10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2004

OR

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

For the transition period from              to             

Commission File Number: 000-31135

INSPIRE PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	04-3209022
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
4222 Emperor Boulevard, Suite 200 Durham, North Carolina	27703
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code: (919) 941-9777

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES  x    NO  ¨

As of June 30, 2004, there were 32,034,049 shares of Inspire Pharmaceuticals, Inc. common stock outstanding.

INSPIRE PHARMACEUTICALS, INC.

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Condensed Balance Sheets – June 30, 2004 and December 31, 2003	3
	Condensed Statements of Operations – Three and Six months ended June 30, 2004 and 2003	4
	Condensed Statements of Cash Flows – Six months ended June 30, 2004 and 2003	5
	Notes to Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22
Item 4.	Controls and Procedures	23
PART II. OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	24
Item 5.	Other Information	25
Item 6.	Exhibits and Reports on Form 8-K	39
Signatures		40
Exhibit Index		41

2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

INSPIRE PHARMACEUTICALS, INC.

Condensed Balance Sheets

(in thousands, except per share amounts)

	(Unaudited) June 30, 2004			December 31, 2003
Assets
Current assets:
Cash and cash equivalents	$	29,425		$	34,324
Investments		19,423			37,130
Receivable from Allergan		2,744			—
Prepaid expenses		1,184			1,389
Other assets		207			207
Total current assets		52,983			73,050
Property and equipment, net		2,404			2,092
Investments		4,716			3,712
Other assets		711			824
Total assets	$	60,814		$	79,678
Liabilities & Stockholders’ Equity
Current liabilities:
Accounts payable	$	2,199		$	4,003
Accrued compensation and benefits		2,619			479
Accrued expenses		2,164			1,735
Notes payable and capital leases		487			602
Deferred revenue		661			—
Total current liabilities		8,130			6,819
Capital leases – noncurrent		1,399			482
Other long-term liabilities		1,637			1,325
Total liabilities		11,166			8,626
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.001 par value, 60,000 shares authorized; 32,034 and 31,847 shares issued and outstanding, respectively		32			32
Additional paid-in capital		199,122			198,393
Accumulated other comprehensive loss		(292	)		(279	)
Accumulated deficit		(149,214	)		(127,094	)
Total stockholders’ equity		49,648			71,052
Total liabilities and stockholders’ equity	$	60,814		$	79,678

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

3

INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Operations

(in thousands, except per share amounts)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30, 2004			June 30, 2003			June 30, 2004			June 30, 2003
Revenues:
Revenues from product co-promotion	$	2,948		$	—		$	3,557		$	—
Collaborative research agreements		—			4,100			—			5,200
Total revenue		2,948			4,100			3,557			5,200
Operating expenses:
Research and development		5,407			8,894			10,556			16,010
Selling and marketing		5,198			72			11,136			428
General and administrative		2,148			1,852			4,334			3,334
Total operating expenses		12,753			10,818			26,026			19,772
Loss from operations		(9,805	)		(6,718	)		(22,469	)		(14,572	)
Other income (expense):
Interest income		254			410			588			530
Interest expense		(24	)		(10	)		(41	)		(23	)
Loss on investments		(117	)		(300	)		(198	)		(300	)
Other income		113			100			349			207
Net loss	$	(9,692	)	$	(6,618	)	$	(22,120	)	$	(14,365	)
Basic and diluted net loss per common share	$	(0.30	)	$	(0.21	)	$	(0.69	)	$	(0.49	)
Common shares used in computing basic and diluted net loss per common share		31,995			31,716			31,948			29,231

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

4

INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Cash Flows

(in thousands)

(Unaudited)

	Six Months Ended
	June 30, 2004			June 30, 2003
Cash flows from operating activities:
Net loss	$	(22,120	)	$	(14,365	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization expense		103			291
Depreciation of fixed assets		439			296
Gain on disposal of property and equipment		(1	)		—
Loss on investments		198			300
Changes in operating assets and liabilities:
Receivables		(2,744	)		(3,072	)
Prepaid expenses		205			270
Other assets		10			5
Accounts payable		(1,804	)		414
Accrued expenses		2,881			1,903
Deferred revenue		661			(2,200	)
Net cash used by operating activities		(22,172	)		(16,158	)
Cash flows from investing activities:
Purchase of investments		(24,561	)		(47,079	)
Proceeds from sale of investments		41,053			4,002
Purchase of property and equipment		—			(497	)
Proceeds from sale of property and equipment		522			—
Net cash provided (used) by investing activities		17,014			(43,574	)
Cash flows from financing activities:
Issuance of common stock, net		729			72,805
Payments on notes payable and capital lease obligations		(470	)		(153	)
Net cash provided by financing activities		259			72,652
(Decrease) increase in cash and cash equivalents		(4,899	)		12,920
Cash and cash equivalents, beginning of period		34,324			27,128
Cash and cash equivalents, end of period	$	29,425		$	40,048

Supplemental disclosure of non-cash investing and financing activities: The Company acquired property and equipment through the assumption of capital lease obligations amounting to $1,272 and $0 during the six months ended June 30, 2004 and 2003, respectively.

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

5

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

1. Organization

Inspire Pharmaceuticals, Inc. (the “Company” or “Inspire”) was incorporated in October 1993 and commenced operations in March 1995 following the Company’s first substantial financing and licensing of initial technology from The University of North Carolina at Chapel Hill. Since that time, Inspire has been engaged in the discovery, development and commercialization of prescription pharmaceutical products for the treatment of various diseases with significant unmet medical needs. The Company’s core area of expertise relates to the class of nucleotide receptors, known as P2, which Inspire believes are important drug targets in various therapeutic areas, including ophthalmology, respiratory disease, cardiovascular disease and pain. In January 2004, Inspire began commercial operations. The Company is co-promoting two products, Elestat^TM and Restasis^®, in the United States. Prior to January 2004, Inspire was considered a development stage company. Inspire is located in Durham, North Carolina, adjacent to the Research Triangle Park.

Inspire has incurred losses and negative cash flows from operations since inception. The Company has recorded revenue from product co-promotions in 2004, but will continue to incur operating losses until revenues reach a level sufficient to support ongoing operations.

2. Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles of the United States of America and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. It is presumed that users of this interim financial information have read or have access to the audited financial statements from the preceding fiscal year contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full year.

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 will differ from those estimates.

Net Loss Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted net income (loss) per common share is computed by dividing net income (loss) 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. The calculation of diluted earnings per share for the three months ended June 30, 2004 and 2003 does not include 1,655 and 1,599, respectively, and for the six months ended June 30, 2004 and 2003, does not include 1,548 and 1,587, respectively, of potential shares of common stock equivalents, as their impact would be antidilutive.

Deferred Compensation and Stock Options

The Company accounts for deferred compensation based on the provisions of Accounting Principles Board Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” which states that no compensation

6

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

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 at the date of grant and the exercise price of the stock option is recorded as deferred compensation. The Company did not recognize any deferred compensation associated with stock option grants for the three and six months ended June 30, 2004 and 2003.

Deferred compensation is amortized over the vesting period of the related stock option, which is generally four years for employee stock option grants and three years (the applicable term in office) for stock options granted to non-employee Directors elected to the Board of Directors. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards (“SFAS”) 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.

SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transaction and Disclosure” requires the Company to disclose pro forma information regarding option grants and warrants issued to its employees. SFAS No. 123 specifies certain valuation techniques that produce estimated compensation charges that are included in the pro forma results below. These amounts, which are set forth below, have not been reflected in the Company’s statement of operations, because the Company has elected to use the provisions of APB No. 25 to account for its stock-based compensation.

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 No. 123, its pro forma net loss and net loss per common share would have been as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net loss – as reported	$	(9,692	)	$	(6,618	)	$	(22,120	)	$	(14,365	)
Compensation expense included in reported net loss		—			144			—			291
Pro forma adjustment for compensation expense		(2,191	)		(1,217	)		(4,345	)		(2,228	)
Net loss – pro forma	$	(11,883	)	$	(7,691	)	$	(26,465	)	$	(16,302	)
Net loss per common share – as reported	$	(0.30	)	$	(0.21	)	$	(0.69	)	$	(0.49	)
Net loss per common share – pro forma	$	(0.37	)	$	(0.24	)	$	(0.83	)	$	(0.56	)

Manufacturing and Concentration of Receivables Risk

The Company relies on single source manufacturers for each of its products and product candidates. In addition, Allergan relies on single source manufacturers for the manufacture of Elestat^TM and Restasis^®, products co-promoted by the Company. Accordingly, delays in the manufacture of any product or product candidate could adversely impact the marketing of our products or the development of our product candidates. Furthermore, Allergan is responsible for the manufacture of both Elestat^TM and Restasis^®. Therefore, the Company has little control over the manufacture of products for which it will receive revenue and over the overall product supply chain.

All revenues recognized and recorded in 2004 and 2003 were from Allergan, Inc. (“Allergan”). The Company is entitled to receive product co-promotion payments on “Net Sales” of Elestat^TM and Restasis^® under the

7

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

terms of its collaborative agreements with Allergan, and, accordingly, all trade receivables are concentrated with Allergan. Due to the nature of these agreements, Allergan has significant influence over the commercial success of these products.

Revenue Recognition

The Company recognizes revenue from product co-promotion based on net sales for Elestat^TM and Restasis^® as defined in the co-promotion agreements, and as reported to Inspire by its collaborative partner, Allergan. Accordingly, the Company’s co-promotion revenue is based upon Allergan’s revenue recognition policy, other accounting policies and the underlying terms of the co-promotion agreements. Allergan recognizes revenue from product sales when goods are shipped and title and risk of loss transfers to the customer. The co-promotion agreements provide for gross sales to be reduced by estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales rebates and other allocated costs as defined in the agreements. The Company also reduces gross sales for incentive programs it manages, estimating the proportion of sales that are subject to such incentive programs and reducing revenue appropriately. Under the Elestat^TM co-promotion agreement, the Company is obligated to meet predetermined minimum annual net sales performance levels. If the annual minimum is not satisfied, the Company receives a percentage of net sales based upon predetermined calendar year net sales target levels. To date, the Company has recognized only those revenues associated with targeted net sales levels achieved during the six months ending June 30, 2004. Amounts contractually due from Allergan in excess of recorded co-promotion revenues associated with Elestat^TM are accounted for as deferred revenue and will be realized in subsequent calendar quarters as the Company achieves greater Elestat^TM net sales levels.

The Company recognizes milestone revenue under its collaborative research and development agreements when Inspire has performed services under such agreements or when Inspire or its collaborative partner has met a contractual milestone triggering a payment to the Company. Non-refundable fees received at the initiation of collaborative agreements for which the Company has an ongoing research and development commitment are deferred and recognized ratably over the period of ongoing research and clinical development commitment. The Company is also entitled to receive milestone payments under its collaborative research and development agreements based upon achievement of development milestones by Inspire or its collaborative partners. The Company recognizes milestone payments as revenues ratably over the remaining period of its research and 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 the Company has fulfilled its research and development commitment. This period is based on estimates by management and the progress towards milestones in the Company’s collaborative agreements. The estimate is subject to revision as the Company’s development efforts progress and the Company gains 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 the Company’s revenue to fluctuate from period to period.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss is comprised of unrealized gains and losses on marketable securities and is disclosed as a component of stockholders’ equity. The Company had $292 and $279 of unrealized loss on its investments that is classified as accumulated other comprehensive loss at June 30, 2004 and December 31, 2003, respectively.

8

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

Comprehensive loss consists of the following components for the three and six months ended June 30:

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net loss	$	(9,692	)	$	(6,618	)	$	(22,120	)	$	(14,365	)
Unrealized (loss) gain on marketable securities		(73	)		144			(13	)		291
Total comprehensive loss	$	(9,765	)	$	(6,474	)	$	(22,133	)	$	(14,074	)

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation.

3. Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (“FIN No. 46”), “Consolidation of Variable Interest Entities,” which requires the assets, liabilities and results of operations of variable interest entities (“VIE”) be consolidated into the financial statements of the company that has controlling financial interest. FIN No. 46 also provides the framework for determining whether a VIE should be consolidated based on voting interest or significant financial support provided to the VIE. The effective date for applying the provisions of FIN No. 46 for interests held by public entities in VIEs or potential VIEs created before February 1, 2003 was deferred and became effective as of March 31, 2004 except for interests in special purpose entities. The Company does not have interests in special purpose entities. FIN No. 46 did not have any impact on the Company’s results of operations and cash flows.

4. Subsequent Event – Stock Offering

On July 30, 2004, the Company completed an underwritten public offering of 6,900 shares of common stock at a price of $12.00 per share, which included the full exercise of the underwriters’ over-allotment option. The shares sold were registered under a Registration Statement on Form S-3 filed with the Securities and Exchange Commission on April 16, 2004. The net proceeds of this offering, after underwriting discounts and costs in connection with the sale and distribution of the securities, were approximately $77,100. The Company intends to use the proceeds for the clinical development of its product candidates and product commercialization, for discovery research and preclinical activities and for working capital and other purposes, including potential strategic alliances and/or the acquisition of businesses, technologies or products complementary to its business.

9

INSPIRE PHARMACEUTICALS, INC.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT

The discussion below contains forward-looking statements regarding our financial condition and our 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 our 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. We evaluate our estimates on an ongoing 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.

We operate in a highly competitive environment that involves a number of risks, some of which are beyond our control. We are subject to risks common to biopharmaceutical companies, including risks inherent in our research, development and commercialization efforts, preclinical testing, clinical trials, uncertainty of regulatory and marketing approvals, reliance on collaborative partners, enforcement of patent and proprietary rights, the need for future capital, potential competition associated with our product candidates, use of hazardous materials and retention of key employees. In order for one of our product candidates to be commercialized, it will be necessary for us to conduct preclinical tests and clinical trials, demonstrate efficacy and safety of the product candidate to the satisfaction of regulatory authorities, obtain marketing approval, enter into manufacturing, distribution and marketing arrangements, obtain market acceptance and, in many cases, obtain adequate reimbursement from government and private insurers. We cannot provide assurance that we will generate significant revenues or achieve and sustain profitability in the future. Statements contained in Management’s Discussion and Analysis of Financial Conditions and Results of Operations which are not historical facts are, or may constitute, forward looking statements. Forward looking statements involve known and unknown risks that could cause our actual results to differ materially from expected results. These risks are discussed in the section entitled “Other Information - Risk Factors,” as well as in our Annual Report on Form 10-K for the year ended December 31, 2003. Although we believe the expectations reflected in the forward looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Our operating expenses are difficult to predict and will depend on several factors. Development expenses, including expenses for drug synthesis and manufacturing, preclinical testing and clinical research activities, will depend on the ongoing requirements of our drug development programs, availability of capital and direction from regulatory agencies, which are difficult to predict. Management may in some cases be able to control the timing of development expenses in part by accelerating or decelerating preclinical testing, other discovery and basic research activities and clinical trial activities, but many of these expenditures will occur irrespective of whether our product candidates are approved when anticipated or at all. We have begun to incur significant selling and marketing expenses to successfully commercialize our products. Once again, management may in some cases be able to control the timing of these expenses, but many of these expenditures will occur irrespective of the commercial success of our products, at least initially. As a result of these factors, we believe that period to period comparisons are not necessarily meaningful and you should not rely on them as an indication of future performance. Due to all of the foregoing factors, it is possible that our consolidated operating results will be below the expectations of market analysts and investors. In such event, the prevailing market price of our common stock could be materially adversely affected.

OVERVIEW

We are a biopharmaceutical company dedicated to the discovery, development and commercialization of prescription pharmaceutical products for the treatment of various diseases with significant unmet medical needs. Our core area of expertise relates to the class of nucleotide receptors, known as P2, which we believe are important drug targets in various therapeutic areas, including ophthalmology, respiratory disease, cardiovascular disease and pain. Our primary focus is in the ophthalmic and respiratory therapeutic areas where we have significant expertise. Our ophthalmic products and product candidates are concentrated in the allergic conjunctivitis, dry eye disease and retinal

10

INSPIRE PHARMACEUTICALS, INC.

disease indications. We are also working on a product candidate for the treatment of cystic fibrosis. Our portfolio of products and product candidates include:

PRODUCTS AND PRODUCT CANDIDATES	COLLABORATIVE PARTNER	INDICATION	CURRENT STATUS
PRODUCTS
ElestatTM	Allergan	Allergic conjunctivitis	Approved by the FDA October 2003; Co-promoting in the United States
Restasis®	Allergan	Dry eye disease	Approved by the FDA December 2002; Co-promoting in the United States
HIGHER PRIORITY PRODUCT CANDIDATES
diquafosol tetrasodium (INS365 Ophthalmic)	Allergan and Santen Pharmaceutical	Dry eye disease	NDA filed, Approvable letter received December 2003, Confirmatory Phase III ongoing
INS37217 Respiratory (denufosol tetrasodium)	Cystic Fibrosis Foundation Therapeutics	Cystic fibrosis	Phase II
INS37217 Ophthalmic (denufosol tetrasodium)	None	Retinal disease	Phase II
INS50589 Cardiovascular	None	Cardiovascular diseases	Preclinical

We have acquired the rights to market Elestat^TM and Restasis^® in the United States under co-promotion agreements with Allergan, Inc., or Allergan, and we receive revenue payments based upon net sales of these products. In January 2004, we completed hiring and training of our specialty sales force, at which time we began co-promoting Restasis^®. In February 2004, we launched Elestat^TM for the treatment of allergic conjunctivitis.

We have product candidates in various stages of clinical development and one product candidate identified in preclinical development for which we expect to file an Investigational New Drug Application, or IND, in the fourth quarter of 2004. All of our product candidates in clinical trials are based on proprietary technology relating to P2 receptors. We have begun to apply our expertise to other applications of P2 receptor subtypes as well as advancing several non-P2Y programs.

