10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the fiscal year ended December 31, 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 No. 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	27703-8466
(Address of Principal Executive Offices)	(Zip Code)

(919) 941-9777

(Registrant’s telephone number, including area code)

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

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

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

Common Stock, $.001 par value

(Title of Class)

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

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

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $530,885,414.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of January 31, 2005.

Class	Number of Shares
Common Stock, $.001 par value	41,861,280

Documents incorporated by reference

Document Description	10-K Part III
Portions of the Registrant’s proxy statement to be filed pursuant to Regulation 14A within 120 days after Registrant’s fiscal year end of December 31, 2004 are incorporated by reference into Part III of this report.	Items 10, 11, 12, 13, 14

INSPIRE PHARMACEUTICALS, INC.

2004 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

		Page
PART I.
Item 1.	Business	1
Item 2.	Properties	36
Item 3.	Legal Proceedings	36
Item 4.	Submission of Matters to a Vote of Security Holders	36
PART II
Item 5.	Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities	37
Item 6.	Selected Financial Data	38
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 7.A	Quantitative and Qualitative Disclosures About Market Risk	49
Item 8.	Financial Statements and Supplementary Data	50
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	50
Item 9A.	Controls and Procedures	50
Item 9B.	Other Information	51
PART III
Item 10.	Directors and Executive Officers of the Registrant	51
Item 11.	Executive Compensation	51
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	51
Item 13.	Certain Relationships and Related Transactions	51
Item 14.	Principal Accountant Fees and Services	51
PART IV
Item 15	Exhibits and Financial Statements Schedules	52
SIGNATURES		57

PART I

Item 1. Business.

Overview

We are a biopharmaceutical company dedicated to discovering, developing and commercializing prescription pharmaceutical products in disease areas with significant commercial markets and unmet medical needs. Our goal is to build and commercialize a sustainable pipeline of innovative new treatments based upon our technical and scientific expertise, focusing in the ophthalmic and respiratory therapeutic areas. Our ophthalmic products and clinical product candidates are currently concentrated in the allergic conjunctivitis, dry eye disease, corneal wound healing and retinal disease indications. In addition, we also have a preclinical program to treat glaucoma. We are also working on a product candidate for the treatment of respiratory complications of cystic fibrosis and an antiplatelet product candidate that could be utilized in cardiopulmonary bypass procedures. Our portfolio of products and product candidates include:

PRODUCTS AND PRODUCT CANDIDATES	THERAPEUTIC AREA/ INDICATION	COLLABORATIVE PARTNER	CURRENT STATUS
Products
Elestat™	Allergic conjunctivitis	Allergan	Co-promoting in the United States since February 2004
Restasis®	Dry eye disease	Allergan	Co-promoting in the United States since January 2004
Product Candidates in Clinical Development
diquafosol tetrasodium (INS365 Ophthalmic)	Dry eye disease	Allergan and Santen Pharmaceutical	FDA approvable letter received December 2003, NDA amendment filing expected by June 30, 2005
	Corneal wound healing	Allergan and Santen Pharmaceutical	Phase 2 pilot study to be initiated by March 2005
INS37217 Respiratory (denufosol tetrasodium)	Cystic fibrosis	Cystic Fibrosis Foundation Therapeutics	Phase 2
INS37217 Ophthalmic (denufosol tetrasodium)	Retinal detachment	None	Phase 2
	Macular edema	None	Phase 2 pilot studies to be initiated in 2005
INS50589 Antiplatelet	Cardiovascular diseases	None	Phase 1

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

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We have several product candidates in various stages of clinical development and various programs in preclinical development. All of our clinical product candidates are based on proprietary technology relating to P2 receptors. Our most clinically advanced product candidates are P2Y₂ receptor agonists that target ophthalmology and respiratory conditions and diseases where current treatments are not adequate.

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. We are located in Durham, North Carolina, adjacent to the Research Triangle Park.

Our Strategy

Our business objective is to become a leading biopharmaceutical company focused on discovering, developing and commercializing new treatments for diseases primarily in the ophthalmic and respiratory areas. We intend to build and commercialize a sustainable pipeline of innovative new treatments based on our technical and scientific expertise, focusing in the ophthalmic and respiratory therapeutic areas. Our strategy is to advance multiple product candidates in areas where we have significant expertise, through drug discovery, clinical trials, strategic alliances and in-licensing, and to be involved in the marketing and sale of our products. The principle elements of our strategy are to:

• Aggressively Advance Our Product Candidates. We focus significant energy and resources to rapidly and efficiently develop our existing product candidates. We target therapeutic markets and pursue product candidates where current therapy is not optimal and where we perceive significant market opportunities to exist.

• Establish Strategic Relationships that Enhance and Complement Our Own Product Development and Commercial Organization. Collaborations are, and we believe will continue to be, a key component of our corporate strategy. We have entered into alliances with pharmaceutical companies for the commercialization of our products, especially to address markets outside North America where we do not intend to develop infrastructure to commercialize our products. In addition, we intend to continue to develop alliances with leading pharmaceutical companies to enrich our product candidate pipeline and optimize our commercial efforts.

• Successfully Commercialize Products Through a Concentrated Sales and Marketing Effort in Our Target Markets. A key element of our strategy is to be involved in the sales and marketing activities of our products in North America. To that end, we have developed a specialty sales and marketing organization to support the commercialization of Elestat^™ and Restasis^® to ophthalmologists, optometrists and allergists in the United States.

• Develop or In-License New Products Outside Our Original Proprietary P2 Technology Platform. Our research focus is to discover new pharmaceutical products that expand upon and beyond our P2 receptor technology. We have internal programs and sponsored research and development agreements with universities to discover, develop and in-license new pharmaceutical products. We intend to be opportunistic with regard to in-licensing products in various stages of development in our core therapeutic areas.

• Protect and Enhance Our Technology Leadership Position. We have a substantial intellectual property position related to our technology. We currently have 48 issued patents: 26 exclusively owned, 7 jointly owned and exclusively licensed, 12 exclusively licensed, and 3 non-exclusively licensed. We also have other U.S. patents pending and multiple foreign patents issued and pending. We intend to continue to pursue an aggressive patent strategy to protect our expanding proprietary discoveries.

Elestat^™

Overview. In December 2003, we entered into an agreement with Allergan to co-promote Elestat^™ (epinastine HCl ophthalmic solution 0.05%) to ophthalmologists, optometrists and allergists in the United States.

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Under this agreement, we receive co-promotion revenue from Allergan on the U.S. net sales of Elestat^™. The Elestat^™ 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^™ under the Hatch-Waxman Act will expire in October 2008, after which time Elestat^™ could face generic competition. The agreement also provides for early termination under certain circumstances.

Elestat^™ 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^™ in the United States and are promoting it to eye care professionals and allergists. Elestat^™, 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^™ works by blocking the H₁ and H₂ histamine receptors, stabilizing mast cells, and stopping the progression of pro-inflammatory mediators.

Market Opportunity. Allergies affect more than 40 million people in the United States annually, including 20% to 30% of adults and up to 40% of children. It has been estimated that allergic conjunctivitis may occur in up to 90% of those patients suffering from allergies. The annual United States market for prescription ocular allergy products is approximately $390 million. The prescription market has experienced a growth rate, in terms of dollars, of approximately 12% over 2003. Elestat^™ is indicated for adults and children at least 3 years old.

Co-Promotion Agreement. We have the primary responsibility for selling, promotional and marketing activities of Elestat^™ in the United States and are responsible for the associated costs. We work with Allergan collaboratively on overall product strategy and management in the United States. Allergan records sales of Elestat^™ and remains responsible for all other product costs. Allergan retains the licensing rights relating to promotion of Elestat^™ to U.S. prescribers other than ophthalmologists, optometrists and allergists; but we have a right of first refusal to obtain such rights in the event Allergan decides to engage a third party to undertake such activities. Under the terms of the agreement, we paid Allergan an up-front payment and Allergan pays co-promotion revenue to us on U.S. net sales of Elestat^™, except in the event that a third party is engaged by Allergan to promote Elestat^™ to prescribers outside of our field, in which case we will be paid a proportionate share of U.S. net sales of Elestat^™ based upon filled prescriptions written by ophthalmologists, optometrists and allergists. Allergan also retains rights to all international sales and marketing activities relating to the drug. See “—Collaborative Agreements.”

Restasis^®

Overview. In June 2001, we entered into a joint license, development and marketing agreement with Allergan to develop and commercialize diquafosol tetrasodium (INS365 Ophthalmic) 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 the third quarter of 2003, we exercised our right to co-promote Restasis^® under the joint license, development and marketing agreement with Allergan. 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 net sales of Restasis^® beginning in April 2004. Restasis^® is the first approved prescription product in the United States for dry eye disease. It is indicated 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.

Market Opportunity. Other than Restasis^®, the current treatments for dry eye disease in the major markets consist of artificial tear solutions and lubricant eye drops. In some cases, small plugs are inserted by physicians in the tear duct to slow tear drainage. Artificial tears, which are available as over-the-counter and, in some countries, as prescription products, provide temporary relief of symptoms, but can also wash out the natural proteins and other components that keep an eye healthy. We estimate, based on an extrapolation from U.S. data,

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that dry eye disease affects approximately thirty million people in the eight major international prescription pharmaceutical markets, of which nine million are in North America. Dry eye disease can be caused by various factors including eye stress, aging, environmental factors, autoimmune disorders and various medications. Since dry eye disease is more prevalent among the elderly and post-menopausal women, this market is expected to grow as populations age. Based upon IMS and Verispan data sources, Allergan estimates the world-wide artificial tear and therapeutic dry eye market to be approximately $790 million and growing at a 20% rate based upon a moving twelve-month average as of September 2004. In the summer of 2005, Allergan commenced a direct-to-customer (DTC) advertising campaign of Restasis^® which we believe had a positive impact on sales of Restasis^®. For the year ending December 31, 2004, Allergan has recognized approximately $100 million of revenue from sales of Restasis^®. Allergan forecasts 2005 sales of Restasis^® to be between $140-160 million.

Collaborative Agreement. In December 2003, at the time we entered into the co-promotion agreement relating to Elestat^™, we amended the joint license, development and marketing agreement to reduce the co-promotion revenue rates that we would receive upon the sale of Restasis^®. See “—Collaborative Agreements.”

Diquafosol tetrasodium (INS365 Ophthalmic)

Treatment of dry eye disease

Overview. 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 fluid. To date, we have completed four Phase 3 clinical trials of diquafosol for the treatment of dry eye disease. In total, we have conducted placebo-controlled clinical trials of diquafosol in more than 2,000 individuals.

We are developing diquafosol as an eye drop for dry eye disease. We believe that diquafosol could 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 there is commercial opportunity for these products.

Development Status. 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. Since the initial submission of the NDA, we have completed two additional diquafosol Phase 3 clinical trials, trials 108 and 109. Although neither of the two additional diquafosol Phase 3 clinical trials met their primary endpoint, we plan to submit an amendment to our diquafosol NDA by June 30, 2005 based upon the totality of data from our diquafosol clinical program, including positive data on certain secondary endpoints and analyses from the 108 and 109 clinical trials.

Pursuant to our agreement with Allergan, Allergan is responsible for regulatory approval of diquafosol in Europe. We intend to consult with Allergan to determine a European regulatory filing strategy for diquafosol for the treatment of dry eye disease.

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 in the range of $0.5 to $1.5 million, excluding the cost of pre-launch clinical product inventory. This estimate includes costs for completing the Phase 3 diquafosol 109 clinical trial, salaries for development personnel, regulatory and consulting costs associated with our NDA amendment and other unallocated development costs. Costs of any other diquafosol clinical trials and any costs associated with a potential corneal wound healing indication for diquafosol are excluded from this

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projection. The projected costs associated with such estimate are difficult to determine and the actual costs are likely to differ. 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 elsewhere in this report.

Collaborative Agreements. Under the joint license, development and marketing agreement with Allergan, we have continued our efforts to develop and commercialize diquafosol. Under this agreement, we have received up-front and milestone payments of $11 million and may receive up to an additional $28 million in milestone payments assuming the successful completion of all remaining milestones under this agreement. We will also receive co-promotion revenue from Allergan on net sales, if any, of diquafosol worldwide, excluding most larger Asian markets. In the third quarter of 2003, we exercised our right under the Allergan agreement to co-promote diquafosol with Allergan in the United States and expect to begin promoting this product if and when we receive FDA approval and the product is launched. Our partner, Santen Pharmaceutical Co., Ltd., or Santen, is developing diquafosol in Japan and nine other Asian countries. Diquafosol is currently in Phase 2 clinical trials in Japan. See “—Collaborative Agreements.”

Treatment of corneal wound healing

We are also evaluating diquafosol in a corneal epithelial wound healing indication. There is support for the wound healing potential of diquafosol based on both preclinical and clinical experience. We are planning to initiate a Phase 2 pilot study of diquafosol in subjects undergoing Photorefractive Keratectomy surgery in March 2005. This study will evaluate the healing rate of the cornea comparing diquafosol versus placebo. Our collaborative agreements with Allergan and Santen cover this potential indication, as well as dry eye disease. See “—Collaborative Agreements.”

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

Overview. We are developing INS37217 Respiratory (denufosol tetrasodium) as an inhaled product candidate for the treatment of cystic fibrosis. We believe that our product candidate could be the first FDA approved product that mitigates the underlying ion transport defect in the airways of patients with cystic fibrosis. This product candidate has been granted orphan drug status by the FDA and fast-track review status. 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 to 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. Based upon the results of recent clinical data, we believe this product candidate could be complementary to Pulmozyme^®.

Cystic fibrosis is a life-threatening disease involving a genetic mutation that disrupts the cystic fibrosis transmembrane regulator protein, an ion channel. In cystic fibrosis patients, a defect in this ion channel leads to poorly hydrated lungs and severely impaired mucociliary clearance. Chronic secondary infections invariably occur, resulting in progressive lung dysfunction and deterioration. Respiratory infections and complications account for more than 95% of the morbidity and mortality associated with this disease. According to the United States Cystic Fibrosis Foundation, the median life expectancy for patients is 33 years.

Development Status. In 2003, we initiated a multi-center Phase 2 clinical trial in 90 patients with mild cystic fibrosis lung disease that was conducted in collaboration with the Cystic Fibrosis Foundation Therapeutics, Inc., or the CFFT. In October 2004, we presented detailed results of this clinical trial at the North American Cystic Fibrosis Conference. This clinical trial was a double-blind, placebo-controlled, randomized trial over a four-week treatment period. The primary purpose of this clinical 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

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than patients receiving placebo after 28 days of treatment. Lung function was assessed by multiple standard spirometric measurements and statistical significance was achieved on all of the spirometric measures employed in the clinical trial. All three doses were well tolerated over the four-week treatment period.

Following discussions with the FDA in September 2004, we have begun long-term toxicology studies in two animal species. We have also initiated an additional Phase 2 clinical trial in approximately 70 patients with cystic fibrosis lung disease in parallel with these toxicology studies in order to broaden our patient experience prior to our initiation of a Phase 3 program. The primary purpose of this additional Phase 2 clinical trial is to assess the safety and tolerability of INS37217 Respiratory in patients with more impaired lung function and taking more concomitant medications, such as inhaled antibiotics, than patients studied in our previous Phase 2 clinical trial. This ongoing Phase 2 clinical trial is not intended to show significant treatment effects, but rather to determine whether patients with lower lung function and those taking other concomitant cystic fibrosis medications, such as inhaled tobramycin, or TOBI^®, could be included in our anticipated Phase 3 program for INS37217 Respiratory. We anticipate holding an End of Phase 2 meeting with the FDA before the end of 2005.

Estimated subsequent costs necessary to submit an NDA for INS37217 Respiratory for the treatment of cystic fibrosis are projected to be in the range of $30 million to $50 million, excluding the cost of pre-launch clinical product inventory and any potential development milestones payable to the CFFT. This estimate includes completing the remaining components of our Phase 2 program, conducting a Phase 3 clinical program, manufacturing INS37217 for clinical trials and toxicology studies, producing qualification lots consistent with current Good Manufacturing Practice, or cGMP, 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 materially 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 elsewhere in this report.

Market Opportunity. The current therapeutic approaches to address cystic fibrosis mainly treat the symptoms and are aimed at reducing respiratory infections and breaking up thickened mucous secretions that cause airflow obstruction and harbor bacteria. For example, TOBI^® is an inhaled antibiotic that treats the infection, and Pulmozyme^® is an inhaled protein that breaks up excessive DNA in cystic fibrosis mucus that reduces the thickness and tackiness of the respiratory secretions. While both products are approved for the treatment of cystic fibrosis, neither product is designed to address the underlying ion-transport defect, which results in dehydrated mucus and severely impaired mucociliary clearance.

There are approximately 30,000 diagnosed cystic fibrosis patients in the United States and we estimate approximately 75,000 in the eight major international prescription pharmaceutical markets. The average annual cost of medicine to treat a cystic fibrosis patient in the United States exceeds $35,000, and the annual healthcare cost for patients in the United States is over $1 billion. We estimate that in the United States sales of prescription pharmaceutical products to treat cystic fibrosis currently are in excess of $390 million annually.

We intend to retain the development and commercial rights for INS37217 Respiratory in North America but to seek a corporate partner to develop and commercialize the product outside of North America.

Collaborative Agreement. In October 2002, we entered into a study funding agreement with the CFFT pursuant to which they funded the majority of the external costs of one Phase 2 clinical trial for the treatment of cystic fibrosis in exchange for certain milestone payments. These milestone payments are contingent upon FDA approval, potential commercialization and achievement of certain aggregate sales volume in the first five years following product approval. In the event of FDA approval, we are obligated to pay to the CFFT, over a period of five years, an amount equal to a multiple of the clinical trial costs incurred by the CFFT as a development milestone payment, which is currently estimated to be approximately $12 million. Additionally, in the event

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aggregate sales of the product exceed a certain level in the first five years subsequent to regulatory approval, we are obligated to pay the CFFT an additional $4 million sales milestone, payable over two years. See “—Collaborative Agreements.”

INS37217 Ophthalmic (denufosol tetrasodium)

Treatment of retinal detachment

Overview. 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 increasing the reabsorption (i.e., draining) of 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. INS37217 Ophthalmic may also 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. (see “Treatment of Macular Edema” below)

Development Status. In January 2004, we met with the FDA and were given guidance on the planning of a well-controlled Phase 2 clinical trial in INS37217 Ophthalmic for the treatment of retinal detachment. In April 2004, we began a 160-patient Phase 2 clinical trial of INS37217 Ophthalmic for the treatment of retinal detachment. The clinical trial provides for a single intravitreal injection or placebo and allows for up to two additional consecutive daily injections in patients who show signs of improvement following the previous injection. Enrollment in this clinical trial has progressed at a significantly slower rate than originally anticipated. We are unlikely to continue this clinical trial as designed due to the clinical trial’s slow enrollment and are evaluating the viability of future development of INS37217 Ophthalmic for the treatment of retinal detachment.

If the INS37217 Ophthalmic program for the treatment of retinal detachment were to continue as currently designed, estimated subsequent costs necessary to submit an NDA for INS37217 Ophthalmic are projected to be in the range of $25 million to $35 million, excluding the cost of pre-launch clinical product inventory and development costs for other retinal diseases. This estimate includes any remaining Phase 2 clinical trials, a Phase 3 clinical program, manufacturing INS37217 for clinical trials and toxicology studies, producing qualification lots consistent with cGMP standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs. The range excludes costs associated with INS37217 Ophthalmic development for a macular edema indication for which Phase 2 pilot studies are expected to be conducted in 2005. These costs are difficult to estimate and actual costs could be materially 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 elsewhere in this report.

Market Opportunity. There are currently no pharmaceutical products approved for rhegmatogenous retinal detachment, or RRD. While surgical techniques used to reattach the retina have relatively high single-operation success rates of 60-95%, patients frequently suffer from post-surgical problems, including diminished visual acuity, loss of eye motility, misaligned eyes, protracted periods of convalescence, and post-operative pain and discomfort. By stimulating fluid reabsorption across the retinal pigment epithelium, INS37217 Ophthalmic may reverse the progression of RRD and stimulate retinal re-attachment in some RRD patients without the need for surgery. Approximately 50,000 retinal detachments occur each year in the United States.

Treatment of macular edema

Macular edema is a swelling of the central region of the retina (macula) that occurs as a result of disease, injury or ocular surgery. Macular edema is often responsible for central visual loss of variable severity. We expect to initiate two Phase 2 pilot studies in 2005; one in macular edema associated with uveitis (a complex intraocular inflammatory disease) and the other in macular edema occurring after cataract surgery.

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INS50589 Antiplatelet

P2Y₁₂ receptor antagonist for the inhibition of platelet aggregation.

Overview. INS50589 Antiplatelet is a reversible P2Y₁₂ receptor antagonist that we are developing as an intravenous inhibitor of platelet aggregation for the use in the acute treatment of cardiovascular diseases. Platelets, small disc-shaped blood cells, are responsible for initiating and maintaining blood clots. Platelet activation occurs in response to pathological conditions such as the rupture of an atherosclerotic plaque or by the loss of the integrity of the endothelial cells lining the blood vessels. Platelet activation also occurs inappropriately during cardiovascular interventions such as cardiopulmonary bypass. Once activated, platelets are no longer able to participate in the clotting process after the surgery, resulting in postoperative blood loss due to platelet dysfunction. Inhibition of platelet P2Y₁₂ receptors by the treatment with INS50589 Antiplatelet may reduce the relative risk of bleeding complications and/or clotting events associated with acute cardiovascular interventions. INS50589 Antiplatelet will be administered intravenously and has a rapid onset and offset mechanism of action. In preclinical studies, it has been shown to produce dose-dependent and sustained inhibition of platelet aggregation during the administration of the drug and to 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.

Development status. In November 2004, we filed an Investigational New Drug Application, or IND, and in December 2004, we initiated a Phase 1 clinical trial of the tolerability, pharmacokinetics and pharmacodynamics of INS50589 Antiplatelet in healthy volunteers. The clinical trial is a single-center, randomized, open labeled dose escalation, followed by a double-blind placebo-controlled clinical trial. We expect to complete the Phase 1 clinical trial and to finalize a key proof of concept animal study in this potential clinical indication in the first half of 2005. After reviewing the Phase 1 data, we intend to evaluate an appropriate partnering strategy for this product candidate. Given the limited data available and the early stage of development of this program, we are unable to reasonably project whether a Phase 2 or Phase 3 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.

Additional discussion of the costs and expenses associated with all of our research and development programs is discussed below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Years Ended December 31, 2004, 2003 and 2002—Costs and Expenses.”

Collaborative Agreements

Allergan, Inc.—Elestat^™

In December 2003, we entered into an agreement with Allergan to co-promote Elestat^™ to ophthalmologists, optometrists and allergists in the United States. Elestat^™ was approved by the FDA in October 2003 for the prevention of itching associated with allergic conjunctivitis. We have the primary responsibility for selling, promotional and marketing activities of Elestat^™ in the United States and are responsible for the associated costs. We work with Allergan collaboratively on overall product strategy and management in the United States. Allergan records sales of Elestat^™ and remains responsible for all other product costs, as well as retaining responsibility for all international marketing and selling activities. Allergan also retains the licensing rights relating to promotion of Elestat^™ to U.S. prescribers other than ophthalmologists, optometrists and allergists; but we have a right of first refusal to obtain such rights in the event Allergan decides to engage a third party to undertake such activities. We have established a joint commercialization committee with Allergan to coordinate and oversee the broad strategies, promotion activities and manage the relationship. Allergan is responsible for supply chain management, managed healthcare, customer order processing and regulatory compliance. Under the terms of the agreement, we paid Allergan an up-front payment and Allergan pays co-promotion revenue to us on U.S. net sales of Elestat^™, except in the event that a third party is engaged by Allergan to promote Elestat^™ to prescribers outside of our field, in which case we will be paid a proportionate share of U.S. net sales of Elestat^™

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based upon filled prescriptions written by ophthalmologists, optometrists and allergists. Under the terms of the agreement, we are required to achieve certain performance minimums to receive some or all of co-promotion revenue contemplated.

The agreement 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; in each case after expiration of the listing of Elestat^™ in the FDA’s publication “Approved Drug Products with Therapeutic Equivalence Evaluations” (generally known as the “Orange Book”). Either Allergan or we may terminate the agreement in the event of a material breach of the agreement by the other or in the event of the other’s insolvency. Allergan can terminate the agreement if we fail to meet a defined minimum of net sales in any given year, or upon a change of control where we become an affiliate of a direct competitor of Allergan’s as that term is defined in the agreement. We can terminate the agreement in the event that Elestat^™ is withdrawn from the market for more than ninety days.

Allergan, Inc. – Restasis^® and diquafosol

In June 2001, we entered into a joint license, development and marketing agreement with Allergan to develop and commercialize diquafosol. The agreement also granted the right to co-promote Restasis^® in the United States. In December 2003, at the time we entered into the co-promotion agreement relating to Elestat^™, we amended the joint license, development and marketing agreement to reduce the co-promotion revenue rates that we would receive upon the sale of Restasis^®.

Under the terms of the amended agreement, Allergan obtained an exclusive license to develop and commercialize diquafosol worldwide, with the exception of Japan and nine other Asian countries covered by our agreement with Santen. In return, we will receive co-promotion revenue from Allergan on net sales of Restasis^® and diquafosol, if any, worldwide, excluding most larger Asian markets. In December 2002, Restasis^® was approved for sale by the FDA and Allergan launched Restasis^® in the United States in April 2003. We began receiving co-promotion revenue on net sales of Restasis^® in April 2004, and have received milestone payments under this agreement. In the third quarter of 2003, we exercised our right under the Allergan agreement to co-promote diquafosol and Restasis^®. We began promoting Restasis^® in January 2004 and will promote diquafosol if and when we receive FDA approval.

We have established a joint development committee with Allergan to oversee the joint development program and a joint commercialization committee to establish the broad strategies and manage the relationship. Under the terms of the agreement, we provide bulk active drug substance while diquafosol is in development and Allergan is responsible for obtaining or manufacturing all of its bulk active drug substance requirements and for commercial supply of product.

We are responsible for conducting, in collaboration with Allergan, the Phase 3 clinical trials for diquafosol for dry eye disease and for United States NDA filing and potential approval. Allergan is responsible for all other development activities under the agreement, including all development outside the United States and in its territories, and for ex-United States regulatory submissions, filings, and approvals relating to products. In addition, all development costs associated with a potential corneal wound healing indication for diquafosol are solely our responsibility until such time, if any, that we receive an NDA approval of diquafosol. Allergan is responsible for all commercial costs except for the cost of our sales force in the United States. Allergan is required to use commercially reasonable efforts to conduct development, seek regulatory approvals and market and sell the products.

The agreement will be in effect until all patents licensed under the agreement have expired. Either Allergan or we may terminate the agreement in the event of a material breach of the agreement. In addition, we have the right to terminate the agreement if we determine, subject to the joint commercialization committee’s review and arbitration, that Allergan has not made reasonably sufficient progress in the commercialization of our product by giving 180 days prior notice. If Allergan breaches the agreement, becomes insolvent or we terminate for failure

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to make progress with the commercialization of our product, Allergan’s license will terminate and Allergan must provide us with all data and information relating to our product and must assign or permit us to cross-reference all regulatory filings and approvals.

Santen Pharmaceutical Co., Ltd.

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

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

Under the terms of the agreement, we received an up-front equity investment of $1.5 million for shares of our preferred stock in December 1998, that were subsequently converted into shares of our common stock. During 2000, we received a milestone payment under the Santen Agreement of $500,000 based on achievement of a regulatory milestone by Santen. In addition, depending on whether all milestones are met, we could receive additional payments of up to $4.25 million, as well as royalties on net sales of licensed products.

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

Cystic Fibrosis Foundation Therapeutics, Inc.

In October 2002, we entered into a study funding agreement with the CFFT, a non-profit drug development affiliate of the Cystic Fibrosis Foundation, for the funding of one Phase 2 clinical trial in INS37217 Respiratory for the treatment of cystic fibrosis. Under the agreement, the CFFT provided the majority of funding of external costs for one Phase 2 clinical trial of INS37217 Respiratory in exchange for post-commercialization development and sales milestone payments. The clinical trial was designed in collaboration with the CFFT and the Therapeutics Development Network. In October 2004, we presented detailed results of this clinical trial and we are progressing the clinical development of this product candidate. If the product candidate ultimately receives FDA approval, we would be obligated to pay a development milestone to the CFFT, calculated as a multiple of the clinical trial costs incurred by the CFFT. In addition, we would be obligated to pay a sales milestone if the product candidate achieves a certain aggregate sales volume in the first five years following product approval. The development milestone is currently estimated to be approximately $12 million, payable over five years and the sales milestone would be an additional $4 million, payable over two years.

The agreement will terminate no later than the expiration of all payment obligations under the agreement. Either the CFFT or we may terminate the agreement if the other materially breaches the agreement.

Kirin Brewery Co., Ltd. Pharmaceutical Division

In September 2000, we entered into a License Agreement with Kirin for the development and commercialization of INS316 Diagnostic. Under the agreement we granted Kirin an exclusive license to commercialize INS316 Diagnostic in 21 Asian countries and regions, including Japan. Kirin terminated its license for this drug candidate in September 2004.

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License Agreements

The University of North Carolina at Chapel Hill

In March 1995, September 1998, and January 2002, we entered into three separate agreements with UNC granting us exclusive worldwide licenses to develop, make, use and sell products based on UNC patented technology relating to the use of P2Y receptor agonists and antagonists for respiratory therapeutics, such as INS365 Respiratory; respiratory diagnostics, such as INS316 Diagnostic; and prevention of platelet aggregation, such as INS50589. In connection with these license agreements, we have paid an aggregate of $105,000 in license initiation fees and have agreed to pay milestone payments totaling $650,000. In addition, we would be obligated to pay royalties based on net sales of certain licensed products as defined in the agreements. In March 1995, we also entered into a fourth agreement that granted us a non-exclusive worldwide license to use other UNC patented technology as a research tool to identify agonists and antagonists for P2Y receptors.

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.

Wisconsin Alumni Research Foundation

In November 2004, we licensed several patents for use in developing and commercializing new treatments for glaucoma from Wisconsin Alumni Research Foundation, or WARF. Under the terms of the agreement, we paid an upfront licensing payment of $150,000 and are obligated for additional contingent payments of up to an aggregate of $1.8 million upon the achievement of development milestones, and royalties on sales of any regulatory approved product utilizing the licensed patents.

We will design and fund all future research, development, testing, regulatory filings and potential marketing activities related to any product developed from the license. Unless terminated earlier, the agreement will expire on a country-by-country basis upon the expiration of the patents in such country.

If we fail to meet performance milestones relating to the timing of regulatory filings or pay the minimum annual payments under this license, WARF may terminate the applicable license.

Research and Development

Discovery

Our scientists have specific expertise and proprietary knowledge relating to the design and synthesis of P2 receptor agonists and antagonists, including P2Y₂ agonists, P2Y₁₂ antagonists and P2X antagonists. We have invested in state-of-the-art equipment and laboratory space for performing synthetic chemistry, determination of compound structure and receptor location and function identification. Our discovery effort is focused on conducting studies using cell-based scientific tests that measure biological activities caused by stimulation or blocking of P2 receptors, to identify new compounds that specifically and selectively bind to members of the P2 receptor family. These tests enable us to identify agonists and antagonists that act at specific receptor subtypes and demonstrate a level of specificity and activity that merits further investigation. We use data from these tests to design and synthesize compounds specific to each P2 receptor subtype that can be advanced to clinical trials.

By screening against several P2 receptor subtypes, we have been able to identify agonists and/or antagonists that interact preferentially with a specific receptor subtype. Several proprietary discovery compounds, including new chemical entities, with promising stability and metabolic profiles are being actively explored. We intend to conduct further preclinical development studies to advance such proprietary compounds to project status, if appropriate. These compounds will then be targeted to the treatment of new disease areas, as identified through our strategic planning process.

