 to treat respiratory
disease from The University of North Carolina at Chapel Hill in 1998. During
the development of INS365 for respiratory uses, our scientists began to
recognize the potential for using INS365 to treat ophthalmic diseases such as
dry eye. We initiated ophthalmic clinical testing of INS365 in the United
Kingdom in early 1999, filed an IND in the United States in the fall of 1999
and completed a Phase II clinical trial in the fall of 2000. We initiated a
Phase III study in January 2001. Our chemistry lab also synthesized INS37217, a
new P2Y2 receptor agonist, in 1998. We began preclinical testing of INS37217
for respiratory uses in 1998 and for ophthalmic uses in 1999. This preclinical
work for the initial studies in both the respiratory and ophthalmic areas has
now been completed. In the fall of 2000, we filed an IND for INS37217
Respiratory for the treatment of cystic fibrosis. In August 2000 we filed an
IND for INS37217 Intranasal for upper respiratory disorders. In June 2001 we
filed an IND for INS37217 Ophthalmic for the treatment of retinal disease. All
three of these early clinical programs involving INS37217 are currently ongoing.

Technology Background

     Mucosal hydration and mucociliary clearance processes are observed at a
number of human mucosal surfaces including those in the respiratory tract,
eyes, sinuses, vaginal and endocervical surfaces. Mucosal hydration and
mucociliary clearance are natural mechanisms for cleansing and protecting
mucosal surfaces and require a coordinated balance of salt, water and mucus.
Studies indicate that P2Y2 receptors regulate these mechanisms on epithelial
cells that line mucosal surfaces. Diseases that are characterized by impairment
of mucosal hydration and/or mucociliary clearance include chronic bronchitis,
allergic rhinitis, cystic fibrosis, dry eye disease and retinal disease.

<PAGE>


Ophthalmic

     The eyes and inner eyelids are surrounded by a mucosal surface which
serves as an important innate defense mechanism, keeping the surface of the
eye, or ocular surface, moist, clear and free from infection. Tears produced by
the mucosal hydration process and the lacrimal glands help maintain eye
moisture, and in response to physical stimuli, can be greatly increased to
flush out irritants. This tear film is a complex mixture of fluid, ions, mucin
and proteins that, when mixed in the proper proportions, coats the cornea with
a protective film. The mucosal hydration process and the lacrimal glands
maintain an optimal balance of salt, water, mucin and proteins in people with a
healthy ocular surface. Studies indicate that stimulating P2Y2 receptors with
effective compounds can help restore the eye's innate mucosal defense mechanism
on the ocular surface by stimulating the release of natural tear components.

     Dry Eye Disease

     Dry eye, an ocular surface disease, is the general term for a condition in
which abnormalities in the eye's tear film lead to burning, painful, red,
irritated, gritty and dry eyes. These abnormalities are typically characterized
by a decrease in tear production, an increase in tear evaporation or the
improper mixture of the eye's tear film components. If left untreated, dry eye
disease can result in permanent corneal damage and visual impairment.

     The current treatments for dry eye disorders in the major markets consist
of artificial tear solutions and lubricant drops. In some cases, small plugs
are inserted by physicians in the corner of the eyes to slow tear drainage.
Artificial tears, which are available as over-the-counter and, in some
countries, as prescription products, provide temporary relief of symptoms, but
can also wash out the natural proteins and other components that keep an eye
healthy. There are currently no FDA approved pharmacologically active agents,
drugs that work by affecting a biological process such as stimulation of a
receptor, for dry eye disease.

     We estimate, based on an extrapolation from United States data, that
moderate to severe dry eye affects approximately nine million people in the
eight major international prescription pharmaceutical markets and can be caused
by eye stress, aging, environmental factors, autoimmune disorders and various
medications. Because dry eye disease is more prevalent among the elderly and
post-menopausal women, this market is expected to grow as populations age. We
estimate that, in the eight major international prescription pharmaceutical
markets, sales of ethical/proprietary pharmaceutical products for dry eye
treatments exceed $230 million annually.

     Retinal Disease

     The retina is a layer of sensory tissue that captures and processes visual
information, and normally remains attached to the underlying retinal pigment
epithelium ("RPE"). Breaks or tears in the retina can lead to an influx of fluid
into the subretinal space between the retina and RPE, thereby creating a
retinal detachment. Delayed treatment of this condition can lead to
degeneration of light-sensing photoreceptor neurons in the retina and permanent
loss of visual acuity.

     There are currently no pharmaceutical products approved for the treatment
of this type of retinal detachment. Relatively invasive surgical techniques are
now generally employed to reattach the retina, but these can lead to
significant patient morbidity as well as protracted periods of convalescence.

Respiratory

     For lungs to function normally, airway surfaces must be kept properly
hydrated and clear of particles. Airway liquid, including salt and water, is
secreted through channels in the membranes of respiratory epithelial cells.
Mucus, secreted by goblet cells, traps microorganisms and particulates.
Specialized epithelial cells containing cilia beat synchronously to propel the
overlying "mucociliary blanket" of salt, water and mucus to the mouth and
throat where secretions are swallowed or expelled. This process is the
principal mechanism by which the body keeps airway surfaces free of dust,
pollutants, bacteria and viruses. Genetic and environmental factors can lead to
a breakdown in the normal process of mucosal hydration and mucociliary
clearance that is observed in many debilitating respiratory diseases, including
chronic bronchitis and cystic fibrosis. Studies indicate that stimulating P2Y2
receptors with effective agonists can help restore the respiratory system's
innate defense mechanisms.

                                      2

<PAGE>

     Respiratory Diagnostics

     Physicians use microscopic examination of lung cells to diagnose lung
cancer and lung infections, including pneumonia and tuberculosis. Effective
diagnosis requires the collection of an adequate specimen, one which is
enriched with deep-lung material obtained from the lower part of the lung.
Bronchoscopy, an invasive medical procedure, can be performed to obtain a
specimen; however, it is a procedure that costs over $1,000 and poses a risk to
patients with impaired lung function. The induction of sputum, either
spontaneously or with inhaled solutions, is a less invasive and less costly
alternative for obtaining a deep-lung specimen. Once the specimens are
collected, they are tested for the presence of cancerous cells or pathogens
associated with lung infections. However, many patients have difficulty
producing adequate specimens on their own, which is a key barrier to early and
effective diagnosis and treatment.

     There are no FDA approved agents currently available to enhance the
production of an adequate deep-lung specimen. In an effort to produce a quality
specimen, non-approved agents are frequently used, including inhaled solutions
such as hypertonic saline and propylene glycol, which cause irritation and
excessive coughing. Because these agents have limited utility and are often
poorly tolerated, pulmonologists and respiratory therapists have expressed a
strong interest in a better-tolerated and more effective inhaled agent, which
could reduce the need for bronchoscopies.

     Our market research, including interviews with pulmonologists and
oncologists, indicates that deep-lung specimens are frequently collected for
the diagnosis of lung cancer and lung infections. The testing of specimens is a
optional component of routine annual physical examinations in Japan.

     Cystic Fibrosis

     Cystic fibrosis is a life-threatening disease involving a genetic mutation
that disrupts the cystic fibrosis transmembrane regulator protein. In healthy
individuals, this protein acts as an ion-specific channel that modulates salt
and water movement. In cystic fibrosis patients, a defect in this channel leads
to poorly hydrated, thickened mucous secretions in the airways, as well as
severely impaired mucociliary clearance. Impairments in these vital lung
defense mechanisms typically begin in early childhood. Chronic secondary
infections invariably occur, resulting in progressive lung dysfunction and
deterioration. Cystic fibrosis-induced damage to the respiratory tract accounts
for more than 95% of the morbidity and mortality associated with this disease.
According to the U.S. Cystic Fibrosis Foundation, the median life expectancy
for patients is 32 years.

     The current therapeutic approaches to address cystic fibrosis mainly treat
the symptoms, but do not cure the disease, and are aimed at reducing
respiratory infections and breaking up thickened mucous secretions that cause
airflow obstruction and harbor bacteria. For example, TOBI(R) is an inhaled
antibiotic that treats the infection, and Pulmozyme(R) is an inhaled protein
that breaks up excessive DNA in cystic fibrosis mucus that reduces the
thickness and tackiness of the respiratory secretions. While both products are
approved for the treatment of cystic fibrosis, neither product is designed to
address the underlying ion-transport defect, which results in dehydrated mucus
and severely impaired mucociliary clearance.

     There are approximately 30,000 diagnosed cystic fibrosis patients in the
United States and approximately 75,000 in the eight major international
prescription pharmaceutical markets. The average annual cost of medicine to
treat a cystic fibrosis patient in the United States exceeds $35,000, and the
annual healthcare cost for patients in the United States is over $1 billion. We
estimate that in the United States sales of ethical/proprietary pharmaceutical
products to treat cystic fibrosis currently are in excess of $200 million
annually.

     Chronic Bronchitis

     Chronic bronchitis is a serious and potentially life-threatening lung
condition characterized by acute and chronic airway inflammation, chronic
obstruction of airflow and a mucus-producing cough. Patients with chronic
bronchitis experience shortness of breath, labored breathing, excessive and
chronic coughing and production and retention of excessive mucus. Chronic
bronchitis can be caused by smoking, environmental toxins, and viral or
bacterial infections. Chronic bronchitis is defined by the American Thoracic
Society as the presence of a mucus-producing cough most days of the month,
three months of the year, for at least two successive years without obvious
alternative explanation. Patients with chronic bronchitis experience acute
flare-ups of the illness, their medication usage increases and they may require
hospitalization. If left untreated these patients may experience progressive
deterioration in lung function which can eventually result in respiratory
failure and death.

     The American Thoracic Society guidelines for the treatment of chronic
bronchitis recommend three main objectives to pharmaceutical intervention:
dilation of the airways, reduction of airway inflammation, and clearance of
retained respiratory secretions. Current management of chronic bronchitis
treats the symptoms, but does not cure the disease, and is based on the

                                      3

<PAGE>

degree of airflow obstruction and the extent of the patient's disability.
Physicians generally prescribe bronchodilators, which act to open airways in
the lungs. These are usually inhaled medications such as Serevent(R),
Ventolin(R), Atrovent(R), or Combivent(R). Physicians may also prescribe
inhaled steroids such as Beclovent(R) and Azmacort(R) to reduce the
inflammation in the airways. Additionally, physicians often use antibiotics
during acute flare-ups of the illness if they diagnose or suspect bacterial
infections. There is currently no FDA approved pharmaceutical agent that
effectively clears retained mucous secretions in this disease.

     Approximately 35.5 million patients have been diagnosed with chronic
bronchitis in the eight major international prescription pharmaceutical
markets, including 13 million in the United States, making it more prevalent
than asthma. Chronic bronchitis is estimated to account for approximately $15
billion in direct costs in the United States annually. In the United States,
there are estimated to be 500,000 hospitalizations per year due to acute
flare-ups of chronic bronchitis and it is the fourth leading cause of death. In
the eight major international prescription pharmaceutical markets, sales of
ethical/proprietary pharmaceutical products to treat chronic bronchitis were
approximately $1.3 billion in 1996.


     Upper Respiratory Disorders

     Upper respiratory disorders such as viral upper respiratory tract
infections or "common cold," allergic rhinitis, and rhinosinusitis are
associated with an impairment in mucociliary clearance in the nasal passages.
Although the etiology of these disorders are varied, they share a common set of
nasal symptoms such as rhinorrhea, nasal congestion/blockage, and post-nasal
drip. In these conditions the mucous membranes of the nose and paranasal
sinuses become irritated, leading to symptoms. In some patients, this
irritation is sufficient to hinder the normal drainage of the sinuses into the
nasal cavity through the sinus ostia, resulting in blockage of the ostia that
may lead to additional impaired ciliary activity, intense pressure/pain, and
increased likelihood of infection.

     Rhinosinusitis can be either viral or bacterial in origin. The only
available prescription treatments for rhinosinusitis are antibiotics.
Antibiotics are generally prescribed as a first-line treatment for
rhinosinusitis. Currently there are no prescription or non-prescription
therapies available that significantly facilitate drainage of the sinuses and
increase mucociliary clearance in the upper airways. A therapy that promoted
drainage of the sinuses would have the potential to relieve the pain, pressure
and congestion associated with the disease and may obviate the need for
antibiotics in some patients.

     Colds are a common disorder prompting nearly 62 million physician visits
by adults and children in the United States annually. There are 23.7 million
cases of allergic rhinitis reported annually in the United States; 15.9 million
of those cases affect the population under the age of 45. Rhinosinusitis
affects approximately 37 million Americans, or 14% of the U.S. population; it
is more than twice as prevalent as asthma, and results in an estimated $2.4
billion yearly in direct medical costs. It is also a painful disease; prompting
16 million annual outpatient office visits in the U.S. and resulting in
significant impairment in patients' ability to function.

Inspire's Solution

     Mucosal hydration and mucociliary clearance are natural mechanisms for
cleansing and protecting epithelial surfaces and require a coordinated balance
of salt, water and mucus. Studies indicate that P2Y2 receptors coordinate these
processes that can be regulated therapeutically by the local delivery of
compounds that bind to and stimulate these receptors. We have focused our
initial efforts on developing P2Y2 receptor agonists to treat diseases by
activating natural processes of mucosal hydration and mucociliary clearance.

     We believe that P2Y2 agonists represent a new pharmacological approach to
the treatment of respiratory and eye diseases. We also believe that a P2Y2
agonist may be effective as a drug that enhances the production of deep-lung
sputum samples for diagnostic tests. Importantly, our product candidates
currently in clinical testing can be applied directly to these mucosal surfaces
in a topical form such as inhaled aerosols and eye drops. These products act
and are degraded locally, resulting in minimizing the potential for systemic
side effects. Our current products are designed to address the medical need for
effective new products for diseases that involve impairment of mucosal
hydration and/or mucociliary clearance on epithelial surfaces. Our principal
product candidates are:

          INS365 Ophthalmic. We are developing INS365 Ophthalmic as an eye drop
     for dry eye disease. We believe that, by promoting the eyes' natural
     defense mechanism, INS365 Ophthalmic can be one of the first FDA approved
     pharmacologically effective agents to treat the symptoms of dry eye, and
     the first one with this mechanism of action. In pre-clinical testing, our
     product increased the secretions of natural tear components, which we
     believe can help restore a natural

                                      4

<PAGE>

     corneal tear film, reduce dry eye symptoms, help prevent long-term
     corneal damage, and improve ocular surface health in dry eye sufferers.

          INS37217 Ophthalmic. We are developing INS37217 Ophthalmic as an
     intra-ocular injection for retinal disease. We believe that our product
     will be the first FDA approved product to help facilitate retinal
     reattachment without the need for surgery or as an adjunct to surgery. We
     believe our product may enhance the reabsorption of fluid across the RPE
     and stimulate the removal of extraneous fluid from the subretinal space.

          INS316 Diagnostic. We are developing INS316 Diagnostic as an inhaled
     diagnostic drug to aid in the detection of lung cancer and lung
     infection. Based on clinical studies, we believe that INS316 Diagnostic
     can be an effective acute-use product to enhance the production of
     adequate deep-lung specimens for diagnostic purposes. As such, we believe
     our product may facilitate the diagnosis of lung cancer and lung
     infection and potentially reduce the need for costly and invasive
     bronchoscopies.

          INS37217 Respiratory. We are developing INS37217 Respiratory as an
     inhaled product for the treatment of cystic fibrosis. We believe our
     product can be the first FDA approved product that mitigates the
     underlying ion-transport defect in the airways of patients with cystic
     fibrosis. By hydrating airways and stimulating mucociliary clearance, our
     product may improve respiratory symptoms, reduce infections and enhance
     the health status of patients with this disease and will be complementary
     to other currently approved products.

          INS365 Respiratory. We are developing INS365 Respiratory as an
     inhaled product for the treatment of chronic bronchitis. We believe our
     product can be the first FDA approved product that addresses the need for
     an effective agent to clear the build-up of mucus in the airways of
     bronchitis sufferers. Thus, we believe our product may reduce the need
     for antibiotics, steroids and bronchodilators, and may reduce the
     frequency and length of flare-ups of the illnesses and hospitalizations.
     In many cases, we believe that our product will be complementary to
     existing treatments.

          INS37217 Intranasal. We are developing INS37217 Intranasal as an
     intranasal spray treatment for upper respiratory disorders in which
     mucociliary clearance is impaired. We believe our product may relieve the
     nasal symptoms associated with these disorders by facilitating drainage
     of the nasal passages and sinuses and increasing mucosal clearance in the
     upper airways.


Our Strategy

     Our objective is to become a leading biopharmaceutical company focused on
discovering, developing and commercializing new treatments for diseases
involving impaired mucosal hydration or inadequate mucociliary clearance and
other disorders. The principal elements of our strategy include:

          Aggressively Advance Our Lead Products. Our focus is on discovering,
     developing and commercializing therapies where current treatments are
     ineffective and where large therapeutic market opportunities exist.

          Establish Collaborative Relationships with Market Leaders while
     Selectively Retaining Marketing Rights. In order to maximize global
     return to us of late-stage development products, we will continue to
     establish and expand strategic alliances with leading corporations in our
     target markets. In general, we seek to advance our compounds into
     later-stage clinical trials before partnering such compounds for rights
     primarily outside the United States so as to retain maximum economic
     benefit to us. We plan to selectively retain partial or full
     commercialization rights to our products in some limited indications in
     certain countries, primarily the United States. An example is our
     co-development and co-promotion options under the Allergan agreement for
     dry eye disease that enables us to retain significant economic benefit in
     this opportunity.

          Develop New Products Outside our Proprietary P2Y Technology Platform.
     Our research focus is to discover new pharmaceutical products that expand
     beyond our P2Y receptor technology. We have internal programs and
     sponsored research and development agreements with universities to
     discover and develop new pharmaceutical products in nonmucosal disorders.

          Protect and Enhance Our Technology Leadership Position. We have a
     substantial intellectual property position related to our technology. We
     intend to continue to pursue an aggressive patent strategy to protect our
     expanding proprietary discoveries.

                                      5

<PAGE>

PRODUCT DEVELOPMENT PROGRAMS

     The following table provides a summary of our development programs by
indication, development status and corporate partners.

<TABLE>
<CAPTION>
================================================================================================================
     Indication             Product Candidate          Development Status                Corporate Partners
================================================================================================================
<S>                    <C>                       <C>                                 <C>
Ophthalmic
----------------------------------------------------------------------------------------------------------------
  Dry eye              INS365 Ophthalmic         Phase III underway in               Santen (Asia);
                                                 U.S.; Phase I completed in Japan    Allergan
                                                                                     (Worldwide, except Asia)
----------------------------------------------------------------------------------------------------------------
  Retinal disease      INS37217                  Phase I/II underway in U.S.         None
                       Ophthalmic
----------------------------------------------------------------------------------------------------------------
Respiratory
----------------------------------------------------------------------------------------------------------------
  Diagnostic aid for   INS316 Diagnostic         Phase III underway in U.S.          Kirin (Asia);
  lung disease                                                                       Uncommitted outside Asia
----------------------------------------------------------------------------------------------------------------
  Cystic fibrosis      INS37217                  Phase II planned to start in 2002   None
                       Respiratory
----------------------------------------------------------------------------------------------------------------
  Chronic bronchitis   INS365 Respiratory        Phase I/II dose ranging             Kissei (Japan); Uncommitted
                                                 underway in U.S.; Phase I           outside Asia
                                                 completed in Japan
----------------------------------------------------------------------------------------------------------------
  Upper Respiratory    INS37217                  Phase II planned to start in 2002   None
  Disorders            Intranasal
================================================================================================================
</TABLE>

     See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations - Years Ended December 31, 2001,
2000 and 1999 -- Costs and Expenses" below for a discussion of the costs and
expenses associated with our research and development programs.

     INS365 Ophthalmic for Dry Eye Disease

     INS365 Ophthalmic is being developed as a topical eye drop for the
treatment of dry eye disease. A series of good laboratory practice ocular
toxicology studies have been completed to support the ongoing clinical program.
In preclinical testing, topically applied INS365 Ophthalmic produced a
consistent, statistically significant increase in tear secretion, relative to
that produced by normal saline controls. INS365 Ophthalmic has also enhanced
mucin secretion on the ocular surface in several preclinical models. Many of
these studies were conducted by our Asian partner, Santen. The preclinical
study results were statistically significant in multiple relevant dry eye
models.

     We have completed one Phase I clinical trial in 50 healthy subjects and
demonstrated good ocular safety and tolerability. We also completed a Phase IIa
study in 35 patients with mild to moderate dry eye, which showed the product
candidate to be well tolerated in the target patient population. In the fall of
2000 we completed a multi-center Phase II clinical trial. This study enrolled
158 patients with dry eye disease. Patients were treated with multiple-daily
doses of placebo (saline drops) or INS365 Ophthalmic for up to six weeks.
Clinical efficacy measures included both objective and subjective parameters
for measuring ocular surface health. The results of this study were positive
and based on these results a large-scale Phase III program was initiated in
2001 in the United States. The Phase III program included two studies with
approximately 1,100 patients. The studies were placebo-controlled,
double-masked and designed to compare the safety and efficacy of two
concentrations of INS365 Ophthalmic to placebo. In January 2002, preliminary
efficacy results from the first Phase III study indicated that INS365
Ophthalmic did not meet the primary efficacy endpoint. Patient improvement on
INS365 was observed. However, patients on placebo showed improvement of similar
magnitude. A thorough analysis of the subgroups and secondary parameters from
this study is underway. The second Phase III study is ongoing, and efficacy
results are expected in the second quarter of 2002.

     In December 1998, we entered into a joint development, license and supply
agreement with Santen in Asia. Santen is a premier ophthalmic company and
markets the only approved prescription product for dry eye disease in Japan.
Santen has filed an

                                      6

<PAGE>

IND with Japanese regulatory authorities and has begun Phase I testing in
Japan. In June 2001, we entered a joint license, development and marketing
agreement with Allergan, Inc. Allergan is a global healthcare company providing
eyecare and specialty pharmaceutical products worldwide. See "--Corporate
Collaborations."


     INS37217 Ophthalmic for Retinal Disease

     INS37217 Ophthalmic is being developed as an intra-ocular injection for
the treatment of retinal disease. INS37217 Ophthalmic is a second generation
P2Y2 receptor agonist. In numerous preclinical studies INS37217 Ophthalmic has
been shown to enhance the reabsorption of fluid across the RPE and thus
stimulate the removal of fluid from the subretinal space.

     In 2001 we initiated a Phase I/II clinical study of INS37217 Ophthalmic.
The study was designed to evaluate the safety and ability to stimulate the
reabsorption of subretinal fluid and to facilitate reattachment in patients
suffering from retinal detachments. Once the Phase I/II study is completed,
which is expected in 2002, we will assess the next steps in the program based
on the study results.


