10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the fiscal year ended December 31, 2006

OR

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

For the transition period from              to             .

Commission File No. 000-31135

INSPIRE PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware	04-3209022
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
4222 Emperor Boulevard, Suite 200, Durham, North Carolina	27703-8466
(Address of Principal Executive Offices)	(Zip Code)

(919) 941-9777

(Registrant’s telephone number, including area code)

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

Title of Each Class	Name of Each Exchange on Which Registered
Common Stock, $.001 par value	The Nasdaq Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:  None

(Title of Class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

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

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

Large accelerated filer  ¨ Accelerated filer  x Non-accelerated filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $195,193,622.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of January 31, 2007.

Class	Number of Shares
Common Stock, $.001 par value	42,238,355

Documents incorporated by reference

Document Description	10-K Part III
Portions of the Registrant’s proxy statement to be filed pursuant to Regulation 14A within 120 days after Registrant’s fiscal year end of December 31, 2006 are incorporated by reference into Part III of this report.	Items 10, 11, 12, 13, 14

INSPIRE PHARMACEUTICALS, INC.

2006 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business	1
Item 1A.	Risk Factors	24
Item 1B.	Unresolved Staff Comments	48
Item 2.	Properties	48
Item 3.	Legal Proceedings	48
Item 4.	Submission of Matters to a Vote of Security Holders	49
PART II
Item 5.	Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities	50
Item 6.	Selected Financial Data	52
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	53
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	69
Item 8.	Financial Statements and Supplementary Data	70
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	70
Item 9A.	Controls and Procedures	70
Item 9B.	Other Information	71
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	71
Item 11.	Executive Compensation	71
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	71
Item 13.	Certain Relationships and Related Transactions, and Director Independence	71
Item 14.	Principal Accountant Fees and Services	72
PART IV
Item 15.	Exhibits, Financial Statements Schedules	72
SIGNATURES		76

PART I

Item 1. Business.

Overview

We are a biopharmaceutical company dedicated to discovering, developing and commercializing prescription pharmaceutical products in disease areas with significant commercial potential or unmet medical needs. Our goal is to build and commercialize a sustainable pipeline of new treatments based upon our technical and scientific expertise, focusing in the ophthalmic and respiratory/allergy therapeutic areas. Our portfolio of products and product candidates include:

PRODUCTS AND PRODUCT CANDIDATES	THERAPEUTIC AREA/ INDICATION	COLLABORATIVE PARTNER	CURRENT STATUS IN THE UNITED STATES
Products
Elestat®	Allergic conjunctivitis	Allergan	Co-promoting
Restasis®	Dry eye disease	Allergan	Co-promoting
Product Candidates in Clinical Development
AzaSite™	Bacterial conjunctivitis	InSite Vision	Phase 3; April 2007 Prescription Drug User Fee Act review date (1)
ProlacriaTM (diquafosol tetrasodium)	Dry eye disease	Allergan and Santen Pharmaceutical	Phase 3; Second FDA approvable letter received December 2005
Bilastine	Seasonal allergic rhinitis	FAES Farma	Phase 3
Denufosol tetrasodium	Cystic fibrosis	None	Phase 3
Epinastine nasal spray	Seasonal allergic rhinitis	Boehringer Ingelheim	Phase 2
INS115644	Glaucoma	Wisconsin Alumni Research Foundation	Phase 1

(1) On February 15, 2007, we entered into a license agreement with InSite Vision Incorporated pursuant to which we licensed exclusive rights to commercialize AzaSite™, a topical anti-infective product candidate currently in late stage development for the treatment of bacterial conjunctivitis, as well as other potential topical anti-infective products containing azithromycin for use in the treatment of human ocular or ophthalmic indications.

We co-promote Elestat and Restasis in the United States under agreements with Allergan, Inc., or Allergan, and we receive co-promotion revenue based upon Allergan’s net sales of these products. Elestat and Restasis are trademarks owned by Allergan. AzaSite is a trademark owned by InSite Vision Incorporated, or InSite Vision.

Our ophthalmic products and product candidates are currently concentrated in the allergic and bacterial conjunctivitis, dry eye disease, and glaucoma indications. Our respiratory/allergy product candidates are currently concentrated in the treatment of respiratory complications of cystic fibrosis and seasonal allergic rhinitis indications.

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Our Strategy

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

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

• Develop and In-License New Products in our Core Therapeutic Areas of Ophthalmology and Respiratory/Allergy. We have a fully integrated research and preclinical organization that works to identify and synthesize new chemical entities for further testing in the respiratory/allergy and ophthalmic therapeutic areas. Also, we collaborate with academic institutions to advance basic and translational research and to augment our internal research capabilities. In addition, we continue to be opportunistic with regard to in-licensing product candidates in various stages of development in our core therapeutic areas.

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

• Successfully Commercialize Products Through a Concentrated Sales and Marketing Effort in Our Target Markets. A key element of our strategy is to be involved in the sales and marketing activities of our products in North America. To that end, we have developed a specialty sales and marketing organization that currently supports the commercialization of Elestat and Restasis to ophthalmologists, optometrists and allergists in the United States. We intend to expand our sales force and marketing organization as appropriate if additional product candidates are approved.

• Build Intellectual Property Around Our Product Candidates. We have a substantial intellectual property position related to our technology and product candidates. We intend to continue to pursue an aggressive patent strategy to protect our expanding proprietary discoveries.

Elestat

Overview. 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 U.S. Food and Drug Administration, or 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.

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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. In addition, we have the right to conduct, and do conduct, Phase 4 clinical trials and other studies in collaboration with Allergan relating to Elestat. 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. See “—Collaborative Agreements—Allergan, Inc.—Elestat.”

In February 2004, we launched Elestat in the United States and are promoting it to ophthalmologists, optometrists and allergists. 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 in October 2008.

Market Opportunity. Allergies affect more than 40 million people in the United States annually, according to the American Academy of Allergy, Asthma & Immunology. We estimate that allergic conjunctivitis may occur in up to 90% of those patients suffering from allergies. The 2006 annual U.S. market for prescription ocular allergy products was approximately $520 million, and has experienced a growth rate, in terms of dollars, of approximately 8% over 2005, based on data compiled and reported by IMS Health, as of September 30, 2006.

Restasis

Overview. 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 patients 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 for sale 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. See “—Collaborative Agreements —Allergan, Inc.—Restasis and Prolacria.”

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.

Market Opportunity. Other than Restasis, the current treatments for dry eye disease in the major markets consist of artificial tear solutions and lubricant eye drops. Dry eye disease is associated with aging, environmental factors, autoimmune disorders and various medications. Since dry eye disease is more prevalent among the elderly and post-menopausal women, this market is expected to grow as populations age. We estimate, based on an extrapolation from U.S. data, that dry eye disease affects over thirty million people in the eight major international prescription pharmaceutical markets, of which over nine million are in North America. For the years ending December 31, 2006, 2005 and 2004, Allergan has recognized $270 million, $191 million and $100 million, respectively, of revenue from net sales of Restasis.

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AzaSite for the treatment of bacterial conjunctivitis

Overview. AzaSite is a topical anti-infective, in which 1% azithromycin is formulated into an ophthalmic solution utilizing DuraSite^®, a novel ocular drug delivery system. The initial indication for AzaSite will be the treatment of bacterial conjunctivitis. Azithromycin is a semi-synthetic antibiotic that is derived from erythromycin and has been available under the trade name Zithromax^® by Pfizer Inc. since 1992.

On February 15, 2007, we entered into a license agreement with InSite Vision pursuant to which we licensed 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 product in the United States and Canada and their respective territories. See “—Collaborative Agreements—InSite Vision Incorporated.” In the United States, AzaSite is expected to have patent protection through 2019.

Development Status. Two Phase 3 clinical trials have been completed in patients with bacterial conjunctivitis. One clinical trial was a vehicle-controlled clinical trial and the second clinical trial included an active comparator, tobramycin ophthalmic solution. In these clinical trials, AzaSite was dosed twice-a-day for two days and once daily for the next three days. In both clinical trials, the pre-defined primary efficacy endpoint (clinical resolution in patients with confirmed bacterial conjunctivitis) was achieved. Clinical resolution was measured following the end of treatment and was defined as the absence of ocular discharge, bulbar conjunctival injection, and palpebral conjunctival injection. Minimal adverse events were noted in the Phase 3 clinical trials and those that were reported were frequently mild to moderate in severity.

InSite Vision previously filed a New Drug Application, or NDA, with the FDA in June 2006. The completion of the FDA’s review of the NDA for AzaSite is expected by the end of April 2007, as determined by the Prescription Drug User Fee Act (PDUFA). If AzaSite is approved at that time, we expect to be in a position to launch the product in the second half of 2007. Following a U.S. approval, we plan to expand our existing sales force to a total of 98 representatives who will call on targeted specialists and select pediatricians and primary care providers.

Market Opportunity. The current ocular antibiotic market is approximately $600 million in annual sales in the United States based on data compiled by IMS Health as of December 31, 2006. This includes approximately $360 million for the single-entity market and approximately $245 million in the combination products market. Total prescriptions in the ocular antibiotic market were approximately 15 million for the twelve months ended December 31, 2006, up 7% from the prior year according to data compiled from IMS Health.

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.

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. See “—Collaborative Agreements—Allergan, Inc.—Restasis and Prolacria.” In the United States, Prolacria is expected to have patent protection through 2017.

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Development Status. In June 2003, we filed an 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. We had two formal meetings in 2006 and an additional formal meeting in early 2007 with the FDA about Prolacria and dry eye disease. Based on those meetings, we have provided additional information to the FDA. We have utilized key experts and corneal specialists throughout this process to engage in a meaningful dialogue regarding the clinical aspects of the diagnosis and treatment of dry eye.

Based on our most recent meeting with the FDA, we are focusing our attention on staining scores in the central region of the cornea. In addition to the data we have already submitted to the FDA to support the importance of the central cornea, we are continuing to work to validate a clinically relevant endpoint based on staining scores in the central region of the cornea. The FDA has agreed to work with us on this pathway providing we can appropriately validate the endpoint. If we are able to validate this endpoint and come to agreement with the FDA, we expect to request a Special Protocol Assessment prior to conducting an additional clinical trial.

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 diquafosol tetrasodium. See “—Collaborative Agreements—Santen Pharmaceutical Co., Ltd.”

Depending on the outcome of our validation exercise and subsequent discussions with the FDA, 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 $1 million to $10 million, depending on our approach to achieving NDA approval of the product. This range includes costs for regulatory and consulting activities, conducting a validation exercise and related studies, completing one additional Phase 3 clinical trial, salaries for development personnel, and other unallocated development costs, but excludes the cost of pre-launch inventory which is Allergan’s responsibility. Currently, we have not initiated an additional Phase 3 clinical trial for Prolacria and we do not anticipate initiating an additional Phase 3 clinical trial until the validation exercise and subsequent discussions with the FDA are complete. Costs of other clinical trials for Prolacria are excluded from this projection. 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.

Bilastine for seasonal allergic rhinitis

Overview. Bilastine is a non-sedating oral H1-antihistamine compound being developed for the treatment or prevention of allergic rhinitis. Rhinitis is a condition that primarily results from exposure to allergens, either at specific times of the year (seasonal allergic rhinitis) or year-round (perennial allergic rhinitis), or from exposure to irritants, such as cigarette smoke or perfume. Symptoms most often include nasal congestion or stuffiness, rhinorrhea (runny nose), sneezing and ocular and nasal itching.

In October 2006, we entered into a licensing agreement with FAES Farma, S.A., or FAES, for the U.S. and Canadian development and commercialization of bilastine. Under the agreement with FAES, we are responsible

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for the development and commercialization of bilastine in the United States and Canada, including conducting any additional necessary clinical trials. See “—Collaborative Agreements—FAES Farma, S.A.” In the United States, bilastine is covered by a composition of matter patent through 2017.

Development Status. FAES has sponsored clinical trials assessing the efficacy, tolerability and safety of bilastine in the once-daily oral tablet formulation in multiple clinical trials, including two large, potentially pivotal Phase 3 seasonal allergic rhinitis clinical trials conducted outside the United States that had met their primary (and secondary) pre-specified endpoints. In these clinical trials, bilastine appeared to have an attractive tolerability profile. More than 4,000 subjects have been studied in clinical trials to date. Multiple studies have been completed in the development of this compound, including standard toxicology, carcinogenicity, cardiac safety, and food and drug interaction studies. FAES announced the acceptance of an Investigational New Drug Application, or IND, by the FDA in April 2006, and the IND was transferred to Inspire in December 2006. Currently, a thorough QT/QTc clinical trial is ongoing in the United States, which top-line results are expected to be reported in the second quarter of 2007. A QT/QTc clinical trial is frequently recommended by the FDA for oral antihistamines to confirm the cardiac safety profile. This clinical trial represents an important “go/no go” decision point in our U.S. program. Furthermore, we have no additional financial commitments to FAES for bilastine until we receive these QT/QTc clinical trial results and they are favorable.

In anticipation of having these QT/QTc clinical trial results, we have scheduled a meeting with the Pulmonary Division of the FDA in the second quarter of 2007 to discuss various aspects of the program. After the FDA meeting, we plan to provide an update on any additional requirements for approval and plans for an NDA filing. We anticipate conducting at least one additional clinical trial in the United States to broaden the experience with the compound and to enhance the competitive position of the product candidate.

In addition to the completed clinical trials evaluating bilastine, FAES is sponsoring other ex-U.S. clinical trials. A clinical trial to assess onset and duration of effect in an allergen-challenge model (or a controlled pollen exposure unit) has been completed in Vienna, Austria. These clinical trial results are expected by mid-year 2007. Also, FAES is conducting a multinational clinical trial evaluating the effectiveness of bilastine compared with placebo and an active comparator, levocetirizine, for the treatment of chronic idiopathic urticaria.

Several abstracts have been submitted to the Congress of the European Academy of Allergology and Clinical Immunology, which will be held in mid-June 2007 in Sweden. At that conference, we expect data from two large European Phase 3 trials of bilastine to be presented.

Estimated subsequent costs necessary to submit an NDA for bilastine for the treatment of seasonal allergic rhinitis are projected to be in the range of $12 million to $20 million and are contingent upon favorable results of the QT/QTc clinical trial currently being conducted by FAES in the United States. This range includes an $8 million milestone payment to FAES if such QT/QTc clinical trial results are favorable, conducting a Phase 3 clinical trial which may be required, and if such clinical trial is favorable, paying a $2 million milestone payment to FAES, manufacturing bilastine for clinical trials, producing qualification lots consistent with current Good Manufacturing Practice, or cGMP, standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs, but excludes the cost of pre-launch inventory. These costs are difficult to project and actual costs could be materially different from our estimate. For example, results from the QT/QTc clinical trial may be unfavorable, which could result in a cancellation of the program. In addition, results from the planned Phase 3 clinical trial may change our planned development program, 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.

Market Opportunity. In the United States, allergic rhinitis affects approximately 40 million people, according to the American Academy of Allergy, Asthma & Immunology. The annual U.S. market for prescription oral antihistamine products is approximately $3.1 billion, based on IMS Health data for the 12 months ended September 30, 2006.

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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, or EMEA. Denufosol is designed to enhance the lung’s innate mucosal hydration and mucociliary clearance mechanisms, which in cystic fibrosis patients are impaired due to a genetic defect. By hydrating airways and stimulating mucociliary clearance through 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. In the United States, denufosol tetrasodium for the treatment of cystic fibrosis is expected to have patent protection through 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 2006, the median life expectancy for patients is approximately 37 years.

Development Status. We have conducted Phase 1 and Phase 2 clinical trials of denufosol, including multiple clinical trials in cystic fibrosis patients, and various preclinical and toxicology testing. In January 2006, we had an End-of-Phase 2 meeting with the FDA and decided to initiate a Phase 3 program to advance denufosol for the treatment of cystic fibrosis. The focus of our Phase 3 program is to develop denufosol as an early intervention therapy for treatment of patients with mild lung disease (FEV₁ (Forced Expiratory Volume in one second) ³ 75% predicted). According to the U.S. Cystic Fibrosis Foundation’s 2004 Patient Registry, approximately two-thirds of cystic fibrosis patients have lung disease defined as mild as measured by the standard pulmonary function test, FEV₁ > 70% predicted. In the pediatric population under 18 years of age, approximately 80% of patients have mild or early lung disease.

Based on the End-of-Phase 2 meeting with the FDA, we plan to conduct two pivotal Phase 3 clinical trials in cystic fibrosis patients. The two Phase 3 clinical trials are designated TIGER-1 and TIGER-2. In July 2006, we initiated our TIGER-1 clinical trial, which is designed to be approximately one year in duration, with a 24-week efficacy treatment period, followed by a 24-week safety extension period. The efficacy portion of the clinical trial is a randomized, double-blind comparison of 60 mg of denufosol to placebo by inhalation three-times daily in approximately 350 patients with mild cystic fibrosis lung disease at approximately 70 clinical centers across the United States. As of February 27, 2007, approximately 170 patients have been randomized or enrolled in the clinical trial. Based on current enrollment rates, we expect to complete enrollment in our TIGER-1 Phase 3 clinical trial in the fourth quarter of 2007. As TIGER-1 enrollment proceeds, the safety data will be reviewed by an independent data monitoring committee that we established for this clinical trial. We intend to unblind, analyze and announce the top-line results within two to three months following completion of the initial 24-week placebo-controlled efficacy portion of the clinical trial. We do not expect this unblinding of efficacy data to result in any statistical penalty.

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 (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. The clinical trial is enrolling cystic fibrosis patients aged five years and above. 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.

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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.

We have previously stated that the initiation of the TIGER-2 clinical trial was targeted to begin in 2007. However, there are a number of considerations that could result in this clinical trial starting later than 2007. The protocol and specific timing of initiation of TIGER-2 are dependant on a number of factors, including discussions with regulatory agencies outside the United States, as well as the FDA, discussions with potential partners and enrollment progress in TIGER-1. In 2006, we conducted several meetings with the EMEA to negotiate various aspects of our program, including the potential inclusion of European clinical sites in TIGER-2 and the discussions are continuing. Also, in January 2007, we submitted a Clinical Trial Application, which is under review, to Health Canada to be able to conduct cystic fibrosis clinical trials in Canada. The duration of TIGER-2 is expected to be no longer than 24 weeks.

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. We expect that the safety margin is sufficient to support the completion of the Phase 3 clinical program. In addition, in November 2006, we initiated the required two-year inhalation carcinogenicity study in rats and the study is ongoing. We believe that this carcinogenicity study is the rate limiting step in the denufosol program which 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 do not expect to receive the final study report for this carcinogenicity study until the second half of 2009.

We intend to initiate a small clinical trial to enhance the scientific data regarding the mechanism of action of denufosol. The single-dose clinical trial is designed as a double-blind, two-way crossover evaluation of the effects of 60 mg of denufosol on mucociliary clearance, compared to placebo, in 12 patients with cystic fibrosis lung disease. In addition, although not requested by the FDA, we may conduct further clinical trials to evaluate denufosol in patients with lower lung function, to gain a better understanding of the initial dose tolerability of denufosol in a patient population with more significant airflow obstruction.

Estimated subsequent costs necessary to submit an NDA for denufosol for the treatment of cystic fibrosis are projected to be in the range of $35 million to $55 million. This estimate includes any additional Phase 2 clinical trials, conducting two Phase 3 clinical trials and any required toxicology and carcinogenicity studies, manufacturing denufosol for clinical trials, producing qualification lots consistent with current 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 potential development milestones payable to the Cystic Fibrosis Foundation Therapeutics, Inc., or the CFFT. See “—Collaborative Agreements—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 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. We would expect that a potential partner for development and commercialization outside of North America would provide assistance related to the design, funding and completion of future clinical trials conducted outside of North America.

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

There are approximately 30,000 diagnosed cystic fibrosis patients in the United States and we estimate approximately 75,000 worldwide. Annual sales of the two prescription pharmaceutical products to treat cystic fibrosis lung disease, Pulmozyme and TOBI, were approximately $415 million in the United States and $600 million on an aggregate worldwide basis, based on data compiled and reported by IMS Health, as of September 30, 2006.

Epinastine nasal spray for seasonal allergic rhinitis

Overview. Epinastine HCl is a topically active, direct H₁-receptor antagonist and inhibitor of histamine release from mast cells that is being developed by us as an intranasal treatment for seasonal allergic rhinitis.

In February 2006, we entered into a development and license agreement with Boehringer Ingelheim International GmbH, or Boehringer Ingelheim. The agreement grants us certain exclusive rights to develop and market an intranasal dosage form of epinastine, in the United States and Canada, for the treatment or prevention of rhinitis. See “—Collaborative Agreements—Boehringer Ingelheim International GmbH.”

Development Status. In October 2006, our IND application for epinastine nasal spray was filed with the FDA and we began Phase 2 clinical trials. The Phase 2 program is expected to include several clinical and toxicology studies to determine the optimal formulation and dose. In late October 2006, the initial Phase 2 clinical trial, which compared several formulations and concentrations over one day, was completed. In December 2006, we initiated an additional Phase 2 clinical trial to evaluate epinastine nasal spray for the treatment of seasonal allergic rhinitis and enrollment is complete. This Phase 2 clinical trial is a 14-day randomized, double-blind comparison of two doses of epinastine nasal spray (0.05% and 0.1%) to placebo in approximately 580 subjects who have a documented history of seasonal allergic rhinitis to mountain cedar pollen. The clinical trial is being conducted at seven clinical sites during the mountain cedar pollen season, primarily in central Texas. There are multiple objectives of this placebo-controlled, dose-ranging clinical trial, including the measurement of nasal and non-nasal symptoms, quality of life scores and standard safety assessments. The doses being studied in this clinical trial were selected based on the small Phase 2 clinical trial completed in October 2006, combined with the preclinical pharmacology data compiled to date. We expect to report the top-line results of this clinical trial by mid-year 2007. If these results are favorable, we plan to meet with the FDA to confirm next steps and would likely initiate a six-month nasal toxicology study which is required by the FDA. Additional clinical studies in seasonal allergic rhinitis could continue while this toxicology study is ongoing.

