10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2008

OR

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

For the transition period from              to             

Commission File Number: 000-31135

INSPIRE PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in Its Charter)

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

4222 Emperor Boulevard, Suite 200 Durham, North Carolina	27703
(Address of Principal Executive Offices)	(Zip Code)

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Large accelerated filer   ¨	Accelerated filer  x
Non-accelerated filer  ¨ (do not check if a smaller reporting company)	Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of March 31, 2008, there were 56,581,571 shares of Inspire Pharmaceuticals, Inc. common stock outstanding.

TABLE OF CONTENTS

	Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)	3
Condensed Balance Sheets – March 31, 2008 and December 31, 2007	3
Condensed Statements of Operations – Three months ended March 31, 2008 and 2007	4
Condensed Statements of Cash Flows – Three months ended March 31, 2008 and 2007	5
Notes to Condensed Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures about Market Risk	37
Item 4. Controls and Procedures	38
PART II: OTHER INFORMATION
Item 1. Legal Proceedings	39
Item 1A. Risk Factors.	40
Item 6. Exhibits	61
SIGNATURES	62

2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

INSPIRE PHARMACEUTICALS, INC.

Condensed Balance Sheets

(in thousands, except per share amounts)

(Unaudited)

	March 31, 2008			December 31, 2007
Assets
Current assets:
Cash and cash equivalents	$	89,410		$	101,892
Investments		12,009			28,129
Trade receivables, net		13,749			12,974
Prepaid expenses and other receivables		4,268			4,617
Inventories, net		1,259			1,280
Other assets		499			614
Total current assets		121,194			149,506
Property and equipment, net		2,911			2,826
Investments		7,713			9,703
Intangibles, net		17,538			17,937
Other assets		470			531
Total assets	$	149,826		$	180,503
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	8,577		$	13,592
Accrued expenses		12,212			13,795
Deferred revenue		3,793			371
Short-term debt and capital leases		15,900			14,097
Total current liabilities		40,482			41,855
Long-term debt and capital leases		39,119			43,604
Other long-term liabilities		3,326			3,351
Total liabilities		82,927			88,810
Commitments and contingencies (See Note 7)
Stockholders’ equity:
Preferred stock, $0.001 par value, 1,860 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.001 par value, 100,000 shares authorized; 56,582 and 56,501 shares issued and outstanding, respectively		57			57
Additional paid-in capital		401,543			400,460
Accumulated other comprehensive income		77			41
Accumulated deficit		(334,778	)		(308,865	)
Total stockholders’ equity	$	66,899		$	91,693
Total liabilities and stockholders’ equity	$	149,826		$	180,503

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

3

INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Operations

(in thousands, except per share amounts)

(Unaudited)

	Three Months Ended
	March 31, 2008			March 31, 2007
Revenues:
Product sales, net	$	2,279		$	—
Product co-promotion		7,424			7,204
Total revenue		9,703			7,204
Operating expenses:
Cost of sales		1,007			—
Research and development		14,797			22,765
Selling and marketing		16,205			7,521
General and administrative		3,546			3,639
Total operating expenses		35,555			33,925
Loss from operations		(25,852	)		(26,721	)
Other income/(expense):
Interest income		1,191			1,061
Interest expense		(1,252	)		(455	)
Other income/(expense), net		(61	)		606
Net loss	$	(25,913	)	$	(26,115	)
Basic and diluted net loss per common share	$	(0.46	)	$	(0.62	)
Weighted average common shares used in computing basic and diluted net loss per common share		56,553			42,273

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

4

INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Cash Flows

(in thousands)

(Unaudited)

	Three Months Ended
	March 31, 2008			March 31, 2007
Cash flows from operating activities:
Net loss	$	(25,913	)	$	(26,115	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization expense		547			101
Depreciation of property and equipment		235			209
Gain on disposal of property and equipment		2			—
Stock-based compensation expense		1,054			446
Changes in operating assets and liabilities:
Trade receivables		(775	)		(1,378	)
Prepaid expenses and other receivables		328			979
Inventories		21			—
Other assets		(46	)		—
Accounts payable		(4,941	)		(2,020	)
Accrued expenses and other liabilities		(1,587	)		(610	)
Deferred revenue		3,422			2,430
Net cash used in operating activities		(27,653	)		(25,958	)
Cash flows from investing activities:
Purchase of investments		(2,554	)		(13,273	)
Proceeds from sale of investments		20,700			23,340
Purchase of property and equipment		(322	)		(405	)
Net cash provided by investing activities		17,824			9,662
Cash flows from financing activities:
Issuance of common stock, net		29			156
Payments on notes payable and capital lease obligations		(2,682	)		(355	)
Net cash used in financing activities		(2,653	)		(199	)
Decrease in cash and cash equivalents		(12,482	)		(16,495	)
Cash and cash equivalents, beginning of period		101,892			50,190
Cash and cash equivalents, end of period	$	89,410		$	33,695

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

5

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

1. Organization

Inspire Pharmaceuticals, Inc. (the “Company” or “Inspire”) was incorporated in October 1993 and commenced operations in March 1995. 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 through 2009. The Company’s liquidity needs will largely be determined by the commercial success of its products and key development and regulatory events. In order to continue its operations substantially beyond 2009 it will need to: (1) successfully increase revenues, (2) obtain additional product candidate approvals, which would trigger milestone payments to the Company, (3) out-license rights to certain of its product candidates, pursuant to which the Company would receive income, (4) raise additional capital through equity or debt financings or from other sources, (5) reduce spending on one or more research and development programs and/or (6) restructure operations. The Company currently receives revenue from sales of AzaSite^® (azithromycin ophthalmic solution) 1% and its co-promotion of Restasis^® (cyclosporine ophthalmic emulsion) 0.05% and Elestat^® (epinastine HCl ophthalmic solution) 0.05%. The Company will continue to incur operating losses until product and co-promotion revenues reach a level sufficient to support ongoing operations. AzaSite is a trademark owned by InSite Vision Incorporated (“InSite Vision”). Restasis and Elestat are trademarks owned by Allergan, Inc. (“Allergan”).

2. Basis of Presentation

The accompanying unaudited Condensed Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States of America and applicable Securities and Exchange Commission (“SEC”) regulations for interim financial information. These financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. It is presumed that users of this interim financial information have read or have access to the audited financial statements from the preceding fiscal year contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the Company’s financial position and operations for the interim periods presented have been made. Operating results for the interim periods presented are not indicative of the results that may be expected for the full year.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results will differ from those estimates.

Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding and dilutive potential common shares then outstanding. Dilutive potential common shares consist of shares issuable upon the exercise of stock options and restricted stock units that are paid in shares of the Company’s stock upon conversion. The calculation of diluted earnings per share for the three months ended March 31, 2008 and 2007 does not include 274 and 557, respectively, of potential common shares, as their impact would be antidilutive.

6

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

Intangible Assets

Costs associated with obtaining 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 future use exists are recorded as expense. In the event a product candidate has been approved by the FDA or an alternative future use exists for a product candidate, patent and license costs are capitalized and amortized over the expected life of the related product candidate. Milestone payments to the Company’s collaborators are recognized when the underlying requirement is met.

Upon FDA approval of AzaSite in April 2007, the Company paid a $19,000 milestone to InSite Vision. The $19,000 is being amortized ratably on a straight-line basis through the term of the underlying patent coverage for AzaSite, or March 2019, which represents the expected period of commercial exclusivity. As of March 31, 2008, the Company had $1,462 in accumulated amortization related to this milestone.

The carrying values of intangible assets 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 intangible assets based on an analysis of undiscounted cash flows over the remaining amortization period. If the review indicates that carrying values may not be recoverable, the Company will reduce the carrying values to the estimated fair value.

Debt

In December 2006, the Company entered into a loan and security agreement with two participating financial institutions, which provided a term loan facility to the Company in an aggregate amount of $40,000. In June 2007, the Company amended the loan and security agreement with the two participating financial institutions to enable the Company to draw upon a new supplemental term loan facility in the amount $20,000, effectively increasing the total term loan facility to $60,000. The Company has borrowed the full $60,000 available under the term loan facility. The interest rates associated with the individual borrowings under the facility range from approximately 7.6% to 8.0%. As of March 31, 2008, the Company had net borrowings under the term loan facility of $54,876. The final maturity date for all loan advances under the original term loan facility and the supplemental term loan facility is March 2011.

Revenue Recognition

The Company records all of its revenue from (1) sales of AzaSite; (2) product co-promotion activities; and (3) collaborative research agreements in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements,” (“SAB No. 104”). SAB No. 104 states that revenue should not be recognized until it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) the seller’s price to the buyer is fixed or determinable; and 4) collectibility is reasonably assured.

Product Revenues

The Company recognizes revenue for sales of AzaSite when title and substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment, with the exception of transactions whereby product stocking incentives were offered approximately one month prior to the product’s August 13, 2007 launch. In the United States, the Company sells AzaSite to wholesalers and distributors, who, in turn, sell to pharmacies and federal, state and commercial healthcare organizations. Accruals, or reserves, for estimated rebates,

7

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

discounts, chargebacks and other sales incentives (collectively, “sales incentives”) are recorded in the same period that the related sales are recorded and are recognized as a reduction in sales of AzaSite. These sales incentive reserves are recorded in accordance with Emerging Issues Task Force (“EITF”), Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer,” which states that cash consideration given by a vendor to a customer is presumed to be a reduction of the selling price of the vendor’s product or services and therefore should be characterized as a reduction of the revenue recognized in the vendor’s income statement. Sales incentive accruals, or reserves, are based on reasonable estimates of the amounts earned or claimed on the sales of AzaSite. These estimates take into consideration current contractual and statutory requirements, specific known market events and trends, internal and external historical data and experience, and forecasted customer buying patterns. Amounts accrued or reserved for sales incentives are adjusted for actual results and when trends or significant events indicate that an adjustment is appropriate. As of March 31, 2008, the Company has reserved approximately $752 for sales incentives.

In addition to SAB No. 104, the Company’s ability to recognize revenue for sales of AzaSite is subject to the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition When Right of Return Exists” (“SFAS No. 48”), as issued by the Financial Accounting Standards Board (“FASB”). SFAS No. 48 states that revenue from sales transactions where the buyer has the right to return the product will be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller, (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. Customers will be able to return short-dated or expired AzaSite that meet the guidelines set forth in the Company’s return goods policy. The Company’s return goods policy generally allows for returns of AzaSite within an 18-month period, from six months prior to the expiration date and up to 12 months after the expiration date, but may differ from customer to customer, depending on certain factors. In accordance with SFAS No. 48, the Company is required to estimate the level of sales that will ultimately be returned pursuant to its return policy and to record a related reserve at the time of sale. These amounts are deducted from the Company’s gross sales of AzaSite in determining its net sales. Future estimated returns of AzaSite are based primarily on the return data for comparative products and the Company’s own historical experience with AzaSite. The Company also considers other factors that could impact sales returns of AzaSite. These factors include levels of inventory in the distribution channel, estimated remaining shelf life, price changes of competitive products, and current and projected product demand that could be impacted by introductions of generic products and introductions of competitive new products, among others. As of March 31, 2008, the Company has reserved approximately $165 for potential returns of AzaSite.

Immediately preceding the launch of AzaSite, the Company offered wholesalers stocking incentives that allowed for extended payment terms, product discounts, and guaranteed sale provisions (collectively, “special terms”). These special terms were only offered during a specified time period of approximately one month prior to the August 13, 2007 launch of AzaSite. Any sales of AzaSite made under these special term provisions were accounted for using a consignment model since substantially all the risks and rewards of ownership did not transfer upon shipment. Under the consignment model, the Company did not recognize revenue upon shipment of AzaSite purchased with the special terms, but recorded deferred revenue at gross invoice sales price, less all appropriate discounts and rebates, and accounted for AzaSite inventory held by the wholesalers as consignment inventory. The Company recognized the revenue from these sales with special terms at the earlier of when the inventory of AzaSite held by the wholesalers was sold through to the wholesalers’ customers or when such inventory of AzaSite was no longer subject to these special terms. For the three months ended March 31, 2008, the Company recognized all of the remaining net deferred revenue of $371 related to sales of AzaSite considered consignment. All sales subsequent to this specified “launch” time period include return rights and pricing that are customary in the industry.

8

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

The Company utilizes data from external sources to help it estimate its gross to net sales adjustments as they relate to the sales incentives and recognition of revenue for AzaSite sold under the special term provisions. External sourced data includes, but is not limited to, information obtained from certain wholesalers with respect to their inventory levels and sell-through to customers as well as data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. The Company also utilizes this data to help estimate and identify prescription trends and patient demand, as well as product levels in the supply chain.

Product Co-promotion Revenues

The Company recognizes co-promotion revenue based on net sales for Restasis and Elestat, as defined in the co-promotion agreements, and as reported to Inspire by Allergan. The Company actively promotes both Restasis and Elestat through its commercial organization and shares in any risk of loss due to returns and other allowances, as determined by Allergan. Accordingly, the Company’s co-promotion revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which the Company has limited or no control and on 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, all of which are determined by Allergan and are outside the Company’s control. The Company records a percentage of Allergan’s net sales for both Restasis and Elestat, reported to Inspire by Allergan, as co-promotion revenue. The Company receives monthly sales information from Allergan and performs analytical reviews and trend analyses using prescription information that it receives from IMS Health. In addition, the Company exercises its audit rights under the contractual agreements with Allergan to annually perform an examination of Allergan’s sales records of both Restasis and Elestat. The Company makes no adjustments to the amounts reported to it by Allergan other than reductions in net sales to reflect the incentive programs managed by the Company. The Company offers and manages certain incentive programs associated with Elestat, which are utilized by it in addition to those programs managed by Allergan. The Company reduces revenue by estimating the portion of Allergan’s sales that are subject to these incentive programs based on information reported to it by a third-party administrator of the incentive program. Since the launch of Elestat, the amount of rebates associated with the Company’s incentive programs in each fiscal year was less than one-half of one percent of co-promotion revenues. The rebates associated with the programs that the Company manages represent an insignificant amount, as compared to the rebate and discount programs administered by Allergan and as compared to the Company’s aggregate co-promotion revenue. Under the co-promotion agreement for Elestat, the Company is obligated to meet predetermined minimum calendar year net sales target levels. If the annual minimum is not achieved, the Company records revenues using a reduced percentage of net sales based upon its level of achievement of the predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue. As of March 31, 2008 and 2007, the Company had deferred revenue associated with sales of Elestat of $3,793 and $2,430, respectively.

Collaborative Research and Development Revenues

The Company recognizes revenue under its collaborative research and development agreements when it has performed services under such agreements or when the Company or its collaborative partner have met a contractual milestone triggering a payment to the Company. The Company recognizes revenue from its research and development service agreements ratably over the estimated service period as related research and development costs are incurred and the services are substantially performed. Upfront non-refundable fees and milestone payments 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 in which the services are substantially performed. This period, if not defined in the collaborative agreement, is based on estimates by the Company’s management and the progress towards agreed upon development events as set forth in the collaborative agreements. These estimates are subject to

9

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

revision as the Company’s development efforts progress and it 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. If the estimated service period is subsequently modified, the period over which the upfront fee or revenue related to ongoing research and development services is modified on a prospective basis. The Company is also entitled to receive milestone payments under its collaborative research and development agreements based upon the achievement of agreed upon development events that are substantively at-risk by its collaborative partners or the Company. This collaborative research revenue is recognized upon the achievement and acknowledgement of the Company’s collaborative partner of a development event, which is generally at the date payment is received from the collaborative partner or is reasonably assured. Accordingly, the Company’s revenue recognized under its collaborative research and development agreements may fluctuate significantly from period to period.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss is comprised of unrealized gains and losses on marketable securities and is disclosed as a component of stockholders’ equity. The Company had $77 and $41 of unrealized gains on its investments that are classified as accumulated other comprehensive income/(loss) at March 31, 2008 and December 31, 2007, respectively. Comprehensive loss consists of the following components:

	Three Months Ended March 31,
	2008			2007
Net loss	$	(25,913	)	$	(26,115	)
Change in unrealized gains on investments		36			60
Total comprehensive loss	$	(25,877	)	$	(26,055	)

Risks from Third Party Manufacturing and Distribution Concentration

The Company relies on single source manufacturers for its commercial products and product candidates. Allergan is responsible for the manufacturing of both Restasis and Elestat and relies on single source manufacturers for the active pharmaceutical ingredients in both products, which are co-promoted by the Company. The Company relies on InSite Vision for supply of the active pharmaceutical ingredient for AzaSite, which InSite Vision obtains from a single source manufacturer. The Company is responsible for the remaining finished product manufacturing of AzaSite, for which it relies on a single source manufacturer. Additionally, the Company relies upon a single third party to provide distribution services for AzaSite. Accordingly, delays in the manufacture or distribution of any product or manufacture of any product candidate could adversely impact the marketing of the Company’s products or the development of the Company’s product candidates. Furthermore, the Company has no control over the manufacturing or the overall product supply chain of Restasis and Elestat.

10

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

Significant Customers and Risk

The Company relies primarily on three pharmaceutical wholesalers to purchase and supply the majority of AzaSite at the retail level. These three pharmaceutical wholesalers accounted for greater than 80% of all AzaSite product sales in the three months ended March 31, 2008. The loss of one or more of these wholesalers as a customer could negatively impact the commercialization of AzaSite. All co-promotion revenues recognized and recorded were from one collaborative partner, Allergan. The Company is entitled to receive co-promotion revenue from net sales of Restasis and Elestat under the terms of its collaborative agreements with Allergan, and accordingly, all trade receivables for these two products are solely due from Allergan. Due to the nature of these agreements, Allergan has significant influence over the commercial success of Restasis and Elestat.

3. Inventories

The Company’s inventories are valued at the lower of cost or market using the first-in, first-out (i.e., FIFO) method. Cost includes materials, labor, overhead, shipping and handling costs. The Company’s inventories are subject to expiration dating and the Company has reserved for potential overstocking. The Company’s inventories consisted of the following:

	As of
	March 31, 2008			December 31, 2007
Finished Goods	$	581		$	669
Raw Materials		533			533
Work-in-Process		270			189
Consignment Inventory at Wholesalers		—			14
Total Inventories	$	1,384		$	1,405
Less Reserve		(125	)		(125	)
Total Inventories, net	$	1,259		$	1,280

4. Recent Accounting Pronouncements

In November 2007, the EITF of the FASB reached consensus on Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF Issue No. 07-1”). EITF Issue No. 07-1 addresses the issue of how costs incurred and revenue generated on sales to third parties should be reported by participants in a collaborative arrangement in each of their respective income statements. EITF Issue No. 07-1 also provides guidance on how an entity should characterize payments made between participants in a collaborative arrangement in the income statement and what participants should disclose in the notes to the financial statements about collaborative arrangements. EITF Issue No. 07-1 is effective for fiscal years beginning after December 15, 2007. As of January 1, 2008, the Company has adopted EITF Issue No. 07-1 and there was no material impact to its financial statements.

In June 2007, the EITF of the FASB reached consensus on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (“EITF Issue No. 07-3”). EITF Issue No. 07-3 addresses the issue of when to record nonrefundable advance payments for goods or

11

INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

services that will be used or rendered for research and development activities as expenses. The EITF has concluded that nonrefundable advance payments for future research and development activities should be deferred and recognized as an expense as the goods are delivered or the related services are performed. EITF Issue No. 07-3 is effective for fiscal years beginning after December 15, 2007. As of January 1, 2008, the Company has adopted EITF Issue No. 07-3 and there was no material impact to its financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115,” (“SFAS No. 159”). SFAS No. 159 permits companies to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. Companies electing the fair value option would be required to recognize changes in fair value in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has not elected the fair value option for financial assets and liabilities existing at January 1, 2008 that were not already measured at fair value or newly transacted in the three months ended March 31, 2008. Any future transacted financial assets or liabilities will be evaluated for the fair value election as prescribed by SFAS No. 159.

5. Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”). SFAS No. 157 establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within that fiscal year. In November 2007, the FASB elected to defer for one year the implementation of SFAS No. 157 for certain non-financial assets and liabilities.

The Company adopted the provisions of SFAS No. 157 effective January 1, 2008. Under SFAS No. 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (the “exit price”) in an orderly transaction between market participants at the measurement date. SFAS No. 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

Level 1	Valuations based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2	Valuations based on quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and
Level 3	Valuations based on prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

The Company’s assets recorded at fair value have been categorized based upon a fair value hierarchy in accordance with SFAS No. 157. The adoption of SFAS No. 157 did not have a material impact on our fair value measurements. In accordance with the provisions of FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” the Company has elected to defer implementation of SFAS No. 157 as it relates to its non-financial assets and non-financial liabilities that are recognized and disclosed at fair value in the financial statements on a nonrecurring basis until January 1, 2009. The Company is evaluating the impact, if any, that SFAS No. 157 will have on its non-financial assets and liabilities.

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

The following fair value hierarchy table presents information about the Company’s assets measured at fair value on a recurring basis as of March 31, 2008:

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Total Balance as of March 31, 2008
Cash equivalents	$	66,812	$	10,469	$	77,281
Investments:
Available-for-sale securities		—		18,907		18,907
Total	$	66,812	$	29,376	$	96,188

Level 1 cash equivalents consist of investments concentrated in two money market funds which are primarily invested in repurchase agreements, treasury securities, commercial paper and variable rate instruments. Level 2 cash equivalents consist of investments in commercial paper which have maturities of less than 90 days and have a credit rating of A1+/P1 as determined by Moody’s Investor Services and/or Standard & Poor’s. Level 2 investments in available-for-sale securities consist of corporate bonds and commercial paper which have a credit rating of at least A/A2 and A1+/P1, respectively. The Company does not have any direct investments in auction-rate securities or securities that are collateralized by assets that include mortgages or subprime debt. The fair value of the Company’s cash equivalents and available-for-sale securities are determined through quoted market prices, broker or dealer quotations, or other observable inputs.

6. Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with SFAS No. 123(R) Share-Based Payment.” For the three months ended March 31, 2008 and 2007, the Company recognized total compensation expense of $1,054 and $446, respectively, related to its two equity compensation plans.

Total stock-based compensation was allocated as follows:

	Three Months Ended March 31,
	2008		2007
Research and development	$	310	$	126
Selling and marketing		321		115
General and administrative		423		205
Total stock-based compensation expense	$	1,054	$	446

Equity Compensation Plans

The Company has two stock-based compensation plans, the Amended and Restated 1995 Stock Plan (the “1995 Plan”) and the Amended and Restated 2005 Equity Compensation Plan (the “2005 Plan”), that allow for share-based

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

payments to be granted to directors, officers, employees and consultants. The 1995 Stock Plan allows for the granting of non-qualified stock options and restricted stock to directors, officers, employees and consultants. The 2005 Plan allows for the granting of both incentive and non-qualified stock options, stock appreciation rights, restricted stock and restricted stock units to directors, officers, employees and consultants. At March 31, 2008, there were 86 and 3,842 shares available for grant as options or other forms of share-based payments under the 1995 Plan and 2005 Plan, respectively.

Basis for Fair Value Estimate of Share-Based Payments

The Company uses its own historical volatility to estimate its future volatility. Actual volatility, and future changes in estimated volatility, may differ substantially from the Company’s current estimates.

Prior to January 1, 2008, the Company utilized a simplified method of calculating the expected life of options for grants made to its employees under the 2005 Plan in accordance with the guidance set forth in the SEC’s Staff Accounting Bulletin No. 107 (“SAB No. 107”) due to the lack of adequate historical data with regard to exercise activity. For grants made under the 2005 Plan subsequent to January 1, 2008, the Company continues to utilize the simplified method of calculating the expected life due to the lack of adequate historical data as allowable under the SEC’s Staff Accounting Bulletin No. 110 (“SAB No. 110”). For options issued under the 1995 Plan prior to fiscal 2007, the Company utilized the historical data available regarding employee and director exercise activity to calculate an expected life of the options. Beginning in fiscal 2007, the Company began granting non-qualified stock options under the 1995 Plan with option terms similar to those granted under the 2005 Plan of five and seven years. Due to the lack of adequate historical data with regard to these shorter option terms, the Company has used the simplified method in accordance with the guidance set forth in SAB No. 107 for grants made prior to January 1, 2008 and in accordance with SAB No. 110 for grants made subsequent to January 1, 2008 when calculating the expected life for new options granted to its employees under the 1995 Plan. For options granted to directors under the 2005 Plan or the 1995 Plan, the Company uses the contractual term of seven years as the expected life of options. The Company will continue with these assumptions in determining the expected life of options under the 1995 Plan and the 2005 Plan until such time that adequate historical data is available. The Company estimates the forfeiture rate based on its historical experience.