Additionally, we are synthesizing compounds that are active as actin cytoskeleton binding agents to discover new treatments for glaucoma. These compounds will be tested in cellular assays and in animal models of intraocular pressure. This research falls under technology licensed from WARF in 2004.

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

We use sponsored research agreements to investigate specific biological processes to augment our technology platform. We have sponsored research agreements at major universities. We use contract research organizations for all toxicology and most animal studies required for regulatory submissions, such as IND applications.

Development

After a molecule is determined to be an appropriate product candidate based upon our research findings and business strategy, it moves into the development function of our organization, where extensive testing of both the characteristics of the actual product and the effects it has on humans are conducted. The progression of products through the various stages of development is overseen by our Portfolio Review Committee, a group comprised of certain company officers and selected senior staff from the Development and Discovery departments. Our development function is divided into four functional areas, Pharmaceutical Development, Regulatory Affairs, Clinical Research, and Biostatistics and Data Management.

When a product candidate is judged as ready for human testing, an IND is filed with the FDA that, upon review, allows us to embark on human testing in the United States. Since 1997, we have filed seven INDs for product candidates that were subsequently evaluated in humans. Some of these product candidates have progressed to later phases of development. In addition to internal resources, we have many collaborations that allow us to perform development activities with a limited number of staff.

See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Research and Development Expenses.”

Sales and Marketing

Beginning in the first quarter of 2004, we initiated commercial operations and began co-promoting Elestat^™ and Restasis^® to a select audience of high prescribing eye care professionals and allergists. As a Company, we have limited sales and marketing experience, having just completed our first year of sales and marketing activities. We employ 64 territory managers and 6 regional sales directors to provide us with national sales coverage for Elestat^™ and Restasis^®. We also have a marketing team and a training and operations team to support our commercialization effort. Our small, specialty commercial organization focuses its promotional efforts on ophthalmologists, optometrists and allergists. We believe our focused marketing organization and a specialty sales force can effectively address these audiences and effectively co-promote these products. Eye care professionals account for the majority of the dry eye disease prescriptions and combined with the allergists these specialties prescribe approximately half of the ocular allergies prescriptions. Targeting these medical specialties is an excellent strategic fit for Elestat^™ and our dry eye disease product and product candidate, Restasis^® and diquafosol.

In the United States, we are co-promoting Elestat^™ and Restasis^® and intend to co-promote diquafosol if and when that product candidate receives FDA approval. We co-promote Restasis^® in the United States with Allergan, but we have primary United States sales and marketing responsibilities for Elestat^™. We have not developed commercial plans for our product candidates beyond Elestat^™, Restasis^® and diquafosol as these plans will be dependent in large part on their market potential and our financial resources. We intend to establish corporate partnering, licensing or other arrangements for the marketing and sale of selected product candidates that we develop, especially outside of North America. We do not intend to develop international

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operations outside of North America. Accordingly, third parties may have significant control or influence over important aspects of the commercialization of our product candidates, including market identification, marketing methods, pricing, composition and magnitude of sales force and promotional activities. We may have limited control over the amount and timing of resources that a third party devotes to our products.

We feel the establishment of our commercial operations provides us with the opportunity and flexibility to market and sell other products we are developing, or products that we may in-license or otherwise acquire, and to maximize their commercial value in the United States.

Compliance

We are committed to conducting our business fairly, honestly, ethically and lawfully. We act responsibly and with integrity in our relationships with patients, health care professionals, providers, governments, regulatory entities, customers, suppliers, vendors and stockholders.

We have designated a Corporate Compliance Officer who reports to the Chief Executive Officer and Chairman of the Audit Committee of the Board of Directors. The Corporate Compliance Officer is responsible for evaluating potential compliance risks within the company and designing control procedures. This is achieved by conducting audits consistent with implementation of codes, policies and other controls. Areas of control include, but are not limited to, compliance with current Federal and State law, such as the Sarbanes-Oxley Act of 2002, U.S. Foreign Corrupt Practices Act of 1977, NASDAQ and National Association of Securities Dealers listing requirements and Securities and Exchange Commission, FDA, and Office of Inspector General regulations. Codes and policies that have been implemented include, but are not limited to, “Code Of Ethics and Conduct Relating to Financial Affairs,” “Code of Business Ethics,” “Whistleblower Policy” and “Code of Conduct: Promotional Interactions with Health Care Professionals.” The Corporate Compliance Officer provides frequent updates to senior management, the Audit Committee of the Board of Directors and to the full Board of Directors.

Manufacturing and Supply

We do not currently engage in, nor do we expect to engage in, the manufacture of bulk active pharmaceutical ingredients, or APIs, for preclinical, clinical or commercial purposes. We rely on a contract manufacturing supply arrangement with a single manufacturer located in Choshi, Japan, for the development stage production of diquafosol and INS37217 (denufosol). We expect that this vendor will ultimately supply commercial quantities of these compounds for both ophthalmic and respiratory applications. We have already obtained cGMP grade batches of these compounds and our vendor has completed the validation of the manufacturing process for diquafosol. INS50589, the API for our antiplatelet program, is manufactured by a vendor located in Ontario, Canada. Although we have identified potential alternative sources for our product candidates, we presently depend on these two vendors as the sole manufacturers of APIs for our various programs. See “Risk Factors— Reliance on a single party to manufacture and supply either finished product or the bulk active pharmaceuticals ingredients for a product or product candidates could adversely affect us.”

In addition to the bulk APIs, our products incorporate pharmacopeial grade excipients such as sodium chloride, sodium hydroxide and hydrochloric acid, all of which are readily available from numerous sources. Many of our clinical trial materials are packaged in form-fill-seal vials, which are manufactured by a single vendor, but similar vials are also available from other commercial filling and packing companies. In addition to form-fill-seal vial packaging, we also administer our product candidates as intravitreal injections and intravenous infusions. The intravitreal injections and intravenous infusions have been manufactured by a single vendor using standard glass vials and rubber stoppers. In the case of both injection products, alternate sources of both components and manufacturing sites are available.

We have established a Corporate Quality and Compliance function to conduct qualification and routine audits of our contract manufacturers. These contract manufacturers are identified in our regulatory agency filings,

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such as with the FDA, and are subject to Regulatory Agency Inspections. We also attempt to stay informed on the financial condition of contract manufacturers and their status with regulatory agencies. Although we also maintain an inventory of drug product in order to minimize the risk of material shortage, a prolonged interruption in supply could adversely disrupt our manufacturing plans.

The manufacture of our products and product candidates is based in part on technology that we believe to be proprietary to our contract manufacturers or our collaborative partners. Such manufacturers may not abide by the limitations or confidentiality restrictions in agreements with us. In addition, any such manufacturer may develop process technology related to the manufacture of our compounds that such supplier owns either independently or jointly with us. This would increase our reliance on such manufacturer or require us to obtain a license from such manufacturer in order to have our products manufactured.

Patents and Proprietary Rights

We believe that the proprietary protection of our product candidates, processes and know-how is important to the success of our business. We aggressively file and prosecute patents covering our proprietary technology and, if warranted, will defend our patents and proprietary technology. As of January 31, 2005, we owned or licensed patent rights consisting of 48 issued United States patents, none of which expire before 2011, and numerous pending applications in the United States and corresponding patents and patent applications in foreign jurisdictions. We seek patent protection for our proprietary technology and products in the United States and Canada and in key commercial European and Asia/Pacific countries and other major commercial sectors of the world, as appropriate. We intend to seek trademark protection in the United States and foreign countries, as appropriate. We also rely upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain our competitive position.

In March 1995, September 1998, and January 2002, we entered into three separate agreements with UNC granting us exclusive worldwide licenses to develop, make, use and sell products based on UNC patented technology relating to the use of P2Y receptor agonists and antagonists for respiratory therapeutics, such as INS365 Respiratory; respiratory diagnostics, such as INS316 Diagnostic; and prevention of platelet aggregation, such as INS50589. The term of each of the UNC exclusive licenses is based upon the duration of the patents covered by each of these agreements. The United States government may have limited rights in some of this UNC patented technology. The agreements require us to pay licensing fees upon the attainment of development milestones and royalties on net sales or a share of sublicensing income on products covered by the patents. We are also required to meet due diligence milestones and UNC may terminate the licenses if we fail to do so. In March 1995, we also entered into a fourth agreement that granted us a non-exclusive worldwide license to use other UNC patented technology as a research tool to identify agonists and antagonists for P2Y receptors.

In November 2004, we entered into an agreement with WARF granting us an exclusive license to develop, make, have made, use, market, distribute, import, offer for sale, and sell products based on WARF patented technology relating to the treatment of ocular diseases. The term of the exclusive license from WARF is based upon the duration of the patents covered by this agreement. The United States government may have limited rights in some of this patented technology. We are also required to meet due diligence milestones and WARF may terminate the license if we fail to do so.

Additional patent applications have been filed on discoveries made in support of the UNC technologies, from research conducted at UNC or in our own laboratories. Our sponsored research agreements, material transfer agreements, and other collaborations have the potential to result in license agreements with universities, institutions and businesses. We believe that our patents and licensed patents provide a substantial proprietary base that will allow us, and our collaborative partners, to exclude others from conducting our business as described in this report and as encompassed by our issued patents and issued patents licensed to us. We cannot be sure, however, that pending or future applications will issue, that the claims of any patents which do issue will provide any significant protection of our technology or that our directed discovery research will yield compounds and products of therapeutic and commercial value.

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

Competition

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

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

There are multiple therapies available to treat or prevent allergic conjunctivitis. The primary brands that Elestat^™ competes with are Patanol^®, Zaditor^® and Optivar^®. Patanol^® currently has the majority of the prescriptions in the allergic conjunctivitis market.

The current prescription and non-prescription treatments for dry eye disease include artificial tear replacement therapy or lubricant eye drops. The FDA approved Restasis^® in December of 2002 for patients with dry eye disease whose tear production is presumed to be suppressed due to ocular inflammation. We are aware of the following dye eye disease pharmaceutical products in clinical development: 15-HETE and rimexolone, by Alcon, Inc.; OPC-12759 (rebamipide), by Otsuka Pharmaceuticals, licensed to Novartis; Ecabet sodium by ISTA Pharmaceuticals, licensed from Senju; ProGraf/FK-506, by Fujisawa Healthcare, Inc.; pimecrolimus by Novartis; and Androgen Tears, by Allergan. We are not aware of any other pharmaceutical approved products or product candidates in clinical development for corneal wound healing.

There are two products approved in the United States specifically for the treatment of complications of cystic fibrosis: Pulmozyme^®, an agent designed to break up thickened airway secretions, and TOBI^®, an inhaled antibiotic. At least one clinical trial has been completed that demonstrated clinical benefit with Zithromax^®, an oral antibiotic. Although Zithromax^® has not been officially approved by the FDA for use in cystic fibrosis, it has been added to the treatment regimen in patients with evidence of airway infection. In addition, Corus Pharma, Inc. is developing aztreonam via inhalation as a therapy for cystic fibrosis.

We are not aware of any other pharmaceuticals treatments available for retinal detachment, but some pharmaceutical companies have product candidates focused on macular edema.

Plavix^® is an approved platelet aggregation inhibitor that irreversibly inhibits the P2Y₁₂ receptor on platelets. There are two additional P2Y₁₂ receptor antagonists in clinical development as platelet aggregation inhibitors. Cangrelor (The Medicines Company) has finished Phase 2 clinical testing using intravenous administration. AZD6140 (AstraZeneca) is in Phase 2 clinical testing and is an oral formulation.

The introduction of new products or the development of new processes by competitors or new information about existing products may result in price reductions or product replacements, even for products protected by patents. However, we believe our competitive position is enhanced by our commitment to research leading to the

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discovery and development of new products. Other factors that may help us meet competition include the quality and breadth of our technology platform, the skill of our employees and our ability to recruit and retain skilled employees, our aggressive program of seeking patent protection and our capabilities for early stage research and drug discovery. However, many large pharmaceutical and biotechnology companies have significantly larger intellectual property estates than we do, more substantial capital resources than we have and greater capabilities and experience than we do in preclinical and clinical development, sales, marketing, manufacturing and regulatory affairs.

Governmental Regulation

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

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

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

• The submission of an NDA to the FDA; and

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

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

Clinical trials to support NDAs are typically conducted in three sequential phases, but the phases may overlap. During Phase 1, the initial introduction of the drug into healthy human subjects or patients, the drug is tested to assess metabolism, pharmacokinetics and pharmacological actions and safety, including side effects associated with increasing doses. Phase 2 usually involves studies in a limited patient population to:

• Assess the efficacy of the drug in specific, targeted indications;

• Assess dosage tolerance and optimal dosage; and

• Identify possible adverse effects and safety risks.

If a compound is found to be potentially effective and to have an acceptable safety profile in Phase 2 evaluations, Phase 3 trials, also called pivotal studies, major studies or advanced clinical trials, are undertaken to further demonstrate clinical efficacy and to further test for safety within an expanded patient population at geographically dispersed clinical trial sites.

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

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If FDA evaluations of the NDA and the manufacturing facilities are favorable, the FDA may give us either an approval letter or an approvable letter. An approvable letter will usually contain a number of conditions that must be met, which may include additional testing, in order to secure final approval of the NDA and authorization of commercial marketing of the drug for particular indications; however, the receipt of an approvable letter does not guarantee the final approval of a product. The FDA may refuse to approve the NDA or give us a non-approvable letter, outlining the deficiencies in the submission. If regulatory approval of a product is granted, it will be limited to particular disease states or conditions.

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

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

Health Care Reform Measures and Third Party Reimbursement

The efforts of governments and third party payors to contain or reduce the cost of health care will continue to affect the business and financial condition of drug companies. A number of legislative and regulatory proposals to change the health care system have been considered in recent years. In addition, an increasing emphasis on managed care in the United States has and will continue to increase pressure on drug pricing. Legislative or regulatory proposals or changes in managed care systems may be adopted that may have a negative effect on our business. The announcement and/or adoption of proposals could have an adverse effect on our ability to earn profits and financial condition. Sales of prescription drugs depend significantly on the availability of reimbursement to the consumer from third party payors, such as government and private insurance plans. These third party payors frequently require that drug companies give them predetermined discounts from list prices and they are increasingly challenging the prices for medical products and services. Third party payors may not consider products we may bring to the market cost effective and may not reimburse the consumer sufficiently to allow us, and/or our collaborators, to sell our products on a profitable basis.

Employees

As of January 31, 2005, we had 165 full-time and part-time employees. In addition, we utilize interns, outside contractors and consultants as needed. Our future success will depend in large part upon our ability to attract and retain highly qualified personnel. Our employees are not represented by any collective bargaining agreements, and we have never experienced a work stoppage. Employees are required to execute confidentiality and assignment of intellectual property agreements.

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

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soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the Securities and Exchange Commission. Please note that the information contained on our website is not incorporated by reference into our reports that are filed with the SEC.

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.

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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 product candidates 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 product candidates meet their requirements for marketing, we will be unable to sell those product candidates 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 product candidates, although we are co-promoting two products with Allergan. We have one product candidate, diquafosol, for which we have received an approvable letter from the FDA. Since the initial submission of our NDA for diquafosol, we have completed two additional diquafosol Phase 3 clinical trials, trials 108 and 109. Although neither of the two additional diquafosol Phase 3 clinical trials met their primary endpoint, we plan to submit an amendment to our diquafosol NDA by June 30, 2005 based upon the totality of data from our diquafosol clinical program, including positive data on certain secondary endpoints and analyses from the 108 and 109 clinical trials. There is no guarantee that the FDA will approve diquafosol and allow Allergan and us to begin selling it in the United States based on the totality of such data. It may be necessary to undertake additional Phase 3 clinical trials in support of our diquafosol NDA and there can be no guarantee that any such additional clinical trials would be successful or that the FDA would approve diquafosol even if such additional clinical trials are successful. Also, if additional diquafosol Phase 3 clinical trials are required by the FDA, we may decide not to conduct those clinical trials and we would therefore be unable to obtain FDA approval of diquafosol. 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.

In addition to our product candidates in clinical development, we have early stage preclinical product candidates for which a substantial amount of work will be required to advance these product candidates to clinical testing and ultimately to commercial approval. We will have to conduct significant additional development activities, 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 product candidates under development may not necessarily indicate the results that will be obtained from later or more extensive testing. Accordingly, some preclinical candidates may not advance to clinical development. Additionally, companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier clinical 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 clinical trials at the rate we expect;

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• We decide to modify the drug during testing; or

• We allocate our 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.

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. Although our agreement with Allergan provides, and we have exercised, the right to co-promote Restasis^® in the United States; Allergan is primarily responsible for marketing and commercializing Restasis^®. Accordingly, our revenues on the net sales of Restasis^® are largely dependent on the actions and success of Allergan, over whom we have no control.

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. We expect selling, promotional and marketing expenses associated with Elestat^™ and Restasis^® will exceed the corresponding revenues derived from these products during the year ending December 31, 2005 and there can be no assurances that revenues associated with such products will ever exceed the related expenses.

In December 2004, Alcon, Inc. received FDA approval of once-daily olopatadine hydrochloride ophthalmic solution, a product which directly competes with Elestat^™. To the best of our knowledge, Alcon has not yet launched once-daily olopatadine hydrochloride ophthalmic solution, but Patanol^® (olopatadine hydrochloride ophthalmic solution) that requires administration twice-a-day currently competes with Elestat^™. We cannot predict what effect, if any, the introduction of once-daily olopatadine hydrochloride ophthalmic solution will have on our sales of Elestat^™.

Until our launch of Elestat^™ and co-promotion of Restasis^®, we had never been involved in the promotion or co-promotion of a product. Our future revenues will depend, in part, upon the acceptance of Elestat^™ and Restasis^® by eye-care professionals, allergists and patients. 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;

• Changes in, or the levels of, third-party reimbursement of product costs;

• Cost of treatment;

• Marketing and sales activities of competitors;

• Pricing and availability of alternative products;

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• 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.

Revenues in future periods could vary significantly and may not cover our operating expenses.

We recognize revenue from product co-promotion based on net sales for Elestat^™ 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. 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. We did not reach any such milestones in 2004 and there can be no assurances that we will reach any during the year ended December 31, 2005 or any later date. Revisions in the commitment period are made in the period that the facts related to the change first become known. Additionally, our revenues may fluctuate from period to period due in part to:

• Fluctuations in sales of Elestat^™, Restasis^® and other future licensed or co-promoted products due to competition, manufacturing difficulties, seasonality, or other factors that affect the sales of a product;

• The timing of approvals, if any, for future products;

• The progress toward and the achievement of developmental milestones by us or our partners;

• Fluctuations in foreign currency exchange rates;

• The initiation of new contractual arrangements with other companies;

• The failure or refusal of a collaborative partner to pay royalties; or

• The expiration or invalidation of our patents or licensed intellectual property.

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

If approved by the FDA and other applicable regulatory authorities outside the United States, 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. In the event diquafosol is approved by the FDA, we plan to co-promote diquafosol within the United States; however, Allergan is primarily responsible for marketing diquafosol in the United States and other major, ex-Asia pharmaceutical markets. If diquafosol is not successfully commercialized, our revenues will be limited.

We cannot sell Restasis^®, Elestat^™ or any of our product candidates if governmental approvals are not obtained and maintained.

Pharmaceutical companies are subject to significant 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

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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;

• 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 may issue 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.

Recent Medicare prescription drug coverage legislation and future legislative or regulatory reform of the healthcare system may affect our or our partner’s ability to sell products profitably.

In both the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes to the healthcare system in ways that could affect our ability to sell our products profitably. In the United States, in December 2003, President Bush signed into law new Medicare prescription drug coverage legislation. Part of the legislation authorizes the Centers for Medicare & Medicaid Services, or CMS, the agency within the Department of Health and Human Services that administers Medicare to implement a new Medicare Part D coverage benefit for prescription drugs. Not all drugs in a class may be covered. Further, payment levels under the new Medicare program may be lower than current payment. Medicare patients will have to pay co-insurance which may influence which products are recommended by physicians and selected by patients. There is no assurance that our drugs will be recognized under the new Medicare Part D program for outpatient prescription drugs or paid at levels that reflect current or historical levels. Further federal Medicare proposals, along with State Medicaid drug payment changes and healthcare reforms could also lower payment for our products. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2006 and 2007 from the Medicare prescription drug coverage legislation. To the extent that private insurers such as Blue Cross and Blue Shield or managed care programs follow Medicare coverage and payment

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developments, the adverse effects of lower Medicare payment may be magnified by private insurers adopting lower payment. New Federal or state legislation in the United States may be enacted or adopted in the future that could further lower payment for our products.

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. While we have implemented corporate quality, ethics and compliance programs based on current best practices, 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.

The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and provisions of the Public Company Accounting and Oversight Board require public companies to review, document and test internal controls to ensure that procedures are effective in timely providing management with material information which needs to be disclosed under the Securities Exchange Act of 1934. Our Chief Compliance Officer, our principal executive officers, other management, as well as consultants conducted an evaluation of our internal controls in accordance with Sarbanes-Oxley requirements. As a result of this evaluation, we have provided a management report on our internal controls over financial reporting. However, we can not be sure that we have addressed all control activities and risks or that our overall control structure will detect all reportable events now or in the future.

Since our clinical candidates utilize a new mechanism of action and in some cases there are no regulatory precedents, conducting 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 established for clinical endpoints, which we establish in the clinical trial. Generally, we will establish these endpoints in consultation with the FDA, and other regulatory authorities, following their 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 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 product candidates 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 clinical 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. The FDA 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 as a result of such problems.

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.

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The number and type of studies that may be required by the FDA, or other regulatory authorities, 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 clinical 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 cGMP standards is required.

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 $56.5 million in the fiscal year ended December 31, 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 2005 will increase from our 2004 operating expenses to provide for clinical trials and toxicology studies for INS37217 Respiratory, INS37217 Ophthalmic and INS50589 Antiplatelet and greater commercial and administrative activities. Our cash, cash equivalents and investments totaled approximately $156.8 million on December 31, 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, clinical trials and undertake commercial sales. Many factors will influence our future capital needs. These factors include:

• The progress of our research programs, including our research program relating to our license agreement with the WARF and our payment obligations thereunder;

• 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 and Santen and any future collaborative programs;

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• Progress by our collaborators;

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

• Competing technological and market developments;

• The costs involved in defending any litigation claims against us;

• 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 payments from future collaborators.

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. For example, enrollment in our Phase 2 clinical trial for INS37217 Ophthalmic has progressed at a significantly slower rate than originally anticipated and will extend the development time anticipated for this product candidate. 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.

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From time to time, 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, INS50589 Antiplatelet 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;

• 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 and Santen;

• 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.

We have been named as a defendant in litigation that could result in substantial damages and costs and divert management’s attention and resources

On February 15, 2005, a purported class action complaint was filed in the United States District Court for the Middle District of North Carolina by Mirco Investors, LLC on behalf of itself and all other similarly situated investors against us and certain of our senior officers. The complaint alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focuses on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of our dry eye product candidate, diquafosol. The plaintiffs seek unspecified damages on behalf of a purported class of purchasers of our securities during the period from June 2, 2004 through February 8, 2005. On February 16, 2005, a similar complaint against the same defendants was filed by Richard and Susan Giorgino. In addition, on March 4, 2005, a similar complaint against the same defendants was filed by Kiah Sai Tan. It is possible that additional

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complaints may be filed in the future. We expect that these individual lawsuits will be consolidated into a single civil action. We intend to defend the litigation vigorously. No assurance can be made that we will be successful in our defense of the pending claims. If we are not successful in our defense of the claims, we could be forced to, among other ramifications, make significant payments to resolve the claims and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carriers or if damages exceed the limits of our insurance. Furthermore, regardless of our success in defending against the litigation, the litigation itself may result in substantial costs, use of resources and divert the attention of management and other employees which could adversely affect our business.

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 $44.1 million for the year ended December 31, 2004, $31.4 million for the year ended December 31, 2003 and $24.7 million for the year ended December 31, 2002. As of December 31, 2004, our accumulated deficit was approximately $171.2 million. We expect to incur 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;

• Commercialization activities to support co-promotion efforts; and

• The costs involved in defending any litigation claims against us.

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 under our license agreements, our licensors may terminate our agreements with them.

We hold licenses for INS365 for respiratory diseases and a P2Y₁₂ receptor program for a cardiovascular indication from UNC. We also hold a license agreement for glaucoma technologies from WARF. If we fail to meet performance milestones relating to the timing of regulatory filings or fail to pay the minimum annual payments under our respective licenses, our licensors may terminate the applicable license. In addition, if any licensor were to re-license some or all of the technologies currently covered by our licenses, competitors could develop products that compete with ours.

It may be necessary in the future for us to obtain additional licenses to avoid infringement of third party patents. Additionally, we may enter into license arrangements with other third parties as we build our product portfolio. We do not know the terms on which such licenses may be available, if at all.

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^™ and Restasis^®. It is our understanding that Allergan relies upon an arrangement with a single third party for the

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manufacture and supply of APIs for both Elestat^™ and Restasis^®. Allergan then 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 for our product candidates for purposes of preclinical testing and clinical trials. We presently depend upon one vendor as the sole manufacturer of our supply of APIs for diquafosol and INS37217 (denufosol) and one vendor as the sole manufacturer for INS50589. We intend to contract with these vendors, as necessary, for commercial scale manufacturing of our products where we are responsible for such activities. In the case of diquafosol, we expect Allergan to purchase commercial quantities of bulk APIs from our sole manufacturer. Although we have identified alternate sources for our product candidates, it would be time consuming and costly to qualify these sources. Under our diquafosol agreement, either our vendor or we may terminate our supply arrangement, without cause, by giving 180 days prior notice. If our vendor 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 product candidates. 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 APIs, all of our partners are responsible for making their own arrangements for the manufacture of drug products, including arranging for the manufacture of bulk APIs. 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 APIs 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 cGMP 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.

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We may not be successful in our efforts to expand our product portfolio.

A key element in our strategy is to develop and commercialize new ophthalmic and respiratory products. We are seeking to do so through our internal research program and through licensing or otherwise acquiring the rights to potential new drugs and drug targets.

A significant portion of the research that we are conducting involves new and unproven technologies. Research programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for a number of reasons, including:

• The research methodology used may not be successful in identifying potential product candidates; or

• Potential product candidates may on further study be shown to have harmful side effects or other characteristics that indicate they are unlikely to be successful drugs.

We may be unable to license or acquire suitable product candidates or products from third parties for a number of reasons. The licensing and acquisition of pharmaceutical products is a competitive area. A number of more established companies are also pursuing strategies to license or acquire products in our core therapeutic areas. These established companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. Other factors that may prevent us from licensing or otherwise acquiring suitable product candidates include the following:

• We may be unable to license or acquire the relevant technology on terms that would allow us to make an appropriate return on the product;

• Companies that perceive us to be their competitors may be unwilling to assign or license their product rights to us; or

• We may be unable to identify suitable products or product candidates within our area of expertise.

If we are unable to develop suitable potential product candidates through internal research programs or by obtaining rights to novel therapeutics from third parties, our business will suffer.

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 a development collaboration with Santen 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. 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^™, 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 or Santen 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

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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, Bristol-Myers Squibb, Boehringer Ingelheim, Chiron, Genentech, GlaxoSmithKline, The Medicines Company, MedPointe Pharmaceuticals, Millennium Pharmaceuticals, Novartis, Pfizer, Otsuka, Schering-Plough and Senju. 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.

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^®. Current treatments for cardiovascular disease include Plavix^®, an anti-platelet agent and Angiomax^®, a thrombin inhibitor. Primary treatments for dry eye disease currently involve over-the-counter artificial tear replacement drops, punctal plugs and Restasis^®. Elestat^™ competes with other treatments for allergic conjunctivitis including antihistamines and mast cell stabilizers, such as Patanol^®, Zaditor^® and Optivar^®. 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^™ and Restasis^®, but we are dependent on Allergan, or other experienced third parties, to perform or assist us in the marketing, distribution or

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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 to compete successfully, which may not be possible. 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^® as well as other potential products. Although the members of our sales force have had experience in sales with other companies, prior to 2004 we never had a sales force and we 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.

Failure to hire and retain key personnel or to identify, appoint and elect qualified directors, 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 and Treasurer. 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. We also depend upon the skills and guidance of the independent members of our Board of Directors. In December 2004, one of our directors resigned to devote additional time to his consulting practice and other matters and in February 2005, our non-executive Chairman of the Board, W. Leigh Thompson, M.D., Ph.D., D.Sc., passed away. While our Board of Directors has instituted succession planning steps to identify qualified board candidates to fill open board seats, there can be no assurance that we can identify, appoint and elect qualified candidates to serve as new members of the Board of Directors. 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.

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.

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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;

• Reimbursement of drug and treatment costs by third party payors;

• Marketing and sales activities of competitors;

• 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. 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

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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.

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 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.

Insurance coverage is increasingly more difficult to obtain or maintain.

While we currently have insurance for our business, property, directors and officers, and our products; insurance is increasingly more costly and narrower in scope, and we may be required to assume more risk in the future. If we are subject to claims or suffer a loss or damage in excess of our insurance coverage, we may be required to share that risk in excess of our insurance limits. Furthermore, any claims made on our insurance policy may impact our ability to obtain or maintain insurance coverage at reasonable costs or at all in the future.

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 January 31, 2005, there were 41,861,280 shares of common stock outstanding. Of these outstanding shares of common stock, approximately 21,500,000 shares were sold in public offerings and are freely tradable without restriction under the Securities Act, unless purchased by our affiliates. In addition, we have the ability to issue additional shares of common stock under an active shelf registration statement, which we filed with the Securities and Exchange Commission on April 16, 2004. 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. 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.

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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 January 31, 2005, there were outstanding options, which were exercisable to purchase 2,592,544 shares of our common stock, and outstanding warrants, which were exercisable to purchase 25,396 shares of our common stock. This amount combined with the total common stock outstanding at January 31, 2005 is 44,479,220 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.

Our rights agreement, the provisions of our Change in Control Severance Benefit Plan and 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.

Effective as of January 28, 2005, the Compensation Committee of the Board of Directors of Inspire adopted the Company’s Change in Control Severance Benefit Plan, or the CIC Plan, which provides severance benefits to certain employees of the Company as of the date on which a Change in Control occurs. Under the CIC Plan and the change in control agreements discussed below, a Change in Control occurs upon a determination by the Board of Directors or upon certain specified events such as merger and consolidation. The CIC Plan covers any regular full-time or part-time employee, other than employees who are parties to employment agreements or transition agreements or who are parties to any severance plan or agreement with the Company (other than the CIC Plan) that provides for the payment of severance benefits in connection with a Change in Control. Under the CIC Plan, if a Change in Control occurs and a participant’s employment is involuntarily terminated within two years, the participant will be entitled to certain payments and benefits based on the participant’s salary range and years of service with the Company. Presently, all executive officers of the Company are parties to individual agreements with the Company regarding a Change in Control or, in one case, a transition agreement and, as a result, are not covered by the CIC Plan. On January 31, 2005, the Company and various executive officers entered into amended and restated change in control agreements. Each agreement is effective as of the date of the prior agreement between the Company and the respective executive officer. Each agreement provides that upon the officer’s termination of employment following a Change in Control, unless such termination is for “cause,”

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because of death or disability or by the officer without “good reason,” within twenty-four (24) months following such Change in Control, the executive will be entitled to a lump sum payment equal to a multiple of the sum of (i) the highest annual base salary received by the officer in any of the three (3) most recently completed fiscal years prior to the Change in Control and (ii) the higher of the highest annual bonus received by the officer in any of the three (3) most recently completed fiscal years preceding the date of the officer’s termination, the three (3) most recent completed fiscal years preceding the Change in Control, or the maximum of the bonus opportunity range for the officer immediately prior to the date of termination. The multiples used to determine the amount of a lump sum payment range from two (2) to three (3). The agreements also provide for ongoing benefits, the vesting of outstanding stock options, and gross-up payments. The CIC Plan and the change in control agreements would increase the acquisition costs to a purchasing company that triggers the change in control provisions. As a result, the CIC Plan and the change in control agreements may delay or prevent a change in control.