Estimated subsequent costs necessary to submit an NDA for epinastine nasal spray for the treatment of seasonal allergic rhinitis are projected to be in the range of $30 million to $50 million. This estimate includes current and future Phase 2 clinical trials, conducting Phase 3 clinical trials and any required toxicology and carcinogenicity studies, manufacturing epinastine for clinical trials, producing qualification lots consistent with current cGMP standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs, but excludes the cost of pre-launch inventory. 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 future clinical trials may change our planned development program, additional Phase 2 clinical trials may be necessary, 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.

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Market Opportunity. The annual U.S. market for prescription nasal allergy products is approximately $2.8 billion based on data compiled and reported by IMS Health, as of September 30, 2006.

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. See “—Collaborative Agreements—Wisconsin Alumni Research Foundation.” 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 IND for the first compound in a series of compounds and in the first quarter of 2007, we initiated a Phase 1 dose-ranging clinical trial in glaucoma patients to evaluate the safety and tolerability of INS115644, as well as changes in intraocular pressure. We expect to report top-line results of this clinical trial by the fourth quarter of 2007. 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.

Market Opportunity. The current market for treatment of glaucoma, the largest market in ophthalmic pharmaceuticals, is approximately $1.6 billion in annual sales in the United States based on data compiled and reported by IMS Health, as of September 30, 2006.

Discontinued Program—INS50589 for use in acute cardiac care

INS50589 is a selective and reversible inhibitor of the platelet P2Y₁₂ adenosine diphosphate receptor. In April 2006, we initiated a proof-of-concept Phase 2 clinical trial to evaluate INS50589 in patients undergoing coronary artery bypass graft. In August 2006, we announced that we terminated this clinical trial, based on the unanimous recommendation of our independent data monitoring committee. We have discontinued the development of INS50589 for this indication and are currently exploring potential collaborative partnerships for this program. We expect that we will incur additional costs related to this program through 2007 as we complete any remaining contractual obligations under the clinical trial agreements.

Additional discussion of the costs and expenses associated with all of our research and development programs is discussed below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Years Ended December 31, 2006, 2005 and 2004—Costs and Expenses.”

Collaborative Agreements

Allergan, Inc.—Elestat

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. In addition, we have the right to conduct Phase 4 clinical trials and other studies in collaboration with Allergan relating to Elestat. We receive co-promotion revenue from Allergan on its U.S. net sales of Elestat. We work with Allergan collaboratively on overall product strategy and management in the United States. Allergan records sales of Elestat and is responsible for other product costs, as well as retaining responsibility for all international marketing and selling activities. Allergan also retains the rights relating to promotion of Elestat to U.S. prescribers other than ophthalmologists, optometrists and allergists. However, we have a right of first refusal to obtain such rights in the event Allergan decides to engage a third party to undertake such activities. We have established a joint commercialization committee with Allergan to coordinate and oversee the broad strategies, promotion activities

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and manage the relationship. Allergan is responsible for supply chain management, managed healthcare, customer order processing and regulatory compliance. Under the terms of the agreement, we paid Allergan an up-front payment and Allergan pays co-promotion revenue to us on its U.S. net sales of Elestat. In the event that a third party is engaged by Allergan to promote Elestat to prescribers outside of our field, we are entitled to be paid a proportionate share of U.S. net sales of Elestat based upon filled prescriptions written by ophthalmologists, optometrists and allergists. Under the terms of the agreement, we are required to achieve certain performance minimums to receive some or all of co-promotion revenue contemplated.

The agreement will be in effect until the earlier of: (i) the approval and launch of the first generic epinastine product; or (ii) the approval and launch of the first over-the-counter epinastine product. The commercial exclusivity period for Elestat under the Hatch-Waxman Act will expire in October 2008, after which time Elestat could face generic competition if there is no other intellectual property protection covering Elestat. Either Allergan or we may terminate the agreement in the event of a material breach of the agreement by the other or in the event of the other’s insolvency. Allergan can terminate the agreement if we fail to meet a defined minimum of net sales in any given year, or upon a change of control where we become an affiliate of a direct competitor of Allergan as that term is defined in the agreement. We can terminate the agreement in the event that Elestat is withdrawn from the market for more than ninety days.

Allergan, Inc.—Restasis and Prolacria

In June 2001, we entered into a joint license, development and marketing agreement with Allergan to develop and commercialize our product candidate, Prolacria, for the treatment of dry eye disease. The agreement also provided us with a royalty on net sales of Allergan’s Restasis and granted us the right to co-promote Restasis in the United States. In December 2003, at the time we entered into the co-promotion agreement relating to Elestat, we amended the joint license, development and marketing agreement to reduce the co-promotion revenue rates that we would receive upon the sale of Restasis.

Under the terms of the amended agreement, Allergan obtained an exclusive license to develop and commercialize Prolacria worldwide, with the exception of Japan and nine other Asian countries covered by our agreement with Santen. In return, we are entitled to receive co-promotion revenue from Allergan on net sales of Restasis and Prolacria, if any, worldwide, excluding most larger Asian markets. Under this agreement, we have received up-front and milestone payments of $11 million related to our development of Prolacria and will be entitled to receive up to an additional $28 million in milestone payments assuming the successful completion of all remaining milestones under this agreement. If and when we receive FDA approval and Prolacria is launched, we expect to begin promoting this product.

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

We are responsible for conducting, in collaboration with Allergan, the Phase 3 clinical trials for Prolacria for dry eye disease needed for potential approval and for filing the U.S. NDA. Allergan is responsible for all other development activities under the agreement, including all development and regulatory activities needed for potential approval outside the United States and in its territories, and for ex-U.S. regulatory submissions, filings, and approvals relating to products. Allergan is responsible for all commercial costs except for the cost of our sales force in the United States. Allergan is required to use commercially reasonable efforts to conduct these development activities, seek ex-U.S. regulatory approvals and market and sell Prolacria.

Unless earlier terminated pursuant to other terms of the agreement, the agreement will expire as to each product (Restasis or Prolacria, as the case may be) in each applicable country on the later of (i) the 10th

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anniversary of the first commercial sale of such product in the applicable country, or (ii) the date on which the sale of such product ceases to be covered by any claim of any applicable Inspire or Allergan patent. The agreement will expire in its entirety upon the expiration of the agreement with respect to all products in all countries as described in the previous sentence. Either Allergan or we may terminate the agreement in the event of a material breach of the agreement. In addition, we have the right to terminate the agreement by giving 180 days prior notice if we determine, subject to the joint commercialization committee’s review and arbitration, that Allergan has not made reasonably sufficient progress in the commercialization of our product. If Allergan breaches the agreement, becomes insolvent or we terminate for failure to make progress with the commercialization of our product, Allergan’s license will terminate and Allergan must provide us with all data and information relating to our product and must assign or permit us to cross-reference all regulatory filings and approvals.

The co-promotion revenue that we receive on the net sales of Restasis is based upon a percentage of net sales of Restasis in the United States, for which this percentage will increase in April 2007, and upon a percentage of net sales of Restasis outside the United States, except in Japan, Taiwan, Korea, Hong Kong and the Peoples Republic of China. In the event that the joint development committee decides to terminate the development program for Prolacria, and any other Inspire product under development pursuant to the agreement, and we do not within six months of the termination of the development program fulfill our obligations under the co-promotion provisions for Restasis, including providing a required minimum percentage of the budgeted sales force effort for Restasis, the royalty that we receive on net sales of Restasis, both with respect to sales in the United States and elsewhere, will be reduced, but not eliminated.

Boehringer Ingelheim International GmbH

In February 2006, we entered into a development and license agreement with Boehringer Ingelheim. The agreement grants us certain exclusive rights to develop and market an intranasal dosage form of epinastine, in the United States and Canada, for the treatment or prevention of rhinitis. Under the terms of the agreement, we have full responsibility for the epinastine nasal spray development program and regulatory filings in the United States and Canada. Upon the receipt of appropriate regulatory approvals for an epinastine nasal spray product, we are responsible for the commercialization of such product in the United States and Canada. Boehringer Ingelheim has retained the rights to develop and commercialize an epinastine nasal spray product outside the United States and Canada, based on any future results of our epinastine nasal spray development program.

In addition to funding all development activities under the terms of the agreement, we paid Boehringer Ingelheim an upfront license fee of $2.5 million. Additionally, we will owe Boehringer Ingelheim a high single digit royalty on net sales of an epinastine nasal spray product in the United States and Canada. If Boehringer Ingelheim commercializes our epinastine nasal spray product outside of the United States and Canada, it will be obligated to pay royalties to us on net sales of the product.

In general, the exclusive license granted to us will expire and convert into a perpetual, fully paid-up, non-exclusive license on December 31, 2022. Certain other rights and royalty obligations will continue beyond such date. For a period of five years following December 31, 2022, Boehringer Ingelheim shall have the right, but not the obligation, to switch a product developed under the agreement from a prescription product to an over-the-counter, or OTC, product. Following such a switch, Boehringer Ingelheim will have the right to commercialize such product in the United States and/or Canada. In connection with such a switch, Boehringer Ingelheim will be required to pay an OTC switch payment and ongoing royalties to us.

Cystic Fibrosis Foundation Therapeutics, Inc.

In October 2002, we entered into a study funding agreement with the CFFT, a non-profit drug development affiliate of the Cystic Fibrosis Foundation, for the funding of one Phase 2 clinical trial for denufosol for the treatment of cystic fibrosis. Under the agreement, the CFFT provided the majority of funding of external costs

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for one Phase 2 clinical trial of denufosol, which we completed in April 2004, in exchange for post-commercialization development and sales milestone payments. If denufosol ultimately receives FDA approval for the treatment of cystic fibrosis, we would be obligated to pay a development milestone to the CFFT, calculated as a multiple of the clinical trial costs incurred by the CFFT. In addition, we would be obligated to pay a sales milestone if the product candidate achieves a certain aggregate sales volume in the first five years following product approval. The development milestone is currently estimated to be approximately $12 million, payable over five years, and the sales milestone would be an additional $4 million, payable over two years. The agreement will terminate no later than the expiration of all payment obligations under the agreement. Either the CFFT or we may terminate the agreement if the other materially breaches the agreement.

FAES Farma, S.A.

In October 2006, we entered into a licensing agreement with FAES for the U.S. and Canadian development and commercialization of bilastine, a Phase 3 oral antihistamine compound for the treatment or prevention of allergic rhinitis. Under the terms of the agreement, we have acquired exclusive rights to further develop and commercialize certain formulations of bilastine in the United States and Canada, as well as the exclusive right to develop and commercialize the ocular formulation worldwide, excluding Spain, Portugal, Guatemala, Belize, El Salvador, Honduras, Nicaragua, Costa Rica, Panama and the countries of South America.

Under the terms of the agreement, we paid an upfront license fee of $7 million and will owe FAES up to an additional $82 million of payments, contingent upon achievement of various development, regulatory and sales-based milestone events. We will also pay a royalty of either 14% or 16% based on the amount of annual net sales of the oral formulations of bilastine in the United States and Canada and 10% on ocular formulations of bilastine in the ocular territory described above, if approved by regulatory authorities. Under the terms of the agreement, our obligation to pay royalties to FAES is subject to annual minimum royalty payments which commence on the first quarter start date that is at least one year after receipt of regulatory approval of the oral tablet formulation of bilastine for the treatment and prevention of allergic rhinitis. Additionally, we granted to FAES a right of first negotiation for commercialization in Spain and Portugal of our cystic fibrosis development compound, denufosol tetrasodium, if we choose to out-license the cystic fibrosis product on a regional basis. Unless terminated earlier upon mutual written consent, voluntary termination or material breach, the term of the agreement will expire upon the later to occur of the expiration of our or FAES’ obligation to make royalty payments under the agreement. We retain the right to terminate the agreement on a partial, country-by-country or product-by-product basis or entirely on the earlier of May 31, 2007 or upon receipt of results of certain studies, with a complete termination requiring 90 or 180 day advance written notice to FAES (depending upon whether we have begun commercial sales of bilastine-based products).

In general, the exclusive license granted to Inspire will become fully paid up, royalty-free, perpetual and irrevocable on June 4, 2017. Certain other rights and royalty obligations may continue beyond such date.

InSite Vision Incorporated

On February 15, 2007, we entered into a license agreement with InSite Vision pursuant to which we licensed exclusive rights to commercialize AzaSite, a topical anti-infective product candidate currently in late stage development for the treatment of bacterial conjunctivitis, as well as other potential topical anti-infective products containing azithromycin for use in the treatment of human ocular or ophthalmic indications. AzaSite is InSite Vision’s proprietary blend of azithromycin formulated with DuraSite, InSite Vision’s patented drug-delivery vehicle. The license agreement also grants us exclusive rights to develop, make, use, market, commercialize and sell the product in the United States and Canada and their respective territories.

Pursuant to the license agreement we paid InSite Vision an upfront license fee of $13 million and will pay an additional $19 million milestone payment contingent upon regulatory approval by the FDA. Additionally, if approved by regulatory authorities, we will pay a royalty on net sales of AzaSite for ocular infections in the

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United States and Canada. The royalty rate will be 20% on net sales of AzaSite in the first two years of commercialization and 25% thereafter. We are obligated to pay royalties under the agreement for the longer of (i) eleven years from the launch of the subject product and (ii) the period during which a valid claim under a patent licensed from InSite Vision covers a subject product. Under the terms of the agreement, our obligation to pay royalties to InSite Vision is subject to annual minimum royalty payments which commence on the first quarter start date that is at least one year after the first commercial sale of any subject product, and may continue for a period of up to five years.

Under the terms of the agreement, InSite Vision is responsible for obtaining regulatory approval of AzaSite in the United States and Canada. No more than twenty-five days after obtaining regulatory approval for a country, InSite Vision will be responsible for transferring the applicable regulatory documentation to us regarding AzaSite, including the NDA and Canadian equivalent. Thereafter, we will be responsible for all regulatory obligations and strategies relating to the further development and commercialization of products in the United States and Canada.

We also have an exclusive option to negotiate a license agreement with InSite Vision for AzaSite Plus^TM, a combination antibiotic/corticosteroid product formulated with DuraSite technology.

The license agreement can be terminated by us for convenience after the earlier of (i) the regulatory approval of the AzaSite product in the United States or (ii) April 27, 2008. We may also terminate the license agreement prior to the first commercial sale of a subject product upon 90 days notice to InSite Vision and after the first commercial sale of a subject product upon 180 days notice to InSite Vision.

Contemporaneously with the license agreement, InSite Vision entered into an exclusive license agreement with Pfizer for certain Pfizer patent rights relating to the treatment of ocular infection with azithromycin for certain products. Under the terms of our license agreement with InSite Vision, we obtained from InSite Vision a sublicense to such Pfizer patent rights, in addition to the license to the InSite Vision patent rights, subject to certain limitations. Also, Inspire and Pfizer have entered into a related agreement that provides for the continuation of our sublicense rights under the Pfizer patent rights upon a termination of the license agreement between InSite Vision and Pfizer. The agreement between us and Pfizer also provides an opportunity to cure any breaches by InSite Vision of the license agreement between InSite Vision and Pfizer and the opportunity to maintain and enforce such Pfizer patent rights under certain circumstances. In combination with the DuraSite patents held by InSite Vision, AzaSite is expected to have patent protection through 2019.

Inspire and InSite Vision have also entered into a trademark license agreement on February 15, 2007 under which InSite Vision granted to us an exclusive license to the AzaSite trademark and domain name and a nonexclusive license to the DuraSite trademark in connection with the commercialization of subject products in the United States and Canada under the terms of the license agreement. In addition, we have entered into a supply agreement dated February 15, 2007 with InSite Vision for the active pharmaceutical ingredient azithromycin. Previously, InSite Vision has entered into a third-party supply agreement for the production of such active ingredient. Under the supply agreement, InSite Vision has agreed to supply our requirements of active ingredient, pursuant to certain forecasting and ordering procedures. The initial term of the supply agreement is until 2012, subject to certain customary termination provisions, such as termination for material breach of the agreement. Either we or InSite Vision may terminate the supply agreement upon 180 days notice to the other party. After 2012, the supply agreement automatically renews for successive three-year periods unless terminated pursuant to such termination provisions. The supply agreement requires that InSite Vision produce for us a specified stockpile of active ingredient. The supply agreement also contains certain provisions regarding the rights and responsibilities of the parties with respect to manufacturing specifications, delivery arrangements, quality assurance, and regulatory compliance, as well as certain other customary matters.

InSite Vision previously entered into an agreement with Cardinal Health PTS, LLC, or Cardinal, for the manufacture of the finished product AzaSite. Under the terms of our license agreement, the parties have agreed to

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arrangements intended to facilitate our access to finished product manufactured by Cardinal on an interim basis and to facilitate execution of a longer-term arrangement for finished product supply.

Santen Pharmaceutical Co., Ltd.

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

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

Under the terms of the agreement, we received an up-front equity investment of $1.5 million in exchange for shares of our preferred stock in December 1998, that were subsequently converted into shares of our common stock. During 2000, we received a milestone payment of $500,000 based on achievement of a regulatory milestone by Santen. In March 2006, Santen completed its Phase 2 clinical trial testing of diquafosol tetrasodium in Japan for which we received a milestone payment of $1.25 million. Depending on whether all milestones are achieved, we could receive up to an additional $3.0 million, as well as royalties on net sales of a licensed product, if the product candidate is approved for commercialization in Santen’s licensed territories. In 2006, Santen began Phase 3 clinical trials in Japan for diquafosol tetrasodium.

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

Wisconsin Alumni Research Foundation

In November 2004, we licensed several patents for use in developing and commercializing new treatments for glaucoma from WARF. Under the terms of the agreement, we paid an upfront licensing payment of $150,000 and a $50,000 milestone payment related to the filing of an IND for our glaucoma program in 2006. We are obligated for additional contingent payments of up to an aggregate of $1.8 million upon the achievement of development milestones, and royalties on sales of any regulatory approved product utilizing the licensed patents.

We will design and fund all future research, development, testing, regulatory filings and potential marketing activities related to any product candidate under development or product developed from the license. Unless terminated earlier, the agreement will expire on a country-by-country basis upon the expiration of the patents in such country. The U.S. government may have limited rights in some of this patented technology. If we fail to meet performance milestones relating to the timing of regulatory filings or pay the minimum annual payments under this license, WARF may terminate the license.

Research and Development

Since our inception, we have made substantial investments in research and development. During the years ended December 31, 2006, 2005 and 2004, we spent $42.5 million, $23.6 million and $25.7 million, respectively, on research and development activities.

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Research and Preclinical Development

We have a fully integrated research and preclinical organization with expertise in medicinal chemistry, development chemistry, molecular pharmacology, biochemistry, screening and preclinical drug evaluation. We have invested in state-of-the-art equipment as well as internal and contracted laboratory space for performing synthetic, process, and analytical chemistry, determination of compound structure and biological activity, and evaluation of drug efficacy, pharmacokinetics, pharmacodynamics, and tolerability. We continue to identify and synthesize new chemical entities with promising activity, stability and metabolic profiles for further testing in the respiratory/allergy and ophthalmic therapeutic areas. We have access to a variety of preclinical disease models in these therapeutic areas to conduct proof-of-concept efficacy experiments for evaluating new drug targets and compounds to make decisions in advancing a lead series through the early drug discovery process. Through the use of material transfer agreements or sponsored research agreements, we collaborate with academic institutions to advance basic and translational research and to augment our internal research capabilities. We conduct preclinical development studies to advance promising compounds to pre-IND status and conduct the requisite preclinical studies to support IND filing, if appropriate. We primarily use contract research organizations for toxicology, pharmacokinetics, toxicokinetics, and other studies required for IND and NDA regulatory submissions.

Our current innovative research programs include cytoskeletal active agents as potential treatments for glaucoma, and novel receptor and enzyme targets for pulmonary inflammation and edema. In addition we have an active research program studying the pharmacological effects (such as potency, efficacy, mechanism and duration of action) of various marketed antihistamines on cloned histamine receptors involved in itch, vasodilation, vaso-permeability, and inflammation. We routinely present our scientific research at ophthalmic, respiratory, allergy, cardiovascular, and neurobiology conferences and in peer-reviewed publications.

Development

After a molecule is determined to be an appropriate product candidate based upon our research findings and business strategy, it moves into the development function of our organization, where extensive testing of both the characteristics of the molecule and the effects it has on humans are conducted. The progression of product candidates through the various stages of development is overseen by our Portfolio Management Board. Our development function is divided into Respiratory Clinical Research, Ophthalmic Clinical Research, Pharmaceutical Sciences, Biostatistics and Data Management, and Medical/Regulatory Affairs.

When a product candidate is judged as ready for human testing, an IND is filed with the FDA that, in the absence of FDA objections, allows us to embark on human testing in the United States. Other regulatory filings outside of the United States are completed as necessary. In addition to internal resources, we collaborate with external contract research organizations that allow us to perform development activities with a limited number of staff.