The table below presents the weighted average expected life in years of options granted under the two plans as described above. The risk-free rate of the stock options is based on the U.S. Treasury yield curve in effect at the time of grant, which corresponds with the expected term of the option granted. The fair value of share-based payments, granted during the period indicated, was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values as follows:

	Stock Options for Three Months Ended March 31,
	2008			2007
Risk-free interest rate		1.88	%		4.46	%
Dividend yield		0	%		0	%
Expected volatility		63	%		70	%
Expected life of options (years)		3.6			3.7
Weighted average fair value of grants	$	1.88		$	3.49

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

The following table summarizes the stock option activity for both the 1995 Plan and 2005 Plan:

	Number of Shares		Weighted Average Exercise Price (per share)			Weighted Average Remaining Contractual Term (in Years)	Aggregate Intrinsic Value
Outstanding at December 31, 2007	8,268		$	9.01		4.9	$	3,721
Granted	426			4.02
Exercised	(81	)		(0.37	)
Forfeited/cancelled/expired	(67	)		(6.79	)
Outstanding at March 31, 2008	8,546		$	8.86		4.6	$	537
Vested and exercisable at March 31, 2008	5,476		$	10.67		4.5	$	537

Total intrinsic value of stock options exercised for the three months ended March 31, 2008 was $296. Cash received from stock option exercises for the three months ended March 31, 2008 was $30. Due to the Company’s net loss position, no windfall tax benefits have been realized during the three months ended March 31, 2008. As of March 31, 2008, approximately $7,760 of total unrecognized compensation cost related to unvested stock options is expected to be recognized over a weighted-average period of 2.4 years.

The value of restricted stock units granted is based on the closing market price of the Company’s common stock on the date of grant and is amortized on a straight-line basis over the five year requisite service period. At the date of grant, the restricted stock units had a total fair value of $811. As of March 31, 2008, there were 195 restricted stock units outstanding, of which 39 were vested. Additionally, approximately $459 of unrecognized share-based compensation expense related to unvested restricted stock units is expected to be recognized over the next 3.3 years.

7. Contingencies

Litigation

On February 15, 2005, the first of five identical purported shareholder class action complaints was filed in the United States District Court for the Middle District of North Carolina against the Company and certain of its senior officers. Each complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focused on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of the Company’s dry eye product candidate, Prolacria^TM. Each complaint sought unspecified damages on behalf of a purported class of purchasers of the Company’s securities during the period from June 2, 2004 through February 8, 2005.

On March 27, 2006, following consolidation of the lawsuits into a single civil action and appointment of lead plaintiffs, the plaintiffs filed a Consolidated Class Action Complaint (the “CAC”). The CAC asserts claims against the Company and certain of its present or former senior officers or directors. The CAC asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 based on statements alleged to be false and misleading regarding a Phase 3 clinical trial of Prolacria, and also adds claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The CAC also asserts claims against certain parties that served as underwriters in the Company’s securities offerings during the period relevant to the CAC. The CAC seeks unspecified damages on behalf of a purported class of purchasers of the Company’s securities during the period from May 10, 2004 through February

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

8, 2005. In May 2006, the plaintiffs agreed to voluntarily dismiss their claims against the underwriters on the basis that they were time-barred. On June 30, 2006, the Company and other defendants moved that the court dismiss the CAC on the grounds that it fails to state a claim upon which relief can be granted and does not satisfy the pleading requirements under applicable law.

On May 14, 2007, Magistrate Judge Eliason, to whom the District Court had referred the motion, issued a Recommendation that the District Court grant Defendants’ motion to dismiss the CAC. Plaintiffs filed objections to this Recommendation in which they argued that the District Court should not accept the Recommendation, and Defendants responded to Plaintiffs’ objections.

On July 26, 2007, the United States District Court for the Middle District of North Carolina accepted the Magistrate Judge’s recommendation and granted the Company’s and the other defendants’ motion and dismissed the CAC with prejudice. On August 24, 2007, the plaintiffs filed an appeal to the United States Court of Appeals for the Fourth Circuit. Plaintiffs filed their opening appellate brief on November 19, 2007. The Company and the other defendants filed an opposition brief on January 18, 2008. Plaintiffs filed their reply on February 22, 2008. The Company will continue to defend the litigation vigorously. As with any legal proceeding, the Company cannot predict with certainty the eventual outcome of these lawsuits, nor can a reasonable estimate of the amounts of loss, if any, be made.

SEC Investigation

On August 30, 2005, the SEC notified the Company that it is conducting a formal, nonpublic investigation which the Company believes relates to its Phase 3 clinical trial of the Company’s dry eye product candidate, Prolacria. On October 19, 2006, the Company received a Wells Notice letter from the staff of the SEC, issued in connection with this investigation. The Company’s Chief Executive Officer and its then Executive Vice President, Operations and Communications, also received Wells Notices.

The Wells Notices provide notification of the SEC staff's determination that it intends to recommend to the SEC that it bring a civil action against the Company and the two officers regarding possible violations of Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and SEC Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13a-14 thereunder. Under the process established by the SEC, the Company and the two officers have the opportunity to respond in writing to the Wells Notice before the staff makes any formal recommendation to the SEC regarding what action, if any, should be brought by the SEC. The Company and the officers receiving these notices provided written submissions to the SEC in response to the Wells Notices during December 2006, and have since had further discussions and meetings with, and have provided further written submissions to, the SEC staff.

The Company cannot predict with certainty the eventual outcome of this investigation, nor can a reasonable estimate of the costs that might result from the SEC’s investigation be made.

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

CAUTIONARY STATEMENT

The discussion below contains forward-looking statements regarding our financial condition and our results of operations that are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted within the United States, 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. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results of our 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 actions and marketing approvals, reliance on collaborative partners, enforcement of patent and proprietary rights, the need for future capital, competition associated with products, potential competition associated with our product candidates and retention of key employees. In order for one of our product candidates to be commercialized, it will be necessary for us, or our collaborative partners, 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 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 Condition 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 revenues are difficult to predict and depend on numerous factors. We launched AzaSite in August 2007 and began recording product revenue in the third quarter of 2007. The effectiveness of our ability and the ability of third parties on which we rely to help us manufacture, distribute and market AzaSite; physician and patient acceptance of AzaSite; competitor response to the launch of AzaSite; discounts, pricing and coverage on governmental and commercial formularies; are all factors, among others, that will impact the level of revenue recorded for AzaSite in subsequent periods. Our co-promotion revenues are based upon Allergan’s revenue recognition policy and other accounting policies, over which we have limited or no control, and on the underlying terms of our co-promotion agreements. Our co-promotion revenues are impacted by the number of governmental and commercial formularies upon which Restasis and Elestat are listed, the discounts and pricing under such formularies, as well as the estimated and actual amount of rebates, all of which are managed by Allergan. Other factors that are difficult to predict and that impact our co-promotion revenues are the extent and effectiveness of Allergan’s sales and marketing efforts as well as our own sales and marketing efforts, coverage and reimbursement under Medicare Part D and Medicaid programs, and the sales and marketing activities of competitors, among others. In addition, the commercial marketing exclusivity period for Elestat provided under the Hatch-Waxman Act will expire on October 15, 2008, at which time competitors will be able to submit to the FDA an ANDA or a 505(b)(2) application for a generic version of epinastine HCl ophthalmic solution. If a generic form of Elestat or an over-the-counter form of epinastine for the eye is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues attributable to Elestat will essentially cease. Revenues related to development activities are dependent upon the progress toward and the achievement of developmental milestones by us or our collaborative partners.

Our operating expenses are also difficult to predict and depend on several factors. Cost of sales as they relate to AzaSite contain variable and fixed cost components, and the variable components will increase or decrease depending on the volume of AzaSite sold. In addition, certain of these variable costs included in cost of sales are

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subject to annual increases which are generally out of our control. Research and development expenses, including expenses for development milestones, drug synthesis and manufacturing, preclinical testing and clinical research activities, depend on the ongoing requirements of our development programs, completion of business development transactions, 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 research and development expenses, in part by accelerating or decelerating preclinical testing, 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 incurred and expect to continue to incur significant selling and marketing expenses to commercialize our products. Again, management may in some cases be able to control the timing and magnitude of these expenses. We have incurred and expect to continue to incur significant costs related to the commercialization of AzaSite. In addition, we have incurred and may incur additional general and administrative expenses related to our current stockholder litigation and Securities and Exchange Commission, or SEC, investigation.

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 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 focused on discovering, developing and commercializing prescription pharmaceutical products for diseases in the ophthalmic and respiratory areas. Our goal is to build and commercialize a sustainable pipeline of innovative new treatments based upon our technical and scientific expertise. Our portfolio of products and product candidates include:

PRODUCTS AND PRODUCT CANDIDATES	THERAPEUTIC AREA/ INDICATION	COLLABORATIVE PARTNER (1)	CURRENT STATUS IN THE UNITED STATES
Products
AzaSite®	Bacterial conjunctivitis	InSite Vision	Promoting
Restasis®	Dry eye disease	Allergan	Co-promoting
Elestat®	Allergic conjunctivitis	Allergan	Co-promoting
Product Candidates in Clinical Development
ProlacriaTM (diquafosol tetrasodium)	Dry eye disease	Allergan; Santen Pharmaceutical	Phase 3; Approvable (2)
Denufosol tetrasodium	Cystic fibrosis	None	Phase 3
INS115644	Glaucoma	Wisconsin Alumni Research Foundation	Phase 1
Epinastine nasal spray	Allergic rhinitis	Boehringer Ingelheim	Program discontinued (3)

⁽¹⁾ See our Annual Report on Form 10-K for the year ended December 31, 2007 for a detailed description of our agreements with these collaborative partners.

⁽²⁾ In June 2003, we filed an NDA with the FDA for Prolacria for the treatment of dry eye disease. We have received two approvable letters from the FDA (in December 2003 and December 2005).

⁽³⁾ On April 23, 2008, we discontinued the development of epinastine nasal spray.

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We employ a U.S. sales force for the promotion of AzaSite for bacterial conjunctivitis, Restasis for dry eye disease and Elestat for allergic conjunctivitis. AzaSite is a trademark owned by InSite Vision Incorporated, or InSite Vision. Restasis, Elestat and Prolacria are trademarks owned by Allergan, Inc., or Allergan.

Our ophthalmic products and product candidates are currently concentrated in the allergic conjunctivitis, bacterial conjunctivitis, dry eye disease and glaucoma indications. Our respiratory product candidate is for the treatment of respiratory complications of cystic fibrosis.

We were incorporated as a Delaware corporation in October 1993 and commenced operations in March 1995. We are located in Durham, North Carolina, adjacent to the Research Triangle Park.

PRODUCTS

AzaSite

AzaSite (azithromycin ophthalmic solution) 1% is a topical anti-infective, in which azithromycin is formulated into an ophthalmic solution utilizing DuraSite®, a novel ocular drug delivery system. Azithromycin is a semi-synthetic antibiotic that is derived from erythromycin and since 1992, has been available via oral administration by Pfizer Inc. under the trade name Zithromax®. In April 2007, AzaSite was approved by the U.S. Food and Drug Administration, or FDA, for the treatment of bacterial conjunctivitis in adults and children one year of age and older.

On February 15, 2007, we entered into a license agreement with InSite Vision pursuant to which we acquired exclusive rights to commercialize AzaSite, as well as other potential topical anti-infective products containing azithromycin for use in the treatment of human ocular or ophthalmic indications. The license agreement also grants us exclusive rights to develop, make, use, market, commercialize and sell the products in the United States and Canada and their respective territories. We are obligated to pay InSite Vision royalties on net sales of AzaSite in the United States and Canada.

In August 2007, we launched AzaSite in the United States and are promoting it to select eye care professionals, pediatricians and primary care providers. The manufacture and sale of AzaSite is protected in the United States under use and formulation patents which expire in March 2019.

Restasis

Restasis (cyclosporine ophthalmic emulsion) 0.05% is the first approved prescription product in the United States for the treatment of dry eye disease. It is indicated to increase tear production in adults and children at least 16 years old whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca, or dry eye disease. In December 2002, Restasis was approved by the FDA and Allergan launched Restasis in the United States in April 2003.

In June 2001, we entered into an agreement with Allergan to develop and commercialize our product candidate, Prolacria^TM (diquafosol tetrasodium), for the treatment of dry eye disease. The agreement also provided us with a royalty on worldwide (except most Asian markets) net sales of Allergan’s Restasis and granted us the right to co-promote Restasis in the United States.

In January 2004, we began co-promotion of Restasis to eye care professionals and allergists in the United States. We began receiving co-promotion revenue on Allergan’s net sales of Restasis beginning in April 2004. The manufacture and sale of Restasis is protected in the United States under a use patent which expires in August 2009 and a formulation patent which expires in May 2014.

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Elestat

Elestat (epinastine HCl ophthalmic solution) 0.05%, a topical antihistamine with mast cell stabilizing and anti-inflammatory activity, was developed by Allergan for the prevention of ocular itching associated with allergic conjunctivitis. Elestat was approved by the FDA in October 2003 and is indicated for adults and children at least three years old. Elestat is a seasonal product with product demand mirroring seasonal trends for topical allergic conjunctivitis products. Typically, demand is highest during the Spring months followed by moderate demand in the Summer and Fall months. The lowest demand is during the Winter months.

In December 2003, we entered into an agreement with Allergan to co-promote Elestat in the United States. Under the agreement, we have the responsibility for promoting and marketing Elestat to ophthalmologists, optometrists and allergists in the United States and paying the associated costs. We receive co-promotion revenue from Allergan on its U.S. net sales of Elestat. Allergan records sales of Elestat and is responsible for other product costs.

In February 2004, we launched Elestat in the United States. We are promoting it to ophthalmologists, optometrists and allergists, and in association with the commercialization of AzaSite, we are also promoting Elestat to select pediatricians and primary care physicians. We work with Allergan collaboratively on overall product strategy and management in the United States.

The commercial exclusivity period for Elestat under the Hatch-Waxman Act will expire on October 15, 2008, at which time competitors will be able to submit to the FDA an abbreviated New Drug Application, or ANDA, or a 505(b)(2) application for a generic version of epinastine HCl ophthalmic solution. We cannot predict with certainty the time frame of an FDA review of such applications, if any are filed. We are aware that several generic pharmaceutical companies have expressed intent to commercialize the ocular form of epinastine after the commercial exclusivity period expires. Our ability to gain additional intellectual property protection related to Elestat has been, and continues to be, challenging. To date, no patent protection or any other form of intellectual property protection has been obtained for Elestat, and we cannot provide any assurance that any form of intellectual property protection covering Elestat will be possible in the United States after the expiration of the commercial exclusivity period under the Hatch-Waxman Act on October 15, 2008. If a generic form of Elestat or an over-the-counter form of epinastine for the eye is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues attributable to Elestat will essentially cease.

For a more detailed discussion of the risks associated with our products and products we co-promote, please see the Risk Factors described elsewhere in this report.

PRODUCT CANDIDATES IN CLINICAL DEVELOPMENT

Prolacria (diquafosol tetrasodium) for the treatment of dry eye disease

Overview. Diquafosol tetrasodium is a dinucleotide that we discovered, which functions as an agonist at the P2Y₂ receptor and is being developed for the treatment of dry eye disease. Prolacria, the proposed U.S. tradename for diquafosol tetrasodium ophthalmic solution 2%, is designed to stimulate the release of three components of natural tears – mucin, lipids and fluid.

We are developing Prolacria as an eye drop for dry eye disease. To date, we have completed four Phase 3 clinical trials of Prolacria for the treatment of dry eye disease. In total, we have conducted placebo-controlled clinical trials of Prolacria in more than 2,000 subjects. If approved, Prolacria could be the second FDA approved pharmacologically active agent to treat dry eye disease and the first one with this mechanism of action. Since Prolacria and Restasis have different mechanisms of action, we consider them complementary products and, if Prolacria is approved by the FDA, we believe there is commercial opportunity for both of these products. The manufacture and sale of Prolacria is protected in the United States under drug substance and formulation patents which expire in July 2016 as well as under use patents which expire in February 2017.

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Under our agreement with Allergan, we are responsible for the development of Prolacria. In 2003, we exercised our right to co-promote Prolacria with Allergan in the United States. If and when we receive FDA approval and Prolacria is launched, we expect to begin promoting this product. Pursuant to this agreement, Allergan is responsible for obtaining regulatory approval of diquafosol tetrasodium in Europe.

Development Status. In June 2003, we filed a New Drug Application, or NDA, with the FDA for Prolacria for the treatment of dry eye disease. In response to that NDA, we were granted a “Priority Review” designation and subsequently, received an approvable letter in December 2003. In June 2005, we submitted an amendment to our NDA for Prolacria and received a second approvable letter in December 2005.

During 2006 and 2007, we conducted meetings with the FDA, primarily to identify a clinical trial design that the FDA and Inspire agreed was appropriate and reasonable to continue our clinical development of Prolacria for dry eye disease. Based upon analysis of our historical clinical trial data, input from experts in the dry eye field, and discussions with the FDA, we are focusing our future development on evaluating the effects of Prolacria on the central region of the cornea, as measured by fluorescein staining scores. In October 2007, we entered into a clinical services agreement with Ophthalmic Research Associates Inc., or ORA, to gain access to its proprietary dry eye model (i.e., the controlled adverse environment or dry eye chamber). The agreement contemplates conducting various studies in a step-wise approach to facilitate optimal clinical trial design for possible future clinical development of Prolacria. We have completed enrollment of approximately 260 patients in a pilot clinical trial studying Prolacria in ORA’s proprietary dry eye model and the trial is ongoing. The purpose of this clinical trial is to confirm an appropriate clinical trial design to be used for a potential pivotal Phase 3 clinical trial. Based upon our current plans, we expect to provide an update on our progress by the third quarter of 2008.

Estimated subsequent costs necessary to amend our NDA submission for Prolacria and resubmit the application for commercial approval in the United States are projected to be in the range of $7 million to $12 million, depending on our approach to achieving NDA approval of the product candidate. This range includes costs for conducting various studies under our clinical services agreement with ORA, regulatory and consulting activities, completing one additional Phase 3 clinical trial, salaries for development personnel, and other unallocated development costs, but excludes any milestone payments upon NDA approval or otherwise under the ORA clinical services agreement, as well as the cost of pre-launch inventory which is Allergan’s responsibility. If we are required to do more than one additional Phase 3 clinical trial, our costs will likely be higher than the projected range. The projected costs associated with Prolacria are difficult to determine due to the ongoing interaction with the FDA and the uncertainty of the FDA’s scientific review and interpretation of what is required to demonstrate safety and efficacy sufficient for approval. Actual costs could be materially different from our estimate. For a more detailed discussion of the risks associated with the development of Prolacria 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.

Our partner, Santen Pharmaceutical Co., Ltd., or Santen, is currently developing diquafosol tetrasodium in Japan. Our agreement with Santen allows Santen to develop diquafosol tetrasodium for the therapeutic treatment of ocular surface diseases, such as dry eye disease, in Japan and nine other Asian countries and provides for certain milestones to be earned by us upon achievement of development milestones by Santen. In 2006, Santen began Phase 3 clinical trials in Japan for a multi-dose formulation of diquafosol tetrasodium, and in January 2008, announced that it plans to file an application for marketing approval with regulators in Japan during the July to September 2008 time frame.

Denufosol tetrasodium for the treatment of cystic fibrosis

Overview. We are developing 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. If approved, we expect denufosol to be an early intervention therapy for cystic fibrosis. This product candidate has been granted orphan drug status and fast-track review status by the FDA, and orphan drug status by the European Medicines Agency. Denufosol is designed to

21

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 activation of the P2Y₂ receptor, we expect denufosol 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. The manufacture and sale of denufosol tetrasodium is protected in the United States under patents that have claims to the drug substance, the formulation, and method of use which expire in February 2017.

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 90% of the mortality associated with this disease. According to the U.S. Cystic Fibrosis Foundation, as published in 2008, the median life expectancy for patients is approximately 37 years.

Development Status. In October 2007, we completed patient enrollment in TIGER-1, the first of two planned pivotal Phase 3 clinical trials with denufosol tetrasodium inhalation solution for the treatment of cystic fibrosis. The TIGER-1 clinical trial, initiated in July 2006, is a double-blind, placebo-controlled, randomized clinical trial comparing 60 mg of denufosol to placebo, administered three-times daily by jet nebulizer, in approximately 350 patients with mild cystic fibrosis lung disease at clinical centers across North America. The approximate mean age of patients enrolled in TIGER-1 is 14 years. The clinical trial includes a 24-week efficacy and safety portion, followed by a 24-week open-label denufosol safety extension. All patients have completed the 24-week efficacy portion of the clinical trial and the safety portion is ongoing. The safety data will continue to be reviewed by an independent data monitoring committee that we established for this clinical trial. Based on the timing assumptions described above, we expect to report TIGER-1 top-line efficacy results in mid-year 2008.

We intend to use TIGER-1 to fulfill the long-term safety regulatory requirement to study denufosol in a specified number of patients for one year. The primary efficacy endpoint is the change from baseline in FEV₁ (Forced Expiratory Volume in one second) (in liters) at the 24-week time point. Secondary endpoints include other lung function parameters, pulmonary exacerbations, requirements for concomitant cystic fibrosis medications and health related quality of life. Use of standard cystic fibrosis therapies approved by the FDA, including Pulmozyme®, TOBI®, macrolides and digestive enzymes, is permitted. The use of hypertonic saline is not permitted to be used by those patients enrolled in the clinical trial.

The size of the TIGER-1 clinical trial was based on multiple considerations including the need for adequate long-term safety exposure at the intended dose of 60 mg and sufficient statistical power required to detect meaningful treatment effects. The TIGER-1 clinical trial has statistical power of greater than 90% to detect at least a 75 ml treatment effect relative to placebo for the primary efficacy endpoint of change from baseline in FEV₁ (in liters). The statistical power calculation was based on numerous assumptions and does not represent a probability of success of the trial.

In February 2008, we initiated patient enrollment in TIGER-2, our second planned pivotal Phase 3 clinical trial, and enrollment is ongoing. The TIGER-2 clinical trial is a 24-week, double-blind, placebo-controlled, randomized clinical trial comparing 60 mg of denufosol to placebo, administered three-times daily by jet nebulizer, in approximately 350 patients with FEV₁ greater than or equal to 75% of predicted normal, with no open-label safety extension. The primary efficacy endpoint is the change from baseline in FEV₁ (in liters) at the 24-week time point. Secondary endpoints include other lung function parameters, pulmonary exacerbations, requirements for concomitant cystic fibrosis medications and health related quality of life. Patients aged 5 years and older are eligible for enrollment. The use of standard cystic fibrosis maintenance therapies is permitted during the trial. The use of hypertonic saline is not permitted to be used by those patients enrolled in the clinical trial. Enrollment has begun in U.S. and Canadian sites and we may include sites outside North America, if necessary. We are targeting the TIGER-2 clinical trial to be completed around the same time frame as the carcinogenicity study results (discussed below).

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In 2006, we completed a 52-week inhalation toxicology study in one animal species, and we have submitted the final study report to the FDA. There were no signs of pulmonary or systemic toxicity at doses well above the Phase 3 clinical dose. In addition, in November 2006, we initiated the required two-year inhalation carcinogenicity study in rats, and the study is ongoing. This carcinogenicity study must be completed prior to submitting an NDA filing. The time from initiation of this study to receipt of the final study report is expected to be up to three years. We expect to receive the final study report for this carcinogenicity study in the second half of 2009.

Estimated subsequent costs necessary to submit an NDA for denufosol for the treatment of cystic fibrosis are projected to be in the range of $20 million to $35 million. This estimate includes completing TIGER-1, TIGER-2 and the carcinogenicity study, as well as conducting any additionally required toxicology studies and other ancillary studies, manufacturing denufosol for clinical trials, producing qualification lots consistent with current Good Manufacturing Practices, or cGMP, standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs, but excludes the cost of pre-launch inventory and any product approval milestones payable to the Cystic Fibrosis Foundation Therapeutics, Inc. These costs are difficult to project and actual costs could be materially different from our estimate. For example, clinical trials, toxicology and carcinogenicity studies may not proceed as planned, results from ongoing or future clinical trials may change our planned development program, additional Phase 3 clinical trials may be necessary, other parties may assist in the funding of our development costs, and an anticipated 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.

We intend to participate in the commercialization in North America for denufosol for the treatment of cystic fibrosis. We are seeking to secure a corporate partner to develop and commercialize this product candidate outside of North America.

INS115644 for glaucoma

Overview. 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 technology licensed from WARF, we are evaluating new and existing compounds, including INS115644, that are active in disrupting the acto-cytoskeleton of the trabecular meshwork as potential treatments for glaucoma. The scientific hypothesis is that the mechanism of action may result in reduction of intraocular pressure by affecting the primary outflow pathway for aqueous humor.

Development Status. We have filed an Investigational New Drug Application, or IND, for INS115644, the first compound in a series of compounds, and in the first quarter of 2007 we initiated a Phase 1 proof-of-concept dose-ranging clinical trial in glaucoma patients to evaluate the safety and tolerability of INS115644, as well as changes in intraocular pressure. We have completed two cohorts of the clinical trial. Our ability to complete the clinical trial is dependent upon the availability of clinical trial material, which has been limited. As a result, we are currently unable to predict the timing of completion of the clinical trial. Given the limited data available and the early stage of development of this program, we are currently unable to reasonably project the future dates and costs that may be associated with clinical trials or a prospective NDA filing. We expect to file an IND for a second compound by the end of 2008.

Discontinued Program - Epinastine nasal spray for allergic rhinitis

Epinastine HCl is a topically active, direct H₁-receptor antagonist and inhibitor of histamine release from mast cells that was being developed by us as an intranasal treatment for allergic rhinitis. In February 2006, we acquired certain exclusive rights from Boehringer Ingelheim International GmbH to develop and market epinastine nasal spray in the United States and Canada for the treatment of rhinitis.