Our amended and restated certificate of incorporation and amended and restated 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 amended and restated 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.

FORWARD LOOKING INFORMATION

This annual report on Form 10-K, including the documents that we incorporate by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to the “safe harbor” created by those sections. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “believe,” “expect,” “future” and “intend” and similar expressions to identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated by any forward-looking statements, including, without limitation, the risk factors

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listed above and those relating to product development, revenue and earnings expectations, intellectual property rights and litigation, competitive products, results of clinical trials, the need for additional research and testing, delays in manufacturing, funding and the timing and content of decisions made by regulatory authorities, including the FDA and other factors presented throughout this annual report and any other documents filed by us with the Securities and Exchange Commission.

In light of these assumptions, risks and uncertainties, the results and events discussed in the forward-looking statements contained in this annual report on Form 10-K or in any document incorporated by reference might not occur. Stockholders are cautioned not to place undue reliance on the forward-looking statements, which speak only of the date of this report or the date of the document incorporated by reference in this document. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent forward-looking statements attributable to us or to any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.

Item 2. Properties.

We lease contiguous administrative and laboratory facilities that comprise approximately 51,000 square feet in Durham, North Carolina, which is adjacent to the Research Triangle Park. The various leases underlying our facilities expire in November 2006 and are renewable. We believe our facilities will be adequate to meet our operational needs through November 2006 when our leases expire.

Item 3. Legal Proceedings.

On February 15, 2005, a purported class action complaint was filed in the United States District Court for the Middle District of North Carolina by Mirco Investors, LLC on behalf of itself and all other similarly situated investors against us and certain of our senior officers. The complaint alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focuses on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of our dry eye product candidate, diquafosol. The plaintiffs seek unspecified damages on behalf of a purported class of purchasers of our securities during the period from June 2, 2004 through February 8, 2005. On February 16, 2005, a similar complaint against the same defendants was filed by Richard and Susan Giorgino. In addition, on March 4, 2005, a similar complaint against the same defendants was filed by Kiah Sai Tan. It is possible that additional complaints may be filed in the future. We expect that these individual lawsuits will be consolidated into a single civil action. We intend to defend the litigation vigorously.

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

Not applicable.

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PART II

Item 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities.

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

2003	High		Low
First Quarter	$	15.89	$	9.06
Second Quarter	$	16.35	$	10.53
Third Quarter	$	18.77	$	10.10
Fourth Quarter	$	21.37	$	12.37
2004	High		Low
First Quarter	$	15.42	$	10.76
Second Quarter	$	18.74	$	12.60
Third Quarter	$	17.04	$	11.37
Fourth Quarter	$	19.19	$	14.75

As of January 31, 2005, there were 61 record stockholders and over 8,000 beneficial stockholders of our common stock. On January 31, 2005, the last sale price reported on the Nasdaq National Market for our common stock was $14.80 per share.

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

On November 19, 2004, we issued 5,728 shares of common stock to a consultant upon the exercise of warrants at a price of $4.20 per share. On December 17, 2004, we issued 253,968 shares of common stock to Genentech, Inc. upon the exercise of warrants at a price of $7.88 per share. The issuance of these shares was deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) as a transaction not involving any public offering. The transferees made appropriate representations as part of the settlements and had, or had access to, adequate information about Inspire. An appropriate legend was affixed to the stock certificates that were issued.

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Item 6. Selected Financial Data.

The selected statement of operations data and balance sheet data with respect to the years ended December 31, 2004, 2003, 2002, 2001 and 2000 set forth below are derived from our financial statements. The selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 below, and our financial statements and the notes thereto appended to this annual report. Historical results are not necessarily indicative of our future results.

	(in thousands, except per share amounts)
	Year Ended December 31,
	2004			2003			2002			2001			2000
Statement of Operations Data:
Revenue	$	11,068		$	5,200		$	4,883		$	7,285		$	5,368
Operating expenses:
Research and development		25,698			27,631			25,229			28,193			16,354
Selling and marketing		21,848			2,838			60			124			—
General and administrative		9,041			7,002			5,091			5,758			3,730
Total operating expenses		56,587			37,471			30,380			34,075			20,084
Loss from operations		(45,519	)		(32,271	)		(25,497	)		(26,790	)		(14,716	)
Other income, net		1,450			876			804			3,655			1,126
Loss before provision for income taxes		(44,069	)		(31,395	)		(24,693	)		(23,135	)		(13,590	)
Provision for income taxes		—			—			—			—			400
Net loss		(44,069	)		(31,395	)		(24,693	)		(23,135	)		(13,990	)
Preferred stock dividends		—			—			—			—			(594	)
Net loss available to common stockholders	$	(44,069	)	$	(31,395	)	$	(24,693	)	$	(23,135	)	$	(14,584	)
Net loss per common share—basic and diluted	$	(1.25	)	$	(1.03	)	$	(0.96	)	$	(0.90	)	$	(1.23	)
Common shares used in computing weighted average common shares outstanding—basic and diluted		35,261			30,526			25,821			25,702			11,871

	(in thousands)
	December 31,
	2004			2003			2002			2001			2000
Balance Sheet Data:
Cash and cash equivalents	$	100,320		$	34,324		$	27,128		$	29,959		$	35,109
Investments		56,476			40,842			4,501			27,895			44,026
Total assets		165,696			79,678			33,564			60,087			82,993
Capital lease obligations, including current portion		1,881			1,084			505			901			812
Deferred revenue		—			—			2,200			4,083			6,368
Common stock		42			32			26			26			26
Accumulated deficit		(171,163	)		(127,094	)		(95,699	)		(71,006	)		(47,871	)
Total stockholders’ equity		149,598			71,052			28,998			52,595			74,505

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Item 7. 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, as well as projections for the future. 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 “Risk Factors.” 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 discovering, developing and commercializing prescription pharmaceutical products in disease areas with significant commercial markets and unmet medical needs. We were incorporated in October 1993 and commenced operations in March 1995 following our first substantial financing and licensing of the initial technology from UNC. We are located in Durham, North Carolina, adjacent to the Research Triangle Park.

Our goal is to build and commercialize a sustainable pipeline of innovative new treatments based upon our technical and scientific expertise, focusing in the ophthalmic and respiratory therapeutic areas. Our ophthalmic

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products and clinical product candidates are currently concentrated in the allergic conjunctivitis, dry eye disease, corneal wound healing and retinal disease indications. In addition, we also have a preclinical program to treat glaucoma. We are also working on a product candidate for the treatment of respiratory complications of cystic fibrosis and an antiplatelet product candidate that could be utilized in cardiopulmonary bypass procedures.

We have several product candidates in various stages of clinical development and various programs in preclinical development. All of our clinical product candidates are based on proprietary technology relating to P2 receptors. Our most clinically advanced product candidates are P2Y₂ receptor agonists that target ophthalmology and respiratory conditions and diseases where current treatments are not adequate.

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

In the first quarter of 2004, we emerged out of the development stage, having transformed into a commercial organization, and began receiving co-promotion revenue from the commercial product sales of Elestat^™ and Restasis^®. Previously, we devoted substantially all of our efforts to the discovery and clinical development of our product candidates as well as the establishment of strategic partnerships. Prior to 2004, our revenues consisted of payments under our various corporate partnerships established for the development and commercialization of our products when approved.

We have incurred significant operating losses since our inception and, as of December 31, 2004, we had an accumulated deficit of $171.2 million. We expect to incur losses for the next several years. We have financed our operations through proceeds received from the sale of equity securities including private sales of preferred stock and public offerings of common stock, as well as revenues received under corporate collaborations and the co-promotion of Elestat^™ and Restasis^®. We operate in a single business segment and do not have any foreign operations.

On June 27, 2003, we submitted an NDA to the FDA for our dry eye product candidate, and we were notified that our NDA was granted a “priority review” on July 31, 2003. On December 19, 2003, we received an approvable letter from the FDA. Since the initial submission of the NDA, we have completed two additional diquafosol Phase 3 clinical trials, trials 108 and 109. Although neither of the two additional diquafosol Phase 3 clinical trials met their primary endpoint, we plan to submit an amendment to our diquafosol NDA by June 30, 2005 based upon the totality of data from our diquafosol clinical program, including positive data on certain secondary endpoints and analyses from the 108 and 109 clinical trials. We intend to consult with Allergan to determine a European regulatory filing strategy for diquafosol for the treatment of dry eye disease.

In December 2003, we entered into an agreement with Allergan to co-promote Elestat^™ in the United States. Allergan records all product sales and retains all product costs and licensing rights, with the exception of primary selling, promotional and marketing activities in the United States which is our responsibility. Under the terms of the agreement, we paid Allergan an up-front payment and Allergan pays co-promotion revenue to us on U.S. net sales of Elestat^™. In February 2004, we began to receive co-promotion revenue from Allergan on net sales of Elestat^™ upon our launch and co-promotion of Elestat^™ in the United States.

In June 2001, we entered into a joint license, development and marketing agreement with Allergan to develop and commercialize diquafosol and granted the right to co-promote Restasis^® in the United States. Under the terms of this agreement, we have received up-front and milestone payments of $11 million and may receive up to an additional $28 million in milestone payments assuming the successful completion of all remaining milestones under this agreement. In the third quarter of 2003, we exercised our right to co-promote Restasis^® and diquafosol and we began co-promotion activities of Restasis^® in January 2004. Allergan records all product sales and retains all product costs and licensing rights with the exception of costs for our domestic sales force which is our responsibility. We receive co-promotion revenue based upon net sales of Restasis^® and we will receive diquafosol

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co-promotion revenue for worldwide, except Asia, net sales if and when the product candidate is approved by regulatory agencies. We began receiving co-promotion revenue on net sales of Restasis^® in April 2004.

In October 2002, we entered into a study funding agreement with the CFFT pursuant to which they funded the majority of the external costs of one Phase 2 trial for the treatment of cystic fibrosis in exchange for a milestone payment upon FDA approval, and the possibility of a sales milestone upon the commercialization and the achievement of a certain aggregate sales volume in the first five years following product approval. In the event of FDA approval, we are obligated to pay to the CFFT, over a period of five years, an amount equal to a multiple of the clinical trial costs incurred by the CFFT as a development milestone payment, which is currently estimated to be approximately $12 million. Additionally, in the event aggregate sales of the product exceed a certain level in the first five years subsequent to regulatory approval, we are obligated to pay the CFFT an additional $4 million sales milestone, payable over two years.

In December 1998, we entered into a Development, License and Supply Agreement with Santen for the development of diquafosol for the therapeutic treatment of ocular surface diseases. We are obligated to supply Santen with its requirements of diquafosol in bulk drug substance form for all preclinical studies, clinical trials and commercial requirements at agreed-upon prices. Under the agreement, we received an up-front equity investment of $1.5 million for shares of our stock and a milestone payment of $500,000. In addition, if all milestones are met, we could receive additional payments of up to $4.25 million, as well as royalties on net sales of licensed products. Santen is developing diquafosol in Japan and nine other Asian countries, and is currently in Phase 2 clinical trials.

Critical Accounting Policies and Estimates

Our 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 situations change, 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, clinical trial, preclinical/toxicology and manufacturing liabilities.

Revenue Recognition

We recognize revenue from product co-promotion based on net sales for Elestat^™ 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^™ co-promotion agreement, we are obligated to meet predetermined minimum annual net sales performance levels. If the annual minimum is not satisfied, we record a reduced percentage of net sales based upon our level of achievement of predetermined calendar year net sales target levels. Amounts contractually due from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue.

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

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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 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.

Taxes

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We have recorded a valuation allowance of $74.9 million as of December 31, 2004 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.

Liabilities

We generally enter into contractual agreements with third party vendors to provide clinical, preclinical/toxicology, manufacturing, research 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, promotion and marketing 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 estimate.

Stock Option Expense

See discussion of the adoption of Statement of Financial Accounting Standards, or SFAS, No. 123 (revised 2004), “Share-Based Payment,” a revision of Financial Accounting Standards Board No. 123, “Accounting for Stock-Based Compensation.”

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 costs of operation or the profitability of our products when marketed.

Results of Operations

Years Ended December 31, 2004, 2003 and 2002

Revenues

Our revenues for the year ended December 31, 2004 were $11.1 million, compared to $5.2 million in 2003 and $4.9 million in 2002. The change in revenue in 2004 as compared to 2003 relates to our recording co-promotion revenue from Elestat^™ and Restasis^® commercial product sales in 2004 as compared to

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collaborative revenue associated with 2003 milestone payments and amortization of deferred revenue recognized in 2003 under our collaborative research and development agreements with strategic partners. The increase in 2003 revenues, as compared to 2002, relates primarily to our receipt of a milestone payment from our strategic partner, Allergan. Fluctuations in revenue between the periods relate to fluctuations in product sales and the associated co-promotion revenue we receive and the timing and magnitude of milestone payments and amortization of deferred revenue recognized under our collaborative agreements.

Revenue from product co-promotion relates to U.S. net sales of Elestat^™ and Restasis^® according to the terms of our collaborative agreements with Allergan. We began realizing co-promotion revenue from Elestat^™ beginning in February 2004, upon its launch in the United States, and recorded $9.6 million of revenue from net sales of Elestat^™ in the eleven-month period. Elestat^™ continues to increase market share and to be widely accepted by patients and physicians, becoming the second most prescribed allergic conjunctivitis product in our target universe, the top 200 highest prescribing ophthalmologists, optometrists, and allergists in each of our 64 sales territories in the United States. Based upon weekly national prescription data from IMS Health for the week ending December 31, 2004, Elestat^™ has achieved over 16% market share in new prescription volume and over 14% market share in total prescriptions in our target universe. In regards to the total United States allergic conjunctivitis market, Elestat^™ represents approximately 8% of new prescriptions and approximately 7% of total prescriptions for the week ending December 31, 2004, based on data compiled and reported by IMS Health. Elestat^™ 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 April 2004, we began receiving co-promotion revenue on Restasis^®, the only FDA approved treatment for dry eye disease. Restasis^® had significant growth in 2004, its first full year of commercial sales, contributing approximately $1.5 million to our 2004 co-promotion revenue. We anticipate that Restasis^® will become a more significant component of our co-promotion revenue in 2005. Our entitled co-promotion percentage of net sales of Restasis^® will increase in April 2005 and Allergan has forecasted net sales of Restasis^® to be $140-160 million in 2005, as compared to $100 million in net sales in 2004.

Our future revenue will depend on the commercial success of Elestat^™ and Restasis^®, seasonality of sales of Elestat^™, whether we enter additional collaboration or co-promotion agreements, achieve milestones under existing or future collaboration agreements and whether we obtain regulatory approvals.

Costs and Expenses

Research and Development Expenses

Research and development expenses for the year ended December 31, 2004 were $25.7 million, compared to $27.6 million in 2003 and $25.2 million in 2002. Research and development expenses vary according to the number of programs in preclinical and clinical development and the stage of development of our clinical programs. Later stage clinical programs tend to cost more than earlier stage programs due to the length of the trial and the number of patients enrolled in later stage clinical trials.

The decrease in 2004 expenses, as compared to 2003, relates to significantly decreased spending on INS37217 Intranasal and INS316 Diagnostic, which were partially offset by increased spending on key programs in aggressive clinical and preclinical development; including expenses associated with our 109 Phase 3 clinical trial of diquafosol, a Phase 2 clinical trial of INS37217 Respiratory, long-term toxicology studies of INS37217 Respiratory and a Phase 2 clinical trial of INS37217 Ophthalmic. In 2003, we reclassified the INS37217 Intranasal and INS316 Diagnostic programs to lower priority programs and correspondingly decreased the resources dedicated to them.

The increase in research and development expenses in 2003, as compared to 2002, was due to increased spending on our clinical programs, particularly our INS37217 Intranasal program, in which we completed a

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Phase 3 clinical trial in perennial allergic rhinitis in 2003, and our INS37217 Ophthalmic program. Also in October 2002, we entered into a research and development agreement with the CFFT, whereby the expenses for one Phase 2 INS37217 Respiratory proof-of-concept clinical trial are funded by the CFFT, but we also record the corresponding expenses and liabilities as the CFFT incurs these costs. If we receive FDA approval for INS37217 Respiratory for the treatment of cystic fibrosis, we will be obligated to pay a development milestone, and possibly a sales milestone, to the CFFT. If we do not receive FDA approval, we will have no financial obligation to the CFFT, including the Phase 2 clinical trial costs the CFFT is funding on our behalf. As of December 31, 2004, we have recorded approximately $1.9 million of contingent liabilities associated with this agreement.

Research and development expenses include all direct costs, including salaries for our research and development personnel, consulting fees, clinical trial costs, sponsored research costs, clinical trial insurance, license fees and other fees and costs related to the development of product candidates.

Our research and development expenses for the years ended December 31, 2004, 2003 and 2002 and from the respective project’s inception are shown below and includes the percentage of overall research and development expenditures for the years listed.

	(In thousands) Year ended December 31,									Cumulative from Inception (October 28, 1993) to December 31, 2004		%
	2004		%	2003		%	2002		%
diquafosol tetrasodium (INS365 Ophthalmic)	$	6,835	27	$	5,896	21	$	7,420	29	$	35,746	24
INS37217 Respiratory (denufosol tetrasodium)		4,256	17		3,146	12		2,962	12		13,009	9
INS50589 Antiplatelet		3,211	12		2,751	10		170	1		6,444	4
INS37217 Ophthalmic (denufosol tetrasodium)		2,893	11		1,365	5		401	1		6,382	4
INS37217 Intranasal (denufosol tetrasodium)		480	2		6,723	24		4,471	18		12,639	9
INS316 Diagnostic (uridine 5’-triphosphate) (1)		746	3		2,873	10		2,423	10		8,823	6
Other discovery and development costs (2)		7,277	28		4,877	18		7,382	29		65,667	44
Total	$	25,698	100	$	27,631	100	$	25,229	100	$	148,710	100

⁽¹⁾ In September 2004, Kirin terminated its license for this drug candidate.

⁽²⁾ Other discovery and development costs represent all unallocated research and development costs or those costs allocated to preclinical projects. 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.

Selling and Marketing Expenses

Selling and marketing expenses for the year ended December 31, 2004 were $21.8 million, compared to $2.8 million in 2003 and $60,000 in 2002. The increase in selling and marketing expenses in 2004, as compared to 2003, resulted from our first year of commercial operations, including increases in personnel, advertising and promotion expenses and other administrative costs to enable our active co-promotion of Restasis^® and Elestat^™.

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The increase in selling and marketing expenses in 2003, as compared to 2002, resulted from increases in personnel and other administrative costs as we began building our sales and marketing infrastructure in the fourth quarter of 2003 for the co-promotion of Elestat^™ and Restasis^®.

Our selling 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, promotion, advertising, public relations, Phase 4 clinical trial costs, physician training and continued medical education and other administrative expenses. We have one Phase 4 clinical trial for Elestat^™ ongoing and are planning to initiate an additional Phase 4 clinical trial in 2005.

In December 2003, we began hiring 64 territory managers and 6 regional sales directors to provide us with national sales coverage for our ophthalmic products. Our commercial organization focuses its promotional efforts on approximately 8,500 highly prescribing ophthalmologists, optometrists and allergists in the United States. We began co-promoting Restasis^® in January 2004 and launched Elestat^™ 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 costs for the year ended December 31, 2004 were $9.0 million, compared to $7.0 million in 2003 and $5.1 million in 2002. Our general and administrative expenses consist primarily of personnel, facility and related costs for general corporate functions, including business development, finance, accounting, legal, human resources, quality/compliance, facilities and information systems. The increase in 2004 general and administrative expenses is primarily due to expenses necessary to support and maintain a commercial organization, costs associated with Sarbanes-Oxley compliance, as well as overall corporate growth. The increase in 2003 general and administrative expenses was primarily due to our increased development activities, building a sales and marketing infrastructure, and continuing corporate growth. Future general and administrative expenses will depend on the level of our future development and commercialization activities; however, we expect an increase in future professional fees as a result of recently filed litigation.

Other Income (Expense)

Other income, net totaled $1.5 million for the year ended December 31, 2004, compared to $0.9 million for 2003 and $0.8 million for 2002. Other income fluctuates from year to year based upon fluctuations in the interest income earned on variable cash and investment balances and realized gains and losses on investments offset by interest expense on debt obligations. The increase in 2004 other income, as compared to 2003, is primarily the result of a write-down of a strategic investment in 2003 and larger cash and investment balances as a result of stock offerings that generated net proceeds in excess of $119 million in 2004. The increase in 2003 other income, as compared to 2002, represents larger interest income earned on higher average cash and investment balances offset by interest expense and increased losses on our investments, including a write-down on a strategic investment. 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^™ and Restasis^®, but do not expect this revenue to exceed our 2005 operating expenses.

At December 31, 2004, we had net working capital of $134.6 million, an increase of approximately $68.3 million from $66.2 million at December 31, 2003. The increase in working capital is principally due to our successful offerings of common stock in July and November 2004, offset by the use of funds for our normal

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operating expenses. In July 2004, we completed a public offering of 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. In November 2004, we completed an offering of approximately 2.5 million shares of common stock, which included the full exercise of the underwriter’s over-allotment option, at $17.10 per share. The net proceeds, after underwriting discounts and costs in connection with the sale and distribution of the securities, were approximately $42.3 million. Our principal sources of liquidity at December 31, 2004 were $100.3 million in cash and cash equivalents and $55.8 million in investments which are considered “available-for-sale”, reflecting a $81.6 million increase of cash, cash equivalents and investment balances over those at December 31, 2003.

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 number, magnitude, scope and timing of our drug development programs, the costs related to the potential FDA approval of diquafosol and denufosol; 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, outcome of pending litigation; and the potential expansion of facility space. We are targeting 2005 operating expenses of $59-65 million. This range, however, does not consider the impact of any non-cash stock option expense as required under SFAS No. 123(R)(issued in 2004). We intend to continue to offer stock options to attract and retain qualified employees and Board of Directors and we will be required to expense this non-cash cost beginning in the third quarter of 2005. Based upon stock options currently outstanding and the valuation model and assumptions consistent with 2004 quarterly calculations, we project stock option expense to be approximately $5 million for the last half of 2005.

We believe our existing cash, cash equivalents and investments, will be adequate to satisfy our anticipated working capital requirements beyond 2006. In order for us to continue operations beyond 2006, we will need to: (1) obtain product candidate approvals, (2) in-license commercial products, (3) obtain additional co-promotion agreements, and/or (4) raise additional capital through equity or debt financings or from other sources. Accordingly, we have the ability to sell approximately $13.9 million worth 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 expand the magnitude or 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, unanticipated professional fees or settlements associated with pending litigation and other factors described under the Risk Factors located elsewhere in this report.

As part of our drug development strategy, we outsource significant amounts of our preclinical and clinical programs and the manufacture of drug substance used in those programs. Accordingly, we have entered into contractual commitments or purchase arrangements with various clinical research organizations, manufacturers of active pharmaceutical ingredients and/or drug product as well as with others. The amount of our financial commitments under these arrangements totaled approximately $6.3 million at December 31, 2004. In addition, we have other contractual commitments outside of drug development under arrangements which totaled approximately $1.3 million at December 31, 2004. These amounts may vary dependent upon the results of underlying studies, the completion of studies and/or projects and certain other variable components that may yield a result that differs from management’s estimate. Also, at December 31, 2004, we have future contractual commitments to pay $3.8 million of lease obligations for our administrative offices, laboratory facilities and equipment. Our existing license, collaboration and sponsored research agreements may require future cash

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payments. In the aggregate, these agreements may require payments of up to $14.5 million assuming the achievement of all development milestones and up to $4.0 million assuming the achievement of all sales milestones. Amounts payable by us under these agreements are uncertain and are contingent on a number of factors, including the progress of our discovery and drug development programs, our ability to obtain regulatory approvals, and the commercial success of our approved products. Additionally, we are obligated to pay royalties on net sales, if any, of certain product candidates currently in our portfolio. Some of our license agreements require minimum annual license preservation fees under our existing license agreements ranging from $5,000 to $10,000. In addition, if we obtain licenses on additional product candidates in the future, or if our collaborative arrangements identify additional product candidates, our license obligations would increase.

Subject to the information and qualifications included in the above paragraph, as of December 31, 2004, our contractual and potential obligations are as follows:

	(In thousands) Payment due by Period
Contractual and Potential Obligations	Total		Less than 1 year		1-2 years		3-5 years		More than 5 years
Capital Lease Obligations	$	2,194	$	636	$	1,282	$	276	$	—
Operating Lease Obligations		1,628		887		719		22		—
Purchase Obligations		7,578		7,578		—		—		—
Minimum Annual Payments		145		25		50		50		20
Development Milestone Obligations		14,450		50		250		12,000		2,150
Sales Milestone Obligations		4,000		—		—		—		4,000
Total	$	29,995	$	9,176	$	2,301	$	12,348	$	6,170

Litigation

On February 15, 2005, a purported class action complaint was filed in the United States District Court for the Middle District of North Carolina by Mirco Investors, LLC on behalf of itself and all other similarly situated investors against us and certain of our senior officers. The complaint alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focuses on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of our dry eye product candidate, diquafosol. The plaintiffs seek unspecified damages on behalf of a purported class of purchasers of our securities during the period from June 2, 2004 through February 8, 2005. On February 16, 2005, a similar complaint against the same defendants was filed by Richard and Susan Giorgino. In addition, on March 4, 2005, a similar complaint against the same defendants was filed by Kiah Sai Tan. It is possible that additional complaints may be filed in the future. We expect that these individual lawsuits will be consolidated into a single civil action. We intend to defend the litigation vigorously. As with any legal proceeding, we cannot predict with certainty the eventual outcome of these pending lawsuits. Furthermore, we will have to incur expenses in connection with these lawsuits, which may be substantial. In the event of an adverse outcome, our business, future results of operations, financial position and/or cash flows could be materially affected. Moreover, responding to and defending the pending litigation will result in a diversion of management’s attention and resources and an increase in professional fees.

Impact of Recently Issued Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 123(R) (revised 2004, or SFAS No. 123(R)), “Share-Based Payment,” a revision of FASB Statement No. 123 “Accounting for Stock-Based Compensation,” or SFAS No. 123. SFAS No. 123(R) supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB No. 25, and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the

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income statement based on their fair values for all periods that begin after June 15, 2005. Pro forma disclosure will no longer be an alternative. SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

1. A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date; or

2. A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either for (a) all prior periods presented or (b) prior interim periods of the year of adoption.

We intend to adopt SFAS No. 123(R) effective July 1, 2005. As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB No. 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations and our overall financial position. An estimate of the non-cash stock option expense for the last half of 2005, based upon the current number of stock options outstanding and calculated using assumptions and a valuation model consistent with 2004 quarterly filings, is approximately $5 million. However, actual expense may be materially different depending on the valuation model, assumptions and methodologies used in implementing SFAS No. 123(R), as well as the number of unvested stock options outstanding during 2005.

In March 2004, the FASB issued Emerging Issues Task Force, or EITF, Issue No. 03-13, or EITF 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144, or FASB No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations.” The FASB staff established a working group to assist in the development of a model for evaluating (a) which cash flows are to be considered in determining whether cash flows have been or will be eliminated and (b) what types of continuing involvement constitute significant continuing involvement. We have adopted FASB No. 144 and EITF 03-13, and they have not had a material impact on our financial position, results of operations or cash flows.

In March 2004, the FASB issued EITF Issue No. 03-1, or EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” which provided new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 included new disclosure requirements for investments that are deemed to be other-than-temporarily-impaired. We have adopted the disclosure requirements of EITF 03-1. In September 2004, the FASB delayed the effective date of application guidance on impairment of securities included within EITF 03-01 and is currently reconsidering conclusions reached in EITF 03-1.

In December 2003, the FASB issued Interpretation No. 46R, or FIN 46R, “Consolidation of Variable Interest Entities,” which replaces Interpretation No. 46. FIN 46R requires existing unconsolidated variable interest entities, or VIEs, to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among the parties involved. VIEs that effectively disperse risks will not be consolidated unless a single party holds an interest or combination of interest that effectively recombines risks that were previously dispersed. Application of FIN 46R is required in financial statements of public entities that have interest in VIEs or potential VIEs, commonly referred to as special-purpose entities, for periods after December 31, 2003. Application by public entities for all other types of entities is required in its financial statements for periods ending after March 31, 2004. We do not have interests in VIEs. FIN 46R did not have any impact on our financial position, results of operations or cash flows.

48

Item 7A. 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 United States government and government agency obligations, money market investments, municipal notes and bonds and asset or mortgage-backed securities. Our portfolio has a current average maturity of less than 12 months, using the stated maturity or reset maturity dates associated with individual maturities as the basis for the calculation.

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 December 31, 2004, our portfolio of available-for-sale investments consisted of approximately $41.4 million of investments maturing within one year and approximately $14.3 million of investments maturing after one year but within 36 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.

49

Item 8. Financial Statements and Supplementary Data.

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

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

Not applicable.

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting. The design, monitoring and revision of the system of internal accounting controls involves, among other items, management’s judgments with respect to the relative cost and expected benefits of specific control measures. The effectiveness of the control system is supported by the selection, retention and training of qualified personnel and an organizational structure that provides an appropriate division of responsibility and formalized procedures. The system of internal accounting controls is periodically reviewed and modified in response to changing conditions. Internal audit consultants regularly monitor the adequacy and effectiveness of internal accounting controls. In addition to the system of internal accounting controls, management maintains corporate policy guidelines that help monitor proper overall business conduct, possible conflicts of interest, compliance with laws and confidentiality of proprietary information. 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 control over financial reporting, identified in connection with the evaluation of our internal control that occurred during our last fiscal quarter, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2004. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management, including our principal executive officer and principal financial officer, concluded that our internal control over financial

50

reporting was effective as of December 31, 2004. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included herein, which expresses unqualified opinions on management’s assessment of the effectiveness of internal control over financial reporting and on the effectiveness of our internal control over financial reporting as of December 31, 2004.

Audit Committee Oversight

The Audit Committee of the Board of Directors, consisting solely of outside directors, appoints the independent auditors and receives and reviews the reports submitted by them. The Audit Committee meets several times during the year with management, the internal auditors and the independent auditors to discuss audit activities, internal controls and financial reporting matters. The internal auditors and the independent auditors have full and free access to the Audit Committee.

ITEM 9B. OTHER INFORMATION

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated by reference to the sections of our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A in connection with the 2005 Annual Meeting (the “Proxy Statement”) to be contained under the headings “Election of Directors”, “Executive Officers who are not Nominees,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the sections of our Proxy Statement to be contained under the headings “Executive Compensation,” “Compensation Committee Report.” and “Relative Stock Performance.”

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated by reference to the section of our Proxy Statement to be contained under the heading “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

To the extent applicable, the information required by this item is incorporated by reference to the sections of our Proxy Statement to be contained under the headings “Executive Compensation.”

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated by reference to the sections of our Proxy Statement to be contained the heading “Audit and Other fees” and related captions.

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ITEM 15. EXHIBITS and FINANCIAL STATEMENTS SCHEDULES

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

1. Financial Statements:

	Page
Report of Independent Registered Public Accounting Firm	F-2
Balance Sheets	F-4
Statements of Operations	F-5
Statements of Cash Flows	F-6
Statements of Stockholders’ Equity	F-7
Notes to Financial Statements	F-8

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

3. Exhibits:

Exhibit Number	Description
3.1	Amended and Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
3.2	Certificate of Amendment of Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed March 26, 2002).
3.3	Certificate of Designations 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 March 7, 2003).
3.4	Amended and Restated Bylaws, as adopted March 30, 2004. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 15, 2004).
4.1	Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
4.2	Rights Agreement, dated as of October 21, 2002, between the Company and Computershare Trust Company, which includes the form of Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. as Exhibit “A”, the form of Rights Certificate as Exhibit “B” and the Summary of Rights to Purchase Preferred Stock as Exhibit “C” (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 22, 2002).
10.1†	Amended and Restated 1995 Stock Plan, as amended. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.2†	Form of Incentive Stock Option. (Incorporated by reference to Exhibit 10.2 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.3†	Form of Non-statutory Stock Option. (Incorporated by reference to Exhibit 10.3 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.4*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and The University of North Carolina at Chapel Hill, dated March 10, 1995. (Incorporated by reference to Exhibit 10.7 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).