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

Sales and Marketing

Beginning in 2004, we initiated commercial operations and began co-promoting Elestat and Restasis to a select number of high prescribing eye care professionals and allergists. We currently employ 64 territory managers to provide us with national sales coverage for Elestat and Restasis. We also have a marketing team and a training and operations team to support our commercialization effort. Our small, specialty sales and marketing organization focuses its promotional efforts on ophthalmologists, optometrists and allergists but in the event of an approval of AzaSite, will expand to select high prescribing pediatricians and primary care physicians. We believe our focused marketing combined with our specialty sales force effectively co-promote Elestat and

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Restasis. Eye care professionals account for the majority of the dry eye disease prescriptions and combined with the allergists, these specialties prescribe approximately half of the ocular allergies prescriptions. Our strategy for advancing Elestat, Restasis and our dry eye disease product candidate, Prolacria, if approved, is to continue to target these medical specialties.

In the United States, we are co-promoting Elestat and Restasis and intend to commercialize AzaSite and co-promote Prolacria if and when those product candidates receive FDA approval. We co-promote Restasis in the United States with Allergan, but we have primary U.S. sales and marketing responsibilities for Elestat. If AzaSite is approved, we will be responsible for all sales and marketing activities associated with this product candidate and expect to increase our sales force to a total of 98 representatives who will call on targeted specialists and selected pediatricians and primary care providers. We have not developed commercial plans for our product candidates beyond Elestat, Restasis, AzaSite and Prolacria as these plans will be dependent in large part on the timing of their commercial launch and our financial resources. We intend to establish corporate partnering, licensing or other arrangements for the marketing and sale of selected product candidates that we develop, especially outside of North America. We do not intend to develop commercial operations outside of North America. Accordingly, third parties may have significant control or influence over important aspects of the commercialization of our product candidates, including market identification, marketing methods, pricing, composition and magnitude of sales force and promotional activities. We may have limited control over the amount and timing of resources that a third party devotes to our products.

We believe our commercial operations function provides us with the foundation to leverage opportunities to market and sell other products we are developing, or products that we may in-license or otherwise acquire, and to maximize their commercial value in the United States.

Compliance

We conduct our business in an ethical, fair, honest and lawful manner. We act responsibly, respectfully and with integrity in our relationships with patients, healthcare professionals, providers, governments, regulatory entities, customers, stockholders, suppliers and vendors.

We have designated a Chief Quality and Compliance Officer who reports to the Chief Executive Officer and the Chairperson of the Audit Committee of the Board of Directors. Among other duties, this officer oversees compliance training, education, auditing and monitoring; enforces disciplinary guidelines for any infractions of our Comprehensive Compliance Program and its implementing policies and procedures; responds to any detected issues; and undertakes corrective action procedures. The Chief Quality and Compliance Officer provides updates to senior management, the Audit Committee of the Board of Directors, and to the full Board of Directors. Our controls address compliance matters relating to requirements and entities that govern public pharmaceutical companies including, but not limited to, Federal and State law, such as the Sarbanes-Oxley Act of 2002; U.S. Foreign Corrupt Practices Act of 1977; NASDAQ listing requirements; National Association of Securities Dealers; Securities and Exchange Commission; Food and Drug Administration; United States Department of Health and Human Services Office of Inspector General; and The Pharmaceutical Research and Manufacturers of America. Our written standards are designed to provide a framework for Corporate Governance in accordance with ethical standards and legal best practices. Our codes and policies that have been implemented include, but are not limited to, “Code of Ethics and Conduct Relating to Financial Affairs”; “Code of Business Ethics”; “Whistleblower Policy”; and “Code of Conduct: Promotional Interactions with Health Care Professionals”.

Manufacturing and Supply

We do not currently engage in, nor do we expect to engage in, the manufacture of bulk active pharmaceutical ingredients, or APIs, for preclinical, clinical or commercial purposes. We rely on a contract manufacturing supply arrangement with a single cGMP compliant manufacturer located in Choshi, Japan, for the development stage production of diquafosol tetrasodium and denufosol tetrasodium. We expect that this vendor

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would ultimately supply commercial quantities of these compounds. Under our agreements with Allergan, Allergan will be responsible for the manufacture and supply of Prolacria, if approved by the FDA. We have obtained several cGMP batches of these compounds from our vendor and it has completed the validation of the manufacturing process for Prolacria. In the case of the Phase 3 oral tablet formulation of bilastine and all other formulations of bilastine, we intend to negotiate a supply agreement pursuant to which FAES will supply us with the bulk bilastine as API for our use in manufacturing, developing and commercializing the bilastine compound. It has been agreed that Boehringer Ingelheim, located in Germany, will be responsible for supplying us with active drug substance for our epinastine nasal spray development program. We have entered into a supply agreement with InSite Vision for the supply of the API azithromycin for use in the manufacture of the finished product AzaSite. InSite Vision previously entered into a thirty-party supply agreement for the production of the API for azithromycin and an agreement with Cardinal Health PTS, LLC for the manufacture of the finished product AzaSite. Under the terms of our license agreement with InSite Vision, the parties have agreed to arrangements intended to facilitate our access to finished product manufactured by Cardinal on an interim basis and to facilitate execution of a longer-term arrangement for finished product supply.

Manufacturing facilities in non-U.S. countries are subject to inspection by the FDA as well as manufacturing requirements of the local regulatory authorities. Actions by local authorities for failure to comply with one or more local requirements could affect the status of the site for manufacturing product for the U.S. market either by notice to the FDA of a cGMP issue or indirectly by affecting production and availability of product for export to the United States. We presently depend on sole manufacturers of APIs for our current clinical development programs. See “Risk Factors—Reliance on a single party to manufacture and supply either finished product or the bulk active pharmaceuticals ingredients for a product or product candidates could adversely affect us.”

In addition to the bulk APIs, our products incorporate pharmacopeial grade excipients such as sodium chloride, sodium hydroxide and hydrochloric acid, all of which are readily available from numerous sources. Some of our clinical trial materials are packaged in form-fill-seal vials, which are manufactured by a single vendor, but similar vials are also available from other commercial filling and packing companies.

We conduct qualification and routine audits of our contract manufacturers. These contract manufacturers are identified in our regulatory agency filings, such as with the FDA, and are subject to regulatory agency inspections. We also attempt to stay informed on the financial condition of contract manufacturers and their status with regulatory agencies.

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

Patents and Proprietary Rights

We believe that the proprietary protection of our product candidates, processes and know-how is important to the success of our business. We aggressively file and prosecute patents covering our proprietary technology and, if warranted, will defend our patents and proprietary technology. Patent applications have been filed on discoveries made in support of the WARF and Boehringer Ingelheim technologies, from research conducted with collaborators and in our own laboratories. We seek patent protection for our proprietary technology and products in the United States and Canada and in key commercial European and Asia/Pacific countries and other major commercial sectors of the world, as appropriate. We seek trademark protection in the United States and foreign countries, as appropriate. We also rely upon trade secrets, know-how, continuing technological innovation and licensing opportunities to develop and maintain our competitive position.

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

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

Competition

Many pharmaceutical and biotechnology companies engage in research and development to commercialize products to treat allergic and bacterial conjunctivitis, dry eye disease, cystic fibrosis, allergic rhinitis, glaucoma, and other diseases that we are researching. We compete with these companies for funding, access to licenses, personnel, third-party collaborators and product development. However, most large pharmaceutical and biotechnology companies have significantly larger intellectual property estates than we do, substantially greater financial, marketing, sales, distribution and technical resources and greater capabilities and experience than we do in preclinical and clinical development, sales, marketing, manufacturing and regulatory affairs. The introduction of new products or the development of new processes by competitors or new information about existing products may result in price reductions or product replacements, even for products protected by patents.

The following treatments may compete with our products and product candidates:

Allergic Conjunctivitis. There are multiple therapies available to treat or prevent allergic conjunctivitis. The primary products that Elestat competes with are Patanol^® and Pataday^®, both by Alcon, Inc.; Zaditor^® by Novartis and its related generic; and Optivar^® by MedPointe Pharmaceuticals. Patanol currently has the majority of the prescriptions in the allergic conjunctivitis market.

Allergic Rhinitis. The current prescription nasal treatments for allergic rhinitis include Flonase^® and Beconase AQ^®, both by GlaxoSmithKline; Nasonex^®, by Schering-Plough; Nasacort AQ^®, by Sanofi-Aventis; Rinocort Aqua^®, by AstraZeneca; Astelin^®, by MedPointe Pharmaceuticals; and ciclesonide, by Altana/Nycomed.

The current prescription oral treatments for allergic rhinitis include Zyrtec^®, by Pfizer; Clarinex^® and Claritin^®, both by Schering-Plough; and Allegra^®, by Sanofi-Aventis. Potential products include Xyzal^®, by UCB.

Bacterial Conjunctivitis. The current prescription treatments for bacterial conjunctivitis include Vigamox^® and Ciloxan^®, both by Alcon; Zymar^® and Ocuflox^®, both by Allergan; and Quixin^® by Vistakon Pharmaceuticals, LLC (single-entity); Zylet^® by Bausch & Lomb, Inc.; and TobryaDex^® by Alcon (combination products). In addition, there are several generics used to treat bacterial conjunctivitis which include erythromycin, gentamycin and tobramycin.

Cystic Fibrosis. There are two products approved in the United States specifically for the treatment of complications of cystic fibrosis lung disease: Pulmozyme^®, by Genentech, Inc., an agent designed to break up thickened airway secretions, and TOBI^®, by Novartis, an inhaled antibiotic. Academic groups have completed at least one clinical trial that demonstrated clinical benefit of hypertonic saline. At least one clinical trial has been completed that demonstrated clinical benefit with Zithromax^®, by Pfizer, Inc., an oral antibiotic. Although Zithromax has not been officially approved by the FDA for use in cystic fibrosis, in some cases, it has been

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added to the treatment regimen in patients with evidence of airway infection. In addition, Gilead Sciences, Inc. is developing and conducting Phase 3 trials of aztreonam lysine for inhalation, an antibiotic therapy for cystic fibrosis. Pharmaxis is developing and conducting Phase 3 clinical trials of Bronchitol^TM, an agent designed to increase mucus clearance in cystic fibrosis patients. Vertex Pharmaceuticals is developing and conducting a Phase 1 clinical trial of VX-770, a potentiator compound that may act to restore the function of the cystic fibrosis transmembrane conductance regulator (CFTR) protein. Predix Pharmaceuticals has preclinical programs related to cystic fibrosis but no compounds in clinical development.

Dry Eye Disease. The current prescription and non-prescription treatments for dry eye disease include Restasis by Allergan; artificial tear solutions and lubricant eye drops. In addition to our development program for Prolacria, several other companies are attempting to develop dry eye therapies. Candidates in various phases of clinical development include: rimexolone by Alcon, Inc.; OPC-12759 (rebamipide), by Novartis, licensed from Otsuka Pharmaceuticals; ecabet sodium by ISTA Pharmaceuticals, licensed from Senju; VISMED^® (sodium hyaluronate) by Lantibio, Inc., licensed from TRB Chemedica; ProGraf/FK-506, by Fujisawa Healthcare, Inc.; pimecrolimus by Novartis; and NP50301 by Nascent Pharmaceuticals; ALTY-0501 (doxycycline 0.05%) by Alacrity Biosciences; and CF101 by Can-Fite BioPharma.

Glaucoma. The current prescription treatments for glaucoma include Xalatan^®, by Pfizer; Alphagan^® and Lumigan^®, by Allergan; Cosopt^®, by Merck & Co., Inc. and Azopt^® and Travatan^® by Alcon.

Governmental Regulation

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

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

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

• The submission of an NDA to the FDA; and

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

Preclinical tests include laboratory evaluation of product toxicity and formulation, as well as animal studies. The results of preclinical testing are submitted to the FDA as part of an IND. A 30-day waiting period after the filing of each IND is required before the commencement of clinical testing in humans. At any time during this 30-day period or later, the FDA may place a clinical hold and halt proposed or ongoing clinical trials for any one of several conditions that are set out in regulations, and the clinical trial may not resume until the FDA withdraws its hold on the clinical trials. The IND process may be costly and substantially delay development of our products. Moreover, positive results of preclinical tests will not necessarily indicate positive results in clinical trials.

Clinical trials to support NDAs are typically conducted in three sequential phases, but the phases may overlap. During Phase 1, the initial introduction of the drug into healthy volunteers, the drug is tested to assess metabolism, pharmacokinetics and pharmacological actions and safety, including side effects associated with increasing doses.

Phase 2 usually involves studies in a limited patient population to:

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

• Assess dosage tolerance and optimal dosage; and

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• Identify possible adverse effects and safety risks.

If a compound is found to be potentially effective and to have an acceptable safety profile in Phase 2 evaluations, Phase 3 clinical trials, also called pivotal studies, major studies or advanced clinical trials, are undertaken to further demonstrate clinical efficacy and to further test for safety within an expanded patient population at geographically dispersed clinical trial sites. In general, the FDA requires that two adequate and well-controlled Phase 3 clinical trials be conducted.

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

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

We and all of our contract manufacturers are also required to comply with the applicable FDA cGMP regulations to ensure that the product can be consistently manufactured to meet the specifications submitted to the FDA in an NDA. Current good manufacturing practice regulations include requirements relating to product quality as well as the corresponding maintenance of records and documentation. Manufacturing facilities are subject to inspection by the FDA. These facilities must be approved by the FDA before we can use them in commercial manufacturing of our products. Based on an inspection, the FDA determines whether manufacturing facilities are in compliance with applicable regulations and could conclude that our contract manufacturers or we are not in compliance with one or more applicable cGMP requirements and other FDA regulatory requirements. Manufacturing facilities in non-U.S. countries are subject to inspection by the FDA as well as the local requirements of the local regulatory authorities. Actions by local authorities for failure to comply with one or more local requirements could affect production and availability of product in relevant markets.

We must also comply with multiple requirements and best practices associated with the marketing, sale and distribution of our products and product samples. These include, but are not limited to, compliance with Federal and State reporting laws; review, approval and distribution of product promotional materials; review and monitoring of promotional and educational programs; and distribution of product samples.

In the event of an approval of AzaSite, we will also be responsible for monitoring the safety of our products, reporting adverse events, and taking corrective actions as necessary. In addition, we will contract with managed care organizations for both private and government programs, including Medicare Part D. We will also contract directly with the government for certain programs, and with the Medicaid program. Without adequate levels of reimbursement by government health care programs and private health insurers, the market for our products will be limited. While we expect to work with the major private insurance carriers with respect to coverage for any product, if our efforts are not successful, the sales of any product would be negatively impacted. We have no experience in these matters and the implementation of the appropriate steps may take significant time and resources.

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

Health Care Reform Measures and Third-Party Reimbursement

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

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, or MMA, established a new 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, or CMS, within the Department of Health and Human Services, or HHS. CMS has issued extensive regulations and other subregulatory guidance documents implementing the new benefit. Moreover, the HHS Office of Inspector General has issued regulations and other guidance in connection with the program. Allergan has contracted with Part D plan sponsors to cover our drugs under the Part D benefit.

The federal government can be expected to continue to issue guidance and regulations regarding the obligations of Part D sponsors and their subcontractors. Participating drug plans may establish drug formularies that exclude coverage of specific drugs, and payment levels for drugs negotiated with Part D drug plans 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 our drugs will be offered by drug plans participating under the Medicare Part D program that, if covered, the terms of any such coverage, or that covered drugs will be reimbursed at amounts that reflect current or historical levels. Allergan is responsible for the implementation of the Medicare Part D program as it relates to Elestat and Restasis. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2007 and in future years from the Medicare prescription drug coverage legislation. 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.

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Employees

As of January 31, 2007, we had approximately 170 full-time and part-time employees. In addition, we utilize interns, outside contractors and consultants as needed. Our future success will depend in large part upon our ability to attract and retain highly qualified personnel. Our employees are not represented by any collective bargaining agreements, and we have never experienced a work stoppage. Employees are required to execute confidentiality and assignment of intellectual property agreements.

Internet Information

Our internet site is located at www.inspirepharm.com. Copies of our reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports may be accessed from our website, free of charge, as soon as reasonably practicable after we electronically file such reports with, or furnish such reports to, the Securities and Exchange Commission, or SEC. Please note that the information contained on our website is not incorporated by reference into our reports that are filed with the SEC. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is www.sec.gov.

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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 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, and if foreign governments do not conclude that our product candidates meet their requirements for marketing, we will be unable to commercialize those product candidates in those foreign markets.

To achieve profitable operations, we must, alone or with others, successfully identify, develop, introduce and market products. We have not received marketing approval for any of our product candidates, although we are co-promoting two products with Allergan. We have one product candidate, Prolacria, for which we have received two approvable letters from the FDA. In addition, an NDA has been filed with respect to AzaSite. There is no guarantee that the FDA will approve either AzaSite or Prolacria and allow the commercialization of either product in the United States. It may be necessary to undertake additional Phase 3 clinical trials in support of the NDA for AzaSite and/or Prolacria and there can be no guarantee that any such additional clinical trials would be successful or that the FDA would approve AzaSite and/or Prolacria even if such additional clinical trials were successful. If additional Phase 3 clinical trials for AzaSite are required by the FDA, InSite Vision may decide not to conduct those clinical trials and if additional Phase 3 clinical trials for Prolacria are required by the FDA, we may decide not to conduct those clinical trials, both of which would result in the inability to obtain FDA approval of either product candidate. Even if FDA approval is received for AzaSite or Prolacria, we (and, in the case of Prolacria, Allergan) may not be able to successfully commercialize the products in the United States.

We have licensed bilastine, an oral antihistamine compound for the treatment or prevention of allergic rhinitis, from FAES, for development and commercialization in the United States and Canada. FAES is currently conducting a thorough QT/QTc clinical trial in the United States of an oral formulation of bilastine to confirm the cardiac safety profile of this product candidate. If this QT/QTc clinical trial is not successful, it is unlikely that we will be able to commercialize bilastine in the United States or Canada. Although FAES previously conducted two large, potentially pivotal Phase 3 seasonal allergic rhinitis clinical trials of an oral tablet formulation of bilastine outside the United States, other than the ongoing QT/QTc clinical trial, no other clinical trials have been conducted in the United States. We have not yet met with the FDA to discuss this product candidate and it may be necessary to conduct an additional Phase 3 clinical trial in the United States in support of an NDA filing. There can be no guarantee that the QT/QTc clinical trial or any additional clinical trial will be successful, or that the FDA would approve bilastine even if such clinical trials are successful. Even if we do receive FDA approval for bilastine, we may not be able to successfully commercialize bilastine in the United States and Canada.

In addition to AzaSite, Prolacria and the oral tablet formulation of bilastine, we have other product candidates in clinical and preclinical development. A substantial amount of work will be required to advance these product candidates through clinical testing and ultimately to commercial approval. We will have to conduct significant additional development activities, non-clinical and clinical tests and obtain regulatory approval before our product candidates can be commercialized. Product candidates that may appear to be promising at early

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

• 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;

• 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.

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.

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, which the FDA evaluates 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. However, the FDA has not published guidelines on the approval of a

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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 such product has a different mechanism of action from Prolacria. It may be necessary to undertake additional Phase 3 clinical trials in support of our NDA for Prolacria and there can be no guarantee that any such additional clinical trials would be successful or that the FDA would approve Prolacria even if such additional clinical trials were 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. Even if such clinical trials are successful, we cannot predict when, or if, the FDA or other regulatory authorities will approve denufosol and allow its commercialization.

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.

Other activities required before submitting an NDA include regulatory preparation for submission, biostatistical analyses, scale-up synthesis, and validation of commercial product. In addition, prior to product launch, production of a certain amount of commercial grade drug product inventory meeting FDA cGMP standards is required, and the manufacturing facility must pass a pre-approval inspection conducted by the FDA to determine whether the product can be consistently manufactured to meet cGMP requirements and to meet specifications submitted to the FDA.

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;

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• 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.

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, parallel versus sequential timing of our clinical trials, 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 and usually younger patients who do not typically participate in clinical trials since new products are generally focused on the sicker patient population. In addition, due to the age group of these mild patients, many will be in school and will be required to take the medication three times-a-day. Even if we successfully complete clinical trials, we may not be able to submit any required regulatory submissions in a timely manner and we may not receive regulatory approval for the product candidate. In addition, if the FDA or foreign regulatory authorities require additional clinical trials, we could face increased costs and significant development delays.

The timing of the registration process with the FDA for the oral formulation of bilastine for the treatment and prevention of allergic rhinitis may be impacted by the outcome of ongoing clinical studies. FAES met with the FDA in 2005 to discuss potential work that might be required for an NDA submission. The FDA advised FAES to perform a thorough QT/QTc clinical trial designed utilizing FDA guidance. In September 2006, the QT/QTc clinical trial was initiated at a United States-based center. The results of this clinical trial are expected to be available in the second quarter of 2007. The results of the QT/QTc clinical trial, as well as the outcome of our meeting with the FDA related to bilastine, could increase development costs, result in significant development delays or result in the cancellation of the program.

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

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

If we fail to reach milestones or to make annual minimum payments or otherwise breach our obligations under our license agreements, our licensors may terminate our agreements with them.

We have acquired exclusive rights to develop and commercialize AzaSite and bilastine in the United States and Canada under licensing agreements with InSite Vision and FAES, respectively. Furthermore, we have a license agreement for glaucoma technologies with WARF, and a development and license agreement with Boehringer Ingelheim which grants us certain exclusive rights to develop and market an intranasal dosage form of epinastine, in the United States and Canada, for the treatment or prevention of rhinitis. 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.

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.

Risks Related to Product Commercialization

Failure to successfully market and commercialize 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.