On April 23, 2008, we announced that our Phase 3 trial with epinastine nasal spray for the treatment of seasonal allergic rhinitis did not meet its primary endpoint. The 14-day, randomized, double-blind trial in 798 patients evaluated two concentrations of epinastine (0.10% and 0.15%) at two spray volumes compared to placebo in patients

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with documented seasonal allergic rhinitis during mountain cedar season in south central Texas. The epinastine treatment groups did not achieve statistical significance compared to placebo for the primary efficacy endpoint of average change from baseline for the reflective Total Nasal Symptom Score, defined as the sum of scores for runny nose, itchy nose and sneezing. The drug was well-tolerated and there were no safety concerns in the trial. Based upon the overall data of this program and the current competitive environment in allergic rhinitis, we decided to discontinue development of epinastine nasal spray.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2008 and 2007

Revenues

Total revenues were approximately $9.7 million for the three months ended March 31, 2008, as compared to approximately $7.2 million for the same period in 2007. The increase in 2008 revenue of approximately $2.5 million, or 35%, as compared to the same period in 2007, was primarily due to increased co-promotion revenue from net sales of Restasis, as well as product revenue from sales of AzaSite, which we launched in August 2007, partially offset by the full deferral of Elestat revenue, as discussed below.

Product Sales, net

Product sales of AzaSite, net of rebates and discounts, for the three months ended March 31, 2008 were approximately $2.3 million, as compared to none for the same period in 2007. Beginning in July 2007, we started receiving and processing orders for AzaSite as part of the initial stocking of the supply chain in preparation of the August 2007 launch. These initial orders were offered with special terms as stocking incentives for wholesalers. Sales with these special terms were accounted for using the consignment model, which requires that we defer revenue until such time that the product is resold further into the supply chain or the product is no longer subject to the special terms. During the three months ended March 31, 2008, we recognized all of the remaining deferred AzaSite revenue, net of estimated rebates and discounts, of approximately $371,000. Sales made subsequent to this specified “launch” time period include return rights that are customary in the industry. For these orders, we are recording revenue at the date of shipment, when title and substantially all the risks and rewards of ownership has transferred to the customer.

In connection with the launch of AzaSite, we created a managed markets group to establish relationships with wholesalers, commercial managed care organizations, state Medicaid agencies, and Medicare managed care organizations to secure access and reimbursement for AzaSite. We expect that we will continue to increase overall access and reimbursement as these organizations review AzaSite during the course of their normal review cycles. For the three months ended March 31, 2008, there were approximately 47,000 prescriptions written for AzaSite, based on prescription data from IMS Health, representing approximately 1% of all prescriptions in the bacterial conjuctivitis market, defined as both branded and generic single-entity ocular antibiotics. For the three months ended March 31, 2008, the bacterial conjunctivitis market, in terms of precriptions, has decreased approximately 2%, compared to the same period in 2007, based on data as reported by IMS Health.

We expect that AzaSite will exhibit a slight seasonal trend similar to other products in the bacterial conjunctivitis market, with a slight decline in sales during the Summer months when children are typically out of school.

Product Co-Promotion

Co-promotion revenue from net sales of Restasis for the three months ended March 31, 2008 was approximately $7.4 million, as compared to approximately $4.8 million for the same period in 2007. The increase in 2008 co-promotion revenue for Restasis of approximately $2.6 million, or 54%, as compared to the same period in 2007, was primarily due to increased patient usage of Restasis, evidenced by an increase of prescriptions year-over-year, as well as an annual price increase in the first quarter of 2008. In addition, in April 2007, there was a final scheduled increase of the percentage of net sales of Restasis to which we were entitled.

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All of our revenue from Restasis is based on worldwide net sales of Restasis according to the terms of our collaborative agreement with Allergan. However, less than 2% of our co-promotion revenue from Restasis is derived from sales of Restasis outside of the United States. Restasis, in terms of prescription volume, has grown significantly since it was first launched in April 2003. Total prescriptions, as reported by IMS Health, were approximately 1.1 million for the three months ended March 31, 2008, representing a prescription volume increase of 23% compared to the same period in 2007.

For the three months ended March 31, 2008, Allergan recorded approximately $100 million of revenue from net sales of Restasis, as compared to approximately $78 million for the same period in 2007. On May 7, 2008, Allergan confirmed 2008 guidance for net sales of Restasis to be in the range of $375-405 million.

All co-promotion revenue from net sales of Elestat for the three months ended March 31, 2008 has been deferred, as compared to approximately $2.4 million of revenue recognized for the same period in 2007. Under the co-promotion agreement for Elestat, we are entitled to an escalating percentage of net sales based upon predetermined minimum calendar year net sales target levels that we are obligated to meet. If the annual minimum is not achieved, we record revenues using a reduced percentage of net sales based upon our level of achievement of the predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of our recorded co-promotion revenue are recognized as deferred revenue and will be realized in future quarters of 2008 to the extent additional minimum annual net sales target levels are achieved. For the three months ended March 31, 2008, we have deferred all $3.8 million of co-promotion revenue associated with net sales of Elestat as the minimum annual target level had not been achieved. In comparison, as of March 31, 2007, we had recorded $2.4 million of deferred revenue, in addition to $2.4 million of recognized revenue associated with net sales of Elestat.

Elestat is a seasonal product with product demand mirroring seasonal trends for topical allergic conjunctivitis products. Typically, demand is highest during the Spring months followed by moderate demand in the Summer and Fall months. The lowest demand is during the Winter months. Overall, net sales of Elestat for the three months ended March 31, 2008 have decreased, as compared to the same period in 2007, primarily due to a 14% decline in the U.S. allergic conjunctivitis market, in terms of prescriptions, and a decline of approximately 1% of Elestat’s market share, partially offset by a price increase for Elestat that became effective during the first quarter of 2008.

Since the beginning of 2006 when Medicare Part D became effective, there has been a decrease in prescriptions for Elestat reimbursed by state Medicaid programs which has been partially offset by an increase of prescriptions reimbursed under Medicare Part D plans and, to a lesser extent, commercial plans. This shift to Medicare Part D plans has resulted in reduced rebates compared to those under Medicaid programs. On an annual basis, Allergan negotiates for coverage under states’ Medicaid programs and coverage under commercial and Medicare programs. To date, the increasing competitive environment and price discounting has resulted in Elestat losing coverage under state Medicaid plans; however, the loss to our co-promotion revenue has been minimal due to the large price concessions associated with these particular plans. Future loss of coverage under additional states or commercial plans may have a negative impact on our co-promotion revenue.

Competition from the introduction of a new branded product and a new generic in 2007 and loss of coverage under state Medicaid plans has caused a decrease in market share for Elestat. Based upon national prescription data from IMS Health, for the three months ended March 31, 2008, Elestat prescriptions represented approximately 8% of the total U.S. allergic conjunctivitis market, as compared to approximately 9% in the same period in 2007. Based on current trends in prescriptions for Elestat, we expect our 2008 market share to remain relatively constant or decline slightly as compared to 2007.

The commercial marketing exclusivity period for Elestat provided under the Hatch-Waxman Act will expire on October 15, 2008, at which time competitors will be able to submit to the FDA an ANDA or a 505(b)(2) application for a generic version of epinastine HCl ophthalmic solution. We cannot predict with certainty the time frame of an FDA review of such

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applications, if any are filed. We are aware that several generic pharmaceutical companies have expressed intent to commercialize the ocular form of epinastine after the commercial exclusivity period expires. Our ability to gain additional intellectual property protection related to Elestat has been, and continues to be, challenging. To date, no patent protection or any other form of intellectual property protection has been obtained for Elestat, and we cannot provide any assurance that any form of intellectual property protection covering Elestat will be possible in the United States after the expiration of the commercial exclusivity period under the Hatch-Waxman Act on October 15, 2008. If a generic form of Elestat or an over-the-counter form of epinastine for the eye is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues attributable to Elestat will essentially cease. Loss of our co-promotion revenue from Elestat will materially impact our results of operations and cash flows.

Our future revenue will depend on various factors including the effectiveness of our commercialization of AzaSite and continued commercial success and duration of commercial exclusivity of Restasis and Elestat. In addition to the foregoing, pricing, rebates, discounts and returns for all products; the effect of competing products; coverage and reimbursement under commercial or government plans; and seasonality of sales of Elestat will impact future revenues. If Allergan significantly under-estimates or over-estimates rebate amounts, there could be a material effect on our revenue. In addition to the continuing sales of AzaSite, Restasis and Elestat, our future revenue will also depend on our ability to enter into additional collaboration agreements, and to achieve milestones under existing or future collaboration agreements, as well as whether we obtain regulatory approvals for our product candidates.

Cost of Sales

Cost of sales related to the sales of AzaSite, which was launched in August 2007, were approximately $1.0 million for the three months ended March 31, 2008. Since AzaSite was launched in August 2007, we had no cost of sales for the three months ended March 31, 2007. Cost of sales expense consists of variable and fixed cost components. Variable cost components include the cost of AzaSite inventory sold, changes to our inventory reserve for overstocking or short-dated material, distribution, shipping and logistic service charges from our third-party logistics provider and royalties to InSite Vision on net sales of AzaSite. These variable cost components will increase or decrease depending on the volume of AzaSite sold. Fixed cost components are predominately the amortization of the $19.0 million approval milestone that we paid InSite Vision as part of our licensing agreement.

Certain costs included in cost of sales are subject to annual increases for which we have limited control. We expect that cost of sales will increase in relation to, but not proportionately to, the expected increases in revenue from sales of AzaSite.

Research and Development Expenses

Research and development expenses were approximately $14.8 million for the three months ended March 31, 2008, as compared to approximately $22.8 million for the same period in 2007. The decrease in research and development expenses of approximately $8.0 million, or 35% for the three months ended March 31, 2008, as compared to the same period in 2007, was primarily due to the February 2007 payment of a $13.0 million upfront licensing fee upon the execution of the agreement with InSite Vision pursuant to which we acquired the exclusive right to commercialize AzaSite in the United States and Canada. Excluding this one-time fee paid in the three months ended March 31, 2007, our research and development expenses associated with our other product candidates’ increased approximately $5.0 million for the three months ended March 31, 2008, as compared to the same period in 2007. Additionally, we incurred a general increase in annual salaries, personnel related expenses and stock-based compensation expense.

Research and development expenses include all direct and indirect costs, including salaries for our research and development personnel, consulting fees, clinical trial costs, sponsored research costs, clinical trial insurance, upfront license fees, milestone and royalty payments relating to research and development, and other fees and costs related to the development of product candidates. Research and development expenses vary according to the number

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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 clinical trial and the number of patients enrolled in later stage clinical trials. Our future research and development expenses will depend on the results and magnitude or scope of our clinical, preclinical and research activities and requirements imposed by regulatory agencies. Year over year spending on active development programs can vary due to the differing levels and stages of development activity, the timing of certain expenses and other factors. Accordingly, our research and development expenses may fluctuate significantly from period to period. In addition, if we in-license or out-license rights to product candidates, our research and development expenses may fluctuate significantly from prior periods.

Our research and development expenses for the three months ended March 31, 2008 and 2007, and from the respective project’s inception are shown below and includes the percentage of overall research and development expenditures for the periods listed.

	(In thousands)
	Three Months Ended March 31,						Cumulative from Inception to March 31, 2008		%
	2008		%	2007		%
Denufosol tetrasodium for cystic fibrosis	$	4,732	32	$	2,578	11	$	50,879	18
Prolacria (diquafosol tetrasodium) for dry eye disease		3,213	22		428	2		46,532	16
Epinastine nasal spray for allergic rhinitis (1)		2,924	20		3,360	15		19,390	7
INS115644 for glaucoma and related research and development		1,386	9		979	4		10,726	4
AzaSite (2)		652	4		13,115	58		15,250	5
Other research, preclinical and development costs (3)		1,890	13		2,305	10		140,224	50
Total	$	14,797	100	$	22,765	100	$	283,001	100

⁽¹⁾ On April 23, 2008, we discontinued the development of epinastine nasal spray.

⁽²⁾ Expense in 2007 includes a $13.0 million upfront licensing fee upon the signing of the license agreement with InSite Vision.

⁽³⁾ Other research, preclinical and development costs represent all unallocated research and development costs or those costs allocated to preclinical programs, discontinued and/or inactive programs. These unallocated costs include personnel costs of our research, preclinical programs, internal and external general research costs and other internal and external costs of other research, preclinical and development programs.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $16.2 million for the three months ended March 31, 2008, as compared to approximately $7.5 million for the same period in 2007. The increase in selling and marketing expenses of approximately $8.7 million, or 115%, for the three months ended March 31, 2008, as compared to the same period in 2007, resulted from an overall increase in various expenses primarily associated with the commercialization of AzaSite, including the expansion of our sales force and creation of our managed markets group, as well as marketing and promotional activities and Phase 4 program costs. In addition, due to the seasonal demand of Elestat, our selling and marketing expenses are generally higher in the first quarter of the year preceding the Spring allergy season. Additionally, we incurred a general increase in annual salaries, personnel related expenses and stock-based compensation expense.

Our commercial organization currently focuses its promotional efforts on approximately 10,500 select pediatricians, primary care physicians, eye care professionals and allergists for AzaSite, Restasis and Elestat. Our selling and marketing expenses include all direct costs associated with the commercial organization, which include our

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sales force and marketing programs. Our sales force expenses include salaries, training and educational program costs, product sample costs, fleet management and travel. Our marketing and promotion expenses include product management, promotion, advertising, public relations, Phase 4 clinical trial costs, physician training and continuing medical education and administrative expenses. We adjust the timing, magnitude and targeting of our advertising, promotional, Phase 4 clinical trials and other commercial activities for our products based on seasonal trends and other factors, and accordingly, these costs can fluctuate from period to period.

We have started a variety of comprehensive Phase 4 programs related to AzaSite in order to obtain additional scientific data related to its pharmacokinetic profile, anti-microbial effects, anti-inflammatory effects, and safety and efficacy in other ocular conditions such as lid margin disease. The costs for Phase 4 clinical trials could fluctuate significantly from period to period depending on the magnitude and timing of Phase 4 programs.

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. In addition, if we in-license or out-license rights to products, our selling and marketing expenses may fluctuate significantly from prior periods.

General and Administrative Expenses

General and administrative expenses were approximately $3.5 million for the three months ended March 31, 2008, as compared to approximately $3.6 million for the same period in 2007. The slight decrease in general and administrative expenses of approximately $100,000, or 3%, for the three months ended March 31, 2008, as compared to the same period in 2007, was primarily due to lower legal and administrative expenses as a result of lower legal expenses associated with our stockholder litigation and SEC investigation partially offset by a general increase in annual salaries, personnel related expenses and stock-based compensation expense.

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.

Future general and administrative expenses will depend on the level of our future research and development and commercialization activities, as well as the level of legal and administrative expenses incurred related to our SEC investigation and stockholder litigation and the extent to which these legal expenses are reimbursed by insurance. (See “Litigation” and “SEC Investigation” described elsewhere in this report).

Other Income/(Expense)

Other expense, net was approximately $61,000 for the three months ended March 31, 2008, as compared to other income, net of approximately $606,000 in the same period in 2007. 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 and capital lease obligations.

The decrease in other income of approximately $667,000 for the three months ended March 31, 2008, as compared to the same period in 2007, was primarily due to an increase in interest expense of approximately $797,000 associated with additional borrowings of an aggregate of $40.0 million in May and June of 2007 under our term loan facility. Interest income earned on our cash and investments was approximately $1.2 million for the three months ended March 31, 2008, as compared to $1.1 million for the same period in 2007. Although our average cash and investments balance was significantly higher during the three months ended March 31, 2008, our interest income was negatively impacted due to experiencing a lower rate of return during the three months ended March 31, 2008, as compared to the same period in 2007. Future other income will depend on our future cash and investment balances, the return and change in fair market value on these investments, as well as levels of debt and the associated interest rates.

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LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations primarily through the sale of equity securities, including private sales of preferred stock and public offerings of common stock and, to a lesser extent, through our term loan facility. We also currently receive co-promotion revenue from net sales of Restasis and Elestat, and product revenue from net sales of AzaSite. We do not expect our 2008 revenue to exceed our operating expenses.

At March 31, 2008, we had net working capital of approximately $80.7 million, a decrease of approximately $27.0 million from approximately $107.7 million at December 31, 2007. The decrease in working capital was principally due to the funding of normal operating expenses associated with commercialization activities and the development of our product candidates. Additionally, we have made interest and principal payments on our term loan facility. Our principal sources of liquidity at March 31, 2008 were approximately $89.4 million in cash and cash equivalents and approximately $18.9 million in investments, which are considered available-for-sale.

On July 20, 2007, we completed a sale of preferred stock to Warburg Pincus Private Equity IX, L.P. pursuant to which we sold 140,186 shares of our Exchangeable Preferred Stock at a price per share of $535.00, for net proceeds of $73.6 million. The Exchangeable Preferred Stock was exchanged for 14,018,600 shares of common stock on October 31, 2007. We filed a Form S-3 registration statement to register the shares of common stock, which was declared effective in January 2008.

In December 2006, we entered into a loan and security agreement in order to obtain debt financing of up to $40.0 million to fund in-licensing opportunities and related development. In June 2007, we amended the loan and security agreement to enable us to draw upon a new supplemental term loan facility in the amount of $20.0 million. We have borrowed the full $60.0 million under the term loan facility of which $54.9 million was outstanding as of March 31, 2008. We make principal and interest payments on a monthly basis after a six-month interest-free period following each advance, and all loan advances made under the agreement have a final maturity date in March 2011.

Our working capital requirements may fluctuate in future periods depending on many factors, including: the number, magnitude, scope and timing of our development programs; the commercial potential and success of our products; the costs related to the commercialization of AzaSite and our other products; the costs related to the potential FDA approval of our other product candidates; the cost, timing and outcome of regulatory reviews, regulatory investigations, 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 efficiency of manufacturing processes developed on our behalf by third parties; 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 product candidates; unreimbursed legal and administrative costs associated with resolving and satisfying any potential outcome of our stockholder litigation and SEC investigation; and any expansion of facility space.

2008 Financial Guidance

As previously disclosed, based upon current AzaSite, Restasis and Elestat trends, we expect to record 2008 aggregate revenue in the range of $62-$76 million and expect 2008 total operating expenses to be in the range of $109-$129 million. Cost of sales, which includes the amortization of the AzaSite approval milestone and royalty obligations to InSite Vision, is expected to be in the range of $5-$8 million and is included as a component of total operating expenses. Total estimated selling and marketing and general and administrative expenses are estimated to be in the range of $50-$57 million and $14-$18 million, respectively. Research and development expenses associated with the further development of our product candidates are estimated to be in the range of $42-$54 million. Included within our operating expenses guidance are projected stock-based compensation costs of approximately $5 million. This estimate is based on the unvested portion of stock options and restricted stock units outstanding as of December 31, 2007, our current stock price, and an anticipated level of share-based payments granted during 2008. Should our stock price or

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strategy change significantly from its current level or plan, and/or if our anticipated headcount or level of share-based payments changes, actual stock-based compensation expense could change significantly from this projection. Stock-based compensation expense for the three months ended March 31, 2008 was $1.1 million.

Our actual 2008 financial results will be highly dependent on the clinical and regulatory developments and corporate plans for our denufosol, Prolacria and glaucoma programs, as well as revenue from AzaSite product sales. Our ability to remain within our operating expense target range is subject to multiple factors 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 our stockholder litigation or SEC investigation and other factors described under the Risk Factors located elsewhere in this report.

Cash utilization in 2008 is expected to be in the range of $50-$80 million and incorporates $14 million of principal repayment on our outstanding debt. For the three months ended March 31, 2008, our cash utilization was approximately $30.6 million. Our commercial and planned development activities in the first quarter of 2008 were considered to be the largest of the four quarters of 2008. Accordingly, we expect that our cash utilization will be lower throughout the remainder of 2008, based on anticipated AzaSite and Restasis revenue growth, seasonal increases in Elestat sales and planned research and development and commercial activities. Based on current operating plans, we expect our cash and investments to provide liquidity through 2009. Our liquidity needs will largely be determined by the commercial success of our products and key development and regulatory events. In order for us to continue operations substantially beyond 2009 we will need to: (1) successfully increase revenues, (2) obtain additional product candidate approvals, which would trigger milestone payments to us, (3) out-license rights to certain of our product candidates, pursuant to which we would receive income, (4) raise additional capital through equity or debt financings or from other sources, (5) reduce spending on one or more research and development programs and/or (6) restructure operations. Additionally, we currently have the ability to sell approximately $130 million of securities, including common stock, preferred stock, debt securities, depositary shares and securities warrants from an effective shelf registration statement which we filed with the SEC on March 9, 2007. The loan and security agreement that we entered into in December 2006, as amended in June 2007, contains a financial covenant that requires us to maintain certain levels of liquidity based on our cash, investment and account receivables balances, as well as negative covenants that may limit us from assuming additional indebtedness and entering into other transactions as defined in the agreement. We are in compliance with all of the covenants under our loan and security agreement.

Litigation

On February 15, 2005, the first of five identical purported shareholder class action complaints was filed in the United States District Court for the Middle District of North Carolina against us and certain of our senior officers. Each complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focused on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of our dry eye product candidate, Prolacria. Each complaint sought 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 March 27, 2006, following consolidation of the lawsuits into a single civil action and appointment of lead plaintiffs, the plaintiffs filed a Consolidated Class Action Complaint, or CAC. The CAC asserts claims against us and certain of our present or former senior officers or directors. The CAC asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 based on statements alleged to be false and misleading regarding a Phase 3 clinical trial of Prolacria, and also adds claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The CAC also asserts claims against certain parties that served as underwriters in our securities offerings during the period relevant to the CAC. The CAC seeks unspecified damages on behalf of a purported class of purchasers of our securities during the period from May 10, 2004 through February 8, 2005. In May 2006, the plaintiffs agreed to voluntarily dismiss their claims against the underwriters on the basis that they were time-barred. On June 30, 2006, we and other defendants moved that the court dismiss the CAC on the grounds that it fails to state a claim upon which

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relief can be granted and does not satisfy the pleading requirements under applicable law. On May 14, 2007, Magistrate Judge Eliason, to whom the District Court had referred the motion, issued a Recommendation that the District Court grant Defendants’ motion to dismiss the CAC. Plaintiffs filed objections to this Recommendation in which they argued that the District Court should not accept the Recommendation, and Defendants responded to Plaintiffs’ objections.

On July 26, 2007, the United States District Court for the Middle District of North Carolina accepted the Magistrate Judge’s recommendation and granted our and the other defendants’ motion and dismissed the CAC with prejudice. On August 24, 2007, the plaintiffs filed an appeal to the United States Court of Appeals for the Fourth Circuit. Plaintiffs filed their opening appellate brief on November 19, 2007. We and the other defendants filed an opposition brief on January 18, 2008. Plaintiffs filed their reply on February 22, 2008. We will continue to defend the litigation vigorously.

As with any legal proceeding, we cannot predict with certainty the eventual outcome of these lawsuits, nor can a reasonable estimate of the amounts of loss, if any, be made. Furthermore, we will have to incur expenses in connection with these lawsuits, which may be substantial. 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. We have various insurance policies related to the risk associated with our business, including directors and officers insurance. However, there is no assurance that our insurance coverage will be sufficient or that our insurance companies will cover all the matters claimed. In the event of an adverse outcome, our business as well as our future results of operations, financial position and/or cash flows could be materially affected to the extent that our insurance fails to cover such costs.

SEC Investigation

On August 30, 2005, the SEC notified us that it is conducting a formal, nonpublic investigation which we believe relates to our Phase 3 clinical trial of our dry eye product candidate, Prolacria. On October 19, 2006, we received a Wells Notice letter from the staff of the SEC, issued in connection with this investigation. Our Chief Executive Officer and our then Executive Vice President, Operations and Communications, also received Wells Notices.

The Wells Notices provide notification of the SEC staff’s determination that it intends to recommend to the SEC that it bring a civil action against us and the two officers regarding possible violations of Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and SEC Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13a-14 thereunder. Under the process established by the SEC, we and the two officers have the opportunity to respond in writing to the Wells Notice before the staff makes any formal recommendation to the SEC regarding what action, if any, should be brought by the SEC. We and the officers receiving these notices provided written submissions to the SEC in response to the Wells Notices during December 2006, and have since had further discussions and meetings with, and have provided further written submissions to, the SEC staff.

We cannot predict with certainty the eventual outcome of this investigation, nor can a reasonable estimate of the costs that might result from the SEC’s investigation be made. Responding to this investigation will result in a diversion of management’s attention and resources and an increase in professional fees. There is no assurance that our insurance coverage, including directors and officers insurance, will be sufficient or that our insurance companies will cover all the matters claimed. In the event of an adverse outcome, our business as well as our future results of operations, financial position and/or cash flows could be materially affected to the extent that our insurance fails to cover such costs.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that

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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 registered public accounting firm. In addition, recognition of revenue from product co-promotion is affected by certain estimates and judgments made by Allergan on which we rely when recording this revenue. We routinely evaluate our estimates and policies regarding revenue recognition, product rebates and incentives, inventory and manufacturing, taxes, stock-based compensation expense, clinical trial, preclinical/toxicology, research and other service liabilities.