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Exhibit Number	Description
10.5	Lease between Inspire Pharmaceuticals, Inc. and Imperial Center, Limited Partnership regarding Royal Center I, Durham, North Carolina, dated as of May 17, 1995, as amended. (Incorporated by reference to Exhibit 10.8 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.6	Lease Agreement between Inspire Pharmaceuticals, Inc. and Petula Associates Ltd. regarding Royal Center II, Durham, North Carolina, dated as of December 30, 1997. (Incorporated by reference to Exhibit 10.10 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.7	Sublease Agreement between ICAgen, Inc. and Inspire Pharmaceuticals, Inc. regarding premises located at 4222 Emperor Boulevard, Suite 500, Durham, North Carolina, dated September 22, 1997 and extension of Sublease Agreement dated February 14, 2000. (Incorporated by reference to Exhibit 10.11 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.8*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and The University of North Carolina at Chapel Hill, dated September 1, 1998. (Incorporated by reference to Exhibit 10.12 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.9*	Development, License and Supply Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.15 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.10	Registration Rights Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.16 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.11	Warrant Agreement between Inspire Pharmaceuticals, Inc. and Genentech, Inc., dated as of December 17, 1999. (Incorporated by reference to Exhibit 10.22 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.12	Amended and Restated Investors’ Rights Agreement among Inspire Pharmaceuticals, Inc. and the holders of Series A, B, E and G Preferred Stock of the Company dated as of December 17, 1999. (Incorporated by reference to Exhibit 10.23 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.13†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Donald Kellerman dated February 3, 2000. (Incorporated by reference to Exhibit 10.24 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.14†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Gregory J. Mossinghoff dated February 4, 2000. (Incorporated by reference to Exhibit 10.25 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.15†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa dated February 4, 2000. (Incorporated by reference to Exhibit 10.26 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).

53

Exhibit Number	Description
10.16†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer dated February 10, 2000. (Incorporated by reference to Exhibit 10.28 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.17†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Richard M. Evans dated February 10, 2000. (Incorporated by reference to Exhibit 10.30 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.18†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Mary Bennett dated February 27, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2001).
10.19†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph Schachle dated April 3, 2001. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2001).
10.20*	License, Development and Marketing Agreement between Inspire Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 29, 2001).
10.21*	Study Funding Agreement, dated as of October 3, 2002, between Inspire Pharmaceuticals, Inc. and The Cystic Fibrosis Foundation Therapeutics, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 4, 2002).
10.22	First Amendment to Lease Agreement between Inspire Pharmaceuticals, Inc. and Royal Center Two IC, LLC for Royal Center Two, Durham, North Carolina, dated as of June 28, 2002. (Incorporated by reference to Exhibit 10.31 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
10.23	Third Amendment to Lease Agreement between Inspire Pharmaceuticals, Inc. and Royal Center One IC, LLC for Royal Center One, Durham, North Carolina, dated as of June 28, 2002. (Incorporated by reference to Exhibit 10.32 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
10.24	Underwriting Agreement by and between Inspire Pharmaceuticals, Inc. and Deutsche Bank Securities and U.S. Bancorp Piper Jaffray Inc. dated March 13, 2003. (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed on March 14, 2003).
10.25	Second Amendment To Lease between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC dated as of June 6, 2003. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.26†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.27†	Form of Inspire Pharmaceuticals, Inc. Director Non-Statutory Stock Option Agreement. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.28*	First Amendment to License, Development and Marketing Agreement, dated December 8, 2003, between Inspire Pharmaceuticals, Inc. and Allergan, Inc. and Allergan Sales, LLC and Allergan Pharmaceuticals Holdings (Ireland) Ltd. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 9, 2003).
10.29*	Elestat (Epinastine) Co-Promotion Agreement, entered into as of December 8, 2003, by and between Allergan Sales, LLC and Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 1, 2004).

54

Exhibit Number	Description
10.30†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II, dated May 16, 2003. (Incorporated by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.31	Second Amendment to Sublease and Consent between ICAgen, Inc., Inspire Pharmaceuticals, Inc. and Imperial Center Partnership and Petula Associates, Ltd., dated August 13, 2003 (Incorporated by reference to Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.32	Master Lease Agreement between GE Capital Fleet Services and Inspire Pharmaceuticals, Inc., dated as of November 18, 2003, and related documentation (Incorporated by reference to Exhibit 10.38 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.33	Master Security Agreement between General Electric Capital Corporation and Inspire Pharmaceuticals, Inc., dated as of November 12, 2003, and related documentation (Incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.34	Underwriting Agreement by and among Inspire Pharmaceuticals, Inc. and Morgan Stanley & Co. Incorporated, Deutsche Bank Securities Inc., Piper Jaffray & Co. and SG Cowen & Co., LLC dated July 26, 2004 (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed July 27, 2004).
10.35†	Agreement between Inspire Pharmaceuticals, Inc. and Christy Shaffer, effective as of March 29, 2004, regarding change in control (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.36†	Form of Change in Control Agreement for other executive officers (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.37	Third Amendment to Lease, dated as of August 4, 2004, between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 12, 2004.)
10.38	Fourth Amendment to Lease, dated as of August 4, 2004, between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on August 12, 2004.)
10.39†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between the Company and R. Kim Brazzell, dated August 5, 2004 (Incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2004).
10.40†	Amended and Restated Director Compensation Policy.
10.41†	Agreement between Inspire Pharmaceuticals, Inc. and Barry G. Pea, effective as of October 11, 2004, regarding change in control.
10.42†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Barry G. Pea, dated October 13, 2004.
10.43†	Transition Agreement between Inspire Pharmaceuticals, Inc. and Gregory J. Mossinghoff, dated October 28, 2004.
10.44**	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and the Wisconsin Alumni Research Foundation, effective November 2, 2004.
10.45	Underwriting Agreement, dated November 10, 2004, by and between Inspire Pharmaceuticals, Inc. and Deutsche Bank Securities Inc. (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed November 12, 2004).

55

Exhibit Number	Description
10.46†	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.47†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.48†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Mary B. Bennett (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.49†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Richard M. Evans (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.50†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Donald J. Kellerman (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.51†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Joseph K. Schachle (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.52†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II (Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.53†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa (Incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.54†	Agreement regarding change in control, dated as of August 2, 2004, by and between Inspire Pharmaceuticals, Inc. and R. Kim Brazzell (Incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.55†	Agreement regarding change in control, dated as of October 11, 2004, by and between Inspire Pharmaceuticals, Inc. and Barry G. Pea (Incorporated by reference to Exhibit 10.10 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.56†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement.
23.1	Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm.
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.

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

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

  † Denotes a management contract or compensation plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of this Form 10-K.

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SIGNATURES

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

Inspire Pharmaceuticals, Inc.
By:	/s/    CHRISTY L. SHAFFER
	Christy L. Shaffer Chief Executive Officer and Director
Date: March 11, 2005

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

Signature	Title	Date
/S/    CHRISTY L. SHAFFER         Christy L. Shaffer	Chief Executive Officer (principal executive officer) and Director	March 11, 2005
/S/    THOMAS R. STAAB, II         Thomas R. Staab, II	Chief Financial Officer (principal financial officer and principal accounting officer)	March 11, 2005
/S/    KENNETH B. LEE, JR.         Kenneth B. Lee, Jr.	Chairman of the Board of Directors	March 11, 2005
/S/    KIP A. FREY         Kip A. Frey	Director	March 11, 2005
/S/    RICHARD S. KENT         Richard S. Kent	Director	March 11, 2005
/S/    WILLIAM R. RINGO, JR.         William R. Ringo, Jr.	Director	March 11, 2005

57

INSPIRE PHARMACEUTICALS, INC.

INDEX TO FINANCIAL STATEMENTS

	Page(s)
Report of Independent Registered Public Accounting Firm	F-2
Balance Sheets	F-4
Statements of Operations	F-5
Statements of Cash Flows	F-6
Statements of Stockholders’ Equity	F-7
Notes to Financial Statements	F-8

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

  of Inspire Pharmaceuticals, Inc.:

We have completed an integrated audit of Inspire Pharmaceuticals, Inc.’s 2004 financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Financial statements

In our opinion, the accompanying balance sheets and the related statements of operations, of stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of Inspire Pharmaceuticals, Inc. at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by The Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting

F-2

includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina

March 11, 2005

F-3

INSPIRE PHARMACEUTICALS, INC.

BALANCE SHEETS

(in thousands, except per share amounts)

	December 31,
	2004			2003
Assets
Current assets:
Cash and cash equivalents	$	100,320		$	34,324
Investments		41,426			37,130
Receivables from Allergan		3,501			—
Prepaid expenses and other receivables		1,916			1,389
Other assets		207			207
Total current assets		147,370			73,050
Property and equipment, net		2,678			2,092
Investments		15,050			3,712
Other assets		598			824
Total assets	$	165,696		$	79,678
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	4,367		$	4,003
Accrued expenses		7,955			2,214
Notes payable and capital leases		489			602
Total current liabilities		12,811			6,819
Capital leases – noncurrent		1,392			482
Other long-term liabilities		1,895			1,325
Total liabilities		16,098			8,626
Commitments and contingencies (Notes 7-11)
Stockholders’ equity:
Preferred stock, $0.001 par value, 2,000 shares authorized; no shares issued and outstanding, respectively		—			—
Common stock, $0.001 par value, 60,000 shares authorized; 41,845 and 31,847 shares issued and outstanding, respectively		42			32
Additional paid-in capital		321,189			198,393
Accumulated other comprehensive loss		(470	)		(279	)
Accumulated deficit		(171,163	)		(127,094	)
Total stockholders’ equity		149,598			71,052
Total liabilities and stockholders’ equity	$	165,696		$	79,678

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

F-4

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

	Year Ended December 31,
	2004			2003			2002
Revenues:
Revenues from product co-promotion	$	11,068		$	—		$	—
Collaborative research agreements		—			5,200			4,883
Total revenue		11,068			5,200			4,883
Operating expenses:
Research and development		25,698			27,631			25,229
Selling and marketing		21,848			2,838			60
General and administrative		9,041			7,002			5,091
Total operating expenses		56,587			37,471			30,380
Loss from operations		(45,519	)		(32,271	)		(25,497	)
Other income (expense):
Interest income		1,765			1,262			878
Interest expense		(117	)		(46	)		(74	)
Loss on investments		(198	)		(340	)		—
Other income		1,450			876			804
Net loss	$	(44,069	)	$	(31,395	)	$	(24,693	)
Basic and diluted net loss per common share	$	(1.25	)	$	(1.03	)	$	(0.96	)
Common shares used in computing basic and diluted net loss per common share		35,261			30,526			25,821

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

F-5

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2004			2003			2002
Cash flows from operating activities:
Net loss	$	(44,069	)	$	(31,395	)	$	(24,693	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization expense		207			399			1,073
Depreciation of fixed assets		907			680			633
(Gain)/loss on disposal of property and equipment		(9	)		80			6
Loss on investments		198			340			—
Changes in operating assets and liabilities:
Receivables from Allergan		(3,501	)		—			—
Prepaid expenses and other receivables		(527	)		(553	)		(99	)
Other assets		19			(993	)		(15	)
Accounts payable		364			3,079			(217	)
Accrued expenses		6,311			2,602			(430	)
Deferred revenue		—			(2,200	)		(1,883	)
Net cash used in operating activities		(40,100	)		(27,961	)		(25,625	)
Cash flows from investing activities:
Purchase of investments		(72,978	)		(74,933	)		(12,306	)
Proceeds from sale of investments		56,955			38,487			35,700
Increase in restricted deposits		—			(515	)		—
Purchase of property and equipment		—			(1,193	)		(229	)
Proceeds from sale of property and equipment		61			5			—
Net cash (used) provided by investing activities		(15,962	)		(38,149	)		23,165
Cash flows from financing activities:
Issuance of common stock, net		122,806			73,330			25
Proceeds from notes payable		—			619			—
Payments on notes payable and capital lease obligations		(748	)		(643	)		(396	)
Net cash provided (used) by financing activities		122,058			73,306			(371	)
Increase (decrease) in cash and cash equivalents		65,996			7,196			(2,831	)
Cash and cash equivalents, beginning of period		34,324			27,128			29,959
Cash and cash equivalents, end of period	$	100,320		$	34,324		$	27,128

Supplemental disclosure of non-cash investing and financing activities: The Company made cash payments for interest of $119, $42 and $73 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company acquired property and equipment through the assumption of capital lease obligations amounting to $1,545 and $603 during the years ended December 31, 2004 and 2003, respectively.

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

F-6

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

	Common Stock			Additional Paid-In Capital			Accumulated Deficit			Deferred Compensation			Accumulated Other Comprehensive (Loss)/income			Stockholders’ Equity
	Number of Shares	Amount
Balance at December 31, 2001	25,752	$	26	$	125,099		$	(71,006	)	$	(1,525	)	$	1		$	52,595
Issuance of common stock	103		—		25			—			—			—			25
Forfeiture of common stock options	—		—		(55	)		—			55			—			—
Amortization of deferred compensation	—		—		—			—			1,071			—			1,071
Net loss	—		—		—			(24,693	)		—			—			(24,693	)
Balance at December 31, 2002	25,855		26		125,069			(95,699	)		(399	)		1			28,998
Issuance of common stock	5,992		6		73,324			—			—			—			73,330
Amortization of deferred compensation	—		—		—			—			399			—			399
Unrealized (loss) on investments	—		—		—			—			—			(280	)		(280	)
Net loss	—		—		—			(31,395	)		—			—			(31,395	)
Balance at December 31, 2003	31,847		32		198,393			(127,094	)		—			(279	)		71,052
Issuance of common stock	9,998		10		122,796						—			—			122,806
Unrealized (loss) on investments	—		—		—			—			—			(191	)		(191	)
Net loss	—		—		—			(44,069	)		—			—			(44,069	)
Balance at December 31, 2004	41,845	$	42	$	321,189		$	(171,163	)	$	—		$	(470	)	$	149,598

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

F-7

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS

(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 the initial technology from The University of North Carolina at Chapel Hill (“UNC”). 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 expects it has sufficient liquidity to continue its planned operations beyond 2006, but also expects that additional capital may be required. Continuation of its operations beyond 2006 will require the Company to: (1) obtain product candidate approvals, (2) in-license commercial products, (3) obtain additional co-promotion agreements, and/or (4) raise additional capital through equity or debt financings or from other sources. The Company began receiving revenue from its co-promotion of Elestat^™ and Restasis^® in 2004, but will continue to incur operating losses until co-promotion and/or product revenues reach a level sufficient to support ongoing operations.

2. Summary of Significant Accounting Policies and Concentrations of Risk

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.

Cash, Cash Equivalents, Interest and Other Receivables

The Company considers all highly-liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. The carrying value of cash, cash equivalents, interest and receivables approximate their fair value due to the short-term nature of these items.

Investments

Investments consist primarily of United States government and government agency obligations, money market investments, municipal notes and bonds and asset or mortgage-backed securities. The Company invests in high-credit quality investments in accordance with its investment policy which minimizes the possibility of loss. Investments with original maturities at date of purchase beyond three months and which mature at or less than twelve months from the balance sheet date are classified as current. The Company has investments in auction rate securities which have long-term stated maturities of 20 to 30 years. However, these securities have characteristics of short-term investments due to a rate-setting mechanism and the ability to liquidate these securities through a Dutch auction process that occurs on predetermined intervals of 90 days or less. Accordingly, the Company classifies auction rate securities with these maturity re-set dates within twelve months of the balance sheet date as short-term as this corresponds to management’s intention and the liquid nature of these securities. Generally, investments with a maturity beyond twelve months from the balance sheet date are classified as long-term. Investments are considered to be available-for-sale and are carried at fair value with unrealized gains and losses recognized in other comprehensive income (loss). Realized gains and losses are determined using the specific identification method and transactions are recorded on a settlement date basis. Marketable and non-marketable equity investments are evaluated periodically for impairment. If it is determined that a decline of any investment is other than temporary, then the investment would be written down to fair value and the write-down would be

F-8

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

included in the Company’s operating results as a realized loss. Since the Company’s investment policy requires it to purchase high-quality marketable securities with a maximum individual maturity of three years and requires an average portfolio maturity of no more than one year, the caliber and short-term nature of its marketable securities generally avoid other than temporary impairment.

The Company has an equity investment in Parion Sciences, Inc. (“Parion”), a non-public entity for which its fair value is not readily determinable. For this investment in which the Company does not have significant influence and owns less than 5% of Parion, the investment is carried at cost and is subject to a write-down for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In 2003, the Company wrote-down the value of its investment in Parion and recognized a loss of $300. As of December 31, 2004 and 2003, this investment’s recorded value was $200.

Property and Equipment

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

The carrying values of property and equipment are periodically reviewed to determine if the facts and circumstances suggest that a potential impairment may have occurred. The review includes a determination of the carrying values of assets based on an analysis of undiscounted cash flows over the remaining depreciation period. If the review indicates that carrying values may not be recoverable, the Company will reduce the carrying values to the estimated fair value.

Restricted Deposits

Restricted deposits consist of cash and cash equivalents which collateralize a letter of credit that is required under the terms of a vehicle fleet financing agreement. Restricted deposits are classified as current or long-term based upon the expected release date of such restriction. The carrying amount of these restricted deposits approximates fair value. At December 31, 2004 and 2003, the Company had $515 of restricted deposits.

Intangible Assets

Costs associated with obtaining and maintaining patents on the Company’s product candidates and license initiation and preservation fees, including milestone payments by the Company to its licensors, are evaluated based on the stage of development of the related product candidate and whether the underlying product candidate has an alternative use. Costs of these types incurred for product candidates not yet approved by the U.S. Food and Drug Administration (“FDA”) and for which no alternative use exists are recorded as expense. In the event a product candidate has been approved by the FDA or an alternative use exists for a product candidate, patent and license costs are capitalized and amortized over the expected life of the related product candidate. License milestone payments to the Company’s licensors are recognized when the underlying requirement is met.

Other Assets

During December 2003, the Company recorded a deferred charge associated with an up-front milestone payment made in conjunction with the Elestat^™ co-promotion agreement executed in December 2003. This asset is amortized ratably on a straight-line basis through October 2008, the expected commercial exclusivity period

F-9

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

for Elestat^™ in the United States. At December 31, 2004 and 2003, the Company had $793 and $1,000 of deferred charge associated with the up-front milestone, respectively, and $207 in accumulated amortization at December 31, 2004.

Revenue Recognition

The Company recognizes revenue from product co-promotion based on net sales for Elestat^™ and Restasis^®, as defined in the co-promotion agreements, and as reported to Inspire by its collaborative partner, Allergan, Inc. (“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^™ 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 records a reduced percentage of net sales based upon its level of achievement of predetermined calendar year net sales target levels. Amounts contractually due from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue.

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 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.

Research and Development

Research and development costs include all direct costs and indirect development costs related to the development of the Company’s portfolio of product candidates. These expenses include: salaries for research and development personnel, consulting fees, clinical trial costs, sponsored research costs, clinical trial insurance, license fees and other fees and costs related to the development of product candidates. These costs have been charged to operating expense as incurred. License milestone payments to the Company’s licensors are recognized when the underlying requirement is met.

F-10

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Income Taxes

The Company accounts for income taxes using the liability method which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of the Company’s assets and liabilities and for tax carryforwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. If it is “more likely than not” that some portion, or all of a deferred tax asset will not be realized, a valuation allowance is recorded.

Deferred Compensation and Stock Options and Warrants

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 expense is recorded for employee stock options 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. If stock options are granted with an exercise price below the estimated fair value of the Company’s common stock, the difference is recorded as deferred compensation. The Company did not recognize any deferred compensation associated with stock option grants for the years ended December 31, 2004, 2003, and 2002.

Deferred compensation is amortized over the service period of the related stock option. The Company recognized $0, $399 and $1,071 of stock-based compensation expense related to amortization of deferred compensation during the years ended December 31, 2004, 2003 and 2002, respectively.

Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock – Based Compensation,” (“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. In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R) “Share-Based Payment,” which requires all share-based payments to employees, including any grants of employee stock options, to be recognized in the income statement based on their fair value for interim or annual reporting periods that begin after June 15, 2005. (See “Recent Accounting Pronouncements” below).

The Company has adopted the disclosure requirements of SFAS No. 123, which requires compensation expense be disclosed based on the fair value of the options granted at the date of the grant. 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:

	Year Ended December 31,
	2004			2003			2002
Net loss as reported	$	(44,069	)	$	(31,395	)	$	(24,693	)
Compensation expense included in reported net loss		—			399			1,071
Pro forma adjustment for compensation expense		(9,670	)		(5,764	)		(3,721	)
Net loss —pro forma	$	(53,739	)	$	(36,760	)	$	(27,343	)
Net loss per common share—as reported	$	(1.25	)	$	(1.03	)	$	(0.96	)
Net loss per common share—pro forma	$	(1.52	)	$	(1.20	)	$	(1.06	)

F-11

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

To determine the impact of SFAS No. 123, the fair value of each option grant is estimated on the date of the grant using the Black-Scholes valuation model and the following assumptions:

	Year Ended December 31,
	2004		2003		2002
Expected dividend yield	0	%	0	%	0	%
Expected stock price volatility	110	%	120	%	136	%
Risk free interest rate	3.33	%	3.19	%	3.82	%
Expected life of options	5 years		5 years		5 years

Net Income (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 years ended December 31, 2004, 2003 and 2002 does not include 1,426, 1,624 and 750, respectively, of potential shares of common stock equivalents, as their impact would be antidilutive.

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. At December 31, 2004 and 2003, the Company had a $470 and $279 unrealized loss on its investments, respectively.

Comprehensive loss consists of the following components for the years ended December 31,:

	2004			2003			2002
Net loss	$	(44,069	)	$	(31,395	)	$	(24,693	)
Reclassification adjustment for gains/losses in net loss		198			40			—
Change in unrealized gains/losses on investments		(389	)		(320	)		—
Total comprehensive loss	$	(44,260	)	$	(31,675	)	$	(24,693	)

Advertising

The Company engages in general and direct-response advertising when promoting and marketing Elestat^TM. These advertising costs are expensed as the costs are incurred. Advertising and product promotion expenses were $3,556 and $247 for the years ended December 31, 2004 and 2003, respectively. Advertising costs for the year ended December 31, 2002 were insignificant.

Significant Customers and Risk

All revenues recognized and recorded in 2004 and 2003 were from one collaborative partner. All revenues recognized and recorded in 2002 were from two collaborative partners. The Company is entitled to receive co-promotion revenue on “Net Sales” of Elestat^TM and Restasis^® under the 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.

F-12

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Credit Risk

Cash equivalents and investments are financial instruments which potentially subject the Company to concentration of risk to the extent recorded on the balance sheet. Management of the Company believes it has established guidelines for investment of its excess cash relative to diversification and maturities that maintain safety and liquidity. To minimize the exposure due to adverse shifts in interest rates, the Company currently maintains a portfolio of investments with an average maturity of 12 months or less at December 31, 2004. The Company keeps all of its cash deposits in financial institutions in the United States.

Risks from third party manufacturing concentration

The Company relies on single source manufacturers for each of its products and product candidates. Accordingly, it has little control over the manufacture of products for which it will receive revenue and over the overall product supply chain.

Reclassifications

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

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123(R) (revised 2004, or “SFAS No. 123(R)”), “Share-Based Payment,” a revision of FASB Statement No. 123 “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes APB No. 25, and amends SFAS No. 95, “Statement of Cash Flows.” SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values for all periods that begin after June 15, 2005. Pro forma disclosure will no longer be an alternative. (See “Deferred Compensation and Stock Options and Warrants” above for historic pro forma disclosure.) SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

1. A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date; or

2. A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either for (a) all prior periods presented or (b) prior interim periods of the year of adoption.

The Company intends to adopt SFAS No. 123(R) effective July 1, 2005. As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB No. 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on the Company’s results of operations and its overall financial position. An estimate of the non-cash stock option expense for the last half of 2005, based upon the current number of stock options outstanding and calculated using assumptions and a valuation model consistent with 2004 quarterly filings, is approximately $5 million. However, actual expense may be materially different depending on the valuation model, assumptions and methodologies used in implementing SFAS No. 123(R), as well as the number of unvested stock options outstanding during 2005.

F-13

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

In March 2004, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 03-13 (“EITF 03-13”), “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 (“FASB No. 144”), Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations.” The FASB staff established a working group to assist in the development of a model for evaluating (a) which cash flows are to be considered in determining whether cash flows have been or will be eliminated and (b) what types of continuing involvement constitute significant continuing involvement. The Company has adopted FASB No. 144 and EITF 03-13 and they have not had a material impact on the Company’s financial position, results of operations or cash flows.

In March 2004, the FASB issued EITF Issue No. 03-1 (“EITF 03-1”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” which provided new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 included new disclosure requirements for investments that are deemed to be other-than-temporarily-impaired. The Company has adopted the disclosure requirements of EITF 03-1. In September 2004, the FASB delayed the effective date of application guidance on impairment of securities included within EITF 03-01 and is currently reconsidering conclusions reached in EITF 03-1.

In December 2003, the FASB issued Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities,” which replaces Interpretation No. 46. FIN 46R requires existing unconsolidated variable interest entities (“VIEs”) to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among the parties involved. VIEs that effectively disperse risks will not be consolidated unless a single party holds an interest or combination of interest that effectively recombines risks that were previously dispersed. Application of FIN 46R is required in financial statements of public entities that have interest in VIEs or potential VIEs, commonly referred to as special-purpose entities, for periods after December 31, 2003. Application by public entities for all other types of entities is required in its financial statements for periods ending after March 31, 2004. The Company does not have interests in VIEs. FIN 46R did not have any impact on the Company’s financial position, results of operations or cash flows.

3. Investments

A summary of the fair market value of investments by classification is as follows:

	December 31,
	2004		2003
United States Government and agencies	$	27,432	$	40,127
Auction rate securities		16,500		—
Corporate bonds		11,829		—
Restricted deposits		515		515
Preferred stock		200		200
	$	56,476	$	40,842

Maturities of debt securities at fair market value are as follows:

	December 31,
	2004		2003
Less than one year	$	41,426	$	37,130
Greater than one year		14,335		2,997
	$	55,761	$	40,127

F-14

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Gross realized and unrealized gains and losses on the Company’s “available-for-sale” securities for the years ended December 31, 2004, 2003 and 2002 were not significant.

4. Property and Equipment

Property and equipment consist of the following:

	Useful Life (Years)	December 31,
		2004			2003
Equipment	5	$	3,807		$	3,004
Leasehold improvements	Lesser of lease term or 5 years		1,296			1,066
Computer hardware	3		931			761
Software	5		894			708
Furniture and fixtures	7		763			688
			7,691			6,227
Less—accumulated depreciation			(5,013	)		(4,135	)
Property and equipment, net		$	2,678		$	2,092

Depreciation expense was $907, $680 and $633 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company leases certain assets under capital lease agreements. The net book value of assets under capital leases at December 31, 2004 and 2003 was approximately $1,621 and $677, respectively. Accumulated depreciation for assets under capital leases at December 31, 2004 and 2003 was $583 and $895, respectively.

5. Accrued Expenses

Accrued expenses are comprised of the following:

	December 31,
	2004		2003
Compensation and benefits	$	4,088	$	479
Development costs		1,555		1,112
Selling and Marketing costs		945		—
Duties and taxes		225		215
Other		1,142		408
	$	7,955	$	2,214

The carrying value of accrued expenses approximates fair value because of their short-term maturity.

F-15

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

6. Income Taxes

The Company had no federal, state or foreign income tax expense for the years ended December 31, 2004, 2003 and 2002.

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

	December 31,
	2004			2003
Current deferred tax assets:
Accrued expenses	$	731		$	561
Compensation related items		224			128
Noncurrent deferred tax assets:
Domestic net operating loss carryforwards		59,417			42,828
Research and development credits		10,704			8,520
Fixed and intangible assets		1,817			1,607
Stock-based compensation		1,688			1,689
Contributions		286			220
Total deferred tax assets		74,867			55,553
Valuation allowance for deferred assets		(74,867	)		(55,553	)
Deferred tax assets	$	—		$	—

At December 31, 2004 and 2003, the Company has provided a full valuation allowance against its net deferred tax assets since realization of these benefits could not be reasonably assured. The increase in valuation allowance of $19,314 during the year ended December 31, 2004 resulted primarily from the generation of additional net operating loss carryforwards.

As of December 31, 2004, the Company had federal and state net operating loss carryforwards of $153,253 and $160,530, respectively. The net operating loss carryforwards expire in various amounts starting in 2008 and 2010 for federal and state tax purposes, respectively. The utilization of the federal net operating loss carryforwards may be subject to limitation under the rules regarding a change in stock ownership as determined by the Internal Revenue Code. If the Company’s utilization of its net operating loss carryforwards is limited and the Company has taxable income which exceeds the permissible yearly net operating loss carryforward, the Company would incur a federal income tax liability even though its net operating loss carryforwards exceed its taxable income. Additionally, as of December 31, 2004 and 2003, the Company has federal research and development and orphan drug credit carryforwards of $10,704 and $8,520, respectively. The credit carryforwards expire in varying amounts starting in 2010.

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

	Year Ended December 31,
	2004			2003			2002
United States Federal tax at statutory rate	$	(14,984	)	$	(10,674	)	$	(8,396	)
State taxes (net of Federal benefit)		(2,075	)		(1,439	)		(1,145	)
Change in valuation reserve		19,314			13,290			12,269
Research and development credit		(2,184	)		(2,044	)		(3,033	)
Nondeductible expenses due to credits		140			335			115
Other nondeductible expenses		(211	)		532			190
Provision for income taxes	$	—		$	—		$	—

F-16

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

7. Stockholders’ Equity

Sales of Common Stock

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

In March 2003, the Company sold 5,750 shares of common stock, including the underwriters’ over-allotment allocation, in a public offering at a price of $13.50 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $72,600.

In July 2004, the Company sold 6,900 shares of common stock, including the underwriters’ over-allotment allocation, in a public offering at a price of $12.00 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $77,100. In November 2004, the Company sold 2,530 shares of common stock, including the underwriter’s over-allotment allocation, in a public offering at a price of $17.10 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $42,300.

The holders of common stock shall be entitled to receive dividends from time to time as may be declared by the Board of Directors, but a common stock dividend has never been declared, nor is a dividend payment expected in the near-term. The holders of shares of common stock are entitled to one vote for each share held with respect to all matters voted on by the stockholders of the Company.

Rights Agreement

In October 2002, the Company entered into a Rights Agreement with Computershare Trust Company. The Rights Agreement provides for a dividend of one preferred stock purchase right for each outstanding share of the Company’s common stock. Each right entitles a stockholder, after the rights become exercisable, to buy 1/1,000th of a share of Inspire’s Series H Preferred Stock at an exercise price of $50. Each right will become exercisable following the tenth day after an acquiring person or group acquires, or announces its intention to acquire, 15% or more of the common stock. The Company will be entitled to redeem the rights at $0.001 per right at any time on or before the close of business on the tenth day following acquisition by a person or group of 15% or more of the common stock. Under the Rights Agreement, if a person acquires 15% or more of the common stock without the approval of the Company’s Board of Directors, all other stockholders will have the right to purchase securities from Inspire at a price that is less than its fair market value, which would substantially reduce the value of the common stock owned by the acquiring person. As a result, the rights will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company’s Board of Directors, except pursuant to an offer conditioned on a substantial number of Rights being acquired. The rights should not interfere with any merger or other business combination approved by the Board of Directors since the rights may be redeemed by the Company at the redemption price of $0.001 prior to the occurrence of a distribution date.