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. 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 Elestat and Restasis will exceed the related selling, promoting and marketing expenses associated with co-promotion activities for these products during the year ending December 31, 2007. 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 the products are listed and making the appropriate regulatory and other filings. Inclusion on certain formularies may require price concessions through rebate programs that impact the level of co-promotion revenue that we receive on a product. The need to give price concessions can be particularly acute where a greater number of competing products are listed on the same formulary. Presently, there are a large number of competing products in the allergic conjunctivitis area. As a result, our revenues from net sales of Elestat have been partially offset by higher rebates associated with formulary additions to state Medicaid plans and to a lesser extent to formulary additions

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on commercial and Medicare Part D plans. In 2006, Elestat lost coverage under several state Medicaid plans. While we do not expect the loss of these coverages to significantly impact our portion of the co-promotion revenue due to the large price concessions associated with these particular states, future loss of coverage under additional states or commercial plans may have a negative impact on our co-promotion revenue.

The commercial marketing exclusivity period for Elestat provided under the Hatch-Waxman Act will expire in October 2008, after which time Elestat could face generic or over-the-counter competition if there is no other intellectual property or marketing exclusivity protection covering Elestat. We are aware that several generic pharmaceutical companies have expressed intent to commercialize the ocular form of epinastine after the commercial exclusivity period expires. While we are exploring various possible forms of additional intellectual property coverage to protect the commercialization of Elestat in the United States, there can be no 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 in October 2008. If a generic form of Elestat 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 cease. Loss of our co-promotion revenue from Elestat will materially impact our results of operations and cash flows.

In December 2004, Alcon, Inc. received FDA approval of Pataday^®, once-daily olopatadine hydrochloride ophthalmic solution. In January 2007, Alcon launched Pataday. Both Pataday and Patanol^® (olopatadine hydrochloride ophthalmic solution), that requires administration twice-a-day, currently compete with Elestat. In October 2006, Novartis received approval for an over-the-counter version of Zaditor^®, and there is a generic version of Zaditor currently available. We cannot predict what effect, if any, the introduction of these new products will have on our future co-promotion revenues related to Elestat.

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

• Satisfaction with existing alternative therapies;

• Perceived efficacy relative to other available therapies;

• Extent and effectiveness of our promotion 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;

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

• Cost of treatment;

• Marketing and sales activities of competitors;

• Duration of market exclusivity of Elestat and Restasis;

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

• 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, or the effects of competition and managed health care on, sales of either product.

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We have had limited experience in sales and marketing of products.

We have established a sales force to market and promote Elestat and Restasis as well as other potential products. Although the members of our sales force have had experience in sales with other companies, prior to 2004 we never had a sales force and we may undergo difficulties maintaining the sales force. We have incurred substantial expenses in establishing and maintaining the sales force, including substantial additional expenses for the training and management of personnel and the infrastructure to enable the sales force to be effective and compliant with the multiple laws and regulations affecting sales and promotion of Elestat and Restasis. We expect to continue to incur substantial expenses in the future. The costs of maintaining our sales force may exceed our product revenues.

If AzaSite is approved, we intend to expand our sales force to 98 sales representatives, to call on eye care professionals, who we currently call on, and select high prescribing pediatricians and primary care physicians. We have never called 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 and candidates, compete for the time and attention of pediatricians and primary care physicians. Furthermore, if additional products are approved, we will consider substantially expanding our sales force. We may not be able to successfully attract and retain the desired number of qualified sales personnel.

In addition, we have no prior experience in negotiating managed care agreements and government contracts, or managing regulatory-related compliance activities such as pharmacovigilance, all of which will be our responsibility if AzaSite is approved.

Failure to adequately market and commercialize AzaSite, Prolacria and other product candidates will limit our revenues.

If approved by the FDA in the United States and other applicable regulatory authorities outside the United States, the commercial success of AzaSite, Prolacria and other candidates will largely depend on a number of factors, including:

• The timing and scope of the product’s launch into the United States and other applicable pharmaceutical markets;

• Acceptance by patients and physicians;

• The effectiveness of our (or our partner’s) sales and marketing efforts;

• A knowledgeable sales force;

• Adequate market penetration;

• Reimbursement under commercial or government plans;

• Successfully contracting for manufacturing capability and distribution services to meet demand;

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

• Our ability to enter into managed care agreements;

• Our ability to expand the indications for which we can market applicable product; and

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

In the event AzaSite is approved by the FDA in April 2007, we expect to be in a position to launch the product in the second half of 2007. The timing of the launch is dependent upon a number of factors, including hiring and training additional employees, and entering into contracts related to supply chain management and managed care. The implementation of these and other steps related to a product launch will take significant time

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and resources. We do not currently have the necessary infrastructure in place to support such a launch and there can be no assurance that we will have the necessary infrastructure in place to support such a launch by the second half of 2007, if at all.

In the case of Prolacria, our revenue on its net sales would be largely dependent on the actions and success of Allergan, over whom we have no control. In the event Prolacria is approved by the FDA, we plan to co-promote Prolacria within the United States; however, Allergan is primarily responsible for launching and marketing Prolacria in the United States and other major worldwide pharmaceutical markets, excluding certain Asian markets. If AzaSite, Prolacria and other product candidates are not successfully commercialized, our revenues may be limited.

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

The manufacturing of sufficient quantities of new and/or approved 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. With the exception of (i) AzaSite for which we have contracted with InSite Vision for APIs and for which we will be responsible for contracting with a third-party manufacturer to manufacture and supply AzaSite in finished product form, (ii) Santen, for which we are required to supply bulk APIs, and (iii) bilastine for which we will be responsible for contracting with a third-party manufacturer to manufacture and supply bilastine in finished product form, all of our partners are responsible for making their own arrangements for the manufacture of drug products, including arranging for the manufacture of bulk APIs. Our dependence upon third parties for the manufacture of both drug substance and finished drug products that remain unpartnered may adversely affect our ability to develop and deliver such products on a timely and competitive basis. Similarly, our dependence on our partners to arrange for their own supplies of finished drug products may adversely affect our operations and revenues. If we, or our partners, are unable to engage or retain third-party manufacturers on commercially acceptable terms, our products may not be commercialized as planned. Our strategy of relying on third parties for manufacturing capabilities presents the following risks:

• The manufacturing processes for most of our APIs and finished products 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, which could harm our reputation in the medical and scientific communities;

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

• The FDA may inspect a facility to confirm cGMP compliance and adherence to the specifications submitted to the FDA before an NDA is approved and the facility is subject to ongoing post-approval FDA inspections to ensure continued compliance with cGMP regulations;

• If the manufacturing facility does not maintain cGMP compliance after NDA approval, the FDA has the authority to seize product produced under such conditions and may seek to enjoin further manufacture and distribution, as well as other equitable remedies such as mandatory recall;

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

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• We may not have intellectual property rights, or may have to share intellectual property rights, to any improvements in the manufacturing processes or new manufacturing processes for our product candidates; and

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

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

Under our agreements with Allergan, Allergan is responsible for the manufacture and supply of Elestat, Restasis, and Prolacria, if approved by the FDA. It is our understanding that Allergan relies upon an arrangement with a single third party for the manufacture and supply of APIs for each of Elestat, Restasis, and for Prolacria. Allergan then completes the manufacturing process to yield finished product.

If AzaSite is approved, we will be responsible for the manufacture of the drug pursuant to regulatory requirements. Under our supply agreement with InSite Vision, InSite Vision will be 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 will be responsible for producing the finished product form of AzaSite, which we currently anticipate will be manufactured by a single party.

In the event a third-party manufacturer is unable to supply Allergan and InSite Vision (as the case may be), if such supply was 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, and one vendor as the sole manufacturer of epinastine. We intend to contract with these vendors, as necessary, for commercial scale manufacturing of our products where we are responsible for such activities. In the case of Prolacria, we expect Allergan to purchase commercial quantities of bulk APIs from a sole manufacturer, including initial launch quantities should the product candidate receive FDA approval. In the case of the Phase 3 oral tablet formulation of bilastine and all other formulations of bilastine, we intend to negotiate a supply agreement pursuant to which FAES will supply us with the bulk bilastine as API for our use in manufacturing, developing and commercializing the bilastine compound. However, we can make no assurance that a supply agreement will be completed in a timely manner, if at all, or that the terms and conditions of such agreement will be acceptable. In addition, we believe that FAES intends to rely upon a single third-party manufacturer for the manufacture and supply of API and that FAES has not entered into a final, binding agreement with such a manufacturer. We will have no control over the terms and conditions of such an agreement between FAES and a third-party manufacturer and the terms and conditions of such agreement may not be acceptable to us. We have not identified an alternative source for the supply of bulk bilastine or a third party to manufacture bilastine in finished product form. We may not be successful in identifying such parties or in entering into acceptable agreements with a party, when they are identified. Delays in any aspect of implementing the manufacturing process could cause significant development delays and increased costs.

In addition, if Allergan, FAES or any third-party manufacturer do not maintain cGMP compliance, the FDA could require corrective actions or take enforcement actions that could affect production and availability of the product thus adversely affecting sales. We presently depend on sole manufacturers of APIs for our product

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candidates and it would be time consuming and costly to identify and qualify new sources. 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, specialized biotechnology firms and universities and other research institutions. Competitors in our core therapeutic areas include: Allergan; Alcon, Inc.; Bausch & Lomb; ISTA Pharmaceuticals, Inc.; Lantibio, Inc.; MedPointe Pharmaceuticals; Merck & Co, Inc.; Nascent Pharmaceuticals; Novartis; Otsuka America Pharmaceutical, Inc.; Pfizer, Inc.; Santen Senju Pharmaceutical Co. Ltd.; Sucampo Pharmaceuticals, Inc.; Vistakon Pharmaceuticals (ophthalmic); Gilead Sciences, Inc.; Genaera Corporation; Genentech, Inc.; Novartis; Predix Pharmaceuticals Holdings, Inc.; Vertex Pharmaceuticals Inc. (cystic fibrosis); AstraZeneca; GlaxoSmithKline; MedPointe Pharmaceuticals; Pfizer; Sanofi-Aventis; and Schering-Plough (allergic rhinitis). Most of these competitors have greater resources than us, 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 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, to treating diseases that we have targeted, such as cystic fibrosis, may make our product candidates obsolete.

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

We have developed a commercialization organization to co-promote Elestat, Restasis, and Prolacria, if approved, but we are dependent on Allergan, or other experienced third parties, to perform or assist us in the marketing, distribution or sale of these products and our product candidates. In addition, we may not identify acceptable partners or enter into favorable agreements with them for our other product candidates. If AzaSite is approved, we will rely on the services of a third-party distributor to deliver our product to our customers. 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

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compete successfully, which may not be possible. If Allergan or other third parties 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 and our overall operations.

If physicians and patients do not accept our product candidates, they will not be commercially successful.

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

• Acceptance by physicians and patients of our products as safe and effective therapies;

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

• 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 our products.

In addition, to achieve broad market acceptance of our product candidates, in many cases we will need to develop, alone or with others, convenient methods for administering the products. 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, 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 methods of administration for our other product candidates.

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 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. Failure to comply with applicable regulatory requirements could, among other things, result in fines, 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 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, and subsequent discovery of previously unknown problems with a product, manufacturing process or facility may result in restrictions, including withdrawal of the product from the market. The FDA is permitted to revisit and change its prior determinations and based on new information it may change its position with regard to the safety or effectiveness of our products. The FDA is authorized to impose post-marketing requirements such as:

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

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• 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 after approval;

• Suspending manufacturing;

• Recalling products;

• Withdrawing marketing approval;

• Seizing adulterated, misbranded or otherwise violative products;

• Seeking to enjoin the manufacture or distribution, or both, of 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 rescinding previous advertisements or promotion; 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 alleged also to violate 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.

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, or MMA, 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, or CMS, within the Department of Health and Human Services, or HHS. CMS has issued extensive regulations and other subregulatory guidance documents implementing the new benefit. Moreover, the HHS Office of Inspector

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General has issued regulations and other guidance in connection with the program. Allergan is responsible for the implementation of the Medicare Part D program as it relates to Elestat and Restasis and has contracted with Part D plan sponsors to cover such drugs under the Part D benefit. We will be responsible for contracting with Part D plan sponsors with respect to AzaSite, if it is approved.

The federal government can be expected to continue to issue guidance and regulations regarding the obligations of Part D sponsors and their subcontractors. Participating drug plans may establish drug formularies that exclude coverage of specific drugs, and payment levels for drugs negotiated with Part D drug plans 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 offered by drug plans participating under the Medicare Part D program that, if covered, the terms of any such coverage, or that covered drugs will be reimbursed at amounts that reflect current or historical levels. Our results of operations could be materially adversely affected by the reimbursement changes emerging in 2007 and in future years from the Medicare prescription drug coverage legislation. 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.

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. These entities include the Department of Justice and its United States Attorneys Offices, the Office of Inspector General of the Department of Health and Human Services, the FDA, the Federal Trade Commission, and various state Attorneys General offices. Many health care laws, including the federal and state anti-kickback laws and 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 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, which also could be instituted as the result of the filing of a qui tam or whistleblower suit by a private relator, 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.

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

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the provision of our products. While we have implemented corporate quality, ethics and compliance programs based on current best practices, we cannot guarantee against all possible transgressions. Moreover, pharmaceutical manufacturers in recent years 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, in such areas as pricing practices, off-label product promotion, sales and marketing practices, improper relationships with physicians and other healthcare professionals, among others. The potential ramifications are far-reaching if there are areas identified as out of compliance by regulatory agencies including, but not limited to, significant financial penalties, manufacturing and clinical trial consent decrees, commercialization restrictions or other restrictions and litigation. 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.

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, Inspire 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. Briefing on that motion is now complete and it is currently pending before the court.

We intend to defend the litigation vigorously. No assurance can be made that we will be successful in our defense of the pending claims. If we are not successful in our defense of the claims, we could be forced to, among other ramifications, make significant payments to resolve the claims and such payments could have a material adverse effect on our business, 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 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 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.

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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 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 may seek a further meeting with 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. 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 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 Elestat and Restasis 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 Elestat and Restasis as reported to us by Allergan. Management has concluded that our internal control over financial reporting was effective as of December 31, 2006, 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.

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

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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 2004 and 2005. There can be no assurances that we or our collaborative partners will reach any additional contractual milestones during 2007 or at any later date.

Additionally, our revenues may fluctuate from period to period due in part to:

• Fluctuations in sales of Elestat, Restasis and other future licensed or co-promoted products due to competition, manufacturing difficulties, 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 as defined in our agreements, all of which are determined by Allergan and are outside our control;

• The duration of market exclusivity of Elestat and Restasis;

• The timing of approvals, if any, and the commercial launch of AzaSite and 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;

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

• Fluctuations in foreign currency exchange rates.

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 activities. Our operating expenses were approximately $83.7 million and approximately $58.8 million for the years ended December 31, 2006 and 2005, respectively. Our cash, cash equivalents and investments totaled approximately $102.3 million on December 31, 2006, which includes $20 million of debt financing we received in December 2006.

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;

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• 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 Elestat and Restasis;

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

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

• Upon any such approval, the ability to generate sufficient sales of AzaSite or Prolacria;

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

• Payments from existing and future collaborators.

In the event that we do not receive timely regulatory approvals, we may need substantial additional funds to fully develop, manufacture, market and sell all of our other potential products and support our co-promotion efforts. We may seek such additional funding through public or private equity offerings and debt financings. Additional financing may not be available when needed. If available, such financing may not be on terms favorable to us or our stockholders. Stockholders’ ownership will be diluted if we raise additional capital by issuing equity securities. If we raise funds through collaborations and licensing arrangements, we may have to give up rights to our technologies or product candidates which are involved in these future collaborations and arrangements or grant licenses on unfavorable terms. If adequate funds are not available, we would have to scale back or terminate research programs and product development and we may not be able to successfully commercialize any product candidate.

If we are unable to make the scheduled principal and interest payments on the 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 million. Upon execution of the agreement, we borrowed an initial amount of $20 million under the agreement. The loan is 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 a minimum liquidity level 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; or

• 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.

Our ability to borrow additional amounts under this agreement are subject to the satisfaction of any one of a number of conditions related to our progress in developing bilastine or our success in obtaining FDA approval for other product candidates owned by or in-licensed to us. To the extent that none of the conditions are satisfied, we

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may still borrow from the term loan facility, but only in the amount by which our research and development expenditures on bilastine and/or another in-licensed product candidate exceed the initial advance of $20 million.

In addition to the conditions above, we may not be able to borrow additional funds under this agreement if we are not able to maintain various negative and financial covenants. Events of default are not limited to, but include the following:

• Payment default;

• Covenant default;

• A material adverse change in Inspire;

• Breach of our agreements with Allegan;

• Breach of agreement with FAES; or

• 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 future advancement of credit under the term loan facility would cease;

• 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.

If we continue to incur operating losses for a period longer than anticipated, or in an amount greater than anticipated, we may be unable to continue our operations.

We have experienced significant losses since inception. We incurred net losses of approximately $42.1 million for the year ended December 31, 2006, and approximately $31.8 million for the year ended December 31, 2005. As of December 31, 2006, our accumulated deficit was approximately $245.1 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 following:

• Timing of regulatory approvals and commercial sales of our product candidates and any co-promotion products;

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

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

• Product candidate development activities in order to achieve regulatory approval;

• Timing of investments in new technologies and commercial capability;

• Commercialization activities to support co-promotion efforts; and

• The costs involved in defending any litigation claims against, 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

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achieve market success is long and uncertain. We may not generate sufficient product revenues to become profitable or to sustain profitability. If the time required to achieve profitability is longer than we anticipate, we may not be able to continue our business.

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, Boehringer Ingelheim, FAES, 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. 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 and platelet programs. We may be unsuccessful in out-licensing these programs or we may out-license these programs on terms that are not favorable to us.

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

Failure to hire and retain key personnel or to identify, appoint and elect qualified directors, may hinder our product development programs and our business efforts.

We depend on the principal members of management and scientific staff, including Christy L. Shaffer, Ph.D., our 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. We also depend upon the skills and guidance of the independent members of our Board of Directors. We presently have one vacancy on our Board of Directors. There can be no assurance that we can identify, appoint and elect qualified candidates to serve as members of the Board of Directors. 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 intense competition for such qualified personnel. We may not be able to attract and retain such personnel.

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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, many of our patents are use patents containing claims covering methods of treating disorders and diseases by administering therapeutic chemical compounds. Use patents, while providing adequate protection for commercial efforts in the United States, may afford a lesser degree of protection in other countries due to their patent laws. Besides our use patents, we have patents and patent applications covering compositions (new chemical compounds), pharmaceutical formulations and processes for large-scale manufacturing. Many of the chemical compounds included in the claims of our use patents and process applications were known in the scientific community prior to our patent applications. None of our composition patents or patent applications 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 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.

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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. We do not have the financial resources to self-insure and it is unlikely that we will have these financial resources in the foreseeable future. If we are unable to protect against potential product liability claims adequately, we may find it difficult or impossible to continue to co-promote our products, or to commercialize the product candidates we develop. If claims or losses exceed our liability insurance coverage, we may go out of business.

Our operations involve a risk of injury from hazardous materials, which could be very expensive to us.

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

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

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.

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 NDA for AzaSite or Prolacria, or foreign regulatory equivalent submissions;

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

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

• Duration of market exclusivity of Elestat and Restasis;

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• 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.

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 January 31, 2007, our current 5% stockholders and their affiliates beneficially owned approximately 42% 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:

• our merger with or into another company;

• 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 January 31, 2007, there were 42,238,355 shares of common stock outstanding. Of these outstanding shares of common stock, approximately 21,500,000 shares were sold in public offerings and are freely tradable without restriction under the Securities Act, unless purchased by our affiliates. In addition, we have the ability to issue additional shares of common stock under an active shelf registration statement, which we filed with the SEC on April 16, 2004. On March 9, 2007, we filed with the SEC a shelf registration statement on Form S-3 that will permit us, if such registration statement is declared effective by the SEC, 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. Up to 10,178,571 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 2005 Equity Compensation Plan. The shares underlying existing stock options and restricted stock units and possible future stock options, stock appreciation rights and

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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 and may be resold in the public market only if registered or if there is an exemption from registration, such as Rule 144.

If some or all of such shares are sold into the public market over a short period of time, the value of all publicly traded shares is likely to decline, as the market may not be able to absorb those shares at then-current market prices. Such sales may make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that our management deems acceptable, or at all. As of January 31, 2007, our 5 largest stockholders and their affiliates beneficially owned approximately 42% of our outstanding common stock.

Further, we may issue additional shares:

• To employees, directors and consultants;

• In connection with corporate alliances;

• In connection with acquisitions; and

• To raise capital.

Based upon our closing stock price of $6.48 on January 31, 2007, there were outstanding options, which were exercisable and in-the-money, to purchase 1,085,651 shares of our common stock. This amount combined with the total common stock outstanding at January 31, 2007 is 43,324,006 shares of common stock. As a result of these factors, a substantial number of shares of our common stock could be sold in the public market at any time causing fluctuations or reductions in our stock price.

Our Rights Agreement, the provisions of our Change in Control Severance Benefit Plan and our Change in Control Agreements with management, the anti-takeover provisions in our 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.

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

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

Our 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. Under the Bylaws, only our Chief Executive Officer, President, Chairman of the Board, Vice-Chairman of the Board or a majority of the Board of Directors are able to call special meetings. The staggering of directors’ terms of office, 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.