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

Revenue Recognition

We record all of our revenue from (1) sales of AzaSite; (2) product co-promotion activities; and (3) collaborative research agreements in accordance with SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements,” or SAB No. 104. SAB No. 104 states that revenue should not be recognized until it is realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services have been rendered; 3) the seller’s price to the buyer is fixed or determinable; and 4) collectibility is reasonably assured.

Product Revenues

We recognize revenue for sales of AzaSite when title and substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment, with the exception of transactions whereby product stocking incentives were offered approximately one month prior to the product’s August 13, 2007 launch. In the United States, we sell AzaSite to wholesalers and distributors, who, in turn, sell to pharmacies and federal, state and commercial healthcare organizations. Accruals, or reserves, for estimated rebates, discounts, chargebacks and other sales incentives (collectively, “sales incentives”) are recorded in the same period that the related sales are recorded and are recognized as a reduction in sales of AzaSite. These sales incentive reserves are recorded in accordance with Emerging Issues Task Force, or EITF, Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer,” which states that cash consideration given by a vendor to a customer is presumed to be a reduction of the selling price of the vendor’s product or services and therefore should be characterized as a reduction of the revenue recognized in the vendor’s income statement. Sales incentive accruals, or reserves, are based on reasonable estimates of the amounts earned or claimed on the sales of AzaSite. These estimates take into consideration current contractual and statutory requirements, specific known market events and trends, internal and external historical data and experience, and forecasted customer buying patterns. Amounts accrued or reserved for sales incentives are adjusted for actual results and when trends or significant events indicate that an adjustment is appropriate. As of March 31, 2008, we have reserved approximately $752,000 for sales incentives.

In addition to SAB No. 104, our ability to recognize revenue for sales of AzaSite is subject to the requirements of Statement of Financial Accounting Standards, or SFAS, No. 48, “Revenue Recognition When Right of Return Exists,” or SFAS No. 48, as issued by the Financial Accounting Standards Board, or FASB. SFAS No. 48 states that revenue from sales transactions where the buyer has the right to return the product will be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale, (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product, (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product, (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller, (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer, and (6) the amount of future returns can be reasonably estimated. Customers will be able to return short-dated or expired AzaSite that meet the guidelines set forth in our return goods policy. Our return goods policy generally allows for returns of AzaSite within an 18-month period, from six months prior to the expiration date and up

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to 12 months after the expiration date, but may differ from customer to customer, depending on certain factors. In accordance with SFAS No. 48, we are required to estimate the level of sales that will ultimately be returned pursuant to our return policy and to record a related reserve at the time of sale. These amounts are deducted from our gross sales of AzaSite in determining our net sales. Future estimated returns of AzaSite are based primarily on the return data for comparative products and our own historical experience with AzaSite. We also consider other factors that could impact sales returns of AzaSite. These factors include levels of inventory in the distribution channel, estimated remaining shelf life, price changes of competitive products, and current and projected product demand that could be impacted by introductions of generic products and introductions of competitive new products, among others. As of March 31, 2008, we have reserved approximately $165,000 for potential returns of AzaSite.

Immediately preceding the launch of AzaSite, we offered wholesalers stocking incentives that allowed for extended payment terms, product discounts, and guaranteed sale provisions (collectively, “special terms”). These special terms were only offered during a specified time period of approximately one month prior to the August 13, 2007 launch of AzaSite. Any sales of AzaSite made under these special term provisions were accounted for using a consignment model since substantially all the risks and rewards of ownership did not transfer upon shipment. Under the consignment model, we did not recognize revenue upon shipment of AzaSite purchased with the special terms, but recorded deferred revenue at gross invoice sales price, less all appropriate discounts and rebates, and accounted for AzaSite inventory held by the wholesalers as consignment inventory. We recognized the revenue from these sales with special terms at the earlier of when the inventory of AzaSite held by the wholesalers was sold through to the wholesalers’ customers or when such inventory of AzaSite was no longer subject to these special terms. For the three months ended March 31, 2008, we recognized all of the remaining net deferred revenue of $371,000 related to sales of AzaSite considered consignment. All sales subsequent to this specified “launch” time period include return rights and pricing that are customary in the industry.

We utilize data from external sources to help us estimate our gross to net sales adjustments as they relate to the sales incentives and recognition of revenue for AzaSite sold under the special term provisions. External sourced data includes, but is not limited to, information obtained from certain wholesalers with respect to their inventory levels and sell-through to customers as well as data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. We also utilize this data to help estimate and identify prescription trends and patient demand, as well as product levels in the supply chain.

Product Co-promotion Revenues

We recognize co-promotion revenue based on net sales for Restasis and Elestat, as defined in the co-promotion agreements, and as reported to us by Allergan. We actively promote both Restasis and Elestat through our commercial organization and share in any risk of loss due to returns and other allowances, as determined by Allergan. Accordingly, our co-promotion revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control and on 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, all of which are determined by Allergan and are outside our control. We record a percentage of Allergan’s net sales for both Restasis and Elestat, reported to us by Allergan, as co-promotion revenue. We receive monthly net sales information from Allergan and perform analytical reviews and trend analyses using prescription information that we receive from IMS Health. In addition, we exercise our audit rights under the contractual agreements with Allergan to annually perform an examination of Allergan’s sales records of both Restasis and Elestat. We make no adjustments to the amounts reported to us by Allergan other than reductions in net sales to reflect the incentive programs managed by us. We offer and manage certain incentive programs associated with Elestat, which are utilized by us in addition to those programs managed by Allergan. We reduce revenue by estimating the portion of Allergan’s sales that are subject to these incentive programs based on information reported to us by our third-party administrator of the incentive programs. Since our launch of Elestat, the amount of rebates associated with our incentive programs in each fiscal year was less than one-half of one percent of our co-promotion revenues. The rebates associated with the programs we manage represent an insignificant amount, as compared to the rebate and discount programs administered by Allergan

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and as compared to our aggregate co-promotion revenue. Under the co-promotion agreement for Elestat, we are obligated to meet predetermined minimum calendar year net sales target levels. If the annual minimum is not achieved, we record revenues using a reduced percentage of net sales based upon our level of achievement of the predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue. As of March 31, 2008 and 2007, we had deferred revenue associated with sales of Elestat of $3.8 million and $2.4 million, respectively.

Collaborative Research and Development Revenues

We recognize revenue under our collaborative research and development agreements when we have performed services under such agreements or when we or our collaborative partner have met a contractual milestone triggering a payment to us. We recognize revenue from our research and development service agreements ratably over the estimated service period as related research and development costs are incurred and the services are substantially performed. Upfront non-refundable fees and milestone payments 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 in which the services are substantially performed. This period, if not defined in the collaborative agreement, is based on estimates by management and the progress towards agreed upon development events as set forth in our collaborative agreements. These estimates are 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. If the estimated service period is subsequently modified, the period over which the upfront fee or revenue related to ongoing research and development services is modified on a prospective basis. We are also entitled to receive milestone payments under our collaborative research and development agreements based upon the achievement of agreed upon development events that are substantively at-risk by our collaborative partners or us. This collaborative research revenue is recognized upon the achievement and acknowledgement of our collaborative partner of a development event, which is generally at the date payment is received from the collaborative partner or is reasonably assured. Accordingly, our revenue recognized under our collaborative research and development agreements may fluctuate significantly from period to period.

Inventories

Our inventories are valued at the lower of cost or market using the first-in, first-out (i.e., FIFO) method. Cost includes materials, labor, overhead, shipping and handling costs. Our inventories are subject to expiration dating. We regularly evaluate the carrying value of our inventories and provide valuation reserves for any estimated obsolete, short-dated or unmarketable inventories. Our determination that a valuation reserve might be required, in addition to the quantification of such reserve, requires us to utilize significant judgment. We base our analysis, in part, on the level of inventories on hand in relation to our estimated forecast of product demand, production requirements for forecasted product demand, expected market conditions and the expiration dates or remaining shelf life of inventories. As of March 31, 2008, our inventory balance is net of a $125,000 reserve for potential overstocking.

Taxes

We account for uncertain tax positions in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of FASB Statement No. 109, “Accounting for Income Taxes.” Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We have recorded a valuation allowance against all potential tax assets due to uncertainties in 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.

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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 services are completed 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, sales and marketing and other service activities and the progression of work related to 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 certain 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-Based Compensation Expense

We recognize stock-based compensation expense in accordance with SFAS No. 123(R) “Share-Based Payment,” which requires us to measure compensation cost for share-based payment awards at fair value and recognize compensation expense over the service period for awards expected to vest. We utilize the Black-Scholes option-pricing model to value our awards and recognize compensation expense on a straight-line basis over the vesting periods of our awards. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Our expected volatility is determined based on our own historical volatility. The estimation of share-based payment awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Significant management judgment is required in determining estimates of future stock price volatility, forfeitures and expected life to be used in the valuation of the options. Actual results, and future changes in estimates, may differ substantially from our current estimates.

See Note 6 “Stock-Based Compensation” for additional discussion of the impact of adopting SFAS No. 123(R).

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. However, as inflation impacts our cost of sales, employee compensation and services that we use, we continually seek to mitigate the adverse effects of inflation through cost containment measures and improved productivity.

Impact of Recently Issued Accounting Pronouncements

In November 2007, the EITF of the FASB reached consensus on Issue No. 07-1, “Accounting for Collaborative Arrangements,” or EITF Issue No. 07-1. EITF Issue No. 07-1 addresses the issue of how costs incurred and revenue generated on sales to third parties should be reported by participants in a collaborative arrangement in each of their respective income statements. EITF Issue No. 07-1 also provides guidance on how an entity should characterize payments made between participants in a collaborative arrangement in the income statement and what participants should disclose in the notes to the financial statements about collaborative arrangements. EITF Issue No. 07-1 is effective for fiscal years beginning after December 15, 2007. As of January 1, 2008, we have adopted EITF 07-1 and there was no material impact to our financial statements.

In June 2007, the EITF of the FASB reached consensus on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities,” or EITF Issue No. 07-3. EITF Issue No. 07-3 addresses the issue of when to record nonrefundable advance payments for goods or

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services that will be used or rendered for research and development activities as expenses. The EITF has concluded that nonrefundable advance payments for future research and development activities should be deferred and recognized as an expense as the goods are delivered or the related services are performed. EITF Issue No. 07-3 is effective for fiscal years beginning after December 15, 2007. As of January 1, 2008, we have adopted EITF Issue No. 07-3 and there was no material impact to our financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115,” or SFAS No. 159. SFAS No. 159 permits companies to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. Companies electing the fair value option would be required to recognize changes in fair value in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We have not elected the fair value option for financial assets and liabilities existing at January 1, 2008 that were not already measured at fair value or newly transacted in the three months ended March 31, 2008. Any future transacted financial assets or liabilities will be evaluated for the fair value election as prescribed by SFAS No. 159.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” or SFAS No. 157. SFAS No. 157 establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within that fiscal year. In November 2007, the FASB elected to defer for one year the implementation of SFAS No. 157 for certain non-financial assets and liabilities. We are evaluating the impact, if any, that SFAS No. 157 will have on our non-financial assets and liabilities covered under this deferral. As of January 1, 2008, we have adopted SFAS No. 157 and there was no material impact on the fair value measure of our financial and non-financial assets and liabilities.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We are subject to interest rate risk on our investment portfolio and borrowings under our term loan facility.

We invest in marketable securities in accordance with our investment policy. The primary objectives of our investment policy are to preserve capital, maintain proper liquidity to meet operating needs and maximize yields. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer or type of investment. Our investment portfolio may consist of a variety of securities, including United States government and government agency obligations, money market and mutual fund investments, municipal and corporate notes and bonds and asset or mortgage-backed securities. As of March 31, 2008, cash equivalents consisted of an $8.5 million money market account, $66.8 million concentrated in two money market funds and $10.5 million of marketable debt securities maturing in less than 90 days. Our investment portfolio as of March 31, 2008 consisted solely of corporate notes and bonds and commercial paper and had an 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. All of our cash, cash equivalents and investments are maintained at two banking institutions.

Our investment 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 portfolio, changes in the market value due to changes in interest rates and other market factors as well as the increase or decrease in any realized gains and losses. 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. At March 31, 2008, our portfolio of available-for-sale investments consisted of approximately $12.0 million of investments maturing within one year and approximately $6.9 million of investments maturing after one year but within 36 months. In general, securities with longer maturities are subject to greater interest-rate risk than those with shorter maturities. 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. 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 materially impacted due to a sudden change in interest rates.

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. In 2007, mortgage-backed securities referencing sub-prime consumer mortgages experienced a significant increase in default rates, resulting in devaluation of asset prices and reduction in market liquidity. We reduced our exposure to such additional market risk and associated credit risk by eliminating our investments in mortgage-backed and auction rate securities during 2007. As of March 31, 2008, we do not have any direct investments in auction-rate securities or securities that are collateralized by assets that include mortgages or subprime debt.

Our risk associated with fluctuating interest expense is limited to future capital leases and other short-term debt obligations we may incur in our normal operations. The interest rates on our long-term debt borrowings under the term loan facility are fixed and as a result, interest due on borrowings are not impacted by changes in market-based interest rates.

Strategic Investment Risk

In addition to our normal investment portfolio, we have a strategic investment in Parion Sciences, Inc. of $200,000 as of March 31, 2008. This investment is in the form of unregistered common 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.

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Foreign Currency Exchange Risk

The majority of our transactions occur in U.S. dollars and we do not have subsidiaries or investments in foreign countries. Therefore, we are not subject to significant foreign currency exchange risk. We do, however, have foreign currency exposure with regard to the purchase of active pharmaceutical ingredients as they relate to AzaSite, which is manufactured by a foreign-based company. We have established policies and procedures for assessing market and foreign exchange risk. As of March 31, 2008, we did not have any material foreign currency hedges.

Item 4. 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 defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 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. There were no changes in our internal control over financial reporting during such period that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II: OTHER INFORMATION

Item 1. Legal Proceedings

On February 15, 2005, the first of five identical purported shareholder class action complaints was filed in the United States District Court for the Middle District of North Carolina against us and certain of our senior officers. Each complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Securities and Exchange Commission Rule 10b-5, and focused on statements that are claimed to be false and misleading regarding a Phase 3 clinical trial of our dry eye product candidate, Prolacria. Each complaint sought 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 March 27, 2006, following consolidation of the lawsuits into a single civil action and appointment of lead plaintiffs, the plaintiffs filed a Consolidated Class Action Complaint, or CAC. The CAC asserts claims against us and certain of our present or former senior officers or directors. The CAC asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 based on statements alleged to be false and misleading regarding a Phase 3 clinical trial of Prolacria, and also adds claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The CAC also asserts claims against certain parties that served as underwriters in our securities offerings during the period relevant to the CAC. The CAC seeks unspecified damages on behalf of a purported class of purchasers of our securities during the period from May 10, 2004 through February 8, 2005. In May 2006, the plaintiffs agreed to voluntarily dismiss their claims against the underwriters on the basis that they were time-barred. On June 30, 2006, we and other defendants moved that the court dismiss the CAC on the grounds that it fails to state a claim upon which relief can be granted and does not satisfy the pleading requirements under applicable law. On May 14, 2007, Magistrate Judge Eliason, to whom the District Court had referred the motion, issued a Recommendation that the District Court grant Defendants’ motion to dismiss the CAC. Plaintiffs filed objections to this Recommendation in which they argued that the District Court should not accept the Recommendation, and Defendants responded to Plaintiffs’ objections.

On July 26, 2007, the United States District Court for the Middle District of North Carolina accepted the Magistrate Judge’s recommendation and granted our and the other defendants’ motion and dismissed the CAC with prejudice. On August 24, 2007, the plaintiffs filed an appeal to the United States Court of Appeals for the Fourth Circuit. Plaintiffs filed their opening appellate brief on November 19, 2007. We and the other defendants filed an opposition brief on January 18, 2008. Plaintiffs filed their reply on February 22, 2008. We will continue to defend the litigation vigorously.

As with any legal proceeding, we cannot predict with certainty the eventual outcome of these lawsuits, nor can a reasonable estimate of the amounts of loss, if any, be made.

On August 30, 2005, the SEC notified us that it is conducting a formal, nonpublic investigation which we believe relates to our Phase 3 clinical trial of our dry eye product candidate, Prolacria. On October 19, 2006, we received a Wells Notice letter from the staff of the SEC, issued in connection with this investigation. Our Chief Executive Officer and our then Executive Vice President, Operations and Communications, also received Wells Notices.

The Wells Notices provide notification of the SEC staff’s determination that it intends to recommend to the SEC that it bring a civil action against us and the two officers regarding possible violations of Section 17(a) of the Securities Act of 1933, Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and SEC Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13a-14 thereunder. Under the process established by the SEC, we and the two officers have the opportunity to respond in writing to the Wells Notice before the staff makes any formal recommendation to the SEC regarding what action, if any, should be brought by the SEC. We and the officers receiving these notices provided written submissions to the SEC in response to the Wells Notices during December 2006, and have since had further discussions and meetings with, and have provided further written submissions to, the SEC staff.

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We cannot predict with certainty the eventual outcome of this investigation, nor can a reasonable estimate of the costs that might result from the SEC’s investigation be made.

Item 1A. Risk Factors.

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 SEC.

Risks Related to Product Commercialization

Failure to adequately market and commercialize AzaSite will limit our revenues.

The commercial success of AzaSite will largely depend on a number of factors, including:

• Acceptance by patients and physicians;

• The effectiveness of our sales and marketing efforts;

• Ability to differentiate AzaSite relative to our competitors’ products;

• Ability to further develop clinical information to support AzaSite;

• Satisfaction with existing alternative therapies;

• Perceived efficacy relative to other available therapies;

• Cost of treatment;

• Pricing and availability of alternative products, including generic or over-the-counter products;

• Marketing and sales activities of competitors;

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

• Relative convenience and ease of administration;

• Prevalence and severity of adverse side effects;

• Regulatory approval in other jurisdictions;

• Market penetration;

• The manufacturer’s successful building and sustaining of manufacturing capability;

• Our ability to enter into managed care and governmental agreements on favorable terms; and

• Any competitor’s ability to successfully commercialize competing therapies.

Establishment and completion of appropriate steps related to a product launch take significant time and resources. We are responsible for all aspects of the commercialization of this product, including determination of formularies upon which AzaSite is listed, manufacturing, distribution, marketing and sales. The determination of formularies upon which AzaSite is listed, the discounts and pricing under such formularies, as well as the amount of time it takes for us to obtain favorable formulary status under various plans will impact our commercialization efforts. Additionally, inclusion on certain formularies will require significant price concessions through rebate programs that impact the level of revenue that we receive. The need to give price concessions can be particularly acute where competing products are listed on the same formulary, such as the area of bacterial conjunctivitis. If AzaSite is not successfully commercialized, our revenues will be limited.

As part of the launch, we have introduced a significant number of trade-size samples into the market place in order to allow customers to rapidly gain experience with AzaSite. If we are not able have a reduced-fill sample validated and manufactured, we may need to continue to use trade-size samples in our marketing efforts. This may result in a reduction in the number of prescriptions written for AzaSite and therefore, our revenues may be negatively impacted.

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Under our agreement with InSite Vision, we are obligated to make pre-determined minimum annual royalty payments to InSite Vision, if our sales of AzaSite would not otherwise require greater royalty payments. In the event we are required to make annual minimum royalty payments, our profits with respect to AzaSite, if any, will be decreased or any losses with respect to the product will be increased. Such circumstances may result in us ceasing our commercialization of AzaSite and terminating our agreement with InSite Vision.

We have had limited experience in commercialization of products.

Although the members of our sales force have had experience in sales with other companies, prior to 2004 we did not have a sales force, and we may experience difficulties maintaining our sales force. We have incurred substantial expenses in establishing and maintaining our sales force and expect to continue to incur substantial expenses in the future.

We are promoting AzaSite to select eye care professionals, pediatricians and primary care providers. We have no prior experience calling on pediatricians and primary care physicians. A large number of pharmaceutical companies, including those with competing products, much larger sales forces and financial resources, and those with products for indications that are completely unrelated to those of our products compete for the time and attention of pediatricians and primary care physicians. As a result, our sales force may not be able to gain sufficient access to these doctors, which would have a negative impact on our ability to promote AzaSite and gain market acceptance.

In addition, prior to the in-licensing and launch of AzaSite, we had limited experience in product pricing, negotiating managed care agreements and government contracts, and managing regulatory-related compliance activities such as pharmacovigilance. As a result, we may have difficulties in establishing such contracts in a timely manner or maintaining all required compliance activities.

Failure to successfully market and co-promote Allergan’s Restasis and Elestat will negatively impact our revenues.

Although we 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.

Our agreement with Allergan provides that we have the responsibility for promoting and marketing Elestat in the United States and paying the associated costs. There can be no assurances that revenues associated with Restasis and Elestat will exceed the related selling, promoting and marketing expenses associated with co-promotion activities for these products during the year ending December 31, 2008 or any future period. Our revenues will be impacted from time to time by the number of formularies upon which these products are listed, the discounts and pricing under such formularies, as well as the estimated and actual amount of rebates. Allergan is responsible for determining the formularies upon which Restasis and Elestat are listed and making the appropriate regulatory and other filings.

Our present revenues depend upon and our future revenues will depend, at least in part, upon the acceptance of Restasis and Elestat by eye-care professionals, allergists and patients. Factors that could affect the acceptance of Restasis and Elestat include:

• Satisfaction with existing alternative therapies;

• Perceived efficacy relative to other available therapies;

• Extent and effectiveness of our sales and marketing efforts;

• Extent and effectiveness of Allergan’s sales and marketing efforts;

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

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• Coverage and reimbursement under Medicare Part D, other state government sponsored plans and commercial plans;

• Cost of treatment;

• Pricing and availability of alternative products, including generic or over-the-counter products;

• Marketing and sales activities of competitors;

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

• Relative convenience and ease of administration;

• Prevalence and severity of adverse side effects; and

• Regulatory approval in other jurisdictions.

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

The manufacture and sale of Restasis is protected under a use patent which expires in August 2009 and a formulation patent which expires in May 2014. If and when we experience competition, including generics, for Restasis, our revenues attributable to Restasis will be significantly impacted.

The loss of commercial exclusivity of Elestat will have a material impact on our cash flows.

The commercial exclusivity period for Elestat under the Hatch-Waxman Act will expire on October 15, 2008, at which time competitors will be able to submit to the FDA an ANDA or a 505(b)(2) application for a generic version of epinastine HCl ophthalmic solution. We cannot predict with certainty the time frame of an FDA review of such applications, if any are filed. We are aware that several generic pharmaceutical companies have expressed intent to commercialize the ocular form of epinastine after the commercial exclusivity period expires. Our ability to gain additional intellectual property protection related to Elestat has been, and continues to be, challenging. To date, no patent protection or any other form of intellectual property protection has been obtained for Elestat, and we cannot provide any assurance that any form of intellectual property protection covering Elestat will be possible in the United States after the expiration of the commercial exclusivity period under the Hatch-Waxman Act on October 15, 2008. If a generic form of Elestat or an over-the-counter form of epinastine for the eye is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues attributable to Elestat will essentially cease. Loss of our co-promotion revenue from Elestat will materially impact our results of operations and cash flows.

If we are unable to contract with third parties for the synthesis of active pharmaceutical ingredients 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.

The manufacturing of sufficient quantities of new and/or approved products or product candidates is a time-consuming and complex process. We have no experience or capabilities to conduct the large-scale manufacture of any of our product candidates. In order to successfully commercialize AzaSite and continue to develop our product candidates, we need to contract or otherwise arrange for the necessary manufacturing. There are a limited number of manufacturers that operate under the FDA’s cGMP regulations capable of manufacturing for us or our collaborators. We depend upon third parties for the manufacture of both drug substance and finished drug products and this dependence 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 operations and revenues. If we, or our partners, are unable to engage or retain third-party manufacturers on a long-term basis or on commercially acceptable terms, our products may not be commercialized as planned, and the development of our product candidates could be delayed.

Under our agreement with the manufacturer of AzaSite, we are required to purchase a minimum number of units of AzaSite annually, regardless of our ability to sell AzaSite. If we are unable to sell the AzaSite that we are required to purchase, our inventory of the product will increase and the shelf life of the inventory will be adversely impacted. In such circumstances, we may be required to make price concessions to sell short-dated product or write-off and dispose of expired product, which may have an adverse affect on our financial condition.

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The manufacturing processes for our product candidates 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. In addition, manufacturing facilities are subject to an FDA inspection to confirm cGMP compliance prior to a product candidate’s potential NDA approval as well as ongoing post-approval FDA inspections to ensure continued compliance with cGMP regulations, over which we have no control.

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 Restasis and Elestat. It is our understanding that Allergan relies upon an arrangement with a single third party for the manufacture and supply of active pharmaceutical ingredients, or APIs, for each of Restasis and Elestat. Allergan then completes the manufacturing process to yield finished product.

Under our supply agreement with InSite Vision, InSite Vision is responsible for supplying us with azithromycin, the API used in AzaSite. InSite Vision, in turn, relies upon an arrangement with a single third party for the manufacture and supply of such API. We are responsible for producing the finished product form of AzaSite, which is currently manufactured by a single party. There can be no assurance that such manufacturer will be able to continue to produce sufficient quantities of finished product in a timely manner to support the commercialization of AzaSite. In the event we are unable to continue to obtain sufficient quantities of AzaSite in finished product form, the long-term supply chain and distribution of AzaSite may be affected and our revenues may be negatively impacted.