F-17

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

8. Options and Warrants

Options

During 1995, the Company adopted the 1995 Stock Plan, which provided for the grant of up to 1,006 options to directors, officers, employees and consultants. In April 1999, the Plan was amended and restated, and is now the Amended and Restated 1995 Stock Plan, as amended (the “Plan”). The option pool was increased to 5,229 shares on September 28, 2001, to 6,429 shares on December 14, 2001 and to 7,179 on June 10, 2004. Under the Plan, both incentive and non-qualified stock options, as well as restricted stock, may be granted. The Board of Directors, or an appropriate committee of the Board of Directors, shall determine the terms, including exercise price and vesting schedule, of all options at their grant date, provided that for incentive stock options, such exercise price shall not be less than the fair market value of the Company’s stock on the date of grant. At December 31, 2004, there were 473 options available for grant under the Plan.

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

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

	Number of Shares		Weighted Average Exercise Price (per share)
Options outstanding, December 31, 2001	2,354		$	6.931
Granted	970			3.379
Exercised	(103	)		(0.240	)
Forfeited	(96	)		(8.947	)
Options outstanding, December 31, 2002	3,125			5.985
Granted	1,443			17.386
Exercised	(237	)		(2.985	)
Forfeited	(118	)		(4.960	)
Options outstanding, December 31, 2003	4,213			10.092
Granted	1,227			14.447
Exercised	(308	)		(4.472	)
Forfeited	(218	)		(12.574	)
Options outstanding, December 31, 2004	4,914		$	11.422

F-18

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

The following table summarizes information concerning options outstanding at December 31, 2004:

	Options Outstanding	Weighted Average Exercise Price (per share)		Weighted Average Remaining Contractual Life (in Years)	Options Exercisable
Exercise Price range (per share):
$   0.123 - $   2.760	936	$	1.308	5.84	759
$   3.960 - $ 12.000	1,177		8.368	6.48	896
$ 12.250 - $ 13.650	912		13.111	8.09	365
$ 13.980 - $ 16.760	831		15.681	9.24	168
$ 16.860 - $ 20.000	792		18.514	8.75	248
$ 20.300 - $ 20.300	266		20.300	8.79	78
	4,914	$	11.422	7.61	2,514

The weighted average exercise price (per share) of options granted during 2004, 2003 and 2002 was $14.447, $17.386 and $3.379, respectively.

SFAS No. 123, “Accounting for Stock-Based Compensation” requires the Company to disclose pro forma information regarding option grants made and warrants issued to its employees. See Note 2, “Summary of Significant Accounting Policies and Concentrations of Risk.”

Common Stock Warrants

In connection with a collaboration agreement entered into with Genentech, Inc. (“Genentech”) on December 17, 1999, the Company issued warrants to purchase shares of common stock at an exercise price of $7.88 per share, of which 254 were exercised on December 17, 2004 and the remainder expire on October 2, 2005. As of December 31, 2004 and 2003, a total of 25 and 285 warrants, respectively, were outstanding. During 2004 and 2003, 260 and 5 warrants, respectively, were exercised for shares of common stock.

9. Collaboration Agreements

On September 10, 1998, the Company entered into a Joint Development, License and Supply Agreement (the “Kissei Agreement”) with Kissei Pharmaceutical Co. Ltd. (“Kissei”) related to the development of INS365 Respiratory for all therapeutic respiratory applications, excluding sinusitis and middle ear infection, in Japan. Upon signing of the Kissei Agreement, Kissei purchased shares of the Company’s preferred stock for $900 and the Company received a non-refundable up-front license fee of $3,600. The Company recognized this collaborative research revenue over the term of its research and development commitment, which ended in November 2002 as a result of the termination of the agreement. Upon termination of the agreement, Kissei returned all rights to INS365 Respiratory back to the Company.

On December 16, 1998, the Company entered into a Development, License and Supply Agreement (the “Santen Agreement”) with Santen Pharmaceutical Co., Ltd. (“Santen”) to complete the development of diquafosol for the therapeutic treatment of ocular surface diseases. Santen received an exclusive license to develop and commercialize diquafosol in Japan, China, South Korea, the Philippines, Thailand, Vietnam, Taiwan, Singapore, Malaysia and Indonesia in the field. The Company retains the right to manufacture and supply diquafosol in bulk drug substance form to Santen.

F-19

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Under the terms of the Santen agreement, Inspire has received a total of $2,000 in equity and non-refundable milestone payments. Depending on whether all milestones under the Santen Agreement are met, the Company could receive milestone payments of up to $4,750. As of December 31, 2004, the Company had received $500 of these contingent development milestones. In addition, the Company will receive royalties on net sales of diquafosol by Santen, if any. No milestone payments were received under the Santen Agreement during 2004, 2003 or 2002.

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

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

Upon signing of the agreement, Genentech paid a non-refundable, non-creditable up-front payment of $5,000, purchased shares of preferred stock for $10,000 and was issued warrants. The Company recognized the $5,000 payment as collaborative research revenue over the term of the Company’s research and development commitment, which ended in November 2001 as a result of the termination of the agreement. On December 20, 2000, upon achievement of a technical milestone, the Company sold shares of common stock to Genentech and issued additional warrants. Genentech returned all rights for use of INS365 Respiratory and other related P2Y₂ agonists back to the Company at no charge upon termination of the agreement.

On September 12, 2000, the Company entered into a License Agreement (the “Kirin Agreement”) with Kirin Brewery Co., Ltd., Pharmaceutical Division (“Kirin”) to complete the development and commercialization of INS316 Diagnostic to aid in the diagnosis of lung cancer. Upon the signing of the Kirin Agreement, the Company received a $2,000 non-refundable up-front license fee which the Company recognized as collaborative research revenue over the term of the Company’s research and development commitment. Kirin terminated the agreement in September 2004.

In June 2001, the Company entered into a Joint License, Development and Marketing Agreement with Allergan to develop and commercialize diquafosol and granted the right to co-promote Allergan’s Restasis^®. This agreement was amended in December 2003, in connection with the execution of the Elestat^TM co-promotion agreement to reduce the co-promotion revenue rates due on net sales of Restasis^®. Under the terms of the amended agreement, Allergan obtained an exclusive license to develop and commercialize diquafosol worldwide, with the exception of Japan and nine other Asian countries covered by Inspire’s agreement with Santen. In return, Inspire received an up-front payment of $5,000 on execution of the agreement and has received $6,000 in milestone payments. Inspire can also receive up to an additional $28,000 in milestone payments assuming the successful completion of all the remaining milestones. The Company will also receive co-promotion revenue from Allergan on sales of diquafosol, if any, and on worldwide sales of Allergan’s Restasis^®, excluding most larger Asian markets. The Company began receiving co-promotion revenue on net sales of Restasis^® in April 2004.

F-20

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

The Company is responsible for conducting, in collaboration with Allergan, the Phase 3 clinical trials for diquafosol for dry eye disease and for United States New Drug Application filing and potential approval. Allergan is responsible for all other development activities under the agreement, including all development outside the United States and in its territories, and for ex-United States regulatory submissions, filings, and approvals relating to products. In addition, all development costs associated with a potential corneal wound healing indication for diquafosol are solely the Company’s responsibility until such time, if any, that it receives an NDA approval of diquafosol. Allergan is responsible for all commercial costs except for the cost of Inspire’s sales force in the United States. Allergan is required to use commercially reasonable efforts to conduct development, seek regulatory approvals and market and sell the products. The agreement will be in effect until all patents licensed under the agreement have expired, unless terminated earlier.

In October 2002, the Company entered into a study funding agreement with the Cystic Fibrosis Foundation Therapeutics, Inc. (“CFFT”), whereby the majority of the expenses for one Phase 2 INS37217 Respiratory proof-of-concept clinical trial were funded by the CFFT, but the Company also recorded the corresponding expenses and liabilities as the CFFT incurred these costs. This clinical trial was completed in 2004. If the Company receives FDA approval for INS37217 Respiratory for the treatment of cystic fibrosis, the Company will be obligated to pay a development milestone, and possibly a sales milestone, to the CFFT. The aggregate milestones under this agreement are approximately $16,000. As of December 31, 2004, and 2003, the Company has recorded $1,895 and $1,325 of contingent liabilities, respectively, in “Other long-term liabilities” associated with this agreement. If it does not receive FDA approval, the Company will have no financial obligation to the CFFT, including the Phase 2 clinical trial costs the CFFT funded on the Company’s behalf.

In December 2003, the Company entered into an agreement with Allergan to co-promote Elestat^™ to ophthalmologists, optometrists and allergists in the United States. Elestat^™ was approved by the FDA in October 2003 for the prevention of itching associated with allergic conjunctivitis. Inspire has the primary responsibility for selling, promotional and marketing activities of Elestat^™ in the United States and is responsible for the associated costs. Allergan records sales of Elestat^™ and remains responsible for all other product costs. Allergan retains the licensing rights relating to promotion of Elestat^™ to U.S. prescribers other than ophthalmologists, optometrists and allergists; but the Company has a right of first refusal to obtain such rights in the event Allergan decides to engage a third party to undertake such activities. Under the terms of the agreement, Inspire paid Allergan an up-front payment and Allergan pays co-promotion revenue to Inspire on U.S. net sales of Elestat^™, except in the event that a third party is engaged by Allergan to promote Elestat^™ to prescribers outside Inspire’s field, in which case Inspire will be paid a proportionate share of U.S. net sales of Elestat^™ based upon filled prescriptions written by ophthalmologists, optometrists and allergists. The Company began receiving co-promotion revenue on sales of Elestat^™ in February 2004.

10. License Agreements

On March 10, 1995, the Company licensed the rights to the patent for a Method of Treating Lung Disease with Uridine Triphosphates which covers INS316 Diagnostic from UNC. In connection with this license agreement, the Company paid $65 in license initiation fees and issued 298 shares of common stock with an estimated value at the date of issuance of $36 or $0.12 per share and has agreed to make milestone payments totaling up to $1,000. As of December 31, 2004, the Company has paid $500 of these contingent milestones. A $10 license preservation payment was made during each of 2004, 2003 and 2002.

On September 1, 1998, the Company licensed the rights to the patents for a Method of Treating Cystic Fibrosis with Dinucleotides, a Method of Treating Bronchitis with Uridine Triphosphates and related compounds, and a Method of Treating Ciliary Dyskinesia with Uridine Triphosphates and related compounds, which cover

F-21

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

INS365 Respiratory, from UNC. In connection with this license agreement, the Company paid $15 in license initiation fees and issued 29 shares of common stock with an estimated value at the date of issuance of $90 or $3.15 per share and has agreed to pay milestone payments totaling $160. The Company has made license preservation payments of $5 in 2004, 2003 and 2002.

In January 2002, the Company licensed the rights to the patent for Composition and Method for Initiating Platelet Aggregation from UNC. In connection with this license agreement, the Company paid $25 in license initiation fees and has agreed to pay milestone payments totaling $50.

If the Company fails to meet performance milestones relating to the timing of regulatory filings or pay the minimum annual payments under its respective UNC licenses, UNC may terminate the applicable license. In connection with the license agreements with UNC, the Company has agreed to pay royalties based on net sales of certain Licensed Products (as defined in the license agreements). The Company enters into sponsored research and development and clinical trial agreements with UNC on an annual basis whereby direct and indirect costs, as defined, are reimbursed by the Company.

On November 2, 2004, the Company executed an exclusive license agreement with the Wisconsin Alumni Research Foundation (“WARF”) under which WARF granted the Company an exclusive license under several patents, including three U.S. patents, for use in developing and commercializing new treatments for glaucoma. Under the terms of the agreement, Inspire will design and fund all future research, development, testing, regulatory filings and potential marketing activities related to any product developed from the license. Inspire has paid WARF an upfront licensing payment of $150, and will pay additional contingent payments of up to an aggregate of $1,800 upon the achievement of development milestones, and royalties on sales of any regulatory approved product utilizing the licensed patents. Unless terminated earlier, the agreement will expire on a country-by-country basis upon the expiration of the patents in such country. If the Company fails to pay the minimum annual payments under its license or commits any material breach of any other material covenant, as defined in the agreement, and fails to remedy such breach within 90 days of written notice, WARF may terminate the applicable license.

11. Debt and other Commitments

The Company is obligated under master capital lease agreements for furniture, equipment, and computers, for which the underlying furniture, equipment and computers serve as collateral. The lease terms under these master lease agreements expire 48 months from the date of inception and have interest rates ranging from 8.2% to 9.6%. The Company also has operating leases for vehicles, facilities and office equipment that extend through January 2009 and are subject to voluntary renewal options.

In addition, the vehicle lease agreement requires the Company to maintain a Standby Letter of Credit in the amount of $515 during the term of the lease for which an equivalent amount of the Company’s cash and investments are held in a restricted account. The vehicle lease agreement also requires that the vehicles under lease serve as collateral for the obligation. Maintenance of the Standby Letter of Credit is subject to an annual review and, when necessary, the amount is subject to adjustment based on the obligation outstanding and the Company’s financial position and operating results.

On August 25, 2003, the Company entered into a short-term financing agreement with a financial institution to finance certain insurance policy premiums, whereby $619 was financed for nine months at an annual percentage rate of 3.75%.

F-22

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Facility rent expense for operating leases during 2004, 2003 and 2002 was $489, $363 and, $376, respectively.

Future minimum lease payments under capital and non-cancelable operating leases with remaining lease payments as of December 31, 2004 are as follows:

Year Ending December 31,	Capital Leases		Operating Leases
2005	$	636	$	887
2006		641		648
2007		641		71
Thereafter		276		22
Total minimum lease payments		2,194	$	1,628
Less amount representing interest		313
Present value of net minimum capital lease payments		1,881
Less current portion of capital lease obligations		489
Capital lease obligations, excluding current portion	$	1,392

The carrying value of the Company’s debt obligations at December 31, 2004 and 2003 approximate their fair value as the interest rates on these obligations approximate rates available in the financial market at such dates.

The Company enters into contractual commitments or purchase arrangements with various clinical research organizations, manufacturers of active pharmaceutical ingredients and/or drug product as well as with others. The amount of these financial commitments totaled approximately $6,306 at December 31, 2004. In addition, the Company has other contractual commitments outside of drug development under arrangements which totaled approximately $1,272 at December 31, 2004. These amounts may vary dependent upon the results of underlying studies, the completion of studies and/or projects and certain other variable components that may yield a result that differs from management’s estimate. As of December 31, 2004, the Company’s existing license, collaboration and sponsored research agreements require future cash payments upon the achievement of future milestones. In the aggregate, these agreements require payments of up to $14,450 assuming the achievement of all development milestones and up to $4,000 assuming the achievement of all sales milestones. Amounts payable by the Company under these agreements are uncertain and are contingent on a number of factors, including the progress of its discovery and drug development programs, its ability to obtain regulatory approvals, and the commercial success of its approved products. Additionally, the Company is obligated to pay royalties on net sales, if any, of certain product candidates currently in its portfolio. Some of the Company’s license agreements require minimum annual license preservation fees.

12. Employee Benefit Plan

The Company has adopted a 401(k) Profit Sharing Plan (“the 401(k) Plan”) covering all qualified employees on August 1, 1995. Participants may elect a salary reduction of 1% or more up to the IRS allowed maximum as a tax-deferred contribution to the 401(k) Plan. The 401(k) Plan permits discretionary employer contributions. If employer discretionary contributions are implemented, participants will begin vesting 100% immediately in such contributions. In 2004, 2003 and 2002, the Company elected a safe harbor contribution at 3.0% of annual compensation. These safe harbor contributions total $455, $231 and $149 for the years ended December 31, 2004, 2003 and 2002, respectively.

F-23

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

13. Co-promotion Revenue by Product Line

The Company operates its business as one business segment. The Company derives all of its Elestat^™ co-promotion revenue from product sales in the United States and predominantly all of its Restasis^® co-promotion revenue from product sales in the United States.

	Year Ended December 31,
	2004		2003		2002
Elestat™	$	9,586	$	—	$	—
Restasis®		1,482		—		—
	$	11,068	$	—	$	—

14. Quarterly Financial Data (unaudited)

2004	First			Second			Third			Fourth			Total
Revenue	$	609		$	2,948		$	3,791		$	3,720		$	11,068
Net loss available to common stockholders		(12,428	)		(9,692	)		(10,150	)		(11,799	)		(44,069	)
Net loss per common share—basic and diluted	$	(0.39	)	$	(0.30	)	$	(0.28	)	$	(0.29	)	$	(1.25	)
2003	First			Second			Third			Fourth			Total
Revenue	$	1,100		$	4,100		$	—		$	—		$	5,200
Net loss available to common stockholders		(7,747	)		(6,618	)		(7,942	)		(9,088	)		(31,395	)
Net loss per common share—basic and diluted	$	(0.29	)	$	(0.21	)	$	(0.25	)	$	(0.29	)	$	(1.03	)

15. Subsequent Events

On February 9, 2005, the Company announced results of a Phase 3 clinical trial of diquafosol for treatment of dry eye disease. In that clinical trial (109), diquafosol failed to demonstrate statistically significant improvement as compared to placebo for the primary endpoint of the incidence of corneal clearing. Improvement compared to placebo was achieved for a number of secondary endpoints. The Company has held preliminary discussions with the FDA concerning the mixed findings and the next steps in the development plan for diquafosol. Based on these discussions, the Company intends to file an amendment to its New Drug Application for diquafosol by the end of the second quarter of 2005.

On February 15, 2005, a purported class action complaint was filed in the United States District Court for the Middle District of North Carolina by Mirco Investors, LLC on behalf of itself and all other similarly situated investors against the Company and certain of its senior officers. The complaint alleges violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focuses on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of the Company’s dry eye product candidate, diquafosol. The plaintiffs seek unspecified damages on behalf of a purported class of purchasers of Inspire’s securities during the period from June 2, 2004 through February 8, 2005. On February 16, 2005, a similar complaint against the same defendants was filed by Richard and Susan Giorgino. In addition, on March 4, 2005, a similar complaint against the same defendants was filed by Kiah Sai Tan. It is possible that additional complaints may be filed in the future. The Company expects that these individual lawsuits will be consolidated into a single civil action. The Company intends to defend the litigation vigorously. As with any legal proceeding, it is difficult to predict the eventual outcome of pending lawsuits; however, an unfavorable resolution of these matters could materially affect the Company’s business, future results of operations, financial position and/or cash flows.

On February 11, 2005, the Company’s Chairman, W. Leigh Thompson, M.D., Ph.D., D.Sc., passed away following a chronic illness. Kenneth B. Lee, Jr. was subsequently appointed as Chairman of the Board on February 17, 2005.

F-24

Exhibit Index

Exhibit Number	Description
3.1	Amended and Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
3.2	Certificate of Amendment of Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K filed March 26, 2002).
3.3	Certificate of Designations 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 March 7, 2003).
3.4	Amended and Restated Bylaws, as adopted March 30, 2004. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 15, 2004).
4.1	Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
4.2	Rights Agreement, dated as of October 21, 2002, between the Company and Computershare Trust Company, which includes the form of Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. as Exhibit “A”, the form of Rights Certificate as Exhibit “B” and the Summary of Rights to Purchase Preferred Stock as Exhibit “C” (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 22, 2002).
10.1†	Amended and Restated 1995 Stock Plan, as amended. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.2†	Form of Incentive Stock Option. (Incorporated by reference to Exhibit 10.2 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.3†	Form of Non-statutory Stock Option. (Incorporated by reference to Exhibit 10.3 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.4*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and The University of North Carolina at Chapel Hill, dated March 10, 1995. (Incorporated by reference to Exhibit 10.7 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.5	Lease between Inspire Pharmaceuticals, Inc. and Imperial Center, Limited Partnership regarding Royal Center I, Durham, North Carolina, dated as of May 17, 1995, as amended. (Incorporated by reference to Exhibit 10.8 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.6	Lease Agreement between Inspire Pharmaceuticals, Inc. and Petula Associates Ltd. regarding Royal Center II, Durham, North Carolina, dated as of December 30, 1997. (Incorporated by reference to Exhibit 10.10 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.7	Sublease Agreement between ICAgen, Inc. and Inspire Pharmaceuticals, Inc. regarding premises located at 4222 Emperor Boulevard, Suite 500, Durham, North Carolina, dated September 22, 1997 and extension of Sublease Agreement dated February 14, 2000. (Incorporated by reference to Exhibit 10.11 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).

Exhibit Number	Description
10.8*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and The University of North Carolina at Chapel Hill, dated September 1, 1998. (Incorporated by reference to Exhibit 10.12 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.9*	Development, License and Supply Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.15 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.10	Registration Rights Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.16 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.11	Warrant Agreement between Inspire Pharmaceuticals, Inc. and Genentech, Inc., dated as of December 17, 1999. (Incorporated by reference to Exhibit 10.22 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.12	Amended and Restated Investors’ Rights Agreement among Inspire Pharmaceuticals, Inc. and the holders of Series A, B, E and G Preferred Stock of the Company dated as of December 17, 1999. (Incorporated by reference to Exhibit 10.23 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.13†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Donald Kellerman dated February 3, 2000. (Incorporated by reference to Exhibit 10.24 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.14†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Gregory J. Mossinghoff dated February 4, 2000. (Incorporated by reference to Exhibit 10.25 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.15†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa dated February 4, 2000. (Incorporated by reference to Exhibit 10.26 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.16†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer dated February 10, 2000. (Incorporated by reference to Exhibit 10.28 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.17†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Richard M. Evans dated February 10, 2000. (Incorporated by reference to Exhibit 10.30 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.18†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Mary Bennett dated February 27, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2001).
10.19†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph Schachle dated April 3, 2001. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2001).

Exhibit Number	Description
10.20*	License, Development and Marketing Agreement between Inspire Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 29, 2001).
10.21*	Study Funding Agreement, dated as of October 3, 2002, between Inspire Pharmaceuticals, Inc. and The Cystic Fibrosis Foundation Therapeutics, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 4, 2002).
10.22	First Amendment to Lease Agreement between Inspire Pharmaceuticals, Inc. and Royal Center Two IC, LLC for Royal Center Two, Durham, North Carolina, dated as of June 28, 2002. (Incorporated by reference to Exhibit 10.31 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
10.23	Third Amendment to Lease Agreement between Inspire Pharmaceuticals, Inc. and Royal Center One IC, LLC for Royal Center One, Durham, North Carolina, dated as of June 28, 2002. (Incorporated by reference to Exhibit 10.32 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
10.24	Underwriting Agreement by and between Inspire Pharmaceuticals, Inc. and Deutsche Bank Securities and U.S. Bancorp Piper Jaffray Inc. dated March 13, 2003. (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed on March 14, 2003).
10.25	Second Amendment To Lease between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC dated as of June 6, 2003. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.26†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.27†	Form of Inspire Pharmaceuticals, Inc. Director Non-Statutory Stock Option Agreement. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.28*	First Amendment to License, Development and Marketing Agreement, dated December 8, 2003, between Inspire Pharmaceuticals, Inc. and Allergan, Inc. and Allergan Sales, LLC and Allergan Pharmaceuticals Holdings (Ireland) Ltd. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 9, 2003).
10.29*	Elestat (Epinastine) Co-Promotion Agreement, entered into as of December 8, 2003, by and between Allergan Sales, LLC and Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 1, 2004).
10.30†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II, dated May 16, 2003. (Incorporated by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.31	Second Amendment to Sublease and Consent between ICAgen, Inc., Inspire Pharmaceuticals, Inc. and Imperial Center Partnership and Petula Associates, Ltd., dated August 13, 2003 (Incorporated by reference to Exhibit 10.36 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.32	Master Lease Agreement between GE Capital Fleet Services and Inspire Pharmaceuticals, Inc., dated as of November 18, 2003, and related documentation (Incorporated by reference to Exhibit 10.38 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.33	Master Security Agreement between General Electric Capital Corporation and Inspire Pharmaceuticals, Inc., dated as of November 12, 2003, and related documentation (Incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K filed March 12, 2004).

Exhibit Number	Description
10.34	Underwriting Agreement by and among Inspire Pharmaceuticals, Inc. and Morgan Stanley & Co. Incorporated, Deutsche Bank Securities Inc., Piper Jaffray & Co. and SG Cowen & Co., LLC dated July 26, 2004 (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed July 27, 2004).
10.35†	Agreement between Inspire Pharmaceuticals, Inc. and Christy Shaffer, effective as of March 29, 2004, regarding change in control (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.36†	Form of Change in Control Agreement for other executive officers (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2004).
10.37	Third Amendment to Lease, dated as of August 4, 2004, between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 12, 2004.)
10.38	Fourth Amendment to Lease, dated as of August 4, 2004, between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on August 12, 2004.)
10.39†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between the Company and R. Kim Brazzell, dated August 5, 2004 (Incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2004).
10.40†	Amended and Restated Director Compensation Policy.
10.41†	Agreement between Inspire Pharmaceuticals, Inc. and Barry G. Pea, effective as of October 11, 2004, regarding change in control.
10.42†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Barry G. Pea, dated October 13, 2004.
10.43†	Transition Agreement between Inspire Pharmaceuticals, Inc. and Gregory J. Mossinghoff, dated October 28, 2004.
10.44**	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and the Wisconsin Alumni Research Foundation, effective November 2, 2004.
10.45	Underwriting Agreement, dated November 10, 2004, by and between Inspire Pharmaceuticals, Inc. and Deutsche Bank Securities Inc. (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed November 12, 2004).
10.46†	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.47†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.48†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Mary B. Bennett (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.49†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Richard M. Evans (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.50†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Donald J. Kellerman (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed January 31, 2005).

Exhibit Number	Description
10.51†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Joseph K. Schachle (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.52†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II (Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.53†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa (Incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.54†	Agreement regarding change in control, dated as of August 2, 2004, by and between Inspire Pharmaceuticals, Inc. and R. Kim Brazzell (Incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.55†	Agreement regarding change in control, dated as of October 11, 2004, by and between Inspire Pharmaceuticals, Inc. and Barry G. Pea (Incorporated by reference to Exhibit 10.10 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.56†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement.
23.1	Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm.
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.

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

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

  † Denotes a management contract or compensation plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of this Form 10-K.

EX-10.40

EXHIBIT 10.40

INSPIRE PHARMACEUTICALS, INC.

AMENDED AND RESTATED

DIRECTOR COMPENSATION POLICY

ADOPTED: September 28, 2004

A. Directors. All non-employee members of the Inspire Pharmaceuticals, Inc. (the “Company”) board of directors (the “Board”) shall receive the following compensation pursuant to the Amended and Restated Director Compensation Policy (this “Policy”):

1) Cash compensation of $25,000 annually to cover general availability and participation in meetings and conference calls of the Board;

2) A stock option grant in the amount of 20,000 shares will be granted to each director upon election at an annual meeting of stockholders to a three-year term, which will vest as follows: 10,000 shares in year one (1/12^th per month), 5,000 shares in year two (1/12^th per month) and 5,000 shares in year three (1/12^th per month); provided, however, that all vesting will cease if the director resigns from the Board or otherwise ceases to serve as director, unless the Board determines that the circumstances warrant continuation of vesting;

3) A stock option grant in the amount of 10,000 shares will be granted to each director serving as such at the time of each annual meeting of stockholders who was not elected at such annual meeting, which grant will be made at the time of such annual meeting (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the Board or otherwise ceases to serve as a director, unless the Board determines that the circumstances warrant continuation of vesting; and

4) Cash compensation of $3,500 per day, plus reasonable out-of-pocket travel expenses, to cover preparation for, attendance at and participation in the meetings, seminars and other events comprising the Company’s “Science Day”, including any follow-up discussions relating to the issues discussed at the Science Day (it being understood that such compensation shall be paid only to those directors that attend a Science Day and that the events constituting a Science Day may take place over a period of time covering up to 48 hours).

B. Audit Committee. In addition to the compensation provided under any other provision of this Policy, all non-employee directors who serve on the Audit Committee will receive the following compensation:

1) Cash compensation of $10,000 annually to cover general availability and participation in Audit Committee conference calls and meetings; and

2) Stock option grants in the amount of 4,000 shares will be granted to each director appointed at each annual meeting of the Board of Directors to serve on the Audit Committee (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the Audit Committee or otherwise ceases to serve as an Audit Committee member (including without limitation as a result of a committee member’s term expiring without re-election), unless the Board determines that the circumstances warrant continuation of vesting.

C. Compensation Committee. In addition to the compensation provided under any other provision of this Policy, all non-employee directors who serve on the Compensation Committee will also receive the following compensation:

1) Cash compensation of $5,000 annually to cover general availability and participation in Compensation Committee conference calls and meetings; and

2) Stock option grants in the amount of 2,000 shares will be granted to each director appointed at each annual meeting of the Board of Directors to serve on the Compensation Committee (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the Compensation Committee or otherwise ceases to serve as a Compensation Committee member (including without limitation as a result of a committee member’s term expiring without re-election), unless the Board otherwise determines that the circumstances warrant continuation of vesting.

D. Corporate Governance Committee. In addition to the compensation provided under any other provision of this Policy, all non-employee directors who serve on the Corporate Governance Committee will also receive the following compensation:

1) Cash compensation of $5,000 annually to cover general availability and participation in Corporate Governance Committee conference calls and meetings; and

2) Stock option grants in the amount of 2,000 shares will be granted to each director appointed at each annual meeting of the Board of Directors to serve on the Corporate Governance Committee (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the Corporate Governance Committee or otherwise ceases to serve as a Corporate Governance Committee member (including without limitation as a result of a committee member’s term expiring without re-election), unless the Board otherwise determines that the circumstances warrant continuation of vesting.

E. Chairman of the Board. In addition to the compensation provided under any other provision of this Policy, the director who serves as the Chairman of the Board will receive the following compensation:

1) Cash compensation of $25,000 annually to cover general availability for consultations and communications with the Company’s senior management, and to work closely with the Chief Executive Officer of the Company on key matters affecting the Company; and

2) Stock option grants in the amount of 4,000 shares will be granted to the director appointed at each annual meeting of the Board of Directors to serve as Chairman of the Board (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the position of Chairman of the Board or otherwise ceases to serve as the Chairman of the Board (including without limitation as a result of the director’s term expiring without re-election), unless the Board otherwise determines that the circumstances warrant continuation of vesting.

F. Vice-Chairman of the Board. In addition to the compensation provided under any other provision of this Policy, the director who serves as the Vice-Chairman of the Board will also receive the following compensation:

1) Cash compensation of $5,000 annually to cover general availability for consultations and communications with the Company’s senior management, and to work closely with the Chairman of the Board and Chief Executive Officer of the Company on key matters affecting the Company; and

2) Stock option grants in the amount of 2,000 shares will be granted to the director appointed at each annual meeting of the Board of Directors to serve as Vice-Chairman of the Board (to vest 1/12^th per month); provided, however, that all vesting will cease if the director resigns from the position of Vice-Chairman of the Board or otherwise ceases to serve as the Vice-Chairman of the Board (including without limitation as a result of the director’s term expiring without re-election), unless the Board otherwise determines that the circumstances warrant continuation of vesting.

G. Vacancies. In the event that a director is appointed to fill a vacancy on the Board, any Committee of the Board, as Chairman of the Board or as Vice-Chairman of the Board, the Board will determine the amount of cash compensation and stock option grants appropriate to provide such director with comparable compensation for the period such director will so serve for the remainder of the term.

H. Payment/Grant Procedure. All cash compensation payments made pursuant to this Policy shall be paid quarterly in arrears as soon as practicable, but not later than 10 days, after the last day of such quarter.

All stock options awarded pursuant to this Policy (other than options granted pursuant to Paragraph G) shall be granted on the date of the annual meeting of the Board of Directors, and the exercise price for each share available under such option will be equal to the fair market value of the common stock of the Company, par value of $.001 per share (the “Common Stock”), on the date of such grant. All stock options awarded pursuant to Paragraph G of this Policy shall be granted on the date of such appointment, and the exercise price for each share available under such option will be equal to the fair market value of the Common Stock, on the date of such grant.