     INS316 for Respiratory Diagnostics

     INS316 Diagnostic, a P2Y2 agonist with a short duration of action, is
being developed as an acute-use inhaled solution to stimulate enhanced
clearance of mucus from the lungs to provide a deep-lung sputum sample for
diagnosing lung disease and infections. We have conducted four clinical trials
to evaluate INS316 Diagnostic's utility as an acute use agent. These clinical
studies have demonstrated that INS316 Diagnostic is well tolerated and appears
to enhance the ability of patients to produce rapidly an adequate deep-lung
specimen. These studies were conducted in healthy volunteers, as well as
chronic smokers and patients with chronic bronchitis who are at a high risk for
developing lung cancer and lung infections. Phase II studies in patients
diagnosed with or suspected of having lung cancer have now been completed.

     INS316 Diagnostic has been administered by inhalation to more than 300
patients, and has been well tolerated in these trials. INS316 Diagnostic's
safety profile is based on studies including non-smokers, smokers, patients
with obstructive lung diseases and patients diagnosed with or suspected of
having lung cancer, and on the results of good laboratory practice,
genotoxicity and 28-day inhalation toxicology studies. We believe that INS316
Diagnostic is rapidly degraded in blood and plasma and so has minimal systemic
absorption. Therefore, the potential for unwanted side effects is minimized.

     These studies have demonstrated that single inhaled doses of INS316
Diagnostic significantly enhance clearing of mucus from the lungs relative to
that following administration of normal saline solution. These effects occurred
within a few minutes following dosing and were dose-related. Specimens obtained
from individuals exposed to INS316 Diagnostic were found to be highly enriched
with cell types characteristic of deep-lung secretions, including alveolar
macrophages and ciliated epithelial cells, when compared to samples from
individuals exposed to a placebo. In a trial in 25 patients with chronic
bronchitis who are at high risk for lung cancer, 90% of the patients produced
an adequate deep-lung specimen following INS316 Diagnostic inhalation versus
only 25% following inhalation of a placebo. Based on these encouraging results
we initiated Phase III testing with INS316 Diagnostic in 2001. We expect
results of the study in 2003.

     In September 2000, we entered into a licensing agreement with Kirin.
Pursuant to this agreement Kirin has obtained rights to develop and
commercialize INS316 Diagnostic in 21 Asian countries and regions, including
Japan. See "--Corporate Collaborations." Kirin has an ongoing Phase I study in
Japan. Kirin is awaiting on our Phase III results in the United States before
moving ahead with further clinical development plans in Japan.


     INS37217 Respiratory for Cystic Fibrosis

     INS37217 Respiratory is a second-generation P2Y2 agonist with an extended
duration of action. This product is highly stable in the mucous secretions of
cystic fibrosis patients, making it an attractive product candidate for this
disease. The previous studies we have conducted with INS365 Respiratory provide
the scientific rationale for the use of INS37217 Respiratory for cystic
fibrosis. We completed all necessary preclinical studies for initial clinical
testing and in the fall of 2000 filed an IND in the United States. We initiated
and completed a Phase I clinical trial for the development of INS37217
Respiratory for cystic fibrosis in late 2000. In 2001 we initiated a Phase I/II
study which is ongoing, and results are expected in the first half of 2002. We
intend to initiate a Phase II program in 2002. We intend to develop INS37217
Respiratory for cystic fibrosis as a chronic use agent in an inhaled delivery
form.

                                      7

<PAGE>

     INS37217 Respiratory is designed to enhance the lung's innate mucosal
hydration and mucociliary clearance mechanisms, which in cystic fibrosis
patients are impaired by a genetic defect. By hydrating airways and stimulating
mucociliary clearance through stimulation of the P2Y2 receptor, we expect that
INS37217 Respiratory will help keep the lungs of cystic fibrosis patients clear
of thickened mucus, reducing infections and the damage that occurs as a
consequence of the retention of thick and tacky infected secretions. We further
believe that these effects may result in reduced frequency and length of
hospitalizations, reduced need for antibiotics and other medications, reduced
deterioration of respiratory function, and improved respiratory symptoms and
health status. In addition, this product is expected to be complementary with
the two approved products, Pulmozyme(R) and TOBI(R), neither of which affects
the underlying ion-transport defects in cystic fibrosis airways.


     INS365 Respiratory for Chronic Bronchitis

     INS365 Respiratory is being developed as an inhaled form for the treatment
of chronic bronchitis. We have completed five Phase I/II clinical trials of
INS365 Respiratory. These trials have evaluated the safety and preliminary
efficacy of INS365 Respiratory in healthy volunteers, chronic smokers who are
at a high risk for developing chronic bronchitis and cystic fibrosis patients
with airflow obstruction. These studies have indicated that INS365 Respiratory
was well tolerated and significantly enhanced mucus clearance when compared to
placebo. One of these studies, conducted in 35 chronic smokers, indicated that
INS365 Respiratory in single inhaled doses significantly enhanced clearing of
mucus from the lungs, which occurred rapidly following dosing. This effect was
dose-related and was significantly greater than mucus cleared from lungs
following inhalation of a saline placebo; the results were statistically
significant. We have conducted a series of good laboratory practice toxicology
studies, including 28-day inhalation studies, which, together with the Phase I
data, have allowed us to progress INS365 Respiratory into a Phase II program.

     In February 2001 we initiated a Phase II clinical study in patients with
chronic bronchitis. In April 2001 we suspended enrollment of the Phase II
program due to dosing and protocol design issues. An additional Phase I/II
dose-ranging trial is currently underway. Plans for reinitiation of the Phase
II trial are currently under review, though this trial is not expected to begin
in 2002.

     In September 1998, we entered into a joint development, license and supply
agreement with Kissei through which Kissei received exclusive rights to develop
and market INS365 Respiratory for respiratory therapeutic indications in Japan.
See "--Corporate Collaborations." Kissei, our partner in Japan, filed a
Japanese IND for INS365 Respiratory in December 1999 and has completed an
initial Phase I clinical trial in smokers and non-smokers. This study
demonstrated safety and tolerability in the subject population. Kissei is
awaiting the results of our Phase I/II dose-ranging trial before moving ahead
with further clinical programs.


     INS37217 Intranasal for Upper Respiratory Disorders

     INS37217 Intranasal is being developed to treat upper respiratory tract
disorders that are characterized by impaired mucociliary clearance and nasal
symptoms. We believe that increasing mucociliary clearance in the nose and
sinuses with INS37217 Intranasal may be beneficial for treating a variety of
upper respiratory conditions. Clinical studies with other P2Y2 agonists such as
INS316 have already shown that these agents open ion channels in the nasal
mucosa that hydrates the surface. We expect that INS37217 Intranasal will also
stimulate mucociliary clearance in the nasal passages and sinuses.

     We have recently completed a Phase I study of INS37217 Intranasal in
healthy subjects and in patients with a history of chronic rhinitis. The study
was designed to evaluate the tolerability of INS37217 and the potential to
improve mucociliary clearance in the upper airways. We plan to initiate the
Phase II program in 2002.


Corporate Collaborations


     Allergan, Inc.

     In June 2001, we entered into a joint license, development and marketing
agreement with Allergan to develop and commercialize two novel therapeutic
treatments for dry eye, INS365 Ophthalmic and Restasis(R). Under the terms of
the agreement, Allergan obtained an exclusive license to develop and
commercialize INS365 Ophthalmic worldwide, with the

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<PAGE>

exception of Japan and nine other Asian countries covered by Inspire's agreement
with Santen. In return, Inspire will receive up to $39 million in up-front and
milestone payments, a co-promotion option for INS365 Ophthalmic in the United
States and royalty payments based on net sales. In addition, Inspire can receive
royalties on global net sales of Allergan's Restasis(R), excluding sales in
Japan, Taiwan, Korea, Hong Kong and Peoples Republic of China markets. The
agreement also provides for potential co-promotion by Inspire of INS365
Ophthalmic and Restasis(R) and one or more of Allergan's other marketed products
in the United States.

     We have established a joint development committee with Allergan to oversee
the joint development programs and a joint commercial committee to establish
the brand strategies and manage the relationship. Under the terms of the
agreement, we provide bulk active drug substance through the end of Phase III.
After Phase III, Allergan is responsible for obtaining or manufacturing all of
its bulk active drug substance requirements and for all commercial supply of
product.

     We are responsible for conducting, in collaboration with Allergan, the
Phase III clinical trials for INS365 Ophthalmic for dry eye and for United
States new drug application ("NDA") filing and approval. Allergan is
responsible for all other development activities under the agreement, including
all development outside the United States and in their territories, and for
ex-United States regulatory submissions, filings and approvals relating to
products. Allergan is required to use commercially reasonable efforts to
conduct development, seek regulatory approvals and market and sell the products.

     The agreement will be in effect until all patents licensed under the
agreement have expired. Either Allergan or we may terminate the agreement in
the event of a material breach of the agreement. In addition, Allergan has the
right, by giving us 180 days prior notice, to terminate the agreement at any
time. If Allergan breaches the agreement or terminates the agreement early,
other than for our breach, Allergan's license will terminate. Allergan must
provide us with all data and information relating to our product, and Allergan
must assign or permit us to cross-reference all regulatory filings and
approvals.


     Kissei Pharmaceutical Co., Ltd.

     In September 1998, we entered into a Joint Development, License and Supply
Agreement with Kissei for the development of INS365 Respiratory for all
therapeutic respiratory applications, excluding sinusitis and middle ear
infection, in Japan. We granted Kissei an exclusive license to INS365
Respiratory in the field in Japan and a first right to negotiate a license to
particular P2Y2 agonists that show utility as inhalation products for
respiratory uses in Japan.

     We established a joint development committee with Kissei to oversee the
development program, approve development plans, protocols and studies, and
review and approve all regulatory submissions and filings. In consultation with
Kissei, we are responsible for formulation of the compound and the design of the
delivery system to be used. We are also responsible, through the use of
development and manufacturing liaisons, for coordinating and facilitating
communications among our corporate partners for the worldwide development and
manufacture of INS365 Respiratory. Kissei is responsible for all development of
the compound and all regulatory filings.

     We received an up-front payment of $4.5 million in 1998, which included the
purchase of shares of our preferred stock, which subsequently converted into
shares of our common stock. In addition, depending on whether all milestones are
met, we could receive additional payments of up to $13.0 million, as well as
royalties on net sales of licensed products. To date, we have received $2.1
million in milestone payments.

     We are obligated to supply Kissei with its requirements of INS365
Respiratory bulk drug substance reimbursed at cost. In addition, we are
obligated to supply Kissei with its requirements of finished product contained
in a vial or nebule and in a delivery system approved by the joint development
committee for all clinical trials to be conducted by Kissei. Kissei will pay us
an agreed-upon transfer price for all such supplies. We have also agreed to
negotiate a commercial supply arrangement with Kissei at the appropriate time to
supply Kissei's requirements of finished product and the delivery system.

     The agreement will terminate when all patents licensed under the agreement
have expired. Either Kissei or we may terminate the agreement if the other
materially breaches the agreement. In addition, Kissei has the right, by giving
us three months prior notice, to terminate the agreement at any time if Kissei
determines that continued development or marketing of the product is
scientifically or economically infeasible. If Kissei breaches the agreement or
terminates the agreement early other than for our breach, Kissei's license will
terminate. Kissei will provide us with all data and information relating to our
products, and Kissei will assign or permit us to cross-reference all regulatory
filings and approvals.

                                      9

<PAGE>

     Santen Pharmaceutical Co., Ltd.

     In December 1998, we entered into a Development, License and Supply
Agreement with Santen for the development of INS365 Ophthalmic for the
therapeutic treatment of ocular surface diseases, such as dry eye disease, in
Asia. Under the agreement, we granted Santen an exclusive license to market
INS365 Ophthalmic for ocular surface diseases in Japan, China, South Korea, the
Philippines, Thailand, Vietnam, Taiwan, Singapore, Malaysia and Indonesia.

     We established a coordinating committee to review and evaluate Santen's
progress in the development and commercialization of products. Santen is
responsible for all development, regulatory submissions, filings and approvals,
and all marketing of products. We are obligated to supply Santen with its
requirements of INS365 Ophthalmic in bulk drug substance form for all
preclinical studies, clinical trials and commercial requirements at agreed-upon
prices.

     Under the terms of the agreement, we received an up-front equity
investment of $1.5 million in shares of our preferred stock in December 1998,
which subsequently converted into shares of our common stock. In addition,
depending on whether all milestones are met, we could receive additional
payments of up to $4.75 million, as well as royalties on net sales of licensed
products. No milestone payments were received under the Santen Agreement during
2001 or 1999. During 2000, the Company received a milestone payment under the
Santen Agreement of $500,000 based on achievement of a regulatory milestone by
Santen.

     The agreement will terminate when all patents licensed under the agreement
have expired. Either Santen or we may terminate the agreement if the other
materially breaches the agreement. In addition, we have the right to terminate
the agreement at any time if we determine, subject to the coordinating
committee's review and arbitration, that Santen has not made reasonably
sufficient progress in the development or commercialization of products. If
Santen breaches the agreement, or if we terminate the agreement because Santen
has not made sufficient progress, Santen's license will terminate. Santen will
provide us with all data and information relating to our products, and will
assign or permit us to cross-reference all regulatory filings and approvals.


     Kirin Brewery Co., Ltd. Pharmaceutical Division

     In September 2000, we entered into a License Agreement with Kirin for the
development and commercialization of INS316 Diagnostic. Under the agreement we
granted Kirin an exclusive license to commercialize INS316 Diagnostic in 21
Asian countries and regions, including Japan.

     We established a coordinating committee to review and evaluate Kirin's
progress in the development and commercialization of a product and to provide
input and recommendations regarding development of the products. Kirin is
responsible for all development regulatory submissions, filings and approvals
and all marketing of the products. We are responsible for providing Kirin
copies of preclinical and clinical data relating to the development and
commercialization of the products. Under the terms of the agreement, we
received an upfront payment in cash and will receive milestone payments based
on clinical success and approval.

     The agreement will terminate as to a product on the later of the 10th
anniversary of the first commercial sale of the product or the date on which
the sale of the product ceases to be covered by a licensed clause under the
agreement. Either Kirin or we may terminate the agreement if the other
materially breaches the agreement. In addition, Kirin has the right, by giving
us 180 days prior notice, to terminate the agreement at any time.


     Genentech, Inc.

     In December 1999, we entered into a collaboration with Genentech to
develop treatments for respiratory disorders, including chronic bronchitis,
cystic fibrosis and sinusitis. Under the terms of the agreement, we granted an
exclusive license to Genentech for the use of INS365 Respiratory and our other
related P2Y2 agonists existing on the date of the agreement for all human
therapeutic uses for the treatment of respiratory tract disorders throughout
the world, excluding Japan. In June 2001, Genentech notified us that they were
terminating the agreement and returned to us all rights for use of INS365
Respiratory and our other related P2Y2 agonists at no charge. The decision to
return the product rights was based on a strategic review by Genentech of its
overall development portfolio. We received in excess of $16 million in equity
and cash payments during our collaboration.

                                      10

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Discovery

     Our scientists have specific expertise and proprietary knowledge relating
to the design and synthesis of P2Y receptor agonists and antagonists, and we
have invested in state-of-the-art equipment and laboratory space for performing
synthetic chemistry, determination of compound structure and receptor location
and function identification. Our discovery effort is focused on conducting
studies using cell-based scientific tests that measure biological activities
caused by stimulation or blocking of P2Y receptors, to identify new compounds
that specifically and selectively bind to members of the P2Y receptor family.
The assay enables us to identify agonists and antagonists that act at specific
receptor subtypes and have demonstrated a level of specificity and activity
that merits further investigation. We use data from the assays to design and
synthesize compounds specific to each P2Y receptor subtype which can be
advanced to clinical trials.

     By screening against several P2Y receptor subtypes, we have been able to
identify agonists and/or antagonists that interact preferentially with a
specific receptor subtype. Several proprietary discovery compounds, including
new chemical entities, with promising stability and metabolic profiles, are
being actively explored. We intend to conduct further preclinical development
studies to advance such proprietary compounds to project status, if
appropriate. These compounds will then be targeted to the treatment of new
disease areas, as identified through our strategic planning process.

     We obtain access to chemical libraries through our own proprietary
chemistry, commercial sources and corporate agreements. The chemicals are
screened for both agonist and antagonist activity. Our chemistry department
also assists in the development of analytical protocols used by contract
service organizations for analysis of a drug substance, clinical trials
material and drug stability studies which will be incorporated into IND and NDA
filings.

     We use sponsored research agreements to investigate specific biological
processes to augment our technology platform. We have sponsored research at
major universities, The University of North Carolina at Chapel Hill, Columbia
University, University of Miami and Cardiff University.


Patents and Proprietary Rights

     We believe that the proprietary protection of our product candidates,
processes and know-how is important to the success of our business. We
aggressively file and prosecute patents covering our proprietary technology,
and, if warranted, will defend our patents and proprietary technology. As of
December 31, 2001, we owned or licensed patent rights consisting of 27 issued
U.S. patents, none of which expire before 2011, and numerous pending
applications in the United States and corresponding patents and patent
applications in foreign jurisdictions. We seek patent protection for our
proprietary technology and products in the United States and Canada and in key
commercial European and Asia/Pacific countries and other major commercial
sectors of the world, as appropriate. We intend to seek protection in the
United States and foreign countries for trademarks from time to time. We also
rely upon trade secrets, know-how, continuing technological innovation and
licensing opportunities to develop and maintain our competitive position.

     In March 1995 and September 1998, we entered into two agreements with The
University of North Carolina at Chapel Hill ("UNC") granting us exclusive
worldwide licenses to develop, make, use and sell products based on UNC
patented technology relating to the use of P2Y2 receptor agonists for
respiratory therapeutics, such as INS365 Respiratory, and respiratory
diagnostics, such as INS316 Diagnostic. The U.S. government may have limited
rights in some of this UNC patented technology. We also entered into a third
agreement that granted us a non-exclusive worldwide license to use other UNC
patented technology as a research tool to identify agonists and antagonists for
P2Y receptors. The agreements require us to pay licensing fees upon the
attainment of development milestones and royalties on net sales or a share of
sublicensing income on products covered by the patents. We are also required to
meet due diligence milestones and UNC may terminate the licenses if we fail to
do so. In connection with the licenses, we issued to UNC an aggregate of
326,286 shares of our common stock, of which 128,610 shares have been
transferred to the inventors of the licensed UNC patented technology. We have
also entered into consulting agreements with some of the inventors of these
technologies, all of whom are from The University of North Carolina at Chapel
Hill, including Dr. Richard C. Boucher, one of our founders and a member of our
Board of Directors, M. Jackson Stutts, Kendall Harden and Michael Knowles, in
which they agreed to consult with us regarding their respective fields of
knowledge.

     Additional patent applications have since been filed on discoveries made
in support of such technologies, from research conducted at The University of
North Carolina at Chapel Hill or in our own laboratories. Our sponsored
research agreements, material transfer agreements, and other collaborations
have the potential to result in license agreements with universities,
institutes and businesses. We believe that our patents and licensed patents
provide a substantial proprietary base that will allow us, and our
collaborative partners, to exclude others from conducting our business as
described in this report and as encompassed by our

                                      11

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issued patents and issued patents licensed to us. We cannot be sure, however,
that pending or future applications will issue, that the claims of any patents
which do issue will provide any significant protection of our technology or
that our directed discovery research will yield compounds and products of
therapeutic and commercial value.

     Our competitors or potential competitors may have filed for or have
received U.S. and foreign patents and may obtain additional patents and
proprietary rights relating to compounds, uses and/or processes which may
compete with our product candidates. Accordingly, there can be no assurance
that our patent applications will result in patents being issued or that, if
issued, the claims of the patents will afford protection against competitors
with similar technology, nor can we be sure that others will not obtain patents
that we would need to license or circumvent in order to practice our inventions.


Manufacturing and Supply

     We do not engage in, and do not expect to engage in, the manufacture of
bulk active pharmaceutical ingredient for preclinical, clinical or commercial
purposes. We rely on a contract manufacturing supply agreement with a single
manufacturer, Yamasa Corporation in Choshi, Japan, for the development stage
production of INS316, INS365 and INS37217. We have already obtained clinical
trial grade material of these compounds from Yamasa. In addition, we expect the
same company will supply commercial quantities of INS316, INS365 and INS37217
for both respiratory and ophthalmic applications. We believe Yamasa is capable
of producing sufficient quantities for commercial purposes within current good
manufacturing practices. Should Yamasa not be able to supply us with active
drug substance, we have identified an alternative supplier as backup. We
currently obtain all of our bulk active ingredient for INS316, INS365 and
INS37217 from Yamasa, but the first two are also available from other fine
chemical manufacturers. See "Risk Factors--If we are unable to contract with
third parties for synthesis and manufacturing of our product candidates for
preclinical testing and clinical trials and for large scale manufacturing of
any of our drug candidates, we may be unable to develop or commercialize
products."

     In addition to the bulk active ingredient, our products are made up of
sodium chloride, sodium hydrochloric acid and sterile water, all of which are
readily available from numerous sources. Our products are packaged in unit-dose
vials, which we obtain from Cardinal Health Manufacturing Services - Automatic
Liquid Packaging of Woodstock, Illinois, but these vials are also available
from other commercial filling and packing companies


Competition

     Many drug companies engage in research and development to commercialize
products to treat chronic bronchitis, cystic fibrosis, dry eye disease and
other diseases that we are researching. We compete with these companies for
funding, access to licenses, personnel, third-party collaborators and product
development. Almost all of these companies have substantially greater
financial, marketing, sales, distribution and technical resources and more
experience in research and development, clinical trials and regulatory matters,
than we do. We are aware of existing palliative treatments that will compete
with our products.

     We believe that several major pharmaceutical companies have initiated
research programs to design P2Y receptor agonists or antagonists; however, we
are not aware of any competing P2Y2 receptor agonists that have entered
clinical testing. If successfully developed and commercialized, our products
will compete with existing therapeutics and improved versions of these
treatments.

     The current therapeutic approaches used in the treatment of chronic
bronchitis are palliative and are aimed at reducing airway inflammation,
respiratory infections and airflow obstruction. These approaches include
corticosteroids and other anti-inflammatory agents, bronchodilators and
antibiotics. We are aware of many anti-inflammatory agents, including
Azmacort(R), Beclovent(R), Flovent(R) and antibiotics such as Biaxin(R) and
Zithromax(R). We believe that other anti-inflammatory agents are in
development. Numerous bronchodilators are also on the market, including among
others generic albuterol, Alupent(R), Proventil(R), Ventolin(R), Serevent(R),
and Theo-Dur(R). Outside of the United States, mucolytics, agents that liquefy
or reduce the viscoelastic consistency of mucus, are widely used even though
they have shown minimal efficacy in well-controlled trials.

     Although we believe that none of the therapeutic approaches described
above address the underlying problem of excessive retained mucus and impaired
mucociliary clearance, drugs based on other therapeutic mechanisms may be
efficacious in treating respiratory diseases. The development by others of
treatments that are not related to our mucociliary clearance approach could
render our product candidates non-competitive or obsolete.