We were incorporated in October 1993 and commenced operations in March 1995 following our first substantial financing and licensing of the initial technology from The University of North Carolina at Chapel Hill, or UNC. Since that time, we have been engaged in the discovery and development of prescription pharmaceutical products, and more recently, in the co-promotion of products. We are located in Durham, North Carolina, adjacent to the Research Triangle Park.

11

INSPIRE PHARMACEUTICALS, INC.

Elestat^TM

In December 2003, we entered into an agreement with Allergan to co-promote Elestat^TM (epinastine HCl ophthalmic solution 0.05%) to ophthalmologists, optometrists and allergists in the United States. Under this agreement, we receive a royalty from Allergan on the U.S. net sales of Elestat^TM. The Elestat^TM arrangement with Allergan will be in effect until the earlier of: (i) the approval and launch of the first generic epinastine product; or (ii) the approval and launch of the first over-the-counter epinastine product. The commercial exclusivity period for Elestat^TM under the Hatch-Waxman Act will expire in October 2008, after which time Elestat^TM could face generic competition. The agreement also provides for early termination under certain circumstances.

Elestat^TM was approved by the U.S. Food and Drug Administration, or FDA, in October 2003 for the prevention of itching associated with allergic conjunctivitis. In February 2004, we launched Elestat^TM in the United States and are promoting it to eye care professionals and allergists. Elestat^TM, a topical antihistamine with mast cell stabilizing and anti-inflammatory activity, was developed by Allergan for the relief of ocular itching associated with ocular allergies. Elestat^TM works by blocking the H₁ and H₂ histamine receptors, stabilizing mast cells, and stopping the progression of pro-inflammatory mediators. In clinical trials, Elestat^TM has shown rapid onset of action providing relief from ocular itching within 3 minutes, and has shown up to an 81% reduction in symptoms, as well as sustained symptom relief. Up to 80% of trial patients experienced significant relief with Elestat^TM at 8 hours, achieving an ocular itch grade of 1 or lower on a 0 to 4 scale. Elestat^TM has also been shown to be very well-tolerated by patients. It has a pH range of 6.5 to 7.5, which is similar to natural tears.

Restasis^®

In June 2001, we entered into a joint license, development and marketing agreement with Allergan to develop and commercialize diquafosol tetrasodium (INS365) for the treatment of dry eye disease. The agreement also granted us the right to co-promote Allergan’s Restasis^® (cyclosporine ophthalmic emulsion) 0.05% for the treatment of dry eye disease in the United States. In December 2002, Restasis^® was approved for sale by the FDA and Allergan launched Restasis^® in the United States in April 2003. In January 2004, we began co-promotion of Restasis^® to eye care professionals and allergists in the United States and began receiving co-promotion revenue on Restasis^® net sales beginning in April 2004. Restasis^® is the first approved pharmacologically active therapy in the United States to increase tear production in patients with keratoconjunctivitis sicca, or dry eye disease, whose tear production is presumed to be suppressed due to ocular inflammation. Restasis^® has been shown to improve tear production.

Diquafosol tetrasodium (INS365) for the treatment of dry eye disease.

Diquafosol is an ophthalmic product candidate designed to treat dry eye disease and is expected to be used alone or as a complement to Restasis^®, if and when it receives regulatory approval. Diquafosol is a dinucleotide that we discovered, which functions as an agonist at the P2Y₂ receptor. Diquafosol stimulates the release of natural tear components targeting all three mechanisms of action involved in tear secretion – mucin, lipids and salt. Because diquafosol targets all three mechanisms of action, it forms a natural composition of tears, which is expected to result in greater efficacy and fewer side effects than other, more palliative therapies (e.g. punctal plugs, artificial tears). To date, we have completed three Phase III clinical trials of diquafosol for the treatment of dry eye disease. In total, we have tested diquafosol in more than 1,500 individuals.

We are developing diquafosol as an eye drop for dry eye disease. We believe that diquafosol can be the second FDA approved pharmacologically active agent to treat dry eye disease, and the first one with this mechanism of action. Because diquafosol and Restasis^® have different mechanisms of action, we consider them complementary products and believe the commercial opportunity of these products to be significant.

On June 27, 2003, we filed a New Drug Application, or NDA, with the FDA for diquafosol for the treatment of dry eye disease. In July 2003, the FDA granted Priority Review designation for the diquafosol NDA. On December 19, 2003, we received an approvable letter from the FDA for diquafosol for the treatment of dry eye disease. In response to this letter, and following a meeting with the FDA, we began a confirmatory Phase III clinical trial of

12

INSPIRE PHARMACEUTICALS, INC.

diquafosol in June 2004. We expect to enroll approximately 520 patients across 36 sites and to complete the trial in the first half of 2005. If the trial is successful, we expect to file an amendment to our diquafosol NDA in the first half of 2005.

Pursuant to our agreement with Allergan, Allergan is responsible for regulatory approval of diquafosol in Europe. We are working closely with Allergan, European regulatory consultants and the European regulatory agencies, to determine what data will be required to support regulatory approval of diquafosol in Europe. We have scheduled meetings with European regulators in September 2004 to discuss specific data requirements for a regulatory submission in Europe.

Based upon discussions with Allergan, we are considering conducting an additional diquafosol clinical trial. This trial will satisfy multiple purposes, including potentially supplementing our European regulatory submission and providing global marketing information to supplement the potential commercialization of diquafosol. Data from this clinical trial may also be used in the United States. We believe that the FDA will not require this particular trial for approval and that it will not affect the timing of our NDA amendment.

Estimated subsequent costs necessary to amend our diquafosol NDA submission and resubmit the application for commercial approval in the United States are projected to be $4 to $7 million, excluding the cost of pre-launch inventory. This estimate assumes that our ongoing confirmatory diquafosol Phase III clinical trial is successful and is the only trial required to obtain U.S. commercial approval. The estimate includes costs for initiating and completing the confirmatory Phase III diquafosol clinical trial, salaries for development personnel, regulatory costs associated with our NDA amendment and other unallocated development costs. Costs of any other contemplated trials are excluded from this projection. The projected costs associated with such estimate are difficult to determine and the actual costs are likely to differ. If the confirmatory Phase III clinical trial does not proceed as planned or is not successful, our NDA amendment will not occur in 2005 and the estimate above will not be applicable. For a more detailed discussion of the risks associated with the development of diquafosol and our other development programs, including factors that could result in a delay of a program and increased costs associated with such a delay, please see the Risk Factors described under Item 5 of this report.

INS37217 Respiratory (denufosol tetrasodium) for the treatment of cystic fibrosis.

We are developing INS37217 Respiratory (denufosol tetrasodium) as an inhaled product for the treatment of cystic fibrosis. We believe our product may become the first FDA approved product that mitigates the underlying ion-transport defect in the airways of patients with cystic fibrosis. This product has been granted orphan drug status by the FDA and is also on fast-track review status for its approval. INS37217 Respiratory is designed to enhance the lung’s innate mucosal hydration and mucociliary clearance mechanisms, which in cystic fibrosis patients are impaired due to 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, reduce infections and limit the damage that occurs as a consequence of the prolonged retention of thick and tacky infected secretions. We further believe that these effects may result in reduced frequency and length of hospitalizations, reduce need for antibiotics and other medications, reduce deterioration of lung function and improve respiratory symptoms and health status. In addition, we believe this product candidate to be complementary to the two currently approved products, Pulmozyme^® and TOBI^®, neither of which affects the underlying ion-transport defects in cystic fibrosis airways.

In 2003, we initiated a multi-center Phase II trial in 90 patients with mild cystic fibrosis lung disease. This trial was conducted in collaboration with the Cystic Fibrosis Foundation Therapeutics, Inc., or the CFFT, who funded the majority of the external costs. In April 2004, we announced positive top-line results of this trial which was a double-blind, placebo-controlled, randomized trial over a four-week treatment period. The primary purpose of this trial was to determine tolerability of three times daily nebulizer doses of up to 60 mgs of INS37217 Respiratory versus placebo over a four-week treatment period. Patients receiving INS37217 Respiratory (pooled results across three doses) had significantly better lung function than patients receiving placebo after four weeks of treatment. Lung function was assessed by multiple standard spirometric measurements and statistical significance was achieved on all of the

13

INSPIRE PHARMACEUTICALS, INC.

spirometric measures employed in the trial. All three doses were well tolerated over the four-week treatment period. Detailed results of this trial will be presented at the North American Cystic Fibrosis Conference in St. Louis in October 2004. Based on the strength of these results, we have scheduled a meeting with the FDA to discuss our plans in moving toward a Phase III program in the second half of 2005. We are currently planning additional required toxicology studies that will support the Phase III program. An additional Phase II trial will be conducted in parallel with the toxicology program in order to broaden our experience in the patient population prior to the initiation of a Phase III program. In order to submit an NDA for INS37217 Respiratory for the treatment of cystic fibrosis, we will need to successfully complete the remaining components of our Phase II program, initiate and successfully complete a Phase III program and successfully complete our toxicology testing to facilitate these future clinical trials. We will be discussing the future development activities of the program with the FDA in the fall, and we are currently planning a second Phase II trial for this product candidate. Due to the early stage of development of this program, we are unable to project when, if ever, we will be in a position to file an NDA.

Estimated subsequent costs necessary to submit an NDA for INS37217 Respiratory for the treatment of cystic fibrosis are projected to be $25 million to $45 million. This estimate excludes the cost of pre-launch inventory and any potential development milestones payable to the CFFT, but includes completing the remaining components of our Phase II program, conducting a Phase III clinical program, manufacturing INS37217 for clinical trials and toxicology studies, producing qualification lots consistent with current Good Manufacturing Practice standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs. These costs are difficult to estimate and actual costs could be different from our estimate. For example, clinical trials and toxicology studies may not proceed as planned, results from future clinical trials may change our planned development program, other parties may assist in the funding of our development costs, and our NDA filing could be delayed. For a more detailed discussion of the risks associated with our development programs, please see the Risk Factors described under Item 5 of this report.

INS37217 Ophthalmic (denufosol tetrasodium) for the treatment of retinal disease.

INS37217 Ophthalmic (denufosol tetrasodium) is an investigative new drug under evaluation for the treatment of retinal diseases associated with pathological sub-retinal or intra-retinal accumulation of fluid. We are developing INS37217 Ophthalmic as an intravitreal injection. INS37217 Ophthalmic has been shown in experimental models of retinal detachment to stimulate retinal re-attachment by reabsorbing (i.e., draining) extraneous sub-retinal fluid across the retinal pigment epithelium, a layer of cells involved in controlling proper hydration of the retina and sub-retinal space. We believe that INS37217 Ophthalmic may become the first FDA approved product to be administered as a first-line therapy to facilitate retinal reattachment in some patients without the need for invasive surgery. INS37217 Ophthalmic may be useful to treat other sight-threatening retinal diseases also associated with pathological accumulation of sub-retinal or intra-retinal fluid, including diabetic and non-diabetic macular edema. Restoration of vision in these disease states is contingent on the removal of the pathological fluid accumulation associated with these disorders.

In January 2004, we met with the FDA and were given guidance on the planning of a well-controlled Phase II trial in INS37217 Ophthalmic for the treatment of retinal disease. In April 2004 we began a 160-patient, Phase II clinical trial of INS37217 Ophthalmic for the treatment of retinal detachment. In order to submit an NDA for INS37217 Ophthalmic for the treatment of retinal disease, we will need to successfully complete the remaining components of our Phase II program and initiate and successfully complete a Phase III program. Due to the early stage of development of this program, including the fact that our current clinical trial is a proof-of-concept trial, we are unable to project when, if ever, we will be in a position to file an NDA with regard to this product candidate.

Estimated subsequent costs necessary to submit an NDA for INS37217 Ophthalmic for the treatment of retinal detachment are projected to be $20 million to $30 million. This estimate excludes the cost of pre-launch inventory and development costs for other retinal diseases, but includes any remaining Phase II clinical trials, a Phase III clinical program, manufacturing INS37217 for clinical trials and toxicology studies, producing qualification lots consistent with current Good Manufacturing Practice standards, salaries for development personnel, other unallocated development

14

INSPIRE PHARMACEUTICALS, INC.

costs and regulatory preparation and filing costs. These costs are difficult to estimate and actual costs could be different from our estimate. For example, clinical trials and toxicology studies may not proceed as planned, and results from future clinical trials may change our planned development program. For a more detailed discussion of the risks associated with our development programs, please see the Risk Factors described under Item 5 of this report.

INS50589 Cardiovascular

P2Y₁₂ receptor antagonists for the inhibition of platelet aggregation.

INS50589 Cardiovascular is a P2Y₁₂ antagonist that we are developing as a potent, selective and reversible inhibitor of platelet aggregation for the use in the treatment of acute cardiovascular diseases. Platelets, small disk-shaped blood cells, are responsible for initiating and maintaining blood clots. These cells have P2 receptors, including the P2Y₁₂ receptor, on their surface which respond to a soluble clotting factor called adenosine 5’ –diphosphate (ADP). It has been demonstrated that pharmacological intervention to inhibit platelet aggregation has potential benefit in a number of debilitating acute and chronic diseases such as myocardial infarction, unstable angina, stroke and peripheral arterial disease. Inhibition of platelet P2Y₁₂ receptors in particular reduces the relative risk of thrombotic events such as myocardial infarction, stroke and cardiovascular death.

INS50589 Cardiovascular has a rapid onset and offset mechanism of action and is intended for intravenous administration. In preclinical studies it has been shown to produce dose-dependent and sustained inhibition of platelet aggregation during the administration of the drug, and protect against mortality resulting from systemic intravascular thromboembolism. We believe that the fast offset pharmacokinetic property, coupled with the ability to inhibit both platelet aggregation and degranulation/secretion, are key differentiating characteristics from other approved anti-platelet agents. We have held a pre-IND meeting with the FDA and we intend to file an IND application and commence a Phase I clinical trial for INS50589 Cardiovascular in the fourth quarter of 2004. Given the limited data available and the early stage of development of this program, we are unable to reasonably project whether a Phase II or Phase III program would be appropriate for the product candidate and, if so, the future dates and costs that may be associated with such clinical trials or prospective NDA filing.

Other Development Programs

INS316 Diagnostic (uridine 5’-triphosphate) is a P2Y₂ agonist with a short duration of action. This lower-priority product candidate was under development as an acute-use inhaled solution to stimulate enhanced clearance of mucus from the lungs to produce a sputum specimen to aid in the diagnosis of lung cancer. Although analysis of a Phase III clinical trial is continuing, we do not intend to pursue additional development of INS316. The data from this program is being provided to our partner, Kirin Brewery Co., Ltd., who is evaluating its future development plans.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2004 and 2003

Revenues

Revenues were $2.9 million for the three months ended June 30, 2004, as compared to $4.1 million for the same period in 2003. The change in revenue relates to recording our second quarter of product co-promotion revenue from net sales of Elestat^TM and our first full quarter of co-promotion revenue from net sales of Restasis^® in 2004 as compared to collaborative revenue associated with milestone payments and amortization of deferred revenue recognized under our collaborative agreements in 2003.

Revenue from product co-promotion relates to United States net sales of Elestat^TM and Restasis^® according to the terms of our collaborative agreements in which we co-promote Elestat^TM and Restasis^® with Allergan. In regards to Elestat^TM revenue, we are entitled to an escalating percentage of net sales based upon predetermined calendar year net sales target levels. To date, we have recognized product co-promotion revenue associated with Elestat^TM targeted net sales levels achieved in the six months ending June 30, 2004. Amounts contractually due from Allergan in excess of our recorded revenue are recognized as deferred revenue and will be realized in subsequent quarters of 2004 when

15

INSPIRE PHARMACEUTICALS, INC.

additional annual net sales target levels are achieved. Accordingly, as of June 30, 2004, we have recorded $661,000 of deferred Elestat^TM revenue. Based upon weekly National Prescription data from IMS Health for the week ending July 23, 2004, Elestat^TM has become the second most prescribed allergic conjunctivitis product, as measured by new prescriptions, in the highest prescriber group of 12,800 ophthalmologists, optometrists, and allergists in the United States. In addition, using this same audience and measure, Elestat^TM has achieved over 14% market share and has consistently achieved weekly market share gain since its launch in February 2004. Elestat^TM is a seasonal product with product demand mirroring seasonal trends for topical allergic conjunctivitis products whereby there is usually a large increase in sales during the Spring and a lesser increase during the Summer and Fall. In addition, approximately $369,000 of our 2004 co-promotion revenue relates to net sales of Restasis^®. We began receiving Restasis^® co-promotion revenue beginning in April 2004.

Research and Development Expenses

Research and development expenses were $5.4 million for the three months ended June 30, 2004, as compared to $8.9 million for the same period in 2003, a decrease of 39%. The decrease in 2004 research and development expenses was due primarily to a decrease in development activities, which was partially offset by an increase in discovery and preclinical activity. Development expenses have decreased primarily due to reduced spending on our INS37217 Intranasal and INS316 Diagnostic programs as we reclassified these projects to lower priority programs and have correspondingly decreased the resources dedicated to them. Additionally, the decrease also relates to decreased spending on our diquafosol program related to the timing associated with the initiation of a confirmatory Phase III trial, to respond to a December 2003 approvable letter we received from the FDA. Although 2004 spending on our clinical trials decreased in the aggregate, as compared to 2003, this decrease was somewhat offset by increased 2004 spending on our retinal detachment program and discovery initiatives, primarily associated with our INS50589 platelet aggregation inhibitor program. Due to the recent initiation of our Phase III diquafosol confirmatory clinical trial, we expect spending on our diquafosol program to increase in the last half of 2004.

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 trial insurance, license fees and other fees and costs related to the development of product candidates.