I. Effective Date. All cash compensation provisions of this Policy shall be effective as of April 1, 2004.

All Stock option grant provisions of this Policy shall be effective for directors elected or serving as of the annual meeting of stockholders to be held in 2004, or appointed to a Committee or as Chairman of the Board or Vice-Chairman of the Board at the annual meeting of the Board of Directors to be held in 2004.

J. Change of Control Provisions. Notwithstanding the foregoing, all options granted under this Policy shall vest immediately if: (i) there is a Change of Control (as hereinafter defined); and (ii) the optionee will cease to serve as a director of the Company as a result of such Change of Control.

For purposes of this Policy, a “Change of Control” shall mean: (i) a dissolution or liquidation of the Company; (ii) a sale of all or substantially all the assets of the Company; (iii) a merger or consolidation in which the Company is not the surviving corporation and in which beneficial ownership of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of directors has changed; (iv) a reverse merger in which the Company is the surviving corporation but the shares of the common stock of the Company outstanding immediately before the merger are converted by virtue of the merger into other property, whether in the form of securities, cash or otherwise, and in which beneficial ownership of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of directors has changed; or (v) an acquisition by any person, entity or group within the meaning of Section 13(d) or 14(d) of the Exchange Act, or any comparable successor provisions (excluding any employee benefit plan, or related trust, sponsored or maintained by the Company or subsidiary of the Company or other entity controlled by the Company) resulting in a change of the beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act, or comparable successor rule) of securities of the Company representing at least fifty percent (50%) of the combined voting power entitled to vote in the election of directors.

EX-10.41

Exhibit 10.41

AGREEMENT

THIS AGREEMENT, dated as of October 11, 2004, is made by and between Inspire Pharmaceuticals, Inc., a Delaware corporation (the “Company”), and Barry G. Pea (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 October 11, 2004 and shall continue in effect through October 11, 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 April 11 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 April 11; 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 eighteen (18) 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 eighteen (18) 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

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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 one and one-half (1.5) 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 eighteen (18) 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 eighteen (18) 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

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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 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;

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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

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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.

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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.

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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.

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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.

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(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).

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(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;

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(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.

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(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 Amended and Restated 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/ Christy L. Shaffer
Name:	Christy L. Shaffer
Title:	CEO

/s/ Barry G. Pea

Executive

Executed on October 11, 2004

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EX-10.42

EXHIBIT 10.42

EMPLOYEE

CONFIDENTIALITY, INVENTION ASSIGNMENT

AND NON-COMPETE AGREEMENT

THIS EMPLOYEE CONFIDENTIALITY, INVENTION ASSIGNMENT AND NON-COMPETE AGREEMENT (“Agreement”) is made as of the date set forth on the signature page below between Inspire Pharmaceuticals, Inc. (“Inspire”), and the person whose name is set forth on the signature page below as Employee (“Employee”).

In consideration of Employee’s employment or continued employment by Inspire, with the intention that this Agreement shall apply to the entire period of Employee’s employment with Inspire (including the period prior to the date of this Agreement), Employee hereby agrees as follows:

1. CONFIDENTIAL INFORMATION DEFINED. “Confidential Information” means trade secrets, proprietary information and materials, and confidential knowledge and information which includes, but is not limited to, matters of a technical nature (such as discoveries, ideas, concepts, designs, drawings, specifications, techniques, models, diagrams, test data, scientific methods and know-how, and materials such as reagents, substances, chemical compounds, subcellular constituents, cell or cell lines, organisms and progeny, and mutants, derivatives or replications derived from or relating to any of the foregoing materials), and matters of a business nature (such as the identity of customers and prospective customers, the nature of work being done for or discussed with customers or prospective customers, suppliers, marketing techniques and materials, marketing and development plans, pricing or pricing policies, financial information, plans for further development, and any other information of a similar nature not available to the public).

“Confidential Information” shall not include information that: (a) was in Employee’s possession or in the public domain before receipt from the Company, as evidenced by the then existing publication or other public dissemination of such information in written or other documentary form; (b) becomes available to the public through no fault of Employee; (c) is received in good faith by Employee from a third party who is not subject to an obligation of confidentiality to the Company or any other party; or (d) is required by a judicial or administrative authority or court having competent jurisdiction to be disclosed by Employee, provided that Employee shall promptly notify the Company and allow the Company a reasonable time to oppose or limit such order.

2. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION OF INSPIRE. Employee acknowledges that, during the period of Employee’s employment with Inspire, Employee has had or will have access to Confidential Information of Inspire. Therefore, Employee agrees that both during and after the period of Employee’s employment with Inspire, Employee shall not, without the prior written approval of Inspire, directly or indirectly (a) reveal, report, publish, disclose or transfer any Confidential Information of Inspire to any person or entity, or (b) use any Confidential Information of Inspire for any purpose or for the benefit of any person or entity, except as may be necessary in the performance of Employee’s work for Inspire.

3. NON-DISCLOSURE OF CONFIDENTIAL INFORMATION OF OTHERS. Employee acknowledges that, during the period of Employee’s employment with Inspire, Employee may have had or will

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have access to Confidential Information of third parties who have given Inspire the right to use such Confidential Information, subject to a non-disclosure agreement between Inspire and such third party. Therefore, Employee agrees that both during and after the period of Employee’s employment with Inspire, Employee shall not, without the prior written approval of Inspire, directly or indirectly (a) reveal, report, publish, disclose or transfer any Confidential Information of such third parties to any person or entity, or (b) use any Confidential Information of such third parties for any purpose or for the benefit of any person or entity, except as may be necessary in the performance of Employee’s work for Inspire.

4. PROPERTY OF INSPIRE. Employee acknowledges and agrees that all Confidential Information of Inspire and all reports, drawings, blueprints, materials, data, code, notes and other documents and records, whether printed, typed, handwritten, videotaped, transmitted or transcribed on data files or on any other type of media, and whether or not labeled or identified as confidential or proprietary, made or compiled by Employee, or made available to Employee, during the period of Employee employment with Inspire (including the period prior to the date of this Agreement) concerning Inspire’s Confidential Information are and shall remain Inspire’s property and shall be delivered to Inspire within five (5) business days after the termination of such employment with Inspire or at any earlier time on request of Inspire. Employee shall not retain copies of such Confidential Information, documents and records.

5. PROPRIETARY NOTICES. Employee shall not, and shall not permit any other person to, remove any proprietary or other legends or restrictive notices contained in or included in any Confidential Information.

6. INVENTIONS.

(a) Employee shall promptly, from time to time, fully inform and disclose to Inspire in writing all inventions, copyrightable material, designs, improvements and discoveries of any kind which Employee now has made, conceived or developed (including prior to the date of this Agreement), or which Employee may later make, conceive or develop, during the period of Employee’s employment with Inspire, which pertain to or relate to Inspire’s business or any of the work or businesses carried on by Inspire (“Inventions”). This covenant applies to all such Inventions, whether or not they are eligible for patent, copyright, trademark, trade secret or other legal protection; and whether or not they are conceived and/or developed by Employee alone or with others; and whether or not they are conceived and/or developed during regular working hours; and whether or not they are conceived and/or developed at Inspire’s facility or not.

(b) Inventions shall not include any inventions made, conceived or developed by Employee prior to Employee’s employment with Inspire, a complete list of which is set forth on Schedule A attached.

(c) All Inventions shall be the sole and exclusive property of Inspire, and shall be deemed part of the Confidential Information of Inspire for purposes of this Agreement, whether or not fixed in a tangible medium of expression. Employee hereby assigns all Employee’s rights in all Inventions and in all related patents, copyrights and trademarks, trade secrets and other proprietary rights therein to Inspire. Without limiting the foregoing, Employee agrees that any copyrightable material shall be deemed to be “works made for hire” and that Inspire shall be deemed the author of such works under the United States Copyright Act, provided that in the event and to the extent such works are determined not to constitute “works made for hire”, Employee hereby irrevocably assigns and transfers to Inspire all right, title and interest in such works.

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(d) Employee shall assist and cooperate with Inspire, both during and after the period of Employee’s employment with Inspire, at Inspire’s sole expense, to allow Inspire to obtain, maintain and enforce patent, copyright, trademark, trade secret and other legal protection for the Inventions. Employee shall sign such documents, and do such things necessary, to obtain such protection and to vest Inspire with full and exclusive title in all Inventions against infringement by others. Employee hereby appoints the Secretary of Inspire as Employee’s attorney-in-fact to execute documents on Employee’s behalf for this purpose.

(e) Employee shall not be entitled to any additional compensation for any and all Inventions made during the period of Employee’s employment with Inspire.

7. COVENANT NOT TO COMPETE. If Employee is, at any time during Employee’s period of employment with Inspire, employed in the discovery or development areas of the Company in a non-clerical position, or as a director level or higher level senior manager of the Company, then this Section 7 shall apply. Employee and Inspire agree that the services rendered by the Employee are unique and irreplaceable, and that competitive use and knowledge of any Confidential Information would substantially and irreparably injure Inspire’s business, prospects and good will. Employee and Inspire also agree that Inspire’s business is global in nature due to the type of products and/or services being provided. Therefore, Employee agrees that during the period of Employee’s employment with Inspire and for a period of one (1) year thereafter, Employee shall not, directly or indirectly, through any other person, firm, corporation or other entity (whether as an officer, director, employee, partner, consultant, holder of equity or debt investment, lender or in any other manner or capacity):

(a) develop, sell, market, offer to sell products and/or services anywhere in the world that have the same or similar technological approach or technology platform (e.g., same receptors (such as P2Y), same mechanism of action (such as mucociliary clearance)) as those being developed, offered or sold by Inspire on the date of the termination of Employee’s employment with Inspire for any reason;

(b) solicit, induce, encourage or attempt to induce or encourage any employee or consultant of Inspire to terminate his or her employment or consulting relationship with Inspire, or to breach any other obligation to Inspire;

(c) solicit, interfere with, disrupt, alter or attempt to disrupt or alter the relationship, contractual or otherwise, between Inspire and any consultant, contractor, customer, potential customer, or supplier of Inspire; or

(d) engage in or participate in any business in the same industry as Inspire which is conducted under any name that shall be the same as or similar to the name of Inspire or any trade name used by Inspire.

Employee acknowledges that the foregoing geographic, activity and time limitations contained in this Section 7 are reasonable and properly required for the adequate protection of Inspire’s business. In the event that any such geographic, activity or time limitation is deemed to be unreasonable by a court, Employee shall submit to the reduction of either said activity or time limitation to such activity or period as the court shall deem reasonable. In the event that Employee is in violation of the aforementioned restrictive covenants, then the time limitation thereof shall be extended for a period of time equal to the pendency of such proceedings, including appeals.

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8. REPRESENTATIONS. Employee represents that Employee has the right to enter into this Agreement, and that Employee’s performance of all the terms of this Agreement and his duties as an employee of Inspire will not breach any confidential information agreement, non-competition agreement or other agreement with any former employer of his services, either as an employee, consultant, contractor or independent contractor, or with any other party. Employee represents that Employee will not disclose to Inspire any trade secrets or confidential or proprietary information of any third party that are not generally available to the public.

9. DISCLOSURE OF THIS AGREEMENT. Employee hereby authorizes Inspire to notify others, including but not limited to customers of Inspire and any of Employee’s future employers, of the terms of this Agreement and Employee’s responsibilities under this Agreement.

10. SPECIFIC PERFORMANCE. Employee acknowledges that money damages alone would not adequately compensate Inspire in the event of a breach or threatened breach by Employee of this Agreement, and that, in addition to all other remedies available to Inspire at law or in equity, Inspire shall be entitled to injunctive relief for the enforcement of its rights and to an accounting of profits made during the period of such breach.

11. NO RIGHTS GRANTED. Employee understands that nothing in this Agreement shall be deemed to constitute, by implication or otherwise, the grant by Inspire to the employee of any license or other right under any patent, patent application or other intellectual property right or interest belonging to Inspire.

12. SEVERABILITY.

(a) Each of the covenants provided in this Agreement are separate and independent covenants. If any provision of this Agreement shall be determined to be invalid or unenforceable, the remainder of this Agreement shall not be affected thereby and any such invalid or unenforceable provision shall be reformed so as to be valid and enforceable to the fullest extent permitted by law.

(b) It is not a defense to the enforcement of any provision of this Agreement that Inspire has breached or failed to perform any obligation or covenant hereunder or under any other agreement or understanding between Employee and Inspire.

13. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of North Carolina without regard to conflict of law rules. All suits and claims shall be made only in state or federal courts located in North Carolina.

14. SUPERSEDES OTHER AGREEMENTS. This Agreement contains the entire agreement of the parties with respect to subject matter hereof and supersedes all previous agreements and understandings between the parties with respect to its subject matter.

15. AMENDMENTS. This Agreement may not be changed, modified, released, discharged, abandoned or otherwise terminated in whole or in part except by an instrument in writing, agreed to and signed by the Employee and a duly authorized officer of Inspire.

16. ACKNOWLEDGEMENTS. THE EMPLOYEE ACKNOWLEDGES THAT (i) THE EMPLOYEE HAS READ AND FULLY UNDERSTANDS THIS AGREEMENT; (ii) THE EMPLOYEE HAS BEEN GIVEN THE OPPORTUNITY TO ASK QUESTIONS; (iii) THE

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EMPLOYEE HAS RECEIVED A COPY OF THIS AGREEMENT, THE ORIGINAL OF WHICH WILL BE RETAINED IN THE EMPLOYEE’S PERSONNEL FILE; AND (iv) THE EMPLOYEE’S OBLIGATIONS UNDER THIS AGREEMENT SURVIVE THE TERMINATION OF THE EMPLOYEE’S EMPLOYMENT WITH INSPIRE FOR ANY REASON.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the date set forth below.

INSPIRE PHARMACEUTICALS, INC.
4222 Emperor Boulevard
Durham, North Carolina 27703
By:	/s/ Christy L. Shaffer
	Christy L. Shaffer, Ph.D.,
	Chief Executive Officer

EMPLOYEE:	Barry G. Pea
	(Print Name)
/s/ Barry G. Pea
(Signature Here)

Date:	10/11/04
Address:	137 New Castle Drive
	Chapel Hill, NC 27517

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SCHEDULE A

PRIOR INVENTIONS

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EX-10.43

Exhibit 10.43

TRANSITION AGREEMENT

This Transition Agreement (this “Agreement”), is made by and between Gregory J. Mossinghoff, an individual (“Mr. Mossinghoff”), and Inspire Pharmaceuticals, Inc. (“Inspire”) (Mr. Mossinghoff and Inspire to be hereinafter referred to individually as a “Party” and collectively as the “Parties”).

BACKGROUND

WHEREAS, Mr. Mossinghoff has been employed by Inspire since June 1998 in various capacities and currently holds the position of President of Inspire, employed “at will” and subject to termination at any time and for any reason, with or without notice or cause;

WHEREAS, the Parties acknowledge that Mr. Mossinghoff has submitted a letter of resignation (“Letter of Resignation”) stating that he wishes to separate from employment with Inspire effective as of June 30, 2005; and

WHEREAS, Inspire wishes to change Mr. Mossinghoff’s “at-will” employment status and guarantee him employment for a period which may be terminated by Inspire only “for cause”, commencing upon the “Effective Date” defined within this Agreement and ending on June 30, 2005 (the “Transition Period”); and

WHEREAS, the Parties wish to confirm the exclusive terms of this Agreement.

NOW, THEREFORE, in consideration of the mutual commitments set forth in this Agreement, inclusive of Mr. Mossinghoff’s change of “at-will” status and guarantee of employment during the Transition Period, and intending to be legally and forever bound, Inspire and Mr. Mossinghoff agree as follows:

TERMS

1. Definitions.

(a) The term “Stock Options”, shall mean the outstanding stock options issued to Mr. Mossinghoff by Inspire pursuant to the Stock Plan (as hereinafter defined) and listed on the attached “Schedule A”.

(b) The term “Stock Plan” shall mean Inspire’s Amended and Restated 1995 Stock Plan, as amended.

(c) The term “Execution Date”, as used throughout this Agreement, shall mean the date Mr. Mossinghoff executed this Agreement, as set forth below under Mr. Mossinghoff’s signature on the final page of this Agreement.

(d) The term “Effective Date” shall have the meaning assigned to such term in Paragraph 4(c) of this Agreement.

(e) All other capitalized or bolded terms shall have the meanings assigned to such terms within the text of this Agreement.

2. Benefits to be Conferred upon Mr. Mossinghoff in Consideration of this Agreement.

(a) In exchange for and in consideration of Mr. Mossinghoff’s promises, covenants and general release stated herein, Inspire agrees to employ Mr. Mossinghoff in the capacity of President from the Effective Date through and including June 30, 2005 (defined herein as the “Transition Period”), under the following conditions:

(i) In the capacity of President, Mr. Mossinghoff shall diligently perform such duties and obligations in such manner and at such location(s) as may be reasonably assigned to Mr. Mossinghoff from time to time by the Chief Executive Officer of Inspire.

(ii) During the Transition Period, Inspire agrees to compensate Mr. Mossinghoff at his current base salary rate, payable in accordance with Inspire’s customary payroll schedule, at all times during Mr. Mossinghoff’s continued employment with Inspire.

(iii) At all times during his continued employment with Inspire, Mr. Mossinghoff shall be covered by such major medical, health benefit, disability insurance benefit, 401(k), and pension plans made available generally by Inspire to its employees. Further, during his continued employment with Inspire throughout the Transition Period, Mr. Mossinghoff will be provided such other employee benefits as are made available generally by Inspire to its employees, except for any bonus payments which would be paid under any policy or practice of Inspire. Mr. Mossinghoff shall also be reimbursed by Inspire, in accordance with its discretionary policies, which may be changed from time to time, for ordinary and reasonable business expenses that are approved by the Chief Executive Officer of Inspire in advance.

(iv) Mr. Mossinghoff’s employment with Inspire during the Transition Period shall be changed from that of an “at-will” employee and, pursuant to this Agreement, may be terminated by Inspire’s Board of Directors “for cause” only, which shall mean exclusively: (A) Mr. Mossinghoff’s conviction from which no further appeals may be taken for, or plea of nolo contendere to, a felony or a crime involving moral turpitude, (B) Mr. Mossinghoff’s commission of a breach of fiduciary duty involving personal profit in connection with his employment by Inspire, (C) Mr. Mossinghoff’s commission of an act which the Board of Directors of the Company shall reasonably have found to have involved willful and material misconduct on the part of Mr. Mossinghoff in the conduct of his duties hereunder, (D) chronic alcoholism or any other form of addiction on the part of Mr. Mossinghoff that impairs his ability to perform the essential functions of his job, provided that such termination shall be made in accordance with any applicable laws, inclusive of the Americans with Disabilities Act of 1990, 42 U.S.C. §12101, et. seq., or (E)

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Mr. Mossinghoff’s material breach of any material provision of this Agreement which remains uncured for a period of ten (10) days following notice by Inspire. With respect to the matters set forth in subsections (C), (D) and (E) hereof, the Board of Directors of Inspire may not terminate Mr. Mossinghoff’s employment unless Mr. Mossinghoff has first been given notice of the conduct forming the cause for such termination and an opportunity to explain such conduct to the Board of Directors or a committee thereof.

(b) In further consideration of this Agreement, and presuming that Mr. Mossinghoff has faithfully executed the duties and obligations of his employment with Inspire and continued in Inspire’s employment through the expiration of the Transition Period, Inspire agrees to present and offer to Mr. Mossinghoff, on or about June 30, 2005 or at such time as his employment with Inspire ends, a Separation Agreement and General Release (which shall include an offer of a severance payment in the gross amount of five thousand dollars ($5,000)) for Mr. Mossinghoff’s consideration, acceptance and execution thereafter in accordance with its terms, which Separation Agreement and General Release shall contain release of claim language that is substantially similar to the release of claim language contained in this Agreement.

(c) In further consideration of this Agreement, Inspire also agrees that in the event Mr. Mossinghoff dies or becomes legally incompetent prior to the expiration of the Transition Period (June 30, 2005), Inspire will offer to Mr. Mossinghoff’s estate, legal guardian or representative, for consideration, acceptance and execution thereafter in accordance with its terms, an agreement to provide the major medical and health benefits to Mr. Mossinghoff’s dependents as are made available generally by Inspire to the dependents of its employees. In exchange for the aforementioned benefits, the agreement offered to Mr. Mossinghoff’s estate, legal guardian or representative will include (and receipt of the medical and health benefits will be contingent upon) the execution of a release of claims by Mr. Mossinghoff’s estate substantially similar to that contained in Paragraph 3 of this Agreement.

(d) In the event Mr. Mossinghoff accelerates his resignation or otherwise voluntarily leaves Inspire’s employment prior to June 30, 2005, payment of compensation to Mr. Mossinghoff shall cease effective as of the date of any such separation. All other benefits, to the extent not explicitly addressed within this Agreement, shall be paid in accordance with Inspire’s discretionary practices.

3. General Release of Claims

(a) Through his execution of this Agreement, Mr. Mossinghoff, for full and adequate consideration as recited above, and on behalf of himself, his spouse, dependents, heirs, estate, executors, family members, successors, assigns, administrators, agents and representatives, hereby unconditionally releases and forever discharges Inspire, and their present and former successors and assigns, affiliates, parents, members, subsidiaries, partnerships, divisions and related persons or entities, as well as the present and former officers, directors, members, owners, shareholders, principals, partners, consultants,

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in-house and outside attorneys, insurance carriers, agents and employees of all of these persons or entities, individually and in their official capacities, and any of their pension, retirement, 401(k), stock ownership, stock appreciation, stock option, profit sharing plans, the Stock Plan, and any other employee benefits plans as well as the administrators, trustees, fiduciaries, employees, attorneys, insurance carriers, agents and parties-in-interest of any such plans, whether formerly or presently sponsored or maintained by any of the above-described Persons or entities (each of the foregoing a “Released Party”, and hereinafter collectively referred to as the “Released Parties”), from all of the following claims, prayers for relief, causes of action or alleged damages and all obligations or duties, whether real or perceived, fixed or contingent, accrued or unaccrued, which arose or existed on or before the Effective Date:

(i) any and all claims, issues, prayers for relief and any other causes of action including, but not limited to, all claims relating to common law tort, harassment, retaliation, promissory or equitable estoppel, negligence, wrongful or constructive discharge, defamation, tortious interference with economic advantage, negligent or intentional infliction of emotional distress, invasion of privacy, breach of any express or implied agreement, contract, policy or other understanding, breach of any covenant of good faith and fair dealing, breach of public policy, loss of consortium, fraud, battery, assault, medical, physical, emotional and psychological injuries or damages, including all claims for attorneys’ fees and costs; and

(ii) any and all claims, issues, prayers for relief, causes of action or damages Mr. Mossinghoff has or may ever have against any Released Party, including all claims whether known or unknown, which Mr. Mossinghoff has or could claim on or before the Effective Date. This release includes, without limitation, all claims arising during Mr. Mossinghoff’s employment or as a result of his resignation and all claims arising under federal, state, or local laws prohibiting employment discrimination based upon age, race, sex, religion, handicap, national origin, or any other protected characteristic, including, but not limited to, the Equal Pay Act of 1963, 29 U.S.C. §206(d) (the “EPA”), Title VII of The Civil Rights Act of 1964, as amended, 42 U.S.C. §2000e, et seq., (“Title VII”), the Family and Medical Leave Act of 1993, 29 U.S.C. §2611, et seq., the Older Workers Benefit Protection Act, 29 U.S.C. § 626(f), et seq. (the “OWBPA”), the Age Discrimination in Employment Act of 1967, as amended, 42 U.S.C. §621, et seq. (the “ADEA”), the Employee Retirement Income Security Act of 1974, 29 U.S.C. §1001, et. seq. (“ERISA”), the Rehabilitation Act of 1973, 29 U.S.C. §701, et. seq., the Fair Labor Standards Act, 29 U.S.C. §215(a)(3), et. seq. (“FLSA”), the Americans with Disabilities Act of 1990, 42 U.S.C. §12101, et. seq. (the “ADA”), the Civil Rights Act of 1990, 42 U.S.C. §§1981, 1983, 1985 and 1988, the North Carolina Equal Employment Practices Act, N.C. Gen. Stat. §§143-422.2 (1988), the United States Constitution, North Carolina’s State Constitution, North Carolina’s Wage and Hour and Wage Payment Laws, N.C. Gen. Stat. §§95-25.20, 241, §95-252, §95-243, §95-25.7, §§95-25.7-25.13 (1997), §95-25.2(16) (1988), et seq., and the Worker Adjustment and Retraining Notification Act, 29 U.S.C. §2101, et seq.(“WARN”).

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(iii) any and all claims, issues, prayers for relief or causes of action relating to any form of employee benefit or employment benefit plan, understanding or agreement, including but not limited to medical, accident, dental, pension, retirement, stock, stock appreciation, the Stock Options, incentive, severance, salary continuation, deferred compensation, short term or long term disability, life or dependent life insurance or other insurance, salary enhancement, bonus, profit sharing or 401(k) plan benefits, commissions, bonuses, the Stock Plan, or other benefits arising from Mr. Mossinghoff’s participation in, or eligibility to participate in, any employee benefit or fringe plans, understandings or agreements attendant to his employment by any Released Party; however, nothing in this Agreement shall be construed to deny Mr. Mossinghoff the right to exercise the stock options that have already vested or will vest during the Transition Period, as set forth on Schedule A; provided, further, that Mr. Mossinghoff acknowledges and agrees that he shall continue to remain subject to applicable laws, rules and regulations of the Securities and Exchange Commission as well as Inspire’s Insider Trading Policy, as it may be amended from time to time, including all “black-out” periods declared in accordance with the Insider Trading Policy; and

(iv) any and all pending or potential claims, demands, issues, or causes of action that Mr. Mossinghoff has, or may have, and of whatever kind or nature, whether known or unknown, against the Released Parties arising or existing on or before the Effective Date.

(b) Mr. Mossinghoff acknowledges that his waivers and releases under this Agreement specifically include any and all claims for attorneys’ fees and costs incurred for any reason. Mr. Mossinghoff further understands that the laws listed above in Paragraph 3(a) and its subparts give him important remedies that relate to claims that he may have arising out of or relating to his employment by, or separation from employment from, any Released Party, and he freely and voluntarily gives up these remedies and claims after having had the opportunity to consult with legal counsel.

(c) Following his execution of this Agreement, and upon the Effective Date hereof, Mr. Mossinghoff, for full and adequate consideration as recited above, and on behalf of himself, his spouse, dependents, heirs, estate, executors, family members, assigns, agents and representatives, hereby agrees not to file a lawsuit or claim against any of the Released Parties in any court of the United States, any state or district thereof, or with any arbitration panel, concerning any claim, demand, issue or cause of action covered by this Agreement. This Agreement shall be a complete defense to any such lawsuit or claim. Notwithstanding any other language in this Agreement, the parties understand that this Agreement does not prohibit Mr. Mossinghoff from: (i) filing an administrative charge of alleged employment discrimination under Title VII, the ADEA, the ADA or the EPA; (ii) filing an action to enforce the terms

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of this Agreement; or (iii) filing an action under the OWBPA, seeking to challenge the validity of Mr. Mossinghoff’s release of claims under the ADEA provided; however, if this Agreement is found invalid under the OWBPA, the Released Parties shall retain any and all rights to offset, recoupment or restitution of benefits paid hereunder in accordance with applicable law. In addition, regarding Mr. Mossinghoff’s right to file administrative charges under this Paragraph, Mr. Mossinghoff expressly waives his right to and assigns to Inspire any monetary or other individual recovery, should any federal, state or local administrative agency pursue any claims on his behalf arising out of or relating to his employment by, and/or separation from employment with any of the Released Parties. Mr. Mossinghoff acknowledges that by signing this Agreement, he will have waived any right he may have had to bring a lawsuit or obtain an individual recovery in the event that an administrative agency were to pursue a claim against any of the Released Parties based on any conduct by any of them up to the date of Mr. Mossinghoff’s execution of this Agreement, and that Mr. Mossinghoff will have released and discharged the Released Parties of any and all claims of any nature arising up to the date he has executed this Agreement.

(d) Mr. Mossinghoff agrees, acknowledges and warrants that the consideration granted through this Agreement, including the change in his employment status and provision of a contract of employment to be terminated only “for cause” as set forth herein, is in excess of, and substantially greater than, any benefits, payments or other consideration to which he may be presently entitled from Inspire or any other Released Party, including, but not limited to, those arising: (i) pursuant to any express or implied agreement, contract, understanding or policy or practice, and (ii) under any prior or current agreements, representations, policies, practices or employee benefit plans, and that such consideration constitutes good and adequate consideration in exchange for his promises, covenants, waivers and releases herein contained.

4. Other Provisions.

(a) Mr. Mossinghoff acknowledges that he has had the opportunity to review and consider this Agreement for twenty-one (21) days, and that any material or immaterial changes to this Agreement will not restart the running of the twenty-one (21) day period. Mr. Mossinghoff also acknowledges and agrees that, by this writing, he has been advised to seek the guidance and advice of legal counsel in considering the terms and effect of this Agreement, and that he has been provided with the opportunity to do so prior to executing this Agreement. Mr. Mossinghoff also acknowledges by signing this Agreement that he has carefully read this Agreement, that he understands completely its contents, that he has had an opportunity to have an attorney explain those contents to him, and that he has executed this Agreement of his own free will, act and deed.

(b) To the extent Mr. Mossinghoff signs this Agreement prior to the expiration of the twenty-one (21) day period and delivers an executed original to Inspire’s Chief Executive Officer,

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he additionally acknowledges and warrants that he has voluntarily and knowingly waived the twenty-one (21) day review period and that the decision to accept such a shortened period of time is not induced by Inspire or any Released Party through fraud, misrepresentation, a threat to withdraw or alter the offer prior to the expiration of the twenty-one (21) day time period, or by providing different terms to workers who sign releases prior to the expiration of such time period.

(c) Mr. Mossinghoff understands and expressly agrees that, following his execution of this Agreement, he shall have a period of seven (7) days during which time he may revoke the Agreement by delivering written notification to Inspire’s Chief Executive Officer no later than the close of business on the seventh (7^th) calendar day after he signs it. If Mr. Mossinghoff timely revokes this Agreement, this Agreement will not be effective and enforceable and he will not receive the benefits described herein. However, this Agreement shall be forever binding and enforceable once the seven (7) day period has expired. For purposes of this Agreement, the term “Effective Date” referenced throughout this Agreement, shall mean the eighth (8^th) calendar day after Mr. Mossinghoff executes this Agreement and Inspire receives an effective, unrevoked original copy.

(d) Mr. Mossinghoff further acknowledges and agrees that he has not been provided any legal or other advice by any of the Released Parties or their legal counsel regarding the tax or withholding consequences of this Agreement, or the consideration hereunder, pursuant to federal, state, or local tax or withholding laws or regulations. Mr. Mossinghoff further holds the Released Parties and their counsel harmless from and indemnifies them for any costs, fines or penalties, including defense counsel fees, as a result of such laws or regulations even if such tax or withholding consequences were not foreseeable at the time he executed this Agreement.

(e) Mr. Mossinghoff expressly warrants and agrees that no promise or inducement has been offered to him except as set forth herein, that this Agreement contains the entire understanding between the parties hereto with respect to the subject matter hereof, and supersedes all prior oral or written agreements, contracts, policies, practices, plans, representations and understandings between the Parties hereto with respect to same. Notwithstanding the foregoing, the Parties agree that the Agreement, dated as of March 29, 2004, by and between Inspire and Mr. Mossinghoff, regarding circumstances arising from the possibility of a change in control of Inspire, is hereby terminated in its entirety. Furthermore, notwithstanding anything to the contrary in this section, nothing in this Agreement shall be construed to supplant, supersede, modify, alter or replace the terms of the Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire and Mr. Mossinghoff dated February 4, 2000.

(f) This Agreement may only be changed, altered or modified by a written document executed by all Parties which expressly references and attaches a copy of this Agreement.