In the event a third-party manufacturer is unable to supply Allergan or InSite Vision (as the case may be), if such supply is unreasonably delayed, or if Allergan or our finished product contract partner are unable to complete the manufacturing cycle, sales of the applicable product could be adversely impacted, which would result in a reduction in any applicable product revenue. In addition, if Allergan or the third-party manufacturers do not maintain cGMP compliance, the FDA could require corrective actions or take enforcement actions that could affect production and availability of the applicable product, thus adversely affecting sales.

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 Prolacria and denufosol. Delays in any aspect of implementing the manufacturing process could cause significant development delays and increased costs.

It would be time consuming and costly to identify and qualify new sources for manufacture of APIs or finished products. If our vendors 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.

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. There are many companies seeking to develop products for the same indications that we are working on. Our competitors in the United States and elsewhere are numerous and include, among others, major multinational pharmaceutical and chemical companies and specialized biotechnology firms.

Most of these competitors have greater resources than we do, including greater financial resources, 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

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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 financial, technical, human and other 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. In addition, alternative approaches, such as gene therapy, in treating diseases that we have targeted, such as cystic fibrosis, may make our product candidates obsolete.

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

We are dependent on third parties to perform or assist us in the distribution or sale of AzaSite, and are dependent on third parties, primarily Allergan, to perform or assist us in the distribution or sale of Restasis and Elestat. We rely on the services of a single source, third-party distributor to deliver AzaSite to our customers. In addition to the physical storage and distribution of AzaSite, this third-party distributor maintains and provides us with information and data with regard to our inventory, AzaSite orders, billings and receivables, chargebacks and returns, among others, on which our accounting estimates are based. If third parties do not successfully carry out their contractual duties, meet expected sales goals, or 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 third parties or Allergan do not perform, or assist us in performing these functions, or if there is a delay or interruption in the distribution of our products, it could have an adverse effect on product revenue, accounting estimates and our overall operations.

We depend on three pharmaceutical wholesalers for the vast majority of our AzaSite sales in the United States, and the loss of any of these wholesalers would negatively impact our revenues.

The prescription drug wholesaling industry in the United States is highly concentrated, with a vast majority of all sales made by three major full-line companies. Those companies are Cardinal Health, McKesson Corporation and AmerisourceBergen. The majority of our AzaSite revenues come from sales to these three companies. The loss of any of these wholesalers could have a negative impact on our commercialization of AzaSite.

It is also possible that these wholesalers, or others, could decide to change their policies and fees in the future. This could result in or cause us to incur higher product distribution costs, lower margins or the need to find alternative methods of distributing our products. Such alternative methods may not be economically or administratively feasible.

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 product candidates may not be commercially successful. Acceptance of and demand for any new products will depend largely on the following:

• Acceptance by physicians and patients of the product as a safe, effective and convenient therapy;

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

• In the case of Prolacria, effectiveness of Allergan’s sales and marketing efforts;

• Effectiveness of our sales and marketing efforts;

• Marketing and sales activities of competitors;

• Safety, effectiveness and pricing of alternative products; and

• Prevalence and severity of side effects associated with the new product.

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In addition, to achieve broad market acceptance of our product candidates, in many cases we will need to develop, alone or with others, convenient dosing and methods for administering the products. For example, we intend that Prolacria 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 its licensed territories, a multi-dose formulation has not been developed by our other partner, Allergan, for use in the remainder of the world. In addition, in our current clinical trials, denufosol for the treatment of cystic fibrosis is administered by a standard nebulizer three times-a-day, but patients may prefer a smaller, more portable, hand-held device. Similar challenges may exist in identifying and perfecting convenient dosing and methods of administration for our other product candidates.

Risks Related to Product Development

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.

We have not received marketing approval for any of our product candidates, except AzaSite, which was in-licensed from InSite Vision. We have one product candidate, Prolacria, for which we have received two approvable letters from the FDA. There is no guarantee that the FDA will approve Prolacria and allow the commercialization of the product in the United States. It will be necessary to undertake at least one additional Phase 3 clinical trial in support of the NDA for Prolacria and there can be no guarantee that the FDA would find any such additional clinical trial to be successful or that the FDA would approve Prolacria even if such additional clinical trial was successful. If additional Phase 3 clinical trials for Prolacria are required by the FDA, we may decide not to conduct those clinical trials, which would result in the inability to obtain FDA approval of the product candidate.

We will have to conduct significant 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 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 or all of our 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 measure of efficacy of the drug is not statistically significant compared to placebo;

• Patients experience severe side effects or serious adverse events 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;

• We decide to modify the drug during testing;

• Clinical investigator conduct or misconduct leads the FDA to stop the clinical trial or to take other action that could delay or impede progress of a clinical trial or progress of a product candidate towards approval;

• Our commercial partners, or future commercial partners, delay, amend or change our development plan or strategy;

• We allocate our limited financial and other resources to other clinical and preclinical programs; and

• Weather events, natural disasters, malicious activities or other unforeseen events occur.

Changes in regulatory policy or new regulations as well as clinical investigator misconduct could also result in delays or rejection of our applications for approval of our product candidates. Clinical investigator misconduct that raises questions about the integrity of data in one or more applications (e.g., fraud, bribery, omission of a material fact, gross negligence) could be used by the FDA as grounds to suspend substantive scientific review of all pending

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marketing applications until the data in question have successfully undergone a validity assessment. Product candidates that fail validity assessments must be withdrawn from FDA review or, if the drug is an approved, marketed product, such product must be removed from the market.

A product candidate designated as a “fast track” product by the FDA may not continue to qualify for expedited review if it no longer (1) demonstrates a potential to address unmet medical needs, or (2) is being studied in a manner that would show the product is able to treat a serious or life-threatening condition. Our product candidates may not meet fast track criteria if, for example, a new product that addressed the same medical needs were approved before our product, or if emerging clinical data failed to show the anticipated advantage over existing therapy. 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.

Additionally, the introduction of our products in foreign markets will subject us to foreign regulatory clearances, the receipt of which may be unpredictable, uncertain and may impose substantial additional costs and burdens which we or our partners in such foreign markets may be unwilling or unable to fund. As with the FDA, foreign regulatory authorities must be satisfied that adequate evidence of safety 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, nor does approval by any foreign regulatory authority ensure approval by the FDA.

Since some of our clinical candidates utilize new or different mechanisms of action and in some cases there may be no regulatory precedents, conducting clinical trials and obtaining regulatory approval may be difficult, expensive and prolonged, which would delay any commercialization of our products.

To complete successful clinical trials, our product candidates must demonstrate safety and provide substantial evidence of efficacy. The FDA generally evaluates efficacy based on the statistical significance of a product candidate meeting predetermined clinical endpoints. The design of clinical trials to establish meaningful endpoints is done in collaboration with the FDA prior to the commencement of clinical trials. We establish these endpoints based on guidance from the FDA, including FDA guidance documents applicable to establishing the efficacy, safety and tolerability measures required for approval of products. However, since some of our product candidates utilize new or different mechanisms of action, 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 concludes that the endpoints established for a clinical trial do not adequately predict a clinical benefit.

We have one product candidate for the treatment of dry eye disease, Prolacria, for which we have received two approvable letters from the FDA. The FDA has not published guidelines on the approval of a product for the treatment of dry eye disease. Furthermore, to date, only one prescription product, Restasis, has been approved by the FDA for the treatment of dry eye disease, and Restasis has a different mechanism of action from Prolacria. It will be necessary to undertake at least one additional Phase 3 clinical trial in support of our NDA for Prolacria and there can be no guarantee that any such additional clinical trial would be successful or that the FDA would approve Prolacria even if such additional clinical trial was successful.

We are developing denufosol tetrasodium as an inhaled product designed to enhance the lung’s innate mucosal hydration and mucociliary clearance mechanisms by mitigating the underlying ion transport defect in the airways of patients with cystic fibrosis. The FDA has not published guidance on the drug approval process associated with such a product candidate. Furthermore, we are not aware of any FDA approved product that mitigates the underlying ion transport defect in the airways of patients with cystic fibrosis. We cannot predict or guarantee the outcome or timing of our Phase 3 program for denufosol for cystic fibrosis. A significant amount of work will be required to advance denufosol through clinical testing, including satisfactory completion of additional clinical trials, toxicology and carcinogenicity studies. We may later decide to change the focus or timing of a Phase 3 program. The Phase 3 clinical trials for denufosol for cystic fibrosis may not be successful or unexpected safety concerns may emerge that would negatively change the risk/benefit profile for this product candidate.

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Estimated development costs are difficult to project and may change frequently prior to regulatory approval.

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

The number and type of studies that may be required by the FDA, 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 and the number and geographical location of clinical trial sites necessary to enroll such patients;

• 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.

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, delays or enhancements to an ongoing development program;

• Commercial partners and the underlying contractual agreements may require additional or more involved clinical or preclinical activities;

• The FDA or other regulatory authorities 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, changes in regulatory policy or review standards, or interim reviews by regulatory agencies may cause delays or changes to development programs; and

• Anticipated manufacturing costs may change significantly due to necessary changes in manufacturing processes, variances from anticipated manufacturing process yields or changes in the cost and/or availability of starting materials, and other costs to ensure the manufacturing facility is in compliance with cGMP requirements and is capable of consistently producing the product candidate in accordance with established specifications submitted to the FDA.

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 expensive and are often lengthy. They require appropriate identification of optimal treatment regimens and relevant patient population, adequate supplies of drug product, and sufficient patient enrollment. Patient enrollment is a function of many factors, including:

• The size and availability of the relevant 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.

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Delays in patient enrollment can result in increased costs and longer development times. The timing of our Phase 3 program for denufosol for the treatment of cystic fibrosis will be impacted by a number of variables, including clinical development decisions regarding identifying the optimal treatment regimens, patient population, competition for clinical trial participants, approval of other products during our clinical trials, number and length of clinical trials, regulatory requirements of the FDA and/or foreign regulatory authorities, the exclusion criteria for the clinical trials and use of therapies such as hypertonic saline. Our cystic fibrosis clinical trials will present some unique challenges due to the early-intervention approach we are taking with regard to the clinical trials. This approach will require studying mild patients, which are usually younger patients who do not typically participate in clinical trials since new products are generally focused on the sicker patient population. Even if we successfully complete clinical trials, 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.

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.

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.

If we fail to meet payment obligations, performance milestones relating to the timing of regulatory filings, development and commercial diligence obligations, fail to make milestone payments in accordance with applicable provisions, or fail to pay the minimum annual payments under our respective licenses, our licensors may terminate the applicable license. As a result, our development of the respective product candidate or commercialization of the product would cease.

Risks Related to Governmental Regulation

Failure to comply with all applicable regulations, including those that require us to obtain and maintain governmental approvals for our product candidates, may result in fines, corrective actions, administrative sanctions and restrictions, including the withdrawal of a product from the market.

Pharmaceutical companies are subject to significant regulation by a number of national, state and local agencies, including the FDA. Such regulations and their authorizing statutes are amended from time to time. Failure to comply with applicable regulatory requirements could, among other things, result in fines, corrective actions, administrative sanctions, suspensions or delays of product manufacture or distribution or both, product recalls, delays in marketing activities and sales, withdrawal of marketing approvals, and civil or criminal sanctions including possible exclusion from eligibility for federal government contracts payment of our products by Medicare, Medicaid, and other third-party payors.

After initial regulatory approval, the manufacturing and marketing of drugs, including our products, are subject to continuing FDA and foreign regulatory review. Additionally, the FDA encourages health professionals to report significant adverse events associated with products. The FDA may require additional clinical studies, known as Phase 4, to evaluate product safety effects. In addition to studies required by the FDA after approval, we may conduct our own Phase 4 studies to explore the use of the approved drug product for treatment of new indications or to broaden our knowledge of the product. The subsequent discovery of previously unknown problems with a product’s safety or efficacy as a result of these studies or as reported in their prescribed use may result in restrictions through labeling changes or withdrawal of the product from the market.

The FDA periodically inspects drug manufacturing facilities to ensure compliance with applicable cGMP regulations. Failure to comply with statutory and regulatory requirements subject the manufacturer to possible legal or regulatory action, such as suspension of manufacturing, seizure of product or voluntary recall of a product.

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Additional authority to take post-approval actions was given to the FDA under the FDA Amendments Act of 2007, which went into effect on October 1, 2007. The FDA is authorized to revisit and change its prior determinations if new information raises questions about our product’s safety profile. The FDA is authorized to impose additional 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;

• Requiring us or our partners to conduct long-term safety studies if new information raises questions about our product’s safety profile;

• Requiring labeling changes to help ensure the safe and effective use of products;

• Requiring development and implementation of a Risk Evaluation and Mitigation Strategies plan if the FDA determines that it is necessary to help ensure that the drug’s benefits continue to outweigh the risks of a serious adverse drug experience;

• Requiring corrective and preventive actions and/or suspending manufacturing;

• Withdrawing marketing approval;

• Seizing adulterated, misbranded or otherwise violative products;

• Seeking to enjoin the manufacture or distribution, or both, of an approved product, or seeking an order to recall an approved product, that is found to be adulterated or misbranded; and

• Seeking monetary fines and penalties, including disgorgement of profits, if a court finds that we are in violation of applicable law.

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, if certain cGMP deviations are found, or if economic conditions support such action.

In its regulation of advertising, the FDA may issue correspondence to pharmaceutical companies alleging that its advertising or promotional materials 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 it may be necessary for us to:

• Incur substantial expenses, including fines, penalties, legal fees and costs to conform to the FDA’s limits on such promotion;

• Change our methods of marketing, promoting and selling products;

• Take corrective action, which could include placing advertisements or sending letters to physicians correcting statements made in previous advertisements or promotions; or

• Disrupt the distribution of products and stop sales until we are in compliance with the FDA’s interpretation of applicable laws and regulations.

In addition, in recent years, some alleged violations of FDA requirements regarding off-label promotion of products by manufacturers have been used to support whistleblower and/or government actions under the federal civil False Claims Act, resulting in substantial monetary settlements. Also, 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.

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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 that could affect our ability to sell our products profitably. In the United States, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a voluntary outpatient prescription drug benefit under Part D of the Social Security Act. The program, which went into effect January 1, 2006, is administered by the Centers for Medicare & Medicaid Services within the Department of Health and Human Services and is implemented and operated by private sector Part D plan sponsors. The federal government can be expected to continue to issue guidance and regulations regarding the obligations of Part D sponsors and their subcontractors. Allergan is responsible for the implementation of the Medicare Part D program as it relates to Restasis and Elestat and has contracted with Part D plan sponsors to cover such drugs under the Part D benefit. We are responsible for contracting with Part D plan sponsors with respect to AzaSite.

Each participating drug plan is permitted by regulation to develop and establish its own unique drug formulary that may exclude certain drugs from coverage, impose prior authorization and other coverage restrictions, and negotiate payment levels for drugs which may be lower than reimbursement levels available through private health plans or other payers. Moreover, beneficiary co-insurance requirements could influence which products are recommended by physicians and selected by patients. There is no assurance that any drug that we co-promote or sell will be covered by drug plans participating under the Medicare Part D program or, if covered, what the terms of any such coverage will be, or that the drugs will be reimbursed at amounts that reflect current or historical payment levels. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2008 and in future years from the Medicare prescription drug coverage legislation or from changes in the formularies or price negotiations with Part D drug plans. To the extent that private insurers or managed care programs follow Medicare coverage and payment developments, the adverse effects of lower Medicare payment may be magnified by private insurers adopting similar lower payment. New federal or state drug payment changes or healthcare reforms in the United States and in foreign countries may be enacted or adopted in the future that could further lower payment for our products.

We are subject to “fraud and abuse” and similar government laws and regulations, and a failure to comply with such laws and regulations, or an investigation into our compliance with such laws and regulations, or a failure to prevail in any litigation related to noncompliance, could harm our business.

We are subject to multiple state and federal laws pertaining to health care fraud and abuse. Pharmaceutical pricing, sales, and marketing programs and arrangements, and related business practices in the health care industry generally are under increasing scrutiny from federal and state regulatory, investigative, prosecutorial, and administrative entities. Many health care laws, including the federal and state anti-kickback laws and federal and state statutory and common law false claims laws, have been construed broadly by the courts and permit government entities to exercise considerable discretion. In the event that any of these government entities believed that wrongdoing had occurred, one or more of them could institute civil administrative or criminal proceedings which, if instituted and resolved unfavorably, could subject us to substantial fines, penalties, and injunctive and administrative remedies, including exclusion from government reimbursement programs. We cannot predict whether any investigations would affect our marketing or sales practices. Any such result could have a material adverse impact on our results of operations, cash flows, financial condition, and our business. Such investigations could be costly, divert management’s attention from our business, and result in damage to our reputation. We cannot guarantee that measures that we have taken to prevent violations, including our corporate compliance program, will protect us from future violations, lawsuits or investigations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant negative impact on our business, including the imposition of significant fines or other sanctions.

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Failure to adequately control compliance with all applicable laws and regulations may adversely affect our business, and we may become subject to investigative or enforcement actions.

There are extensive state, federal and foreign laws and regulations applicable to public pharmaceutical companies engaged in the discovery, development and commercialization of medicinal products. There are laws and regulations that govern areas including financial controls, clinical trials, testing, manufacturing, labeling, safety, packaging, shipping, distribution and promotion of pharmaceuticals, including those governing interactions with prescribers and healthcare professionals in a position to prescribe, recommend, or arrange for the provision of our products.

In recent years, pharmaceutical companies have been the targets of extensive whistleblower actions in which the person bringing an action alleges a variety of violations of the civil False Claims Act or its state equivalent, in such areas as pricing practices, off-label product promotion, sales and marketing practices, improper relationships with physicians and other healthcare professionals, among others. If our promotional or other activities fail to comply with applicable regulations or guidelines, we may be subject to warnings from, or enforcement action by, regulatory authorities. 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, exclusion from government programs, product recalls or seizures, or other restrictions and litigation. Furthermore, there can be no assurance that we will not be subject to a whistleblower or other investigative or enforcement action at some time in the future.

Risks Associated with Our Business and Industry

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

We continue to defend against a Consolidated Class Action Complaint, or CAC, filed against us and certain of our present or former senior officers or directors. The CAC asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder based on statements alleged to be false and misleading regarding a Phase 3 clinical trial of Prolacria and adds claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. 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, future results of operations, financial position and/or cash flows if not covered by our insurance carriers or if damages exceed the limits of our insurance coverage. Furthermore, regardless of our success in defending against the litigation, the litigation itself has resulted, and may continue to result, in substantial costs, use of resources and diversion of the attention of management and other employees, which could adversely affect our business. We have various insurance policies related to the risks associated with our business, including directors and officers insurance. However, there is no assurance that our insurance coverage will be sufficient or that our insurance companies will cover all the matters claimed. In the event of an adverse outcome, our business as well as our future results of operations, financial position and/or cash flows could be materially affected to the extent that our insurance fails to cover such costs.

The investigation by the U.S. Securities and Exchange Commission could have a material adverse effect on our business.

On August 30, 2005, the SEC notified us that it is conducting a formal, nonpublic investigation which we believe relates to our Phase 3 clinical trial of our dry eye product candidate, Prolacria. On October 19, 2006, we received a Wells Notice letter from the staff of the SEC, issued in connection with this investigation. Our Chief Executive Officer and our then Executive Vice President, Operations and Communications, also received Wells Notices.

The Wells Notices provide notification of the SEC staff’s determination that it intends to recommend to the SEC that it bring a civil action against us and the two officers regarding possible violations of Section 17(a) of the

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Securities Act of 1933, Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and SEC Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13, and 13a-14 thereunder. Under the process established by the SEC, we and the two officers have the opportunity to respond in writing to the Wells Notice before the staff makes any formal recommendation to the SEC regarding what action, if any, should be brought by the SEC. We and the officers receiving these notices provided written submissions to the SEC in response to the Wells Notices during December 2006, and have since had further discussions and meetings with, and have provided further written submissions to, the SEC staff.

We are unable to predict the outcome of the investigation and no assurance can be made that the investigation will be concluded favorably. In the event of an adverse outcome, our business, future results of operations, financial position and/or cash flows could be materially affected. Furthermore, regardless of the outcome of the investigation, the investigation itself has resulted, and may continue to result, in substantial uninsured costs, use of resources and diversion of the attention of management and other employees, which could adversely affect our business. There is no assurance that our insurance coverage, including directors and officers insurance, will be sufficient or that our insurance companies will cover all the matters claimed. In the event of an adverse outcome, our business as well as our future results of operations, financial position and/or cash flows could be materially affected to the extent that our insurance fails to cover such costs.

Our co-promotion revenues are based, in part, upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control.

We recognize co-promotion revenue based on Allergan’s net sales for Restasis and Elestat as defined in the co-promotion agreements and as reported to us by Allergan. Accordingly, our co-promotion revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control and the underlying terms of our co-promotion agreements. Allergan’s filings with the SEC indicate that Allergan maintains disclosure controls and procedures in accordance with applicable laws, which are designed to provide reasonable assurance that the information required to be reported by Allergan in its Exchange Act filings is reported timely and in accordance with applicable laws, rules and regulations. We are not entitled to review Allergan’s disclosure controls and procedures. All of our co-promotion revenues are currently derived from Allergan’s net sales of Restasis and Elestat as reported to us by Allergan. Management has concluded that our internal control over financial reporting was effective as of December 31, 2007, and these internal controls allow us 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; however, we are unable to provide complete assurance that Allergan will not revise reported revenue amounts in the future. If Allergan’s reported revenue amounts were inaccurate, it could have a material impact on our financial statements, including financial statements for previous periods.

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

Our revenues may fluctuate from period to period due in part to:

• Fluctuations in future sales of AzaSite, Restasis and Elestat due to competition, the intensity of an allergy season, disease prevalence, manufacturing difficulties, reimbursement and pricing under commercial or government plans, seasonality, or other factors that affect the sales of a product;

• Deductions from gross sales relating to estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales rebates and other allocated costs;

• The effectiveness of the commercialization of AzaSite;

• The duration of market exclusivity of AzaSite, Elestat and Restasis;

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

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

• The initiation of new contractual arrangements with other companies;

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

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

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Inventory levels of AzaSite held by wholesalers can also cause our operating results to fluctuate unexpectedly. Although we attempt to monitor wholesaler inventory of our products, we rely upon information provided by third parties to quantify the inventory levels maintained by wholesalers. In addition, we and the wholesalers may not be effective in matching inventory levels to end-user demand. Significant differences between actual and estimated inventory levels and product demand may result in inadequate or excessive (1) inventory production, (2) product supply in distribution channels, (3) product availability at the retail level, and (4) unexpected increases or decreases in orders from our major customers. Any of these events may cause our revenues to fluctuate significantly from quarter to quarter, and in some cases may cause our operating results for a particular quarter to be below expectations.

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. In the year ended December 31, 2006, we recognized milestone revenue of $1.25 million from Santen associated with the completion of Phase 2 clinical testing of diquafosol tetrasodium in Japan. We or our collaborative partners did not reach any such contractual milestones in 2007. There can be no assurances that we or our collaborative partners will reach any additional contractual milestones during 2008 or at any later date.

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 candidate development.

We have used substantial amounts of cash to fund our research and development and commercial activities. Our operating expenses were approximately $35.6 million in the three months ended March 31, 2008, and were approximately $114.5 million for the year ended December 31, 2007. Our cash, cash equivalents and investments totaled approximately $109.1 million on March 31, 2008.

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 commercial activities. Many factors will influence our future capital needs, including:

• The number, breadth and progress of our 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 or future collaborations and licensing agreements;

• Progress by our collaborators with respect to the development of product candidates;

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

• Competing technological and market developments;

• The timing and terms of any business development activities;

• The timing and amount of debt repayment requirements;

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

• The costs involved in responding to SEC investigations;

• The costs involved in enforcing patent claims and other intellectual property rights, including costs associated with enhancing market exclusivity for Elestat; 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 Restasis and Elestat;

• The receipt of revenue from wholesalers and other customers on net sales of AzaSite;

• The ability to generate sufficient sales of AzaSite;

• The receipt or payment of milestone payments under our collaborative agreements;

• The ability to obtain approval from the FDA for Prolacria;

• Our ability to obtain approval from the FDA for any of our other product candidates; and

• Payments from existing and future collaborators.

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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 product commercialization and 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.

If we are unable to make the scheduled principal and interest payments on our term loan facility or maintain minimum liquidity levels or compliance with other debt covenants as defined in the loan and security agreement, we may default on our debt.

In December 2006, we entered into a loan and security agreement for up to $40.0 million. In June 2007, we amended the loan and security agreement to expand the principal we were able to borrow by an additional $20.0 million, as well as revise the minimum liquidity we are required to maintain under the facility. Borrowings under the $60.0 million term loan facility are secured by substantially all of our assets, except for our intellectual property, but including all accounts, license and royalty fees and other revenues and proceeds arising from our intellectual property. Under the agreement, we are required to maintain minimum liquidity levels based on the balance of the outstanding advances. The agreement may affect our operations in several ways, including the following:

• A portion of our cash flow from operations will be dedicated to the payment of the principal and interest on our indebtedness;

• Our future cash flow may be insufficient to meet our required principal and interest payments;

• We may need to raise additional capital in order to remain in compliance with the loan covenants;

• Our ability to enter into certain transactions may be limited; and

• We may need to delay or reduce planned expenditures or clinical trials as well as other development and commercial activities if our current operations are not sufficient enough to service our debt.