Selling and Marketing Expenses

Selling and marketing expenses were $5.2 million for the three months ended June 30, 2004, as compared to $72,000 for the same period in 2003. The increase in selling and marketing expenses resulted from our development of a commercial infrastructure in 2004, including increases in personnel and other administrative costs from our active co-promotion of Restasis^® and Elestat^TM. Our sales and marketing expenses include all direct costs for our sales force and marketing programs. Our sales force expenses include training costs, salaries, fleet management and travel costs. Our marketing expenses include product management, public relations, physician training and continued medical education and other administrative expenses.

General and Administrative Expenses

General and administrative expenses were $2.1 million for the three months ended June 30, 2004, as compared to $1.9 million for the same period in 2003. The increase is primarily due to expenses necessary to support and maintain our commercial organization as well as overall corporate growth. General and administrative costs include finance, legal, human resources, information technology, and quality/compliance expenses.

Other Income

Other income was $0.1 million for the three months ended June 30, 2004, and 2003. Other income includes interest income, interest expense and gains/losses on our investment portfolio.

16

INSPIRE PHARMACEUTICALS, INC.

Six Months Ended June 30, 2004 and 2003

Revenues

Revenues were $3.6 million for the six months ended June 30, 2004, as compared to $5.2 million for the same period in 2003. The change in revenue relates to recording revenue from product co-promotion associated with Elestat^TM and Restasis^® net sales in 2004 as compared to collaborative revenue associated with milestone payments and amortization of deferred revenue recognized under our collaborative agreements in 2003. We began realizing co-promotion revenue from product sales when we launched Elestat^TM, our first commercial product, in February 2004.

Our future revenues will depend on the commercial success of Elestat^TM and Restasis^®, whether we enter additional collaboration agreements, achieve milestones under existing or future collaboration agreements and whether we obtain regulatory approvals. In addition, we expect to experience seasonality in Elestat^TM sales, with a large increase in sales during the Spring and a lesser increase during the Summer and Fall.

Research and Development Expenses

Research and development expenses were $10.6 million for the six months ended June 30, 2004, as compared to $16.0 million for the same period in 2003, a decrease of 34%. The decrease in 2004 research and development expenses was due primarily to a decrease in development expenses in our INS37217 Intranasal, diquafosol, and INS316 Diagnostic programs, which was partially offset by an increase in our INS37217 Ophthalmic program. The decrease in the INS37217 Intranasal and INS316 Diagnostic programs resulted from our reclassifying these projects to lower priority programs and correspondingly decreasing the resources dedicated to them. Our decreased spending in diquafosol relates to the timing associated with the initiation of our confirmatory Phase III trial, which we began in June 2004. Due to the recent initiation of our Phase III diquafosol confirmatory clinical trial, we expect spending on our diquafosol program to increase in the last half of 2004.

Our research and development expenses for the six months ended June 30, 2004 and 2003 and from the projects’ inception are shown below (in thousands).

	Six Months Ended June 30,						Cumulative from Inception (October 28, 1993) to June 30, 2004		%
	2004		%	2003		%
diquafosol tetrasodium (INS365)	$	2,027	19	$	4,028	25	$	30,938	23
INS37217 Ophthalmic (denufosol tetrasodium)		1,161	11		124	1		4,649	4
INS37217 Respiratory (denufosol tetrasodium)		962	9		839	5		9,715	7
INS316 Diagnostic (uridine 5’-triphosphate)		733	7		1,133	7		8,810	7
INS37217 Intranasal (denufosol tetrasodium)		413	4		5,659	35		12,572	9
Other discovery and development costs (1)		5,260	50		4,227	27		66,884	50
Total	$	10,556	100	$	16,010	100	$	133,568	100

(1) Other discovery and development costs represent all unallocated research and development costs or those costs allocated to preclinical projects, including INS50589 Cardiovascular. These costs include personnel costs of our discovery programs, internal and external general research costs and other internal and external costs of other drug discovery and development programs.

Our future research and development expenses will depend on the results and magnitude of our clinical, preclinical and discovery activities and requirements imposed by regulatory agencies. Accordingly, our development expenses may fluctuate significantly from period to period. In addition, if we in-license or out-license rights to product candidates, our development expenses may fluctuate significantly from prior periods.

17

INSPIRE PHARMACEUTICALS, INC.

Selling and Marketing Expenses

Selling and marketing expenses were $11.1 million for the six months ended June 30, 2004, as compared to $0.4 million for the same period in 2003. The increase in selling and marketing expenses resulted from our development of a commercial infrastructure in 2004, including increases in personnel and other administrative costs from our active co-promotion of Restasis^® and Elestat^TM. We began co-promoting Restasis^® in January 2004 and launched Elestat^TM in February 2004. Future selling and marketing expenses will depend on the level of our future commercialization activities. We expect selling and marketing expenses will increase in periods that immediately precede and follow product launches.

General and Administrative Expenses

General and administrative expenses were $4.3 million for the six months ended June 30, 2004, as compared to $3.3 million for the same period in 2003. The increase is primarily due to expenses necessary to support and maintain a commercial organization as well as overall corporate growth. Future general and administrative expenses will depend on the level of our future development and commercialization activities.

Other Income

Other income was $0.3 million for the six months ended June 30, 2004, compared to $0.2 million for the same period in 2003. Other income includes interest income, interest expense and gains/losses on our investment portfolio. The increase in 2004 other income, as compared to 2003, is primarily the result of a write-down of a strategic investment in 2003. Future other income will depend on our future cash and investment balances, the return on these investments, as well as levels of debt and the associated interest rates.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations through the sale of equity securities, including private sales of preferred stock and public offerings of common stock. We currently receive revenue from co-promotion of Elestat^TM and Restasis^®, but do not expect this revenue to exceed our 2004 operating expenses. On July 30, 2004, we completed a public offering whereby we sold 6.9 million shares of common stock, which included the full exercise of the underwriters’ over-allotment option, at $12.00 per share. The net proceeds, after underwriting discounts and costs in connection with the sale and distribution of the securities, were approximately $77.1 million.

At June 30, 2004, without considering the impact of our July 2004 public offering, we had net working capital of $44.9 million, a decrease of approximately $21.4 million from December 31, 2003. The decrease in working capital is principally due to normal operating expenses which currently exceed our revenue. Our principal sources of liquidity at June 30, 2004 were $29.4 million in cash and cash equivalents and $23.9 million in investments, which are considered “available-for-sale.”

Our working capital requirements may fluctuate in future periods depending on many factors, including: the efficiency of manufacturing processes developed on our behalf by third parties; the magnitude, scope and timing of our drug development programs; the cost, timing and outcome of regulatory reviews and changes in regulatory requirements; the costs of obtaining patent protection for our product candidates; the timing and terms of business development activities; the rate of technological advances relevant to our operations; the timing, method and cost of the commercialization of our product candidates; the level of required administrative and legal support; the availability of capital to support product candidate development programs we pursue, the commercial potential of our products and product candidates; and the potential expansion of facility space. We are targeting 2004 operating expenses of $54-58 million. We believe the net proceeds of our July 2004 public offering combined with our existing cash, cash equivalents and investments, will be adequate to satisfy our anticipated working capital requirements beyond 2005. In addition, we have the ability to sell approximately $57.2 million worth of additional shares of common stock under an active shelf registration statement, which we filed with the Securities and Exchange Commission on April 16, 2004. However, additional funding may not be available on favorable terms from any of these sources or at all. Our ability to achieve our operating expense target range is subject to several risks including unanticipated cost overruns, the need to

18

INSPIRE PHARMACEUTICALS, INC.

expand the magnitude of scope of existing development programs, the need to change the number or timing of clinical trials, unanticipated regulatory requirements, costs to successfully commercialize our products and product candidates, commercial success of our products and product candidates and other factors described under the Risk Factors contained in Item 5 of this report.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our condensed financial statements, which have been prepared in accordance with generally accepted accounting principles, require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, judgments and the policies underlying these estimates on a periodic basis as the situation changes, and regularly discuss financial events, policies, and issues with members of our audit committee and our independent auditors. In addition, recognition of revenue from product co-promotion is affected by certain estimates and judgments made by Allergan on which we rely in recording this revenue on a quarterly basis. We routinely evaluate our estimates and policies regarding revenue recognition, taxes and clinical trial, preclinical/toxicology and manufacturing liabilities.

Revenue Recognition

We recognize revenue from product co-promotion based on net sales for Elestat^TM and Restasis^® as defined in the co-promotion agreements, and as reported to us by our collaborative partner, Allergan. Accordingly, our co-promotion revenue is based upon Allergan’s revenue recognition policy, other accounting policies and the underlying terms of our co-promotion agreements. Allergan recognizes revenue from product sales when goods are shipped and title and risk of loss transfers to the customer. The co-promotion agreements provide for gross sales to be reduced by estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales rebates and other allocated costs as defined in the agreements. We also reduce gross sales for incentive programs we manage, estimating the proportion of sales that are subject to such incentive programs and reducing revenue appropriately. Under the Elestat^TM co-promotion agreement, we are obligated to meet predetermined minimum annual net sales performance levels. If the annual minimum is not satisfied, we receive a percentage of net sales based upon predetermined calendar year net sales target levels. To date, we have recognized only those revenues associated with targeted net sales levels achieved during the six months ending June 30, 2004. Amounts contractually due from Allergan in excess of recorded co-promotion revenues associated with Elestat^TM are accounted for as deferred revenue and will be realized in subsequent calendar quarters as we achieve greater Elestat^TM net sales levels.

We recognize milestone 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 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 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.

Income 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 against all potential tax assets 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.

19

INSPIRE PHARMACEUTICALS, INC.

Liabilities

We generally enter into contractual agreements with third party vendors to provide clinical, preclinical/toxicology, manufacturing and other services in the ordinary course of business. Many of these contracts are subject to milestone-based invoicing and the contract could be conducted over an extended period of time. We record liabilities under these contractual commitments when we determine an obligation has been incurred, regardless of the timing of the invoice. We monitor all significant research and development, manufacturing and other service activities and the related progression of work for these activities. We estimate the underlying obligation for each activity based upon our estimate of the amount of work performed and compare the estimated obligation against the amount that has been invoiced. Because of the nature of contracts and related delay in the contract’s invoicing, the obligation to these vendors may be based upon management’s estimate of the underlying obligation. We record the larger of our estimated obligation or invoiced amounts for completed service. In all cases, actual results may differ from our estimates.

Impact of Inflation

Although it is difficult to predict the impact of inflation on our costs and revenues in connection with our products, we do not anticipate that inflation will materially impact our cost of operation or the profitability of our products when marketed.

20

INSPIRE PHARMACEUTICALS, INC.

Impact of Recently Issued Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, or FIN No. 46, “Consolidation of Variable Interest Entities,” which requires the assets, liabilities and results of operations of variable interest entities, or VIE, be consolidated into the financial statements of the company that has controlling financial interest. FIN No. 46 also provides the framework for determining whether a VIE should be consolidated based on voting interest or significant financial support provided to the VIE. The effective date for applying the provisions of FIN No. 46 for interests held by public entities in VIEs or potential VIEs created before February 1, 2003 was deferred and became effective as of March 31, 2004, except for interests in special purpose entities. We do not have interests in special purpose entities. FIN No. 46 did not have any impact on our results of operations and cash flows.

21

INSPIRE PHARMACEUTICALS, INC.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Sensitivity

We are subject to interest rate risk on our investment portfolio. We maintain an investment portfolio consisting primarily of high quality money market instruments and government obligations. Our portfolio has a current average maturity of less than 12 months.

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, changes in the market value of investments due to changes in interest rates, the increase or decrease in realized gains and losses on investments and the amount of interest expense we must pay with respect to various outstanding debt instruments. Our risk associated with fluctuating interest expense is limited to capital leases and other short-term debt obligations. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We 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. Our investment portfolio includes only marketable securities and instruments with active secondary or resale markets to help ensure portfolio liquidity and we have implemented guidelines limiting the duration of investments. 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 June 30, 2004, our portfolio of available-for-sale investments consisted of approximately $19.4 million of investments maturing within one year and approximately $4.0 million of investments maturing after one year but within 19 months. In addition, we have $0.5 million of our long-term investments that are held in a restricted account that collateralizes a letter of credit with a financial institution. Additionally, we generally have the ability to hold our fixed income investments to maturity and therefore do not expect that our operating results, financial position or cash flows will be affected by a significant amount due to a sudden change in interest rates.

Strategic Investment Risk

In addition to our normal investment portfolio, we have a strategic investment in Parion Sciences, Inc. valued at $0.2 million. This investment represents unregistered preferred stock and is subject to higher investment risk than our normal investment portfolio due to the lack of an active resale market for the investment.

22

INSPIRE PHARMACEUTICALS, INC.

Item 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective in timely providing them with material information relating to us which is required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934. There were no changes in our internal controls during the three month period ended June 30, 2004.

Internet Information

Our internet site is located at www.inspirepharm.com. Copies of our reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports may be accessed from our website, free of charge, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the Securities and Exchange Commission.

We file our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 electronically with the Securities and Exchange Commission, or the SEC. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is www.sec.gov.

23

INSPIRE PHARMACEUTICALS, INC.

PART II: OTHER INFORMATION

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

On June 10, 2004, we held our annual meeting of stockholders. The results of the proposals submitted for vote at this meeting were as follows:

1. Election of two directors (there were no abstentions or broker non-votes in connection with the election of directors).

	For:	Withheld:
Christy L. Shaffer	19,190,250	5,203,331
Richard Kent	24,079,709	313,872

2. Ratification of the appointment of PricewaterhouseCoopers LLP as our independent auditors for the fiscal year ending December 31, 2004 (there were no broker non-votes in connection with the ratification of our independent auditor).

For:	Against:	Abstain:
24,130,957	261,285	1,339

3. Ratification of the amendment to the Amended and Restated 1995 Stock Plan, as amended, to increase the number of shares of common stock reserved for issuance pursuant to stock awards under the plan from 6,428,571 to 7,178,571.

For:	Against:	Abstain:	Non Voted:
8,843,307	8,469,380	10,070	7,070,824

24

INSPIRE PHARMACEUTICALS, INC.

Item 5. Other Information

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 the FDA does not conclude that our products meet statutory requirements for safety and efficacy, we will be unable to obtain regulatory approval for marketing in the United States, and if foreign governments do not conclude that our products meet their requirements for marketing, we will be unable to sell those products in those foreign markets.

To achieve profitable operations, we must, alone or with others, successfully identify, develop, introduce and market proprietary products. We have not received marketing approval for any of our products, although we are co-promoting two products with Allergan, and have one product candidate, diquafosol for dry eye disease, under review by the FDA for commercial approval. Although our NDA has been accepted and we have received an approvable letter for diquafosol, the FDA has informed us that an additional clinical trial must be conducted to replicate the efficacy that was demonstrated by an earlier clinical trial. There is no guarantee that an additional clinical trial will be successful or that the FDA will approve diquafosol and allow us to begin selling it in the United States. Even if we do receive FDA approval for diquafosol, we and Allergan may not be able to successfully commercialize diquafosol in the United States. We have not applied for marketing approval of diquafosol in any other jurisdiction.

With the exception of our five product candidates in clinical trials, diquafosol, INS37217 Respiratory, INS37217 Ophthalmic, INS37217 Intranasal and INS316 Diagnostic, all of our remaining product candidates are in research or preclinical development. A substantial amount of work will be required to advance these candidates to clinical testing. We will have to conduct significant additional development activities and non-clinical and clinical tests, and obtain regulatory approval before our product candidates 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. 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 trials 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 trial 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 trials at the rate we expect;

• We decide to modify the drug during testing; or

• We allocate limited financial and other resources to other clinical programs.

The introduction of our products in foreign markets will subject us to foreign regulatory clearances, the receipt of which may be unpredictable and uncertain, and which may impose substantial additional costs and burdens which we or our partners in such foreign markets may be unwilling or unable to pay. As with the FDA, foreign regulatory authorities must be satisfied that adequate evidence of safety, quality, and efficacy of the product has been presented before marketing authorization is granted. The foreign regulatory approval process includes all of the risks associated with obtaining FDA marketing approval. Approval by the FDA does not ensure approval by other regulatory authorities.

25

INSPIRE PHARMACEUTICALS, INC.

Failure to successfully market and commercialize Restasis^® and Elestat^™ will limit our revenues.

Allergan launched Restasis^® in the United States in April 2003 and we began receiving co-promotion revenue from Allergan on the net sales of Restasis^® beginning in April 2004. Allergan is primarily responsible for marketing and commercializing Restasis^®. Our agreement with Allergan provides, and we have exercised, the right to co-promote Restasis^® in the United States. In February 2004, we launched Elestat^™ in the United States. Our agreement with Allergan provides that we will have the primary responsibility for selling, promotional and marketing activities related to Elestat^™ in the United States. We are required to pay the costs in relation to such activities.

Until our launch of Elestat^™ and co-promotion of Restasis^®, we had never been involved in the promotion or co-promotion of a product. The commercial success of both Restasis^® and Elestat^™ will largely depend on the acceptance by eye care professionals, allergists and patients, the launch into other major pharmaceutical markets, ongoing promotional activities, a knowledgeable sales force and adequate market penetration.

Failure to adequately control compliance with all applicable regulations may adversely affect our business.

There are extensive state, federal and foreign regulations applicable to public pharmaceutical companies engaged in the discovery, development and commercialization of medicinal products. There are laws that govern areas including financial controls, testing, manufacturing, labeling, safety, packaging, shipping, distribution and promotion of pharmaceuticals. We have implemented corporate quality, ethics and compliance programs, however we cannot guarantee against all possible transgressions. The potential ramifications are far-reaching if there are areas identified as out of compliance by regulatory agencies including, but not limited to, significant financial penalties, manufacturing and clinical trial consent decrees, commercialization restrictions or other restrictions and litigation.

Failure to adequately market and commercialize diquafosol, if approved by the FDA, will limit our revenues.