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(g) Notwithstanding anything to the contrary contained in this Agreement, Mr. Mossinghoff shall be permitted to seek and interview for other employment and business opportunities during the Transition Period so long as in doing so Mr. Mossinghoff does not violate: (1) the terms of this Agreement; (2) the terms of any other agreement between the Parties; or (3) any other fiduciary obligations Mr. Mossinghoff owes to Inspire under law.

5. Confidentiality.

(a) Mr. Mossinghoff acknowledges and agrees that, as a material and indivisible part of the consideration for this Agreement, he warrants and represents that he will not disclose, discuss or communicate with any person or entity any information or opinion concerning alleged claims that Mr. Mossinghoff might have raised or damages that he might have alleged if he had not given the general release of the Released Parties set forth in Paragraph 3 of this Agreement, including all of its sub-parts. However, nothing in this Agreement shall prohibit Mr. Mossinghoff from disclosing such information or opinion to his attorneys, his spouse, or as may be reasonably required by his tax advisors, provided that such tax advisors are persons or entities that regularly provide such advice to the general public on an ongoing basis and provided those individuals are instructed not to further disclose the terms.

(b) Mr. Mossinghoff further warrants and represents to Inspire, as of the Execution Date, that: (i) he will treat all information and matters, whether oral or written, relating to Inspire’s business as the confidential and proprietary information of Inspire (the “Confidential Information”) as defined in his Confidentiality, Incentive Assignment and Non-Compete Agreement, dated February 4, 2000 (the “Confidentiality Agreement”) and (ii) that he will abide by the terms and conditions of such Confidentiality Agreement, which remain in full effect, notwithstanding any of the terms of this Agreement.

(c) Mr. Mossinghoff further agrees that he is barred from seeking to introduce this Agreement (and the release required pursuant to Paragraph 3 hereof) into evidence during any arbitration hearing, or any federal, state court or administrative proceeding, except to challenge its validity under the OWBPA or to prove or enforce its terms, as this Agreement is not in any way an admission by the Released Parties that they breached any legal duty owed to Mr. Mossinghoff or that they are liable to Mr. Mossinghoff in any way.

(d) Should Mr. Mossinghoff hereinafter be subjected to a court order or other compulsory process to compel the disclosure of any Confidential Information or agreement, Mr. Mossinghoff shall immediately notify the Released Parties or their legal counsel of such order or process and consent to their intervention in the matter to seek to prevent such disclosure.

(e) Within fourteen (14) calendars days of June 30, 2005, Mr. Mossinghoff shall return all copies of the Confidential Information, including but not limited to any and all customer lists,

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client lists, investor lists, computer-stored data, disks, plans, reports, financial projections, business plans, engineering studies, contracts, agreements, letters, files, or other information that relates to the business, management or administration of Inspire or any of its principals, officers, directors and employees, that may be in his possession as of the such date. Mr. Mossinghoff shall not retain any originals of such Confidential Information and other materials without the prior written consent of Inspire.

(f) Mr. Mossinghoff acknowledges and agrees that Inspire may be obligated, pursuant to the rules and regulations of the Securities Exchange Act of 1934, as amended, to file a copy of this Agreement with the Securities and Exchange Commission and that Inspire shall be permitted to file this Agreement with the Securities and Exchange Commission if it determines, in its sole discretion, that such a filing is necessary or appropriate.

6. Cooperation. Mr. Mossinghoff agrees to cooperate fully with the reasonable requests of Inspire during the Transition Period.

7. Breach. In the event of an actual or alleged breach of the terms of this Agreement by Mr. Mossinghoff, Inspire may commence an action against Mr. Mossinghoff for damages, and also for equitable relief seeking to prevent future breaches or to ameliorate the impact of any prior breach. In the event that any such action is commenced, the remaining provisions of this Agreement shall remain in full force and effect at the sole option of Inspire.

8. Non-Disparagement. Mr. Mossinghoff agrees that he shall not, now or ever in the future, publicly or privately, in any way make any disparaging or otherwise inflammatory remarks about Inspire, its officers, principals, agents or employees, or the conduct, operations or business practices, policies or procedures of Inspire to any third parties. In addition, Inspire agrees that its executive officers and directors shall not, now or ever in the future publicly or privately, in any way, make any disparaging or otherwise inflammatory remarks about Mr. Mossinghoff to any third parties.

9. Governing Law. The parties agree that this Agreement is to be construed under the laws of the State of North Carolina, except to the extent of preemption by federal law, and without regard to choice of law rules.

10. Interpretation. The Parties agree that the terms of this Agreement are severable, and that if any term herein is found unenforceable by a court of competent jurisdiction, the remaining terms shall remain in full force and effect. The Parties further agree that the terms of this Agreement shall not be construed against the drafter in any respect, as the terms stated herein were reached after arms-length negotiations. Further, no action shall be filed by any Party to enforce this Agreement until written demand is made to the other Party specifying the nature of the relief requested and the nature of the dispute, and after that Party has been provided with a reasonable opportunity of not less than ten (10) business days to provide a written response to such written demand (except in the case of any breach of

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confidentiality or restrictive covenants upon Mr. Mossinghoff), with the exception of any action for equitable relief which may be filed immediately by either Party without providing advance written notice or awaiting a written response to same.

11. Use of Subheadings. The use of subheadings is merely for the convenience of the parties and has no operative effect on the terms and conditions of this Agreement.

12. Assignment. Mr. Mossinghoff may not assign his rights or obligations, in whole or in part, under this Agreement. This Agreement may be freely assigned by Inspire without restriction, and without notice to or the consent of Mr. Mossinghoff. This Agreement shall be binding upon, and shall inure to the benefit of, Inspire’s successors and assigns.

13. No Other Proceedings. Each Party represents that he/it has no pending legal or administrative claims against the other Party and that he/it has not filed any actions in any forum against the other Party.

14. No Undue Influence. Mr. Mossinghoff warrants that he has not been subject to any undue or improper influence interfering with the exercise of his free will in deciding whether to execute this Agreement.

15. Counterparts. This Agreement may be executed in counterparts and by facsimile, and each counterpart and facsimile shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the undersigned, upon receipt of the original or faxed copy of the counterpart signed by the other Party.

16. Notices. All notices, requests and other documents that are required by this Agreement to be communicated in writing shall be hand-delivered to the Parties, or mailed by registered or certified mail, return receipt requested, postage prepaid, or delivered by overnight courier, with signature required upon delivery, addressed as follows:

If to Inspire:

Inspire Pharmaceuticals, Inc.

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703-8466

Attn: Chief Executive Officer

If to Mr. Mossinghoff:

Gregory J. Mossinghoff

2108 Summer Azure Way

Raleigh, NC 27613

All notices required by this Agreement shall be deemed to have been delivered to, and received by, the addressee as of the date that such addressee accepts such delivery by signing a receipt therefore.

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IN WITNESS WHEREOF, intending to be forever legally bound hereby, the Parties have executed this Agreement, being of eleven (11) pages in length, exclusive of Schedule A, as of the Execution Date listed below.

Inspire Pharmaceuticals, Inc.
By:	/s/ Christy L. Shaffer
By:	/s/ Mary B. Bennett

/s/ Gregory Mossinghoff

Gregory Mossinghoff

Executed as of October 28, 2004

(the “Execution Date”)

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Schedule A

Inspire Pharmaceuticals, Inc.

Stock Option Grants to

Gregory J. Mossinghoff

Option No.	Grant Date	Type	Strike Price		Total Shares Underlying Option*
00000077	12-Oct-99	ISO	$	0.84	71,428
NQ000035	3-Aug-00	NQ		12.00	85,714
00000141	1-Jun-01	ISO		13.65	5,000
NQ000052	4-Jun-02	NQ		2.76	30,000
NQ000055	4-Jun-02	NQ		2.76	100,000
00000404	15-Oct-03	ISO		20.30	18,116
00000405	15-Oct-03	NQ		20.30	3,634

* Reflects the total number of shares underlying the option, without regard to vesting and exercisability. Vesting and exercisability differs from option to option and is not accelerated or otherwise amended as a result of this Agreement.

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EX-10.44

EXHIBIT 10.44

[NOTE: CERTAIN PORTIONS OF THIS DOCUMENT HAVE BEEN MARKED TO INDICATE THAT CONFIDENTIAL INFORMATION HAS BEEN OMITTED. CONFIDENTIALITY HAS BEEN REQUESTED FOR THIS CONFIDENTIAL INFORMATION. THE CONFIDENTIAL PORTIONS HAVE BEEN PROVIDED SEPARATELY TO THE SECURITIES AND EXCHANGE COMMISSION]

EXCLUSIVE LICENSE AGREEMENT

This Exclusive License Agreement (hereinafter called the “Agreement”) is made effective the 2nd day of November, 2004, by and between Wisconsin Alumni Research Foundation (hereinafter called “WARF”), a nonstock, nonprofit Wisconsin corporation, and Inspire Pharmaceuticals, Inc. (hereinafter called “Licensee”), a corporation organized and existing under the laws of Delaware.

WHEREAS, WARF and Yeda Research and Development Co. Ltd. (hereinafter called “Yeda”) own certain inventions described in the “Licensed Patents” defined below and have entered into an agreement under which Yeda has granted to WARF the exclusive right to grant, negotiate, execute, administer and enforce licenses under the Licensed Patents for the benefit of WARF and Yeda (collectively referred to hereinafter as the “Licensors”); and

WHEREAS, WARF is willing to grant a license to Licensee under any one or all of the Licensed Patents and Licensee desires a license under all of them;

NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth below, the parties covenant and agree as follows:

Section 1. Definitions.

For the purpose of this Agreement, the Appendix A definitions shall apply.

Section 2. Grant.

A. License.

WARF hereby grants to Licensee on behalf of the Licensors, and Licensee hereby accepts, subject to the terms and conditions hereof, an exclusive license under the Licensed Patents, with the right to grant sublicenses in accordance with Section 2B below, to develop, make, have made, use, market, distribute, import, offer for sale and sell Products in the Licensed Field and Licensed Territory.

B. Sublicenses.

(i) Licensee may grant written sublicenses to third parties with respect to the rights licensed hereunder. Any agreement granting a sublicense shall state that the sublicense is subject to the termination of this Agreement, but that such Sublicensee shall have the right simultaneously with such termination to obtain a license directly from WARF, and WARF shall simultaneously grant such a license, under the terms and conditions set forth in this Agreement. During the term of this Agreement, Licensee shall have the same responsibility for the activities of any Sublicensee as if the activities were directly those of Licensee. Licensee shall provide WARF with the name, contact information and address of each Sublicensee, as well as information regarding the number of full-time employees of any such Sublicensee to allow WARF to determine whether it can maintain its small entity filing status for patent prosecution and maintenance purposes.

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(ii) With respect to sublicenses granted by Licensee under this Section 2B, Licensee shall pay to WARF what Licensee would have been required to pay to WARF had Licensee sold the amount of Products sold by such Sublicensee. In addition, if Licensee receives fees or milestone payments in consideration for the grant of rights under any sublicense, and such amounts are not royalty payments based directly upon the amount or value of Products sold by the Sublicensee, then Licensee shall pay to WARF a percentage of such fee or milestone payments as follows:

(a) [CONFIDENTIAL] of such fee or milestone payments received under each sublicense agreement entered into within [CONFIDENTIAL] of the date hereof;

(b) [CONFIDENTIAL] of such fee or milestone payments received under each sublicense agreement entered into prior to the date that is [CONFIDENTIAL] from the date hereof but subsequent to the date that is [CONFIDENTIAL] from the date hereof; and

(c) [CONFIDENTIAL] of such fee or milestone payments received under each sublicense agreement entered into subsequent to the date that is [CONFIDENTIAL] from the date hereof.

The parties agree that payments received by Licensee as payment to or reimbursement for actual costs and expenses, including direct, indirect and overhead allocations, calculated in accordance with Licensee’s accounting practices applied on a consistent basis in accordance with generally accepted accounting principles, incurred in conducting research or other activities on behalf of a Sublicensee as part of a research or collaboration or other agreement, or payments received by Licensee as consideration for services or goods provided to a Sublicensee, shall not be considered as payments subject to the percentage distribution set forth above. If goods provided by Licensee to its Sublicensees are Products as defined under this Agreement, then any payments received by Licensee for such goods shall be subject to Section 4C. Licensee shall not receive from its Sublicensees anything of value in lieu of cash payments in consideration for any sublicense granted under this Agreement, without the express prior written consent of WARF, such consent not to be unreasonably withheld, conditioned or delayed.

C. Reservation of Rights.

Licensors hereby reserve the right to practice and use the inventions of the Licensed Patents solely for Non-Commercial Research Purposes, and to grant non-profit research institutions and governmental agencies non-exclusive licenses under the Licensed Patents for Non-Commercial Research Purposes, provided that such use shall specifically prohibit any human use or clinical administration.

D. License to WARF.

Licensee hereby grants WARF a nonexclusive, royalty-free, irrevocable, paid-up license, with the right to grant sublicenses solely to non-profit research institutions and governmental agencies, to practice and use “Improvements” for Non-Commercial Research Purposes, provided that such use shall specifically prohibit any human use or clinical administration. “Improvements” shall mean any patented modification by Licensee during the term of this Agreement of an invention described in the Licensed Patents that (1) would be infringed by the practice of an invention claimed in the Licensed Patents; or (2) if not for the license granted under this Agreement, would infringe one or more Valid Claims of the Licensed Patents. Licensee shall provide WARF with a written, enabling disclosure of each such invention, unambiguously identifying it as an invention governed by this paragraph, within six (6) months of the issuance of a patent thereon.

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Section 3. Development.

Licensee agrees to and warrants that it has, or will obtain, the expertise reasonably necessary to independently evaluate the inventions of the Licensed Patents and to undertake the development of Products for sale in the commercial market, and that it so intends to develop Products for the commercial market. Further, the parties agree that Licensee has, as of the date hereof, provided WARF with a development plan encompassing at least the information set forth in Appendix E describing the steps Licensee reasonably anticipates, consistent with industry practice, as necessary to allow the inventions of the Licensed Patents to be utilized to provide Products for sale in the commercial market. The parties acknowledge that such plan may be subject to change, as determined by Licensee in its sole and reasonable discretion. In addition, within one (1) month following the end of each annual period ending on December 31 until the Date of First Commercial Sale of Products, Licensee will provide WARF with a written Development Report summarizing Licensee’s product development activities since the last Development Report and any necessary adjustments to the development plan. If Licensee fails to provide a written Development Report to WARF within forty-five (45) days of receipt of written request from WARF as a result of Licensee’s failure to provide the Development Report to WARF within the required time period set forth above (i.e., by January 31 for the prior calendar year), such failure shall be deemed a material breach of a material covenant under this Agreement. All development activities and strategies and all aspects of product design and decisions to market and the like are entirely at the discretion of Licensee, and Licensee shall rely entirely on its own expertise and/or the expertise of Licensee’s contractors and collaborators with respect thereto. WARF’s review of Licensee’s development plan is solely to verify the existence of Licensee’s commitment to the development activity described in Appendix E hereto and to assure compliance with Licensee’s obligations to utilize the inventions of the Licensed Patents to commercialize Products for the marketplace. WARF reserves the right to audit Licensee’s records relating to development of Products as required hereunder. Such record keeping and audit procedures shall be subject to the procedures and restrictions set forth in Section 6 for auditing the financial records of Licensee.

Section 4. Consideration.

A. License Fee.

Licensee agrees to pay to WARF a license fee of $150,000 within thirty (30) days of execution of this Agreement.

B. Milestone Fees.

Licensee agrees to pay to WARF the amounts detailed below within thirty (30) days of the achievement of the corresponding milestones.

Milestone	Milestone Fee
[CONFIDENTIAL]	$[CONFIDENTIAL]
[CONFIDENTIAL]	$[CONFIDENTIAL]
[CONFIDENTIAL]	$[CONFIDENTIAL]
[CONFIDENTIAL]	$[CONFIDENTIAL]

Page 3 of 19

Each milestone payment above shall only be made once under this Agreement upon the initial accomplishment of the relevant milestone in connection with the first Product for which such milestone event occurs. Thus, a maximum of $1,800,000 in potential milestones is payable during the term of this Agreement.

C. Royalty; Combination Products; Third Party Royalties.

(i) In addition to the Section 4A license fee and Section 4B milestone fees, Licensee agrees to pay to WARF a royalty calculated as [CONFIDENTIAL] of the Selling Price of Products sold by or on behalf of Licensee in jurisdictions in the Licensed Territory where the use or sale of such Products would, but for the licenses granted hereunder, infringe a Valid Claim of the Licensed Patents in that jurisdiction. The royalty shall be deemed earned as of the earlier of the date the Product is actually sold or otherwise transferred for consideration, or the date an invoice is sent by Licensee. No multiple royalty shall be payable because the manufacture, use, sale or distribution of a Product is covered by more than one Valid Claim. In addition, with respect to transfers of Products by, between or among Licensee and Licensee’s affiliates or Sublicensees, no royalty shall be due and payable where the affiliate or Sublicensee will resell the Products and such resale will be subject to the earned royalty calculation.

(ii) Notwithstanding the foregoing or anything to the contrary in this Agreement, in the event that Products are sold by Licensee as part of a combination or bundled product, the Selling Price of such combination/bundled product, for the purposes of determining royalty payments due under this Agreement, shall be determined by multiplying the Selling Price (as defined on Appendix A) of the combination/bundled product by the fraction A/(A+B), where A is the average sale price of the Product when sold separately in finished form and B is the average sale price of the other product(s) or system sold separately in finished form, so that A+B is the average sale price of the product(s). In the event that such average sale price cannot be determined for both the Product and such other product(s) or system(s) in combination, the Selling Price for the purposes of determining royalty payments with respect to such combination or bundled product shall be commercially reasonable and determined by good faith negotiation between WARF and Licensee.

(iii) Notwithstanding the foregoing, in addition to and without limitation of any reduction in royalties pursuant to Section 4C(ii) above, if Licensee makes payments to one or more independent third parties during any calendar year to obtain or maintain a license or similar right under intellectual property owned by such independent third party as determined in good faith by Licensee, after consultation with WARF, to be reasonably necessary to avoid infringement thereof by the manufacture, use, or sale of Products, or to reasonably avoid infringement-related litigation with respect to such patent(s), then Licensee may deduct [CONFIDENTIAL] of such third party payments from royalties payable to WARF with respect to that calendar year, provided that such deduction does not exceed [CONFIDENTIAL] of the royalties payable to WARF under this Agreement during any such calendar year.

Page 4 of 19

D. Minimum Royalty.

Licensee further agrees to pay to WARF a minimum royalty of $10,000 per calendar year, or pro rated portion thereof for each partial calendar year, during which this Agreement is in effect starting in calendar year 2008, against which any earned royalty paid for the same calendar year will be credited. The minimum royalty for a given year shall be due at the time payments are due for the calendar quarter ending on December 31. It is understood that the minimum royalties will apply on a calendar year basis, and that sales of Products requiring the payment of earned royalties made during a prior or subsequent calendar year shall have no effect on the annual minimum royalty due WARF for any given calendar year.

E. Patent Fees and Costs.

(i) Licensee also agrees to reimburse the Licensors for all reasonable, documented costs associated with the filing, prosecution and maintenance of the Licensed Patents. Licensee shall pay to WARF $67,353.32 within thirty (30) days of execution of this Agreement to reimburse the Licensors for the previously-incurred expenses incurred with respect to the Licensed Patents. Licensee shall pay to WARF all reasonable, documented future expenses associated with the filing, prosecution and maintenance of the Licensed Patents within thirty (30) days of receiving an invoice from WARF with respect thereto.

(ii) WARF shall keep Licensee advised as to the maintenance of all Licensed Patents by promptly forwarding to Licensee copies of all official correspondence received or provided to the corresponding patent office relating thereto (including, but not limited to, patent applications, Office Actions, responses, etc.). Licensee shall have the right to advise WARF as to such maintenance; and further, Licensee shall have the right to make reasonable requests to WARF as to the conduct of such maintenance; provided, however, that Licensee understands and agrees that WARF has the sole and final authority to make final decisions.

(iii) WARF will maintain the Licensed Patents until WARF makes a good faith determination, in consultation with Licensee, that continued maintenance is unnecessary. If WARF makes such a good faith determination to abandon a Licensed Patent, WARF shall provide Licensee written notice of WARF’s intent to abandon such patent at least ninety (90) days in advance of any applicable statutory deadline. In such event, Licensee shall have the right to continue maintenance of said patent, at its own expense, on behalf of WARF, Yeda and Licensee, to the extent allowed under applicable law, by providing written notice thereof to WARF within such ninety (90) day period.

F. Accounting; Payments; Taxes.

(i) Amounts owing to WARF under Sections 2B and 4C shall be paid on a quarterly basis, with such amounts due and received by WARF on or before the sixtieth (60^th) day following the end of the calendar quarter ending on March 31, June 30, September 30 or December 31 in which such amounts were earned. The balance of any amounts which remain unpaid more than thirty (30) days after they are due to WARF shall accrue interest until paid at the rate of the lesser of one percent (1%) per month or the maximum amount allowed under applicable law. However, in no event shall this interest provision be construed as a grant of permission for any payment delays.

(ii) Except as otherwise directed, all amounts owing to Licensors under this Agreement shall be paid in U.S. dollars to WARF at the address provided in Section 16(a). For converting any royalty payments on Selling Prices made in a currency other than U.S. dollars, Selling Prices shall first be determined in the currency of the country in which they are earned and shall be converted each calendar quarter into an account in U.S. dollars at the average of the bid and ask prices reported in the Wall Street Journal as of the close of the last business day of such calendar quarter in which such royalty is due. If the last day of such calendar quarter is not a business day, then the closest preceding business day shall be used for such calculation. All such converted Selling Prices

Page 5 of 19

for each country shall be consolidated for each calendar quarter and the applicable royalty payable determined therefrom. WARF is exempt from paying income taxes under U.S. law. Therefore, all payments due under this Agreement shall be made without deduction for income taxes, assessments, or other charges of any kind which may be imposed on WARF by any government outside of the United States or any political subdivision of such government with respect to any amounts payable to WARF pursuant to this Agreement, where WARF has registered as a tax exempt entity and any such jurisdiction has approved such claim; otherwise, Licensee shall be entitled to deduct from any payments due to WARF all applicable taxes.

(iii) A full accounting showing how any amounts owing to WARF under Sections 2B and 4C have been calculated shall be submitted to WARF on the date of each such payment. Such accounting shall be on a per-country and product line, model or trade name basis and shall be summarized on a form similar to that shown in Appendix C of this Agreement. In the event no payment is owed to WARF, a statement setting forth that fact shall be supplied.

Section 5. Certain Warranties.

A. WARF represents and warrants that, except as otherwise provided under Section 14 of this Agreement with respect to U.S. Government interests:

(i) WARF and Yeda are the sole owners of the Licensed Patents or otherwise have the sole and exclusive right to grant the licenses granted to Licensee in this Agreement, and to the best of the WARF’s knowledge, free and clear of any liens, claims, and encumbrances of any non-governmental third party;

(ii) WARF and Yeda have entered into a definitive agreement granting to WARF the exclusive right to grant, negotiate, execute, administer and enforce exclusive licenses under the Licensed Patents with Licensee and such definitive agreement does not conflict with any provision or right or obligation granted or received hereunder;

(iii) subject to Section 2C above and to any research rights previously granted by Licensors to the inventors of the Licensed Patents or research rights reserved by the inventors of the Licensed Patents, WARF and Yeda have not granted to any third party any rights to or under the Licensed Patents that currently conflict or in the future will conflict with, contradict, or overlap with those granted hereunder; and

(iv) WARF and Yeda have not received any notification that the Licensed Patents are invalid or that the exercise of any rights granted hereunder will infringe on any patent or other proprietary right of any third party.

Nothing in this Agreement shall be construed as:

(i) a warranty or representation by the Licensors as to the validity or scope of any of the Licensed Patents;

(ii) a warranty or representation that anything made, used, sold or otherwise disposed of under the license granted in this Agreement will or will not infringe patents of third parties; or

(iii) an obligation to furnish any intellectual property not provided in the Licensed Patents or any services other than those specified in this Agreement.

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B. THE LICENSORS MAKE NO REPRESENTATIONS, EXTEND NO WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED, AND ASSUME NO RESPONSIBILITIES WHATSOEVER WITH RESPECT TO THE USE, SALE, OR OTHER DISPOSITION BY LICENSEE, ITS SUBLICENSEE(S), OR THEIR VENDEES OR OTHER TRANSFEREES, OF PRODUCTS INCORPORATING OR MADE BY USE OF INVENTIONS LICENSED UNDER THIS AGREEMENT.

C. Licensee represents and warrants that Products produced under the license granted herein for sale in the United States shall be manufactured substantially in the United States as required by 35 U.S.C § 204 and applicable regulations of Chapter 37 of the Code of Federal Regulations.

Section 6. Recordkeeping.

A. Licensee shall keep books and records sufficient to verify the accuracy and completeness of Licensee’s accounting referred to above, including, without limitation, inventory, purchase and invoice records relating to all Products and their manufacture. In addition, Licensee shall maintain documentation evidencing that Licensee is in fact pursuing the development of Products as required herein. Such documentation may include, but is not limited to, invoices for studies advancing development of Products, laboratory notebooks, internal job cost records, and filings made to the Internal Revenue Department to obtain tax credit, if applicable, for research and development activities. Such books and records shall be preserved for a period of not less than four (4) years after they are created during the term of this Agreement. Licensee shall use commercially reasonable efforts to include similar recordkeeping provisions in any sublicense granted under this Agreement.

B. Licensee shall take all steps necessary so that WARF may, within thirty (30) days of its request and at WARF’s cost and expense (except as provided under Section 6D below), but not more than once in any consecutive four (4) calendar quarters, review all the relevant books and records relating to Licensee’s activities under this Agreement to allow WARF to verify the accuracy of Licensee’s royalty reports and Development Reports. Such review may be performed by any qualified WARF employee as to the Development Reports, or any registered certified public accountant (“CPA”) from a nationally-recognized accounting firm designated by WARF, upon reasonable notice as set forth above and during Licensee’s regular business hours. Licensee shall use commercially reasonable efforts to include similar auditing provisions in any sublicense granted pursuant to this Agreement. WARF agrees that any such WARF employee and registered CPA shall be subject to an obligation to maintain any information reviewed in confidence.

C. If a royalty payment deficiency is reasonably determined by such registered CPA, after normal adjustments, detailed information supporting such deficiency shall be provided to Licensee. If Licensee agrees with the determination, Licensee shall pay the royalty deficiency outstanding within thirty (30) days of receiving written notice thereof, plus interest on outstanding amounts as described in Section 4F(i); provided, however, if Licensee contests the validity of any such deficiency, the parties shall, within ninety (90) days of notice of disagreement, submit the results of the review and information deemed relevant by Licensee, to an independent third party to resolve the dispute. Such third party shall be a nationally recognized accounting firm and the costs associated with the review performed by any such firm shall be divided and paid equally by the parties.

D. If a royalty payment deficiency for a calendar year exceeds five percent (5%) of the royalties due for that year, then Licensee shall be responsible for paying WARF’s reasonable, documented out-of-pocket expenses incurred with respect to such review. Upon the expiration of four (4) years following the end of any calendar year, the calculation of royalties in respect of such calendar year shall be binding and conclusive upon WARF; provided, however, such limitation shall not apply to any instance of fraud, gross negligence or intentional misrepresentation with respect to the Licensee’s calculation of royalties hereunder.

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Section 7. Term and Termination.

A. The term of this Agreement and the licenses granted hereunder shall begin on the effective date of this Agreement and continue until: (i) this Agreement is terminated as provided herein, or (ii) on a country-by-country basis, until the date that no Licensed Patent with respect to a given country remains an enforceable patent.

B. Licensee may terminate this Agreement at any time by giving at least ninety (90) days written and unambiguous notice of such termination to WARF. Such a notice shall be accompanied by a statement of the reasons for termination.

C. If Licensee at any time defaults in the timely payment of any monies due to the Licensors or commits any material breach of any other material covenant herein contained, and Licensee fails to remedy any such breach or default within ninety (90) days after written notice thereof by WARF, or, if such breach is not remediable within such ninety (90) day period, Licensee fails to undertake reasonable steps to remedy such breach within such ninety (90) day period, or if Licensee commits any act of bankruptcy, is unable to pay its debts as they become due, files a petition under any bankruptcy or insolvency act, or has any such petition filed against it which is not dismissed within sixty (60) days, WARF may, at its option, within ninety (90) days of the discovery of the event giving rise to the right to terminate this Agreement, elect to terminate this Agreement by giving notice of such termination to Licensee; provided, however, that time is of the essence with respect to WARF’s option to terminate within the referenced ninety (90) day period. WARF shall exercise its option to terminate this Agreement within the ninety (90) day period or such option shall terminate.

D. Upon the termination of this Agreement, and subject to Section 7D below, Licensee shall remain obligated to provide an accounting for and to pay royalties earned up to the date of termination, and any minimum royalties shall be prorated as of the date of termination by the number of days elapsed in the applicable calendar year.

E. Upon termination of this Agreement by WARF or Licensee, Licensee shall provide WARF with a written inventory of all Products in the process of being manufactured, in use, in stock, or otherwise under Licensee’s control, for which the Licensed Patents have not expired. Licensee shall have the privilege of disposing of such inventory of Products within a period of one hundred and eighty (180) days of such termination, and any such dispositions shall bear royalties if royalties would otherwise have been payable on such Products under this Agreement. Licensee will also have the right to complete performance of all contracts requiring practice of the technology claimed in the Licensed Patents or the use of Products within and beyond said one hundred eighty (180) day period, provided that the remaining term of any such contract does not exceed beyond one (1) year from the effective date of the termination of this Agreement and any such contract shall bear royalties as set forth in this Agreement. All Products for which the Licensed Patents have not expired which are not disposed of as provided above shall be delivered to WARF or destroyed, in WARF’s sole discretion, at Licensee’s sole expense.

F. Waiver by either party of a single breach or default, or a succession of breaches or defaults, shall not deprive such party of any right to terminate this Agreement in the event of any subsequent breach or default.

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G. Upon expiration of this Agreement due to the expiration of all Licensed Patents with respect to a particular jurisdiction, Licensee shall have the unrestricted royalty-free right to develop, make, have made, use, market, distribute, import, offer for sale and sell Products in such jurisdiction.

Section 8. Assignability.

This Agreement may not be transferred or assigned by Licensee without the prior written consent of WARF. Notwithstanding the foregoing, Licensee may assign this Agreement or otherwise transfer its rights hereunder without such consent to the following parties: (a) a successor to Licensee’s business by sale, exchange, transfer, merger or consolidation, or a successor to that portion of Licensee’s business that pertains to the subject matter of the Licensed Patents, or (b) any entity or entities controlled by, controlling or under common control with Licensee, where control means ownership of more than fifty percent (50%) of the entity’s outstanding equity or the ability to control the entity through voting shares or otherwise; provided that such assignee or transferee agrees to be bound by the terms and conditions of this Agreement. Subject to the foregoing, this Agreement shall be binding on and inure to the benefit of each of WARF, Yeda, and Licensee, and each of their respective successors and assigns.

Section 9. Contest of Validity.

In the event Licensee or any Sublicensee contests the validity or enforceability of any Licensed Patent, Licensee shall continue to pay royalties with respect to that patent as if such contest were not underway until the patent is adjudicated invalid or unenforceable by a court of last resort.

Section 10. Patent Enforcement and Infringement Defense.

A. Each party shall inform the other parties promptly in writing of any alleged infringement of the Licensed Patents by a third party, of which it becomes aware, and any available evidence thereof. WARF maintains the sole right to prosecute, at its own expense, all infringements of the Licensed Patents, and to settle any such suit or action, provided that such settlement does not: (i) subject Licensee to any non-indemnified liability, (ii) admit fault or wrongdoing on the part of Licensee, or (iii) permit continuing use of or grant of any on-going rights that conflict with the license granted to Licensee under this Agreement. Upon WARF’s request, Licensee shall take action, join in an action and otherwise provide WARF with such assistance and information as may be useful to WARF in connection with such action (if the cause of action arose during the term of this Agreement and WARF reimburses Licensee for Licensee’s reasonable out-of-pocket expenses).