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     There are two products approved in the United States specifically for the
treatment of cystic fibrosis: Pulmozyme(R), an agent designed to break up
thickened airway secretions, and TOBI(R), an inhaled antibiotic.

     The current prescription and non-prescription treatments for dry eye
disease include artificial tear replacement therapy or lubricant drops. To our
knowledge, INS365 Ophthalmic and Restasis(R) are the only prescription
pharmacological agents in late-stage clinical trials for dry eye. We are aware
of early clinical trials with various other potential products as possible
alternative modes of therapy.

     There are no prescription therapies available to treat colds, allergic
rhinitis or rhinosinusitis, which significantly increase mucociliary clearance.
Other therapies that are used to treat the symptoms of colds, allergic rhinitis
or rhinosinusitis include antihistamines, antibiotics, decongestants and
anti-inflammatory steroids. There are numerous antihistamines and decongestants
on the market. Two marketed anti-inflammatory steroidal agents are Flonase(R)
and Nasonex(R). We believe that other intra-nasal steroids are in development.
There are also antivirals in clinical development to treat colds, including
Picovir(R).


Governmental Regulation

     The research, development, testing, manufacture, promotion, marketing and
distribution of human therapeutic and diagnostic products are extensively
regulated by government authorities in the United States and other countries.
In the United States, the FDA regulates drugs and diagnostic products and
similar regulatory bodies exist in other countries. The steps ordinarily
required before a new drug may be marketed in the United States, which are
similar to steps required in most other countries, include:

     .    preclinical laboratory tests, preclinical studies in animals and
          formulation studies and the submission to the FDA of an IND for a
          new drug;

     .    adequate and well-controlled clinical trials to establish the
          safety and efficacy of the drug for each indication;

     .    the submission of an NDA to the FDA; and

     .    FDA review and approval of the NDA before any commercial sale or
          shipment of the drug.

     Preclinical tests include laboratory evaluation of product toxicity and
formulation, as well as animal studies. The results of preclinical testing are
submitted to the FDA as part of an IND. A 30-day waiting period after the
filing of each IND is required before the commencement of clinical testing in
humans. At any time during this 30-day period or later, the FDA may halt
proposed or ongoing clinical trials until the FDA authorizes trials under
specified terms. The IND process may be extremely costly and substantially
delay development of our products. Moreover, positive results of preclinical
tests will not necessarily indicate positive results in clinical trials.

     Clinical trials to support NDAs are typically conducted in three
sequential phases, but the phases may overlap. During Phase I, the initial
introduction of the drug into healthy human subjects or patients, the drug is
tested to assess metabolism, pharmacokinetics and pharmacological actions and
safety, including side effects associated with increasing doses. Phase II
usually involves studies in a limited patient population to:

     .    assess the efficacy of the drug in specific, targeted indications;

     .    assess dosage tolerance and optimal dosage; and

     .    identify possible adverse effects and safety risks.

     If a compound is found to be potentially effective and to have an
acceptable safety profile in Phase II evaluations, Phase III trials, also
called pivotal studies, major studies or advanced clinical trials, are
undertaken to further demonstrate clinical efficacy and to further test for
safety within an expanded patient population at geographically dispersed
clinical study sites.

     After successful completion of the required clinical testing, generally a
NDA is submitted. The FDA may request additional information before accepting a
NDA for filing, in which case the application must be resubmitted with the
additional information. Once the submission has been accepted for filing, the
FDA has 180 days to review the application and respond to the applicant. The
review process is often significantly extended by FDA requests for additional
information or clarification. The FDA may refer the NDA to an appropriate
advisory committee for review, evaluation and recommendation as to whether the
application should be approved, but the FDA is not bound by the recommendation
of an advisory committee.

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     If FDA evaluations of the NDA and the manufacturing facilities are
favorable, the FDA may give us either an approval letter or an approvable
letter. An approvable letter will usually contain a number of conditions that
must be met in order to secure final approval of the NDA and authorization of
commercial marketing of the drug for particular indications. The FDA may refuse
to approve the NDA or give us a non-approvable letter, outlining the
deficiencies in the submission and often requiring additional testing or
information. If regulatory approval of a product is granted, it will be limited
to particular disease states or conditions.

     We and any of our contract manufacturers are also required to comply with
the applicable FDA current good manufacturing practice regulations. Good
manufacturing practice regulations include requirements relating to quality
control and quality assurance as well as the corresponding maintenance of
records and documentation. Manufacturing facilities are subject to inspection
by the FDA. These facilities must be approved before we can use them in
commercial manufacturing of our products. Our contract manufacturers or we may
not be able to comply with the applicable good manufacturing practice
requirements and other FDA regulatory requirements.

     Outside the United States, our ability to market our products will also
depend on our receipt of marketing authorizations from the appropriate
regulatory authorities. The requirements governing the conduct of clinical
trials and marketing authorization vary widely from country to country. At
present, foreign marketing authorizations are applied for at a national level,
although within Europe procedures are available to companies wishing to market
a product in more than one European Union member state. If the regulatory
authority is satisfied that adequate evidence of safety, quality and efficacy
has been presented, a marketing authorization will be granted. This foreign
regulatory approval process, including those in Europe and Japan, involves all
of the risks associated with FDA clearance discussed above.


Employees

     As of December 31, 2001, we had 56 full-time employees, 20 of whom were
involved in our drug discovery and preclinical programs, 22 of whom were
engaged in development programs, and 14 of whom were involved in administrative
activities. In addition, we utilize part-time employees and outside contractors
and consultants as needed. Employees are required to execute a confidentiality
and assignment of trade secrets agreement. Our employees are not represented by
a labor union.

Scientific Advisory Board

     We are advised by an international scientific advisory board currently
composed of eight members with expertise in the fields of statistics, molecular
biology, genetic research and medicine. We meet periodically with our
scientific advisory board to review and discuss specific projects with those
members who are experts in the subjects being discussed. In addition, we may
consult individual board members as to matters in their respective areas of
expertise. Our scientific advisory board currently is composed of the following
individuals:

          Richard Boucher, M.D. and Benjamin R. Yerxa, Ph.D. are Co-Chairmen of
     the Scientific Advisory Board. See "Management--Executive Officers and
     Directors."

          Dennis Ausiello, M.D. is Chief of Medicine at Massachusetts General
     Hospital and Professor of Medicine at Harvard Medical School. He is an
     internationally recognized expert in the cell biology of ATP receptors,
     sodium ion channels and water channels.

          Carol Basbaum, Ph.D. is Professor of Anatomy at the University of
     California at San Francisco and is an expert in lung mucin production.
     Her interests focus on both the biology of the mucin secretory cell in
     the lung and the regulation of mucin gene expression. A particular
     interest has been bacterial pathogen-mucin gene regulatory interactions.

          Geoffrey Burnstock, D.Sc. is Director, Autonomic Neuroscience
     Institute, and Professor, Department of Anatomy and Developmental Biology,
     Royal Free Hospital School of Medicine. He originally conceived the idea
     of purinergic nerves and receptors for extracellular adenine nucleotides.
     He is the leader of the purinergic receptor field. He is the recipient of
     many international awards and is a fellow of the Royal Society.

          Mark Leppert, Ph.D. is Associate Professor, Eccles Institute of Human
     Genetics, University of Utah. He is a geneticist/molecular biologist. He
     is a central figure in the internationally recognized University of Utah
     human genome effort. His particular interest is mapping human diseases to
     define the molecular basis of human disease.

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     Lee Limbird, Ph.D. is Associate Vice Chancellor for Research, Vanderbilt
University Medical Center, Professor of Pharmacology and Chair, Department of
Pharmacology Vanderbilt University. Her research has focused on the structure
and function of G-protein coupled receptors with particular emphasis on
adrenergic receptors. A current interest is delineation of the molecular basis
of membrane targeting of receptors in polarized cells. She was awarded the John
Jacob Abel Award given to the most outstanding young pharmacologist in 1987.

     David Westfall, Ph.D. is Vice President, Academic Affairs, University of
Nevada-Reno and Professor of Pharmacology, University of Nevada School of
Medicine. He has been a leader in physiological and pharmacological studies of
purinergic receptors for the last two decades. His research includes a major
interest in purinergic receptors in the nervous system and on smooth muscle of
the urinary tract.


Risk Factors

     An investment in the shares of our common stock involves a substantial
risk of loss. You should carefully read this entire report and should give
particular attention to the following risk factors. You should recognize that
other significant risks may arise in the future, which we cannot foresee at
this time. Also, the risks that we now foresee might affect us to a greater or
different degree than expected. There are a number of important factors that
could cause our actual results to differ materially from those indicated by any
forward-looking statements in this document. These factors include, without
limitation, the risk factors listed below and other factors presented
throughout this document and any other documents filed by us with the
Securities and Exchange Commission.

IF OUR PRODUCTS FAIL IN CLINICAL STUDIES, WE WILL BE UNABLE TO OBTAIN FDA
APPROVAL AND WILL NOT BE ABLE TO SELL THOSE PRODUCTS.

     To achieve profitable operations, we must, alone or with others,
successfully identify, develop, introduce and market proprietary products. Even
if we identify potential products, we will have to conduct significant
additional development activities and preclinical and clinical tests, and
obtain regulatory approval before our products can be commercialized. Product
candidates that may appear to be promising at early stages of development may
not successfully reach the market for a number of reasons. We have not
submitted any products for marketing approval by the U.S. Food and Drug
Administration (FDA) or any other regulatory body.

     Generally, all of our product candidates are in research or preclinical
development, with only six, INS365 Ophthalmic, INS316 Diagnostic, INS37217
Respiratory, INS365 Respiratory, INS37217 Intranasal, and INS37217 Ophthalmic
currently in clinical trials. The results of preclinical and initial clinical
testing of our products under development may not necessarily indicate the
results that will be obtained from later or more extensive testing. Companies
in the pharmaceutical and biotechnology industries have suffered significant
setbacks in advanced clinical trials, even after obtaining promising results in
earlier trials. Our ongoing clinical studies might be delayed or halted for
various reasons, including:

     .    the drug is not effective, or physicians think that the drug is not
          effective;

     .    the drug effect is not statistically significant compared to placebo;

     .    patients experience severe side effects during treatment;

     .    patients die during the clinical study because their disease is too
          advanced or because they experience medical problems that may or may
          not relate to the drug being studied;

     .    patients do not enroll in the studies at the rate we expect;

     .    drug supplies are not sufficient to treat the patients in the studies;
          or

     .    we decide to modify the drug during testing.

BECAUSE OUR PRODUCT CANDIDATES UTILIZE A NEW MECHANISM OF ACTION, OBTAINING
REGULATORY APPROVAL MAY BE DIFFICULT, EXPENSIVE AND PROLONGED, WHICH WOULD
DELAY ANY MARKETING OF OUR PRODUCTS.

     We cannot apply for regulatory approval to market a product candidate
until we successfully complete pivotal clinical trials for the product. To
complete successful clinical trials, the products must meet the criteria for
clinical approval, or endpoints, which we establish for the product in the
clinical study.

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     Generally, we will establish these endpoints in consultation with the
regulatory authorities, following design guidelines on the efficacy, safety and
tolerability measures required for approval of products.

     Because our existing product candidates utilize a new approach to the
treatment of respiratory and eye diseases, we may have trouble establishing
endpoints that the regulatory authorities agree sufficiently evaluate the
effectiveness of each product candidate. For this and other reasons, we could
encounter delays and increased expenses in our clinical trials if the
regulatory authorities determine that the endpoints established for a clinical
trial do not predict a clinical benefit, and the authorities will not approve
the product for marketing without further clinical trials. The regulatory
authorities could change their view on clinical trial design and establishment
of appropriate standards for efficacy, safety and tolerability and require a
change in study design, additional data or even further clinical trials before
approval of a product candidate.

     After initial regulatory approval, regulatory authorities continue to
review a marketed product and its manufacturer. They may require us to conduct
long-term safety studies after approval. Discovery of previously unknown
problems through adverse event reporting may result in restrictions on the
product, including withdrawal from the market. Additionally, we and our
officers and directors could be subject to civil and criminal penalties.

IF PHYSICIANS AND PATIENTS DO NOT ACCEPT OUR PRODUCT CANDIDATES, THEY MAY NOT
BE COMMERCIALLY SUCCESSFUL.

     Even if regulatory authorities approve our product candidates, those
products may not be commercially successful. Acceptance of and demand for our
products will depend largely on the following:

     .    acceptance by physicians and patients of our products as safe and
          effective therapies;

     .    reimbursement of drug and treatment costs by third-party payors;

     .    safety, effectiveness and pricing of alternative products; and

     .    prevalence and severity of side effects associated with our products.

     In addition, to achieve broad market acceptance of our product candidates,
in many cases we will need to develop, alone or with others, convenient methods
for administering product candidates. Physicians have administered our current
product candidates for the treatment or diagnosis of respiratory disorders,
INS365 Respiratory, INS316 Diagnostic and INS37217 Respiratory, using a jet
nebulizer, a device that generates and delivers a fine mist derived from a
liquid, which is inhaled into the lungs, in their respective clinical studies.
Although the use of a jet nebulizer is an effective and well accepted means for
administering products for inhalation with respect to acute use and, to a
lesser degree, chronic use, we believe more convenient methods of delivery and
administration, such as a hand-held inhalation device, may be necessary in the
case of INS365 Respiratory and INS37217 Respiratory, to more fully address
chronic use. INS37217 Intranasal is administered through a nasal mist pump.
Patients may find the pump difficult to operate. Our current product candidate
for the treatment of dry eye disease, INS365 Ophthalmic, is applied from a vial
containing a single dose of medication. Patients may prefer to purchase the
medication in a bottle containing a sufficient quantity of medication for
multiple doses. We have not yet established a plan to develop a multi-dose
formulation. INS37217 Ophthalmic is administered through an intraocular
injection. Patients may prefer to a have a sustained delivery device. We have
not yet established a plan for a sustained delivery device. Similar challenges
exist in identifying and perfecting convenient methods of administration for
many of our other product candidates.

WE INTEND TO RELY ON THIRD PARTIES TO DEVELOP, MARKET, DISTRIBUTE AND SELL OUR
PRODUCT CANDIDATES AND THOSE THIRD PARTIES MAY NOT PERFORM.

     We do not yet have the ability to independently market, distribute or sell
our products and intend to rely on experienced third parties to perform, or
assist us in the performance of, all of those functions. We may not identify
acceptable partners or enter into favorable agreements with them. If third
parties do not successfully carry out their contractual duties or meet expected
deadlines, we will be unable to obtain required governmental marketing
approvals and will be unable to sell our products.

OUR DEPENDENCE ON COLLABORATIVE RELATIONSHIPS MAY LEAD TO DELAYS IN PRODUCT
DEVELOPMENT AND DISPUTES OVER RIGHTS TO TECHNOLOGY.

     Our business strategy depends to some extent upon the formation of
research collaborations, licensing and/or marketing arrangements. We currently
have development collaborations with four collaborators, Allergan, Kissei,
Santen and Kirin. The

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termination of any collaboration may lead to delays in product development and
disputes over technology rights and may reduce our ability to enter into
collaborations with other potential partners. Allergan has the right, by giving
us 180 days prior notice, to terminate our collaboration. Similarly, Kirin has
the right to terminate our license agreement by giving us 180 days prior notice.
If we do not maintain the Allergan, Kissei, Santen or Kirin collaborations or
establish additional research and development collaborations or licensing
arrangements it will be difficult to develop and commercialize therapeutic or
diagnostic products using our technology. Any future collaborations or licensing
arrangements may not be on terms favorable to us. Our current or any future
collaborations or licensing arrangements ultimately may not be successful. Under
our current strategy, and for the foreseeable future, we do not expect to
develop or market therapeutic or diagnostic products on our own. As a result, we
will continue to depend on collaborators and contractors for the preclinical
study and clinical development of therapeutic products and for regulatory
approval, manufacturing and marketing of therapeutic and diagnostic products
which result from our technology. The agreements with collaborators typically
will allow them some discretion in electing whether to pursue such activities.
If any collaborator were to breach or terminate its agreement with us or
otherwise fail to conduct collaborative activities in a timely and successful
manner, the preclinical or clinical development or commercialization of product
candidates or research programs would be delayed or terminated. Any delay or
termination in clinical development or commercialization would delay or
eliminate potential product revenues relating to our research programs.

     We intend to rely on Allergan, Kissei, Santen, Kirin and any future
collaborators for significant funding in support of our development efforts. If
Allergan, Kissei, Santen or Kirin reduces or terminates its funding, we will
need to devote additional internal resources to product development, scale back
or terminate certain research and development programs or seek alternative
collaborators.

     Disputes may arise in the future over the ownership of rights to any
technology developed with collaborators. These and other possible disagreements
between us and our collaborators could lead to delays in the collaborative
development or commercialization of therapeutic or diagnostic products. Such
disagreement could also result in litigation or require arbitration to resolve.

IF WE ARE UNABLE TO CONTRACT WITH THIRD PARTIES FOR SYNTHESIS AND MANUFACTURING
OF PRODUCT CANDIDATES FOR PRECLINICAL TESTING AND CLINICAL TRIALS AND FOR LARGE
SCALE MANUFACTURING OF ANY OF OUR DRUG CANDIDATES, WE MAY BE UNABLE TO DEVELOP
OR COMMERCIALIZE PRODUCTS.

     We have no experience or capabilities in large scale commercial
manufacturing of any of our product candidates or any experience or capabilities
in the manufacturing of pharmaceutical products generally. We do not generally
expect to engage directly in the manufacturing of products, but instead intend
to contract with others for these services. We have relied upon supply
agreements with third parties for the manufacture and supply or our product
candidates for purposes of preclinical testing and clinical trials. Although we
have previously received preclinical and clinical supplies of our product
candidates from several suppliers, we presently depend upon Yamasa Corporation
as the sole manufacturer of our supply of product candidates. If we are unable
to retain third party manufacturing on commercially acceptable terms, we may not
be able to commercialize products as planned. Our manufacturing strategy
presents the following risks:

     .    the manufacturing processes for most of our product candidates have
          not been tested in quantities needed for commercial sales;

     .    delays in scale-up to commercial quantities and any change to a
          manufacturer other than Yamasa Corporation could delay clinical
          studies, regulatory submissions and commercialization of our products;

     .    manufacturers of our products are subject to the FDA's good
          manufacturing practices regulations and similar foreign standards, and
          we do not have control over compliance with these regulations by
          third-party manufacturers;

     .    if we need to change to manufacturers other than Yamasa Corporation,
          FDA and comparable foreign regulators would require new testing and
          compliance inspections and the new manufacturers would have to be
          educated in the processes necessary for the production of our product
          candidates;

     .    without satisfactory long-term agreements with manufacturers, we will
          not be able to develop or commercialize our product candidates as
          planned or at all; and

     .    we may not have intellectual property rights, or may have to share
          intellectual property rights, to any improvements in the manufacturing
          processes or new manufacturing processes for our product candidates.

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IF WE ARE UNABLE TO SUPPLY KISSEI AND SANTEN WITH SUFFICIENT QUANTITIES OF
MATERIALS WE MAY BREACH OUR AGREEMENTS WITH SUCH PARTIES.

     We are currently a party to a development, license and supply agreement
with each of Kissei and Santen, under which we granted each a license to
develop and market INS365 Respiratory and INS365 Ophthalmic, respectively.
Generally, the agreements with Kissei and Santen will require us to supply such
partners with either sufficient quantities of materials or finished products,
as applicable, for the purpose of commercial distribution. We will need to
establish, alone or with third parties, a manufacturing process in relation to
each product. Our dependence upon third parties for the manufacture of products
may adversely affect our ability to develop and deliver products on a timely
and competitive basis.

     Our inability to successfully manufacture commercial products could result
in our breach of the terms of our agreements with Kissei and Santen. Any of
these factors could delay our preclinical studies, clinical trials or
commercialization of our product candidates, entail higher costs and result in
our inability to effectively sell our product candidates.

IF OUR PATENT PROTECTION IS INADEQUATE, THE DEVELOPMENT AND ANY POSSIBLE SALES
OF OUR PRODUCT CANDIDATES COULD SUFFER OR COMPETITORS COULD FORCE OUR PRODUCTS
COMPLETELY OUT OF THE MARKET.

     Our business and competitive position depends on our ability to continue
to develop and protect our products and processes, proprietary methods and
technology. Except for one patent covering new chemical compounds, most of our
patents are use patents containing claims covering methods of treating
disorders and diseases by administering therapeutic chemical compounds. Use
patents, while providing adequate protection for commercial efforts in the
United States, may afford a lesser degree of protection in European and
possibly other countries due to their particular patent laws. Besides our use
patents, we have patents covering pharmaceutical formulations of these chemical
compounds. We also have patent applications covering processes for large-scale
manufacturing of these chemical compounds. Many of the chemical compounds
included in the claims of our use patents, formulation patents and process
applications were known in the scientific community prior to our formation.
None of our patents cover these previously known chemical compounds themselves,
which are in the public domain. As a result, competitors may be able to
commercialize products that use the same chemical compounds used by us for the
treatment of disorders and diseases not covered by our use patents. In such a
case, physicians, pharmacies and wholesalers could possibly substitute these
products for our products. Such substitution would reduce any revenues received
from the sale of our products.

     We believe that there may be significant litigation in the pharmaceutical
and biotechnology industry regarding patent and other intellectual property
rights. A patent does not provide the patent holder with freedom to operate in
a way that infringes the patent rights of others. While we are not aware of any
patent that we are infringing, nor have we been accused of infringement by any
other party, other companies currently have or may acquire patent rights which
we might be accused of infringing. If we must defend a patent suit, or if we
choose to initiate a suit to have a third party patent declared invalid, we may
need to make considerable expenditures of money and management time in
litigation. A judgment against us in a patent infringement action could cause
us to pay monetary damages, require us to obtain licenses, or prevent us from
manufacturing or marketing the affected products. In addition, we may need to
initiate litigation to enforce our proprietary rights against others, or we may
have to participate in interference proceedings in the United States Patent and
Trademark Office (USTPO) to determine the priority of invention of any of our
technologies.

     In general, the development of patent rights in pharmaceutical,
biopharmaceutical and biotechnology products to a degree sufficient to support
commercial efforts in these areas is typically uncertain and involves complex
legal and factual questions. For instance, while the USPTO has recently issued
guidelines addressing the requirements for demonstrating utility for
biotechnology inventions, USPTO examiners may not follow these guidelines in
examining patent applications. Such applications may have to be appealed to the
USPTO's Appeals Board for a final determination of patentability.

IF WE FAIL TO REACH MILESTONE OR OTHER OBLIGATIONS, THE UNIVERSITY OF NORTH
CAROLINA AT CHAPEL HILL AND OTHER LICENSORS MAY TERMINATE OUR AGREEMENTS WITH
THEM.

     Two of our six current clinical development programs depend on two
exclusive licenses and one non-exclusive license from The University of North
Carolina at Chapel Hill. Generally, if we fail to meet milestones under the
respective UNC licenses, UNC may terminate the applicable license. In addition,
it may be necessary in the future for us to obtain additional licenses from UNC
or other third parties to develop future commercial opportunities or to avoid
infringement of third party patents. We do not know the terms on which such
licenses may be available, if at all.