Although we plan to co-promote our diquafosol product candidate in the event we receive approval from the FDA, Allergan is primarily responsible for marketing diquafosol in the United States and other major, ex-Asia pharmaceutical markets in the event the FDA, or foreign regulatory authorities, approves such product candidate. If approved by the FDA and other applicable regulatory authorities, the commercial success of diquafosol will largely depend on the scope of the launch into the United States and other major pharmaceutical markets, acceptance by patients and eye care professionals and allergists, ongoing promotional activities, a knowledgeable sales force and adequate market penetration. If diquafosol is not successfully commercialized, our revenues will be adversely affected.

We cannot sell Restasis^®, Elestat^™ or any of our product candidates if we do not obtain and maintain governmental approvals.

Pharmaceutical companies are subject to heavy regulation by a number of national, state and local agencies, including the FDA. Failure to comply with applicable regulatory requirements could, among other things, result in fines, suspensions of regulatory approvals of products, product recalls, delays in product distribution, marketing and sale, and civil or criminal sanctions.

The manufacturing and marketing of drugs, including our products, are subject to continuing FDA and foreign regulatory review, and later discovery of previously unknown problems with a product, manufacturing process or facility may result in restrictions, including withdrawal of the product from the market. The FDA is permitted to revisit and change its prior determinations and it may change its position with regard to the safety or effectiveness of our products. The FDA is authorized to impose post-marketing requirements such as:

• testing and surveillance to monitor the product and its continued compliance with regulatory requirements;

26

INSPIRE PHARMACEUTICALS, INC.

• submitting products for inspection and, if any inspection reveals that the product is not in compliance, the prohibition of the sale of all products from the same lot;

• suspending manufacturing;

• recalling products; and

• withdrawing marketing approval.

Even before any formal regulatory action, we, or our collaborative partners, could voluntarily decide to cease distribution and sale or recall any of our products if concerns about safety or effectiveness develop.

In its regulation of advertising, the FDA from time to time issues correspondence to pharmaceutical companies alleging that some advertising or promotional practices are false, misleading or deceptive. The FDA has the power to impose a wide array of sanctions on companies for such advertising practices, and if we were to receive correspondence from the FDA alleging these practices we might be required to:

• incur substantial expenses, including fines, penalties, legal fees and costs to comply with the FDA’s requirements;

• change our methods of marketing and selling products;

• take FDA-mandated corrective action, which could include placing advertisements or sending letters to physicians rescinding previous advertisements or promotion; or

• disrupt the distribution of products and stop sales until we are in compliance with the FDA’s position.

In recent years, various legislative proposals have been offered in Congress and in some state legislatures that include major changes in the health care system. These proposals have included price or patient reimbursement constraints on medicines and restrictions on access to certain products. We cannot predict the outcome of such initiatives, and it is difficult to predict the future impact of the broad and expanding legislative and regulatory requirements affecting us.

If Elestat^™ and, to a lesser extent, Restasis^® do not gain and sustain market acceptance, our revenues may not be predictable and may not cover our operating expenses.

Our future revenues will depend, in part, upon eye care professionals, allergists and patient acceptance of Elestat^™ and, to a lesser extent, Restasis^®. Factors that could affect the acceptance of Elestat^™ and Restasis^® include:

• Satisfaction with existing alternative therapies;

• Regulatory approval in other jurisdictions;

• Perceived efficacy relative to other available therapies;

• Effectiveness of our sales and marketing efforts;

• Effectiveness of Allergan’s sales and marketing efforts;

• Cost of treatment;

• Pricing and availability of alternative products;

• Shifts in the medical community to new treatment paradigms or standards of care;

• Relative convenience and ease of administration; and

• Prevalence and severity of adverse side effects.

We cannot predict the potential long-term patient acceptance of, or the effects of competition and managed health care on, sales of either product.

27

INSPIRE PHARMACEUTICALS, INC.

If Allergan is unsuccessful in its litigation with the FDA regarding the reclassification of Restasis^®, it will continue to be classified as an antibiotic, thus exempting it from benefits under the Hatch-Waxman Act.

In March 2003, soon after the FDA approved Restasis^® as a new drug, the FDA reclassified the active ingredient of Restasis^®, cyclosporine, as an antibiotic, resulting in Restasis^® not being eligible to benefit from the patent term extension or non-patent market exclusivity protections of the Hatch-Waxman Act. Allergan has commenced litigation against the FDA regarding the reclassification of Restasis^® and the loss of the protections of the Hatch-Waxman Act. Because Restasis^® does not currently have the protections of the Hatch-Waxman Act, and in the absence of protection under the patents pertaining to Restasis^®, a generic competitor will be able to file an Abbreviated New Drug Application, or ANDA, for the FDA’s review without providing Allergan with notice of such filing. If the FDA approves such an ANDA, the generic competitor may enter the market to compete with Allergan and us. Therefore, if Allergan is not successful in its litigation with the FDA, Restasis^® may face increased competition from third parties, possibly reducing our potential revenues from our Restasis^® co-promotion agreement with Allergan.

Because our clinical candidates utilize a new mechanism of action and in some cases there are no regulatory precedents, designing clinical trials and obtaining regulatory approval may be difficult, expensive and prolonged, which would delay any marketing of our products.

To complete successful clinical trials, our candidates must meet the criteria for clinical approval, or endpoints, which we establish in the clinical trial. Generally, we will establish these endpoints in consultation with the FDA, following its clinical trial design guidelines on the efficacy, safety and tolerability measures required for approval of products. However, since our product candidates are based on our novel receptor technology, and some of the diseases we are researching do not have products that have been approved by the FDA, the FDA may not have established guidelines for the design of our clinical trials and may take longer than average to consider our products for approval. The FDA could change its view on clinical trial design and establishment of appropriate standards for efficacy, safety and tolerability and require a change in trial design, additional data or even further clinical trials before granting approval of our product candidates. We could encounter delays and increased expenses in our clinical trials if the FDA determines that the endpoints established for a clinical trial do not predict a clinical benefit. To the best of our knowledge, no P2Y₂ products have received marketing approval from the FDA.

After initial regulatory approval, the FDA continues to review a marketed product and its manufacturer. They may require us or our partners 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.

Projected development costs are difficult to estimate and may change frequently prior to regulatory approval.

While all new compounds require standard regulated phases of testing, the actual type and scope of testing can vary significantly among different product candidates which may result in significant disparities in total costs required to complete the respective development programs.

The number and type of studies that may be required by the FDA for a particular compound are based on the compound’s clinical profile compared to existing therapies for the targeted patient population. Factors that affect the costs of a clinical trial include:

• The number of patients required to participate in clinical trials to demonstrate statistical significance for a drug’s safety and efficacy;

• The time required to enroll the targeted number of patients in clinical trials, which may vary depending on the size and availability of the targeted patient population and the perceived benefit to the trial participants; and

• The number and type of required laboratory tests supporting clinical trials.

Other activities required before submitting a NDA include regulatory preparation for submission, biostatistical analyses, scale-up synthesis, and validation of commercial product. In addition, prior to product launch, production of a certain amount of commercial grade drug product inventory meeting FDA current good manufacturing practice standards is required.

28

INSPIRE PHARMACEUTICALS, INC.

Also, ongoing development programs and associated costs are subject to frequent, significant and unpredictable changes due to a number of factors, including:

• Data collected in preclinical or clinical trials may prompt significant changes or enhancements to an ongoing development program;

• The FDA may direct the sponsor to change or enhance its ongoing development program based on developments in the testing of similar compounds or related compounds;

• Unexpected regulatory requirements or interim reviews by regulatory agencies may cause delays or changes to development programs; and

• Anticipated manufacturing costs may change significantly due to required changes in manufacturing processes, variances from anticipated manufacturing process yields or changes in the cost and/or availability of starting materials.

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. Our operating expenses exceeded $26.0 million in the six months ended June 30, 2004, $37.4 million in the fiscal year ended December 31, 2003 and $30.3 million in the fiscal year ended December 31, 2002. We anticipate that our operating expenses in 2004 will increase from our 2003 operating expenses to provide for a new clinical trial for diquafosol and greater commercial activities. Our cash, cash equivalents and investments totaled approximately $53.6 million on June 30, 2004. We expect that our capital and operating expenditures will continue to exceed our revenue over the next several years as we conduct our research and development activities, address possible difficulties with clinical trials and undertake 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 research and development programs;

• The size and scope of our marketing programs;

• Our ability to attract collaborators for our products and establish and maintain those relationships;

• Achievement of milestones under our existing collaborations with Allergan, Santen Pharmaceutical Co., Ltd, or Santen, and Kirin Brewery Co., Ltd., or Kirin, and any future collaborative programs;

• Progress by our collaborators;

• The level of activities relating to commercialization of our products;

• 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.

In addition, our capital requirements will depend upon:

• The receipt of revenue from Allergan on net sales of Elestat^™ and Restasis^®;

• The receipt of milestone payments from collaborative agreements;

• Our ability to obtain approval from the FDA for our first product candidate, diquafosol;

• Upon any such approval, our ability together with the ability of our marketing partner, Allergan, to generate sufficient sales of diquafosol; and

• Future potential revenue from Santen and Kirin and payments from future collaborators.

29

INSPIRE PHARMACEUTICALS, INC.

In the event that we do not receive timely regulatory approvals, we may need substantial additional funds to fully develop, manufacture, market and sell all of our other potential products and support our co-promotion efforts. We may seek such 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 and we may not be able to successfully commercialize any product candidate.

Clinical trials may take longer to complete and cost more than we expect, which would adversely affect our ability to commercialize product candidates and achieve profitability.

Clinical trials are lengthy and expensive. They require adequate supplies of drug product and sufficient patient enrollment. Patient enrollment is a function of many factors, including:

• The size of the patient population;

• The nature of the protocol;

• The proximity of patients to clinical sites;

• The eligibility criteria for the clinical trial; and

• The perceived benefit of participating in a clinical trial.

Delays in patient enrollment can result in increased costs and longer development times. Even if we successfully complete clinical trials, we may not be able to submit any required regulatory submissions in a timely manner and we may not receive regulatory approval for the product candidate. In addition, if the FDA or foreign regulatory authorities require additional clinical trials we could face increased costs and significant development delays.

We conduct clinical trials in different countries around the world and are subject to the risks and uncertainties of doing business internationally. Disruptions in communication and transportation, changes in governmental policies, civil unrest and currency exchange rates may affect the time and costs required to complete clinical trials in other countries.

Changes in regulatory policy or new regulations could also result in delays or rejection of our applications for approval of our product candidates. Product candidates designed as “fast track” products by the FDA may not continue to qualify for expedited review. Even if some of our product candidates receive “fast track” designation, the FDA may not approve them at all or any sooner than other product candidates that do not qualify for expedited review.

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. These fluctuations create a greater risk of capital losses for our stockholders as compared to less volatile stocks. Factors that have caused volatility and could cause additional volatility in the market price of our common stock include among others:

• Announcements regarding our NDA or foreign regulatory equivalent submissions;

• Announcements made by us concerning results of our clinical trials with diquafosol, INS37217 Respiratory, INS37217 Ophthalmic, INS37217 Intranasal, INS316 Diagnostic and any other product candidates;

• Market acceptance and market share of products we co-promote;

• Volatility in other securities including pharmaceutical and biotechnology securities;

• Changes in government regulations;

30

INSPIRE PHARMACEUTICALS, INC.

• Regulatory actions;

• Changes in the development priorities of our collaborators that result in changes to, or termination of, our agreements with such collaborators, including our agreements with Allergan, Santen and Kirin;

• Developments concerning proprietary rights including patents by us or our competitors;

• Variations in our operating results;

• Terrorist attacks;

• Military actions; and

• Litigation.

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

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 $22.1 million for the six month period ended June 30, 2004, $31.4 million for the year ended December 31, 2003 and $24.7 million for the year ended December 31, 2002. As of June 30, 2004, our accumulated deficit was approximately $149.2 million. We expect to incur additional significant operating losses over the next several years and expect that cumulative losses may increase in the near-term due to expanded research and development efforts, preclinical studies, clinical trials and commercialization efforts. 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 and any co-promotion products;

• The level of patient demand for our products and any licensed products;

• Timing of payments to and from licensors and corporate partners;

• Timing of investments in new technologies and commercial capability; and

• Commercialization activities to support co-promotion efforts.

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 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 fail to reach milestones or to make annual minimum payments or otherwise breach our obligations, UNC may terminate our agreements with them.

Our INS316 Diagnostic clinical development program depends on two exclusive licenses and one non-exclusive license from UNC. We hold licenses for INS365 for respiratory diseases and a P2Y₁₂ receptor program for a cardiovascular indication. If we fail to meet performance milestones relating to the timing of regulatory filings or pay the minimum annual payments under our respective UNC licenses, UNC may terminate the applicable license. In addition, if UNC were to re-license some or all of the technologies currently covered by our licenses, competitors could develop products that compete with ours.

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.

31

INSPIRE PHARMACEUTICALS, INC.

Reliance on a single party to manufacture and supply either finished product or the bulk active pharmaceutical ingredients for a product or product candidates could adversely affect us.

Under our agreements with Allergan, Allergan is responsible for the manufacture and supply of Elestat^TM and Restasis^®. We understand that in each case Allergan relies upon an arrangement with a single third party for the manufacture and supply of active pharmaceutical ingredients, or APIs, and then Allergan completes the manufacturing process to yield finished product. In the event such third party was unable to supply Allergan, or Allergan was unable to complete the manufacturing cycle, sales of the product could be adversely impacted, which would result in a reduction in any revenue from product co-promotion received under our agreements with Allergan.

In addition, we have relied upon supply agreements with third parties for the manufacture and supply of the bulk APIs of our product candidates for purposes of preclinical testing and clinical trials. We presently depend upon Yamasa Corporation as the sole manufacturer of our supply of APIs for our product candidates in clinical trials and intend to contract with Yamasa, as necessary, for commercial scale manufacturing of our products where we are responsible for such activities. In the case of diquafosol, Allergan will purchase commercial quantities of bulk APIs from Yamasa. Although we have identified alternate sources for these supplies, it would be time consuming and costly to qualify these sources. Under our current agreements, either Yamasa or we may terminate our supply arrangement, without cause, by giving 180 days prior notice. If Yamasa were to terminate our arrangement or fail to meet our supply needs we might be forced to delay our development programs and/or be unable to supply products to the market which could delay or reduce revenues and result in loss of market share.

If we are unable to contract with third parties for the synthesis of APIs required for preclinical testing, for the manufacture of drug products for clinical trials, or for the large-scale manufacture of any approved products, we may be unable to develop or commercialize our drug products.

We have no experience or capabilities to conduct the large-scale manufacture of any of our drug substance candidates and no capabilities to manufacture any pharmaceutical drug products. We do not currently expect to engage directly in the manufacturing of drug substance or drug products, but instead intend to contract with third parties to accomplish these tasks. With the exception of Santen, for which we are required to supply bulk active pharmaceutical ingredient, all of our partners are responsible for making their own arrangements for the manufacture of drug products, including arranging for the manufacture of bulk active pharmaceutical ingredient. Our dependence upon third parties for the manufacture of both drug substance and finished drug products that remain unpartnered may adversely affect our ability to develop and deliver such products on a timely and competitive basis. Similarly, our dependence on our partners to arrange for their own supplies of finished drug products may adversely affect our revenues. If we, or our partners, are unable to engage or retain third party manufacturers on commercially acceptable terms, our products may not be commercialized as planned. Our strategy of relying on third parties for manufacturing capabilities presents the following risks:

• The manufacturing processes for most of our active pharmaceutical ingredients have not been validated at the scale required for commercial sales;

• Delays in scale-up to commercial quantities and any change at the site of manufacture could delay clinical trials, regulatory submissions and ultimately the commercialization of our products;

• Manufacturers of our products are subject to the FDA’s current good manufacturing practices regulations, and similar foreign standards that apply, and we do not necessarily have full control over compliance with these regulations by third party manufacturers;

• If we need to change manufacturers, the 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;

• 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; and

• If we are unable to engage or retain an acceptable third party manufacturer for any of our product candidates, we would either have to develop our own manufacturing capabilities or delay the development of such product candidate.

32

INSPIRE PHARMACEUTICALS, INC.

Our dependence on collaborative relationships may lead to delays in product development, lost revenues 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 Santen and Kirin and development and commercialization collaborations with Allergan. The 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. Kirin has the right to terminate our license agreement, without cause, by giving us 180 days prior notice or, if we breach the agreement, Kirin may terminate immediately, if we fail to: (i) cure the breach, within 60 days of notice of the breach; or (ii) if such breach cannot be cured within 60 days, commence diligent efforts to cure the breach. Allergan and Santen may immediately terminate their agreements with us if we breach the applicable agreement and fail to cure the breach within sixty (60) days of being notified of such breach. If we materially breach our co-promotion agreement with Allergan for Elestat^TM, Allergan has the right to terminate the agreement upon ninety (90) days written notice if we fail to cure the breach within that ninety (90) day period. If we do not maintain the Allergan, Santen or Kirin collaborations, or establish additional research and development collaborations or licensing arrangements, it will be difficult to develop and commercialize 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 products on our own in all global markets. As a result, we will continue to depend on collaborators and contractors for the preclinical study and clinical development of therapeutic products and for manufacturing and marketing of products which result from our technology. Our agreements with collaborators typically 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.

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.

We may not be able to successfully compete with other 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 Alcon, AstraZeneca, Aventis, Boehringer Ingelheim, Chiron, Genentech, GlaxoSmithKline, Millennium Pharmaceuticals, Novartis, Pfizer and Schering-Plough. Most of these competitors have greater financial and other resources than we or our collaborative partners, including larger research and development staffs and more experienced marketing and manufacturing organizations.

In addition, most 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 product 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’ existing products or products under development.

33

INSPIRE PHARMACEUTICALS, INC.