B. If: (i) within six (6) months after having been notified by Licensee of an alleged infringement of the Licensed Patents in the Licensed Field and Licensed Territory, WARF has not been successful in persuading the alleged infringer to desist, or has not brought and is not diligently prosecuting an infringement action with respect to such alleged infringement; or (ii) if WARF notifies Licensee at any time prior thereto of its intention not to bring suit or to seek a settlement with respect to such infringement or to take reasonable action against any alleged infringer, then, and only in those events and subject to the prior written consent of WARF, such consent not to be unreasonably withheld, conditioned or delayed, Licensee shall have the right, but not the obligation, to prosecute at its own expense any infringement of the Licensed Patents in the Licensed Field and Licensed Territory. Licensee may, for such purposes, use the name of the Licensors as party plaintiffs; provided that Licensee shall permit Licensors the opportunity to cooperate and jointly participate in such action and Licensee agrees to take into account the reasonable concerns and requests of the Licensors in such action. During said litigation, Licensee shall act in good faith to preserve the right, title and interest of the Licensors in and to the Licensed Patents, shall keep the Licensors advised as to the status of the litigation and shall not enter into a settlement of such litigation without first allowing WARF the option of either approving the settlement or of continuing the litigation at WARF’s expense (upon payment to Licensee of its out-of-

Page 9 of 19

pocket costs and expenses of the litigation). Licensee shall bear all costs and expenses of any suit brought under this Section 10B, and Licensee shall keep any recovery or damages for past infringement derived therefrom; provided, however, that if Licensor becomes involved in such litigation, the parties agree to equitably allocate any recovery or damages awarded based upon the applicable economics of this Agreement and the relative contribution of the parties to such litigation. Nothing herein shall permit or allow Licensee to commence any action for infringement of the Licensed Patent for any activity allowed under a settlement arrangement entered into by the Licensors in good faith with a third party infringer. WARF reserves the right to select and retain counsel of its own to preserve and defend the rights and interest of the Licensors in the Licensed Patents.

Section 11. Patent Marking.

Licensee and its Sublicensees shall mark all Products or Product packaging with the appropriate patent number reference if and as may be necessary to comply with the requirements of U.S. law, 35 U.S.C. § 287.

Section 12. Product Liability; Conduct of Business.

A. Licensee shall, at all times during the term of this Agreement and thereafter, indemnify, defend and hold Licensors and the inventors of the Licensed Patents (the “Indemnified Parties”; each, an “Indemnified Party”) harmless against all third party claims and expenses, including legal expenses and reasonable attorneys fees, arising out of the death of or injury to any person or persons or out of any damage to property and against any other claim, proceeding, demand, expense and liability of any kind whatsoever resulting from the production, manufacture, sale, use, lease, consumption or advertisement of Products manufactured, used, or sold by Licensee or any Sublicensee, provided that Licensee shall not be obligated to indemnify any Indemnified Party to the extent any such claim results from the negligence, intentional misconduct, breach of this Agreement, or the failure to comply with any applicable laws, rules, and regulations by an Indemnified Party or any third party under an Indemnified Party’s reasonable control. Each Indemnified Party shall, at all times, have the right to select and retain counsel of its own to defend its interests.

B. The Indemnified Parties agree to give Licensee prompt written notice of any matter with respect to which any Indemnified Party intends to claim indemnification hereunder. The Indemnified Parties shall permit Licensee, at its discretion, to settle any such action, claim or liability and agree to the complete control of such defense or settlement by Licensee; provided, however, that such settlement does not adversely affect the Indemnified Parties, or any property rights of the Indemnified Parties, or impose any obligation on the Indemnified Parties in addition to those set forth in this Agreement. Each Indemnified Party shall cooperate fully with Licensee in the investigation and defense of any matter for which indemnification is claimed hereunder.

C. Licensee warrants that it now maintains and will continue to maintain such liability insurance coverage as it reasonably deems appropriate to the risk involved in developing or marketing the products subject to this Agreement, and that such insurance coverage is sufficient to cover the Licensors and inventors of the Licensed Patents. WARF shall provide Licensee with the names of such inventors of the Licensed Patents. Within ninety (90) days after the execution of this Agreement and thereafter annually between January 1 and January 31 of each year, Licensee will present evidence to WARF that the coverage is being maintained. In addition, Licensee shall use commercially reasonable efforts to provide WARF with at least thirty (30) days prior written notice of any material reduction in or cancellation of the insurance coverage.

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Section 13. Use of Names.

Neither Licensee nor its Sublicensees shall use WARF’s name, Yeda’s name, the name of any inventor of the technology governed by this Agreement, or the name of the University of Wisconsin or the Weizmann Institute of Science in sales promotion, advertising, or any other form of publicity without the prior written approval of the entity or person whose name is being used, provided that, notwithstanding anything to the contrary in this Agreement, Licensee shall have the right to identify Licensors as the licensors hereunder and the inventors of the technology licensed hereunder as the inventors thereof and to describe the technology licensed hereunder. WARF acknowledges Licensee’s intent to issue a press release regarding this Agreement and the technology licensed hereunder after execution of the Agreement. Licensee shall have the right to disclose, under conditions of confidentiality, the terms of this Agreement to prospective investors, sublicensees, investment bankers, attorneys, auditors, and regulatory authorities in connection with its financing, auditing, regulatory, development, licensing, partnership, and stockholder relations activities. In addition, Licensee shall have the right to disclose the terms of this Agreement as Licensee may deem to be required in any prospectus, offering memorandum, or other document or filing prepared in connection with its compliance obligations under applicable securities law or other applicable law or regulation.

Section 14. United States Government Interests.

It is understood that if the United States Government (through any of its agencies or otherwise) has funded research, during the course of or under which any of the inventions of the Licensed Patents were conceived or made, the United States Government is entitled, as a right, under the provisions of 35 U.S.C. §§ 200-212 and applicable regulations of Chapter 37 of the Code of Federal Regulations, to a nonexclusive, nontransferable, irrevocable, paid-up license to practice or have practiced the invention of such Licensed Patents for governmental purposes. Any license granted under this Agreement to Licensee or any of its sublicensee shall be subject to such right.

Section 15. Miscellaneous.

This Agreement shall be governed by and construed in all respects in accordance with the laws of the State of Wisconsin. If any provisions of this Agreement are or shall come into conflict with the laws or regulations of any jurisdiction or any governmental entity having jurisdiction over the parties or this Agreement, those provisions shall be deemed automatically deleted, if such deletion is allowed by relevant law, and the remaining terms and conditions of this Agreement shall remain in full force and effect. If such a deletion is not so allowed or if such a deletion leaves terms thereby made clearly illogical or inappropriate in effect, the parties agree to substitute new terms as similar in effect to the present terms of this Agreement as may be allowed under the applicable laws and regulations. The parties hereto are independent contractors and not joint venturers or partners.

Section 16. Notices.

Any notice required to be given pursuant to the provisions of this Agreement shall be in writing and shall be deemed to have been given at the earlier of the time when actually received as a consequence of any effective method of delivery, including but not limited to hand delivery, transmission by telecopier, or delivery by a professional courier service or the time when sent by certified or registered mail addressed to the party for whom intended at the address below or at such changed address as the party shall have specified by written notice, provided that any notice of change of address shall be effective only upon actual receipt.

(a)	Wisconsin Alumni Research Foundation
	Attn: Managing Director
	614 Walnut Street
	Madison, Wisconsin 53726

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(b)	Yeda Research and Development Co. Ltd.
	Attn: President
	P.O. Box 95
	Rehovot, 76100, Israel
(c)	Inspire Pharmaceuticals, Inc.
	Attn: General Counsel
	4222 Emperor Boulevard, Suite 200
	Durham, NC 27703

Section 17. Integration.

This Agreement constitutes the full understanding between the parties with reference to the subject matter hereof, and no statements or agreements by or between the parties, whether orally or in writing, except as provided for elsewhere in this Section 17, made prior to or at the signing hereof, shall vary or modify the written terms of this Agreement. Neither party shall claim any amendment, modification, or release from any provisions of this Agreement by mutual agreement, acknowledgment, or otherwise, unless such mutual agreement is in writing, signed by the other party, and specifically states that it is an amendment to this Agreement.

Section 18. Confidentiality.

Except to the extent expressly authorized by this Agreement or otherwise agreed in writing, the parties hereto agree that, for the term of this Agreement and for five (5) years thereafter, the receiving party shall keep confidential and shall not disclose or use for any purpose other than as permitted under this Agreement any confidential information furnished to it by the other party pursuant to this Agreement. “Confidential Information” shall include Licensee’s development plan, development reports, and royalty reports, any information reviewed by or on behalf of WARF under Section 6 hereof, the Licensed Patents, and all information concerning them and any other information marked confidential or accompanied by correspondence indicating such information is exchanged in confidence between the parties. Except as may be authorized in advance in writing by WARF, Licensee shall grant access to the Confidential Information of WARF and Yeda only to its Sublicensees and those employees, consultants, and contractors of Licensee and its Sublicensees involved in research, development or other activities relating to Products or the Licensed Patents who are under conditions of confidentiality, and to prospective investors, sublicensees, investment bankers, auditors, attorneys, and regulatory authorities in connection with its financing, regulatory, product development, and business development activities. Licensee shall use commercially reasonable efforts to require its Sublicensees and all such employees, consultants, contractors, prospective investors, sublicensees, investment bankers, auditors, attorneys, and regulatory authorities (if possible), to be bound by terms of confidentiality no less restrictive than those set forth in this Section 18. Licensee shall use such Confidential Information only in the course of exercising the rights granted under this Agreement or in the fulfillment of the obligations entered into hereunder. The confidentiality and use obligations set forth above apply to all or any part of the Confidential Information disclosed hereunder except to the extent that:

(i) WARF, Yeda, Licensee or its Sublicensees can show by written record that it possessed the information prior to its receipt from the other party;

(ii) the information was already available to the public or became so through no fault of WARF, Yeda, Licensee or Sublicensees; or

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(iii) the information is subsequently disclosed without obligation of confidentiality to WARF, Yeda, Licensee or Sublicensees by a third party that has the right to disclose it free of any obligations of confidentiality or

(iv) the recipient can demonstrate by written record was developed by or for the recipient independently of the disclosure of information by the other party.

Section 19. Authority.

The persons signing on behalf of Licensors and Licensee hereby warrant and represent that they have authority to execute this Agreement on behalf of the party for whom they have signed.

IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the dates indicated below.

WISCONSIN ALUMNI RESEARCH FOUNDATION
By:	/s/ Carl E. Gulbrandsen	Date: November 2, 2004
	Carl E. Gulbrandsen, Managing Director

INSPIRE PHARMACEUTICALS, INC.
By:	/s/ Chrsity L. Shaffer	Date: November 1, 2004
	Christy L. Shaffer, Chief Executive Officer
Reviewed by WARF’s Attorney:

/s/ David M. Kettner, Esq.	Date: October 29, 2004
David M. Kettner, Esq.

(WARF’s attorney shall not be deemed a signatory to this Agreement.)

WARF Ref: Kaufman – P95212US

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APPENDIX A

A. “Date of First Commercial Sale” shall mean the date when cumulative sales to the retail market of Products exceeds $50,000.

B. “Development Report” shall mean a written account of Licensee’s progress under the development plan having at least the information specified on Appendix D to this Agreement, which shall be sent to the address specified on Appendix D.

C. “Licensed Field” shall be limited to ocular human therapeutics.

D. “Licensed Patents” shall refer to and mean those patents listed on Appendix B attached hereto in the Licensed Territory, and any subsequent patents owned by WARF or YEDA in a country in the Licensed Territory, including any reissues, reexaminations, renewals, extensions, divisions, continuations or requests for continued examinations, but only to the extent they claim inventions claimed in a patent listed on Appendix B.

E. “Licensed Territory” shall be limited to the United States, its territories and possessions and those countries or regions for which patents are included on Appendix B.

F. “Non-Commercial Research Purposes” shall mean the use of the inventions of the Licensed Patents and/or Improvements solely for academic research purposes or other not-for-profit or scholarly purposes not involving the use of the inventions of the Licensed Patents or Improvements to perform services for a fee or for the production or manufacture of products for sale to third parties, and the parties agree that the permitted right to practice and use reserved under rights related to Non-Commercial Research Purposes shall not include the ability of any person or entity to perform sponsored research wherein the sponsor receives a right, whether actual or contingent, direct or indirect, license, option or otherwise, to the results of the sponsored research or to any proprietary property or intellectual property or property rights derived directly from such sponsored research.

G. “Products” shall refer to and mean any and all products the use or sale of which would, but for the licenses granted under this Agreement, otherwise constitute infringement of any Valid Claim of the Licensed Patents.

H. “Selling Price” shall mean, in the case of Products that are sold or licensed, the invoice price to the end user of Products less any (i) shipping, postage, freight, and insurance costs, (ii) allowances, rebates, credits and refunds for returned or defective Products, (iii) allowances, rebates, credits, discounts and refunds for normal trade and quantity concessions, (iv) sales taxes, and other taxes or duties related to product sales (excluding income taxes), (v) chargeback payments and rebates (or the equivalent thereof) granted to managed health care organizations, wholesalers, or to federal, state/provincial, local and other governments, including their agencies, purchasers, and/or reimbursers, or to trade customers, and (vi) any import or export duties, tariffs, or similar charges incurred with respect to the import or export of Products and/or currency (to make royalty payments) into or out of any country in the Licensed Territory. Notwithstanding the foregoing, the Selling Price shall not include, and shall be deemed zero with respect to: (1) the distribution of reasonable quantities of promotional samples of Products distributed for the sole purpose of promoting that Product, or (2) Products provided for clinical trials or research purposes. The Selling Price for a Product that is transferred to a third party for promotional purposes without charge in excess of what is reasonable according to industry standards, or for promoting another product, shall be the average invoice price to the end user of that type of Product during the applicable calendar quarter.

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I. “Sublicensee” shall mean any party who is granted a license by Licensee under the rights granted to Licensee under this Agreement.

J. “Valid Claim” shall mean any claim in an issued and unexpired patent included within the Licensed Patents which claim has not been revoked or held unenforceable, unpatentable or invalid by a decision of a court or other governmental agency of competent jurisdiction, or that remains unappealable or unappealed within the time allowed for appeal, or that has not been disclaimed, denied or admitted to be invalid or unenforceable through reissue, re-examination, disclaimer or otherwise.

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APPENDIX B

LICENSED PATENTS

REFERENCE NUMBER	COUNTRY	PATENT NUMBER	ISSUE DATE	APPLICATION SERIAL NUMBER
CYTOSKELETAL ACTIVE AGENTS FOR GLAUCOMA THERAPY (Paul L. Kaufman and Benjamin Geiger)
P95212US	UNITED STATES	5,798,380	8/25/1998	08/604,568
P95212WO	PCT	—	—	US97/02709
P95212IL	ISRAEL	125735	12/18/2003	125735
CYTOSKELETAL ACTIVE AGENTS FOR GLAUCOMA THERAPY (Paul L. Kaufman and Benjamin Geiger)
P98048US	UNITED STATES	6,110,912	8/29/2000	09/022,228
CYTOSKELETAL ACTIVE AGENTS FOR GLAUCOMA THERAPY (Paul L. Kaufman and Benjamin Geiger)
P01051US	UNITED STATES	6,586,425	7/1/2003	09/772,412

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APPENDIX C

WARF ROYALTY REPORT

Licensee:	Agreement No:
Inventor:	P#:        P

Period Covered:             From:         /        /              Through:         /        /            

Prepared By:	Date:
Approved By:	Date:

If license covers several major product lines, please prepare a separate report for each line. Then combine all product lines into a summary report.

Report Type:    ¨     Single Product Line Report:                                                                          

¨ Multiproduct Summary Report.    Page 1 of          Pages

¨ Product Line Detail. Line:                      Tradename:                      Page:             

Report Currency:    ¨    U. S. Dollars            ¨     Other                                                              

	Gross Sales	* Less: Allowances	Net Sales	Royalty Rate	Period Royalty Amount
Country					This Year	Last Year
U.S.A.
Canada
Europe:
Japan
Other:
TOTAL:

Total Royalty:                      Conversion Rate:                      Royalty in U.S. Dollars:   $  

The following royalty forecast is non-binding and for WARF’s internal planning purposes only:

Royalty Forecast Under This Agreement: Next Quarter:             Q2:             Q3:             Q4:            

* On a separate page, please indicate the reasons for returns or other adjustments if significant.

Also note any unusual occurrences that affected royalty amounts during this period.

To assist WARF’s forecasting, please comment on any significant expected trends in sales volume.

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APPENDIX D

(a) DEVELOPMENT REPORT

A. Date development plan initiated and time period covered by this report.

B. Development Report (4-8 paragraphs).

1. Activities completed since last report including the object and parameters of the development, when initiated, when completed and the results.

2. Activities currently under investigation, i.e., ongoing activities including object and parameters of such activities, when initiated, and projected date of completion.

C. Future Development Activities (4-8 paragraphs).

1. Activities to be undertaken before next report including, but not limited to, the type and object of any studies conducted and their projected starting and completion dates.

2. Estimated total development time remaining before a product will be commercialized.

D. Changes to initial development plan (2-4 paragraphs).

1. Reasons for change.

2. Variables that may cause additional changes.

E. Items to be provided if applicable:

1. Development work being performed by third parties other than Licensee to include name of third party and type of work.

PLEASE SEND DEVELOPMENT REPORTS TO:

Wisconsin Alumni Research Foundation

Attn.: Contract Coordinator

614 Walnut Street

P.O. Box 7365

Madison, WI 53707-7365

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APPENDIX E

DEVELOPMENT PLAN

Licensee agrees that it will evaluate H-7, latrunculinat A and/or latrunculin B along with internally synthesized compounds and compounds from external sources to identify the optimal compound to develop and market as a human therapeutic agent. The licensee will strive to make a determination of which compound(s) to pursue into development no later than [CONFIDENTIAL], 2006. This evaluation will include an assessment of the preclinical safety/efficacy of the various compounds, preliminary formulation/stability evaluations, evaluation of the complexity and cost of manufacturing of the bulk drug, and other standard preclinical evaluations. In the event a compound is identified in this timeframe, the Licensee will make every reasonable efforts to pursue the following activities within the following timelines:

1. Formulation optimization and GLP toxicology testing will be initiated on or about [CONFIDENTIAL].

2. Phase I clinical trials with the final formulation will be completed on or about [CONFIDENTIAL].

3. Phase II clinical trials will be completed on or about [CONFIDENTIAL].

4. Phase III clinical trials will be completed on or about [CONFIDENTIAL].

5. Submission of an NDA with FDA will be completed on or about [CONFIDENTIAL].

6. NDA approval and product launch would be expected by [CONFIDENTIAL].

The milestones described, and dates estimated, above are based upon Licensee’s good faith belief as to the time required to achieve each of the designated milestones. To the extent any early milestone is not achieved, the subsequent milestones will be delayed. No guaranty is made that the dates will be achieved. Licensee shall not be in violation of any provision of this License as a result of changing any anticipated milestone or failing to meet any anticipated milestone. It is the understanding of the parties that drug development is complex, and that forecasting events related to the success of drug development may be affected, positively or adversely, by many factors that may or may not be under the control of Licensee. Factors that may have significant impacts on the timely achievement of any milestone include the responsiveness of the FDA, and any development or marketing conditions that may be imposed upon the Licensee by the FDA or any similar foreign regulatory body.

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EX-10.56

EXHIBIT 10.56

No.                     

INSPIRE PHARMACEUTICALS, INC.

EMPLOYEE STOCK OPTION AGREEMENT

Inspire Pharmaceuticals, Inc. (the “Company”), a Delaware corporation, as an incentive and inducement to the Optionee, who is presently an employee of the Company, to devote his or her best efforts to the affairs of the Company, which incentive and inducement the Board of Directors of the Company or a committee of the Board of Directors (either, the “Board”) has determined to be sufficient consideration for the grant of this option, hereby grants to the Optionee the right and option (the “Option”) to purchase shares of the Company’s Common Stock, $0.001 par value per share (the “Stock”), under the following terms:

Optionee:
Grant Date:
Vesting Commencement Date:
Exercise Price:
Number of Shares Available for Purchase (“Option Shares”):
Expiration Date:
Type of Stock Option:	Incentive Stock Option
	Non-Statutory Stock Option

1. The Option shall vest and become exercisable in installments in accordance with the following provisions:

(a) The Option shall not vest and become exercisable for any shares unless and until the first anniversary of the Vesting Commencement Date;

(b) Upon attainment of the first anniversary of the Vesting Commencement Date the Option shall vest and become exercisable for the number of Option Shares set forth in Appendix 1;

(c) The Option shall vest and become exercisable for the remaining Option Shares in a series of successive monthly installments after the first anniversary of the Vesting Commencement Date until fully vested. Each month, the Option shall vest and become exercisable for a number of Option Shares equal to the number (i.e. the quotient) obtained by dividing the number set forth in the “Shares” column of Appendix 1 for the year pertaining to the applicable month (i.e. the numerator) by the number of months during such year(s) that the Option shall vest

as indicated by the “Full Vest” column of Appendix 1 (i.e. the denominator). Each installment will vest on that day of each month which corresponds to the date of the month of the Vesting Commencement Date, provided, however, if a given month does not have such a date, the monthly tranche shall vest on the last day of such month;

(d) The Option shall expire and shall not be exercisable for any of the Option Shares after the Expiration Date; and

(e) Notwithstanding the above, the Option shall cease vesting if the Optionee terminates employment or otherwise ceases to serve as an employee (unless the Board otherwise determines that the circumstances warrant continuation of vesting).

2. Optionee understands and agrees that the Option is granted subject to and in accordance with the terms of the Inspire Pharmaceuticals, Inc. Amended and Restated 1995 Stock Plan, as amended (the “Plan”).

3. The Option may be exercised at any time and from time to time, subject to the limitation of Section 1 above, up to the aggregate number of shares specified herein; provided, however, the Option shall be exercisable only with respect to whole shares. Any fractional shares which vest during any vesting period shall be aggregated until such time as the fractional shares shall have accumulated to equal a whole share and become exercisable. Written notice of exercise shall be delivered to the Company specifying the number of shares with respect to which the Option is being exercised and a date not later than fifteen days after the date of the delivery of such notice as the date on which the Optionee will take up and pay for such shares. On the date specified in such notice, the Company will deliver to the Optionee a certificate for the number of shares with respect to which the Option is being exercised against payment therefor in cash or by certified check.

4. The Optionee shall not be deemed, for any purpose, to have any rights whatever in respect of Option Shares to which the Option shall not have been exercised and payment made as aforesaid. The Optionee shall not be deemed to have any rights to continued employment by virtue of the Option.

5. 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 Option, the maximum aggregate number and kind of shares or securities of the Company subject to the Option, and the Exercise Price of the Option, shall be appropriately adjusted by the Board (whose determination shall be conclusive) so that the proportionate number of Option Shares or other securities subject to the Option and the proportionate interest of the Optionee shall be maintained as before the occurrence of such event.

6. In the event of a Change in Control (as defined below) of the Company, the unvested portion of the Option shall become immediately vested and fully exercisable immediately prior

2

to a Change in Control. In addition, notwithstanding anything in the Plan or Section 8 of this Agreement to the contrary, in the event of a Change in Control the Option shall remain exercisable for the lesser of three (3) years or the Expiration Date.

For purposes of this Agreement, a “Change in Control” shall mean a determination by the Board (which maybe made effective as of a particular date specified by the Board), 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 vote of the Board 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 subsections shall have been satisfied:

(a) Any Person (other than the Person in control of the Company as of the effective date of the Company’s Change in Control Severance Benefit Plan, 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

(b) The stockholders of the Company approve: (i) a plan of complete liquidation of the Company; (ii) an agreement for the sale or disposition of all or substantially all of the Company’s assets; or (iii) 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.

(c) However, in no event shall a Change in Control be deemed to have occurred, with respect to an Optionee, if the Optionee is part of a purchasing group which consummates the Change in Control transaction. An Optionee shall be deemed “part of the purchasing group” for purposes of the preceding sentence if the Optionee 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 Board).

7. During the Optionee’s lifetime, the Option shall be exercisable only by such Optionee or, in the case of his or her legal incapacity, his or her guardian or legal representative. The Option shall be transferable by the Optionee only by will or the laws of descent and distribution. After

3

the Optionee’s death, the Option shall be exercisable only by the person or persons entitled to do so under the Optionee’s last will and testament or if the Optionee fails to make a testamentary disposition of the Option or dies intestate, by the person or persons entitled to receive the Option under any applicable laws of descent and distribution. In no event shall the Option be exercisable by any person to a greater extent than the Option could have been exercised by the Optionee immediately prior to his or her death or the effective date of his or her termination of employment due to Disability, as defined in Section 22(e)(3) of the Code (as applicable). The Board shall have the right to require evidence to its satisfaction of the rights of any person or persons seeking to exercise the Option hereunder, e.g., an authenticated copy of the will. Any attempted assignment, transfer, pledge, hypothecation or other disposition of the Option contrary to the provisions hereof, and the levy of any execution, attachment or similar process upon the Option, shall be null and void and without effect. Any transferee described above shall be treated as the Optionee for purposes of all other provisions of this agreement and the terms of the Plan.

8. If the Optionee terminates employment during any period in which the Option Shares are exercisable, but prior to the Expiration Date (the “Exercise Period”), such period shall be adjusted as follows, except that in no event shall the Exercise Period be extended beyond the Expiration Date:

(a) The Exercise Period shall end immediately upon the date of the Optionee’s breach of any agreement, covenant or representation by and between the Optionee and the Company, including but not limited to any promise or warrant made as consideration for this agreement or the terms of any severance agreement;

(b) The Exercise Period shall end immediately upon the effective date of the Optionee’s termination of employment by his or her: (i) voluntary resignation in violation of any agreement to remain in the employ of the Company; (ii) involuntary “Discharge for Cause” for reasons which may include, without limitation, any illegal or improper conduct that injures or impairs the reputation, goodwill, or business of the Company, involves the misappropriation of funds of the Company, or the misuse of data, information or documents acquired in connection with employment by the Company, or violates any other directive or policy promulgated by the Company; (iii) resignation in anticipation of Discharge for Cause; or (iv) resignation accepted by the Company in lieu of a formal Discharge for Cause;

(c) The Exercise Period shall end three months after the effective date of the Optionee’s termination of employment for any reason OTHER THAN: (i) by transfer to an affiliated corporation which owns directly or indirectly 50 percent (50%) or more of the total combined voting power of the Company or in which the Company owns directly or indirectly 50 percent (50%) or more of the total combined voting power or has a significant financial interest as determined by the Board (“Affiliate”); or (ii) any reason for which the Option would expire immediately, as described under Sections 8(a) and 8(b), or following death or disability, as described under Section 8(d); and

4

(d) The Exercise Period shall end twelve months after the effective date of the Optionee’s death or termination of employment due to Disability, subject to such proof of Disability as the Board may require.

9. It shall be a condition of exercise hereunder that:

(a) The Optionee shall execute and deliver to the Company a counterpart of any agreement and any amendment thereto or restatement or replacement thereof as the Company may reasonably require, and such other steps, if any, the Company deems necessary to comply with any law, rule or regulation applicable to the issue of such shares by the Company;

(c) The certificates representing the shares purchased under the Option may contain such legends as counsel for the Company shall deem necessary to comply with the applicable law, rule or regulation;

(d) The Optionee shall, if the Company so requests, provide payment of all state and federal taxes imposed upon the exercise of the Option and the issue of the shares covered hereby. If the Optionee satisfies the payment of any taxes by having shares withheld at the time of exercise, then the amount of shares withheld cannot exceed the Optionee’s minimum applicable withholding tax rate for federal (including FICA), state and local tax liabilities.

10. The Option is issued pursuant to the terms of the Plan. This Certificate does not set forth all of the terms and conditions of the Plan, which are incorporated herein by reference. Copies of the Plan may be obtained upon written request without charge from the Treasurer of the Company.

11. If the Option is intended to be treated as an Incentive Stock Option, it shall be treated as an Incentive Stock Option to the extent permitted by applicable laws or regulations; otherwise, to the extent not so permitted, it shall be treated as a Non-Statutory Stock Option. To the extent the Option is treated as an Incentive Stock Option:

(a) The Optionee agrees to notify the Company in writing within 30 days of the disposition of one or more shares of Stock which were transferred to him or her pursuant to the exercise of the Option if such disposition occurs within two years from the Date of Grant of the Option or within one year after the transfer of such shares.

(b) The Optionee acknowledges that:

(i) In the event the Optionee terminates employment with the Company or an Affiliate for reasons other than death or Disability, the Option shall cease to be eligible for tax treatment as an Incentive Stock Option, unless it is exercised within three months from the date of such termination; and

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(ii) In the event the Optionee dies or terminates employment due to Disability, the Option shall cease to be eligible for tax treatment as an Incentive Stock Option, unless it is exercised within twelve months from the date of death or such termination due to Disability.

12. This agreement may be amended unilaterally by the Company upon written notice to the Optionee, provided that no such amendment shall adversely impact the rights of the Optionee unless the Optionee expressly consents to such amendment in a written document specifically referencing this paragraph.

* * *

6

IN WITNESS WHEREOF the Company has caused the Option to be executed by its duly authorized officers on its behalf as of                              , 200    .

INSPIRE PHARMACEUTICALS, INC.

By: Barry G. Pea

Title: Executive Vice President of

Corporate Development, General

Counsel and Secretary

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Appendix 1	Inspire Pharmaceuticals, Inc.
	ID: 04-3209022
	4222 Emperor Boulevard, Ste. 200
	Durham, NC 27703
Optionee	Option Number:
Address #1	Plan:                         1995
Address #2	ID:

Effective [Insert grant date]], you have been granted a(n) Incentive Stock Option to purchase [Insert # of Shares]shares of common stock of Inspire Pharmaceuticals at an Exercise Price of [Insert Exercise Price] per share, subject to the terms and conditions of the Option.

The total purchase price for all of the Option Shares is [Insert Total Exercise Price].

The Option shall vest and become exercisable as follows:

I. Upon attainment of the first anniversary of the Vesting Commencement Date the Option shall vest and become exercisable for the number of Option Shares set forth below:

Shares	Vest Type	Full Vest	Expiration
	On Vest Date

II. The Option shall vest and become exercisable for the remaining Option Shares in a series of successive monthly installments after the first anniversary of the Vesting Commencement Date until fully vested. Each month, the Option shall vest and become exercisable for a number of Option Shares equal to the number obtained by dividing (i) the number set forth in the “Shares” column below for the year pertaining to the applicable month, by (ii) the number of months during such year(s) that the Option shall vest as indicated by the “Full Vest” column.

Shares	Vest Type	Full Vest	Expiration
	Monthly

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (File No. 333-114517) and Form S-8 (File No. 333-56360) of Inspire Pharmaceuticals, Inc. of our report dated March 11, 2005 relating to the financial statements, management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting which is included in this Annual Report on Form 10-K.

/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina

March 11, 2004

EX-31.1

Exhibit 31.1

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

I, Christy L. Shaffer, certify that:

1. I have reviewed this annual report on Form 10-K 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) 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

d) 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 has 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: March 11, 2005	/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 annual report on Form 10-K 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) 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

d) 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 has 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: March 11, 2005	/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 annual report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-K for the year ending December 31, 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: March 11, 2005	/s/    CHRISTY L. SHAFFER
	Christy L. Shaffer Chief Executive Officer (principal executive officer)

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 annual report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-K for the year ending December 31, 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: March 11, 2005	/s/    THOMAS R. STAAB, II
	Thomas R. Staab, II Chief Financial Officer (principal financial officer)