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     Failure to license or otherwise acquire necessary technologies may reduce
or eliminate our ability to develop product candidates. Even if we acquire all
necessary licenses, if we breach any license provision, either intentionally or
unintentionally, we may lose our right to continued use of the licensed
technology.

BECAUSE WE RELY UPON TRADE SECRETS AND AGREEMENTS TO PROTECT SOME OF OUR
INTELLECTUAL PROPERTY, THERE IS A RISK THAT UNAUTHORIZED PARTIES MAY OBTAIN AND
USE INFORMATION THAT WE REGARD AS PROPRIETARY.

     We rely upon the laws of trade secrets and non-disclosure agreements and
other contractual arrangements to protect our proprietary compounds, methods,
processes, formulations and other information for which we are not seeking
patent protection. We have taken security measures to protect our proprietary
technologies, processes, information systems and data, and we continue to
explore ways to further enhance security. However, despite these efforts to
protect our proprietary rights, unauthorized parties may obtain and use
information that we regard as proprietary. Employees, academic collaborators
and consultants with whom we have entered confidentiality and/or non-disclosure
agreements, may improperly disclose our proprietary information. In addition,
competitors may, through a variety of proper means, independently develop
substantially the equivalent of our proprietary information and technologies,
gain access to our trade secrets, or properly design around any of our patented
technologies.

BECAUSE ALL OF OUR PRODUCT CANDIDATES USE RELATED MECHANISMS OF ACTION, WE MAY
NOT BE ABLE TO COMMERCIALIZE OUR PRODUCTS IF THE MECHANISM OF ACTION IS NOT
EFFECTIVE.

     Any products resulting from our product development efforts are not
expected to be available for sale for at least two years, if at all. Six of our
product candidates, INS365 Ophthalmic, INS365 Respiratory, INS37217
Respiratory, INS316 Diagnostic, INS37217 Intranasal and INS37217 Ophthalmic
operate in a similar manner. If the clinical results of one of the compounds is
not favorable, the results of the other compound may not be favorable.
Moreover, we have designed all of our product candidates to use related
mechanisms of action. If these mechanisms of action are not effective, we may
not be able to commercialize any of our product candidates. Even if all of our
product candidates prove effective, we may choose not to commercialize all of
them.

IF WE CONTINUE TO INCUR OPERATING LOSSES FOR A PERIOD LONGER THAN ANTICIPATED,
OR IN AN AMOUNT GREATER THAN ANTICIPATED, WE MAY BE UNABLE TO CONTINUE OUR
OPERATIONS.

     We have experienced significant losses since inception. We incurred net
losses of $23.1 million for the year ended December 31, 2001, $14.6 million for
the year ended December 31, 2000 and $9.0 million for the year ended December
31, 1999. As of December 31, 2001 our accumulated deficit was approximately
$71.0 million. We expect to incur additional significant operating losses over
the next several years and expect cumulative losses to increase in the
near-term due to expanded research and development efforts, preclinical studies
and clinical trials. We expect that losses will fluctuate from quarter to
quarter and that such fluctuations may be substantial. Such fluctuations will
be affected by the following:

     .    timing of regulatory approvals and commercial sales of our product
          candidates;

     .    the level of patient demand for our products;

     .    timing of payments to and from licensors and corporate partners; and

     .    timing of investments in new technologies.

     No regulatory authorities have approved any of our product candidates for
marketing, and therefore, we are not generating any revenues from product
sales. To achieve and sustain profitable operations, we must, alone or with
others, develop successfully, obtain regulatory approval for, manufacture,
introduce, market and sell our products. The time frame necessary to achieve
market success is long and uncertain. We do not expect to generate product
revenues for at least the next few years. We may not generate sufficient
product revenues to become profitable or to sustain profitability. If the time
required to achieve profitability is longer than we anticipate, we may not be
able to continue our business.

IF WE ARE NOT ABLE TO OBTAIN SUFFICIENT ADDITIONAL FUNDING TO MEET OUR
EXPANDING CAPITAL REQUIREMENTS, WE MAY BE FORCED TO REDUCE OR ELIMINATE
RESEARCH PROGRAMS AND PRODUCT DEVELOPMENT.

     We have used substantial amounts of cash to fund our research and
development activities. In the fiscal year ended December 31, 2001 our
operating expenses exceeded $30.0 million. We expect our capital and operating
expenditures to exceed

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our revenue over the next several years as we conduct our research and
development activities, address possible difficulties with clinical studies and
prepare for commercial sales. Many factors will influence our future capital
needs. These factors include:

     .    the progress of our research programs;

     .    the number and breadth of these programs;

     .    our ability to attract collaborators for our products;

     .    achievement of milestones under our existing collaborations with
          Allergan, Kissei, Santen and Kirin;

     .    our ability to establish and maintain additional collaborations;

     .    progress by our collaborators: Allergan, Kissei, Santen and Kirin;

     .    the level of activities relating to commercialization rights we retain
          in our collaborations;

     .    competing technological and market developments;

     .    the costs involved in enforcing patent claims and other intellectual
          property rights; and

     .    the costs and timing of regulatory approvals.

     We anticipate that our operating expenses will exceed $25.0 million in
2002. We also expect to purchase capital equipment at a cost of approximately
$1.5 million in 2002. We intend to rely on Allergan, Kissei, Santen, Kirin,
future collaborators and the proceeds of our initial public offering for
significant funding in support of our development efforts. In addition, we may
seek additional funding through public or private equity offerings and debt
financings. Additional financing may not be available when needed. If
available, such financing may not be on terms favorable to us or our
stockholders. Stockholders' ownership will be diluted if we raise additional
capital by issuing equity securities. If we raise funds through collaborations
and licensing arrangements, we may have to give up rights to our technologies
or product candidates which are involved in these future collaborations and
arrangements or grant licenses on unfavorable terms. If adequate funds are not
available, we would have to scale back or terminate research programs and
product development.

WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE WITH BIOTECHNOLOGY COMPANIES AND
ESTABLISHED PHARMACEUTICAL COMPANIES.

     The biotechnology and pharmaceutical industries are intensely competitive
and subject to rapid and significant technological change. Our competitors in
the United States and elsewhere are numerous and include, among others, major
multinational pharmaceutical and chemical companies, specialized biotechnology
firms and universities and other research institutions. These competitors
include Abbott, Alcon, Astra Zeneca, Boehringer Ingelheim, Chiron, Genentech,
GlaxoSmithKline, Novartis, and Pfizer. Most of these competitors employ greater
financial and other resources, including larger research and development staffs
and more effective marketing and manufacturing organizations, than we or our
collaborative partners. Acquisitions of competing companies and potential
competitors by large pharmaceutical companies or others could enhance
financial, marketing and other resources available to such competitors. As a
result of academic and government institutions becoming increasingly aware of
the commercial value of their research findings, such institutions are more
likely to enter into exclusive licensing agreements with commercial
enterprises, including our competitors, to market commercial products. Our
competitors may develop technologies and drugs that are safer, more effective
or less costly than any we are developing or which would render our technology
and future drugs obsolete and non-competitive. The products of our competitors
marketed to treat chronic bronchitis include anti-inflammatory products, such
as Azmacort(R), Beclovent(R) and Flovent(R), bronchodilators such as
Atrovent(R), Proventil(R) and Serevent(R), and antibiotics such as Biaxin(R)
and Zithromax(R). Pulmozyme(R) and TOBI(R) are examples of products used to
treat cystic fibrosis. The main current treatments for dry eye disease involve
artificial tear replacement drops. The main current treatments for colds,
allergic rhinitis and rhinosinusitis include antihistamines, antibiotics,
decongestants and anti-inflammatory steroids. Our competitors market
anti-inflammatory steroidal agents, such as Flonase(R) and Nasonex(R). In
addition, alternative approaches to treating diseases which we have targeted,
such as gene therapy, may make our product candidates obsolete. Our competitors
may also be more successful in production and marketing.

     In addition, some of our competitors have greater experience than we do in
conducting preclinical and clinical trials and obtaining FDA and other
regulatory approvals. Accordingly, our competitors may succeed in obtaining FDA
or other regulatory approvals for drug candidates more rapidly than we do.
Companies that complete clinical trials, obtain required regulatory approvals
and commence commercial sale of their drugs before we do may achieve a
significant competitive advantage, including patent and FDA marketing
exclusivity rights that would delay our ability to market products. Drugs
resulting from our research and development efforts, or from our joint efforts
with our collaborative partners may not compete successfully with competitors'

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<PAGE>

existing products or products under development.

FAILURE TO HIRE AND RETAIN KEY PERSONNEL MAY HINDER OUR PRODUCT DEVELOPMENT
PROGRAMS AND OUR BUSINESS EFFORTS.

     We depend on the principal members of management and scientific staff,
including Christy L. Shaffer, Ph.D., our President, Chief Executive Officer and
director; and Gregory J. Mossinghoff, our Senior Vice President, Chief Business
Officer and director. If either of these people leaves us, we may have
difficulty conducting our operations. We have not entered into agreements with
any of the above principal members of our management and scientific staff that
bind any of them to a specific period of employment. Our future success also
will depend in part on our ability to attract, hire and retain additional
personnel skilled or experienced in the pharmaceutical industry. There is
intense competition for such qualified personnel. We may not be able to
continue to attract and retain such personnel.

OUR OPERATIONS INVOLVE A RISK OF INJURY FROM HAZARDOUS MATERIALS, WHICH COULD
BE VERY EXPENSIVE TO US.

     Our research and development activities involve the controlled use of
hazardous materials and chemicals. We cannot completely eliminate the risk of
accidental contamination or injury from these materials. If such an accident
were to occur, we could be held liable for any damages that result and any such
liability could exceed our resources. In addition, we are subject to laws and
regulations governing the use, storage, handling and disposal of these
materials and waste products. The costs of compliance with these laws and
regulations could be substantial.

USE OF OUR PRODUCTS MAY RESULT IN PRODUCT LIABILITY CLAIMS FOR WHICH WE MAY NOT
HAVE ADEQUATE INSURANCE COVERAGE.

     Clinical trials or manufacturing, marketing and sale of our potential
products by our collaborative partners may expose us to liability claims from
the use of those products. Although we carry clinical trial liability
insurance, we currently do not carry product liability insurance. We or our
collaborators may not be able to obtain or maintain sufficient or even any
insurance. If we can, it may not be at a reasonable cost. If we cannot or are
unable otherwise to protect against potential product liability claims, we may
find it difficult or impossible to commercialize pharmaceutical products we or
our collaborators develop. If claims or losses exceed our liability insurance
coverage, we may go out of business.

IF THIRD PARTY PAYORS WILL NOT PROVIDE COVERAGE OR REIMBURSE PATIENTS FOR ANY
PRODUCTS WE DEVELOP, OUR ABILITY TO DERIVE REVENUES WILL SUFFER.

     Our success will depend in part on the extent to which government and
health administration authorities, private health insurers and other third
party payors will pay for our products. Reimbursement for newly approved health
care products is uncertain. In the United States and elsewhere, third party
payors, such as Medicare, are increasingly challenging the prices charged for
medical products and services. Government and other third party payors are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new therapeutic products. In the United
States, a number of legislative and regulatory proposals aimed at changing the
health care system have been proposed in recent years. In addition, an
increasing emphasis on managed care in the United States has and will continue
to increase pressure on pharmaceutical pricing. While we cannot predict whether
legislative or regulatory proposals will be adopted or what effect those
proposals or managed care efforts, including those relating to Medicare
payments, may have on our business, the announcement and/or adoption of such
proposals or efforts could increase our costs and reduce or eliminate profit
margins. Third party insurance coverage may not be available to patients for
any products we discover or develop. If government and other third party payors
do not provide adequate coverage and reimbursement levels for our products, the
market acceptance of these products may be reduced. In various foreign markets,
pricing or profitability of medical products is subject to government control.

OUR EXISTING DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS HOLD A
SUBSTANTIAL AMOUNT OF OUR COMMON STOCK AND MAY BE ABLE TO PREVENT OTHER
STOCKHOLDERS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS.

     Our directors, executive officers and current 5% stockholders and their
affiliates beneficially own over 37% of the common stock as of February 15,
2002. These stockholders, if they act together, may be able to direct the
outcome of matters requiring approval of the stockholders, including the
election of our directors and other corporate actions such as our merger with
or into another company, a sale of substantially all of our assets and
amendments to our amended and restated certificate of incorporation. The
decisions of these stockholders may conflict with our interests or those of our
other stockholders.

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ANTI-TAKEOVER PROVISIONS IN OUR AMENDED AND RESTATED CERTIFICATE OF
INCORPORATION AND BYLAWS, AND OUR RIGHT TO ISSUE PREFERRED STOCK, MAY
DISCOURAGE A THIRD PARTY FROM MAKING A TAKE-OVER OFFER THAT COULD BE BENEFICIAL
TO US AND OUR STOCKHOLDERS.

     Our amended and restated certificate of incorporation and bylaws contain
provisions which could delay or prevent a third party from acquiring shares of
our common stock or replacing members of our board of directors. Our amended
and restated certificate of incorporation allows our board of directors to
issue shares of preferred stock. The board can determine the price, rights,
preferences and privileges of those shares without any further vote or action
by the stockholders. As a result, our board of directors could make it
difficult for a third party to acquire a majority of our outstanding voting
stock.

     Our amended and restated certificate of incorporation provides that the
members of the board will be divided into three classes. Each year the terms of
approximately one-third of the directors will expire. Our bylaws will not
permit our stockholders to call a special meeting of stockholders. Under the
bylaws, only our President, Chairman of the Board or a majority of the board of
directors will be able to call special meetings. The bylaws also require that
stockholders give advance notice to our Secretary of any nominations for
director or other business to be brought by stockholders at any stockholders'
meeting. These provisions may delay or prevent changes of control or management.

     Further, we are subject to the anti-takeover provisions of Section 203 of
the Delaware General Corporation Law. Under this law, if anyone becomes an
"interested stockholder" in the company, we may not enter a "business
combination" with that person for three years without special approval.

     These provisions could discourage a third party from making a take-over
offer and could delay or prevent a change of control.

OUR COMMON STOCK PRICE HAS BEEN HIGHLY VOLATILE AND YOUR INVESTMENT IN OUR
STOCK MAY DECLINE IN VALUE.

     The market price of our common stock has been highly volatile. Factors
that have caused volatility and could cause additional volatility in the market
price of our common stock include among others:

     .    announcements made by us concerning results of our clinical trials
          with INS365 Ophthalmic, INS37217 Ophthalmic, INS316 Diagnostic,
          INS37217 Respiratory, INS365 Respiratory, INS37217 Intranasal and any
          other product candidates;

     .    changes in government regulations;

     .    regulatory actions as a result of their therapeutic approach;

     .    changes in concerns of our collaborators, in particular our
          collaborations with Allergan, Kissei, Santen and Kirin;

     .    developments concerning proprietary rights including patents by us or
          our competitors;

     .    variations in our operating results; and

     .    litigation.

     Extreme price and volume fluctuations occur in the stock market from time
to time and that can particularly affect the prices of biotechnology companies.
These extreme fluctuations are sometimes unrelated to the actual performance of
the affected companies. These broad market fluctuations could result in
significant declines in the market price of our common stock.

FUTURE SALES BY OUR CURRENT STOCKHOLDERS MAY CAUSE OUR STOCK PRICE TO DECLINE.

     Sales of our common stock by our current stockholders in the public market
could cause the market price of our stock to fall. Sales may also make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that our management deems acceptable, or at all. As
of December 31, 2001, there were 25,751,468 shares of common stock outstanding.
Of these outstanding shares of common stock, all of the 6,325,000 shares sold
in our initial public offering are freely tradable, without restriction under
the Securities Act of 1933, as amended, unless purchased by our "affiliates."
The remaining common stock may be resold in the public market only if
registered or if there is an exemption from registration, such as Rule 144
under the Securities Act. Similarly, all of the 3,004,220 shares of our common
stock that were registered pursuant to our registration statement on Form S-8
are, or will be, freely tradable in accordance with such registration statement.

                                      22

<PAGE>

     We may issue additional shares:

     .    to employees, directors and consultants;

     .    in connection with corporate alliances;

     .    in connection with acquisitions; and

     .    to raise capital.

     As a result of these factors, a substantial number of shares of our common
stock could be sold in the public market at any time.

ITEM 2.   PROPERTIES.

     We lease facilities that comprise approximately 24,630 square feet in
Durham, North Carolina adjacent to the Research Triangle Park, through several
leases. The leases expire in October 2002, August 2003, May 2003 and December
2003 and are renewable.

ITEM 3.   LEGAL PROCEEDINGS.

     We are not a party to any material legal proceedings.

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

     Not applicable.

                                      23

<PAGE>

                                    PART II

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

     Our common stock has been traded on the Nasdaq National Market under the
symbol "ISPH" since August 3, 2000. The following table sets forth, for the
calendar periods indicated, the range of high and low sale prices for our
common stock on the Nasdaq National Market:

                             2000                         High      Low
                             ----                         ----      ---

          Third Quarter (commencing August 3, 2000)      $30.63    $13.50
          Fourth Quarter                                 $31.75    $18.00
                             2001
                             ----
          First Quarter                                  $24.31    $ 6.00
          Second Quarter                                 $15.22    $ 6.63
          Third Quarter                                  $13.72    $ 6.99
          Fourth Quarter                                 $15.17    $ 8.00

     As of March 1, 2002, there were 123 record holders of our common stock,
with beneficial stockholders in excess of 400. On March 1, 2002, the last sale
price reported on the Nasdaq National Market for our common stock was $2.27 per
share.

     We have not paid or declared dividends on our common stock since our
inception and do not plan to pay dividends on our common stock in the
foreseeable future. Any earnings that we may realize will be retained to
finance our growth.

     On August 2, 2000, the Securities and Exchange Commission declared a
Registration Statement on Form S-1, as amended (Registration No. 333-31174)
effective, registering 6,325,000 shares of our common stock. The aggregate net
proceeds from the sale of such shares after deduction of expenses were
approximately $69.3 million. Through December 31, 2001, we have used
approximately $25.1 million of the net proceeds of the offering as follows:

          Discovery and research programs                $ 20,035,000
          General and administrative expenses               3,883,000
          Purchase of equipment                               685,000
          Payment of debt                                     529,000
                                                         ------------

          Total                                          $ 25,132,000
                                                         ============

     Except with respect to the compensation of our officers and the
reimbursement of director expenses included in discovery and research programs
and general and administrative expenses, all of the net proceeds of the
offering which have been used to date were payable to parties other than our
directors, officers or their associates of such persons, persons owning ten
percent or more of any class of our equity securities, or our affiliates.
Through December 31, 2001, all of the remaining net proceeds of the offering
were being invested in interest bearing investment grade securities and
certificates of deposit which are classified as available for sale.

                                      24

<PAGE>

Item 6.   Selected Financial Data.

     The selected statement of operations data and balance sheet data with
respect to the years ended December 31, 2001, 2000, 1999, 1998 and 1997 set
forth below are derived from our financial statements which have been audited
by PricewaterhouseCoopers LLP, independent accountants. The selected financial
data set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contained in Item 7 below, and our financial statements and the notes thereto
contained in Item 8 below. Historical results are not necessarily indicative of
our future results.

<TABLE>
<CAPTION>
                                                                 (In thousands, except per share amounts)
                                                                 ----------------------------------------
                                                                        Year Ended December 31,
                                                                        -----------------------
                                                          2001         2000          1999         1998      1997
                                                          ----         ----          ----         ----      ----
<S>                                                     <C>          <C>            <C>         <C>        <C>
Statement of Operations Data:
Revenue                                                 $  7,285     $  5,368       $ 1,104     $   360    $    --
                                                        --------     --------       -------     -------    -------
Operating expenses:
  Research and development (includes $519, $866,
    $516, $68 and $0, respectively, of stock-based
    compensation)                                         28,190       16,353         7,694       5,597      6,569
  General and administrative (includes $687, $678,
    $519, $46 and $0, respectively, of stock-based
    compensation                                           5,882        3,694         2,406       1,967      1,494
                                                        --------     --------       -------     -------    -------
Total operating expenses                                  34,072       20,047        10,100       7,564      8,063
                                                        --------     --------       -------     -------    -------
Operating loss                                           (26,787)     (14,679)       (8,996)     (7,204)    (8,063)
Other income (expense), net                                3,652        1,089           122          36        116
                                                        --------     --------       -------     -------    -------
Loss before provision for income taxes                   (23,135)     (13,590)       (8,874)     (7,168)    (7,947)
Provision for income taxes                                    --          400            60         360         --
                                                        --------     --------       -------     -------    -------
Net loss                                                 (23,135)     (13,990)       (8,934)     (7,528)    (7,947)
Preferred stock dividends                                     --         (594)          (62)         --         --
                                                        --------     --------       -------     -------    -------
Net loss available to common stockholders               $(23,135)    $(14,584)      $(8,996)    $(7,528)   $(7,947)
                                                        ========    ========        =======     =======    =======
Net loss per common share - basic and diluted           $  (0.90)    $  (1.23)      $ (3.75)    $ (3.65)   $ (4.01)
                                                        ========     ========       =======     =======    =======
Weighted average common shares outstanding - basic
    and diluted                                           25,702       11,871         2,401       2,061      1,981
<CAPTION>

                                                                               December 31,
                                                                               ------------
                                                          2001         2000          1999         1998      1997
                                                          ----         ----          ----         ----      ----
<S>                                                     <C>          <C>            <C>         <C>        <C>
Balance Sheet Data:
Cash and cash equivalents                               $ 29,959     $ 35,109       $22,728       4,138    $ 5,826
Total assets                                              60,087       82,993        25,620       5,446      7,229
Convertible preferred stock                                   --           --        45,895      24,467     22,067
Common stock                                                  26           26             2           2          2
Total stockholders' equity                                52,595       74,505        16,034         662      5,544
</TABLE>


Item 7.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations.

     The discussion below contains forward-looking statements regarding our
financial condition and results of operations that are based upon our financial
statements, which have been prepared in accordance with accounting principles
generally accepted within the United States. The preparation of these financial
statements requires Inspire management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. Inspire evaluates its
estimates on an on-going basis. These estimates are based on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances. The results of these estimates form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Our future results, performance or
achievements could differ materially from those expressed in, or implied by,
any such forward-looking statements as a result of certain factors, including,
but not limited to, those discussed in this section as well as in the section
entitled "Risk Factors."