FORWARD LOOKING STATEMENTS

This annual report on Form 10-K, including the documents that we incorporate by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to the “safe harbor” created by those sections. Any statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “estimate,”

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“plan,” “project,” “continuing,” “believe,” “expect,” “future” and “intend” and similar expressions to identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated by any forward-looking statements, including, without limitation, the risk factors listed above and those relating to product development, revenue and earnings expectations, intellectual property rights and litigation, competitive products, results of clinical trials, the need for additional research and testing, delays in manufacturing, funding and the timing and content of decisions made by regulatory authorities, including the FDA and other factors presented throughout this annual report and any other documents filed by us with the SEC.

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

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

We lease contiguous administrative and laboratory facilities that comprise approximately 51,000 square feet in Durham, North Carolina, which is adjacent to the Research Triangle Park. The various leases underlying our facilities expire in January 2011 and are renewable. We believe our facilities are adequate to meet our current operational needs. In addition, we lease approximately 500 square feet of administrative space as a sales office in Dallas, Texas.

Item 3. 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, Inspire 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. Briefing on that motion is now complete and it is currently pending before the court.

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We intend to defend the litigation vigorously. As with any legal proceeding, we cannot predict with certainty the eventual outcome of these pending 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 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 may seek a further meeting with 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.

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

Not applicable.

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PART II

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

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

2005	High		Low
First Quarter	$	16.81	$	7.13
Second Quarter	$	9.09	$	6.24
Third Quarter	$	10.14	$	7.15
Fourth Quarter	$	8.35	$	4.63
2006	High		Low
First Quarter	$	5.70	$	4.52
Second Quarter	$	5.23	$	3.92
Third Quarter	$	5.48	$	4.16
Fourth Quarter	$	6.75	$	4.51

As of January 31, 2007, there were 60 record stockholders and approximately 4,000 beneficial stockholders of our common stock. On January 31, 2007, the last sale price reported on the Nasdaq Global Market for our common stock was $6.48 per share.

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

The following table sets forth certain information with respect to securities authorized for issuance under equity incentive plans as of December 31, 2006.

Equity Compensation Plan Information

Plan category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted-average exercise price of outstanding options, warrants and rights	(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))
Equity compensation plans approved by security holders	6,801,204	$9.90	1,192,280
Equity compensation plans not approved by security holders	0	0	0
Total	6,801,204	$9.90	1,192,280

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RELATIVE STOCK PERFORMANCE

Set forth below is a line graph comparing the percentage change in the cumulative total stockholder return on our common stock to the cumulative total return of the NASDAQ Composite Index and the NASDAQ Biotechnology Index for the period commencing December 31, 2001 and ended December 31, 2006:

	Cumulative Return Total
	12/31/01		12/31/02		12/31/03		12/31/04		12/31/05		12/31/06
INSPIRE PHARMACEUTICALS, INC.	$	100.00	$	66.29	$	100.43	$	119.02	$	36.05	$	45.07
NASDAQ COMPOSITE		100.00		71.97		107.18		117.07		120.50		137.02
NASDAQ BIOTECHNOLOGY		100.00		62.08		90.27		99.08		111.81		110.06

The graph assumes $100 was invested on December 31, 2001, in our common stock, and each of the indices, and that dividends were reinvested. The comparisons in the graph are required by the SEC and are not intended to forecast or be indicative of possible future performance of our common stock.

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Item 6. Selected Financial Data.

The selected statement of operations data and balance sheet data with respect to the years ended December 31, 2006, 2005, 2004, 2003 and 2002 set forth below are derived from our financial statements. The selected financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7 below, and our financial statements and the notes thereto appended to this annual report. Historical results are not necessarily indicative of our future results.

	(in thousands, except per share amounts)
	Year Ended December 31,
	2006			2005			2004			2003			2002
Statement of Operations Data:
Revenue	$	37,059		$	23,266		$	11,068		$	5,200		$	4,883
Operating expenses:
Research and development		42,537			23,566			25,698			27,631			25,229
Selling and marketing		25,265			23,223			21,848			2,838			60
General and administrative		15,880			12,004			9,041			7,002			5,091
Total operating expenses		83,682			58,793			56,587			37,471			30,380
Loss from operations		(46,623	)		(35,527	)		(45,519	)		(32,271	)		(25,497	)
Other income, net		4,508			3,680			1,450			876			804
Net loss	$	(42,115	)	$	(31,847	)	$	(44,069	)	$	(31,395	)	$	(24,693	)
Net loss per common share—basic and diluted	$	(1.00	)	$	(0.76	)	$	(1.25	)	$	(1.03	)	$	(0.96	)
Common shares used in computing weighted average common shares outstanding—basic and diluted		42,227			42,101			35,261			30,526			25,821

	(in thousands)
	December, 31
	2006		2005		2004		2003		2002
Balance Sheet Data:
Cash, cash equivalents and investments	$	102,281	$	122,323	$	156,796	$	75,166	$	31,629
Receivables from Allergan		8,245		4,898		3,501		—		—
Working capital		89,655		99,265		134,559		66,231		27,603
Total assets		116,699		132,446		165,696		79,678		33,564
Debt obligations, including current portion (1)		21,357		1,392		1,881		1,084		505
Total stockholders’ equity		78,371		118,689		149,598		71,052		28,998
Shares of common stock outstanding		42,238		42,211		41,845		31,847		25,855

(1) Includes capital leases.

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

Cautionary Statement

The discussion below contains forward-looking statements regarding our financial condition and our results of operations that are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted within the United States, as well as projections for the future. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. 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 Restasis and Elestat, potential competition associated with our product candidates, use of hazardous materials and retention of key employees. In order for one of our product candidates to be commercialized, it will be necessary for us, 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 obtain adequate reimbursement from government and private insurers. We cannot provide assurance that we will generate significant revenues or achieve and sustain profitability in the future. Statements contained in Management’s Discussion and Analysis of Financial Conditions and Results of Operations which are not historical facts are, or may constitute, forward-looking statements. Forward-looking statements involve known and unknown risks that could cause our actual results to differ materially from expected results. These risks are discussed in the section entitled “Risk Factors.” Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Our revenues are difficult to predict and depend on several factors. 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 the marketing and sales activities of competitors, among others. 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. Research and development expenses, including expenses for drug synthesis and manufacturing, preclinical testing and clinical research activities, depend on the ongoing requirements of our development programs, completion and/or success 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. Once again, management may in some cases be able to control the

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timing and magnitude of these expenses. In addition, we have incurred and expect to incur significant general and administrative expenses as we work to resolve our current stockholder litigation and SEC investigation.

Overview

We are a biopharmaceutical company dedicated to discovering, developing and commercializing prescription pharmaceutical products in disease areas with significant commercial potential or unmet medical needs. Our goal is to build and commercialize a sustainable pipeline of new treatments based upon our technical and scientific expertise, focusing in the ophthalmic and respiratory/allergy therapeutic areas. Our ophthalmic products and product candidates are currently concentrated in the allergic and bacterial conjunctivitis, dry eye disease and glaucoma indications. Our respiratory/allergy product candidates are currently concentrated in the treatment of respiratory complications of cystic fibrosis and seasonal allergic rhinitis indications.

In 2004, we expanded our operations beyond research and development activities by creating a commercial organization to co-promote two of Allergan’s eye products, Elestat and Restasis in the United States. In January 2004, we began co-promoting Restasis for the treatment of dry eye disease. In February 2004, we launched Elestat for the treatment of allergic conjunctivitis. Under agreements with Allergan, we receive co-promotion revenue based upon Allergan’s net sales of these products.

Prior to 2004, we devoted substantially all of our efforts to the discovery and clinical development of our product candidates as well as the establishment of strategic partnerships and our revenues consisted of payments under our various corporate partnerships established for the development and commercialization of our products if approved.

See Part I of this report for a full discussion of our co-promotion agreements with Allergan and other significant collaborative agreements.

In February 2006, we entered into a development and license agreement with Boehringer Ingelheim. The agreement grants us certain exclusive rights to develop and market an intranasal dosage form of epinastine, in the United States and Canada, for the treatment or prevention of rhinitis.

In October 2006, we entered into a licensing agreement with FAES for the U.S. and Canadian development and commercialization of bilastine, a Phase 3 oral antihistamine compound for the treatment and prevention of allergic rhinitis. FAES announced the acceptance of an IND application by the FDA in April 2006 and there is currently an ongoing thorough QT/QTc clinical trial in the United States, the top-line results of which are expected to be reported in the second quarter of 2007.

In February 2007, we signed an exclusive licensing agreement with InSite Vision for U.S. and Canadian commercialization of AzaSite for the treatment of bacterial conjunctivitis. InSite Vision previously filed an NDA for AzaSite with the FDA in June 2006. The completion of the FDA’s review of the NDA for AzaSite is expected by the end of April 2007.

See Part I of this report for a full discussion of all our in-licensing activities, as well our other product candidates in clinical development.

We have incurred significant operating losses since our inception and, as of December 31, 2006, we had an accumulated deficit of $245.1 million. We expect to incur losses for the next several years. We have financed our operations through the sale of equity securities, including private sales of preferred stock and public offerings of common stock; debt; and with revenue from corporate partnerships, including co-promotion revenue. Co-promotion revenue from Elestat and Restasis did not exceed our total operating expenses in 2006. We operate in a single business segment and do not have any foreign operations.

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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 require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, judgments and the policies underlying these estimates on a periodic basis as situations change, and regularly discuss financial events, policies, and issues with members of our audit committee and our independent 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 in recording this revenue. We routinely evaluate our estimates and policies regarding revenue recognition, taxes, clinical trial, preclinical/toxicology, manufacturing, 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 product co-promotion activities and collaborative research agreements in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements.”

We recognize co-promotion revenue based on net sales for Elestat and Restasis, as defined in the co-promotion agreements, and as reported to us by Allergan. We actively promote both Elestat and Restasis 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 Elestat and Restasis, 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, an independent provider of pharmaceutical data. 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 Elestat and Restasis. 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 sales that are subject to these incentive programs based on information reported to us by our third-party administrator of the incentive programs. In each of the years ended December 31, 2006, 2005 and 2004, the amount of rebates associated with our incentive programs 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 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 satisfied, we record revenues using a reduced percentage of net sales based upon our level of achievement of predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue. We achieved our annual 2006 net sales target level during the three-month period ended June 30, 2006.

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

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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. In the year ended December 31, 2006, we recognized $1.25 million of collaborative research revenue. No collaborative research revenue was recognized for the years ended December 31, 2005 and 2004.

Taxes

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We have recorded a valuation allowance of $110.0 million as of December 31, 2006 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.

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, promotion 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 Option Expense

As of January 1, 2006, we adopted Statement of Financial Accounting Standards, or SFAS No. 123(R), which requires us to measure compensation cost for share-based payment awards at fair value and recognize compensation over the service period for awards expected to vest. We have selected the Black-Scholes option-pricing model as the most appropriate fair-value method for our awards and will recognize compensation expense on a straight-line basis over the vesting periods of our awards. 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

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revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. We use a blended volatility calculation utilizing volatility of peer group companies with similar operations and financial structures in addition to our own historical volatility. 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. We have implemented the modified prospective method in recognizing stock-based compensation expense for 2006 upon the adoption of SFAS No. 123(R). Under this method, we are required to record compensation expense for all share-based payments granted after the date of adoption and for the unvested portion of previously granted stock option awards that remain outstanding at the date of adoption. Accordingly, prior period amounts have not been restated. For stock options granted to non-employees, we have recognized compensation expense in accordance with the requirements of SFAS No. 123 “Accounting for Stock-Based Compensation,” or SFAS No. 123. SFAS No. 123 required that companies recognize compensation expense based on the estimated fair value of options granted to non-employees over their vesting period, which is generally the period during which services are rendered by such non-employees.

See “Impact of Recently Issued Accounting Pronouncements” in this section of the report as well as Note 8 “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.

Results of Operations

Years Ended December 31, 2006, 2005 and 2004

Revenues

Total revenues were approximately $37.1 million for the year ended December 31, 2006, as compared to approximately $23.3 million in 2005 and approximately $11.1 million in 2004. The increase in 2006 revenue of approximately $13.8 million, or 59%, was due to increased co-promotion revenue from net sales of Elestat and Restasis in 2006, as compared to 2005, as well as the recognition of a development milestone of $1.25 million for diquafosol tetrasodium from Santen in accordance with our development, license and supply agreement.

Co-promotion revenue from net sales of Elestat for the year ended December 31, 2006 was approximately $20.3 million, as compared to approximately $16.8 million in 2005, and approximately $9.6 million in 2004. The increase in 2006 co-promotion revenue for Elestat of approximately $3.5 million, or 21%, was primarily due to an increase in the market share of Elestat, a price increase for Elestat that became effective during the first quarter of 2006, as well as an overall increase in the U.S. allergic conjunctivitis market, defined by branded prescription, topically applied products to treat allergic conjunctivitis. Co-promotion revenue from net sales of Restasis for the year ended December 31, 2006 was approximately $15.5 million, as compared to approximately $6.5 million in 2005, and approximately $1.5 million in 2004. Restasis is currently the only approved prescription product indicated for dry eye disease. The increase in 2006 co-promotion revenue for Restasis of approximately $9.0 million, or 140%, was primarily due to increased patient usage of Restasis, based on the increase of prescriptions year-over-year, a price increase that became effective during the first quarter of 2006, and to a lesser extent, an increase in the number of physicians prescribing Restasis. In addition, in April 2006 there was a scheduled increase of the percentage of net sales of Restasis to which we were entitled. In 2006, the revenue generated from our co-promotion of Elestat and Restasis exceeded our selling and marketing expenses.

The increase in 2005 revenue, as compared to 2004, was due to significantly increased co-promotion revenue from net sales of both Elestat and Restasis. This increase is attributable to: 1) a full year of co-promotion

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activities in 2005 for both products; 2) increased market share for Elestat; and 3) increased acceptance of Restasis, based on the increase of prescriptions year-over-year, and 4) an increase of the percentage of net sales of Restasis to which we were entitled (effective April 2005). In 2005, the revenue generated from our commercial organization exceeded our selling and marketing expenses. When compared to 2004, 2005 co-promotion revenue from net sales of Elestat increased 75% and co-promotion revenue from net sales of Restasis increased 337%.

We began realizing co-promotion revenue from Elestat beginning in February 2004. All of our revenue related to Elestat is from net sales in the United States according to the terms of our collaborative agreement with Allergan. 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.

For the year ended December 31, 2006, Elestat was the second most prescribed allergic conjunctivitis product in the United States, based upon prescription volume data as reported by IMS Health, and in our target universe, the top 200 highest prescribing ophthalmologists, optometrists, and allergists in each of our 64 sales territories. Based upon weekly national prescription data from IMS Health, Elestat had a market share of approximately 19% for total prescription volume in our target universe for the three and twelve months ended December 31, 2006, as compared to 19% and 17%, for the three and twelve months ended December 31, 2005, respectively. Based upon weekly data from IMS Health, the total U.S. allergic conjunctivitis market, in terms of prescriptions, increased approximately 5% and approximately 6% for the years ended December 31, 2006, and 2005, respectively, compared to the previous year. For the year ended December 31, 2006, Elestat represented approximately 10% of the total U.S. allergic conjunctivitis market, as compared to approximately 8% in 2005 and approximately 4% in 2004. Based on current trends in prescriptions for Elestat, we expect no market share growth or declining market share in future periods, unless we expand our commercial rights to Elestat.

In regards to co-promotion revenue from net sales of Elestat, we are entitled to an escalating percentage of net sales based upon predetermined calendar year net sales target levels. During a fiscal year, we recognize product co-promotion revenue associated with targeted net sales levels for Elestat achieved during that time period and defer revenue in excess of the sales level achieved. We achieved the annual 2006 net sales target level for Elestat during the three month period ended June 30, 2006, the annual 2005 net sales target level in the three-month period ended June 30, 2005, and achieved the annual 2004 net sales target level in the three-month period ended September 30, 2004.

Since the launch of Elestat, Allergan has secured coverage on formularies of certain commercial and government plans. This coverage allows Allergan and us to increase and maintain prescription market share, but generally requires price concessions through rebate programs which impact the level of co-promotion revenue that we receive from net sales of Elestat. Due to the large number of competing products in the allergic conjunctivitis market, some of these price concessions have been significant. 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 were 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 lesser amounts of rebates than under Medicaid programs. Additionally, in 2006, Elestat lost coverage under several state Medicaid plans. While we do not expect the loss of these coverages to significantly impact our portion of the co-promotion revenue due to the large price concessions associated with these particular states, future loss of coverage under additional states or commercial plans may have a negative impact on our co-promotion revenue.

The commercial marketing exclusivity period for Elestat provided under the Hatch-Waxman Act will expire in October 2008, after which time Elestat could face generic or over-the-counter competition if there is no other intellectual property or marketing exclusivity protection covering Elestat. We are aware that several generic pharmaceutical companies have expressed intent to commercialize the ocular form of epinastine after the commercial exclusivity period expires. While we are exploring various possible forms of additional intellectual property coverage to protect the commercialization of Elestat in the United States, there can be no assurance that

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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 in October 2008. If a generic form of Elestat 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 cease. Loss of our co-promotion revenue from Elestat will materially impact our results of operations and cash flows.

We began co-promotion activities related to Restasis in January 2004 and began receiving co-promotion revenue in April 2004. 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. Our entitled percentage of net sales of Restasis increased in April 2006 and the last scheduled increase will occur in April 2007. Co-promotion revenue from Restasis is becoming a larger component of our total co-promotion revenue. For the year ended December 31, 2006, co-promotion revenue from Restasis represented approximately 43% of our total co-promotion revenue compared to approximately 28% in 2005. We expect that this trend will continue in 2007 and future reporting periods. For the year ended December 31, 2006, Allergan recorded approximately $270 million of revenue from net sales of Restasis, as compared to approximately $191 million in 2005 and approximately $100 million in 2004.

Restasis, in terms of prescription volume, has grown significantly since it was first launched in April 2003. Since we began co-promoting Restasis in January 2004, total prescriptions, as reported by IMS Health, have been approximately 2.9 million, 2.1 million and 1.3 million for the twelve months ended December 31, 2006, 2005 and 2004, respectively. This represents year-over-year prescription volume increases of 35% and 64% for the twelve months ended December 31, 2006 and 2005, respectively.

In March 2006, Santen completed its Phase 2 clinical trial testing of diquafosol tetrasodium in Japan, which entitled us to receive a milestone payment of $1.25 million. Santen is responsible for all development, regulatory submissions, filings and approvals, and the commercialization of potential products in Japan and nine other Asian countries. We could receive additional development milestone payments from Santen of up to $3.0 million, as well as royalties on net sales of diquafosol tetrasodium, if the product candidate is approved for commercialization in Santen’s licensed territories. In 2006, Santen began Phase 3 clinical trials in Japan for diquafosol tetrasodium.

Our future revenue will depend on various factors including the continued commercial success of Elestat and Restasis, pricing, rebates, discounts and returns for both products, coverage and reimbursement under commercial or government plans, our entitled percentage of U.S. net sales of Restasis which will have a final increase in April 2007, seasonality of sales of Elestat and duration of market exclusivity of Elestat and Restasis. If Allergan significantly under-estimates or over-estimates rebate amounts, there could be a material effect on our revenue. In addition to sales of Elestat and Restasis, our revenue will also depend on whether we enter additional collaboration agreements, achieve milestones under existing or future collaboration agreements and whether we obtain regulatory approvals for our product candidates.

Costs and Expenses

Research and Development Expenses

Research and development expenses were approximately $42.5 million for the year ended December 31, 2006, as compared to approximately $23.6 million in 2005 and approximately $25.7 million in 2004. Included in the research and development expenses for the year ended December 31, 2006, is approximately $576,000 of stock-based compensation expense related to our adoption of SFAS No. 123(R) effective January 1, 2006, including stock-based compensation expense related to restricted stock units issued for the first time in July 2006. There is no stock-based compensation expense included in research and development for years ended December 31, 2005 and 2004, respectively, due to our adoption of SFAS No. 123(R) using the modified prospective method.

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The increase in research and development expenses of approximately $19 million, or 81%, for the year ended December 31, 2006, as compared to 2005, was primarily due to the development activities associated with our epinastine nasal spray program for seasonal allergic rhinitis, including the payment of a $2.5 million up-front licensing fee and the initiation of Phase 2 clinical trials, the in-licensing of bilastine, a Phase 3 oral antihistamine compound for which we paid an upfront licensing fee of $7.0 million in November 2006, and performing preclinical research and filing an IND for our glaucoma program. In addition, we had increased costs associated with our denufosol for cystic fibrosis program, relating to the initiation of the Phase 3 TIGER-1 clinical trial, as well as increased costs related to our antiplatelet program, which included conducting our proof-of-concept Phase 2 clinical trial. On August 7, 2006, we announced the termination of the antiplatelet clinical trial based upon the unanimous recommendation of our independent data monitoring committee, following a planned interim safety analysis. These cost increases were partially offset by less spending on our Prolacria program as we continued our discussions with the FDA regarding the future of this program, the discontinuation of the denufosol for retinal disease program in January 2006 and the discontinuation of the corneal wound healing program in August 2005.

The decrease in research and development expenses in 2005, as compared to 2004, was primarily due to significantly less spending on Prolacria due to our NDA amendment filing on June 1, 2005. Additionally, we spent less on our denufosol for retinal disease program due to the discontinuation of this program. These decreases were partially offset by an increase in denufosol for cystic fibrosis expenditures related to conducting six-month and twelve-month inhalation toxicology studies and Phase 2 clinical trials during 2005 prior to initiation of our Phase 3 program, as well as an increase in expenses related to our corneal wound healing Phase 2 pilot study which was initiated in 2005 but was later discontinued in the third quarter of 2005.