Acquisitions of competing companies and potential competitors by large pharmaceutical companies or others could enhance financial, marketing and other resources available to such competitors. Academic and government institutions have become increasingly aware of the commercial value of their research findings and are more likely to enter into exclusive licensing agreements with commercial enterprises to market commercial products. Many of our competitors have far greater resources than we do and may be better able to afford larger license fees and milestones attractive to those institutions. Our competitors may also 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. Current products marketed to treat cystic fibrosis include Pulmozyme^® and TOBI^®. Primary treatments for dry eye disease currently involve over-the-counter artificial tear replacement drops, punctal plugs and Restasis^®. Current treatments for allergic conjunctivitis include antihistamines such as Patanol^®, Zaditor^® and Optivar^®, as well as mast cell stabilizers. Current treatments for colds, allergic rhinitis and rhinosinusitis include antihistamines, antibiotics, decongestants and anti-inflammatory steroids, such as Flonase^® and Nasonex^®. In addition, alternative approaches to treating diseases which we have targeted, such as gene therapy, may make our product candidates obsolete.

We will rely substantially on third parties to market, distribute and sell our products and those third parties may not perform.

We have developed a commercialization organization to co-promote Elestat^TM and Restasis^®, but we are dependent on Allergan, or other experienced third parties, to perform or assist us in the marketing, distribution or sale of these products and our product candidates. In addition, we may not identify acceptable partners or enter into favorable agreements with them for our other product candidates. If third parties do not successfully carry out their contractual duties, meet expected sales goals, maximize the commercial potential of our products, we may be required to hire or expand our own staff and sales force. If Allergan, or other third parties do not perform, or assist us in performing, these functions, it could have an adverse effect on our operations.

We have had limited experience in sales, marketing or distribution of products.

We have established a sales force to market and distribute Elestat^™, Restasis^® and other potential products. Although the members of our sales force have had experience in sales with other companies, we have never had a sales force and may undergo difficulties maintaining the sales force. We have incurred substantial expenses in establishing the sales force, including substantial additional expenses for the training and management of personnel, and the infrastructure to enable the sales force to be effective. We expect to continue to incur substantial expenses in the future. The costs of maintaining our sales force may exceed our product revenues. We compete with many companies that currently have extensive and well-funded marketing and sales operations. Many of these competing companies have had substantially more experience in, and financial resources for sales, marketing and distribution. Our selling and marketing efforts may be unsuccessful.

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 Chief Executive Officer and a director, and Thomas R. Staab, II, our Chief Financial Officer. If these people leave us, we may have difficulty conducting our operations. We have not entered into agreements with any officers or any other members of our management and scientific staff that bind 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.

34

INSPIRE PHARMACEUTICALS, INC.

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 patent claims 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 other countries due to their patent laws. Besides our use patents, we have patents and patent applications covering compositions (new chemical compounds), pharmaceutical formulations and processes for large-scale manufacturing. Many of the chemical compounds included in the claims of our use patents and process applications were known in the scientific community prior to our patent applications. None of our composition patents or patent applications cover these previously known chemical compounds, which are in the public domain. As a result, competitors may be able to commercialize products that use the same previously known chemical compounds used by us for the treatment of disorders and diseases not covered by our use patents. Such competitors’ activities may reduce our revenues.

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. We believe that there is 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 may have, or may acquire, patent rights which we might be accused of infringing. 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. Should we choose to do this, as with the above, we may need to make considerable expenditures of money and management time in litigation. Further, we may have to participate in interference proceedings in the United States Patent and Trademark Office, or USPTO, to determine the priority of invention of any of our technologies.

Our ability to develop sufficient patent rights in our pharmaceutical, biopharmaceutical and biotechnology products to support commercialization efforts is uncertain and involves complex legal and factual questions. For instance, the USPTO examiners may not allow our claims in examining our patent applications. If we have to appeal a decision to the USPTO’s Appeals Board for a final determination of patentability we could incur substantial legal fees.

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.

If physicians and patients do not accept our product candidates, they will 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;

35

INSPIRE PHARMACEUTICALS, INC.

• 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 the products. INS37217 Intranasal is administered as a nasal spray. Some patients may find the spray difficult to administer. We intend that diquafosol for the treatment of dry eye disease will be applied from a vial containing a single day’s dosage of non-preserved medication. Patients may prefer to purchase preserved medication for multiple doses. We have not yet established a plan to develop a multi-dose formulation. Although our partner, Santen, is developing a multi-dose formulation for use in their licensed territories, a multi-dose formulation has not been developed by our other partner, Allergan, for use in the remainder of the world. INS37217 Ophthalmic is administered through an intravitreal injection. It may be beneficial to patients to have a sustained delivery device. We have not yet established a plan for a sustained delivery device for certain indications such as for chronic use. Similar challenges exist in identifying and perfecting convenient methods of administration for our other product candidates.

If third party payors will not provide coverage or reimburse patients for any products we develop, our ability to derive revenues will suffer.

If government and health administration authorities, private health insurers 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. Reimbursement for newly approved health care products is uncertain. 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 to do so 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. In various foreign markets, pricing or profitability of medical products is subject to government control.

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 are substantial.

Our commercial insurance and umbrella policies include limited coverage designated for pollutant clean-up and removal and limited general liability coverage per occurrence and in the aggregate. The cost of these policies is significant and there can be no assurance that we will be able to maintain these policies or that coverage amounts will be sufficient to insure potential losses.

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 may expose us to liability claims from the use of those products. Although we carry clinical trial liability insurance and product liability insurance, we, or our collaborators, may not maintain sufficient insurance. If our insurance is insufficient, we do not have the financial

36

INSPIRE PHARMACEUTICALS, INC.

resources to self-insure and it is unlikely that we will have these financial resources in the foreseeable future. If we are unable to protect against potential product liability claims adequately, we may find it difficult or impossible to continue to co-promote our products, or to commercialize the products we develop. If claims or losses exceed our liability insurance coverage, we may go out of business.

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.

As of June 30, 2004, our directors, executive officers and their affiliates beneficially own over 4% of our outstanding common stock and together with our current 5% stockholders and their affiliates, beneficially own over 20% of our outstanding common stock, based on the most recent filings by such parties with the Securities and Exchange Commission. 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.

Future sales by stockholders into the public market may cause our stock price to decline.

Future sales of our common stock by current stockholders into the public market could cause the market price of our stock to fall. As of June 30, 2004, there were 32,034,049 shares of common stock outstanding. Of these outstanding shares of common stock, 12,075,000 shares were sold in public offerings and are freely tradable without restriction under the Securities Act of 1933, unless purchased by our affiliates. In addition, we have completed an underwritten public offering of 6,900,000 shares on July 30, 2004, which shares are not reflected in these amounts. Up to 7,178,571 shares of our common stock are issued or issuable upon exercise of stock options that have been, or may be, issued pursuant to our stock plan. Except with respect to an additional 750,000 shares of common stock issuable under our stock plan as a result of an amendment to our stock plan ratified by our stockholders on June 10, 2004, which we intend to register in 2004, the shares underlying existing, and possible future stock awards have been registered pursuant to a registration statement on Form S-8. The remaining shares of common stock outstanding are not registered under the Securities Act and may be resold in the public market only if registered or if there is an exemption from registration, such as Rule 144.

If some or all of such shares are sold into the public market over a short period of time, the value of all publicly traded shares is likely to decline, as the market may not be able to absorb those shares at then-current market prices. Such sales may 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.

Further, we may issue additional shares:

• To employees, directors and consultants;

• In connection with corporate alliances;

• In connection with acquisitions; and

• To raise capital.

As of June 30, 2004, there were outstanding options, which were exercisable to purchase 2,120,537 shares of our common stock, and outstanding warrants, which were exercisable to purchase 285,092 shares of our common stock. This amount combined with the total common stock outstanding at June 30, 2004 is 34,439,678 shares of common stock.

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.

In addition, we have completed an underwritten public offering of 6,900,000 shares on July 30, 2004, which are not reflected in these amounts.

37

INSPIRE PHARMACEUTICALS, INC.

Our rights agreement, the provisions of our Change in Control Agreements with management, the 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 and may make it difficult for stockholders to replace the board of directors and effect a change in our management if they desire to do so.

In October 2002, we entered into a Rights Agreement with Computershare Trust Company. The Rights Agreement could discourage, delay or prevent a person or group from acquiring 15% or more of our common stock. The Rights Agreement provides that if a person acquires 15% or more of our common stock without the approval of our board of directors, all other stockholders will have the right to purchase securities from us at a price that is less than its fair market value, which would substantially reduce the value of our common stock owned by the acquiring person. As a result, our board of directors has significant discretion to approve or disapprove a person’s efforts to acquire 15% or more of our common stock.

Inspire and each of our executive officers have entered into a Change in Control Agreement, to be effective March 2004. Each agreement provides for a payment to the executive officer that is equal to the highest salary and bonus, or in the case of our Chief Executive Officer, Dr. Christy Shaffer, 2 times (2x) such salary and bonus, earned by the executive officer in the three years preceding a change in control. In addition, all unvested stock options, restricted shares and performance shares will become fully vested upon a change in control, and the exercise period shall be extended for five years, but not beyond the original term. Health, life, accident and disability insurance benefits will be provided for the term of the agreements, subject to reduction if similar benefits are provided by a subsequent employer. The executive officers may also receive gross up payments so they may pay the excise tax on the additional payments. Under the agreements, a change in control means the determination by the board that a change of control has occurred, or is about to occur.

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. Since management is appointed by the board of directors, any inability to effect a change in the board may result in the entrenchment of management.

Our amended and restated certificate of incorporation also 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 do not permit our stockholders to call a special meeting of stockholders. Under the bylaws, only our Chief Executive Officer, President, Chairman of the Board, Vice-Chairman of the Board or a majority of the board of directors are able to call special meetings. The staggering of directors’ terms of office and the inability of stockholders to call a special meeting may make it difficult for stockholders to remove or replace the board of directors should they desire to do so. 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, either by third parties or by stockholders seeking to change control or management.

We are also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. Under these provisions, if anyone becomes an “interested stockholder,” we may not enter a “business combination” with that person for three years without special approval, which could discourage a third party from making a take-over offer and could delay or prevent a change of control. For purposes of Section 203, “interested stockholder” means, generally, someone owning 15% or more of our outstanding voting stock or an affiliate of ours that owned 15% or more of our outstanding voting stock during the past three years, subject to certain exceptions as described in Section 203.

38

INSPIRE PHARMACEUTICALS, INC.

Item 6. Exhibits and Reports on Form 8-K

a) Exhibits:

Exhibit No.	Description of Exhibit
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 2, 2000).
3.2	Certificate of Amendment of Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed on March 26, 2002).
3.3	Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K filed on March 7, 2003).
3.4	Amended and Restated Bylaws (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 15, 2004).
10.1	Amended and Restated 1995 Stock Plan, as amended.
10.2	Agreement between Inspire Pharmaceuticals, Inc. and Christy Shaffer, effective as of March 29, 2004, regarding change in control.
10.3	Form of change in control Agreement for other executive officers.
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b) Reports on Form 8-K

On April 15, 2004, we filed a Current Report on Form 8-K, dated March 30, 2004, to file our Amended and Restated Bylaws.

On April 27, 2004, we filed a Current Report on Form 8-K, dated April 27, 2004, announcing top-line results in a Phase II clinical trial of INS37217 Respiratory in patients with mild cystic fibrosis.

39

SIGNATURES

Pursuant to requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Inspire Pharmaceuticals, Inc.
Date: August 9, 2004	By:	/s/ Christy L. Shaffer
		Christy L. Shaffer
		Chief Executive Officer and Director
		(principal executive officer)
Date: August 9, 2004	By:	/s/ Thomas R. Staab, II
		Thomas R. Staab, II
		Chief Financial Officer
		(principal financial and chief accounting officer)

40

EXHIBIT INDEX

Exhibit No.	Description of Exhibit
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 2, 2000).
3.2	Certificate of Amendment of Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed on March 26, 2002).
3.3	Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K filed on March 7, 2003).
3.4	Amended and Restated Bylaws (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 15, 2004).
10.1	Amended and Restated 1995 Stock Plan, as amended.
10.2	Agreement between Inspire Pharmaceuticals, Inc. and Christy Shaffer, effective as of March 29, 2004, regarding change in control.
10.3	Form of change in control Agreement for other executive officers.
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

41

EX-10.1

EXHIBIT 10.1

INSPIRE PHARMACEUTICALS, INC.

AMENDED AND RESTATED

1995 STOCK PLAN, AS AMENDED

A. Inspire Pharmaceuticals, Inc. (the “Company”) heretofore established this 1995 Stock Plan (the “Plan”) to encourage ownership of Common Stock, $0.001 par value (the “Stock”) of by its directors, officers, employees and consultants (“Participants”) through the grant of Incentive Stock Options, Nonstatutory Stock Options (as such terms are defined in Section 3(a) below (collectively, “Options”) and Restricted Stock (as such term is defined in Section 8 below).

B. Pursuant to Section 11 of the Plan, the Company now desires to amend and restate the Plan in order to clarify the right of the Board to amend existing Options and Options granted hereafter and the consequences of any such amendments.

NOW THEREFORE, effective March 30, 2004, the Plan is hereby amended and restated as follows:

1. Administration of the Plan.

The administration of the Plan shall be under the general supervision of the Board of Directors of the Company or any committee of such board to which such board delegates such administrative responsibility (the “Board”). The Board may establish such rules as it deems necessary for the proper administration of the Plan, make such determinations and interpretations with respect to the Plan and Options and Restricted Stock granted under it as may be necessary or desirable and include such further provisions or conditions in Options and Restricted Stock granted under the Plan as it deems advisable. To the extent permitted by law, the Board may delegate its authority under the Plan to a sub-committee of the Board. Within the limits of the Plan, the Board shall determine:

(a) the individuals to whom, and the times at which, Options or Restricted Stock shall be granted;

(b) in the case of Options, the type of Option to be granted, the duration of each Option, the price at which Option Shares (as defined in Section 2(a)) may from time to time be purchased through exercise of an Option (“Strike Price”) and method of payment for each Option, and the time or times within which (during its term) all or portions of each Option may be exercised; and

(c) in the case of Restricted Stock, the repurchase provisions of such Restricted Stock and the price and method of payment for such Restricted Stock.

2. Shares Subject to the Plan.

(a) Number and Type of Shares. The aggregate number of shares of Stock of the Company which may be issued pursuant to Options (“Option Shares”) or Restricted Stock granted under the Plan is 7,178,571 shares. In the event that the Board in its discretion determines that any stock dividend, split-up, combination or reclassification of shares, recapitalization or other similar capital change affects the Stock such that adjustment is required in order to preserve the benefits or potential benefits of the Plan or any Option granted under the Plan, the maximum aggregate number and kind of shares or securities of the Company which may be issued under the Plan and as to which Options then outstanding shall be exercisable, and the Strike Price of such Options or the repurchase price of Restricted Stock, shall be appropriately adjusted by the Board (whose determination shall be conclusive) so that the proportionate number of Option Shares or other securities as to which Options or Restricted Stock may be granted and the proportionate interest of holders of outstanding Options shall be maintained as before the occurrence of such event.

(b) Effect of Certain Transactions. In the event of a consolidation or merger of the Company with another corporation, or the sale or exchange of all or substantially all of the assets of the Company, or a reorganization or

liquidation of the Company, each holder of an outstanding Option shall be entitled to receive upon exercise and payment in accordance with the terms of the Option the same shares, securities or property as he would have been entitled to receive upon the occurrence of such event if he had been, immediately prior to such event, the holder of the number of Option Shares; provided, however, that in lieu of the foregoing the Board may upon written notice to each holder of an outstanding Option provide that such Option shall terminate on a date not less than 20 days after the date of such notice unless theretofore exercised. In connection with such notice, the Board may in its discretion accelerate or waive any deferred exercise period.

(c) Restoration of Shares. If any Option expires or is terminated unexercised or is forfeited for any reason or settled in a manner that results in fewer shares outstanding than were initially awarded, including without limitation the surrender of shares in payment of the Strike Price or any tax obligation thereon, or if any shares of Restricted Stock are repurchased by the Company pursuant to the terms thereof, the shares subject to such Option or so surrendered or repurchased, as the case may be, to the extent of such expiration, termination, forfeiture, repurchase or decrease, shall again be available for granting Options or Restricted Stock under the Plan, subject, however, in the case of Incentive Stock Options, to any requirements under the Internal Revenue Code of 1986, as amended (the “Code”).

(d) Reservation of Shares. The Company shall at all times while the Plan is in force reserve such number of shares of Stock as will be sufficient to satisfy the requirements of the Plan. Shares issued under the Plan may consist in whole or in part of authorized but unissued shares or treasury shares.

3. Grant of Options, Eligible Persons

(a) Types of Options. Options shall be granted under the Plan either as incentive stock options (“Incentive Stock Options”), as defined in Code Section 422 or as Options which do not meet the requirements of Section 422 (“Nonstatutory Stock Options”). Options may be granted from time to time by the Board, within the limits set forth in Sections 1 and 2 of the Plan, to all employees of the Company or of any parent corporation or subsidiary corporation of the Company (as claimed in Sections 424(e) and (f), respectively, of the Code), and, with regard to Nonstatutory Stock Options, to all consultants and directors of the Company.

(b) Date of Grant. The date of grant for each Option shall be the date on which it is approved by the Board, or such later date as the Board may specify. No Incentive Stock Options shall be granted hereunder after ten years from the date on which the Plan was approved by the Board.

(c) Automatic Awards. The Board may provide for the automatic award of an Option upon the delivery of shares to the Company in payment of an Option for up to the number of shares so delivered.

4. Form of Options.

Options granted hereunder shall be evidenced by a writing delivered to the optionee specifying the terms and conditions thereof and containing such other terms and conditions not inconsistent with the provisions of the Plan as the Board considers necessary or advisable to achieve the purposes of the Plan or comply with applicable tax and regulatory laws and accounting principles. The form of such Options may vary among optionees.