Events of default under the loan and security agreement are not limited to, but include the following:

• Payment default;

• Covenant default;

• A material adverse change in Inspire;

• Breach of our agreements with Allegan; and

• Judgments against us over a certain dollar amount.

In case of an uncured default, the following actions may be taken against us by the lending institutions:

• All outstanding obligations associated with the term loan facility would be immediately due and payable;

• Any of our balances and deposits held by the lending institutions would be applied to the obligation;

• Balances and accounts at other financial institutions could be “held” or exclusive control be transferred to the lending institutions; and

• All collateral, as defined in the agreement, could be seized and disposed of.

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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 operating losses of approximately $25.9 million for the three months ended March 31, 2008, and approximately $63.7 million for the year ended December 31, 2007. As of March 31, 2008, our accumulated deficit was approximately $334.8 million. We currently 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 timing and level of the following:

• Commercialization activities to support AzaSite, Restasis and Elestat;

• Regulatory approvals of our product candidates;

• Patient demand for our products and any licensed products;

• Payments to and from licensors and corporate partners;

• Research and development activities;

• Investments in new technologies and product candidates; and

• The costs involved in defending any litigation claims against, or government investigations of, 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 operations.

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 collaboration agreements with several collaborators, including Allergan, InSite Vision and Santen. The termination of any collaboration will result in the loss of any unmet development or commercial milestone payments, 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. In the event we breach an agreement with a collaborator, the collaborator is entitled to terminate our agreement with them in the event we do not cure the breach within a specified period of time, which is typically 60 or 90 days from the notice date. With respect to the Allergan collaboration, in the event we become an affiliate of a third party that manufactures, markets or sells any then currently promoted prescription ophthalmic product, Allergan will have the right to terminate our Elestat Co-Promotion Agreement, which right must be exercised within 3 months of the occurrence of such event. If we do not maintain our current collaborations, or establish additional research and development collaborations or licensing arrangements, it will be difficult to develop and commercialize potential products. 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 outside North America without a collaborative partner or outside our therapeutic areas of focus. We are currently pursuing the out-licensing of certain rights related to our cystic fibrosis program. We may be unsuccessful in out-licensing this program or we may out-license this program on terms that are not favorable to us.

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.

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We currently depend upon ORA to provide clinical research services relating to Prolacria using ORA’s proprietary dry eye database and models, including access to its proprietary dry eye chambers. Due to the unique features of these dry eye models, if ORA were to terminate its agreement with us, we would be required to find another clinical service provider to provide us access to dry eye chambers, which may not be available, and we would need to change our Prolacria development plans. This would have a significant effect on our future development of Prolacria, including delays in, or possible termination of, the development program.

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 potential products. Our agreements with collaborators typically allow them some discretion in electing whether to pursue such activities. If any collaborator were to breach or terminate its agreement with us or otherwise fail to conduct collaborative activities in a timely and successful manner, the preclinical or clinical development or commercialization of product candidates or research programs would be delayed or terminated. Any delay or termination in clinical development or commercialization would delay or eliminate potential product revenues relating to our product candidates.

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 disagreements could also result in litigation or require arbitration to resolve.

Failure to hire and retain key personnel may hinder our product development programs and our business efforts.

We depend on the principal members of management and scientific staff, including Christy L. Shaffer, Ph.D., our President and 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. Our future success will depend in part on our ability to attract, hire or appoint, and retain additional personnel skilled or experienced in the pharmaceutical industry. There is significant competition for such qualified personnel and we may not be able 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 manufacturing our new chemical compounds. 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 covers these previously known chemical compounds, which are in the public domain. As a result, competitors may be able to commercialize products that use the same previously known chemical compounds used by us for the treatment of disorders and diseases not covered by our use patents. Such competitors’ activities may reduce our revenues.

If we must defend a patent suit, or if we choose to initiate a suit to have a third-party patent declared invalid, we may need to make considerable expenditures of money and management time in litigation. We believe that there is significant litigation in the pharmaceutical and biotechnology industry regarding patent and other intellectual property rights. A patent does not provide the patent holder with freedom to operate in a way that infringes the patent rights of others. While we are not aware of any patent that we are infringing, nor have we been accused of infringement by any other party, other companies may have, or may acquire, patent rights, which we might be accused of infringing. A

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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 significant legal fees.

Since 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.

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. Product liability claims could result in the imposition of substantial liability on us, a recall of products, or a change in the indications for which they may be used. Although we carry clinical trial liability insurance and product liability insurance, we, or our collaborators, may not maintain sufficient insurance to cover these potential claims. 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 commercialize our products or the product candidates we develop. If claims or losses exceed our liability insurance coverage, we may go out of business.

Insurance coverage is increasingly more costly and 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 will be required to share that risk in excess of our insurance limits. If we are subject to claims or suffer a loss or damage that is outside of our insurance coverage, we may incur significant uninsured costs associated with loss or damage that could have an adverse effect on our operations and financial position. Furthermore, any claims made on our insurance policies may impact our ability to obtain or maintain insurance coverage at reasonable costs or at all.

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Risks Related to Our Stock

Our common stock price has been volatile and your investment in our stock may decline in value.

The market price of our common stock has been 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 the commercialization of AzaSite;

• Announcements regarding FDA approval of any of our own or in-licensed product candidates;

• Announcements regarding the NDA for Prolacria;

• Announcements made by us concerning results of clinical trials with our product candidates;

• Market acceptance and market share of AzaSite, Restasis and Elestat;

• Duration of market exclusivity of AzaSite, Restasis and Elestat;

• Volatility in other securities including pharmaceutical and biotechnology securities;

• Changes in government regulations;

• Regulatory actions and/or investigations, including our ongoing SEC investigation;

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

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

• Variations in our operating results;

• FDA approval of other treatments for the same indication as any one of our product candidates;

• Business development activities;

• Litigation;

• Terrorist attacks; and

• Military actions.

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.

Warburg Pincus will be able to exercise substantial control over our business.

On July 17, 2007, we entered into a Securities Purchase Agreement with Warburg Pincus Private Equity IX, L.P., or Warburg, pursuant to which we sold an aggregate of 140,186 shares of Series A Exchangeable Preferred Stock. In October 2007, our stockholders approved the exchange of all outstanding Series A Exchangeable Preferred Stock for 14,018,600 shares of our common stock. As of March 31, 2008, this represented approximately 25% of our outstanding common stock. Additionally, we amended the terms of our stockholder rights plan, which allows Warburg and its affiliates to acquire the lesser of: (x) 32.5% of our voting securities on a fully diluted basis and (y) 34.9% of our then outstanding voting securities plus outstanding Exchangeable Preferred Stock on an as exchanged to common stock basis, without triggering the provisions of the stockholder rights plan. Pursuant to the Securities Purchase Agreement, Warburg has the right to designate one person for election to our Board of Directors for so long as Warburg owns a significant percentage of our securities. Pursuant to this right, effective July 20, 2007, our Board of Directors elected Jonathan S. Leff as a Class C member of the Board of Directors. As a result of the foregoing, Warburg will be able to exercise substantial influence over our business, policies and practices.

Our existing principal stockholders hold a substantial amount of our common stock and may be able to influence significant corporate decisions, which may conflict with the interest of other stockholders.

As of March 31, 2008, our current 5% and greater stockholders (which includes Warburg) and their affiliates beneficially owned approximately 48% of our outstanding common stock. These stockholders, if they act together, may be able to influence the outcome of matters requiring approval of the stockholders, including the election of our directors and other corporate actions such as:

• a merger or corporate combination with or into another company;

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• a sale of substantially all of our assets; and

• amendments to our certificate of incorporation.

The decisions of these stockholders may conflict with our interests or those of our other stockholders.

Future sales of securities 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 March 31, 2008, there were 56,581,571 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 of 1933, unless purchased by our affiliates. We have also filed a registration statement on Form S-3 for all 14,018,600 shares of common stock held by Warburg as the result of the Warburg transaction. In addition, we have the ability to sell up to $130 million of securities, including common stock, preferred stock, debt securities, depositary shares and securities warrants, from time to time at prices and on terms to be determined at the time of sale under an active shelf registration statement, which we filed with the SEC on March 9, 2007. Up to 15,178,571 shares of our common stock are issued or issuable upon exercise of stock options that have been, or stock options, stock appreciation rights, stock awards and restricted stock units that may be, issued pursuant to our Amended and Restated 1995 Stock Plan and our Amended and Restated 2005 Equity Compensation Plan. The shares underlying existing stock options and restricted stock units and possible future stock options, stock appreciation rights and stock awards have been registered pursuant to registration statements on Form S-8. The remaining shares of common stock outstanding are not registered under the Securities Act of 1933 and may be resold in the public market only if registered or if there is an exemption from registration, such as Rule 144.

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

Our Rights Agreement, the provisions of our Change in Control Severance Benefit Plans, the anti-takeover provisions in our Restated Certificate of Incorporation and Amended and Restated 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 our 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. In connection with the transaction with Warburg, we and Computershare entered into a First Amendment to Rights Agreement which provides that Warburg and its affiliates will be exempt from the definition of an “Acquiring Person” under the Rights Agreement, unless Warburg or certain of its affiliates becomes the beneficial owner of the lesser of: (x) 32.5% of our voting securities on a fully diluted basis and (y) 34.9% of our then outstanding voting securities plus the outstanding Exchangeable Preferred Stock on an as exchanged to common stock basis. In addition to Warburg’s ability to exercise substantial control over our business, the First Amendment to Rights Agreement could further discourage, delay or prevent a person or group from acquiring 15% or more of our common stock.

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Our employees are covered under Change in Control Severance Benefit Plans which provide severance benefits as of the date on which a change in control occurs. The plans would increase the acquisition costs to a purchasing company that triggers the change in control provisions and as a result, may delay or prevent a change in control.

Our 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 Restated Certificate of Incorporation allows our Board of Directors to issue shares of preferred stock. Our Board of Directors 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 of Directors may result in the entrenchment of management.

Our 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 include director nomination procedures and do not permit our stockholders to call a special meeting of stockholders. The staggering of directors’ terms of office, the director nomination procedures 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 director nomination requirements include a provision that requires stockholders give advance notice to our Secretary of any nominations for director or other business to be brought by stockholders at any stockholders’ meeting. Our directors may be removed from our Board of Directors only for cause. 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. In connection with the sale of the Exchangeable Preferred Stock, we agreed to waive Warburg’s acquisition of the Exchangeable Preferred Stock from the provisions of Section 203 of the Delaware General Corporation Law.

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Item 6. Exhibits

Exhibit No.	Description of Exhibit
3.1	Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2006).
3.2	Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 18, 2007).
10.1	Inspire Pharmaceuticals, Inc. Executive Change in Control Severance Benefit Plan, effective as of March 29, 2008.
10.2	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan, amended and restated as of March 29, 2008.
31.1	Certification of the President & 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 & Treasurer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the President & 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 & Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

	Inspire Pharmaceuticals, Inc.
Date: May 9, 2008	By:	/s/ Christy L. Shaffer
		Christy L. Shaffer
		President & Chief Executive Officer (principal executive officer)
Date: May 9, 2008	By:	/s/ Thomas R. Staab, II
		Thomas R. Staab, II
		Chief Financial Officer & Treasurer (principal financial and chief accounting officer)

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EXHIBIT INDEX

Exhibit No.	Description of Exhibit
3.1	Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2006).
3.2	Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 18, 2007).
10.1	Inspire Pharmaceuticals, Inc. Executive Change in Control Severance Benefit Plan, effective as of March 29, 2008.
10.2	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan, amended and restated as of March 29, 2008.
31.1	Certification of the President & 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 & Treasurer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the President & 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 & Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

EX-10.1

EXHIBIT 10.1

Inspire Pharmaceuticals, Inc.

Executive Change in Control

Severance Benefit Plan

Effective March 29, 2008

Preamble

Inspire Pharmaceuticals, Inc. (the “Company”) established the Inspire Pharmaceuticals, Inc. Executive Change in Control Severance Benefit Plan (this “Plan”) for the purpose of providing severance benefits to certain Executives whose employment terminates following a Change in Control of the Company as provided herein. This Plan constitutes a formal employee welfare benefit plan under the Executive Retirement Income Security Act of 1974, as amended (“ERISA”).

This Plan, as set forth herein, is intended to help retain qualified executives, maintain a stable work environment, and alleviate in part or in full financial hardships that may be experienced by certain of those Executives of the Company and its U.S. affiliated companies, whose employment is terminated for certain reasons. In essence, benefits under this Plan are intended to be supplemental unemployment benefits. This Plan is not intended to be included in the definitions of “employee pension benefit plan” and “pension plan” set forth under Section 3(2) of ERISA as a “severance pay arrangement” within the meaning of Section 3(2)(b)(i) of ERISA. Rather, this Plan is intended to meet the descriptive requirements of a plan constituting a “severance pay plan” within the meaning of regulations published by the Secretary of Labor at Title 29, Code of Federal Regulations, Section 2510.3-2(b).

This Plan shall continue until such time as it is amended or terminated in accordance with Article VI.

TABLE OF CONTENTS

		Page
ARTICLE I DEFINITIONS		1
ARTICLE II PARTICIPATION AND ELIGIBILITY FOR BENEFITS		4
Section 2.01	Eligibility.	4
Section 2.02	Termination of Eligibility for Benefits	5
Section 2.03	General Release	5
Section 2.04	Noncompete, Nonsolicit, and Confidentiality	5
ARTICLE III BENEFITS		5
Section 3.01	Amount of Severance Pay	5
Section 3.02	Health and Welfare Benefits	6
Section 3.03	Acceleration of Vesting	6
Section 3.04	Outplacement Services	6
Section 3.05	Legal Fees and Expenses	6
Section 3.06	Reduction for Other Payments; Offsets	6
Section 3.07	Excess Parachute Payments	7
ARTICLE IV METHOD OF SEVERANCE PAYMENTS		7
Section 4.01	Method of Payment	7
ARTICLE V THE ADMINISTRATIVE COMMITTEE		8
Section 5.01	Authority and Duties	8
Section 5.02	Payment	8
ARTICLE VI AMENDMENT AND TERMINATION		8
ARTICLE VII CLAIMS PROCEDURES		8
Section 7.01	Claim	8
Section 7.02	Appeals of Denied Claims for Benefits	9
ARTICLE VIII MISCELLANEOUS		9
Section 8.01	Nonalienation of Benefits	9
Section 8.02	No Contract of Employment	10
Section 8.03	Severability of Provisions	10
Section 8.04	Heirs, Assigns, and Personal Representatives	10
Section 8.05	Headings and Captions	10
Section 8.06	Number	10
Section 8.07	Unfunded Plan	10
Section 8.08	Payments to Incompetent Persons, Etc.	10
Section 8.09	Lost Payees	10
Section 8.10	Controlling Law	10

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ARTICLE I

DEFINITIONS

When used herein, the following terms shall have the meanings set forth below.

Section 1.01 “Administrative Committee” means the Compensation Committee of the Board of Directors of the Company or its designee.

Section 1.02 “Annual Base Rate of Pay” means the Executive’s highest annual base rate of pay for the calendar year.

Section 1.03 “Benefits” means the cash and in kind benefits that a Participant is eligible to receive pursuant to Article III of this Plan.

Section 1.04 “Board” means the Board of Directors of Inspire.

Section 1.05 “Cause” means (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 Plan, 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 Administrative Committee by clear and convincing evidence that Cause exists.

Section 1.06 “Change in Control” means the determination (which may be made effective as of a particular date specified by the Board) 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 Inspire 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 becomes the beneficial owner, directly or indirectly, of securities of Inspire representing more than thirty-five percent (35%) of the combined voting power of Inspire’s then outstanding securities; or

(b) The stockholders of Inspire approve:

(i) A plan of complete liquidation of Inspire;

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

(iii) A merger, consolidation or reorganization of Inspire with or involving any other entity, other than a merger, consolidation or reorganization that would result in the voting securities of Inspire 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 Inspire (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 entity or group (except for (i) passive ownership of less than five percent (5%) of the voting securities of the purchasing entity; or (ii) ownership of equity participation in the purchasing entity 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).

Section 1.07 “Company” means Inspire Pharmaceuticals, Inc. and its successors and its or their U.S. affiliated companies.

Section 1.08 “Disability” means a total and permanent disability as defined in the Company’s long-term disability plan.

Section 1.09 “Executive” means any officer of the Company who is subject to Section 16 of the Securities Exchange Act of 1934, as amended, immediately prior to a Change in Control of the Company.

Section 1.10 “ERISA” means the Employee Retirement Income Security Act of 1974, as amended.

Section 1.11 “Inspire” means Inspire Pharmaceuticals, Inc.

Section 1.12 “Participant” means any Executive eligible for Benefits in accordance with Article II.

Section 1.13 “Person” shall have the meaning given in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended, as modified and used in Sections 13(d) and 14(d) thereof, except that such term shall not include (i) Inspire or any of its subsidiaries; (ii) a trustee or other fiduciary holding securities under an employee benefit plan of Inspire 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 Inspire in substantially the same proportions as their ownership of stock of the Company; or (v) an entity or entities which

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are eligible to file and have filed a Schedule 13G under Rule 13d-l(b) of the Securities Exchange Act of 1934, as amended, which Schedule indicates beneficial ownership of fifteen percent (15%) or more of the outstanding shares of common stock of Inspire or the combined voting power of Inspire’s then outstanding securities.

Section 1.14 “Plan” means this Inspire Pharmaceuticals, Inc. Executive Change in Control Severance Benefit Plan, as set forth herein, and as the same may from time to time be amended.

Section 1.15 “Plan Year” means for the first Plan Year, the period commencing on March 29, 2008 and ending on December 31, 2008, and for each subsequent Plan Year, the period commencing on each January 1 during which this Plan is in effect and ending on the subsequent December 31.

Section 1.16 “Target Incentive Bonus” means the target incentive bonus applicable to the Executive under the Company’s primary annual performance incentive plan for any given performance measuring period that is equal to a year.

Section 1.17 “Termination Due to Change in Control” means a termination of an Executive’s employment by the Company (or the Executive’s Voluntary Resignation for Good Reason) within two (2) years following a Change in Control. “Termination Due to Change of Control” shall also include the termination of the Executive by the Company prior to a Change of Control at the direction of, or in concert with, a person or entity that becomes in a position to control at least fifty percent (50%) of the voting power of the Company immediately following the Change of Control.

Section 1.18 “Voluntary Resignation for Good Reason” means the occurrence of any one of the following events:

(a) the assignment to the Executive by the Company 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 or position from those in effect immediately prior to the Change in Control;

(b) 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;

(c) the relocation of the Executive’s principal place of employment to a location more than fifty (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 that is closer to the Executive’s principal residence) except for required travel on the Company’s business to an extent substantially consistent with the Executive’s business travel obligations as they existed immediately prior to the Change in Control;

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(d) 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;

(e) 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; or

(f) 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 the higher of the agreed upon vacation days set forth in the terms and conditions of the Executive’s employment with the Company or the Executive’s 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;

Notwithstanding anything herein to the contrary, (i) the Executive’s agreement that any circumstances will not result in a Voluntary Resignation for Good Reason shall not be effective unless it is made in a signed written document that specifically references Section 1.18 of this Plan; and (ii) an alteration of the Executive’s title without any other changes to the Executive’s responsibilities or position, shall not be sufficient to give rise to Voluntary Resignation for Good Reason.

ARTICLE II

PARTICIPATION AND ELIGIBILITY FOR BENEFITS

Section 2.01 Eligibility.

(a) Except as otherwise provided in this Plan, each Executive who experiences a Termination Due to Change in Control shall be eligible for Benefits under this Plan in accordance with the provisions set forth herein.

(b) Notwithstanding anything herein to the contrary, the Executive shall not be entitled to any Benefit under this Plan, if his or her termination of employment is caused by:

(i) A termination by the Company for Cause;

(ii) Death;

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(iii) Disability; or

(iv) The Executive’s voluntary termination that is not a Voluntary Termination for Good Reason.

Section 2.02 Termination of Eligibility for Benefits. A Participant shall cease to participate in this Plan, and all Benefits shall cease (other than those Benefits that have vested or been triggered hereunder) upon the occurrence of the earliest of:

(a) Termination of this Plan more than one (1) year prior to a Change in Control; and

(b) Completion of payment to the Participant of the Benefits for which the Participant is eligible.

Section 2.03 General Release. Notwithstanding anything in this Plan to the contrary, unless determined otherwise by the Administrative Committee in its sole discretion, no Benefits shall be due or paid under this Plan to any Executive, unless the Executive executes (and does not rescind) a written general release, in the form attached hereto as Exhibit A.

Section 2.04 Noncompete, Nonsolicit, and Confidentiality. Notwithstanding anything in this Plan to the Contrary, Executive shall forfeit any and all unpaid Benefits under this Plan if he or she breaches any noncompete, nonsolicit, confidentiality or similar agreement that he or she has entered into with the Company.

ARTICLE III

BENEFITS

Section 3.01 Amount of Severance Pay. The amount of severance pay payable to a Participant shall be equal to the applicable multiplier set forth in the chart below multiplied by the sum of:

(a) the Executive’s highest of the Annual Base Rate of Pay for the calendar year in which his or her Termination Due to Change in Control occurs or any of the two calendar years immediately preceding such year; plus

(b) the higher of the Executive’s Target Incentive Bonus applicable as of the date of (i) the Change in Control or (ii) his or her Termination Due to Change in Control.

Position (Level)	Multiplier
Chief Executive Officer	2.5
Executive Vice President and Chief Financial Officer	2.0
Senior Vice President	1.5

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Section 3.02 Health and Welfare Benefits. For the number of years immediately following the Executive’s termination date equal to the applicable multiplier set forth in Section 3.01 above, the Company shall arrange to provide the Participant (which includes the Participant’s eligible dependents for purposes of this Section) with life, disability, accident and health insurance benefits substantially similar to those which the Participant was receiving immediately prior to the Date of Termination (or, with respect to any benefit, immediately prior to the Change in Control, if such benefit was of greater value at that time); provided, however, that, unless the Participant expressly consents to a different method in writing by reference to this Section 3.02 of this Plan, such health insurance benefits shall be provided through a third-party insurer. Benefits otherwise receivable by the Participant pursuant to this Section 3.02 shall be eliminated prospectively in the event that, and at the time that, comparable benefits (including continued coverage for any preexisting medical condition of any person covered by the benefits provided to the Participant and his or her eligible dependents immediately prior to a notice of Termination Due to Change in Control) are actually received by or made available to the Participant by a subsequent employer without cost during such period (and any such benefits actually received by or made available to the Participant shall be reported to the Company by the Participant). The applicable benefit continuation period for the Participant and the Participant’s qualifying dependents under the Consolidated Omnibus Budget Reconciliation Act of 1984, as amended, shall commence at the expiration of the period of continued benefits referenced above in this Section 3.02. To the extent that the provision of any of the in kind benefits in this Section 3.02 would result in the imposition of excise tax under Section 409A of the Code, the Company shall pay the Executive the fair market value of such benefit in cash in accordance with Section 4.01(a) of this Plan.

Section 3.03 Acceleration of Vesting. Notwithstanding anything in this Plan or in any Company-sponsored equity compensation plan to the contrary, all outstanding unvested options and awards under any Company-sponsored equity compensation grant held by any Executive shall become immediately vested and fully exercisable immediately prior to a Change in Control. Notwithstanding anything in any such equity compensation plan to the contrary, in the event of a Change in Control, all outstanding options under any such plan shall remain exercisable for the lesser of three (3) years or the period of time remaining in the term of the option.

Section 3.04 Outplacement Services. The Company shall provide each Participant with outplacement services for a period of twelve (12) months following a Termination Due to Change in Control.

Section 3.05 Legal Fees and Expenses. The Company also shall reimburse all reasonable legal fees and expenses incurred by the Participant in disputing any issue hereunder in a good faith attempt to obtain or enforce any benefit or right provided by this Plan.

Section 3.06 Reduction for Other Payments; Offsets. The Benefits payable hereunder to any Participant shall be reduced by any and all payments required to be made by the Company or its affiliates under federal, state, and local law, under any employment agreement or special severance arrangement or under any other separation policy, plan, or program. The Benefits payable hereunder to any Participant shall also be reduced by (i) any benefits previously paid to such Participant under this or any other separation or severance plan sponsored by the Company with respect to any periods of service with respect to which Benefits are being paid under this Plan; and (ii) any and all amounts that the Participant owes to the Company or an affiliate.

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Section 3.07 Excess Parachute Payments. Anything in this Plan 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 Plan or otherwise) (each, 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:

(a) If the total of such Payments to the Executive, exceeds 2.99 times the Executive’s “base amount” as defined in Section 280G of the Code by more than ten (10) percent, then the Executive shall be entitled to receive an additional payment (a “Gross-Up Payment”) in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and 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; or

(b) If the total of such Payments to the Executive, exceeds 2.99 times the Executive’s “base amount” as defined in Section 280G of the Code by ten (10) percent or less, then the cash severance payments payable under this Plan shall be reduced to the maximum amount that would be payable without subjecting the Executive to the excise tax imposed by Section 4999 of the Code.