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, up-front 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 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 research and development expenses for the years ended December 31, 2006, 2005 and 2004 and from the respective project’s inception are shown below and includes the percentage of overall research and development expenditures for the years listed.

	(In thousands) Year ended December 31,									Cumulative from Inception to December 31, 2006		%
	2006		%	2005		%	2004		%
Denufosol tetrasodium for cystic fibrosis	$	10,316	24	$	9,223	39	$	4,256	17	$	32,548	15
Epinastine nasal spray for seasonal allergic rhinitis (1)		8,110	19		365	2		—	—		8,475	4
Bilastine for seasonal allergic rhinitis (2)		7,139	17		—	—		—	—		7,139	3
INS50589 for use in acute cardiac care (3)(4)		3,606	9		2,746	12		3,384	13		12,969	6
INS115644 for glaucoma		3,077	7		334	1		232	1		3,643	2
Denufosol tetrasodium for retinal disease (4)		1,258	3		1,465	6		2,893	11		9,105	4
Prolacria (diquafosol tetrasodium) for dry eye disease		1,431	3		1,961	8		6,835	27		39,138	18
Other research, preclinical and development costs (5)		7,600	18		7,472	32		8,098	31		101,796	48
Total	$	42,537	100	$	23,566	100	$	25,698	100	$	214,813	100

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(1) Includes a $2.5 million up-front licensing fee upon the signing of the license and development agreement with Boehringer Ingelheim.

(2) Includes a $7.0 million up-front licensing fee upon the signing of the license agreement with FAES.

(3) On August 7, 2006, we terminated our only Phase 2 clinical trial for this program.

(4) As of December 31, 2006, these programs were not in active development.

(5) 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.

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. 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.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $25.3 million for the year ended December 31, 2006, as compared to approximately $23.2 million in 2005 and approximately $21.8 million in 2004. Included in selling and marketing expenses for the year ended December 31, 2006, is approximately $293,000 of stock-based compensation expense related to our adoption of SFAS No. 123(R) effective January 1, 2006, including stock-based compensation expense related to restricted stock units issued for the first time in July 2006. There is no stock-based compensation expense included in selling and marketing for the years ended December 31, 2005 and 2004, respectively, due to our adoption of SFAS No. 123(R) using the modified prospective method.

The increase in selling and marketing expenses for the year December 31, 2006, as compared to 2005, resulted from an overall increase in promotional activities, primarily the increased costs associated with our sales force including increased salary, personnel related expenses and stock-based compensation expense. We adjust the timing, magnitude and targeting of our advertising, promotional, Phase 4 clinical trials and other commercial activities for Elestat and Restasis based on seasonal trends and other factors. The increase in selling and marketing expenses in 2005, as compared to 2004, resulted from a full year of active promotion of Elestat and Restasis and expanded commercial activity as we continued to build the Elestat brand.

Our commercial organization focuses its promotional efforts on approximately 8,500 highly prescribing ophthalmologists, optometrists and allergists in our target universe. Our selling and marketing expenses include all direct costs associated with the commercial organization, which include our 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.

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 may immediately precede and follow product launches.

General and Administrative Expenses

General and administrative costs were approximately $15.9 million for the year ended December 31, 2006, as compared to approximately $12.0 million in 2005, and approximately $9.0 million in 2004. Included in general and administrative expenses for the year ended December 31, 2006, is approximately $678,000 of stock-based compensation expense related to our adoption of SFAS No. 123(R) effective January 1, 2006, including

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stock-based compensation expense related to restricted stock units issued for the first time in July 2006. There is no stock-based compensation expense included in general and administrative for the years ended December 31, 2005 and 2004, respectively, due to our adoption of SFAS No. 123(R) using the modified prospective method.

The increase in general and administrative expenses of approximately $3.9 million, or 32%, for the year ended December 31, 2006, as compared to 2005, was primarily due to significantly increased legal and administrative expenses associated with our stockholder litigation and SEC investigation and to a lesser extent increased salary and personnel related expenses, including stock-based compensation expense, business development activities and overall corporate growth. Legal fees were approximately $4.1 million for the year ended December 31, 2006, as compared to approximately $2.3 million in 2005. The increase in 2005 general and administrative expenses, as compared to 2004, was primarily due to increased salary and personnel related expenses, increased legal and administrative expenses associated with our stockholder litigation and SEC investigation, and overall corporate growth.

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 to resolve our stockholder litigation and SEC investigation, and to the extent our legal expenses associated with the stockholder litigation and SEC investigation are reimbursed by insurance. We expect our future professional fees to continue to increase as a result of our stockholder litigation and SEC investigation (See “Litigation” and “SEC Investigation” described elsewhere in this report).

Other Income (Expense)

Other income, net was approximately $4.5 million for the year ended December 31, 2006, as compared to approximately $3.7 million for 2005 and approximately $1.5 million for 2004. 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 increase in other income for the year ended December 31, 2006, as compared to 2005, was primarily due to an increase in interest income resulting from a portfolio mix of higher yielding investments during 2006, and a general increase in the short-term interest rate environment. The increase in 2005 other income, as compared to 2004, was primarily due to an increase in interest income resulting from larger average cash and investment balances during 2005 as a result of stock offerings in the second half of 2004 and of higher yielding investments overall. This increase was partially offset by write-down of available-for-sale investments of approximately $516,000 due to an impairment deemed other-than-temporary. 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.

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. In December 2006, we entered into a loan and security agreement in order to obtain debt financing of up to $40 million to fund in-licensing opportunities and related development, including the in-licensing of bilastine from FAES in November 2006. We have borrowed $20 million under this agreement. All loan advances made under the agreement mature in March 2011. We also currently receive revenue from net sales of Elestat and Restasis, but do not expect this revenue to exceed our 2007 operating expenses.

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At December 31, 2006, we had net working capital of approximately $89.7 million, a decrease of approximately $9.6 million from approximately $99.3 million at December 31, 2005. The decrease in working capital was principally due to the use of funds for our normal operating expenses, which exceeded the revenue we recognized. Our principal sources of liquidity at December 31, 2006 were approximately $50.2 million in cash and cash equivalents and approximately $51.4 million in investments, which are considered available-for-sale, and the potential to borrow an additional $20 million under our loan and security agreement.

On February 15, 2007, we signed an exclusive licensing agreement with InSite Vision for U.S. and Canadian commercialization of AzaSite. An NDA for AzaSite is currently under review by the FDA for treatment of bacterial conjunctivitis. In conjunction with this licensing agreement, we paid InSite Vision an upfront license fee of $13.0 million and will pay an additional $19.0 million milestone payment contingent upon regulatory approval by the FDA. We will also pay a 20% royalty for the first 2 years and a 25% royalty thereafter on net sales of AzaSite for ocular infections in the United States and Canada, if approved by regulatory authorities.

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 costs related to the potential FDA approval and launch of AzaSite and 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 products and product candidates; 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.

Our 2007 financial results will be largely contingent on events associated with the potential approval of AzaSite by the FDA in April 2007 and the product candidate’s subsequent launch, as well as favorable data and subsequent progression of our bilastine, epinastine nasal spray and Prolacria programs. The following 2007 forecasted guidance does not include the expected impact of an AzaSite approval in 2007. Should the product candidate be approved, expected 2007 revenues and expenses would change significantly, and we would issue revised guidance.

Based upon current Elestat and Restasis trends and projected operating plans, we expect to record aggregate revenue in the range of $40-$47 million and expect operating expenses to be in the range of $90-$112 million. Research and development expenses associated with the further development of our product candidates, as described below, are estimated to be in the range of $45-$74 million, including the $13.0 million upfront license fee related to the execution of the AzaSite agreement. Total estimated sales and marketing and general and administrative expenses are estimated to be in the range of $26-$29 million and $15-$19 million, respectively.

The upper end of our range of forecasted research and development expenses assumes the following potential program progress:

• Receive favorable QT/QTc clinical trial results in the second quarter of 2007; pay an $8 million milestone payment to FAES; meet with the FDA and initiate one U.S. Phase 3 clinical trial of bilastine;

• Complete patient enrollment and continue dosing of Phase 3 TIGER-1 clinical trial of denufosol tetrasodium for the treatment of cystic fibrosis;

• Depending on discussions with the FDA, validate a clinical endpoint related to central corneal staining and initiate an additional Phase 3 clinical trial of Prolacria for the treatment of dry eye disease;

• Receive favorable results of a Phase 2 clinical trial of epinastine nasal spray for seasonal allergic rhinitis, meet with the FDA and initiate next clinical trial and toxicology work; and

• Complete a Phase 1 clinical trial in the glaucoma program.

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Included within our operating expenses guidance are projected stock-based compensation costs of approximately $3 million. This estimate is based on the unvested portion of stock options and restricted stock units outstanding as of December 31, 2006, our current stock price, and an anticipated level of share-based payments granted during 2007, exclusive of the hiring of additional employees needed to support the launch of AzaSite in 2007. Should our stock price change significantly from its current level, and/or if our anticipated headcount changes, particularly to support an AzaSite launch, actual stock-based compensation expense could change significantly from this projection. However, the actual amount of stock-based compensation expense recognized in the future will largely depend on levels of share-based payments granted in future periods and changes in our stock price.

Our projected cash burn in 2007 is expected to be in the range of $45-$65 million. This range includes the $13.0 million up-front cash payment for AzaSite that will be included in our research and development expense and reflected in our first quarter 2007 results, as well as the $8 million cash milestone payment related to a favorable QT/QTc clinical trial result for bilastine, which would also be reflected in research and development expense. The current cash burn guidance does not include the potential $19.0 million cash milestone payment related to an AzaSite FDA approval, nor does it include additional borrowing under our term loan facility.

As our 2007 forecasted results will be largely dependent on key development and regulatory events, we expect to adjust our guidance throughout 2007 as additional information concerning these events is obtained. The actual amount of operating expenses could differ significantly should our anticipated development plans change, based upon program progress and events associated with our portfolio of product candidates. In addition, the current forecast is exclusive of regulatory approval for AzaSite, and therefore, revenue and operating expense guidance would change significantly upon the approval and launch of the product candidate. If regulatory approval for AzaSite is received, it is likely we will draw an additional $20 million of debt on our existing loan facility. Additionally, if we are successful with the AzaSite or bilastine programs, we would likely raise additional capital in the next twelve months to support our expanded commercial and development activities.

Although our liquidity needs will largely be determined by key development and regulatory events, we will most likely need to: (1) obtain product candidate approvals, (2) out-license rights to our product candidates, and/or (3) raise additional capital through equity or debt financings or from other sources in order for us to continue operations beyond 2007. We currently have the ability to sell approximately $13.9 million of common stock under an effective shelf registration statement, which we filed with the SEC on April 16, 2004. On March 9, 2007, we filed with the SEC a shelf registration statement on Form S-3 that will permit us, if such registration statement is declared effective by the SEC, 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. In addition, we have the ability to borrow the remaining $20 million under our loan facility subject to certain conditions which must occur within the commitment period which ends on June 30, 2007. The commitment period may be extended by us to December 31, 2007, subject to additional fees and upon satisfaction of certain conditions. Our ability to borrow additional amounts under the loan facility are subject to the satisfaction of any one of a number of conditions related to our progress in developing bilastine or our success in obtaining FDA approval for other product candidates owned by or in-licensed to us. To the extent that none of the conditions are satisfied, we may still borrow from the term loan facility, but only in the amount by which our research and development expenditures on bilastine and/or another in-licensed product candidate exceed the initial advance of $20 million.

In addition, the loan and security agreement that we entered into in December 2006 contains a financial covenant that requires us to maintain a certain level 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.

Our ability to remain within our operating expense target range is subject to several other risks including unanticipated cost overruns, the need to expand the magnitude or scope of existing development programs, the

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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.

Contractual Commitments

As part of our drug development strategy, we outsource significant amounts of our preclinical and clinical programs and the manufacture of drug substance used in those programs. Accordingly, we have entered into contractual commitments or purchase arrangements with various clinical research organizations, manufacturers of active pharmaceutical ingredients and/or drug product as well as with others. The amount of our financial commitments which includes both cancelable and non-cancelable arrangements totaled approximately $14.3 million at December 31, 2006. In addition, we have other contractual commitments outside of drug development under cancelable and non-cancelable arrangements which totaled approximately $3.1 million at December 31, 2006. Many of these commitment amounts are dependent upon the results of underlying studies, the completion of studies and/or projects and certain other variable components of the agreements that may result in actual payments and the timing of those payments that differ from management’s estimate.

Also, at December 31, 2006, we have future contractual commitments to pay approximately $4.6 million of lease obligations for our administrative offices, fleet vehicles, laboratory facilities and equipment. In addition, we had outstanding debt obligations as of December 31, 2006 of $20.5 million, of which $20 million relates to the loan and security agreement that we entered into in December 2006. Under this agreement, the debt obligation fully matures in March 2011, with repayment of loan borrowings made according to a schedule of six monthly installments of interest only followed by equal monthly installments of principal and interest until the maturity date.

The terms of our existing license, collaboration and sponsored research agreements may require that we make future cash payments. In the aggregate, these agreements may require payments of up to $85.8 million assuming the achievement of all development milestones and up to an additional $14.0 million assuming the achievement of all sales milestones. Amounts payable by us under these agreements are uncertain and are contingent on a number of factors, including the progress of our research, preclinical and development programs, our ability to obtain regulatory approvals, and the commercial success of our approved products. In addition, there is approximately $650,000 of development milestones under existing license agreements related to currently inactive development programs and we believe it is unlikely the milestones will be achieved and payments made. We are also obligated to pay royalties on net sales, if any, of certain product candidates currently in our portfolio. Some of our existing license agreements require minimum annual license preservation fees of up to $10,000. In addition, if we obtain licenses on additional product candidates in the future, or if our collaborative arrangements identify additional product candidates, our license obligations would increase.

In conjunction with the licensing agreement for AzaSite that we signed with InSite Vision in February 2007, we paid InSite Vision an upfront license fee of $13.0 million. We will also be obligated to pay an additional $19.0 million milestone payment contingent upon regulatory approval by the FDA. The $13.0 million upfront license fee that we paid in 2007 and the $19.0 million potential milestone are not reflected in the table below.

If certain of our product candidates are approved by the FDA and are subsequently commercialized, we will be obligated to pay royalties on net sales of the commercialized products. See Part I of this report for a full discussion of our royalty obligations under our in-licensing agreements with InSite Vision for AzaSite, FAES for bilastine and Boehringer Ingelheim for epinastine nasal spray.

In addition, we may enter into various manufacturing, distribution, consulting and other agreements in anticipation of an AzaSite launch in the second half of 2007. These agreements are not reflected in the commitments as of December 31, 2006, or in the underlying table below.

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We have also engaged legal counsel to represent us in our SEC investigation and stockholder litigation, but we are not contractually obligated to incur future costs under the applicable engagement letters. However, we do anticipate future costs to be incurred to retain counsel until these proceedings are resolved. Because of the nature of the situation, we are unable to estimate any future commitment in regards to these legal proceedings and have not included any committed costs in our projected contractual commitment disclosures.

Subject to the information and qualifications included in the above paragraph, the table below sets forth our enforceable and legally binding obligations and future commitments and obligations related to all contracts that we are likely to continue regardless of the fact that the contracts may be terminated. The table reflects contractual and potential obligations as of December 31, 2006, but does not reflect obligations entered into in 2007. Some of the figures we include in this table are based on management’s estimate and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties, and other factors. Because these estimates and assumptions are necessarily subjective, the obligations we will actually pay in future periods may vary from those reflected in the table:

	(In thousands) Payment due by Period as of December 31, 2006
Contractual and Potential Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Capital Lease Obligations	$	917	$	641	$	276	$	—	$	—
Debt Obligations		20,502		2,847		10,338		7,317		—
Interest on Debt Obligations		4,180		1,421		1,978		781		—
Operating Lease Obligations (1)		3,652		1,255		1,712		685		—
Purchase Obligations		17,372		14,727		2,645		—		—
Minimum Annual License Payments		100		15		50		35		—
Development Milestone Obligations (2)(3)		85,750		10,000		43,750		32,000		—
Sales Milestone Obligations (3)		14,000		—		—		5,000		9,000
Total	$	146,473	$	30,906	$	60,749	$	45,818	$	9,000

(1) Includes estimated payments for cancelable portion of fleet vehicles under a master lease agreement. See Note 11, “Commitments and Contingencies” for a full discussion.

(2) Includes $1.9 million of “other long-term liabilities” as recorded on our Balance Sheet as of December 31, 2006.

(3) Development and sales milestone obligations represent potential amounts payable by us contingent on a number of factors, including the progress of our research, preclinical and development programs, our ability to obtain regulatory approvals, and the commercial success of our approved products.

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

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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, Inspire 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. Briefing on that motion is now complete and it is currently pending before the court.

We intend to defend the litigation vigorously. As with any legal proceeding, we cannot predict with certainty the eventual outcome of these pending 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 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 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 may seek a further meeting with 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. 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 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.

Impact of Recently Issued Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board, or 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. We are currently evaluating the impact, if any, of SFAS No. 159 on our financial statements. If elected, SFAS No. 159 would be effective as of January 1, 2008.

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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. We are currently evaluating the impact of adopting this statement.

Also in September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” or SAB No. 108. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. It requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. The provisions of SAB No. 108 must be applied to annual financial statements no later than the first fiscal year ending after November 15, 2006. We have assessed the effect of adopting this guidance and have determined that there was no impact on our financial statements or related disclosures.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” or FIN No. 48. FIN No. 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN No. 48 and in subsequent periods. FIN No. 48 will be effective for fiscal years beginning after December 15, 2006. We are currently evaluating the potential impact of FIN No. 48 on our financial statements; however, we do not expect a material impact on our current disclosures due to our current net operating loss position and related valuation allowance against all deferred tax assets.

We adopted SFAS No. 123(R) effective January 1, 2006, as required, and have incorporated the modified prospective method for recognizing stock-based compensation expense which does not require restated results for prior periods. Under the modified prospective method, stock-based compensation cost recognized for the year ended December 31, 2006 includes: (a) stock-based compensation cost for all share-based payments granted, but not yet vested as of January 1, 2006, based on grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) stock-based compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Such amounts are reduced by our estimate of forfeitures of all unvested awards. In March 2005, the SEC issued Staff Accounting Bulletin No. 107, or SAB No. 107, regarding the SEC’s interpretation of SFAS No. 123(R) and the valuation of share-based payments for public companies. We have applied the provisions of SAB No. 107 in our adoption of SFAS No. 123(R).

Prior to January 1, 2006, we accounted for our stock-based compensation plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” or APB No. 25, and related interpretations for all awards granted to employees. Under APB No. 25, when the exercise price of options granted to employees under these plans equals the market price of the common stock on the date of grant, no compensation expense is recorded. When the exercise price of options granted to employees under these plans is less than the market price of the common stock on the date of grant, compensation expense is recognized over the vesting period.

As a result of adopting SFAS No. 123(R) on January 1, 2006, our net loss for the year ended December 31, 2006 was approximately $1.5 million greater than if we had continued to account for share-based compensation under APB No. 25. We estimated the fair value of share-based payments granted to employees using the Black-Scholes model and related assumptions, consistent with our fair value estimates made under SFAS No. 123.

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As of December 31, 2006, approximately $4.4 million of total unrecognized compensation cost related to the unvested portion of our stock options and restricted stock units is expected to be recognized over a weighted-average period of 3.1 years. We currently estimate total stock-based compensation expense to be approximately $3 million in 2007. This estimate is based on the unvested portion of stock options and restricted stock units outstanding as of December 31, 2006, our current stock price, and an anticipated level of share-based payments granted during 2007, exclusive of the hiring of additional employees needed to support the launch of AzaSite in 2007. Should our stock price change significantly from its current level, and/or if our anticipated headcount changes, particularly to support an AzaSite launch, actual stock-based compensation expense could change significantly from this projection. However, the actual amount of stock-based compensation expense recognized in the future will largely depend on levels of share-based payments granted in future periods and changes in our stock price.

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

Interest Rate Sensitivity

We are subject to interest rate risk on our investment portfolio. We maintain an investment portfolio consisting of 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. Our portfolio has a current average maturity of less than 12 months, using the stated maturity or reset maturity dates associated with individual maturities as the basis for the calculation.

Our exposure to market risk for changes in interest rates relates to the increase or decrease in the amount of interest income we can earn on our investment portfolio, changes in the market value of investments due to changes in interest rates, the increase or decrease in realized gains and losses on investments and the amount of interest expense we must pay with respect to various outstanding debt instruments. Our risk associated with fluctuating interest expense is limited to capital leases, other short-term debt obligations and future borrowings under the term loan facility. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We ensure the safety and preservation of invested principal funds by limiting default risk, market risk and reinvestment risk. We reduce default risk by investing in investment grade securities. Our investment portfolio includes only marketable securities and instruments with active secondary or resale markets to help ensure portfolio liquidity and we have implemented guidelines limiting the duration of investments. A hypothetical 100 basis point drop in interest rates along the entire interest rate yield curve would not significantly affect the fair value of our interest sensitive financial instruments. At December 31, 2006, our portfolio of available-for-sale investments consisted of approximately $45.4 million of investments maturing within one year and approximately $6.0 million of investments maturing after one year but within 36 months. In addition, we have $515,000 of our long-term investments that are held in a restricted account that collateralizes a letter of credit with a financial institution. Additionally, we generally have the ability to hold our fixed-income investments to maturity and therefore do not expect that our operating results, financial position or cash flows will be affected by a significant amount due to a sudden change in interest rates.