                                      25

<PAGE>

Significant Accounting Policies

     Revenue Recognition

     We recognize revenue under our collaborative research and development
agreements when we have performed services under such agreements or when we or
our collaborative partner has met a contractual milestone triggering a payment
to us. Non-refundable fees received at the initiation of collaborative
agreements for which we have an ongoing research and development commitment are
deferred and recognized ratably over the period of ongoing research and
clinical development commitment. We are also entitled to receive milestone
payments under our collaborative research and development agreements based upon
achievement of development milestones by us or our collaborative partners. We
recognize milestone payments as revenues ratably over the remaining period of
our research and clinical development commitment. The recognition period begins
at the date the milestone is achieved and acknowledged by the collaborative
partner, which is generally at the date payment is received from the
collaborative partner, and ends on the date that we have fulfilled our research
and clinical development commitment. This period is based on estimates by
management and the progress towards milestones in our collaborative agreements.
The estimate is subject to revision as our development efforts progress and we
gain knowledge regarding required additional development. Revisions in the
commitment period are made in the period that the facts related to the change
first become known. This may cause our revenue to fluctuate from period to
period.

     Taxes

     Significant management judgment is required in determining our provision
for income taxes, deferred tax assets and liabilities and any valuation
allowance recorded against net deferred tax assets. We have recorded a
valuation allowance of $30.0 million as of December 31, 2001, due to
uncertainties related to our ability to utilize deferred tax assets, primarily
consisting of certain net operating losses carried forward, before they expire.
The valuation allowance is based on estimates of taxable income in each of the
jurisdictions in which we operate and the period over which our deferred tax
assets will be recoverable. In the event the actual results differ from these
estimates or we adjust these estimates in future periods we may need to
establish an additional valuation allowance which could materially impact our
financial position and results of operations.

Overview

     We were incorporated in October 1993 and commenced operations in March
1995 following our first substantial financing. Since that time, we have been
engaged in the discovery and development of novel pharmaceutical products that
treat diseases which are characterized by deficiencies in the body's innate
defense mechanisms of mucosal hydration and mucociliary clearance as well as
other diseases. Our technologies are based in part on exclusive license
agreements with The University of North Carolina at Chapel Hill for rights to
certain developments from the founders' laboratories.

     To date, we have devoted substantially all of our efforts to discovery and
clinical development of our product candidates as well as establishing
strategic partnerships for the development and potential marketing of our
products when approved. Currently, we have six product candidates in clinical
development. We have not derived any commercial revenues from product sales and
we do not expect to receive sales revenues for at least the next several years.

     We have incurred significant operating losses since our inception and, as
of December 31, 2001, we had an accumulated deficit of $71.0 million. We have
primarily financed our operations through proceeds received from the sale of
equity securities including private sales of preferred stock and the sale of
common stock in our initial public offering, as well as revenues received under
corporate collaborations. We operate in a single business segment and do not
have any foreign operations.

     In June 2001, we entered into a joint license, development and marketing
agreement with Allergan to develop and commercialize INS365 Ophthalmic and
Allergan's Restasis(R). Under the agreement, we may receive up to $39 million
in up-front and milestone payments. We will also receive royalty payments on
sales, if any, of INS365 Ophthalmic in the United States and on Allergan's
Restasis(R) worldwide, excluding most Asian markets. The agreement also
provides for potential co-promotion by Inspire of INS365 Ophthalmic and
Restasis(R) and one or more of Allergan's other marketed products in the United
States.

     In September 2000, we entered into a License Agreement with Kirin for the
development and commercialization of INS316 Diagnostic. Under the agreement we
granted Kirin an exclusive license to commercialize INS316 Diagnostic in most
of Asia. Under the terms of the agreement, we received an upfront payment in
cash and may receive milestone payments based on clinical success and approval.

                                      26

<PAGE>

     In December 1999, we entered into a collaboration with Genentech to
develop treatments for respiratory disorders, pursuant to which we received in
excess of $16 million in equity and cash payments prior to the termination of
the agreement in November 2001. Upon termination, Genentech returned to us all
rights for the use of INS365 Respiratory and our other related P2Y2 agonist at
no charge.

     In December 1998, we entered into a Development, License and Supply
Agreement with Santen for the development of INS365 Ophthalmic for the
therapeutic treatment of ocular surface diseases. We are obligated to supply
Santen with its requirements of INS365 Ophthalmic in bulk drug substance form
for all preclinical studies, clinical trials and commercial requirements at
agreed-upon prices. Under the agreement, we received an up-front equity
investment of $1.5 million for shares of our stock. In addition, if all
milestones are met, we could receive additional payments of up to $4.75
million, as well as royalties on net sales of licensed products. We have not
received any milestone payments to date under the agreement.

     In September 1998, we entered into a Joint Development, License and Supply
Agreement with Kissei for the development of INS365 Respiratory for therapeutic
lower respiratory applications in Japan. Pursuant to the agreement with Kissei,
we received an up-front payment of $4.5 million, which included the purchase of
shares of our stock. In addition, if all milestones under the agreement are
met, we would receive additional payments of up to $13.0 million. We will also
receive royalties on net sales, if any, of licensed products. To date, we have
received $2.1 million in milestone payments.


Results of Operations

Years Ended December 31, 2001, 2000 and 1999

     Revenues

     Our revenues for the year ended December 31, 2001 were $7.3 million
compared to $5.4 million in 2000 and $1.1 million in 1999. Revenues in each
year were derived primarily from collaborative research and development
agreements with strategic partners. Under these agreements we received payments
based both on our achievement, and our partners' achievement, of defined
development milestones. Milestone payments from our collaborative partners are
recognized over the period of ongoing research and development commitment under
the applicable collaborative research and development agreements with the
respective companies.

     The increase in 2001 revenues relate to milestone payments received
pursuant to the execution of a License, Development and Marketing Agreement with
Allergan in the third quarter of 2001. The increase in revenues in 2000 over
1999 relate to milestone payments received from Genentech and Kissei in the
fourth quarter of 1999 and the milestone payments received from Genentech,
Kissei and Kirin during 2000.

     Costs and Expenses

     Research and development expenses include all direct costs, including
salaries for our research and development personnel, consulting fees, clinical
trial costs, sponsored research and clinical trials insurance, and other fees
and costs related to the development of product candidates. Costs associated
with obtaining and maintaining patents on our drug compounds, and license
initiation and continuation fees, are evaluated based on the stage of
development of the related drug compound and whether the underlying compound
has an alternative use. Costs of these types incurred for drug compounds not
yet approved by the FDA and for which no alternative use exists are recorded as
research and development expense. In the event the drug compound has been
approved by the FDA or an alternative use exists for the drug compound, patent
costs and license costs are capitalized and amortized over the expected life of
the related drug compound. Milestone payments are recognized when the
underlying requirement is met by us.

     Research and development expenses for the year ended December 31, 2001 were
$28.2 million, compared to $16.4 million in 2000 and $7.7 million in 1999.
The increase in research and development expenses from year to year reflect the
continued advancement of our drug candidates through progressive clinical
development phases. We expect expenditures to decrease in 2002 as we focus
our development efforts on our higher priority programs.

     The increase in research and development expense for 2001 over 2000 was
primarily due to increased external costs related to patent activities,
research costs, preclinical testing, toxicology studies, clinical development
activities, including the enrollment of Phase III clinical trials, and
increased internal costs associated with additional personnel necessary to
perform or manage these

                                      27

<PAGE>

activities. The increase in research and development expense for 2000 over 1999
relates to increased preclinical testing, costs related to patent activities,
toxicology studies, increased clinical development activities and associated
increases in personnel costs.

     Our research and development expense from inception through December 31,
2001 was $70.1 million. Of this amount, we have spent the following amounts on
the pre-clinical and clinical development of the indicated product candidates:
$2.3 million on INS316 Diagnostic; $12.1 million on INS365 Ophthalmic; $5.5
million on INS365 Respiratory; $2.3 million on INS37217 Respiratory for cystic
fibrosis; $0.7 million on INS37217 Intranasal and $1.5 million on INS37217
Ophthalmic. The balance of our historic research and development expenses,
$45.7 million, was spent on various discovery programs and other development
programs. We cannot reasonably predict future research and development expense
for these programs.

     General and administrative costs for the year ended December 31, 2001 were
$5.9 million, compared to $3.7 million in 2000 and $2.4 million in 1999. Our
general and administrative expenses consist primarily of personnel and related
costs for general corporate functions, including business development, finance,
accounting, legal, human resources, facilities and information systems. The
increase in general and administrative expenses from year to year resulted
primarily from increases in administrative personnel costs, and increases in
insurance and additional professional services, including legal, accounting and
public relations services, to support the Company's strategic business
collaborations and operations as a publicly traded company.

     Other Income (Expense)

     Other income (expense), net totaled $3.7 million for the year ended
December 31, 2001, compared to $1.1 million for 2000 and $0.1 million for 1999.
The increase in 2001 over 2000, and in 2000 over 1999, was due to higher
interest income earned from larger average cash and investment balances
partially offset by increased interest expense related to leased equipment and
amortization of debt issuance costs.

     Income Taxes

     The provision for income taxes for the year ended December 31, 2001 was
$0, compared to $400,000 in 2000 and $60,000 in 1999. The fluctuations in the
provision for income taxes are directly attributable to Japanese withholding
taxes paid on milestone payments received from Japanese collaborative partners.

     Liquidity and Capital Resources

     Historically, we have financed our operations through the sale of equity
securities, including private sales of preferred stock and the sale of common
stock in our initial public offering.

     As of December 31, 2001, our cash and cash equivalents totaled $30.0
million, a decrease of $5.2 million as compared to December 31, 2000. The
decrease in cash and cash equivalents resulted from approximately $20.5 million
in cash used by operations, purchase of property, plant and equipment of
$496,000, the payments of notes payable of $20,000 and the payments of capital
lease obligations of $312,000, which was partially offset by the proceeds of
net investments in investment grade securities of $16.1 million and the
issuance of common stock of $69,000.

     Cash used by operations of $20.5 million for the year ended December 31,
2001, represented the net loss of $23.1 million, non-cash expenses of $3.4
million, an increase of $711,000 in accounts payable, an increase of $509,000
in accrued expenses, a decrease of $367,000 in receivables and a decrease in
other assets of $59,000, partially offset by decreases of $116,000 in prepaid
expenses and $2.3 million in deferred revenue.

     Cash used in our investing activities for the year ended December 31, 2001
was comprised of the proceeds of investment grade securities, net of
maturities, of $16.1 million and the purchase of property and equipment
totaling $496,000.

     Cash from our financing activities for the year ended December 31, 2001
was comprised of proceeds in the amount of $69,000 from the issuance of common
stock partially offset by the payments of notes payable of $20,000 and the
payment of capital lease obligations of $312,000.

     We do not expect to generate revenues, other than possible license and
milestone payments, from the commercial sale of our products unless and until
we or our licensees receive marketing clearance from the FDA and appropriate
regulatory agencies in other countries. We cannot predict the timing of any
potential marketing clearance nor can assurances be given that the FDA or other
such agencies will approve any of our product candidates.

                                      28

<PAGE>

     The Company has contractual commitments or purchase arrangements with
various clinical research organizations, manufacturers of drug product and
others. Most of these arrangements are for a period of less than 12 months. The
amount of the Company's financial commitments under these arrangements totals
approximately $7.7 at December 31, 2001. This estimate is dependent upon the
results of the underlying studies and certain other variable components that
may yield a result that differs from management's estimate.

Impact of Recently Issued Accounting Pronouncements

     In July 2001, the Financial Accounting Standards Board ("FASB") issued
FASB Statements Nos. 141 ("SFAS 141"), "Business Combinations" and 142 ("SFAS
142"), "Goodwill and Other Intangible Assets." SFAS 141 eliminates
pooling-of-interests accounting prospectively and provides guidance on purchase
accounting related to the recognition of intangible assets and accounting for
negative goodwill. SFAS 142 changes the accounting for goodwill from an
amortization method to an impairment-only approach. SFAS 141 and SFAS 142 are
effective for all business combinations completed after June 30, 2001. We have
adopted SFAS 142 as of January 1, 2002, as required, and as of July 1, 2001 for
goodwill and intangible assets acquired after June 30, 2001. We do not expect
that the adoption of SFAS 141 and 142 will have any impact on our financial
position or results of operations.

     In August 2001, the FASB issued FASB Statement No. 143 ("SFAS 143"),
"Accounting for Asset Retirement Obligations." The objectives of SFAS 143 are
to establish accounting standards for the recognition and measurement of an
asset retirement obligation and its associated asset retirement cost. SFAS 143
is effective for fiscal years beginning after June 15, 2002. We do not expect
the adoption of SFAS 143 to have any impact on our financial position or
results of operations.

     In October 2001, the FASB issued FASB Statement No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets." The Statement
supersedes FASB Statement No. 121 ("SFAS 121"), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and APB 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." The provisions of SFAS 144 are required to be applied
to fiscal years beginning after December 15, 2001. We do not expect the
adoption of SFAS 144 to have any impact on our financial position or results of
operations.


Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.

     Our exposure to market risk for changes in interest rates relates to the
increase or decrease in the amount of interest income we can earn on our
investment portfolio and on the increase or decrease in the amount of interest
expense it must pay with respect to various outstanding debt instruments. Our
risk associated with fluctuating interest expense is limited, however, to
capital lease obligations. The interest rates are closely tied to market rates
and our investments in interest rate sensitive financial instruments. Under our
current policies, we do not use interest rate derivative instruments to
manage exposure to interest rate changes. We attempt to ensure the safety and
preservation of invested principal funds by limiting default risk, market risk
and reinvestment risk. We reduce default risk by investing in investment grade
securities. A hypothetical 100 basis point drop in interest rates along the
entire interest rate yield curve would not significantly affect the fair value
of our interest sensitive financial instruments at December 31, 2001 or
December 31, 2000. Declines in interest rates over time will, however, reduce
our interest income while increases in interest rates over time will increase
interest expense.


Item 8.   Financial Statements and Supplementary Data.

     The financial statements required to be filed pursuant to this Item 8 are
appended to this Annual Report on Form 10-K. A list of the financial statements
filed herewith is found at "Index to Financial Statements" on page F-1.

Item 9.   Changes in and Disagreements With Accountants On Accounting and
          Financial Disclosure.

     Not applicable.

                                      29

<PAGE>

                                    PART III

Item 10.  Directors and Executive Officers of the Company.

     For information concerning this item, see the information under "Election
of Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's Proxy Statement to be filed with respect
to the Annual Meeting of Stockholders to be held on June 4, 2002, which
information is incorporated herein by reference.

Item 11.  Executive Compensation.

     For information concerning this item, see the information under
"Executive Compensation" in the Company's Proxy Statement to be filed with
respect to the Annual Meeting of Stockholders to be held on June 4, 2002, which
information is incorporated herein by reference.

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

     For information concerning this item, see the information under "Security
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement to be filed with respect to the Annual Meeting of Stockholders to be
held on June 4, 2002, which information is incorporated herein by reference.

Item 13.  Certain Relationships and Related Transactions.

     For information concerning this item, see the information under "Certain
Relationships and Related Transactions" in the Company's Proxy Statement to be
filed with respect to the Annual Meeting of Stockholders to be held on June 4,
2002, which information is incorporated herein by reference.

                                    PART IV

Item 14.  Exhibits, Financial Statements Schedules, and Reports On Form 8-K.

(a)       The following documents are included as part of this Annual Report
          on Form 10-K:

     1.   Financial Statements:

                                                                          Page
                                                                          ----
     Report of Independent Accountants .................................   F-2
     Balance Sheets ....................................................   F-3
     Statements of Operations ..........................................   F-4
     Statements of Cash Flows ..........................................   F-5
     Statements of Stockholders' Equity (Deficit) ......................   F-6
     Notes to Financial Statements .....................................   F-7

     2.   All schedules are omitted as the information required is
          inapplicable or the information is presented in the financial
          statements.

                                      30

<PAGE>

     3.   Exhibits:

Exhibit
Number         Description
------         -----------

3.1            Amended and Restated Certificate of Incorporation.
               (Incorporated by reference to Exhibit 3.1 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

3.2            Certificate of Amendment of Amended and Restated Certificate
               of Incorporation.

3.3            Amended and Restated Bylaws. (Incorporated by reference to
               Exhibit 3.2 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

4.1            Specimen Common Stock Certificate. (Incorporated by reference
               to Exhibit 4.1 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.1+           Amended and Restated 1995 Stock Plan, as amended.
               (Incorporated by reference to Exhibit 10.1 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.2+          Form of Incentive Stock Option. (Incorporated by reference to
               Exhibit 10.2 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.3+          Form of Non-statutory Stock Option. (Incorporated by
               reference to Exhibit 10.3 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.4           Consultation and scientific Advisory Board Agreement between
               Inspire Pharmaceuticals, Inc. and Dr. Richard Boucher, dated
               March 10, 1995. (Incorporated by reference to Exhibit 10.4 to
               the Company's registration statement on Form S-1 (Registration
               No. 333-31174) which became effective on August 3, 2000).

10.5*          Sponsored Research Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill,
               effective March 10, 1995. (Incorporated by reference to
               Exhibit 10.5 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.6*          Exclusive License Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill,
               dated March 10, 1995. (Incorporated by reference to Exhibit
               10.7 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August
               3, 2000).

10.7           Lease between Inspire Pharmaceuticals, Inc. and Imperial
               Center, Limited Partnership regarding Royal Center I, Durham,
               North Carolina, dated as of May 17, 1995, as amended.
               (Incorporated by reference to Exhibit 10.8 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.8           Master Lease Agreement between Inspire Pharmaceuticals, Inc.
               and Comdisco, Inc., dated October 13, 1995, as amended.
               (Incorporated by reference to Exhibit 10.9 to the Company's
               registration statement on Form S-1 (Registration No. 333-
               31174) which became effective on August 3, 2000).

10.9           Lease Agreement between Inspire Pharmaceuticals, Inc. and
               Petula Associates Ltd. regarding Royal Center II, Durham,
               North Carolina, dated as of December 30, 1997. (Incorporated
               by reference to Exhibit 10.10 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.10          Sublease Agreement between ICAgen, Inc. and Inspire
               Pharmaceuticals, Inc. regarding premises located at 4222
               Emperor Boulevard, Suite 500, Durham, North Carolina, dated
               September 22, 1997 and extension of Sublease Agreement dated
               February 14, 2000. (Incorporated by reference to Exhibit 10.11
               to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August
               3, 2000).

10.11*         Exclusive License Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill,
               dated September 1, 1998. (Incorporated by reference to Exhibit
               10.12 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August
               3, 2000).

                                      31

<PAGE>

Exhibit
Number         Description
------         -----------

10.12*         Joint Development, License and Supply Agreement between
               Inspire Pharmaceuticals, Inc. and Kissei Pharmaceutical Co.,
               Ltd., dated as of September 10, 1998. (Incorporated by
               reference to Exhibit 10.13 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.13          Registration Rights Agreement between Inspire
               Pharmaceuticals, Inc. and Kissei Pharmaceutical Co., Ltd.,
               dated as of September 10, 1998. (Incorporated by reference to
               Exhibit 10.14 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.14*         Development, License and Supply Agreement between Inspire
               Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd.,
               dated as of December 16, 1998. (Incorporated by reference to
               Exhibit 10.15 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.15          Registration Rights Agreement between Inspire
               Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd.,
               dated as of December 16, 1998. (Incorporated by reference to
               Exhibit 10.16 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.16*         Development, License and Supply Agreement between Inspire
               Pharmaceuticals, Inc. and Genentech, Inc., dated as of
               December 17, 1999. (Incorporated by reference to Exhibit 10.20
               to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August
               3, 2000).

10.17*         Series G Preferred Stock and Warrant Purchase Agreement
               between Inspire Pharmaceuticals, Inc. and Genentech, Inc.,
               dated as of December 17, 1999. (Incorporated by reference to
               Exhibit 10.21 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.18*         Warrant Agreement between Inspire Pharmaceuticals, Inc. and
               Genentech, Inc., dated as of December 17, 1999. (Incorporated
               by reference to Exhibit 10.22 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.19          Amended and Restated Investors' Rights Agreement among Inspire
               Pharmaceuticals, Inc. and the holders of Series A, B, E and G
               Preferred Stock of the Company dated as of December 17, 1999.
               (Incorporated by reference to Exhibit 10.23 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.20+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Donald Kellerman dated February 3, 2000. (Incorporated by
               reference to Exhibit 10.24 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.21+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Gregory J. Mossinghoff dated February 4, 2000.
               (Incorporated by reference to Exhibit 10.25 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.22+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Benjamin R. Yerxa dated February 4, 2000. (Incorporated by
               reference to Exhibit 10.26 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.23+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Christy L. Shaffer dated February 10, 2000. (Incorporated
               by reference to Exhibit 10.28 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.24          Master Agreement between Inspire Pharmaceuticals, Inc. and
               ClinTrials BioResearch Ltd. dated as of December 23, 1999.
               (Incorporated by reference to Exhibit 10.29 to the Company's
               registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).
                                      32

<PAGE>

Exhibit
Number         Description
------         -----------

10.25+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Richard M. Evans dated February 10, 2000. (Incorporated by
               reference to Exhibit 10.30 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which
               became effective on August 3, 2000).

10.26*         License Agreement between Inspire Pharmaceuticals, Inc. and
               Kirin Brewery Company, Ltd., Pharmaceutical Division, dated as
               of September 12, 2000. (Incorporated by reference to Exhibit
               10.1 to the Company's Quarterly Report on Form 10-Q filed on
               November 3, 2000).

10.27+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Mary Bennett dated February 27, 2001. (Incorporated by
               reference to Exhibit 10.1 to the Company's quarterly report on
               Form 10-Q filed on May 15, 2001).

10.28          Sublease between Inspire Pharmaceuticals, Inc. and Circuit
               City Stores, Inc., dated as of May 7, 2001. (Incorporated by
               reference to Exhibit 10.1 to the Company's quarterly report on
               Form 10-Q filed on August 10, 2001).

10.29+         Employee Confidentiality, Invention Assignment and
               Non-Compete Agreement between Inspire Pharmaceuticals, Inc.
               and Joseph Schachle dated April 3, 2001. (Incorporated by
               reference to Exhibit 10.2 to the Company's quarterly report
               [dagger] on Form 10-Q filed on August 10, 2001).

10.30*         License, Development and Marketing Agreement between Inspire
               Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22,
               2001. (Incorporated by reference to Exhibit 10.1 to the
               Company's Current Report on Form 8-K filed on June 29, 2001).

23.1           Consent of PricewaterhouseCoopers LLP, independent public
               accountants

-------------------

*    Confidential treatment has been granted with respect to a portion of this
     Exhibit.

+    Denotes a management contract or compensation plan or arrangement required
     to be filed as an exhibit pursuant to Item 14(a) of this Form 10-K.

(b)  Reports on Form 8-K

               No Current Report on Form 8-K was filed by the Company during
               the quarter ended December 31, 2001.

                                      33

<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 of 15(d) 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.

                          Inspire Pharmaceuticals, Inc.