ARTICLE IV

METHOD OF SEVERANCE PAYMENTS

Section 4.01 Method of Payment. The severance benefits to which a Participant is entitled under Sections 3.01, 3.02, 3.03, 3.04 and 3.07, shall be paid or delivered in accordance with the provisions of this Article IV.

(a) To the extent that cash payments to be made to an Executive exceed the lesser of two (2) times the compensation limit established by Section 401(a)(17) of the Internal Revenue Code, as amended or two (2) times the Executive’s compensation (as defined for purposes of the involuntary separation exception to Section 409A of the Code), such cash payments shall be made in a single sum cash payment but shall be delayed for a period of six months following the Executive’s termination of employment. During such six-month delay such payments shall earn interest at the applicable prime rate of interest in effect at the beginning of the delay as published in the Wall Street Journal. Cash payments that do not exceed the limits described above in this paragraph shall be made in a single lump sum within ten (10) business days immediately following the expiration of the applicable revocation period described in paragraph (c) of this Section below.

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(b) Payment shall be made in person, by certified mail to the last address provided by the Participant to the Company or, at the request of the Participant, by deposit to a bank account identified by the Participant. Separate payment(s) shall be made to pay any earned and unused vacation pay for the year during which the Employment Termination Date occurs.

(c) Notwithstanding anything herein to the contrary, no Benefits under this Plan shall be made prior to the execution of the release required under Section 2.03, and the expiration of the required release revocation period, but in no event later than ten (10) business days immediately following the expiration of the applicable revocation period.

ARTICLE V

THE ADMINISTRATIVE COMMITTEE

Section 5.01 Authority and Duties. Prior to the occurrence of a Change in Control, the Administrative Committee shall have the full power, authority, and discretion to construe, interpret, and administer this Plan, to correct deficiencies therein, and to supply omissions; provided that in doing so it acts in the best interests of Participants and in a manner consistent with the terms of this Plan. Notwithstanding anything herein to the contrary, after a Change in Control occurs, neither the Administrative Committee nor any other entity shall have discretion in administering, construing, or interpreting this Plan.

Section 5.02 Payment. The Company shall make payments of Benefits, in such amount as provided under Article III, from its general assets to Participants in accordance with the terms of this Plan.

ARTICLE VI

AMENDMENT AND TERMINATION

Prior to the occurrence of a Change in Control, this Plan may be amended, suspended, discontinued, or terminated at any time by the Board or its designee, in whole or in part, for any reason, and without either the consent of or the prior notification to any Participant. Notwithstanding the foregoing, no such amendment shall become effective to the extent that it adversely affects a Participant if a Change in Control occurs within one (1) year after the later of the effective date of such amendment or the date such amendment is adopted. Upon the occurrence of a Change in Control and for a period of twenty-four (24) months thereafter, the Plan, as it applies to any Participant, may only be amended by the Board or its designee with the express written consent of such affected Participant. In no event shall any amendment or termination of this Plan that is adopted or becomes effective after a Participant experiences a Termination Due to Change in Control adversely affect the benefits and rights to which such Participant is or may become entitled hereunder.

ARTICLE VII

CLAIMS PROCEDURES

Section 7.01 Claim. Each eligible terminated Executive may contest the administration of Benefits by completing and filing with the Administrative Committee a written request for review in the manner specified by the Administrative Committee. Each such application must be filed within sixty (60) days following the Executive’s termination of employment and must be supported by such information as the Administrative Committee deems relevant and appropriate.

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Section 7.02 Appeals of Denied Claims for Benefits. In the event that any claim for benefits is denied in whole or in part, the claimant whose claim has been so denied shall be notified of such denial by the Administrative Committee within ninety (90) days of receipt of the claim (unless the Administrative Committee determines that special circumstances require an extension of time of up to an additional ninety (90) days for processing the claim). The notice advising of the denial shall specify the reason(s) for denial, make specific reference to relevant Plan provisions, describe any additional material or information necessary for the claimant to perfect the claim (explaining why such material or information is needed), and shall advise the claimant of the procedure for the appeal of such denial and a statement of the claimant’s right to bring a civil action under Section 502(a) of ERISA following an adverse benefit determination on appeal. All appeals shall be made by the following procedure:

(a) A claimant whose claim has been denied shall file with the Administrative Committee a notice of desire to appeal the denial. Such notice shall be filed within sixty (60) days of notification by the Administrative Committee of the initial claim denial, be made in writing, and set forth all of the facts upon which the appeal is based. Appeals not timely filed shall be barred.

(b) The Administrative Committee shall consider the merits of the claimant’s written presentations, the merits of any facts or evidence in support of the denial of benefits, and such other facts and circumstances as the Administrative Committee shall deem relevant.

(c) The Administrative Committee shall render a determination upon the appealed claim within sixty (60) days of its receipt of such appeal (unless the Administrative Committee determines that special circumstances require an extension of time of up to an additional sixty (60) days for processing the appeal). The determination shall specify the reason(s) for the denial, make specific reference to relevant Plan provisions, and contain a statement of the claimant’s right to bring a civil action under Section 502(a) of ERISA.

(d) The determination so rendered shall be binding upon all parties.

No Executive may bring a civil action under Section 502(a) of ERISA until the Executive has exhausted his or her rights under this Section 7.02.

ARTICLE VIII

MISCELLANEOUS

Section 8.01 Nonalienation of Benefits. None of the payments, benefits, or rights of any Participant shall be subject to any claim of any creditor, and, in particular, to the fullest extent permitted by law, all such payments, benefits and rights shall be free from attachment, garnishment, trustee’s process, or any other legal or equitable process available to any creditor of such Participant. No Participant shall have the right to alienate, anticipate, commute, plead, encumber, or assign any of the benefits or payments which he/she may expect to receive, contingently or otherwise, under this Plan.

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Section 8.02 No Contract of Employment. Neither the establishment of this Plan, nor any modification thereof, nor the creation of any fund, trust or account, nor the payment of any benefits shall be construed as giving any Participant or Executive, or any person whosoever, the right to be retained in the service of the Company, and all Participants and other Executives shall remain subject to discharge to the same extent as if this Plan had never been adopted.

Section 8.03 Severability of Provisions. If any provision of this Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof, and this Plan shall be construed and enforced as if such provisions had not been included.

Section 8.04 Heirs, Assigns, and Personal Representatives. This Plan shall bind any successor of the Company, its assets or its businesses in the same manner and to the same extent that the Company would be obligated under this Plan as if no succession had taken place. The term “Company” as used in this Plan, shall mean and refer to the Company as heretofore defined and any successor or assignee to the business or assets which by reason of a Change in Control becomes bound by this Plan

Section 8.05 Headings and Captions. The headings and captions herein are provided for reference and convenience only, shall not be considered part of this Plan, and shall not be employed in the construction of this Plan.

Section 8.06 Number. Except where otherwise clearly indicated by context, the singular shall include the plural, and vice-versa.

Section 8.07 Unfunded Plan. This Plan shall not be funded. No Participant shall have any right to, or interest in, any assets of the Company that may be applied by the Company to the payment of Benefits.

Section 8.08 Payments to Incompetent Persons, Etc. Any benefit payable to or for the benefit of a minor, an incompetent person or other person incapable of receipting therefor shall be deemed paid when paid to such person’s guardian or to the party providing or reasonably appearing to provide for the care of such person, and such payment shall fully discharge the Company, the Administrative Committee and all other parties with respect thereto.

Section 8.09 Lost Payees. Benefits shall be deemed forfeited if the Administrative Committee is unable to locate a Participant to whom Benefits are due. Such Benefits shall be reinstated if application is made by the Participant for the forfeited Benefits within one (1) year of the Participant’s employment termination date and while this Plan is in operation.

Section 8.10 Controlling Law. This Plan shall be construed and enforced according to the laws of the State of North Carolina to the extent not superseded by federal law.

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Inspire Pharmaceuticals, Inc.

Executive Change in Control Severance Benefit Plan

Exhibit A

(General Release)

This General Release (“General Release”) is entered into by and between Inspire Pharmaceuticals, Inc. (the “Company”) and [FULL NAME of EXECUTIVE] (the “Executive”).

WHEREAS, the Company has provided written notification to the Executive that his/her employment with the Company has or will be terminated effective [Termination Date];

WHEREAS, as a result of the termination of the Executive’s employment and subject to the Executive’s execution of this General Release, the Executive is entitled to a severance payment under the Inspire Pharmaceuticals, Inc. Executive Change in Control Severance Benefit Plan (the “Severance Plan”);

WHEREAS, the Executive desires to execute this General Release and, thereby, become eligible for receipt of severance benefits and, through this General Release, the Company and the Executive also wish to resolve, finally and completely and with prejudice, any and all matters between them relating to the Executive’s employment with the Company and the termination of that employment;

NOW, THEREFORE, in consideration of the above recitals and the mutual promises and covenants set forth below, the Company and the Executive, intending to be legally bound hereby, agree as follows:

1. In exchange for the Executive’s execution of this General Release, the Executive is eligible to receive benefits under the Severance Plan.

2. The Executive expressly agrees that, except as specifically provided in Section 1 above and as contemplated under the Severance Plan, he/she shall receive no other payment or benefit from the Company, and the Company shall not ever be required to make any further payment or provide any further benefit, for any reason whatsoever, to him/her or to any person or entity regarding any claim or right whatsoever which might possibly be asserted by him/her or on the Executive’s behalf. The Executive acknowledges that he/she would not be entitled to the severance payment described herein merely upon the termination of the Executive’s employment with the Company without the benefit of this General Release and he/she acknowledges that the severance payment is sufficient consideration for the Executive’s execution of this General Release.

3. The Executive, on behalf of himself/herself, his/her heirs, executors, administrators, successors, and assigns, hereby expressly and unconditionally releases, revises, settles, compromises, and forever discharges the Company, its affiliates, partners, employees,

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representatives, employee benefit plans, funds, programs, or arrangements providing pension, welfare, and fringe benefits, trustees, plan administrators, attorneys, agents, and successors, and/or assigns, jointly and individually, of and from any and all possible suits, claims, rights, demands, costs, actions, causes of action, obligations, damages, and liabilities (“claims”) whether known or unknown and of whatever kind or nature, which arose on or before the effective date of this General Release, arising out of or in any way related to, or as a consequence of, the Executive’s employment with the Company, the terms and conditions of that employment, and the termination of his/her employment with the Company, as well as the continuing effects thereof. This release includes, but is not limited to, (i) all claims under any possible legal, equitable, tort, contract, common law, or statutory theory, including, but not limited to, any claim for constructive or wrongful discharge or for breach of contract, and any claim for defamation; (ii) all claims under any possible statutory theory, including, but not limited to, any and all claims under Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1990, 42 U.S.C. §§ 1981, 1983, 1985 and 1988, the Age Discrimination in Employment Act of 1967, the Older Workers Benefit Protection Act, the Americans with Disabilities Act, any state human rights or human relations act and any amendments to any of these statutes, as well as any other federal, state, or local law, statute, ordinance, regulation, or executive order, prohibiting employment discrimination based on religion, sex, ethnicity, race, color, national origin, handicap, disability, age, retaliation, or any other characteristic proscribed by law; (iii) all claims under the Fair Labor Standards Act, the Equal Pay Act of 1963, the Executive Retirement Income Security Act of 1974, any wage payment and collection law, and the federal and any state or local Family and Medical Leave Act; and (iv) all claims for the fees, costs, and expenses of any and all attorneys who have at any time or are now representing the Executive in connection with this General Release or in connection with any matter released by him/her. The Executive also covenants that, to his/her knowledge, he/she has not sustained any work-related injury during his/her employment at the Company.

4. The Executive also represents that he/she has not previously filed or joined in any complaint, charge, or lawsuit against the Company or any of its partners or employees in any court of law or with any governmental agency on any of the claims mentioned above. Notwithstanding any other language in this General Release, the Executive understands that this General Release does not prohibit him/her from filing an administrative charge of alleged employment discrimination with the Equal Employment Opportunity Commission or any similar agency. The Executive, however, waives the Executive’s right to any monetary or other recovery against the Company or any of the released persons or entities should any federal, state, or local administrative agency pursue any claim on the Executive’s behalf arising out of or relating to the Executive’s employment with the Company or the termination of the Executive’s employment with the Company.

5. Nothing in this General Release affects the Executive’s right to elect, at the Executive’s sole expense, continued coverage under the Company’s Welfare Benefit Plan pursuant to the continuation coverage provisions of the Consolidated Omnibus Budget Reconciliation Act.

6. The Executive agrees that the Company’s entry into this General Release is not to be construed as, and is not, an admission that the Company violated any of its duties or obligations to the Executive or treated the Executive improperly, unlawfully, or unfairly in any

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manner whatsoever. Neither this General Release nor the implementation thereof shall be construed to be, or shall be admissible in any proceedings as, evidence of an admission by the Company of any violation of or failure to comply with any federal, state, or local law, common law, agreement, rule, regulation, or order; the preceding portion of this sentence does not preclude introduction of this General Release by the Company to establish that any and all claims which the Executive might possibly have were settled, compromised, and released according to the terms of this General Release.

7. Except as required by law, the Executive agrees to keep confidential and not discuss, disclose, or reveal, directly or indirectly, the terms of this General Release to any person, corporation, or entity with the exception of the members of the Executive’s immediate family, the Executive’s attorney, or the Executive’s accountant who (prior to disclosure to them) shall likewise agree to maintain the confidentiality of this General Release.

8. The Executive understands and agrees that the terms and conditions of this General Release constitute the full and complete understandings, agreements, and promises between him/her and the Company with respect to all matters covered by this General Release, that there are no other agreements, covenants, promises, or arrangements between him/her and the Company other than those set forth herein, that the terms and conditions of this General Release cancel and supersede any prior agreements or understandings that may have been between him/her and the Company with respect to all matters covered by this General Release, that no other promise or inducement has been offered to him/her except as set forth herein, and that this General Release is binding upon him/her, the Executive’s heirs, executors, administrators, and assigns. Notwithstanding any language herein to the contrary, this General Release does not cancel or suspend the Employee Confidentiality, Invention Assignment and Non-Compete Agreement (or any other agreement(s) serving similar functions) entered into by and between the Company and the Executive.

9. If any term, condition, clause, or provision of this General Release shall be determined by a court of competent jurisdiction to be void or invalid at law, or for any other reason, then only that term, condition, clause, or provision as is determined to be void or invalid shall be stricken from this General Release, and this General Release shall remain in full force and effect in all other respects. The Executive expressly agrees that this General Release shall not be construed against the Company and that it shall be governed by North Carolina law.

10. The Executive hereby expressly warrants that he/she was advised in writing of the Executive’s right to consult with an attorney prior to executing this General Release. The Executive further expressly warrants that he/she has, in fact, had the opportunity to consult with, and to be advised by, an attorney before executing this General Release to help him/her fully understand and appreciate its legal effect. The Executive acknowledges that he/she has been afforded the opportunity to consider this General Release for a period of twenty-one (21) days, which is a reasonable period of time. If the Executive signs this General Release in less than twenty-one (21) days, he/she acknowledges that he/she has thereby waived the Executive’s right to the full twenty-one (21) day period. The Executive shall have a period of seven (7) days following the Executive’s execution of this General Release to revoke it, and this General Release shall not be effective or enforceable prior to the expiration of that period. Revocation can be made by delivering a written notice to the office of the Director of Human Resources of

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the Company. The revocation of this General Release by the Executive will automatically revoke the Company’s obligation to pay the severance benefit to the Executive. If the Executive does not advise the Company in writing that he/she revokes this General Release within seven (7) days of the Executive’s execution of it, this General Release shall be forever enforceable. The eighth (8^th) day following the Executive’s execution of this General Release shall be deemed the Effective Date of this General Release.

11. This General Release may be signed in two (2) counterparts, each of which shall be deemed an original when signed and shall constitute the same instrument. The Company shall retain Counterpart No. 1 of this General Release and the Executive shall retain Counterpart No. 2 of this General Release.

THE EXECUTIVE ACKNOWLEDGES THAT HE/SHE HAS CAREFULLY READ THE FOREGOING GENERAL RELEASE, THAT HE/SHE UNDERSTANDS COMPLETELY ITS CONTENTS, THAT HE/SHE UNDERSTANDS THE SIGNIFICANCE AND CONSEQUENCE OF SIGNING IT, AND THAT HE/SHE INTENDS TO BE LEGALLY BOUND BY ITS TERMS. THE EXECUTIVE FURTHER ACKNOWLEDGES THAT HE/SHE HAS HAD A REASONABLE AND SUFFICIENT PERIOD OF TIME WITHIN WHICH TO CONSIDER THIS GENERAL RELEASE AND THAT HE/SHE HAS HAD THE OPPORTUNITY TO REVIEW THIS GENERAL RELEASE WITH COUNSEL. THE EXECUTIVE SWEARS THAT HE/SHE HAS AGREED TO AND SIGNED THIS GENERAL RELEASE VOLUNTARILY AND AS HIS/HER OWN FREE WILL, ACT, AND DEED, AND FOR FULL AND SUFFICIENT CONSIDERATION.

IN WITNESS WHEREOF, INSPIRE PHARMACEUTICALS, INC. and [FULL NAME OF EXECUTIVE] have caused this General Release to be executed this day      of             .

[FULL NAME OF EXECUTIVE]

INSPIRE PHARMACEUTICALS, INC.

By:

Title:

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EX-10.2

EXHIBIT 10.2

Inspire Pharmaceuticals, Inc.

Change in Control

Severance Benefit Plan

Effective January 28, 2005

(amended and restated as of March 29, 2008)

Preamble

Inspire Pharmaceuticals, Inc. (the “Company”) established the Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (this “Plan”) for the purpose of providing severance benefits to certain Employees whose employment terminates following a Change in Control of the Company as provided herein. This Plan constitutes a formal employee welfare benefit plan under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

This Plan, as set forth herein, is intended to help retain qualified employees, maintain a stable work environment, and alleviate in part or in full financial hardships that may be experienced by certain of those Employees of the Company and its U.S. affiliated companies, whose employment is terminated for certain reasons. In essence, benefits under this Plan are intended to be supplemental unemployment benefits. This Plan is not intended to be included in the definitions of “employee pension benefit plan” and “pension plan” set forth under Section 3(2) of ERISA as a “severance pay arrangement” within the meaning of Section 3(2)(b)(i) of ERISA. Rather, this Plan is intended to meet the descriptive requirements of a plan constituting a “severance pay plan” within the meaning of regulations published by the Secretary of Labor at Title 29, Code of Federal Regulations, Section 2510.3-2(b). Accordingly, the benefits paid by this Plan are not deferred compensation and no employee shall have a vested right to such benefits.

This Plan shall continue until such time as it is amended or terminated in accordance with Article VI.

Table of Contents

	Page
ARTICLE I DEFINITIONS	1
ARTICLE II PARTICIPATION AND ELIGIBILITY FOR BENEFITS	4
ARTICLE III BENEFITS	5
ARTICLE IV METHOD OF SEVERANCE PAYMENTS	7
ARTICLE V THE ADMINISTRATIVE COMMITTEE	8
ARTICLE VI AMENDMENT AND TERMINATION	8
ARTICLE VII CLAIMS PROCEDURES	8
ARTICLE VIII MISCELLANEOUS	9

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ARTICLE I

DEFINITIONS

When used herein, the following terms shall have the meanings set forth below.

Section 1.01 “Administrative Committee” means the Compensation Committee of the Board of Directors of the Company or its designee.

Section 1.02 “Annual Base Rate of Pay” means fifty-two (52) times the Employee’s highest Weekly Base Rate of Pay during the fifty-two (52) week period prior to his or her termination or, if greater, the Employee’s Weekly Base Rate of Pay in effect immediately prior to the last Change in Control preceding his or her termination.

Section 1.03 “Benefits” means the benefits that a Participant is eligible to receive pursuant to Article III of this Plan.

Section 1.04 “Change in Control” means 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 vote of the Board of Directors of the Company or whether or not the Board of Directors 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 date of this 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 entity, other than a merger, consolidation or reorganization

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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 Employee, if the Employee is part of a purchasing group which consummates the Change in Control transaction. The Employee shall be deemed “part of the purchasing group” for purposes of the preceding sentence if the Employee is an equity participant or has agreed to become an equity participant in the purchasing entity 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).

Section 1.05 “Company” means Inspire Pharmaceuticals, Inc. and its successors and its or their U.S. affiliated companies.

Section 1.06 “Comparable Position” means employment with the Company or a successor employer in which the individual’s level of responsibilities would not constitute a Demotion. For this purpose, a position shall not be a Comparable Position if such position would require the Employee’s principal business location to be relocated more than fifty (50) miles from the Employee’s principal business location immediately prior to the Change in Control.

Section 1.07 “Demotion” means continued employment in a position that results in a reduction in the Employee’s base salary or Incentive Bonus, or a position that is one (1) or more levels lower on a Company-recognized career ladder, whether or not such employment is with the Company or a successor employer.

Section 1.08 “Decline to Relocate” means a termination of a Participant’s employment as a result of his or her rejection of an offer of continued employment in the same position or a Comparable Position that would require relocation of the Participant’s principal business location of more than fifty (50) miles.

Section 1.09 “Employee” means any regular full-time or regular part-time employee of the Company who is employed in the United States and as to whom the terms and conditions of employment are not covered by a collective bargaining agreement unless the collective bargaining agreement specifically provides for coverage under this Plan. For this purpose, a regular part-time employee shall be an employee who is regularly scheduled to work between twenty (20) to thirty (30) hours per week. The term “Employee” shall not include (i) temporary employees (including college coops, summer employees, high school coops, flexible workforce employees and any other such temporary classifications), (ii) any individual characterized by the Company as an

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“independent contractor” or as a “contract worker,” (iii) officers and other employees of the Company who are parties to employment agreements or transition agreements, (iv) officers or other employees of the Company who participate in any severance plan or agreement of the Company (other than this Plan) that provides for the payment of severance benefits in connection with a Change in Control of the Company and such individual qualifies for the payment of such benefits, or (v) any other individual who is not treated by the Company as an employee for purposes of withholding federal income taxes, regardless of any contrary Internal Revenue Service, governmental, or judicial determination relating to such employment status or tax withholding. In the event that an individual engaged in an independent contractor or similar non-employee capacity is subsequently reclassified by the Company, the Internal Revenue Service, or a court as an employee, such individual, for purposes of this Plan, shall be deemed an Employee from the actual (and not effective) date of such classification, unless expressly provided otherwise by the Company.

Section 1.10 “Employment Service Date” means the first day on which an individual became an Employee.

Section 1.11 “Employment Termination Date” means the date on which the employment of the Employee by the Company is terminated.

Section 1.12 “ERISA” means the Employee Retirement Income Security Act of 1974, as amended.

Section 1.13 “Incentive Bonus” means the greater of the maximum of the bonus opportunity range applicable to the Employee for the Plan Year immediately preceding his or her termination or the maximum of the bonus opportunity range applicable to the Employee for the Plan Year immediately preceding the Change in Control.

Section 1.14 “Misconduct” means (i) willful and continued failure by the Employee to substantially perform the Employee’s duties with the Company (other than any such failure resulting from the Employee’s incapacity due to physical or mental illness) or (ii) the willful engaging by the employee in conduct which is demonstrably injurious to the Company, monetarily or otherwise. For purposes of this definition, no act, or failure to act, on the Employee’s part shall be deemed “willful” unless done, or omitted to be done, by the Employee not in good faith or without reasonable belief that the Employee’s act, or failure to act, was in the best interest of the Company.

Section 1.15 “Participant” means any Terminated Employee eligible for Benefits in accordance with Article II.

Section 1.16 “Person” shall have the meaning given in Section 3(a)(9) of the Securities Exchange Act of 1934, as amended, 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

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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 Securities Exchange Act of 1934, as amended, which Schedule indicates beneficial ownership of fifteen percent (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.

Section 1.17 “Plan” means this Change in Control Severance Benefit Plan, as set forth herein, and as the same may from time to time be amended.

Section 1.18 “Plan Year” means the period commencing on each January 1 during which this Plan is in effect and ending on the subsequent December 31.

Section 1.19 “Terminated Employee” means an Employee who has experienced an Employment Termination Date.

Section 1.20 “Termination Due to Change in Control” means a termination of a Participant’s employment by the Company within two (2) years following a Change in Control that is involuntary or that is as a result of his or her written rejection of an offer of continued employment with the Company or an affiliate if such employment is not a Comparable Position.

Section 1.21 “Voluntary Resignation” means a resignation that is a voluntary separation from employment initiated by the Employee.

Section 1.22 “Weekly Base Rate of Pay” means:

(a) for a regular full-time Employee paid on a monthly basis, the Employee’s rate of pay for one (1) payroll period multiplied by twelve-fifty-seconds (12/52);

(b) for a regular full-time Employee paid on a weekly payroll period basis, the Employee’s rate of pay for one (1) payroll period;

(c) for a regular full-time Employee paid on a bi-monthly payroll period basis, the Employee’s rate of pay for one (1) payroll period multiplied by twenty –four-fifty-seconds (24/52); or

(d) for a regular part-time Employee paid on any hourly basis, the Employee’s highest base hourly rate during the last twelve (12) months multiplied by the average number of weekly hours worked during that twelve (12)-month period.