5. Option Strike Price.

(a) Incentive Stock Options. In the case of Incentive Stock Options, the Strike Price shall be determined by the Board, provided that such price shall not be less than the fair market value of the Stock on the date of granting (or the date on which a modification of an existing Option is treated as the grant of a new Option, pursuant to Section 11(b) of the Plan), as determined in good faith by the Board; and provided further that no Incentive Stock Option shall be granted to any individual who is ineligible to be granted an Incentive Stock Option because his or her ownership of stock of the Company or its parent or subsidiary corporations exceeds the limitations set forth in Code Section 422(b)(6) (a “Ten Percent Owner”) unless such Strike Price is at least 110% of the fair market value of the Stock on the date of grant.

(b) Nonstatutory Stock Options. In the case of Nonstatutory Stock Options (and Incentive Stock Options which have been converted by the Board to Nonstatutory Stock Options pursuant to Section 11(b) of the Plan), the Strike Price shall be determined by the Board.

(c) Payment Method. The Board may in its discretion permit the Strike Price to be paid in whole or in part by a note or in installments or with shares of Stock or such other lawful consideration as the Board may determine.

6. Term of Option and Dates of Exercise.

(a) Exercisability. The Board shall determine the term of all Options, the time or times that Options are exercisable and whether they are exercisable in installments; provided, however, that (i) the term of each Nonstatutory Stock Option shall not exceed a period of eleven years from its Date of Grant; (ii) the term of each Incentive Stock Option granted to anyone who is not a Ten Percent Owner shall not exceed a period of ten years from its Date of Grant; (iii) the term of each Incentive Stock Option granted to any Ten Percent Owner shall not exceed a period of five years from its Date of Grant.

(b) Effect of Disability, Death or Termination of Employment. The Board shall determine the effect on an Option of the disability, death, retirement or other termination of employment of an optionee and the extent to which, and during the period which, the optionee’s estate, legal representative, guardian, or beneficiary on death may exercise rights thereunder. Any beneficiary on death shall be designated by the optionee, in the manner determined by the Board, to exercise rights of the optionee in the case of the optionee’s death.

(c) Other Conditions. The Board may impose such conditions with respect to the exercise of Options, including conditions relating to applicable federal or state securities laws, as it considers necessary or advisable.

(d) Withholding. The optionee shall pay to the Company, or make provision satisfactory to the Board for payment of, any taxes required by law to be withheld in respect of any Options under the Plan no later than the date of the event creating the tax liability. In the Board’s discretion, such tax obligations may be paid in whole or in part in shares of Stock, including shares retained from the exercise of the Option creating the tax obligation, valued at the fair market value of the Stock on the date of delivery to the Company as determined in good faith by the Board. The Company and any parent corporation or subsidiary corporation of the Company (as defined in Sections 424(e) and (f), respectively, of the Code) may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to the optionee.

(e) Amendment or Termination of Existing Options. The Board may amend, modify, or terminate any outstanding Option, including substituting therefor another Option of the same or different type, (for example, changing the date of exercise or realization and converting an Incentive Stock Option to a Nonstatutory Stock Option, provided that the optionee’s consent (which consent may be withheld for any reason) shall be required unless the Board determines that the action, taking into account any related action, would not materially and adversely affect the optionee. Any such amendment which results in a “modification” of an existing option (as defined under Section 1.425-1(e) (2) of the proposed Income Tax Regulations for purposes of Code Section 421 and 424) shall be treated as a grant of new option if the Board determines that such option should continue to qualify as an “incentive stock option” (as defined in Code Section 422).

7. Non-transferability of Options.

(a) Incentive Stock Options granted under the Plan shall not be transferable by the holder thereof otherwise than by will or the laws of descent and distribution, and shall be exercisable, during the holder’s lifetime, only by him or her.

(b) Nonstatutory Stock Options granted under the Plan shall not be transferable by the holder thereof, except as expressly provided by the applicable Option Agreement.

8. Restricted Stock.

(a) Subject to the provisions of the Plan, the Committee may award shares of Stock subject to the Company’s right to repurchase such shares (“Restricted Stock”). The Committee shall determine the duration of the period of time (the “Restricted Period”) during which, and the price at which and other the conditions under which, the shares may be repurchased by the Company and other terms and conditions of such grants. Shares of Restricted Stock may be issued without cash consideration or for such consideration as may be determined by the Committee.

(b) Shares of Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered, except as permitted by the Committee, during the Restricted Period. Shares of Restricted Stock shall be evidenced in such manner as the Committee may determine. Any certificates issued in respect of shares of Restricted Stock shall be registered in the name of the holder and if requested by the Committee, shall be deposited by the holder, together with a stock power endorsed in blank, with the Company. At the expiration of the Restricted Period, the Company shall deliver such certificates to the Participant or if the Participant has died, to the Participant’s designated beneficiary.

(c) Each recipient of Restricted Stock shall enter into a Restricted Stock Purchase Agreement with the Company which shall specify the terms and conditions of such grant of Restricted Stock and shall contain such other terms and conditions not inconsistent with the provisions of this Plan as the Committee considers necessary or advisable to achieve the purposes of the Plan or comply with applicable tax and regulatory laws and accounting principles. The form of such Restricted Stock Purchase Agreement may vary among Participants.

9. No Right to Employment.

No persons shall have any claim or right to be granted an Option or Restricted Stock, and the grant of an Option or Restricted Stock shall not be construed as giving an optionee the right to continued employment. The Company expressly reserves the right at any time to dismiss a Participant free from any liability or claim under the Plan, except as specifically provided in the applicable Option or Restricted Stock Purchase Agreement.

10. No Rights as a Shareholder.

Subject to the provisions of the applicable Option or Restricted Stock Purchase Agreement, no optionee or any person claiming through an optionee shall have any rights as a shareholder with respect to any shares of Stock to be distributed under the Plan until he or she becomes the holder thereof.

11. Amendment or Termination.

The Board may amend or terminate the Plan at any time, provided that no amendment shall be made without stockholder approval if such approval is necessary to comply with any applicable tax or regulatory requirement, including any requirement for exemptive relief under Section 16(b) of the Securities Exchange Act of 1934, or any successor provision.

12. Stockholder Approval.

The Plan is subject to approval by the stockholders of the Company by the affirmative vote of the holders of a majority of the shares of capital stock of the Company entitled to vote thereon and present or represented at a meeting duly held in accordance with the laws of the State of Delaware, or by any other action that would be given the same effect under the laws of such jurisdiction, which action in either case shall be taken within twelve (12) months from the date the Plan was adopted by the Board. In the event such approval is not obtained, all Options granted under the Plan shall be void and without effect.

13. Governing Law.

The provisions of the Plan shall be governed by and interpreted in accordance with the laws of Delaware.

Adopted by the Board of Directors on March 30, 2004.

Approved by the Stockholders on June 10, 2004.

EX-10.2

EXHIBIT 10.2

AGREEMENT

THIS AGREEMENT, dated as of March 29, 2004, is made by and between Inspire Pharmaceuticals, Inc., a Delaware corporation (the “Company”), and Christy L. Shaffer (the “Executive”).

WHEREAS, the Board considers it essential to the best interests of the Company to foster the continued employment of key management personnel; and

WHEREAS, the Board recognizes that, as is the case with many publicly held corporations, the possibility of a Change in Control exists and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company; and

WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company’s management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control;

NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and the Executive hereby agree as follows:

1. Defined Terms. The definitions of capitalized terms used in this Agreement are provided in the last Section hereof.

2. Term of Agreement. This Agreement shall be effective March 29, 2004 and shall continue in effect through March 29, 2006; provided, however, that commencing on March 29, 2005 and each March 29 thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than September 29 of the prior year, the Company or the Executive shall have given notice not to extend this Agreement or a Change in Control shall have occurred prior to such September 29; and further provided, however, that if a Change in Control shall have occurred during the term of this Agreement, this Agreement shall continue in effect for a period of not less than twenty-four (24) months beyond the month in which such Change in Control occurred.

3. Company’s Covenants Summarized. In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive’s covenants set forth in Section 4 hereof, the Company agrees, under the conditions described herein, to pay the Executive the Severance Payments and the other payments and benefits described herein. Except as provided in Section 10.1 hereof, no amount or benefit shall be payable under this Agreement unless there shall have been (or, under the terms of the second sentence of Section 6.1 hereof, there shall be deemed to have been) a termination of the Executive’s employment with the Company following a Change in Control and during the term of this Agreement. This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any right to be retained in the employ of the Company.

4. The Executive’s Covenants.

4.1. The Executive agrees that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control during the term of this Agreement, the Executive will remain in the employ of the Company until the earliest of (i) a date which is six (6) months

after the date of such Potential Change in Control, (ii) the date of a Change in Control, (iii) the date of termination by the Executive of the Executive’s employment for Good Reason or by reason of death or Disability, or (iv) the termination by the Company of the Executive’s employment for any reason.

4.2 The Executive further acknowledges and agrees that any covenant of non-competition, nonsolicitation or other restrictive covenant applicable to Executive under any employment or other agreement between the Company and the Executive shall continue to apply in accordance with its terms following the Date of Termination except that the term of the restricted period shall apply for the longer of twenty-four (24) months following the Date of Termination or the term set forth in such agreement.

5. Compensation Unrelated to Severance Payments.

5.1. Following a Change in Control and during the term of this Agreement, during any period that the Executive fails to perform the Executive’s full-time duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive’s full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits payable to the Executive under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period, until the Executive’s employment is terminated by the Company for Disability.

5.2. If the Executive’s employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay the Executive’s full salary to the Executive through the Date of Termination at the rate in effect immediately prior to the Change in Control or at the time the Notice of Termination is given, whichever is greater, together with all compensation and benefits to which the Executive is entitled in respect of all periods preceding the Date of Termination under the terms of the Company’s compensation and benefit plans, programs or arrangements.

5.3. If the Executive’s employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay to the Executive the Executive’s normal post-termination compensation and benefits as such payments become due. Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company’s retirement, insurance and other compensation or benefit plans, programs and arrangements as in effect immediately prior to the Change in Control or, if more favorable to the Executive, as in effect immediately prior to the Date of Termination.

6. Severance Payments.

6.1. The Company shall pay the Executive the payments described in this Section 6.1 (the “Severance Payments”) upon the termination of the Executive’s employment following a Change in Control and during the term of this Agreement (in addition to any payments and benefits to which the Executive is entitled under Section 5 and 8 hereof), unless such termination is (i) by the Company for Cause, (ii) by reason of death or Disability, or (iii) by the Executive without Good Reason. For purposes of this Agreement, the Executive’s employment shall be deemed to have been terminated by the Company without Cause or by the Executive with Good Reason following a Change in Control if (i) the Executive’s employment is terminated without Cause prior to a Change in Control which actually occurs during the term of this Agreement and such termination was at the request or direction of a Person who has entered into an agreement with the Company the consummation of which would constitute a Change in Control, (ii) the Executive terminates his employment with Good Reason prior to a Change in Control which actually occurs during the term of this Agreement and the circumstance or event which constitutes Good Reason occurs at the request or direction of such Person, (iii) the Executive’s

-2-

employment is terminated by the Company without Cause or by the Executive for Good Reason prior to a Change in Control and the Executive reasonably demonstrates that such termination is otherwise in connection with or in anticipation of a Change in Control which actually occurs during the term of this Agreement, or (iv) the Executive’s employment is terminated without Cause after a Potential Change in Control of the type described in paragraph (I) of the definition of “Potential Change in Control”.

(A) In lieu of any further salary payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to two (2) times the sum of (i) the higher of the Executive’s annual base salary in effect immediately prior to the occurrence of the event or circumstance upon which the Notice of Termination is based or the Executive’s highest annual base salary in effect during the three (3) completed fiscal years immediately preceding the Change in Control (the “Change in Control Salary”), and (ii) the higher of the highest annual bonus earned by the Executive pursuant to any annual bonus or incentive plan maintained by the Company in respect of the three (3) completed fiscal years immediately preceding the year in which the Date of Termination occurs or the highest annual bonus so earned in respect of the three (3) completed fiscal years immediately preceding the year in which the Change in Control occurs (the “Change in Control Bonus”).

(B) Notwithstanding any provision of any annual incentive plan to the contrary, the Company shall pay to the Executive a lump sum amount, in cash, equal to a pro rata portion to the Date of Termination of the value of the target incentive award under such plan for the then uncompleted period under such plan, calculated by multiplying the Executive’s target award by the fraction obtained by dividing the number of full months and any fractional portion of a month during such performance award period through the Date of Termination by the total number of months contained in such performance award period.

(C) For the twenty-four (24) month period immediately following the Date of Termination, the Company shall arrange to provide the Executive (which includes the Executive’s eligible dependents for purposes of this paragraph (C)) with life, disability, accident and health insurance benefits substantially similar to those which the Executive was receiving immediately prior to the Notice of Termination (without giving effect to any amendment to such benefits made subsequent to the earlier of a Potential Change in Control or a Change in Control which amendment adversely affects in any manner the Executive’s entitlement to or the amount of such benefits); provided, however, that, unless the Executive consents to a different method, such health insurance benefits shall be provided through a third-party insurer. Benefits otherwise receivable by the Executive pursuant to this Section 6.1(C) shall be reduced to the extent comparable benefits (including continued coverage for any preexisting medical condition of any person covered by the benefits provided to the Executive and his eligible dependents immediately prior to the Notice of Termination) are actually received by or made available to the Executive by a subsequent employer without cost during the twenty-four (24) month period following the Executive’s Date of Termination (and any such benefits actually received by or made available to the Executive shall be reported to the Company by the Executive).

6.2. (A) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment, award, benefit or distribution (or any acceleration of any payment, award, benefit or distribution) by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a “Payment”) would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Executive with respect to the excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the “Excise Tax”), then the Executive shall be entitled to receive an additional payment (a “Gross-Up Payment”) in an amount such that after payment by the Executive of all

-3-

taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed on the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments.

(B) Subject to the provisions of Section 6.2(C), all determinations required to be made under this Section 6.2, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment, shall be made by a nationally recognized accounting firm designated by the Company (the “Accounting Firm”) which shall provide detailed supporting calculations both to the Company and the Executive within fifteen (15) business days after there has been a Payment, or such earlier time as requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Company shall appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 6, shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm’s determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross- Up Payments which will not have been made by the Company should have been made (“Underpayment”), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 6.2(C) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive.

(C) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall:

(i) give the Company any information reasonably requested by the Company relating to such claim;

(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company;

(iii) cooperate with the Company in good faith in order effectively to contest such claim; and

(iv) permit the Company to participate in any proceedings relating to such claim;

-4-

provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 6.2(C), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

(D) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6.2(C), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 6.2(C)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6.2(C), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid.

6.3. The payments provided for in subsections (A), (B) and (C) of Section 6.1 hereof shall be made not later than the thirtieth (30th) day following the Date of Termination; provided, however, that if the amounts of such payments cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Executive of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments (together with interest at 120% of the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined but in no event later than the sixtieth (60th) day after the Date of Termination; provided, however, that in the event the Executive becomes entitled to Severance Payments pursuant to the second sentence of Section 6.1 (except for a termination occurring with respect to clause (iv) of such sentence, which shall be paid as set forth above) such payments shall be due and payable within thirty (30) days following the actual Change in Control that triggered the Severance Payments. In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the fifth (5th) business day after demand by the Company (together with interest at 120% of the rate provided in Section 1274(b)(2)(B) of the Code). In the event the Company should fail to pay when due the amounts described in subsections (A), (B) and (C) of Section 6.1 hereof, the Executive shall also be entitled to receive from the Company an amount

-5-

representing interest on any unpaid or untimely paid amounts from the due date, as determined under this Section 6.3 (without regard to any extension of the Date of Termination pursuant to Section 7.3 hereof), to the date of payment at a rate equal to 120% of the rate provided in Section 1274(b)(2)(B) of the Code.

6.4. The Company also shall pay to the Executive all legal fees and expenses incurred by the Executive in disputing in good faith any issue hereunder relating to the termination of the Executive’s employment, in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of Section 4999 of the Code to any payment or benefit provided hereunder. Such payments shall be made within five (5) business days after delivery of the Executive’s written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require.

7. Termination Procedures and Compensation During Dispute.

7.1. Notice of Termination. After a Potential Change in Control or, if there is no Potential Change in Control, after a Change in Control and during the term of this Agreement, any purported termination of the Executive’s employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 11 hereof. For purposes of this Agreement, a “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated. Further, a Notice of Termination for Cause is required to include a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3/4) of the entire membership of the Board at a meeting of the Board which was called and held for the purpose of considering such termination (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive’s counsel, to be heard before the Board) finding that, in the good-faith opinion of the Board, the Executive was guilty of conduct set forth in clause (i) or (ii) of the definition of Cause herein, and specifying the particulars thereof in detail.

7.2. Date of Termination. “Date of Termination,” with respect to any purported termination of the Executive’s employment after a Change in Control and during the term of this Agreement, shall mean (i) if the Executive’s employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive’s duties during such thirty (30) day period), and (ii) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company, shall not be less than thirty (30) days (except in the case of a termination for Cause) and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given).

7.3. Dispute Concerning Termination. If within fifteen (15) days after any Notice of Termination is given, or, if later, prior to the Date of Termination (as determined without regard to this Section 7.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of an arbitrator or a court of competent jurisdiction (which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided, however, that the Date of Termination shall be extended by a notice of dispute given by the Executive only if such notice is given in good faith and the Executive pursues the resolution of such dispute with reasonable diligence.

-6-

7.4. Compensation During Dispute. If a purported termination occurs following a Change in Control and during the term of this Agreement and the Date of Termination is extended in accordance with Section 7.3 hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, salary) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the Date of Termination, as determined in accordance with Section 7.3 hereof. Amounts paid under this Section 7.4 are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement.