                          By:  /s/ Christy L. Shaffer
                              ----------------------------------
                                Christy L. Shaffer
                                President, Chief Executive Officer and Director

                          Date: March 21, 2002

     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>
            Signature                            Title                 Date
<S>                                    <C>                           <C>
     /s/ Christy L. Shaffer            President, Chief Executive    March 21, 2002
------------------------------------   Officer (principal executive
       Christy L. Shaffer              officer) and Director

     /s/ Gregory J. Mossinghoff        Senior Vice President,        March 21, 2002
------------------------------------   Chief Business Officer,
       Gregory J. Mossinghoff          Secretary, Treasurer
                                       (principal financial officer
                                       and principal accounting
                                       officer) and Director

     /s/ Terrance G. McGuire           Chairman of the Board         March 21, 2002
------------------------------------
       Terrance G. McGuire

     /s/ Richard Boucher, M.D.         Director                      March 21, 2002
------------------------------------
       Richard Boucher, M.D.

     /s/ H. Jefferson Leighton         Director                      March 21, 2002
------------------------------------
       H. Jefferson Leighton

     /s/ W. Leigh Thompson             Director                      March 21, 2002
------------------------------------
       W. Leigh Thompson

     /s/ Jesse I. Treu                 Director                      March 21, 2002
------------------------------------
       Jesse I. Treu
</TABLE>

                                       34

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                          INDEX TO FINANCIAL STATEMENTS


                                                                  Page(s)
                                                                ----------
Report of Independent Accountants                                  F-2

Balance Sheets                                                     F-3

Statements of Operations                                           F-4

Statements of Cash Flows                                           F-5

Statements of Stockholders' Equity (Deficit)                       F-6

Notes to Financial Statements                                      F-7

                                      F-1

<PAGE>


                        REPORT OF INDEPENDENT ACCOUNTANTS



To the Board of Directors and Stockholders
Inspire Pharmaceuticals, Inc.


     In our opinion, the accompanying balance sheets and the related
statements of operations, of stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of Inspire
Pharmaceuticals, Inc. (a development stage company) at December 31, 2001 and
2000 and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001 and the period from inception
(October 28, 1993) to December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statements presentation. We believe that our audits provide a
reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina
February 8, 2002

                                      F-2

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                                 BALANCE SHEETS
               (In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                                      December 31,
                                                              ----------------------------
                                                                   2001           2000
                                                              -------------  -------------
<S>                                                           <C>            <C>
Assets
Current assets:
   Cash and cash equivalents                                    $    29,959    $    35,109
   Short-term investments                                            22,395         44,026
   Other receivables                                                    104            209
   Interest receivable                                                  102            364
   Prepaid expenses                                                     531            415
                                                              -------------  -------------
Total current assets                                                 53,091         80,123

Property and equipment, net                                           1,471          1,214
Other assets                                                          5,525          1,656
                                                              -------------  -------------
Total assets                                                    $    60,087    $    82,993
                                                             ==============  =============
Liabilities and stockholders' equity (deficit)
Current liabilities:
   Accounts payable                                             $     1,141    $       430
   Accrued expenses                                                   1,367            852
   Notes payable, current portion                                         -             26
   Capital leases, current portion                                      376            289
   Deferred revenue, current portion                                  4,083          5,618
                                                              -------------  -------------
Total current liabilities                                             6,967          7,215

Capital leases, excluding current portion                               525            523
Deferred revenue, excluding current portion                               -            750
                                                              -------------  -------------

Total liabilities                                                     7,492          8,488

Commitments (Notes 10, 11 and 12)

Stockholders' equity (deficit):
   Common stock, $0.001 par value, 60,000,000 shares authorized;
     25,751,468 and 25,515,087 shares issued and outstanding at
     December 31, 2001 and 2000, respectively                            26             26
   Additional paid-in capital                                       125,099        126,081
   Other comprehensive income                                             1             51
   Deferred compensation                                             (1,525)        (3,782)
   Deficit accumulated during the development stage                 (71,006)       (47,871)
                                                              -------------  -------------
Total stockholders' equity (deficit)                                 52,595         74,505
                                                              -------------  -------------
Total liabilities and stockholders' equity (deficit)            $    60,087    $    82,993
                                                              =============  =============
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F-3

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                            STATEMENTS OF OPERATIONS
               (In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                                                                  Cumulative
                                                                                                from Inception
                                                                                                 (October 28,
                                                           Year Ended December 31,                 1993) to
                                               ----------------------------------------------    December 31,
                                                    2001             2000           1999             2001
                                               -------------    -------------    ------------    -----------
<S>                                            <C>              <C>              <C>            <C>
Revenues:
   Collaborative research agreements             $     7,285      $     5,368      $    1,104      $  14,117
                                               -------------    -------------    ------------    -----------
Operating expenses:
   Research and development (includes $519,
    $866, $516 and $1,940, of stock-based
    compensation, respectively)                       28,190           16,353           7,694         70,144
General and administrative (includes $687,
    $678, $519 and $1,930, of stock-based
    compensation, respectively)                        5,882            3,694           2,406         18,359
                                               -------------    -------------    ------------    -----------
   Total operating expenses                           34,072           20,047          10,100         88,503
                                               -------------    -------------    ------------    -----------
   Operating loss                                    (26,787)         (14,679)         (8,996)       (74,386)
                                               -------------    -------------    ------------    -----------

Other income (expense), net:
   Interest income                                     3,787            2,120             238          7,016
   Interest expense                                     (132)            (994)           (111)        (1,791)
   Loss on disposal of property and equipment             (3)             (37)             (5)          (369)
                                               -------------    -------------    ------------    -----------
   Other income (expense), net                         3,652            1,089             122          4,856
                                               -------------    -------------    ------------    -----------
   Loss before provision for income taxes            (23,135)         (13,590)         (8,874)       (69,530)
Provision for income taxes                                 -              400              60            820
                                               -------------    -------------    ------------    -----------
   Net loss                                          (23,135)         (13,990)         (8,934)       (70,350)
Preferred stock dividends                                  -             (594)            (62)          (656)
                                               -------------    -------------    ------------    -----------
Net loss available to common stockholders        $   (23,135)     $   (14,584)     $   (8,996)     $ (71,006)
                                               ==============    ============    ============    ===========
Net loss per common share - basic and
   Diluted                                       $     (0.90)     $     (1.23)     $    (3.75)
                                               ==============    ============    ============

Weighted average common shares
   outstanding - basic and diluted                25,702,274       11,870,521       2,401,028
                                               ==============    ============    ============
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F-4

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                            STATEMENTS OF CASH FLOWS
                                 (In thousands)


<TABLE>
<CAPTION>
                                                                                                        Cumulative
                                                                                                           from
                                                                                                        Inception
                                                                                                       (October 28,
                                                                   Year Ended December 31,               1993) to
                                                            ---------------------------------------      December
                                                               2001            2000         1999         31, 2001
                                                            ------------    ----------    ---------    -----------
<S>                                                         <C>             <C>           <C>          <C>
Cash flows from operating activities:
    Net loss                                                  $  (23,135)    $ (13,990)    $ (8,934)    $  (70,350)
    Adjustments to reconcile net loss to net cash
       used in operating activities:
      Depreciation and amortization                                2,209         1,420          666          5,782
      Stock issued for exclusive license                               -             -            -            144
      Stock issued for consulting services                             -             -            -             72
      Amortization of deferred compensation                        1,206         1,544        1,035          3,899
      Loss on disposal of property and equipment                       3            37            5            369
      Changes in operating assets and liabilities:
           Other receivables                                         105          (190)         (14)          (104)
           Interest receivable                                       262          (364)           -           (102)
           Prepaid expenses                                         (116)         (283)          (9)          (531)
           Other assets                                               59            (1)           1            (23)
           Accounts payable                                          711          (202)         341          1,141
           Accrued expenses                                          509           243          166          1,363
           Deferred revenue                                       (2,285)       (1,368)       4,496          4,083
                                                            ------------    ----------    ---------    -----------
      Net cash used in operating activities                      (20,472)      (13,154)      (2,247)       (54,257)
                                                            ------------    ----------    ---------    -----------
Cash flows from investing activities:
   Purchase of investments                                      (145,936)      (55,021)           -       (200,957)
   Proceeds from sale of investments                             162,017        11,046            -        172,985
   Purchase of property and equipment                               (496)         (522)        (151)        (2,451)
   Proceeds from sale of property and equipment                        -             -            -            127
                                                            ------------    ----------    ---------    -----------
      Net cash provided by (used in) investing activities         15,585       (44,497)        (151)       (30,296)
                                                            ------------    ----------    ---------    -----------
Cash flows from financing activities:
   Proceeds from bridge loans                                          -             -            -            780
   Proceeds from issuance of notes payable                             -             -            1            408
   Payments on notes payable                                         (20)            -            -           (420)
   Issuance of common stock, net                                      69        70,249           38         70,416
   Issuance of convertible preferred stock, net                        -             -       21,406         45,061
   Payments on capital lease obligations                            (312)         (217)        (457)        (1,733)
                                                            ------------    ----------    ---------    -----------
      Net cash (used in) provided by financing activities           (263)       70,032       20,988        114,512
                                                            ------------    ----------    ---------    -----------
     (Decrease) increase in cash and cash equivalents             (5,150)       12,381       18,590         29,959
Cash and cash equivalents, beginning of period                    35,109        22,728        4,138              -
                                                            ------------    ----------    ---------    -----------
Cash and cash equivalents, end of period                      $   29,959     $  35,109     $ 22,728     $   29,959
                                                            ============    ==========    =========    ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F-5

<PAGE>

                         INSPIRE PHARMACEUTICALS, INC.
                         (A Development Stage Company)
                  STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
     For the Period from Inception (October 28, 1993) to December 31, 2001
                      (In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                           Preferred Stock                Common Stock            Common Stock
                                                     ---------------------------    -----------------------   ---------------------
                                                          Number                       Number                   Number
                                                         of shares       Amount      of Shares      Amount     of Shares    Amount
                                                     ---------------   ---------    ------------   --------   ----------   --------
<S>                                                  <C>               <C>          <C>            <C>        <C>         <C>
Inception (October 28, 1993)                                     -     $       -              -    $      -           -    $      -
                                                     ---------------   ---------    ------------   --------   ----------   --------
Balance at December 31, 1993                                     -             -              -           -           -           -
Issuance of Class A and B Common Stock                           -             -              -           -      10,000          10
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------    ------------   --------   ----------   --------
Balance at December 31, 1994                                     -             -              -           -      10,000          10
Issuance of common stock and cancellation of
     Class A and B common stock                                  -             -        850,286           1     (10,000)        (10)
Stock issued for consulting services                             -             -        585,714           1           -           -
Stock issued in exchange for exclusive license                   -             -        297,714           -           -           -
Issuance of Series A convertible preferred stock         9,200,000         9,100              -           -           -           -
Issuance of Series A warrants                                    -             -              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 1995                             9,200,000         9,100      1,733,714           2           -           -
Issuance of common stock                                         -             -        227,340           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 1996                             9,200,000         9,100      1,961,054           2           -           -
Issuance of common stock                                         -             -         31,954           -           -           -
Issuance of Series B convertible preferred stock        10,866,014        12,966              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 1997                            20,066,014        22,066      1,993,008           2           -           -
Issuance of common stock                                         -             -        137,502           -           -           -
Stock issued in exchange for exclusive license                   -             -         28,572           -           -           -
Issuance of Series C convertible preferred stock           375,000           900              -           -           -           -
Issuance of Series D convertible preferred stock           416,667         1,500              -           -           -           -
Issuance of Series B warrants                                    -             -              -           -           -           -
Deferred compensation                                            -             -              -           -           -           -
Amortization of deferred compensation                            -             -              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 1998                            20,857,681        24,466      2,159,082           2           -           -
Issuance of common stock                                         -             -        306,775           -           -           -
Issuance of Series E convertible preferred stock         6,201,985        11,406              -           -           -           -
Issuance of Series G convertible preferred stock           833,333        10,000              -           -           -           -
Issuance of Series F warrants                                    -             -              -           -           -           -
Issuance of common stock warrants                                -             -              -           -           -           -
Preferred stock dividends                                        -            23              -           -           -           -
Deferred compensation                                            -             -              -           -           -           -
Amortization of deferred compensation                            -             -              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 1999                            27,892,999        45,895      2,465,857           2           -           -
Issuance of common stock                                         -             -        369,006           -           -           -
Issuance of common stock warrants                                -             -              -           -           -           -
Preferred stock dividends                                        -             -              -           -           -           -
Issuance of common stock at initial public offering
   and exercise of over-allotment                                -             -      6,325,000           7           -           -
Conversion of preferred stock and preferred stock
   dividends into common stock at initial public
   offering                                            (27,892,999)      (45,895)    16,355,224          17           -           -
Deferred compensation                                            -             -              -           -           -           -
Amortization of deferred compensation                            -             -              -           -           -           -
Unrealized gain on investments                                   -             -              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------     ------------  --------   ----------   --------
Balance at December 31, 2000                                     -             -     25,515,087          26           -           -
Issuance of common stock                                         -             -        236,381           -           -           -
Forfeiture of common stock options                               -             -              -           -           -           -
Amortization of deferred compensation                            -             -              -           -           -           -
Unrealized gain on investments                                   -             -              -           -           -           -
Net loss                                                         -             -              -           -           -           -
                                                     ---------------   ---------    ------------  ---------   ----------  ---------
Balance at December 31, 2001                                     -     $       -     25,751,468     $    26           -     $     -
                                                     ===============  ==========    ===========  ==========   ==========  =========

<CAPTION>
                                                    Additional
                                                     Paid-In     Accumulated      Deferred         Comprehensive  Stockholder's
                                                     Capital       Deficit       Compensation      Income/(Loss)     Equity
                                                    ---------    ------------   -------------     --------------  -------------
<S>                                                 <C>         <C>            <C>               <C>             <C>
Inception (October 28, 1993)
                                                    $       -     $        -     $         -        $        -      $     -
Balance at December 31, 1993                        ---------    ------------   -------------     --------------   ---------
Issuance of Class A and B Common Stock                      -              -               -                 -            -
Net loss                                                    -              -               -                 -           10
                                                            -           (330)              -                 -         (330)
Balance at December 31, 1994                        ---------    ------------   -------------     --------------   ---------
Issuance of common stock and cancellation of                -           (330)              -                 -         (320)
     Class A and B common stock
Stock issued for consulting services                        9              -               -                 -            -
Stock issued in exchange for exclusive license             71              -               -                 -           72
Issuance of Series A convertible preferred stock           36              -               -                 -           36
Issuance of Series A warrants                               -              -               -                 -        9,100
Net loss                                                   92              -               -                 -           92
                                                            -         (2,704)              -                 -       (2,704)
Balance at December 31, 1995                        ---------    ------------   -------------     --------------   ---------
Issuance of common stock                                  208         (3,034)              -                 -        6,276
Net loss                                                   13              -               -                 -           13
                                                            -         (5,782)              -                 -       (5,782)
Balance at December 31, 1996                        ---------    ------------   -------------     --------------   ---------
Issuance of common stock                                  221         (8,816)              -                 -          507
Issuance of Series B convertible preferred stock           18              -               -                 -           18
Net loss                                                    -              -               -                 -       12,966
                                                            -         (7,947)              -                 -       (7,947)
Balance at December 31, 1997                        ---------    ------------   -------------     --------------   ---------
Issuance of common stock                                  239        (16,763)              -                 -        5,544
Stock issued in exchange for exclusive license             17              -               -                 -           17
Issuance of Series C convertible preferred stock          108              -               -                 -          108
Issuance of Series D convertible preferred stock            -              -               -                 -          900
Issuance of Series B warrants                               -              -               -                 -        1,500
Deferred compensation                                       7              -               -                 -            7
Amortization of deferred compensation                   2,714              -          (2,714)                -            -
Net loss                                                    -              -             114                 -          114
                                                            -         (7,528)              -                 -       (7,528)
                                                    ---------    ------------   -------------     --------------   ---------
Balance at December 31, 1998                            3,085        (24,291)         (2,600)                -          662
Issuance of common stock                                   38              -               -                 -           38
Issuance of Series E convertible preferred stock            -              -               -                 -       11,406
Issuance of Series G convertible preferred stock            -              -               -                 -       10,000
Issuance of Series F warrants                              53              -               -                 -           53
Issuance of common stock warrants                       1,813              -               -                 -        1,813
Preferred stock dividends                                   -            (62)              -                 -          (39)
Deferred compensation                                   3,359              -          (3,359)                -            -
Amortization of deferred compensation                       -              -           1,035                 -        1,035
Net loss                                                    -         (8,934)              -                 -       (8,934)
                                                    ---------    ------------   -------------     --------------   ---------
Balance at December 31, 1999                            8,348        (33,287)         (4,924)                -       16,034
Issuance of common stock                                1,062              -               -                 -        1,062
Issuance of common stock warrants                         577              -               -                 -          577
Preferred stock dividends                                   -           (594)              -                 -         (594)
Issuance of common stock at initial public offering
   and exercise of over-allotment                      69,180              -               -                 -       69,187
Conversion of preferred stock and preferred stock
   dividends into common stock at initial public
   offering                                            46,512              -               -                 -          634
Deferred compensation                                     402              -            (402)                -            -
Amortization of deferred compensation                       -              -           1,544                 -        1,544
Unrealized gain on investments                              -              -               -                51           51
Net loss                                                    -        (13,990)              -                 -      (13,990)
                                                    ---------    ------------   -------------     --------------   ---------
Balance at December 31, 2000                          126,081        (47,871)         (3,782)               51       74,505
Issuance of common stock                                   69              -               -                 -           69
Forfeiture of common stock options                     (1,051)             -           1,051                 -            -
Amortization of deferred compensation                       -              -           1,206                 -        1,206
Unrealized gain on investments                              -              -               -               (50)         (50)
Net loss                                                    -        (23,135)              -                 -      (23,135)
                                                   ----------    ------------   -------------     --------------   ---------
Balance at December 31, 2001                         $125,099     $  (71,006)    $    (1,525)       $        1      $52,595
                                                   ==========    ============   =============     ==============   =========
</TABLE>

   The accompanying notes are an integral part of these financial statements.

                                      F-6

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                          NOTES TO FINANCIAL STATEMENTS
               (In thousands, except share and per share amounts)

1.   Organization

Inspire Pharmaceuticals, Inc. (the "Company" or "Inspire") was founded on
October 28, 1993 to develop and commercialize novel pharmaceutical products
that treat diseases which are characterized by deficiencies in the body's
innate defense mechanisms of mucosal hydration and mucociliary clearance. The
Company's technologies are based in part on exclusive license agreements with
The University of North Carolina at Chapel Hill for rights to certain
developments from the founders' laboratories.

The Company is considered a development stage enterprise. Since inception, the
Company has devoted substantially all of its efforts towards establishing its
business and research and development programs.

2.   Summary of Significant Accounting Policies

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 reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.

Investments

Investments consist primarily of U. S. government agency obligations and other
fixed or variable income investments. The Company invests in high-credit
quality investments in accordance with its investment policy which minimizes
the possibility of loss. Investments with original maturities at date of
purchase beyond three months and which mature at or less than twelve months
from the balance sheet date are classified as current. Investments with a
maturity beyond twelve months from the balance sheet date are classified as
long-term. Investments are considered to be available for sale and are carried
at fair value with unrealized gains and losses recognized in other
comprehensive income (loss). Realized gains and losses are determined using the
specific identification method and transactions are recorded on a settlement
date basis.

Property and Equipment

Property and equipment is primarily comprised of furniture, laboratory and
computer equipment which are recorded at cost and depreciated using the
straight-line method over their estimated useful lives which range from three
to seven years. Property and equipment, which includes certain equipment under
capital leases, and leasehold improvements are depreciated over the shorter of
the lease period or their estimated useful lives.

Other Assets

At December 31, 2001, other assets are primarily comprised of long-term
investments totaling $5.5 million and $25 related to deposits and deferred
costs. At December 31, 2000, other assets were comprised of $1.6 million in
deferred costs which were incurred when the Company issued warrants in
conjunction with collaborative research agreements and capital lease
arrangements and $56 in deposits. Deferred costs are amortized using the
effective interest rate method over the life of the related collaborative
research agreement or lease.

                                      F-7

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

Stock-Based Compensation

The Company accounts for stock-based compensation based on the provisions of
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees," which states that no compensation expense is recorded for
stock options or other stock-based awards to employees that are granted with an
exercise price equal to or above the estimated fair value per share of the
Company's common stock on the grant date. In the event that stock options are
granted with an exercise price below the estimated fair value of the Company's
common stock, the difference between the estimated fair value of the Company's
common stock and the exercise price of the stock option is recorded as deferred
compensation. The Company recognized deferred compensation of $0 and $402
related to stock option grants during the years ended December 31, 2001 and
2000, respectively.

Deferred compensation is amortized over the vesting period of the related stock
option, which is generally four years. The Company recognized $1,206, $1,544
and $1,035 of stock based compensation expense related to amortization of
deferred compensation during the years ended December 31, 2001, 2000 and 1999,
respectively. The Company has adopted the disclosure requirements of Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" which requires compensation expense to be disclosed based on the
fair value of the options granted at the date of the grant.

Income Taxes

The Company accounts for income taxes using the liability method which requires
the recognition of deferred tax assets or liabilities for the temporary
differences between financial reporting and tax bases of the Company's assets
and liabilities and for tax carryforwards at enacted statutory tax rates in
effect for the years in which the differences are expected to reverse. The
effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date. In addition, valuation allowances
are established when necessary to reduce deferred tax assets to the amounts
expected to be realized.

Revenue Recognition

Revenue is recognized under collaborative research agreements when services are
performed or when contractual obligations are met. Nonrefundable fees received
at the initiation of collaboration agreements for which the Company has an
ongoing research and development commitment are deferred and recognized ratably
over the period of the related research and development commitment. Milestone
payments under collaboration agreements and research agreements will be
recognized as revenues, ratably over the remaining period of the research and
development commitment beginning on the date the Company achieves the indicated
milestone and such achievement is acknowledged by the collaborative partner,
which generally coincides with the receipt of the milestone payment.

Research and Development

Research and development costs include all direct costs, including salaries for
Company personnel, outside consultant's, costs of clinical trials, sponsored
research and clinical trials insurance related to the development of drug
compounds. These costs have been charged to operating expense as incurred.
Costs associated with obtaining and maintaining patents on the Company's drug
compounds and license initiation and continuation fees, including milestone
payments by the Company to its licensors, are evaluated based on the stage of
development of the related drug compound and whether the underlying drug
compound has an alternative use. Costs of these types incurred for drug
compounds not yet approved by the United States Food and Drug Administration
("FDA") and for which no alternative use exists are recorded as research and
development expense. In the event the drug compound has been approved by the
FDA or an alternative use exists for the drug compound, patent costs and
license costs are capitalized and amortized over the expected life of the
related drug compound. License milestone payments to the Company's licensors
are recognized when the underlying requirement is met by the Company.

                                      F-8

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

Significant Customers and Credit Risk

All revenues recognized and recorded in 2001 were from five collaborative
partners. All revenues recognized and recorded in 2000 were from four
collaborative partners. All revenues recognized and recorded in 1999 were from
a single collaborative partner. Financial instruments which potentially subject
the Company to concentrations of credit risk consist principally of short-term
cash investments. The Company primarily invests in short-term interest-bearing
investment-grade securities and certificates of deposits. Cash deposits are all
in financial institutions in the United States.