The interest rate on our long-term debt is fixed on outstanding borrowings from the term loan facility, but future draws on the facility will be assumed interest based upon current market interest rates at the time of borrow. Assuming other factors are held constant, an increase in interest rates from the fixed rate on our debt generally results in a decrease in the fair value of our long-term debt, and a decrease in interest rates generally results in an increase in the fair value of our long-term debt. However, neither an increase nor a decrease in interest rates will impact the carrying value of the long-term debt. As of December 31, 2006, the fair value of our long-term debt approximates its carrying value of $20 million.

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Strategic Investment Risk

In addition to our normal investment portfolio, we have a strategic investment in Parion Sciences, Inc. valued at $200,000 as of December 31, 2006. 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.

Item 8. Financial Statements and Supplementary Data.

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

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

Not applicable.

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting. The design, monitoring and revision of the system of internal accounting controls involves, among other items, management’s judgments with respect to the relative cost and expected benefits of specific control measures. The effectiveness of the control system is supported by the selection, retention and training of qualified personnel and an organizational structure that provides an appropriate division of responsibility and formalized procedures. The system of internal accounting controls is periodically reviewed and modified in response to changing conditions. Internal audit consultants regularly monitor the adequacy and effectiveness of internal accounting controls. In addition to the system of internal accounting controls, management maintains corporate policy guidelines that help monitor proper overall business conduct, possible conflicts of interest, compliance with laws and confidentiality of proprietary information. Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2006. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management, including our principal executive officer and principal financial officer, concluded that our internal control over financial reporting was effective as of December 31, 2006. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included herein.

Changes in Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation of our internal control that occurred during our last fiscal quarter, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Audit Committee Oversight

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

ITEM 9B. OTHER INFORMATION

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item is incorporated by reference to the material responsive to this item contained in our Proxy Statement to be filed in connection with our 2007 Annual Meeting of Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the material responsive to this item contained in our Proxy Statement to be filed in connection with our 2007 Annual Meeting of Stockholders.

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

The information required by this item is incorporated by reference to the material responsive to this item contained in our Proxy Statement to be filed in connection with our 2007 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is incorporated by reference to the material responsive to this item contained in our Proxy Statement to be filed in connection with our 2007 Annual Meeting of Stockholders.

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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated by reference to the material responsive to this item contained in our Proxy Statement to be filed in connection with our 2007 Annual Meeting of Stockholders.

ITEM 15. EXHIBITS and FINANCIAL STATEMENTS SCHEDULES

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

1. Financial Statements:

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

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

3. Exhibits:

Exhibit Number	Description
3.1	Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2006).
3.2	Certificate of Designations of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
3.3	Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2005).
4.1	Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
4.2	Rights Agreement, dated as of October 21, 2002, between the Company and Computershare Trust Company, which includes the form of Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. as Exhibit “A”, the form of Rights Certificate as Exhibit “B” and the Summary of Rights to Purchase Preferred Stock as Exhibit “C” (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 22, 2002).
10.1†	Inspire Pharmaceuticals, Inc. Amended and Restated 1995 Stock Plan, as amended (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 21, 2005).
10.2†	Form of Incentive Stock Option. (Incorporated by reference to Exhibit 10.2 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.3†	Form of Non-statutory Stock Option. (Incorporated by reference to Exhibit 10.3 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.4*	Development, License and Supply Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.15 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).

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Exhibit Number	Description
10.5†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Donald Kellerman dated February 3, 2000. (Incorporated by reference to Exhibit 10.24 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.6†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa dated February 4, 2000. (Incorporated by reference to Exhibit 10.26 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.7†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer dated February 10, 2000. (Incorporated by reference to Exhibit 10.28 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.8†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Mary Bennett dated February 27, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2001).
10.9†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph Schachle dated April 3, 2001. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2001).
10.10*	License, Development and Marketing Agreement between Inspire Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 29, 2001).
10.11*	Study Funding Agreement, dated as of October 3, 2002, between Inspire Pharmaceuticals, Inc. and The Cystic Fibrosis Foundation Therapeutics, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 4, 2002).
10.12†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.13†	Form of Inspire Pharmaceuticals, Inc. Director Non-Statutory Stock Option Agreement. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.14*	First Amendment to License, Development and Marketing Agreement, dated December 8, 2003, between Inspire Pharmaceuticals, Inc. and Allergan, Inc. and Allergan Sales, LLC and Allergan Pharmaceuticals Holdings (Ireland) Ltd. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 9, 2003).
10.15*	Elestat (Epinastine) Co-Promotion Agreement, entered into as of December 8, 2003, by and between Allergan Sales, LLC and Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 1, 2004).
10.16†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II, dated May 16, 2003. (Incorporated by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.17	Master Lease Agreement between GE Capital Fleet Services and Inspire Pharmaceuticals, Inc., dated as of November 18, 2003, and related documentation (Incorporated by reference to Exhibit 10.38 to the Company’s Annual Report on Form 10-K filed March 12, 2004).

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Exhibit Number	Description
10.18	Master Security Agreement between General Electric Capital Corporation and Inspire Pharmaceuticals, Inc., dated as of November 12, 2003, and related documentation (Incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.19†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between the Company and R. Kim Brazzell, dated August 5, 2004 (Incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2004).
10.20†	Amended and Restated Director Compensation Policy (Incorporated by reference to Exhibit 10.40 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.21*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and the Wisconsin Alumni Research Foundation, effective November 2, 2004. (Incorporated by reference to Exhibit 10.44 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.22†	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.23†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.24†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Mary B. Bennett (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.25†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Donald J. Kellerman (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.26†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Joseph K. Schachle (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.27†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II (Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.28†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa (Incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.29†	Agreement regarding change in control, dated as of August 2, 2004, by and between Inspire Pharmaceuticals, Inc. and R. Kim Brazzell (Incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.30†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement (Incorporated by reference to Exhibit 10.56 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.31†	Inspire Pharmaceuticals, Inc. 2005 Equity Compensation Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 21, 2005).
10.32†	Form of Incentive Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.33†	Form of Nonqualified Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.34†	Form of Director’s Nonqualified Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on June 16, 2005).

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Exhibit Number	Description
10.35†	Form of Stock Appreciation Right Grant Agreement (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.36†	Form of Stock Award Grant Agreement (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.37†	Agreement regarding change in control, dated as of March 2, 2006, by and between Inspire Pharmaceuticals, Inc. and Joseph M. Spagnardi (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 8, 2006).
10.38†	Consulting Agreement dated as of March 7, 2006, by and between Inspire Pharmaceuticals, Inc. and Barry G. Pea (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 10, 2006).
10.39**	Development and License Agreement between Inspire Pharmaceuticals, Inc. and Boehringer Ingelheim International GmbH, effective February 17, 2006. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed May 10, 2006)
10.40†	Form of Restricted Stock Unit Agreement (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 7, 2006).
10.41	Amended and Restated Lease Agreement, dated as of November 30, 2006, by and between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC with respect to certain premises located within the Royal Center I building at 4222 Emperor Blvd., Durham, North Carolina (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 6, 2006).
10.42	Amended and Restated Lease Agreement, dated as of November 30, 2006, by and between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC with respect to certain premises located within the Royal Center II building at 4222 Emperor Blvd., Durham, North Carolina (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on December 6, 2006).
10.43†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph M. Spagnardi, dated May 10, 2005.
10.44**	License Agreement by and between Inspire Pharmaceuticals, Inc. and FAES Farma, S.A, dated as of October 31, 2006.
10.45	Loan and Security Agreement, dated as of December 22, 2006, among Inspire Pharmaceuticals, Inc., Merrill Lynch Capital and Silicon Valley Bank.
23.1	Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm.
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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

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

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

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SIGNATURES

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

Inspire Pharmaceuticals, Inc.
By:	/s/    CHRISTY L. SHAFFER
	Christy L. Shaffer President & Chief Executive Officer and Director
Date: March 15, 2007

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

Signature	Title	Date
/s/    CHRISTY L. SHAFFER         Christy L. Shaffer	President & Chief Executive Officer (principal executive officer) and Director	March 15, 2007
/s/    THOMAS R. STAAB, II         Thomas R. Staab, II	Chief Financial Officer & Treasurer (principal financial officer and principal accounting officer)	March 15, 2007
/s/    KENNETH B. LEE, JR.         Kenneth B. Lee, Jr.	Chairman of the Board of Directors	March 15, 2007
/s/    KIP A. FREY         Kip A. Frey	Director	March 15, 2007
/s/    NANCY J. HUTSON         Nancy J. Hutson	Director	March 15, 2007
/s/    RICHARD S. KENT         Richard S. Kent	Director	March 15, 2007
/s/    WILLIAM R. RINGO, JR.         William R. Ringo, Jr.	Director	March 15, 2007

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INSPIRE PHARMACEUTICALS, INC.

INDEX TO FINANCIAL STATEMENTS

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

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

  of Inspire Pharmaceuticals, Inc.:

We have completed integrated audits of Inspire Pharmaceuticals, Inc.’s financial statements and of its internal control over financial reporting as of December 31, 2006 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Financial statements

In our opinion, the financial statements listed in the index appearing under Item 15(a)1 present fairly, in all material respects, the financial position of Inspire Pharmaceuticals, Inc. at December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 2 and Note 8 to the financial statements, the Company changed the manner in which it accounts for share-based compensation in 2006.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control—Integrated Framework issued by The Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,

F-2

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

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

/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina

March 15, 2007

F-3

INSPIRE PHARMACEUTICALS, INC.

BALANCE SHEETS

(in thousands, except per share amounts)

	December 31,
	2006			2005
Assets
Current assets:
Cash and cash equivalents	$	50,190		$	65,018
Investments		45,377			37,697
Receivables from Allergan		8,245			4,898
Prepaid expenses and other receivables		3,530			2,432
Other assets		404			207
Total current assets		107,746			110,252
Property and equipment, net		1,754			2,181
Investments		6,714			19,608
Other assets		485			405
Total assets	$	116,699		$	132,446
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	6,297		$	3,460
Accrued expenses		8,359			6,990
Short-term debt and capital leases		3,435			537
Total current liabilities		18,091			10,987
Capital leases—noncurrent		267			855
Long-term debt		17,655			—
Other long-term liabilities		2,315			1,915
Total liabilities		38,328			13,757
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.001 par value, 2,000 shares authorized; no shares issued and outstanding		—			—
Common stock, $0.001 par value, 100,000 shares authorized; 42,238 and 42,211 shares issued and outstanding, respectively		42			42
Additional paid-in capital		323,606			321,984
Accumulated other comprehensive loss		(152	)		(327	)
Accumulated deficit		(245,125	)		(203,010	)
Total stockholders’ equity		78,371			118,689
Total liabilities and stockholders’ equity	$	116,699		$	132,446

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

F-4

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

	Year Ended December 31,
	2006			2005			2004
Revenues:
Product co-promotion	$	35,809		$	23,266		$	11,068
Collaborative research agreements		1,250			—			—
Total revenue		37,059			23,266			11,068
Operating expenses:
Research and development		42,537			23,566			25,698
Selling and marketing		25,265			23,223			21,848
General and administrative		15,880			12,004			9,041
Total operating expenses		83,682			58,793			56,587
Loss from operations		(46,623	)		(35,527	)		(45,519	)
Other income (expense):
Interest income		4,702			4,343			1,765
Interest expense		(165	)		(147	)		(117	)
Loss on investments		(29	)		(516	)		(198	)
Other income, net		4,508			3,680			1,450
Net loss	$	(42,115	)	$	(31,847	)	$	(44,069	)
Basic and diluted net loss per common share	$	(1.00	)	$	(0.76	)	$	(1.25	)
Weighted average common shares used in computing basic and diluted net loss per common share		42,227			42,101			35,261

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

F-5

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2006			2005			2004
Cash flows from operating activities:
Net loss	$	(42,115	)	$	(31,847	)	$	(44,069	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization expense		213			207			207
Depreciation of property and equipment		1,277			1,126			907
Loss/(gain) on disposal of property and equipment		3			18			(9	)
Loss on investments		29			516			198
Stock-based compensation expense		1,547			—			—
Changes in operating assets and liabilities:
Receivables from Allergan		(3,347	)		(1,397	)		(3,501	)
Prepaid expenses and other receivables		(1,098	)		(516	)		(527	)
Other assets		10			(14	)		19
Accounts payable		2,837			(907	)		364
Accrued expenses		1,369			(945	)		6,311
Net cash used in operating activities		(39,275	)		(33,759	)		(40,100	)
Cash flows from investing activities:
Purchase of investments		(49,789	)		(158,609	)		(72,978	)
Proceeds from sale of investments		55,149			157,407			56,955
Purchase of property and equipment		(854	)		(648	)		—
Proceeds from sale of property and equipment		1			1			61
Net cash provided by (used in) investing activities		4,507			(1,849	)		(15,962	)
Cash flows from financing activities:
Issuance of common stock, net		75			795			122,806
Proceeds from long-term debt		20,000			—			—
Proceeds from short-term debt		781			—			—
Debt issuance cost		(100	)		—			—
Payments on debt and capital lease obligations		(816	)		(489	)		(748	)
Net cash provided by financing activities		19,940			306			122,058
(Decrease)/increase in cash and cash equivalents		(14,828	)		(35,302	)		65,996
Cash and cash equivalents, beginning of year		65,018			100,320			34,324
Cash and cash equivalents, end of year	$	50,190		$	65,018		$	100,320

Supplemental disclosure of non-cash investing and financing activities: The Company made cash payments for interest of $215, $145 and $119 for the years ended December 31, 2006, 2005 and 2004, respectively. The Company acquired property and equipment through the assumption of capital lease obligations amounting to $1,545 during the year ended December 31, 2004.

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

F-6

INSPIRE PHARMACEUTICALS, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive (Loss)/income			Accumulated Deficit			Stockholders’ Equity
	Number of Shares	Amount
Balance at December 31, 2003	31,847	$	32	$	198,393	$	(279	)	$	(127,094	)	$	71,052
Issuance of common stock	9,998		10		122,796		—			—			122,806
Unrealized loss on investments	—		—		—		(191	)		—			(191	)
Net loss	—		—		—		—			(44,069	)		(44,069	)
Balance at December 31, 2004	41,845		42		321,189		(470	)		(171,163	)		149,598
Issuance of common stock	366		—		795		—			—			795
Unrealized gain on investments	—		—		—		143			—			143
Net loss	—		—		—		—			(31,847	)		(31,847	)
Balance at December 31, 2005	42,211		42		321,984		(327	)		(203,010	)		118,689
Issuance of common stock	27		—		75		—			—			75
Unrealized gain on investments	—		—		—		175			—			175
Stock-based compensation	—		—		1,547		—			—			1,547
Net loss	—		—		—		—			(42,115	)		(42,115	)
Balance at December 31, 2006	42,238	$	42	$	323,606	$	(152	)	$	(245,125	)	$	78,371

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

F-7

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS

(in thousands, except per share amounts)

1. Organization

Inspire Pharmaceuticals, Inc. (the “Company” or “Inspire”) was incorporated in October 1993 and commenced operations in March 1995. 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 2007. Although the Company’s liquidity needs will largely be determined by key development and regulatory events, it will most likely need to: (1) obtain product candidate approvals, (2) out-license rights to its product candidates, and/or (3) raise additional capital through equity or debt financings or from other sources in order to continue its operations beyond 2007. The Company began receiving revenue from its co-promotion of Elestat^® (epinastine HCl ophthalmic solution) 0.05% and Restasis^® (cyclosporine ophthalmic emulsion) 0.05% in 2004, but will continue to incur operating losses until co-promotion and/or product revenues reach a level sufficient to support ongoing operations. Elestat and Restasis are trademarks owned by Allergan, Inc. (“Allergan”).

2. Summary of Significant Accounting Policies and Concentrations of Risk

Use of Estimates

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

Cash, Cash Equivalents, Interest and Other Receivables

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

Investments

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

F-8

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

other than temporary, then the investment would be written down to fair value and the write-down would be included in the Company’s operating results. The Company’s investment policy requires it to purchase high-quality marketable securities with a maximum individual maturity of three years and requires an average portfolio maturity of no more than one year.

The Company has an equity investment in Parion Sciences, Inc. (“Parion”), a non-public entity for which its fair value is not readily determinable. For this investment in which the Company does not have significant influence and owns less than 5% of Parion, the investment is carried at cost and is subject to a write-down for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. As of December 31, 2006, 2005 and 2004, this investment’s recorded value was $200.

Property and Equipment

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

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

Restricted Deposits

Restricted deposits consist of cash and cash equivalents which collateralize a letter of credit that is required under the terms of a vehicle fleet financing agreement. Restricted deposits are classified as current or long-term based upon the expected release date of such restriction. The carrying amount of these restricted deposits approximates fair value. At December 31, 2006, 2005 and 2004, the Company had $515 of restricted deposits recorded as long-term investments.

Intangible Assets

Costs associated with obtaining and maintaining patents on the Company’s product candidates and license initiation and preservation fees, including milestone payments by the Company to its licensors, are evaluated based on the stage of development of the related product candidate and whether the underlying product candidate has an alternative use. Costs of these types incurred for product candidates not yet approved by the U.S. Food and Drug Administration (“FDA”) and for which no alternative 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.

F-9

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Other Assets

During December 2003, the Company recorded a deferred charge associated with an up-front milestone payment made in conjunction with the co-promotion agreement for Elestat executed in December 2003. This asset is amortized ratably on a straight-line basis through October 2008, the expected commercial exclusivity period for Elestat in the United States. At December 31, 2006, 2005 and 2004, the Company had $379, $586 and $793 of deferred charges associated with the up-front milestone, respectively, and $621 in accumulated amortization at December 31, 2006.

In addition, in December 2006, the Company entered into a loan and security agreement and received an initial loan advance of $20,000. Total expenses associated with entering into the loan agreement of $500, including commitment fees paid of $100, have been capitalized and classified as deferred financing costs. At December 31, 2006, the Company had $494 in deferred financing costs that are being amortized to interest expense over the term of the loan, which matures in March 2011, using the effective interest rate method.

Revenue Recognition

The Company records all its revenue from product co-promotion activities and collaborative research agreements in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements.”

The Company recognizes co-promotion revenue based on net sales for Elestat and Restasis, as defined in the co-promotion agreements, and as reported to Inspire by Allergan. The Company actively promotes both Elestat and Restasis 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 it 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 Elestat and Restasis, 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, an independent provider of pharmaceutical data. 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 Elestat and Restasis. 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. In each of the years ended December 31, 2006, 2005 and 2004, the amount of rebates associated with the Company’s incentive programs 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 satisfied, the Company records revenues using a reduced percentage of net sales based upon its level of achievement of predetermined calendar year net sales target levels. Amounts

F-10

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

receivable from Allergan in excess of recorded co-promotion revenue are recorded as deferred revenue. The Company achieved its annual 2006 net sales target level during the three-month period ended June 30, 2006.

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 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. In the year ended December 31, 2006, the Company recognized $1,250 of collaborative research revenue. No collaborative research revenue was recognized for the years ended December 31, 2005 and 2004.

Research and Development

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

Income Taxes

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

F-11

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Stock-Based Compensation

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Stock-based compensation expense for all share-based payments granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognizes these compensation costs net of an expected forfeiture rate and recognizes the compensation costs on a straight-line basis for only those shares expected to vest over the requisite service period of the award, which is generally three to five years. Prior to the adoption of SFAS No. 123(R), the Company recognized stock-based compensation expense in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”) regarding the SEC’s interpretation of SFAS No. 123(R) and the valuation of share-based payments for public companies. The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R). See Note 8 to the Financial Statements for a further discussion on stock-based compensation.

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 only paid in shares of the Company’s stock upon conversion. The calculation of diluted earnings per share for the years ended December 31, 2006, 2005 and 2004 does not include 482, 695 and 1,426, respectively, of potential common shares, as their impact would be antidilutive.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss is comprised of unrealized gains and losses on marketable securities and is disclosed as a component of stockholders’ equity. At December 31, 2006, 2005 and 2004, the Company had $152, $327 and $470 of unrealized loss on its investments, respectively.

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

	2006			2005			2004
Net loss	$	(42,115	)	$	(31,847	)	$	(44,069	)
Adjustment for realized losses in net loss		29			516			198
Change in unrealized gain/(losses) on investments		146			(373	)		(389	)
Total comprehensive loss	$	(41,940	)	$	(31,704	)	$	(44,260	)

F-12

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Advertising

The Company engages in general and direct-response advertising when promoting and marketing Elestat. These advertising costs are expensed as the costs are incurred. Advertising and product promotion expenses were $4,433, $4,748 and $4,666 for the years ended December 31, 2006, 2005 and 2004, respectively.

Significant Customers and Risk

All co-promotion revenues recognized and recorded in 2006, 2005 and 2004 were from one collaborative partner. The Company is entitled to receive co-promotion revenue from net sales of Elestat and Restasis under the terms of its collaborative agreements with Allergan, and accordingly, all trade receivables are concentrated with Allergan. Due to the nature of these agreements, Allergan has significant influence over the commercial success of these products.

Credit Risk

Cash equivalents and investments are financial instruments which potentially subject the Company to concentration of risk to the extent recorded on the balance sheet. Management of the Company believes it has established guidelines for investment of its excess cash relative to diversification and maturities that maintain safety and liquidity. To minimize the exposure due to adverse shifts in interest rates, the Company currently maintains a portfolio of investments with an average maturity of 12 months or less at December 31, 2006. The Company keeps all of its cash deposits in financial institutions in the United States.