8. Acceleration of Certain Stock-Based Benefits.

(A) All unvested options with respect to the Company’s stock held by the Executive shall vest and become immediately exercisable immediately prior to the occurrence of a Change in Control and will be exercisable for a period ending on the later of (i) the fifth anniversary of such Change in Control or (ii) the last date that such option would otherwise be exercisable under the terms of the option agreement or the plan pursuant to which such option was granted; provided, that in no event shall any option be exercisable after the expiration of the original term of the option.

(B) Upon the occurrence of a Change in Control, all unearned performance-based awards held by the Executive under the Company’s Stock Plan shall be deemed to have been earned to the maximum extent permitted under the Stock Plan for any performance period not then completed and all unvested stock awards shall immediately vest and the restrictions on all shares subject to restriction shall lapse.

(C) In the event that this Section 8 is determined for any reason to be inconsistent with the terms of any plan pursuant to which such stock options, performance restricted shares and restricted stock awards were issued, the terms of this Agreement shall supersede the terms of such plan.

9. No Mitigation. The Company agrees that, if the Executive’s employment with the Company terminates during the term of this Agreement, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Section 6 hereof or Section 7.4 hereof. Further, the amount of any payment or benefit provided for in this Agreement (other than Section 6.1(C) hereof) shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise.

10. Successors; Binding Agreement.

10.1. In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive’s employment for Good Reason after a Change in Control, except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination.

-7-

10.2. This Agreement shall inure to the benefit of and be enforceable by the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive’s estate.

11. Notices. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed, if to the Executive, to the address shown for the Executive in the personnel records of the Company and, if to the Company, to the address set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt:

To the Company:

Inspire Pharmaceuticals, Inc.

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703

Attention: Ms. Mary Bennett, Senior Vice President

With a copy to:

Reed Smith LLP

136 Main Street, Suite 250

Princeton Forrestal Village

Attention: Diane M. Frenier, Esquire

12. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Board. No waiver by either party hereto at any time of any breach by the other party hereto of, or of any lack of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. This Agreement supersedes any other agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof which have been made by either party. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of North Carolina. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed. The obligations of the Company and the Executive under Sections 6 and 7 hereof shall survive the expiration of the term of this Agreement. If the Executive elects not to enter into this Agreement, the Executive will continue to be eligible for change in control benefits, if any, provided under the Company’s existing employee benefit plans. The Company agrees that it will not argue in any form for any purpose that this Agreement constitutes an “employee benefit plan” within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended.

-8-

13. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.

14. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

15. Settlement of Disputes; Arbitration. All claims by the Executive for benefits under this Agreement shall be directed in writing to and determined by the Committee (as defined below), which shall give full consideration to the evidentiary standards set forth in this Agreement. Any denial by the Committee of a claim for benefits under this Agreement shall be delivered to the Executive in writing and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon. The Committee shall afford a reasonable opportunity to the Executive for a review of the decision denying a claim and shall further allow the Executive to appeal to the Committee a decision of the Committee within sixty (60) days after notification by the Committee that the Executive’s claim has been denied. Any further dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in the Raleigh/Durham, North Carolina metropolitan area in accordance with the rules of the American Arbitration Association then in effect; provided, however, that the evidentiary standards set forth in this Agreement shall apply. Judgment may be entered on the arbitrator’s award in any court having jurisdiction. Notwithstanding any provision of this Agreement to the contrary, the Executive shall be entitled to seek specific performance of the Executive’s right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement.

16. Definitions. For purposes of this Agreement, the following terms shall have the meanings indicated below:

(A) “Accounting Firm” shall have the meaning stated in Section 6.2(B) hereof.

(B) “Beneficial Owner” shall have the meaning set forth in Rule 13d-3 under the Exchange Act.

(C) “Board” shall mean the Board of Directors of the Company.

(D) “Cause” for termination by the Company of the Executive’s employment shall mean (i) the deliberate and continued failure by the Executive to devote substantially all the Executive’s business time and best efforts to the performance of the Executive’s duties after a demand for substantial performance is delivered to the Executive by the Board which specifically identifies the manner in which the Executive has not substantially performed such duties; (ii) the deliberate engaging by the Executive in gross misconduct which is demonstrably and materially injurious to the Company, monetarily or otherwise, including but not limited to fraud or embezzlement by the Executive; or (iii) the Executive’s conviction (or entering into a plea bargain admitting guilt) of any felony. For the purposes of this Agreement, no act, or failure to act, on the part of the Executive shall be considered “deliberate” unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that such action or omission was in the best interests of the Company. In the event of a dispute concerning the application of this provision, no claim by the Company that Cause exists shall be given effect unless the Company establishes to the Committee by clear and convincing evidence that Cause exists.

-9-

(E) “Change in Control” shall mean the determination (which may be made effective as of a particular date specified by the Board of Directors of the Company) by the Board of Directors of the Company, made by a majority vote that a change in control has occurred, or is about to occur. Such a change shall not include, however, a restructuring, reorganization, merger or other change in capitalization in which the Persons who own an interest in the Company on the date hereof (the “Current Owners”) (or any individual or entity which receives from a Current Owner an interest in the Company through will or the laws of descent and distribution) maintain more than a fifty percent (50%) interest in the resultant entity. Regardless of the Board’s vote or whether or not the Board votes, a Change-in-Control will be deemed to have occurred as of the first day any one (1) or more of the following subparagraphs shall have been satisfied:

(i) Any Person (other than the Person in control of the Company as of the date of this Agreement, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, or a company owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company), becomes the beneficial owner, directly or indirectly, of securities of the Company representing more than thirty five percent (35%) of the combined voting power of the Company’s then outstanding securities; or

(ii) The stockholders of the Company approve:

(A) A plan of complete liquidation of the Company;

(B) An agreement for the sale or disposition of all or substantially all of the Company’s assets; or

(C) A merger, consolidation or reorganization of the Company with or involving any other company, other than a merger, consolidation or reorganization that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the combined voting power of the voting securities of the Company (or such surviving entity) outstanding immediately after such merger, consolidation or reorganization.

However, in no event shall a Change-in-Control be deemed to have occurred, with respect to the Executive, if the Executive is part of a purchasing group which consummates the Change-in-Control transaction. The Executive shall be deemed “part of the purchasing group” for purposes of the preceding sentence if the Executive is an equity participant or has agreed to become an equity participant in the purchasing company or group (except for (i) passive ownership of less than five percent (5%) of the voting securities of the purchasing company; or (ii) ownership of equity participation in the purchasing company or group which is otherwise deemed not to be significant, as determined prior to the Change-in-Control by a majority of the non-employee continuing Directors of the Board of Directors of the Company).

-10-

(F) “Change in Control Salary” shall have the meaning stated in Section 6.1 hereof.

(G) “Change in Control Bonus” shall have the meaning stated in Section 6.1 hereof.

(H) “Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

(I) “Committee” shall mean (i) the individuals (not fewer than three in number) who, on the date six (6) months before a Change in Control or, in the event of a Potential Change in Control, on the date one (1) month before a Potential Change in Control, constitute the Compensation Committee of the Board, plus (ii) in the event that fewer than three individuals are available from the group specified in clause (i) above for any reason, such individuals as may be appointed by the individual or individuals so available (including for this purpose any individual or individuals previously so appointed under this clause (ii)).

(J) “Company” shall mean Inspire Pharmaceuticals, Inc. and, except in determining under Section 16(E) hereof whether or not any Change in Control of the Company has occurred, shall include its subsidiaries and any successor to its business and/or assets which assumes and agrees to perform this Agreement by operation of law, or otherwise.

(K) “Date of Termination” shall have the meaning stated in Section 7.2 hereof.

(L) “Disability” shall be deemed the reason for the termination by the Company of the Executive’s employment, if, as a result of the Executive’s incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive’s duties with the Company for a period of six (6) consecutive months, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive’s duties.

(M) “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended from time to time.

(N) “Excise Tax” shall have the meaning stated in Section 6.2(A) hereof.

(O) “Executive” shall mean the individual named in the first paragraph of this Agreement.

(P) “Good Reason” for termination by the Executive of the Executive’s employment shall mean the occurrence (without the Executive’s express written consent) after any Change in Control, or prior to a Change in Control under the circumstances described in clauses (ii) or (iii) of the second sentence of Section 6.1 hereof (treating all references in paragraphs (I) through (VII) below to a “Change in Control” as references to a “Potential Change in Control”), of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (I), (V), (VI) or (VII) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof:

(I) the assignment to the Executive of any duties inconsistent with the Executive’s status as an executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive’s responsibilities from those in effect immediately prior to the Change in Control;

-11-

(II) a reduction by the Company in the Executive’s annual base salary as in effect on the date hereof or as the same may be increased from time to time except for (i) across-the-board salary reductions similarly affecting all salaried employees of the Company or (ii) across-the-board salary reductions similarly affecting all senior executive officers of the Company and all senior executives of any Person in control of the Company;

(III) the relocation of the Executive’s principal place of employment to a location more than 50 miles from the Executive’s principal place of employment immediately prior to the Change in Control (unless such relocation is closer to the Executive’s principal residence) or the Company’s requiring the Executive to be based anywhere other than such principal place of employment (or permitted relocation thereof) except for required travel on the Company’s business to an extent substantially consistent with the Executive’s present business travel obligations;

(IV) the failure by the Company, to pay to the Executive any portion of the Executive’s current compensation or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due;

(V) the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to the Change in Control which is material to the Executive’s total compensation, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive’s participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount or timing of payment of benefits provided and the level of the Executive’s participation relative to other participants, as existed immediately prior to the Change in Control;

(VI) the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by the Executive under any of the Company’s savings, life insurance, medical, health and accident, or disability plans in which the Executive was participating immediately prior to the Change in Control, the taking of any action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in accordance with the Company’s normal vacation policy in effect at the time of the Change in Control; or

(VII) any purported termination of the Executive’s employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 7.1 hereof; for purposes of this Agreement, no such purported termination shall be effective.

-12-

(Q) “Gross-Up Payment” shall have the meaning stated in Section 6.2(A) hereof.

(R) “Notice of Termination” shall have the meaning stated in Section 7.1 hereof.

(S) “Payment” shall have the meaning stated in Section 6.2(A) hereof.

(T) “Person” shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof, except that such term shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries, (iii) an underwriter temporarily holding securities pursuant to an offering of such securities, (iv) a corporation owned, directly or indirectly, by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company, or (v) an entity or entities which are eligible to file and have filed a Schedule 13G under Rule 13d-l(b) of the Exchange Act, which Schedule indicates beneficial ownership of 15% or more of the outstanding shares of common stock of the Company or the combined voting power of the Company’s then outstanding securities.

(U) “Potential Change in Control” shall be deemed to have occurred if the event set forth in any one of the following clauses shall have occurred: (I) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control; (II) the Company or any Person publicly announces an intention to take or to consider taking actions which, if consummated, would constitute a Change in Control; or (III) any Person becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 20% or more of either the then outstanding shares of common stock of the Company or the combined voting power of the Company’s then outstanding securities (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates).

(V) “Severance Payments” shall mean those payments described in Section 6.1 hereof.

(W) “Stock Plan” shall mean the Company’s 1995 Stock Plan, as the same may be amended from time to time, and any successor plan to such plan.

(X) “Underpayment” shall have the meaning stated in Section 6.2(B) hereof.

INSPIRE PHARMACEUTICALS, INC.
By:	/s/  Gregory J. Mossinghoff
Name:	Gregory J. Mossinghoff
Title:	President and Secretary

/s/  Christy L. Shaffer

Christy L. Shaffer

Executed on August 5, 2004

-13-

EX-10.3

EXHIBIT 10.3

Officers entering into Change in Control Agreements

Mary B. Bennett

Richard M. Evans

Donald J. Kellerman

Gregory J. Mossinghoff

Joseph K. Schachle

Thomas R. Staab, II

Benjamin R. Yerxa

AGREEMENT

THIS AGREEMENT, dated as of March 29, 2004, is made by and between Inspire Pharmaceuticals, Inc., a Delaware corporation (the “Company”), and                      (the “Executive”).

WHEREAS, the Board considers it essential to the best interests of the Company to foster the continued employment of key management personnel; and

WHEREAS, the Board recognizes that, as is the case with many publicly held corporations, the possibility of a Change in Control exists and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company; and

WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company’s management, including the Executive, to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a Change in Control;

NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the Company and the Executive hereby agree as follows:

1. Defined Terms. The definitions of capitalized terms used in this Agreement are provided in the last Section hereof.

2. Term of Agreement. This Agreement shall be effective March 29, 2004 and shall continue in effect through March 29, 2005; provided, however, the term of this Agreement shall automatically be extended for one additional year on each anniversary of the date of this Agreement unless, not later than September 29 of the prior year, the Company or the Executive shall have given notice not to extend this Agreement or a Change in Control shall have occurred prior to such September 29; and further provided, however, that if a Change in Control shall have occurred during the term of this Agreement, this Agreement shall continue in effect for a period of not less than twelve (12) months beyond the month in which such Change in Control occurred.

3. Company’s Covenants Summarized. In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive’s covenants set forth in Section 4 hereof, the Company agrees, under the conditions described herein, to pay the Executive the Severance Payments and the other payments and benefits described herein. Except as provided in Section 10.1 hereof, no amount or benefit shall be payable under this Agreement unless there shall have been (or, under the terms of the second sentence of Section 6.1 hereof, there shall be deemed to have been) a termination of the Executive’s employment with the Company following a Change in Control and during the term of this Agreement. This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any right to be retained in the employ of the Company.

4. The Executive’s Covenants.

4.1. The Executive agrees that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control during the term of this Agreement, the Executive will remain in the employ of the Company until the earliest of (i) a date which is six (6) months after the date of such Potential Change in Control, (ii) the date of a Change in Control, (iii) the date of termination by the Executive of the Executive’s employment for Good Reason or by reason of death or Disability, or (iv) the termination by the Company of the Executive’s emp1oyment for any reason.

4.2 The Executive further acknowledges and agrees that any covenant of non-competition, nonsolicitation or other restrictive covenant applicable to Executive under any employment or other agreement between the Company and the Executive shall continue to apply in accordance with its terms following the Date of Termination except that the term of the restricted period shall apply for the longer of twelve (12) months following the Date of Termination or the term set forth in such agreement.

5. Compensation Unrelated to Severance Payments.

5.1. Following a Change in Control and during the term of this Agreement, during any period that the Executive fails to perform the Executive’s full-time duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive’s full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits payable to the Executive under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period, until the Executive’s employment is terminated by the Company for Disability.

5.2. If the Executive’s employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay the Executive’s full salary to the Executive through the Date of Termination at the rate in effect immediately prior to the Change in Control or at the time the Notice of Termination is given, whichever is greater, together with all compensation and benefits to which the Executive is entitled in respect of all periods preceding the Date of Termination under the terms of the Company’s compensation and benefit plans, programs or arrangements.

5.3. If the Executive’s employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay to the Executive the Executive’s normal post-termination compensation and benefits as such payments become due. Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company’s retirement, insurance and other compensation or benefit plans, programs and arrangements as in effect immediately prior to the Change in Control or, if more favorable to the Executive, as in effect immediately prior to the Date of Termination.

6. Severance Payments.

6.1. The Company shall pay the Executive the payments described in this Section 6.1 (the “Severance Payments”) upon the termination of the Executive’s employment following a Change in Control and during the term of this Agreement (in addition to any payments and benefits to which the Executive is entitled under Section 5 and 8 hereof), unless such termination is (i) by the Company for Cause, (ii) by reason of death or Disability, or (iii) by the Executive without Good Reason. For purposes of this Agreement, the Executive’s employment shall be deemed to have been terminated by the Company without Cause or by the Executive with Good Reason following a Change in Control if (i) the Executive’s employment is terminated without Cause prior to a Change in Control which actually occurs during the term of this Agreement and such termination was at the request or direction of a Person who has entered into an agreement with the Company the consummation of which would constitute a Change in Control, (ii) the Executive terminates his employment with Good Reason prior to a Change in Control which actually occurs during the term of this Agreement and the circumstance or event which constitutes Good Reason occurs at the request or direction of such Person, (iii) the Executive’s employment is terminated by the Company without Cause or by the Executive for Good Reason prior to a Change in Control and the Executive reasonably demonstrates that such termination is

2

otherwise in connection with or in anticipation of a Change in Control which actually occurs during the term of this Agreement, or (iv) the Executive’s employment is terminated without Cause after a Potential Change in Control of the type described in paragraph (I) of the definition of “Potential Change in Control”.

(A) In lieu of any further salary payments to the Executive for periods subsequent to the Date of Termination and in lieu of any severance benefit otherwise payable to the Executive, the Company shall pay to the Executive a lump sum severance payment, in cash, equal to one (1) times the sum of (i) the higher of the Executive’s annual base salary in effect immediately prior to the occurrence of the event or circumstance upon which the Notice of Termination is based or the Executive’s highest annual base salary in effect during the three (3) completed fiscal years immediately preceding the Change in Control (the “Change in Control Salary”), and (ii) the higher of the highest annual bonus earned by the Executive pursuant to any annual bonus or incentive plan maintained by the Company in respect of the three (3) completed fiscal years immediately preceding the year in which the Date of Termination occurs or the highest annual bonus so earned in respect of the three (3) completed fiscal years immediately preceding the year in which the Change in Control occurs (the “Change in Control Bonus”).

(B) Notwithstanding any provision of any annual incentive plan to the contrary, the Company shall pay to the Executive a lump sum amount, in cash, equal to a pro rata portion to the Date of Termination of the value of the target incentive award under such plan for the then uncompleted period under such plan, calculated by multiplying the Executive’s target award by the fraction obtained by dividing the number of full months and any fractional portion of a month during such performance award period through the Date of Termination by the total number of months contained in such performance award period.