Cash Flows

The Company made cash payments for interest of $145, $100 and $67 for the years
ended December 31, 2001, 2000 and 1999, respectively. The Company made cash
payments for foreign withholding taxes of $0, $400 and $60 during the years
ended December 31, 2001, 2000 and 1999, respectively.

The Company acquired property and equipment through the assumption of capital
lease obligations amounting to $401 and $522 during the years ended December
31, 2001 and 2000, respectively.

Net Income (Loss) Per Common Share

Basic net income (loss) per common share ("basic EPS") is computed by dividing
net income (loss) available to common stockholders by the weighted average
number of common shares outstanding. Diluted net income (loss) per common share
("diluted EPS") is computed by dividing net income (loss) available to common
stockholders by the weighted average number of common shares and dilutive
potential common share equivalents then outstanding. Potential common shares
consist of shares issuable upon the exercise of stock options and warrants and
conversion of convertible preferred stock. The calculation of diluted EPS for
the years ended December 31, 2001, 2000 and 1999 does not include 1,886,277,
1,526,008 and 14,486,662, respectively, of potential shares of common stock
equivalents, as their impact would be antidilutive.


Segment Reporting

The Company has determined that it did not have any separately reportable
operating segments as of December 31, 2001, 2000 or 1999.

Other Comprehensive Income (Loss)

During 2001, the Company had $1 of unrealized gain on investments that is
classified as other comprehensive income and is disclosed as a component of
statements of stockholders' equity for 2001. The Company had $51 of unrealized
gain on investments in 2000 and no items of other comprehensive income in 1999.

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board ("FASB") issued FASB
Statements Nos. 141 ("SFAS 141"), "Business Combinations" and 142 ("SFAS 142"),
"Goodwill and Other Intangible Assets. " SFAS 141 eliminates
pooling-of-interests accounting prospectively and provides guidance on purchase
accounting related to the recognition of intangible assets and accounting for
negative goodwill. SFAS 142 changes the accounting for goodwill from an
amortization method to an impairment-only approach. SFAS 141 and SFAS 142 are
effective for all business combinations completed after June 30, 2001. The
Company adopted SFAS 142 as of January 1, 2002, as required, and as of July 1,
2001 for goodwill and intangible assets acquired after June 30, 2001. The
Company does not expect that the adoption of SFAS 141 and 142 will have any
impact on its financial position or results of operations.

                                      F-9

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

In August 2001, the FASB issued FASB Statement 143 ("SFAS 143"), "Accounting
for Asset Retirement Obligations". The objectives of SFAS 143 are to establish
accounting standards for the recognition and measurement of an asset retirement
obligation and its associated asset retirement cost. SFAS 143 is effective for
fiscal years beginning after June 15, 2002. The adoption of SFAS 143 is not
expected to have any impact on the Company's financial position or results of
operations.

In October 2001, the FASB issued FASB Statement No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets". The Statement
supersedes FASB Statement No. 121 ("SFAS 121"), "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" and APB 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." The provisions of SFAS 144 are required to be applied
to fiscal years beginning after December 15, 2001. The adoption of SFAS 144 is
not expected to have any impact on the Company's financial position or results
of operations.

3.   Property and Equipment

Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                         December 31,
                                       Useful Life               --------------------------------
                                         (Years)                     2001               2000
                                      ----------------           -------------     --------------
<S>                                  <C>                        <C>                  <C>
Equipment                                  5                     $       2,286        $    1,679
Leasehold improvements              Lesser of lease term                   888               845
                                        or 5 years
Computer hardware and software             5                               896               742
Furniture and fixtures                     7                               450               384
                                                                 -------------       -----------
                                                                         4,520             3,650
Less - accumulated depreciation and
amortization                                                            (3,049)           (2,436)
                                                                 -------------       -----------
Property and equipment, net                                      $       1,471        $    1,214
                                                                 =============       ===========
</TABLE>

Depreciation expense was $637, $546 and $623 for the years ended December 31,
2001, 2000 and 1999, respectively. The Company leases certain equipment under
capital lease agreements. The book value of equipment under capital leases at
December 31, 2001 and 2000 was approximately $669 and $847, respectively.

4.   Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable and
accounts payable at December 31, 2001 and 2000 approximate their fair value due
to the short-term nature of these items.

The fair value of the Company's short-term investments at December 31, 2001 and
2000, approximate their carrying values as these investments are primarily in
short-term interest-bearing investment-grade securities.

The carrying value of the Company's notes payable and capital lease obligations
at December 31, 2001 and 2000 approximate their fair value as the interest
rates on these obligations approximate rates available in the financial market
at such dates.

                                      F-10

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

5. Accrued Expenses

Accrued expenses are comprised of the following:

                                                          December 31,
                                                    ----------------------
                                                        2001        2000
                                                    ----------  ----------
Research costs                                      $      750  $      472
Accrued payroll and benefits                               243          67
Accrued legal and patent costs                             107         111
Other                                                      267         202
                                                    ----------  ----------
                                                    $    1,367  $      852
                                                    ==========  ==========

6. Income Taxes

The components of the Company's income tax expense consist of the following:

                                          Years Ended December 31,
                                    --------------------------------------
                                       2001          2000          1999
                                    ----------    ----------    ----------
Current expense (benefit):
   Federal                          $        -    $        -    $        -
   Foreign                                   -           400            60
   State                                     -             -             -
                                    ----------    ----------    ----------
   Current tax expense (benefit)             -           400            60
                                    ----------    ----------    ----------
Deferred expense (benefit)
   Federal                                   -             -             -
   Foreign                                   -             -             -
                                    ----------    ----------    ----------
   State                                     -             -             -
                                    ----------    ----------    ----------
   Deferred tax expense (benefit)            -             -             -
                                    ----------    ----------    ----------
   Net tax expense (benefit)        $        -    $      400    $       60
                                    ==========    ==========    ==========

The Company has no current or deferred federal and state income tax expense for
the years ended December 31, 2001, 2000 and 1999 because the Company generated
net operating losses during such periods.

                                     F-11

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

Significant components of the Company's deferred tax assets and liabilities
consist of the following:

                                                     December 31,
                                              -------------------------
                                                  2001           2000
                                              ------------   ----------
Current deferred tax assets:
  Compensation related items                   $       53     $      26
  Accrued expenses                                     77             -

Noncurrent deferred tax assets:
  Domestic net operating loss carryforwards        22,101        14,105
  Deferred revenue                                  1,574         2,470
  Research and development credits                  3,443         1,575
  Fixed and intangible assets                       1,055           886
  Stock-based compensation                          1,543         1,084
  Contributions                                       148           116
                                              ------------   ----------
   Total deferred tax assets                       29,994        20,262
   Valuation allowance for deferred assets        (29,994)      (19,664)
                                              ------------   ----------
Noncurrent deferred tax liabilities:
  Stock warrants                                        -           598
                                              ------------   ----------
   Total deferred tax liabilities                       -           598

   Net deferred tax asset (liability)          $        -     $       -
                                              ============   ==========

At December 31, 2001 and 2000, the Company provided a full valuation allowance
against its net deferred tax assets since realization of these benefits could
not be reasonably assured.  The increase in valuation allowance of $10,330
during the year ended December 31, 2001 resulted primarily from the generation
of additional net operating loss carryforward.

As of December 31, 2001 and 2000, the Company had federal and state net
operating loss carryforwards of $57,087 and $59,086, respectively. The net
operating loss carryforwards expire in various amounts starting in 2008 and 2010
for federal and state tax purposes, respectively. The utilization of the federal
net operating loss carryforwards may be subject to limitation under the rules
regarding a change in stock ownership as determined by the Internal Revenue
Code. If the Company's utilization of its net operating loss carryforwards is
limited and the Company has taxable income which exceeds the permissible yearly
net operating loss carryforward, the Company would incur a federal income tax
liability even though its net operating loss carryforwards exceed its taxable
income.

Additionally, as of December 31, 2001, the Company has federal research and
development and orphan drug credit carryforwards of $3,443.  The credit
carryforwards expire in varying amounts starting in 2010.

                                     F-12

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

Taxes computed at the statutory federal income tax rate of 34% are reconciled
to the provision for income taxes as follows:

<TABLE>
<CAPTION>
                                                       Years Ended December 31,
                                                 -----------------------------------
                                                     2001        2000        1999
                                                 ----------   ---------  -----------
<S>                                              <C>         <C>         <C>
United States federal tax at statutory federal
  income tax rate                                $   (7,866)  $  (4,621)   $ (3,107)
State taxes (net of federal benefit)                   (993)       (642)       (439)
Change in valuation reserve                          10,330       6,021       3,713
Research and development credit                      (1,868)       (664)       (151)
Foreign withholding tax, net of federal
  benefit                                                 -         264          39
Nondeductible expenses                                  279           -           -
Other nondeductible expenses                            118          42           5
                                                 ----------  ----------  ----------
Provision for income taxes                       $        -   $     400   $      60
                                                 ==========  ==========  ==========
</TABLE>

7. Notes Payable

On November 13, 1996, the Company entered into a Collaborative Funding
Agreement ("CFA") with The North Carolina Biotechnology Center ("NCBC") and the
Kenan Institute whereby NCBC agreed to loan the Company a total of $20. Loans
made to the Company by NCBC under the CFA are to be used for specific research
activities. All such loans are unsecured and bear interest at 8.25%, with
principal and accrued interest payable on November 7, 2001. The Company had
total borrowings from NCBC under the CFA of $20 as of December 31, 2000. The
Company paid off the note in 2001, prior to paying off the note, the Company
accrued interest on these loans of $2 in 2001. Accrued interest totaled $0 and
$6 at December 31, 2001 and 2000, respectively.

8. Stockholders' Equity

At December 31, 2001, the Company was authorized to issue 60,000,000 shares of
common stock with a par value of $.001 per share and 2,000,000 shares of
preferred stock with a par value of $0.001 per share.

On August 2, 2000, the Company's Registration Statement on Form S-1, as
amended, registering 6,325,000 shares of common stock was declared effective by
the Securities and Exchange Commission and permitted the Company to sell shares
of common stock in its initial public offering ("IPO"). On August 8, 2000, the
Company sold 5,500,000 shares of common stock at the IPO for $12.00 per share
which resulted in proceeds to the Company of $66,000. On September 5, 2000, the
Company sold an additional 825,000 shares of common stock at the IPO price of
$12.00 per share pursuant to the exercise by the underwriters of their
over-allotment option with respect to such shares, generating additional gross
proceeds of $9,900. Total stock issuance costs related to the IPO and exercise
of the over-allotment was $6,713.

At the IPO, all 26,684,666 shares of Series A preferred stock ("Series A
Preferred"), Series B preferred stock ("Series B Preferred"), Series D
preferred stock ("Series D Preferred") and Series E preferred stock ("Series E
Preferred") converted into 15,248,361 shares of common stock at a 1-for-1.75
conversion ratio. The 375,000 Series C preferred stock ("Series C Preferred")
converted into 214,284 shares of common stock at a 1-for-1.75 conversion ratio
plus an additional 6,438 shares of common stock were issued to the Series C
preferred stockholders as a result of their antidilution protection.
Additionally, 833,333 shares of Series G preferred stock ("Series G Preferred")
converted into 476,190 shares of common stock plus an additional 52,808 shares
of common stock were received by the Series G preferred stockholders in payment
of accrued dividends of $634.

                                     F-13

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

Common Stock

The holders of common stock shall be entitled to receive dividends from time to
time as may be declared by the Board of Directors. The holders of shares of
common stock are entitled to one vote for each share held with respect to all
matters voted on by the shareholders of the Company.

Preferred Stock

There were no outstanding shares of preferred stock at December 31, 2001 and
2000.

Sales of Preferred Stock

In March 1995, the Company issued 8,388,679 shares of Series A Preferred to a
group of venture capital investors at a price per share of $1.00 which resulted
in proceeds to the Company of $8,289, net of offering costs of $100. In
addition, bridge loans from the Series A Preferred investors totaling $811,
including accrued interest, were converted into 811,321 shares of Series A
Preferred, using a conversion price of $1.00 per share.

In June and September 1997, the Company issued 10,866,014 shares of Series B
Preferred to a group of venture capital investors at a price per share of $1.20
which resulted in proceeds to the Company of $12,966, net of offering costs of
$73.

In September 1998, the Company issued 375,000 shares of Series C Preferred to a
strategic partner, Kissei Pharmaceutical Co. Ltd.  ("Kissei"), at a price per
share of $2.40 which resulted in proceeds to the Company of $900, in
conjunction with entering into a collaboration agreement with Kissei relating
to the development of INS365 Respiratory (see Note 10).

In December 1998, the Company issued 416,667 shares of Series D Preferred to
Santen Pharmaceutical Company Ltd., at a price per share of $3.60 which
resulted in proceeds to the Company of $1,500, in conjunction with entering
into a collaboration agreement relating to the development of INS365 Ophthalmic
(See Note 10).

In July and October 1999, the Company issued 6,201,985 shares of Series E
Preferred stock to a group of venture capital investors at a price per share of
$2.00 which resulted in proceeds to the Company of $11,406, net of offering
costs of $998.

In December 1999, the Company issued 833,333 shares of Series G Preferred to
Genentech, Inc. ("Genentech"), at a price per share of $12.00 which resulted in
proceeds to the Company of $10,000 in conjunction with entering into a
collaboration agreement (See Note 10). The shares automatically converted into
shares of the common stock upon the initial public offering at an exchange rate
determined by dividing the total proceeds plus accrued and unpaid dividends by
the initial offering price of the Company's common stock.

Dividends

Prior to the IPO, the holders of Series A Preferred, Series B Preferred, Series
C Preferred and Series E Preferred were entitled to receive dividends equal to
any dividends paid on common stock. The holders of Series G Preferred were
entitled to cumulative dividends at the prime rate plus 1% of the Series G
preferred preference amount calculated on a per share basis. There were no
accrued Series G Preferred dividends at December 31, 2001 and 2000,
respectively. All accrued Series G Preferred dividends for $634 were paid at
the date of the IPO in the form of 52,808 common shares.

                                     F-14

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

9.  Stock Options and Warrants

1995 Stock Plan

During 1995, the Company adopted the 1995 Stock Plan, which provided for the
grant of up to 1,005,714 options to directors, officers, employees and
consultants. In April 1999, the Plan was amended and restated, and is now the
Amended and Restated 1995 Stock Plan (the "Plan"). The option pool was
increased to 5,228,571 shares on September 28, 2001 and to 6,428,571 shares on
December 14, 2001 by the Board of Directors subject to shareholder approval.
Under the Plan, both incentive and non-qualified stock options, as well as
restricted stock, can be granted. The Board of Directors shall determine the
term and dates of the exercise of all options at their grant date, provided
that for incentive stock options, such price shall not be less than the fair
market value of the Company's stock on the date of grant. At December 31, 2001,
there were 2,931,121 stock option shares available for grant.

The maximum exercise terms for an option grant is ten years from the date of
the grant. Options granted under the plan generally vest 25% upon completion of
one full year of employment and on a monthly basis over the following three
years. Vesting begins from the date of hire for new employees and on the date
of grant for existing employees.

The following table summarizes the stock option activity for the Plan:

                                                                  Weighted
                                               Number of          Average
                                                Shares         Exercise Price
                                           ----------------   ----------------
Options outstanding, December 31, 1998          1,490,102         $     0.200
   Granted                                        395,000               0.688
   Exercised                                     (306,775)             (0.124)
   Forfeited                                     (103,809)             (0.212)
                                           --------------     ----------------
Options outstanding, December 31, 1999          1,474,518               0.345
   Granted                                        748,995              12.228
   Exercised                                     (295,526)             (0.207)
   Forfeited                                     (157,629)             (6.227)
                                           --------------     ----------------
Options outstanding, December 31, 2000          1,770,358               4.872
   Granted                                        740,500              10.640
   Exercised                                     (144,534)             (0.471)
   Forfeited                                      (12,470)             (9.707)
                                           --------------     ----------------
Options outstanding, December 31, 2001          2,353,854         $     6.931
                                           ==============     ================

                                     F-15

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
               (In thousands, except share and per share amounts)

The following table summarizes information concerning options
outstanding at December 31, 2001:

<TABLE>
<CAPTION>
                                                                  Weighted
                                                                  Average
                                             Weighted             Remaining
                                              Average            Contractual
                             Options         Exercise               Life        Options
                           Outstanding         Price             (in Years)   Exercisable
                          -------------   ---------------    ---------------- -----------
<S>                       <C>             <C>                <C>              <C>
Price range
   $ 0.123 - $ 0.123           108,933    $         0.123               4.06      108,933
   $ 0.210 - $ 0.210           468,119              0.210               6.61      410,764
   $ 0.315 - $ 1.750           404,677              0.683               7.37      251,204
   $ 7.810 - $ 8.360           392,500              8.045               9.36            -
   $ 9.905 - $ 9.905            45,712              9.905               8.53       16,842
   $12.370 - $20.000           933,913             13.189               8.90      261,824
                          -------------   ---------------    ---------------- -----------
                             2,353,854    $         6.931               8.03    1,049,567
                          =============   ===============    ================ ===========
</TABLE>

Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting
for Stock-Based Compensation" requires the Company to disclose pro forma
information regarding option grants made and warrants issued to its employees.
SFAS 123 specifies certain valuations techniques that produce estimated
compensation charges that are included in the pro forma results below. These
amounts have not been reflected in the Company's statement of operations,
because the Company has made the election to use the provisions of APB 25 to
account for its stock based compensation.

The weighted average fair value of options granted during 2001, 2000 and 1999
was $11.66, $7.04 and $4.95, respectively.

The fair value of options granted to employees was estimated using the
following assumptions:

                                           Years Ended December 31,
                                  ---------------------------------------------
                                    2001             2000            1999
                                  --------------  --------------  -------------
Expected dividend yield                   0%                0%             0%
Expected stock price volatility       99.00%            65.04%             0%
Risk free interest rate                4.55%             6.50%          5.39%
Expected life of options             5 years           5 years         5 years

For purposes of pro forma disclosures, the estimated fair value of equity
instruments is amortized to expense over their respective vesting period.  If
the Company had elected to recognize compensation expense based on the fair
value of stock-based instruments at the grant date, as prescribed by SFAS 123,
its pro forma net loss and net loss per common share would have been as follows:

<TABLE>
<CAPTION>
                                                     Years Ended December 31,
                                            -----------------------------------------------
                                                 2001           2000            1999
                                            ------------   ---------------   --------------
<S>                                           <C>             <C>             <C>
Net loss available to common stockholders
     - as reported                            $   (23,135)    $   (14,584)    $    (8,996)
Net loss available to common stockholders
     - pro forma                              $   (23,665)    $   (15,109)    $    (8,943)
Net loss per common share - as reported       $     (0.90)    $     (1.23)    $     (3.75)
Net loss per common share - pro forma         $     (0.92)    $     (1.27)    $     (3.72)
</TABLE>

                                     F-16

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
                (In thousands, except share and per share amounts)

Warrants

Preferred Stock Warrants

In connection with the capital lease agreement executed on October 13, 1995,
the Company issued warrants which entitle the holder to purchase 165,000 shares
of Series A Preferred with an exercise price of $1.00 per share. These warrants
had an estimated fair value of $92 at the date of issuance which was deferred
and is being amortized as an increase to interest expense over the term of the
related lease agreement using the effective interest rate method. The warrants
are exercisable prior to the fifth anniversary date of the Company's initial
public offering.

In connection with an amendment on June 18, 1998 to increase the amount of
equipment under the capital lease agreement executed on October 13, 1995, the
Company issued warrants which entitle the holder to purchase 15,000 shares of
Series B Preferred with an exercise price of $1.20 per share. These warrants
had an estimated value of $7 at the date of issuance which was calculated using
the Black-Scholes method in accordance with SFAS 123. This amount was deferred
and is being amortized as an increase to interest expense over the term of the
related lease agreement using the effective interest rate method. The warrants
are exercisable prior to the fifth anniversary date of the Company's initial
public offering.

In connection with additional amendments to increase the amount of equipment
under the Company's capital lease agreement which were executed on February 8,
1999 and April 15, 1999, the Company issued warrants which entitle the holder
to purchase 20,000 and 8,170 shares, respectively, of Series F Preferred stock
("Series F Preferred") with an exercise price of $2.40 per share. These
warrants had an estimated fair value of $53 at their respective dates of
issuance which was calculated using the Black-Scholes method in accordance with
SFAS 123. These amounts were deferred and are being amortized as an increase to
interest expense over the term of the related lease agreement using the
effective interest rate method. The warrants are exercisable prior to the fifth
anniversary date of the Company's initial public offering.

During 2001, 148,500 of the Series A Preferred stock warrants, 15,000 of the
Series B Preferred stock warrants and 28,170 of the Series F Preferred stock
warrants were exercised as 109,523 common stock shares based on the 1-for-1.75
IPO conversion ratio. During 2000, 16,500 of the Series A Preferred stock
warrants were exercised and issued as 9,428 common stock shares based on the
1-for-1.75 IPO conversion ratio. At December 31, 2001, there were no
outstanding Preferred stock warrants.

Common Stock Warrants

In connection with a consulting agreement, the Company issued 11,428 warrants
on January 15, 1999 to purchase shares of the Company's common stock with an
exercise price of $4.20 per share. The warrants had an estimated value of $3.00
per share at the date of issuance as calculated using the Black-Scholes model
in accordance with SFAS 123. The warrants shall be exercisable prior to the
tenth anniversary of the grant date.

In connection with the sale of the Series G Preferred and the collaboration
agreement entered into with Genentech on December 17, 1999, the Company issued
warrants which entitle the holder to purchase 253,968 shares of common stock
with an exercise price of $7.88 per share. The warrants had an estimated value
of $1,782 at the date of issuance as determined using the Black-Scholes model
which was deferred and recorded in other assets and was amortized to research
and development expense over the period of the Company's research and
development commitment. The warrants are exercisable prior to December 17,
2004.

                                     F-17

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
                (In thousands, except share and per share amounts)

In connection with the sale of stock to Genentech (see Note 10), the Company
issued warrants on December 20, 2000 which entitle the holder to purchase
25,396 shares of common stock with an exercise price of $7.88 per share. The
warrants had an estimated value of $577 at the date of issuance as determined
using the Black-Scholes model, which was deferred and recorded as other assets
and was amortized to research and development expense over the period of the
Company's research and development commitment. The warrants are exercisable
prior to December 17, 2004.

None of the common stock warrants have been exercised as of December 31, 2001
and 2000.

Outstanding warrants to purchase the Company's common stock at December 31,
2001 are as follows:

                         Number of      Exercise Price
                         Warrants
                       --------------   -----------------
                             11,428      $        4.20
                            279,364      $        7.88

10. Collaboration Agreements

On September 10, 1998, the Company entered into a Joint Development, License
and Supply Agreement (the "Kissei Agreement") with Kissei related to the
development of INS365 Respiratory for all therapeutic respiratory applications,
excluding sinusitis and middle ear infection, in Japan. INS365 Respiratory for
respiratory therapeutic uses is licensed by the Company from The University of
North Carolina at Chapel Hill. Under the terms of the Kissei Agreement, Kissei
will develop, commercialize, and market INS365 Respiratory in Japan. The
Company maintains the right to manufacture and supply INS365 to Kissei. Kissei
also has the first right to negotiate a license to particular P2Y2 agonist that
show utility as inhalation products for respiratory uses in Japan.