Section 1.23 “Years of Service” means the total number of Participant’s full years of active service with the Company subject to the following rules:

(a) For purposes of determining a Participant’s number of Years of Service, a full year of active service is any consecutive twelve (12)-month period of service occurring after the Participant’s most recent break in service lasting one (1) year or more. For example, a Participant whose Employment Service Date is June 21, 2003 will be credited with one (1) Year of Service at the end of the business day June 20, 2004 provided that he or she has been continuously employed by the Company through that date.

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(b) For purposes of determining a Participant’s number of Years of Service, such Participant shall be treated as if his Employment Termination Date was December 31 of the calendar year in which his or her actual Employment Termination Date occurs.

(c) Any break in a Participant’s active service for a period of less than one (1) year shall be disregarded for purposes of calculating a Participant’s number of Years of Service. For example, a Participant who was hired on June 1, 2000, was terminated on February 3, 2002, rehired on December 18, 2002, and terminated again on March 3, 2003 shall have three (3) Years of Service under the Plan.

ARTICLE II

PARTICIPATION AND ELIGIBILITY FOR BENEFITS

Section 2.01 Eligibility.

(a) Subject to Sections 2.01(b), 2.02, and 2.03, any Terminated Employee (other than an employee who is employed in Puerto Rico) who has experienced a Termination Due to Change in Control shall become a Participant and shall be eligible for Benefits in accordance with the provisions of this Plan.

(b) Notwithstanding anything herein to the contrary, a Terminated Employee shall not be considered to have incurred a Termination Due to Change in Control for the purposes of this Plan, if his or her employment is discontinued due to (i) a Voluntary Resignation; (ii) a rejection of an offer of a Comparable Position that is not a Decline to Relocate; or (iii) discharge for Misconduct.

(c) Notwithstanding anything herein to the contrary, if, at the time of his or her termination of employment, an Employee or former Employee is receiving or entitled to benefits pursuant to an agreement with the Company, another Company-sponsored severance or separation benefit plan or program, or a Company-sponsored long-term disability plan, then such Employee or former employee shall not be eligible for Benefits under this Plan.

Section 2.02 Termination of Eligibility for Benefits. A Participant shall cease to participate in this Plan, and all Benefits shall cease (other than those Benefits that have vested or been triggered hereunder) upon the occurrence of the earliest of:

(a) Termination of this Plan prior to, or more than (2) two years following, a Change in Control;

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(b) Completion of payment to the Participant of the Benefits for which the Participant is eligible; and

(c) The occurrence of the Employee’s Misconduct on or before Employee’s Employment Termination Date.

Section 2.03 General Release. Notwithstanding anything in this Plan to the contrary, unless determined otherwise by the Administrative Committee in its sole discretion, no Benefits shall be due or paid under this Plan to any Employee, unless the Employee executes (and does not rescind) a written general release, in the form attached hereto as Exhibit B.

ARTICLE III

BENEFITS

Section 3.01 Amount of Severance Pay. The amount of severance pay payable to a Participant shall be equal to the number of weeks of severance pay that corresponds to the Participant’s Annual Base Rate of Pay on the table included on Exhibit A to this Plan multiplied by the sum of (i) the Participant’s Weekly Base Rate of Pay; and (ii) one-fifty-second (1/52) of the Participant’s Incentive Bonus, if any.

Section 3.02 Health and Welfare Benefits. For a period of time immediately following the Date of Termination equal to the applicable number of weeks of severance pay to which the Participant is entitled under Section 3.01 of this Plan, the Company shall arrange to provide the Participant (which includes the Participant’s eligible dependents for purposes of this Section) with life, disability, accident and health insurance benefits substantially similar to those which the Participant was receiving immediately prior to the Date of Termination (or, with respect to any benefit, immediately prior to the Change in Control, if such benefit was of greater value at that time); provided, however, that, unless the Participant expressly consents to a different method in writing by reference to this Section 3.02 of this Plan, such health insurance benefits shall be provided through a third-party insurer. Benefits otherwise receivable by the Participant pursuant to this Section 3.02 shall be eliminated prospectively in the event that, and at the time that, comparable benefits (including continued coverage for any preexisting medical condition of any person covered by the benefits provided to the Participant and his or her eligible dependents immediately prior to a notice of Termination Due to Change in Control) are actually received by or made available to the Participant by a subsequent employer without cost during the number of weeks of severance pay corresponding to the Participant’s Annual Base Rate of Pay set forth on the table included on Exhibit A hereto following the Participant’s Employment Termination Date (and any such benefits actually received by or made available to the Participant shall be reported to the Company by the Participant). The applicable benefit continuation period for the Participant and the Participant’s qualifying dependents under the Consolidated Omnibus Budget Reconciliation Act of 1984, as amended, shall commence at the expiration of the period of continued benefits referenced above in this Section 3.02.

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Section 3.03 Reduction for Other Payments; Offsets. The Benefits payable hereunder to any Participant shall be reduced by any and all payments required to be made by the Company or its affiliates under federal, state, and local law, under any employment agreement or special severance arrangement or under any other separation policy, plan, or program. The Benefits payable hereunder to any Participant shall also be reduced by (i) any benefits previously paid to such Participant under this or any other separation or severance plan sponsored by the Company with respect to any periods of service with respect to which Benefits are being paid under this Plan; and (ii) any and all amounts that the Participant owes to the Company or an affiliate.

Section 3.04 Acceleration of Vesting. Notwithstanding anything in this Plan or in any Company-sponsored equity compensation plan to the contrary, all outstanding unvested options and awards under any Company-sponsored equity compensation plan held by any Employee shall become immediately vested and fully exercisable immediately prior to a Change in Control. Notwithstanding anything in any such equity compensation plan to the contrary, in the event of a Change in Control, all outstanding options under any such plan shall remain exercisable for the lesser of three (3) years or the period of time remaining in the term of the option.

Section 3.05 Outplacement Services. Following a Change in Control, the Company shall provide each Participant who so requests outplacement services suitable to the Participant’s position for a period equal in length to the number of weeks of severance pay set forth opposite his or her Annual Base Rate of Pay as determined under the table included on Exhibit A hereof commencing on the date the Participant first uses such outplacement services; provided, however, such first use must occur prior to the expiration of the number of weeks after the Participant’s Termination Date equal to the number of weeks of severance pay to which the Participant is entitled under Section 3.01 of this Plan as set forth on Exhibit A. Notwithstanding the foregoing, in no event shall the outplacement services provided pursuant to this Section 3.05 exceed a period of one (1) year.

Section 3.06 Legal Fees and Expenses. The Company also shall reimburse legal fees and expenses incurred by the Participant in disputing any issue hereunder in an attempt to obtain or enforce any benefit or right provided by this Plan, provided that a court of competent jurisdiction determines that the Company did not act in good faith in denying such benefit or right. Such payments shall be made within five (5) business days after delivery of the judgment or decree by such court, without regard to any right of the Company to appeal any such judgment or decree.

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ARTICLE IV

METHOD OF SEVERANCE PAYMENTS

Section 4.01 Method of Payment. The severance pay to which a Participant is eligible, as calculated pursuant to Article III, shall be paid in accordance with the provisions of this Article IV.

(a) Severance payments payable under this Plan shall be made in a single sum cash payment.

(b) Payment shall be made in person, by certified mail to the last address provided by the Participant to the Company or, at the request of the Participant, by deposit to a bank account identified by the Participant. Separate payment(s) shall be made to pay any earned and unused vacation pay for the year during which the Employment Termination Date occurs. In no event shall interest be credited on any amounts for which a Participant may become eligible.

(c) Subject to Section 4.01(d) to the extent applicable, payments shall be made as promptly as practicable after the participant’s Employment Termination Date, the execution of the release required under Section 2.03, and the expiration of the required release revocation period, but in no event later than ten (10) business days immediately following the expiration of the applicable revocation period.

(d) In the event that any severance payments become payable to a specified employee (as defined in Section 409A of the Code), to the extent that such payments exceed the lesser of two times the Section 401(a)(17) limit on compensation and two times the Participant’s compensation (as defined for the involuntary separation exception to section 409A of the Code), then such payments shall be made six (6) months and one (1) day after such specified employee’s termination date.

ARTICLE V

THE ADMINISTRATIVE COMMITTEE

Section 5.01 Authority and Duties. The Administrative Committee shall have the full power, authority, and discretion to construe, interpret, and administer this Plan, to correct deficiencies therein, and to supply omissions; provided that in doing so it acts in the best interests of Plan Participants and in a manner consistent with the terms of this Plan.

Section 5.02 Payment. The Company shall make payments of Benefits, in such amount as determined by the Administrative Committee under Article III, from its general assets to Participants in accordance with the terms of this Plan, as directed by the Administrative Committee.

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ARTICLE VI

AMENDMENT AND TERMINATION

This Plan may be amended, suspended, discontinued, or terminated at any time by the Board of Directors of the Company or its designee, in whole or in part, for any reason, and without either the consent of or the prior notification to any Participant. Notwithstanding the foregoing, no such amendment may reduce the benefits to which any Participant may become entitled in the two (2) years following any Change in Control. Following any Participant’s severance, no Plan termination or amendment shall adversely affect the rights of such Participant without the Participant’s express written consent.

ARTICLE VII

CLAIMS PROCEDURES

Section 7.01 Claim. Each eligible terminated Employee may contest the administration of Benefits by completing and filing with the Administrative Committee a written request for review in the manner specified by the Administrative Committee. Each such application must be filed within sixty (60) days following the Employee’s termination of employment and must be supported by such information as the Administrative Committee deems relevant and appropriate.

Section 7.02 Appeals of Denied Claims for Benefits. In the event that any claim for benefits is denied in whole or in part, the claimant whose claim has been so denied shall be notified of such denial by the Administrative Committee within ninety (90) days of receipt of the claim (unless the Administrative Committee determines that special circumstances require an extension of time of up to an additional ninety (90) days for processing the claim). The notice advising of the denial shall specify the reason(s) for denial, make specific reference to relevant Plan provisions, describe any additional material or information necessary for the claimant to perfect the claim (explaining why such material or information is needed), and shall advise the claimant of the procedure for the appeal of such denial and a statement of the claimant’s right to bring a civil action under Section 502(a) of ERISA following an adverse benefit determination on appeal. All appeals shall be made by the following procedure:

(a) A claimant whose claim has been denied shall file with the Administrative Committee a notice of desire to appeal the denial. Such notice shall be filed within sixty (60) days of notification by the Administrative Committee of the initial claim denial, be made in writing, and set forth all of the facts upon which the appeal is based. Appeals not timely filed shall be barred.

(b) The Administrative Committee shall consider the merits of the claimant’s written presentations, the merits of any facts or evidence in support of the denial of benefits, and such other facts and circumstances as the Administrative Committee shall deem relevant.

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(c) The Administrative Committee shall render a determination upon the appealed claim within sixty (60) days of its receipt of such appeal (unless the Administrative Committee determines that special circumstances require an extension of time of up to an additional sixty (60) days for processing the appeal). The determination shall specify the reason(s) for the denial, make specific reference to relevant Plan provisions, and contain a statement of the claimant’s right to bring a civil action under Section 502(a) of ERISA.

(d) The determination so rendered shall be binding upon all parties.

No Employee may bring a civil action under Section 502(a) of ERISA until the Employee has exhausted his or her rights under this Section 7.02.

ARTICLE VIII

MISCELLANEOUS

Section 8.01 Nonalienation of Benefits. None of the payments, benefits, or rights of any Participant shall be subject to any claim of any creditor, and, in particular, to the fullest extent permitted by law, all such payments, benefits and rights shall be free from attachment, garnishment, trustee’s process, or any other legal or equitable process available to any creditor of such Participant. No Participant shall have the right to alienate, anticipate, commute, plead, encumber, or assign any of the benefits or payments which he/she may expect to receive, contingently or otherwise, under this Plan.

Section 8.02 No Contract of Employment. Neither the establishment of this Plan, nor any modification thereof, nor the creation of any fund, trust or account, nor the payment of any benefits shall be construed as giving any Participant or Employee, or any person whosoever, the right to be retained in the service of the Company, and all Participants and other Employees shall remain subject to discharge to the same extent as if this Plan had never been adopted.

Section 8.03 Severability of Provisions. If any provision of this Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof, and this Plan shall be construed and enforced as if such provisions had not been included.

Section 8.04 Heirs, Assigns, and Personal Representatives. This Plan shall be binding upon the heirs, executors, administrators, successors, and assigns of the parties, including each Participant, present and future.

Section 8.05 Headings and Captions. The headings and captions herein are provided for reference and convenience only, shall not be considered part of this Plan, and shall not be employed in the construction of this Plan.

Section 8.06 Number. Except where otherwise clearly indicated by context, the singular shall include the plural, and vice-versa.

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Section 8.07 Unfunded Plan. This Plan shall not be funded. No Participant shall have any right to, or interest in, any assets of the Company that may be applied by the Company to the payment of Benefits.

Section 8.08 Payments to Incompetent Persons, Etc. Any benefit payable to or for the benefit of a minor, an incompetent person or other person incapable of receipting therefor shall be deemed paid when paid to such person’s guardian or to the party providing or reasonably appearing to provide for the care of such person, and such payment shall fully discharge the Company, the Administrative Committee and all other parties with respect thereto.

Section 8.09 Lost Payees. Benefits shall be deemed forfeited if the Administrative Committee is unable to locate a Participant to whom Benefits are due. Such Benefits shall be reinstated if application is made by the Participant for the forfeited Benefits within one (1) year of the Participant’s Employment Termination Date and while this Plan is in operation.

Section 8.10 Controlling Law. This Plan shall be construed and enforced according to the laws of the State of North Carolina to the extent not superseded by federal law.

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Inspire Pharmaceuticals, Inc.

Change in Control Severance Benefit Plan

Exhibit A

Annual Base Rate of Pay	Number of Weeks of Severance Pay
$25,000 - $49,999	Thirteen (13) weeks plus one (1) additional week for each of the Participant’s Years of Service
$50,000 - $74,999	Twenty (20) weeks plus one (1) additional week for each of the Participant’s Years of Service
$75,000 - $99,999	Twenty-six (26) weeks plus one (1) additional week for each of the Participant’s Years of Service
$100,000 - $124,999	Thirty-three (33) weeks plus one (1) additional week for each of the Participant’s Years of Service
$125,000 - $149,999	Thirty-nine (39) weeks plus one (1) additional week for each of the Participant’s Years of Service
$150,000 and up (excluding all officers subject to Section 16 of the Securities Exchange Act of 1934)	Fifty-two (52) weeks plus one (1) additional week for each of the Participant’s Years of Service

A-1

Inspire Pharmaceuticals, Inc.

Change in Control Severance Benefit Plan

Exhibit B

(General Release)

This General Release (“General Release”) is entered into by and between Inspire Pharmaceuticals, Inc. (the “Company”) and [FULL NAME of EMPLOYEE] (the “Employee”).

WHEREAS, the Company has provided written notification to the Employee that his/her employment with the Company has or will be terminated effective [Termination Date];

WHEREAS, as a result of the termination of the Employee’s employment and subject to the Employee’s execution of this General Release, the Employee is entitled to a severance payment under Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (the “Severance Plan”);

WHEREAS, the Employee desires to execute this General Release and, thereby, become eligible for receipt of severance benefits and, through this General Release, the Company and the Employee also wish to resolve, finally and completely and with prejudice, any and all matters between them relating to the Employee’s employment with the Company and the termination of that employment;

NOW, THEREFORE, in consideration of the above recitals and the mutual promises and covenants set forth below, the Company and the Employee, intending to be legally bound hereby, agree as follows:

1. In exchange for the Employee’s execution of this General Release, the Employee is eligible to receive benefits under the Severance Plan.

2. The Employee expressly agrees that, except as specifically provided in Section 1 above and as contemplated under the Severance Plan, he/she shall receive no other payment or benefit from the Company, and the Company shall not ever be required to make any further payment or provide any further benefit, for any reason whatsoever, to him/her or to any person or entity regarding any claim or right whatsoever which might possibly be asserted by him/her or on the Employee’s behalf. The Employee acknowledges that he/she would not be entitled to the severance payment described herein merely upon the termination of the Employee’s employment with the Company without the benefit of this General Release and he/she acknowledges that the severance payment is sufficient consideration for the Employee’s execution of this General Release.

3. The Employee, on behalf of himself/herself, his/her heirs, executors, administrators, successors, and assigns, hereby expressly and unconditionally releases, revises, settles, compromises, and forever discharges the Company, its affiliates, partners, employees, representatives, employee benefit plans, funds, programs, or arrangements providing pension, welfare, and fringe benefits, trustees, plan administrators, attorneys, agents, and successors,

B-1

and/or assigns, jointly and individually, of and from any and all possible suits, claims, rights, demands, costs, actions, causes of action, obligations, damages, and liabilities (“claims”) whether known or unknown and of whatever kind or nature, which arose on or before the effective date of this General Release, arising out of or in any way related to, or as a consequence of, the Employee’s employment with the Company, the terms and conditions of that employment, and the termination of his/her employment with the Company, as well as the continuing effects thereof. This release includes, but is not limited to, (i) all claims under any possible legal, equitable, tort, contract, common law, or statutory theory, including, but not limited to, any claim for constructive or wrongful discharge or for breach of contract, and any claim for defamation; (ii) all claims under any possible statutory theory, including, but not limited to, any and all claims under Title VII of the Civil Rights Act of 1964, the Civil Rights Act of 1990, 42 U.S.C. §§ 1981, 1983, 1985 and 1988, the Age Discrimination in Employment Act of 1967, the Older Workers Benefit Protection Act, the Americans with Disabilities Act, any state human rights or human relations act and any amendments to any of these statutes, as well as any other federal, state, or local law, statute, ordinance, regulation, or executive order, prohibiting employment discrimination based on religion, sex, ethnicity, race, color, national origin, handicap, disability, age, retaliation, or any other characteristic proscribed by law; (iii) all claims under the Fair Labor Standards Act, the Equal Pay Act of 1963, the Employee Retirement Income Security Act of 1974, any wage payment and collection law, and the federal and any state or local Family and Medical Leave Act; and (iv) all claims for the fees, costs, and expenses of any and all attorneys who have at any time or are now representing the Employee in connection with this General Release or in connection with any matter released by him/her. The Employee also covenants that, to his/her knowledge, he/she has not sustained any work-related injury during his/her employment at the Company.

4. The Employee also represents that he/she has not previously filed or joined in any complaint, charge, or lawsuit against the Company or any of its partners or employees in any court of law or with any governmental agency on any of the claims mentioned above. Notwithstanding any other language in this General Release, the Employee understands that this General Release does not prohibit him/her from filing an administrative charge of alleged employment discrimination with the Equal Employment Opportunity Commission or any similar agency. The Employee, however, waives the Employee’s right to any monetary or other recovery against the Company or any of the released persons or entities should any federal, state, or local administrative agency pursue any claim on the Employee’s behalf arising out of or relating to the Employee’s employment with the Company or the termination of the Employee’s employment with the Company.

5. Nothing in this General Release affects the Employee’s right to elect, at the Employee’s sole expense, continued coverage under the Company’s Welfare Benefit Plan pursuant to the continuation coverage provisions of the Consolidated Omnibus Budget Reconciliation Act.

6. The Employee agrees that the Company’s entry into this General Release is not to be construed as, and is not, an admission that the Company violated any of its duties or obligations to the Employee or treated the Employee improperly, unlawfully, or unfairly in any manner whatsoever. Neither this General Release nor the implementation thereof shall be construed to be, or shall be admissible in any proceedings as, evidence of an admission by the

B-2

Company of any violation of or failure to comply with any federal, state, or local law, common law, agreement, rule, regulation, or order; the preceding portion of this sentence does not preclude introduction of this General Release by the Company to establish that any and all claims which the Employee might possibly have were settled, compromised, and released according to the terms of this General Release.

7. Except as required by law, the Employee agrees to keep confidential and not discuss, disclose, or reveal, directly or indirectly, the terms of this General Release to any person, corporation, or entity with the exception of the members of the Employee’s immediate family, the Employee’s attorney, or the Employee’s accountant who (prior to disclosure to them) shall likewise agree to maintain the confidentiality of this General Release.

8. The Employee understands and agrees that the terms and conditions of this General Release constitute the full and complete understandings, agreements, and promises between him/her and the Company with respect to all matters covered by this General Release, that there are no other agreements, covenants, promises, or arrangements between him/her and the Company other than those set forth herein, that the terms and conditions of this General Release cancel and supersede any prior agreements or understandings that may have been between him/her and the Company with respect to all matters covered by this General Release, that no other promise or inducement has been offered to him/her except as set forth herein, and that this General Release is binding upon him/her, the Employee’s heirs, executors, administrators, and assigns. Notwithstanding any language herein to the contrary, this General Release does not cancel or suspend the Employee Confidentiality, Invention Assignment and Non-Compete Agreement (or any other agreement(s) serving similar functions) entered into by and between the Company and the Employee.

9. If any term, condition, clause, or provision of this General Release shall be determined by a court of competent jurisdiction to be void or invalid at law, or for any other reason, then only that term, condition, clause, or provision as is determined to be void or invalid shall be stricken from this General Release, and this General Release shall remain in full force and effect in all other respects. The Employee expressly agrees that this General Release shall not be construed against the Company and that it shall be governed by North Carolina law.

10. The Employee hereby expressly warrants that he/she was advised in writing of the Employee’s right to consult with an attorney prior to executing this General Release. The Employee further expressly warrants that he/she has, in fact, had the opportunity to consult with, and to be advised by, an attorney before executing this General Release to help him/her fully understand and appreciate its legal effect. The Employee acknowledges that he/she has been afforded the opportunity to consider this General Release for a period of twenty-one (21) days, which is a reasonable period of time. If the Employee signs this General Release in less than twenty-one (21) days, he/she acknowledges that he/she has thereby waived the Employee’s right to the full twenty-one (21) day period. The Employee shall have a period of seven (7) days following the Employee’s execution of this General Release to revoke it, and this General Release shall not be effective or enforceable prior to the expiration of that period. Revocation can be made by delivering a written notice to the office of the Director of Human Resources of the Company. The revocation of this General Release by the Employee will automatically revoke the Company’s obligation to pay the severance benefit to the Employee. If the Employee

B-3

does not advise the Company in writing that he/she revokes this General Release within seven (7) days of the Employee’s execution of it, this General Release shall be forever enforceable. The eighth (8^th) day following the Employee’s execution of this General Release shall be deemed the Effective Date of this General Release.

11. This General Release may be signed in two (2) counterparts, each of which shall be deemed an original when signed and shall constitute the same instrument. The Company shall retain Counterpart No. 1 of this General Release and the Employee shall retain Counterpart No. 2 of this General Release.

THE EMPLOYEE ACKNOWLEDGES THAT HE/SHE HAS CAREFULLY READ THE FOREGOING GENERAL RELEASE, THAT HE/SHE UNDERSTANDS COMPLETELY ITS CONTENTS, THAT HE/SHE UNDERSTANDS THE SIGNIFICANCE AND CONSEQUENCE OF SIGNING IT, AND THAT HE/SHE INTENDS TO BE LEGALLY BOUND BY ITS TERMS. THE EMPLOYEE FURTHER ACKNOWLEDGES THAT HE/SHE HAS HAD A REASONABLE AND SUFFICIENT PERIOD OF TIME WITHIN WHICH TO CONSIDER THIS GENERAL RELEASE AND THAT HE/SHE HAS HAD THE OPPORTUNITY TO REVIEW THIS GENERAL RELEASE WITH COUNSEL. THE EMPLOYEE SWEARS THAT HE/SHE HAS AGREED TO AND SIGNED THIS GENERAL RELEASE VOLUNTARILY AND AS HIS/HER OWN FREE WILL, ACT, AND DEED, AND FOR FULL AND SUFFICIENT CONSIDERATION.

IN WITNESS WHEREOF, INSPIRE PHARMACEUTICALS, INC. and [FULL NAME OF EMPLOYEE] have caused this General Release to be executed this      day of             .

[FULL NAME OF EMPLOYEE]

INSPIRE PHARMACEUTICALS, INC.

By:

Title:

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EX-31.1

Exhibit 31.1

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

I, Christy L. Shaffer, certify that:

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

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

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

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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: May 9, 2008	/s/ Christy L. Shaffer
	Christy L. Shaffer
	President & Chief Executive Officer (principal executive officer)

EX-31.2

Exhibit 31.2

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

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

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

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

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

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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: May 9, 2008	/s/ Thomas R. Staab, II
	Thomas R. Staab, II
	Chief Financial Officer & Treasurer (principal financial officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2008, as filed with the Securities and Exchange Commission (the “Report”), I, Christy L. Shaffer, President & 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: May 9, 2008	/s/ Christy L. Shaffer
	Christy L. Shaffer
	President & 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 quarterly report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2008, as filed with the Securities and Exchange Commission (the “Report”), I, Thomas R. Staab, II, Chief Financial Officer & Treasurer 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: May 9, 2008	/s/ Thomas R. Staab, II
	Thomas R. Staab, II
	Chief Financial Officer & Treasurer (principal financial officer)