(C) For the twelve(12) month period immediately following the Date of Termination, the Company shall arrange to provide the Executive (which includes the Executive’s eligible dependents for purposes of this paragraph (C)) with life, disability, accident and health insurance benefits substantially similar to those which the Executive was receiving immediately prior to the Notice of Termination (without giving effect to any amendment to such benefits made subsequent to the earlier of a Potential Change in Control or a Change in Control which amendment adversely affects in any manner the Executive’s entitlement to or the amount of such benefits); provided, however, that, unless the Executive consents to a different method, such health insurance benefits shall be provided through a third-party insurer. Benefits otherwise receivable by the Executive pursuant to this Section 6.1(C) shall be reduced to the extent comparable benefits (including continued coverage for any preexisting medical condition of any person covered by the benefits provided to the Executive and his eligible dependents immediately prior to the Notice of Termination) are actually received by or made available to the Executive by a subsequent employer without cost during the twelve (12) month period following the Executive’s Date of Termination (and any such benefits actually received by or made available to the Executive shall be reported to the Company by the Executive).

6.2. (A) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment, award, benefit or distribution (or any acceleration of any payment, award, benefit or distribution) by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise) (a “Payment”) would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Executive with respect to the excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the “Excise Tax”), then the Executive shall be entitled to receive an additional payment (a “Gross-Up Payment”) in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and

3

Excise Tax imposed on the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments.

(B) Subject to the provisions of Section 6.2(C), all determinations required to be made under this Section 6.2, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment, shall be made by a nationally recognized accounting firm designated by the Company (the “Accounting Firm”) which shall provide detailed supporting calculations both to the Company and the Executive within fifteen (15) business days after there has been a Payment, or such earlier time as requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Company shall appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 6, shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm’s determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross- Up Payments which will not have been made by the Company should have been made (“Underpayment”), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 6.2(C) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive.

(C) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall:

(i) give the Company any information reasonably requested by the Company relating to such claim;

(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company;

(iii) cooperate with the Company in good faith in order effectively to contest such claim; and

(iv) permit the Company to participate in any proceedings relating to such claim;

provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income

4

tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 6.2(C), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

(D) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6.2(C), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 6.2(C)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6.2(C), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid.

6.3. The payments provided for in subsections (A), (B) and (C) of Section 6.1 hereof shall be made not later than the thirtieth (30th) day following the Date of Termination; provided, however, that if the amounts of such payments cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Executive of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments (together with interest at 120% of the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined but in no event later than the sixtieth (60th) day after the Date of Termination; provided, however, that in the event the Executive becomes entitled to Severance Payments pursuant to the second sentence of Section 6.1 (except for a termination occurring with respect to clause (iv) of such sentence, which shall be paid as set forth above) such payments shall be due and payable within thirty (30) days following the actual Change in Control that triggered the Severance Payments. In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the fifth (5th) business day after demand by the Company (together with interest at 120% of the rate provided in Section 1274(b)(2)(B) of the Code). In the event the Company should fail to pay when due the amounts described in subsections (A), (B) and (C) of Section 6.1 hereof, the Executive shall also be entitled to receive from the Company an amount representing interest on any unpaid or untimely paid amounts from the due date, as determined under this Section 6.3 (without regard to any extension of the Date of Termination pursuant to Section 7.3 hereof), to the date of payment at a rate equal to 120% of the rate provided in Section 1274(b)(2)(B) of the Code.

5

6.4. The Company also shall pay to the Executive all legal fees and expenses incurred by the Executive in disputing in good faith any issue hereunder relating to the termination of the Executive’s employment, in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of Section 4999 of the Code to any payment or benefit provided hereunder. Such payments shall be made within five (5) business days after delivery of the Executive’s written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require.

7. Termination Procedures and Compensation During Dispute.

7.1. Notice of Termination. After a Potential Change in Control or, if there is no Potential Change in Control, after a Change in Control and during the term of this Agreement, any purported termination of the Executive’s employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 11 hereof. For purposes of this Agreement, a “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated. Further, a Notice of Termination for Cause is required to include a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3/4) of the entire membership of the Board at a meeting of the Board which was called and held for the purpose of considering such termination (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive’s counsel, to be heard before the Board) finding that, in the good-faith opinion of the Board, the Executive was guilty of conduct set forth in clause (i) or (ii) of the definition of Cause herein, and specifying the particulars thereof in detail.

7.2. Date of Termination. “Date of Termination,” with respect to any purported termination of the Executive’s employment after a Change in Control and during the term of this Agreement, shall mean (i) if the Executive’s employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive’s duties during such thirty (30) day period), and (ii) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company, shall not be less than thirty (30) days (except in the case of a termination for Cause) and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given).

7.3. Dispute Concerning Termination. If within fifteen (15) days after any Notice of Termination is given, or, if later, prior to the Date of Termination (as determined without regard to this Section 7.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be extended until the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of an arbitrator or a court of competent jurisdiction (which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided, however, that the Date of Termination shall be extended by a notice of dispute given by the Executive only if such notice is given in good faith and the Executive pursues the resolution of such dispute with reasonable diligence.

6

7.4. Compensation During Dispute. If a purported termination occurs following a Change in Control and during the term of this Agreement and the Date of Termination is extended in accordance with Section 7.3 hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, salary) and continue the Executive as a participant in all compensation, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the Date of Termination, as determined in accordance with Section 7.3 hereof. Amounts paid under this Section 7.4 are in addition to all other amounts due under this Agreement and shall not be offset against or reduce any other amounts due under this Agreement.

8. Acceleration of Certain Stock-Based Benefits.

(A) All unvested options with respect to the Company’s stock held by the Executive shall vest and become immediately exercisable immediately prior to the occurrence of a Change in Control and will be exercisable for a period ending on the later of (i) the fifth anniversary of such Change in Control or (ii) the last date that such option would otherwise be exercisable under the terms of the option agreement or the plan pursuant to which such option was granted; provided, that in no event shall any option be exercisable after the expiration of the original term of the option.

(B) Upon the occurrence of a Change in Control, all unearned performance-based awards held by the Executive under the Company’s Stock Plan shall be deemed to have been earned to the maximum extent permitted under the Stock Plan for any performance period not then completed and all unvested stock awards shall immediately vest and the restrictions on all shares subject to restriction shall lapse.

(C) In the event that this Section 8 is determined for any reason to be inconsistent with the terms of any plan pursuant to which such stock options, performance restricted shares and restricted stock awards were issued, the terms of this Agreement shall supersede the terms of such plan.

9. No Mitigation. The Company agrees that, if the Executive’s employment with the Company terminates during the term of this Agreement, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Section 6 hereof or Section 7.4 hereof. Further, the amount of any payment or benefit provided for in this Agreement (other than Section 6.1(C) hereof) shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise.

10. Successors; Binding Agreement.

10.1. In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive’s employment for Good Reason after a Change in Control, except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination.

7

10.2. This Agreement shall inure to the benefit of and be enforceable by the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive’s estate.

11. Notices. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed, if to the Executive, to the address shown for the Executive in the personnel records of the Company and, if to the Company, to the address set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt:

To the Company:

Inspire Pharmaceuticals, Inc.

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703

Attention: Ms. Mary Bennett, Senior Vice President

With a copy to:

Reed Smith LLP

136 Main Street, Suite 250

Princeton Forrestal Village

Attention: Diane M. Frenier, Esquire

12. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Board. No waiver by either party hereto at any time of any breach by the other party hereto of, or of any lack of compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. This Agreement supersedes any other agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof which have been made by either party. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of North Carolina. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed. The obligations of the Company and the Executive under Sections 6 and 7 hereof shall survive the expiration of the term of this Agreement. If the Executive elects not to enter into this Agreement, the Executive will continue to be eligible for change in control benefits, if any, provided under the Company’s existing employee benefit plans. The Company agrees that it will not argue in any form for any purpose that this Agreement constitutes an “employee benefit plan” within the meaning of Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended.

8

13. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.

14. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

15. Settlement of Disputes; Arbitration. All claims by the Executive for benefits under this Agreement shall be directed in writing to and determined by the Committee (as defined below), which shall give full consideration to the evidentiary standards set forth in this Agreement. Any denial by the Committee of a claim for benefits under this Agreement shall be delivered to the Executive in writing and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon. The Committee shall afford a reasonable opportunity to the Executive for a review of the decision denying a claim and shall further allow the Executive to appeal to the Committee a decision of the Committee within sixty (60) days after notification by the Committee that the Executive’s claim has been denied. Any further dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in the Raleigh/Durham, North Carolina metropolitan area in accordance with the rules of the American Arbitration Association then in effect; provided, however, that the evidentiary standards set forth in this Agreement shall apply. Judgment may be entered on the arbitrator’s award in any court having jurisdiction. Notwithstanding any provision of this Agreement to the contrary, the Executive shall be entitled to seek specific performance of the Executive’s right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement.

16. Definitions. For purposes of this Agreement, the following terms shall have the meanings indicated below:

(A) “Accounting Firm” shall have the meaning stated in Section 6.2(B) hereof.

(B) “Beneficial Owner” shall have the meaning set forth in Rule 13d-3 under the Exchange Act.

(C) “Board” shall mean the Board of Directors of the Company.

(D) “Cause” for termination by the Company of the Executive’s employment shall mean (i) the deliberate and continued failure by the Executive to devote substantially all the Executive’s business time and best efforts to the performance of the Executive’s duties after a demand for substantial performance is delivered to the Executive by the Board which specifically identifies the manner in which the Executive has not substantially performed such duties; (ii) the deliberate engaging by the Executive in gross misconduct which is demonstrably and materially injurious to the Company, monetarily or otherwise, including but not limited to fraud or embezzlement by the Executive; or (iii) the Executive’s conviction (or entering into a plea bargain admitting guilt) of any felony. For the purposes of this Agreement, no act, or failure to act, on the part of the Executive shall be considered “deliberate” unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that such action or omission was in the best interests of the Company. In the event of a dispute concerning the application of this provision, no claim by the Company that Cause exists shall be given effect unless the Company establishes to the Committee by clear and convincing evidence that Cause exists.

9

(E) “Change in Control” shall mean the determination (which may be made effective as of a particular date specified by the Board of Directors of the Company) by the Board of Directors of the Company, made by a majority vote that a change in control has occurred, or is about to occur. Such a change shall not include, however, a restructuring, reorganization, merger or other change in capitalization in which the Persons who own an interest in the Company on the date hereof (the “Current Owners”) (or any individual or entity which receives from a Current Owner an interest in the Company through will or the laws of descent and distribution) maintain more than a fifty percent (50%) interest in the resultant entity. Regardless of the Board’s vote or whether or not the Board votes, a Change-in-Control will be deemed to have occurred as of the first day any one (1) or more of the following subparagraphs shall have been satisfied:

(i) Any Person (other than the Person in control of the Company as of the date of this Agreement, or other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company, or a company owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company), becomes the beneficial owner, directly or indirectly, of securities of the Company representing more than thirty five percent (35%) of the combined voting power of the Company’s then outstanding securities; or

(ii) The stockholders of the Company approve:

(A) A plan of complete liquidation of the Company;

(B) An agreement for the sale or disposition of all or substantially all of the Company’s assets; or

(C) A merger, consolidation or reorganization of the Company with or involving any other company, other than a merger, consolidation or reorganization that would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the combined voting power of the voting securities of the Company (or such surviving entity) outstanding immediately after such merger, consolidation or reorganization.

However, in no event shall a Change-in-Control be deemed to have occurred, with respect to the Executive, if the Executive is part of a purchasing group which consummates the Change-in-Control transaction. The Executive shall be deemed “part of the purchasing group” for purposes of the preceding sentence if the Executive is an equity participant or has agreed to become an equity participant in the purchasing company or group (except for (i) passive ownership of less than five percent (5%) of the voting securities of the purchasing company; or (ii) ownership of equity participation in the purchasing company or group which is otherwise deemed not to be significant, as determined prior to the Change-in-Control by a majority of the non-employee continuing Directors of the Board of Directors of the Company).

10

(F) “Change in Control Salary” shall have the meaning stated in Section 6.1 hereof.

(G) “Change in Control Bonus” shall have the meaning stated in Section 6.1 hereof.

(H) “Code” shall mean the Internal Revenue Code of 1986, as amended from time to time.

(I) “Committee” shall mean (i) the individuals (not fewer than three in number) who, on the date six (6) months before a Change in Control or, in the event of a Potential Change in Control, on the date one (1) month before a Potential Change in Control, constitute the Compensation Committee of the Board, plus (ii) in the event that fewer than three individuals are available from the group specified in clause (i) above for any reason, such individuals as may be appointed by the individual or individuals so available (including for this purpose any individual or individuals previously so appointed under this clause (ii)).

(J) “Company” shall mean Inspire Pharmaceuticals, Inc. and, except in determining under Section 16(E) hereof whether or not any Change in Control of the Company has occurred, shall include its subsidiaries and any successor to its business and/or assets which assumes and agrees to perform this Agreement by operation of law, or otherwise.

(K) “Date of Termination” shall have the meaning stated in Section 7.2 hereof.

(L) “Disability” shall be deemed the reason for the termination by the Company of the Executive’s employment, if, as a result of the Executive’s incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive’s duties with the Company for a period of six (6) consecutive months, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive’s duties.

(M) “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended from time to time.

(N) “Excise Tax” shall have the meaning stated in Section 6.2(A) hereof.

(O) “Executive” shall mean the individual named in the first paragraph of this Agreement.

(P) “Good Reason” for termination by the Executive of the Executive’s employment shall mean the occurrence (without the Executive’s express written consent) after any Change in Control, or prior to a Change in Control under the circumstances described in clauses (ii) or (iii) of the second sentence of Section 6.1 hereof (treating all references in paragraphs (I) through (VII) below to a “Change in Control” as references to a “Potential Change in Control”), of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (I), (V), (VI) or (VII) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof:

(I) the assignment to the Executive of any duties inconsistent with the Executive’s status as an executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive’s responsibilities from those in effect immediately prior to the Change in Control;

11

(II) a reduction by the Company in the Executive’s annual base salary as in effect on the date hereof or as the same may be increased from time to time except for (i) across-the-board salary reductions similarly affecting all salaried employees of the Company or (ii) across-the-board salary reductions similarly affecting all senior executive officers of the Company and all senior executives of any Person in control of the Company;

(III) the relocation of the Executive’s principal place of employment to a location more than 50 miles from the Executive’s principal place of employment immediately prior to the Change in Control (unless such relocation is closer to the Executive’s principal residence) or the Company’s requiring the Executive to be based anywhere other than such principal place of employment (or permitted relocation thereof) except for required travel on the Company’s business to an extent substantially consistent with the Executive’s present business travel obligations;

(IV) the failure by the Company, to pay to the Executive any portion of the Executive’s current compensation or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due;

(V) the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to the Change in Control which is material to the Executive’s total compensation, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive’s participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount or timing of payment of benefits provided and the level of the Executive’s participation relative to other participants, as existed immediately prior to the Change in Control;

(VI) the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by the Executive under any of the Company’s savings, life insurance, medical, health and accident, or disability plans in which the Executive was participating immediately prior to the Change in Control, the taking of any action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in accordance with the Company’s normal vacation policy in effect at the time of the Change in Control; or

(VII) any purported termination of the Executive’s employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 7.1 hereof; for purposes of this Agreement, no such purported termination shall be effective.

12

(Q) “Gross-Up Payment” shall have the meaning stated in Section 6.2(A) hereof.

(R) “Notice of Termination” shall have the meaning stated in Section 7.1 hereof.

(S) “Payment” shall have the meaning stated in Section 6.2(A) hereof.

(T) “Person” shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof, except that such term shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries, (iii) an underwriter temporarily holding securities pursuant to an offering of such securities, (iv) a corporation owned, directly or indirectly, by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company, or (v) an entity or entities which are eligible to file and have filed a Schedule 13G under Rule 13d-l(b) of the Exchange Act, which Schedule indicates beneficial ownership of 15% or more of the outstanding shares of common stock of the Company or the combined voting power of the Company’s then outstanding securities.

(U) “Potential Change in Control” shall be deemed to have occurred if the event set forth in any one of the following clauses shall have occurred: (I) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control; (II) the Company or any Person publicly announces an intention to take or to consider taking actions which, if consummated, would constitute a Change in Control; or (III) any Person becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 20% or more of either the then outstanding shares of common stock of the Company or the combined voting power of the Company’s then outstanding securities (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates).

(V) “Severance Payments” shall mean those payments described in Section 6.1 hereof.

(W) “Stock Plan” shall mean the Company’s 1995 Stock Plan, as the same may be amended from time to time, and any successor plan to such plan.

(X) “Underpayment” shall have the meaning stated in Section 6.2(B) hereof.

INSPIRE PHARMACEUTICALS, INC.

By:

Name:

Title:

Executive

Executed on August     , 2004

13

EX-31.1

Exhibit 31.1

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

I, Christy L. Shaffer, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Inspire Pharmaceuticals, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2004	/s/ Christy L. Shaffer
	Christy L. Shaffer Chief Executive Officer (principal executive officer)

EX-31.2

Exhibit 31.2

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

I, Thomas R. Staab, II, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Inspire Pharmaceuticals, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2004	/s/ Thomas R. Staab, II
	Thomas R. Staab, II Chief Financial Officer (principal financial officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, Christy L. Shaffer, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 9, 2004	/s/ Christy L. Shaffer
	Christy L. Shaffer Chief Executive Officer (principal executive officer)

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the period ending June 30, 2004, as filed with the Securities and Exchange Commission (the “Report”), I, Thomas R. Staab, II, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 9, 2004	/s/ Thomas R. Staab, II
	Thomas R. Staab, II Chief Financial Officer (principal financial officer)

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.