Upon the signing of the Kissei Agreement, Kissei purchased 375,000 shares of
the Company's Series C Preferred for $900 or $2.40 per share. In addition, the
Company received a non-refundable up front license fee of $3,600 which was
initially deferred and is being recognized as license revenue ratably over the
period of the Company's ongoing research and development commitment. In
addition, depending on whether all milestones are met, the Company could
receive milestone payments of up to $13,000 over the term of the Kissei
Agreement. The Company is receiving reimbursement for liaison staff positions
which totaled $250 in each of the years ended December 31, 2001 and 2000,
respectively. In addition, the Company will receive royalties on net sales of
INS365 Respiratory by Kissei. During 1999, the Company received a milestone
payment under the Kissei Agreement of $600 based on achievement of technical
milestones by Inspire. In January 2000, the Company received a milestone
payment of $1,500 based on achievement of a technical milestone by Kissei in
its development of INS365 Respiratory. No milestone payments were received
under the Kissei Agreement during 2001.

The Company is obligated to supply Kissei with its requirements of INS365
Respiratory bulk drug substance reimbursed at cost. In addition, the Company is
obligated to supply Kissei with its requirements of finished product contained
in a vial or nebule and in a delivery system approved by the joint development
committee for all clinical trials to be conducted by Kissei. Kissei will pay us
an agreed-upon transfer price for all such supplies. We have also agreed to
negotiate a commercial supply arrangement with Kissei at the appropriate time
to supply Kissei's requirements of finished product and the delivery system.

The agreement will terminate when all patents licensed under the agreement have
expired. Either Kissei or the Company may terminate the agreement if the other
materially breaches the agreement. In addition, Kissei has the right, by giving
the Company three months prior notice, to terminate the agreement at any time
if Kissei determines that continued development or marketing of the product is
scientifically or economically infeasible. If Kissei breaches the agreement or
terminates the agreement early other than for the Company's breach, Kissei's
license will terminate. Kissei will provide us with all data and information
relating to our products, and Kissei will assign or permit us to
cross-reference all regulatory filings and approvals.

                                     F-18

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
                (In thousands, except share and per share amounts)

On December 16, 1998, the Company entered into a Development, License and
Supply Agreement (the "Santen Agreement") with Santen Pharmaceutical Company,
Ltd. ("Santen") to complete the development of INS365 Ophthalmic for the
therapeutic treatment of ocular surface diseases. Santen received an exclusive
license to INS365 Ophthalmic in Japan, China, South Korea, the Philippines,
Thailand, Vietnam, Taiwan, Singapore, Malaysia and Indonesia in the field.
Under the terms of the Santen Agreement, Santen will develop, commercialize,
and market INS365 Ophthalmic in the geographical areas mentioned above. The
Company retains the right to manufacture and supply INS365 Ophthalmic in bulk
drug substance to Santen.

Upon the signing of the Santen Agreement, Santen purchased 416,667 shares of
the Company's Series D Preferred for $1,500 or $3.60 per share. In addition,
depending on whether all milestones under the Santen Agreement are met, the
Company could receive milestone payments of up to $4,750. In addition, the
Company will receive royalties on net sales on INS365 Ophthalmic by Santen.

No milestone payments were received under the Santen Agreement during 2001 or
1999. During 2000, the Company received a milestone payment under the Santen
Agreement of $500 based on achievement of a regulatory milestone by Santen.

The agreement will terminate when all patents licensed under the agreement have
expired. Either Santen or the Company may terminate the agreement if the other
materially breaches the agreement. In addition, the Company has the right to
terminate the agreement at any time if we determine, subject to the
coordinating committee's review and arbitration, that Santen has not made
reasonably sufficient progress in the development or commercialization of
products. If Santen breaches the agreement, or if the Company terminates the
agreement because Santen has not made sufficient progress, Santen's license
will terminate. Santen will provide us with all data and information relating
to our products, and will assign or permit us to cross-reference all regulatory
filings and approvals.

On December 17, 1999, the Company entered into a Development, License and
Supply Agreement (the "Genentech Agreement") with Genentech to jointly develop
INS365 Respiratory and other related P2Y2 agonists existing on the date of the
Genentech Agreement for all human therapeutic uses for (a) the treatment of
respiratory tract disorders, including chronic bronchitis and cystic fibrosis,
throughout the world, excluding Japan and (b) the treatment of sinusitis and
middle ear infection worldwide.

The Genentech Agreement provided that Genentech would pay the Company a
non-refundable, non-creditable up-front payment of $5,000 upon execution of the
Genentech Agreement, which the Company recorded as license revenue over the
term of its research and development commitment, which ended in November 2001
as a result of the termination of the agreement.

Upon the signing of the agreement, Genentech purchased 833,333 shares of Series
G Preferred for $12.00 per share or an aggregate purchase price of $10,000 and
Genentech was issued 253,968 warrants to purchase shares of the Company's
common stock with an exercise price of $7.88 per share. In addition, upon the
occurrence of certain milestone events, the Company was obligated to sell, and
Genentech was obligated to purchase: (i) up to $2,000 of the Company's common
stock, at a per share price determined, using the 20-day trailing average close
price of the Company's common stock as quoted on an established stock exchange,
and (ii) Genentech would have been issued warrants for up to 50,793 shares of
the Company's common stock at an exercise price of $7.88 per share.

On December 20, 2000, upon achievement of a technical milestone the Company
sold 64,806 shares of common stock to Genentech at $15.40 per share and issued
warrants which entitle the holder to purchase 25,396 shares of common stock
with an exercise price of $7.88 (see Note 9).

On June 20, 2001, Genentech notified the Company that they were terminating the
agreement and returned all rights for use of INS365 Respiratory and our other
related P2Y2 agonists at no charge. The decision to return the product rights
was based on a strategic review by Genentech of its overall development
portfolio. The Company received in excess of $16 million in equity and cash
payments during the collaboration.

                                     F-19

<PAGE>

                          INSPIRE PHARMACEUTICALS, INC.
                          (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
                (In thousands, except share and per share amounts)

On September 12, 2000, the Company entered into a License Agreement (the "Kirin
Agreement") with Kirin Brewery Company, Ltd., Pharmaceutical Division ("Kirin")
to complete the development and commercialization of INS316 Diagnostic to aid
in the diagnosis of lung cancer. Kirin received an exclusive license to INS316
Diagnostic in twenty-one Asian countries and regions ("the Territory") in the
field. Under the terms of the Kirin Agreement, Kirin will develop, manufacture,
commercialize, and market INS316 Diagnostic in the Territory.

Upon the signing of the Kirin Agreement, the Company received a non-refundable
up front license fee which was initially deferred and is being recognized as
license revenue ratably over the period of the Company's ongoing research and
development commitment. In addition, depending on whether all milestones under
the Kirin Agreement are met, the Company could receive milestone payments based
on clinical success. Upon commercialization, the Company will receive royalties
on net sales of INS316 Diagnostic by Kirin within the Territory.

The agreement will terminate as to a product on the later of the 10th
anniversary of the first commercial sale of the product or the date on which
the sale of the product ceases to be covered by a licensed clause under the
agreement. Either Kirin or the Company may terminate the agreement if the other
materially breaches the agreement. In addition, Kirin has the right, by giving
Inspire 180 days prior notice, to terminate the agreement at any time.

In June 2001, the Company entered into a joint license, development and
marketing agreement with Allergan to develop and commercialize two novel
therapeutic treatments for dry eye. Under the terms of the agreement, Allergan
obtained an exclusive license to develop and commercialize INS365 Ophthalmic
worldwide, with the exception of Japan and nine other Asian Countries covered
by Inspire's agreement with Santen. In return, Inspire will receive up to $39
million in up-front and milestone payments, a co-promotion option for INS365
Ophthalmic in the United States and royalty payments based on net sales. In
addition, Inspire will receive royalties on global net sales of Allergan's
Restasis(R) excluding sales in Japan, Taiwan, Korea, Hong Kong and Peoples
Republic of China. The agreement also provides for potential co-promotion by
Inspire of INS365 Ophthalmic and Restasis(R) and one or more of Allergan's
other marketed products in the United States.

Inspire and Allergan have established a joint development committee to oversee
the joint development programs and a joint commercial committee to establish
the brand strategies and manage the relationship. Under the terms of the
agreement, Inspire will provide bulk active drug substance through the end of
Phase III clinical trial for INS365 Ophthalmic. After Phase III, Allergan is
responsible for obtaining or manufacturing all of its bulk active drug
substance requirements and for all commercial supply of product.

Inspire is responsible for conducting, in collaboration with Allergan, the
Phase III clinical trials for INS365 Ophthalmic for dry eye and for U.S. NDA
filing and approval. Allergan is responsible for all other development
activities under the agreement, including all development outside the United
States and in their territories, and for regulatory submissions, filings and
approvals relating to products outside the United States. Allergan is required
to use commercially reasonable efforts to conduct development, seek regulatory
approvals and market and sell the products.

The agreement will be in effect until all patents licensed under the agreement
have expired, unless earlier terminated. Either Allergan or Inspire may
terminate the agreement if the other materially breaches the agreement. In
addition, Allergan has the right, by giving the Company 180 days prior notice,
to terminate the agreement at any time. If Allergan breaches the agreement or
terminates the agreement early, other than for Inspire's breach, Allergan's
license will terminate. Allergan must provide Inspire all data and information
relating to the Company's products, and Allergan must assign or permit Inspire
to cross-reference all regulatory filings and approvals.

                                     F-20

<PAGE>

                         INSPIRE PHARMACEUTICALS, INC.
                         (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
              (In thousands, except share and per share amounts)

11.  License Agreement

On March 10, 1995, the Company licensed the rights to the patent for a Method
of Treating Lung Disease with Uridine Triphosphates which covers INS316
Diagnostic from The University of North Carolina at Chapel Hill. In connection
with this license agreement, the Company paid $65 in license initiation fees
and issued 297,714 shares of common stock with an estimated value at the date
of issuance of $36 or $0.12 per share and has agreed to make milestone payments
totaling up to $1,000. The Company reached one such milestone in 1997 and made
the milestone payment of $500 in the same year. A $10 milestone payment was
made during each of 2001 and 2000.

On September 1, 1998, the Company licensed the rights to the patents for a
Method of Treating Cystic Fibrosis with Dinucleotides, a Method of Treating
Bronchitis with Uridine Triphosphates and related compounds, and a Method of
Treating Ciliary Dyskinesia with Uridine Triphosphates and related compounds,
which cover INS365 Respiratory, from The University of North Carolina at Chapel
Hill. In connection with this license agreement, the Company paid $15 in
license initiation fees and issued 28,572 shares of common stock with an
estimated value at the date of issuance of $90 or $3.15 per share and has
agreed to pay milestone payments totaling $160. The Company made milestone
payments of $5 each during 2001 and 2000.

In connection with the license agreements with The University of North Carolina
at Chapel Hill, the Company has agreed to pay royalties based on net sales of
certain Licensed Products (as defined in the license agreements).

The Company enters into sponsored research and development and clinical trial
agreements with The University of North Carolina at Chapel Hill on an annual
basis whereby direct and indirect costs, as defined, are reimbursed by the
Company.

12.  Commitments

The Company is obligated under a master capital lease for furniture, equipment,
and computers. Each lease term under the master lease agreement expires between
30 to 48 months from the date of inception.

The Company also has several non-cancelable operating leases, primarily for
office space and office equipment, that extend through May 2004 and are subject
to certain voluntary renewal options. Rental expense for operating leases
during 2001, 2000 and 1999 for the cumulative period from inception (October
28, 1993) to December 31, 2001 was $319, $186 (net of sublease rentals $11),
$164 (net of sublease rentals $25), and $1,115 (net of sublease rentals of
$108), respectively.

Future minimum lease payments under capital and non-cancelable operating leases
with remaining lease payments as of December 31, 2001 are as follows:

                                                   Capital       Operating
Year Ending December 31,                           Leases          Leases
----------------------------------------------   ------------   -----------
  2002                                              $    468      $    326
  2003                                                   338           163
  2004                                                   215            10
                                                 ------------   -----------
Total minimum lease payments                           1,021      $    499
                                                                ===========
Less amount representing interest                        120
                                                 ------------
Present value of net minimum capital lease
  payments                                               901
Less current portion of capital lease
  obligations                                            376
                                                 ------------
Capital lease obligations, excluding current
  portion                                           $    525
                                                 ============

                                     F-21

<PAGE>

                         INSPIRE PHARMACEUTICALS, INC.
                         (A Development Stage Company)
                    NOTES TO FINANCIAL STATEMENTS (Continued)
              (In thousands, except share and per share amounts)

The Company has contractual commitments or purchase arrangements with various
clinical research organizations, manufacturers of drug product and others. Most
of these arrangements are for a period of less than 12 months. The amount of
the Company's financial commitments under these arrangements totals
approximately $7,744 at December 31, 2001.

During 2001, the Company signed a letter of intent to enter into an equipment
financing agreement under which the Company can borrow up to $1.5 million to
finance the purchase of scientific and other equipment. At December 31, 2001,
$0 was outstanding under this agreement.

13.  Employee Benefit Plan

The Company has adopted a 401(k) Profit Sharing Plan ("the 401(k) Plan")
covering all qualified employees. The effective date of the 401(k) Plan is
August 1, 1995. Participants may elect a salary reduction of 1% to 15% as a
contribution to the 401(k) Plan. Modifications of salary reductions can be made
quarterly.

The 401(k) Plan permits employer matching of up to 8% of a participant's
salary. If employer matching is implemented, participants will begin vesting
100% immediately in employer contributions.

In 2001 the Company elected a safe harbor contribution at 3.0% of annual
compensation. All Company safe harbor contributions vest 100% immediately.

14.  Quarterly Financial Data (Unaudited)


             2001               First    Second     Third     Fourth    Total
----------------------------  --------  --------   --------  --------  ---------
Revenue:
  Collaborative research
    agreements                 $ 1,405   $ 1,404   $ 2,238   $ 2,238   $  7,285

Net loss available to common
  stockholders                  (5,238)   (5,908)   (4,916)   (7,073)   (23,135)

Net loss per common
  share - basic and diluted    $ (0.20)  $ (0.23)  $ (0.19)  $ (0.28)  $   (.90)

             2000
----------------------------
Revenue:
  Collaborative research
    agreements                 $ 1,154   $ 1,154   $ 1,155   $ 1,905   $  5,368

Net loss available of common
  stockholders                  (2,512)   (3,000)   (4,237)   (4,835)   (14,584)

Net loss per common
  share - basic and diluted    $ (1.01)  $ (1.15)  $ (0.25)  $ (0.19)  $  (1.23)

Earnings per common share are computed independently for each of the quarters
presented and therefore may not sum to the total for the year.

                                     F-22

<PAGE>


                                  Exhibit Index

Exhibit
Number         Description
------         -----------

3.1            Amended and Restated Certificate of Incorporation. (Incorporated
               by reference to Exhibit 3.1 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which became
               effective on August 3, 2000).

3.2            Certificate of Amendment of Amended and Restated Certificate of
               Incorporation.

3.3            Amended and Restated Bylaws. (Incorporated by reference to
               Exhibit 3.2 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

4.1            Specimen Common Stock Certificate. (Incorporated by reference to
               Exhibit 4.1 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.1+          Amended and Restated 1995 Stock Plan, as amended. (Incorporated
               by reference to Exhibit 10.1 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which became
               effective on August 3, 2000).

10.2+          Form of Incentive Stock Option. (Incorporated by reference to
               Exhibit 10.2 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.3+          Form of Non-statutory Stock Option. (Incorporated by reference
               to Exhibit 10.3 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.4           Consultation and scientific Advisory Board Agreement between
               Inspire Pharmaceuticals, Inc. and Dr. Richard Boucher, dated
               March 10, 1995. (Incorporated by reference to Exhibit 10.4 to
               the Company's registration statement on Form S-1 (Registration
               No. 333-31174) which became effective on August 3, 2000).

10.5*          Sponsored Research Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill,
               effective March 10, 1995. (Incorporated by reference to Exhibit
               10.5 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.6*          Exclusive License Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill, dated
               March 10, 1995. (Incorporated by reference to Exhibit 10.7 to
               the Company's registration statement on Form S-1 (Registration
               No. 333-31174) which became effective on August 3, 2000).

10.7           Lease between Inspire Pharmaceuticals, Inc. and Imperial Center,
               Limited Partnership regarding Royal Center I, Durham, North
               Carolina, dated as of May 17, 1995, as amended. (Incorporated by
               reference to Exhibit 10.8 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which became
               effective on August 3, 2000).

10.8           Master Lease Agreement between Inspire Pharmaceuticals, Inc. and
               Comdisco, Inc., dated October 13, 1995, as amended.
               (Incorporated by reference to Exhibit 10.9 to the Company's
               registration statement on Form S-1 (Registration No. 333-31174)
               which became effective on August 3, 2000).

10.9           Lease Agreement between Inspire Pharmaceuticals, Inc. and Petula
               Associates Ltd. regarding Royal Center II, Durham, North
               Carolina, dated as of December 30, 1997. (Incorporated by
               reference to Exhibit 10.10 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which became
               effective on August 3, 2000).

10.10          Sublease Agreement between ICAgen, Inc. and Inspire
               Pharmaceuticals, Inc. regarding premises located at 4222 Emperor
               Boulevard, Suite 500, Durham, North Carolina, dated September
               22, 1997 and extension of Sublease Agreement dated February 14,
               2000. (Incorporated by reference to Exhibit 10.11 to the
               Company's registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.11*         Exclusive License Agreement between Inspire Pharmaceuticals,
               Inc. and The University of North Carolina at Chapel Hill, dated
               September 1, 1998. (Incorporated by reference to Exhibit 10.12
               to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

<PAGE>



Exhibit
Number         Description
------         -----------

10.12*         Joint Development, License and Supply Agreement between Inspire
               Pharmaceuticals, Inc. and Kissei Pharmaceutical Co., Ltd., dated
               as of September 10, 1998. (Incorporated by reference to Exhibit
               10.13 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.13          Registration Rights Agreement between Inspire Pharmaceuticals,
               Inc. and Kissei Pharmaceutical Co., Ltd., dated as of September
               10, 1998. (Incorporated by reference to Exhibit 10.14 to the
               Company's registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.14*         Development, License and Supply Agreement between Inspire
               Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated
               as of December 16, 1998. (Incorporated by reference to Exhibit
               10.15 to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.15          Registration Rights Agreement between Inspire Pharmaceuticals,
               Inc. and Santen Pharmaceutical Co., Ltd., dated as of December
               16, 1998. (Incorporated by reference to Exhibit 10.16 to the
               Company's registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.16*         Development, License and Supply Agreement between Inspire
               Pharmaceuticals, Inc. and Genentech, Inc., dated as of December
               17, 1999. (Incorporated by reference to Exhibit 10.20 to the
               Company's registration statement on Form S-1 (Registration No.
               333-31174) which became effective on August 3, 2000).

10.17*         Series G Preferred Stock and Warrant Purchase Agreement between
               Inspire Pharmaceuticals, Inc. and Genentech, Inc., dated as of
               December 17, 1999. (Incorporated by reference to Exhibit 10.21
               to the Company's registration statement on Form S-1
               (Registration No. 333-31174) which became effective on August 3,
               2000).

10.18*         Warrant Agreement between Inspire Pharmaceuticals, Inc. and
               Genentech, Inc., dated as of December 17, 1999. (Incorporated by
               reference to Exhibit 10.22 to the Company's registration
               statement on Form S-1 (Registration No. 333-31174) which became
               effective on August 3, 2000).

10.19          Amended and Restated Investors' Rights Agreement among Inspire
               Pharmaceuticals, Inc. and the holders of Series A, B, E and G
               Preferred Stock of the Company dated as of December 17, 1999.
               (Incorporated by reference to Exhibit 10.23 to the Company's
               registration statement on Form S-1 (Registration No. 333-31174)
               which became effective on August 3, 2000).

10.20+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Donald
               Kellerman dated February 3, 2000. (Incorporated by reference to
               Exhibit 10.24 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.21+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Gregory J.
               Mossinghoff dated February 4, 2000. (Incorporated by reference
               to Exhibit 10.25 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.22+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Benjamin R.
               Yerxa dated February 4, 2000. (Incorporated by reference to
               Exhibit 10.26 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.23+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Christy L.
               Shaffer dated February 10, 2000. (Incorporated by reference to
               Exhibit 10.28 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.24          Master Agreement between Inspire Pharmaceuticals, Inc. and
               ClinTrials BioResearch Ltd. dated as of December 23, 1999.
               (Incorporated by reference to Exhibit 10.29 to the Company's
               registration statement on Form S-1 (Registration No. 333-31174)
               which became effective on August 3, 2000).

<PAGE>



Exhibit
Number         Description
------         -----------

10.25+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Richard M.
               Evans dated February 10, 2000. (Incorporated by reference to
               Exhibit 10.30 to the Company's registration statement on Form
               S-1 (Registration No. 333-31174) which became effective on
               August 3, 2000).

10.26*         License Agreement between Inspire Pharmaceuticals, Inc. and
               Kirin Brewery Company, Ltd., Pharmaceutical Division, dated as
               of September 12, 2000. (Incorporated by reference to Exhibit
               10.1 to the Company's Quarterly Report on Form 10-Q filed on
               November 3, 2000).

10.27+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Mary Bennett
               dated February 27, 2001. (Incorporated by reference to Exhibit
               10.1 to the Company's quarterly report on Form 10-Q filed on May
               15, 2001).

10.28          Sublease between Inspire Pharmaceuticals, Inc. and Circuit City
               Stores, Inc., dated as of May 7, 2001. (Incorporated by
               reference to Exhibit 10.1 to the Company's quarterly report on
               Form 10-Q filed on August 10, 2001).

10.29+         Employee Confidentiality, Invention Assignment and Non-Compete
               Agreement between Inspire Pharmaceuticals, Inc. and Joseph
               Schachle dated April 3, 2001. (Incorporated by reference to
               Exhibit 10.2 to the Company's quarterly report on Form 10-Q
               filed on August 10, 2001).

10.30*         License, Development and Marketing Agreement between Inspire
               Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22,
               2001. (Incorporated by reference to Exhibit 10.1 to the
               Company's Current Report on Form 8-K filed on June 29, 2001).

23.1           Consent of PricewaterhouseCoopers LLP, independent public
               accountants

--------------------

*    Confidential treatment has been granted with respect to a portion of this
     Exhibit.

+    Denotes a management contract or compensation plan or arrangement required
     to be filed as an exhibit pursuant to Item 14(a) of this Form 10-K.