Risks from Third Party Manufacturing Concentration

The Company relies on single source manufacturers for each of its product candidates. In addition, Allergan is responsible for the manufacturing of both Elestat and Restasis and relies on single source manufacturers for the active pharmaceutical ingredients in both products, which are co-promoted by the Company. Accordingly, delays in the manufacture of any product or 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 manufacture of products for which it is entitled to receive revenue and the overall product supply chain.

Reclassifications

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

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“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. The Company is currently evaluating the impact, if any, of SFAS No. 159 on its financial statements. If elected, SFAS No. 159 would be effective as of January 1, 2008.

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. The Company is currently evaluating the impact of adopting this statement.

F-13

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Also in September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” (“SAB No. 108”). SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. It requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. The provisions of SAB No. 108 must be applied to annual financial statements no later than the first fiscal year ending after November 15, 2006. The Company has assessed the effect of adopting this guidance and has determined that there was no impact on its financial statements or related disclosures.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN No. 48”). FIN No. 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN No. 48 and in subsequent periods. FIN No. 48 will be effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the potential impact of FIN No. 48 on its financial statements; however, the Company does not expect a material impact on its current disclosures due to its current net operating loss position and related valuation allowance against all deferred tax assets.

3. Investments

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

	December 31,
	2006		2005
Available-for-sale securities	$	51,376	$	56,590
Restricted deposits		515		515
Preferred stock		200		200
	$	52,091	$	57,305

The following is a summary of the Company’s marketable debt securities which are classified as available-for-sale:

	December 31, 2006
	Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
Auction rate securities	$	19,525	$	—	$	—		$	19,525
Corporate bonds and commercial paper		11,767		1		(54	)		11,714
U.S. Government and agencies		20,236		—		(99	)		20,137
Total	$	51,528	$	1	$	(153	)	$	51,376

F-14

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

	December 31, 2005
	Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
Auction rate securities	$	13,600	$	—	$	—		$	13,600
Corporate bonds and commercial paper		26,224		7		(162	)		26,069
U.S. Government and agencies		17,093		—		(172	)		16,921
Total	$	56,917	$	7	$	(334	)	$	56,590

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

	December 31,
	2006		2005
Less than one year	$	45,377	$	37,697
Greater than one year		5,999		18,893
	$	51,376	$	56,590

The following table shows the gross unrealized losses and fair value of the Company’s marketable debt securities with unrealized losses that are deemed to be temporarily impaired, aggregated by length of time that the individual securities have been in a continuous unrealized loss position.

	December 31, 2006
	Less than 12 months				12 months or greater				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government and agencies	$	6,831	$	5	$	11,511	$	93	$	18,342	$	98
Corporate bonds		1,981		1		7,138		54		9,119		55
Total	$	8,812	$	6	$	18,649	$	147	$	27,461	$	153
	December 31, 2005
	Less than 12 months				12 months or greater				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government and agencies	$	11,516	$	77	$	5,405	$	95	$	16,921	$	172
Corporate bonds		13,513		106		8,569		56		22,082		162
Total	$	25,029	$	183	$	13,974	$	151	$	39,003	$	334

The unrealized losses on the Company’s investments in U.S. Treasury obligations and direct obligations of U.S. Government agencies were caused by an increase in interest rates since acquisition. The unrealized losses on the Company’s investments in corporate bonds are primarily due to an increase in interest rates and to a lesser extent, changes in credit rating. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be at maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2006. Gross realized losses, including impairments, on the Company’s available-for-sale securities were $29, $516 and $198 for the years ended December 31, 2006, 2005 and 2004, respectively.

F-15

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

4. Property and Equipment

Property and equipment consist of the following:

	Useful Life (Years)	December 31,
		2006			2005
Equipment	5	$	4,631		$	4,073
Leasehold improvements	Lesser of lease term or 5 years		1,584			1,452
Computer hardware	3		1,120			1,046
Software	5		904			872
Furniture and fixtures	7		808			771
			9,047			8,214
Less—accumulated depreciation			(7,293	)		(6,033	)
Property and equipment, net		$	1,754		$	2,181

The Company leases certain assets under capital lease agreements. The net book value of assets under capital leases at December 31, 2006 and 2005 was approximately $407 and $1,006, respectively. Accumulated amortization for assets under capital leases at December 31, 2006 and 2005 was $1,799 and $1,200, respectively.

5. Accrued Expenses

Accrued expenses are comprised of the following:

	December 31,
	2006		2005
Compensation and benefits	$	4,607	$	3,164
Development costs		2,303		1,626
Professional fees		605		751
Selling and marketing costs		314		883
Duties and taxes		208		324
Other		322		242
	$	8,359	$	6,990

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

6. 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. Any borrowings under the loan agreement are secured by substantially all of the Company’s assets, with the exception of its intellectual property but including all accounts, license and royalty fees and other revenues and proceeds arising from its intellectual property. In addition, the Company established and maintains its primary depository and operating accounts and security accounts with one of the participating financial institutions and will keep a certain percentage of its cash and investments within these accounts depending upon its total cash and investment balances. An initial term loan advance of $20,000 was made to the Company in December 2006. Subsequent borrowings are subject to certain conditions and may be requested by the Company in amounts not less than

F-16

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

$1,000 each during the term of the commitment period which ends on June 30, 2007. The commitment period may be extended by the Company to December 31, 2007, subject to additional fees and upon satisfaction of certain conditions. The Company’s ability to borrow additional amounts under this agreement are subject to the satisfaction of any one of a number of conditions related to its progress in developing bilastine or its success in obtaining FDA approval for other product candidates owned by or in-licensed to the Company. To the extent that none of the conditions are satisfied, the Company may still borrow from the term loan facility, but only in the amount by which its research and development expenditures on bilastine and/or another in-licensed product candidate exceed the initial advance of $20,000.

The maturity date for all loan advances under the term loan facility is March 2011. Interest accrues on the unpaid principal amount of each loan advance at a per annum rate equal to the five-year U.S Treasury note yield plus 3% at the time each advance is made. Repayment of each advance will be made according to a schedule of six monthly installments of interest-only followed by equal monthly installments of principal and interest until the maturity date. During the term of the loan and security agreement, the Company is required to maintain a minimum liquidity level based on the balance of the outstanding advances. In addition to maintaining other covenants within the agreement, the Company may not enter into certain transactions such as a merger, acquisition, additional indebtedness or dispose of certain assets of the business as defined in the agreement without written approval of the lenders. The Company has the right to prepay the principal of any advance, without penalty, in minimum incremental amounts of $1,000. Any repayment of principal by the Company is subject to a final payment equal to 2% of the principal amount being repaid. Amounts cannot by reborrowed by the Company once repaid.

As of December 31, 2006, the Company had borrowings of $20,000 under the loan and security agreement that bears interest at 7.59%. The carrying amount of the debt of $20,000 approximates its fair value based on prevailing interest rates as of the balance sheet date. Scheduled maturities, representing principal repayments, of the term loan facility are as follows:

Term-Loan Maturities
2007	$	2,345
2008		4,969
2009		5,369
2010		5,797
2011		1,520
Total	$	20,000

In addition to its long-term debt, in 2006 the Company entered into a short-term financing agreement for certain insurance premiums. The term of the agreement is 11 months ending in July 2007, and the obligation bears interest at 6.5%. The remaining amount of the obligation as of December 31, 2006 was $502 and is classified as short-term debt.

7. Stockholders’ Equity

Sales of Common Stock

On August 2, 2000, the Company’s Registration Statement on Form S-1, as amended, registering 6,325 shares of common stock, was declared effective by the Securities and Exchange Commission (“SEC”) and permitted the Company to sell shares of common stock in its Initial Public Offering (“IPO”). On August 8, 2000, the Company sold 5,500 shares of common stock at the IPO for $12.00 per share which resulted in proceeds to

F-17

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

the Company of $66,000. On September 5, 2000, the Company sold an additional 825 shares of common stock pursuant to the exercise by the underwriters of their over-allotment option with respect to such shares, generating additional gross proceeds of $9,900. Total stock issuance costs related to the IPO and exercise of the over-allotment option were $6,713.

In March 2003, the Company sold 5,750 shares of common stock, including the underwriters’ over-allotment allocation, in a public offering at a price of $13.50 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $72,600. In July 2004, the Company sold 6,900 shares of common stock, including the underwriters’ over-allotment allocation, in a public offering at a price of $12.00 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $77,100. In November 2004, the Company sold 2,530 shares of common stock, including the underwriter’s over-allotment allocation, in a public offering at a price of $17.10 per share. The proceeds from the offering, net of applicable issuance costs and expenses, totaled approximately $42,300.

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

Rights Agreement

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

8. Stock-Based Compensation

The Company has two stock-based compensation plans:

During 1995, the Company adopted the 1995 Stock Plan, which provided for the grant of up to 1,006 options to directors, officers, employees and consultants. In April 1999, the Plan was amended and restated, and is now the Amended and Restated 1995 Stock Plan, as amended (the “1995 Plan”). The option pool was increased to 5,229 shares on September 28, 2001, to 6,429 shares on December 14, 2001 and to 7,179 on June 10, 2004. As of December 31, 2006, non-qualified stock options and restricted stock may be granted under the 1995 Plan. The Board of Directors, or an appropriate committee of the Board of Directors, shall determine the terms, including exercise price and vesting schedule, of all options at grant date.

F-18

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

In June 2005, the Company adopted the 2005 Equity Compensation Plan (the “2005 Plan”), which provided for the grant of up to 3,000 options to directors, officers, employees and consultants. Under the 2005 Plan, both incentive and non-qualified stock options, as well as stock appreciation rights and restricted stock, may be granted. The Board of Directors, or an appropriate committee of the Board of Directors, shall determine the terms, including exercise price and vesting schedule, of all grants at grant date, provided that for incentive stock options, such exercise price shall not be less than the fair market value of the Company’s stock on the date of grant.

The maximum term for any option grant under the 1995 Plan and the 2005 Plan are ten and seven years, respectively, from the date of the grant. Prior to July 2006, options granted to employees under both plans generally vested 25% upon completion of one full year from date of grant and on a monthly basis over the following three years of their employment and the term of the options was the maximum permitted under the applicable plan.

Beginning in July 2006, the Compensation Committee of the Company’s Board of Directors authorized stock option grants with a three-year vesting period and a maximum term of five years for all future issuances to non-executive employees. Under these new terms, options granted to non-executive employees will vest 33% upon completion of one full year from date of grant and on a monthly basis over the following two years of their employment. The vesting period typically begins on the date of hire for new employees and on the date of grant for existing employees.

Also in July 2006, the Compensation Committee authorized the issuance of restricted stock units to each of the Company’s executive officers, in the aggregate totaling 195 units. The restricted stock units vest annually over five years from the date of grant or earlier upon the event of change in control. Any restricted stock units that have not vested at the time of termination of service to the Company are forfeited. The restricted stock units do not have voting rights and the shares underlying the restricted stock units are not considered issued and outstanding until conversion. The restricted stock units will convert into an equivalent number of shares of common stock upon termination of employment with the Company.

At December 31, 2006, there were 918 and 275 shares available for grant as options or other forms of share-based compensation under the 1995 Plan and 2005 Plan, respectively.

F-19

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(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, 2003	4,213		$	10.09
Granted	1,227			14.45
Exercised	(308	)		(4.47	)
Forfeited/cancelled/expired	(218	)		(12.57	)
Outstanding at December 31, 2004	4,914		$	11.42
Granted	1,306			9.13
Exercised	(365	)		(1.55	)
Forfeited/cancelled/expired	(298	)		(14.31	)
Outstanding at December 31, 2005	5,557		$	11.38		6.7	$	2,628
Granted	1,481			5.05
Exercised	(28	)		(2.69	)
Forfeited/cancelled/expired	(404	)		(12.95	)
Outstanding at December 31, 2006	6,606		$	9.90		5.7	$	5,534
Vested and exercisable at December 31, 2006	5,109		$	11.26		5.7	$	3,745

The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2006. These amounts change based on the fair market value of the Company’s stock. Total intrinsic value of stock options exercised for the year ended December 31, 2006 was $54. Cash received from stock option exercises for the year ended December 31, 2006 was $75. Due to the Company’s net loss position, no windfall tax benefit has been realized during the year ended December 31, 2006.

The following table summarizes information concerning options outstanding at December 31, 2006:

	Options Outstanding	Weighted Average Exercise Price (per share)		Weighted Average Remaining Contractual Life (in Years)	Options Exercisable
Exercise Price range (per share):
$   0.21 - $   4.82	1,128	$	2.73	4.8	931
$   4.85 - $   5.25	1,127		5.12	5.7	12
$   5.27 - $   9.42	1,486		8.66	5.6	1,301
$   9.44 - $ 13.60	1,119		12.34	5.2	1,119
$ 13.65 - $ 18.28	1,112		15.75	6.8	1,112
$ 18.30 - $ 20.30	634		19.45	6.7	634
	6,606	$	9.90	5.7	5,109

The weighted average fair value (per share) of options granted during 2006, 2005 and 2004 using the Black-Scholes option-pricing model was $3.17, $5.90 and $11.79, respectively.

F-20

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Stock-Based Compensation

For the year ended December 31, 2006, the Company recognized total stock-based compensation expense of $1,547 related to stock option and other share-based awards made from its two equity compensation plans. Prior to January 1, 2006, the Company accounted for those plans under the recognition and measurement provisions of APB No. 25. Accordingly, the Company generally recognized compensation expense only when it granted options with an exercise price below the estimated fair value of the Company’s common stock.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), using the modified prospective transition method and therefore has not restated prior periods’ results. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123. Stock-based compensation expense for all share-based payments granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognizes these compensation costs net of an expected forfeiture rate and recognizes the compensation costs on a straight-line basis for only those shares expected to vest over the requisite service period of the award, which is generally three to five years. The Company estimated the forfeiture rate for the year ended December 31, 2006 based on its historical experience.

As a result of adopting SFAS No. 123(R), the impact to the Company’s net loss for the year ended December 31, 2006, was $1,475 greater than if the Company had continued to account for its stock options under APB No. 25. Total stock-based compensation, including compensation expense associated with restricted stock units issued in July 2006, was allocated as follows:

	Year Ended 2006
Research and development	$	576
Selling and marketing		293
General and administrative		678
Total stock-based compensation expense	$	1,547

Prior to January 1, 2006, the Company provided pro forma disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS No. 148”), as if the fair value method defined by SFAS No. 123 had been applied to its stock-based compensation. The pro forma table below reflects net loss and basic and diluted net loss per share for the years ended December 31, 2005 and 2004, had the Company applied the fair value recognition provisions of SFAS No. 123, as follows:

	Year Ended December 31,
	2005			2004
Net loss—as reported	$	(31,847	)	$	(44,069	)
Compensation expense included in reported net loss		—			—
Pro forma adjustment for compensation expense		(29,177	)		(9,670	)
Net loss—pro forma	$	(61,024	)	$	(53,739	)
Net loss per common share—as reported	$	(0.76	)	$	(1.25	)
Net loss per common share—pro forma	$	(1.45	)	$	(1.52	)

F-21

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

In December 2005, the Company’s Board of Directors approved the acceleration of vesting of unvested stock options held by directors and employees, including officers, which had an exercise price equal to or greater than $9.42. As a result of the accelerated vesting, options to purchase approximately 2,100 shares of common stock, including 687 shares held by executive officers, which otherwise would have vested on a monthly basis through 2009, became immediately exercisable. The weighted average exercise price of the options subject to the acceleration was $13.02. The decision to accelerate these options was made primarily to reduce compensation expense that would be expected to be recorded in future periods following the Company’s adoption of SFAS No. 123(R). In addition, the Board of Directors determined that because these options had exercise prices well in excess of the current market value, they were not fully achieving their original objectives of incentive compensation and employee retention. Reflected in the pro forma table above is approximately $20,000 of additional compensation expense in the year ended December 31, 2005 related to the options that were accelerated.

Basis for Fair Value Estimate of Share-Based Payments

Based on analysis of its historical volatility, the Company expects that the future volatility of its share price is likely to be lower than the historical volatility the Company experienced prior to the commercial activities initiated in the second half of 2003 and the subsequent commencement of co-promotion activities for Elestat and Restasis beginning in fiscal 2004, due to the diversification of operations as well as the additional and ongoing cash flow generated by these activities. The Company used a blended volatility calculation utilizing volatility of peer group companies with similar operations and financial structures in addition to the Company’s own historical volatility to estimate its future volatility for purposes of valuing the share-based payments granted during fiscal 2005 and 2006. Actual volatility, and future changes in estimated volatility, may differ substantially from the Company’s current estimates.

In 2005, the Company adopted and began granting options under the 2005 Plan. Due to lack of historical data with regards to exercise activity under the 2005 Plan, the Company adopted a simplified method of calculating the expected life of options for grants made to its employees in accordance with the guidance set forth in SAB No. 107. For options issued to directors under the 2005 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 2005 Plan until such time that adequate historical data is available. For options issued under the 1995 Plan, the Company utilized the historical data available regarding employee and director exercise activity to calculate an expected life of the options. 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 was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values for grants made during the periods indicated.

	Stock Options for Year Ended December 31,
	2006			2005			2004
Risk-free interest rate		4.61	%		4.02	%		3.33	%
Dividend yield		0	%		0	%		0	%
Expected volatility		80	%		79	%		110	%
Expected life of options (years)		4.4			4.8			5.2
Weighted average fair value of grants (per option)	$	3.17		$	5.90		$	11.79

F-22

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

As of December 31, 2006, approximately $3,700 of total unrecognized compensation cost related to unvested stock options is expected to be recognized over a weighted-average period of 2.9 years.

As of December 31, 2006, the Company has 195 outstanding restricted stock units, none of which were vested. The value of the restricted stock units 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 fair value of $811. As of December 31, 2006, there was $739 of unrecognized share-based compensation expense related to unvested restricted stock unit awards, which is expected to be recognized over the next 4.6 years.

9. Income Taxes

The Company had no federal, state or foreign income tax expense for the years ended December 31, 2006, 2005 and 2004.

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

	December 31,
	2006			2005
Current deferred tax assets:
Compensation related items	$	311		$	267
Noncurrent deferred tax assets:
Accrued expenses		738			738
Domestic net operating loss carryforwards		79,888			70,150
Research and development credits		20,678			15,622
Property, equipment and intangible assets		5,713			1,802
Stock-based compensation		1,956			1,688
Contributions		307			289
Investments		417			275
Total deferred tax assets		110,008			90,831
Valuation allowance for deferred assets		(110,008	)		(90,831	)
Deferred tax assets	$	—		$	—

At December 31, 2006 and 2005, the Company has provided a full valuation allowance against its net deferred tax assets since realization of these benefits could not be reasonably assured. The valuation allowance has increased $19,177, $15,964 and $19,314 for the years ended December 31, 2006, 2005 and 2004, respectively. The increase in the valuation allowance of $19,177 during the year ended December 31, 2006 resulted primarily from the generation of additional net operating loss carryforwards and research and development credits.

As of December 31, 2006, the Company had federal and state net operating loss carryforwards of $205,247 and $221,874, respectively. The net operating loss carryforwards expire in various amounts starting in 2008 and 2010 for federal and state tax purposes, respectively. The utilization of the federal net operating loss carryforwards may be subject to limitation under the rules regarding a change in stock ownership as determined by the Internal Revenue Code. If the Company’s utilization of its net operating loss carryforwards is limited and the Company has taxable income which exceeds the permissible yearly net operating loss carryforward, the Company would incur a federal income tax liability even though its net operating loss carryforwards exceed its

F-23

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

taxable income. Additionally, as of December 31, 2006 and 2005, the Company has federal research and development and orphan drug credit carryforwards of $20,678 and $15,622, respectively. The credit carryforwards expire in varying amounts starting in 2010.

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

	Year Ended December 31,
	2006			2005			2004
U.S. Federal tax at statutory rate	$	(14,319	)	$	(10,828	)	$	(14,984	)
State taxes (net of Federal benefit)		(1,875	)		(1,483	)		(2,075	)
Change in valuation reserve		19,177			15,964			19,314
Research and development credit		(5,056	)		(4,918	)		(2,184	)
Nondeductible expenses due to credits		(13	)		80			140
Other nondeductible expenses		2,086			1,185			(211	)
Provision for income taxes	$	—		$	—		$	—

10. Collaboration Agreements

Allergan, Inc.

In December 2003, the Company entered into an agreement with Allergan to co-promote Elestat in the United States. Under the agreement, Inspire has the responsibility for promoting and marketing Elestat to ophthalmologists, optometrists and allergists in the United States and paying the associated costs. In addition, Inspire has the right to conduct Phase 4 clinical trials and other studies in collaboration with Allergan relating to Elestat. Inspire receives co-promotion revenue from Allergan on its U.S. net sales of Elestat. Inspire works with Allergan collaboratively on overall product strategy and management in the United States. Allergan records sales of Elestat and is responsible for other product costs, as well as retaining responsibility for all international marketing and selling activities. Allergan also retains the licensing rights relating to promotion of Elestat to U.S. prescribers other than ophthalmologists, optometrists and allergists. However, Inspire has a right of first refusal to obtain such rights in the event Allergan decides to engage a third party to undertake such activities. Inspire has established a joint commercialization committee with Allergan to coordinate and oversee the broad strategies, promotion activities and manage the relationship. Allergan is responsible for supply chain management, managed healthcare, customer order processing and regulatory compliance. Under the terms of the agreement, Inspire paid Allergan an up-front payment and Allergan pays co-promotion revenue to Inspire on its U.S. net sales of Elestat. In the event that a third party is engaged by Allergan to promote Elestat to prescribers outside of Inspire’s field, the Company is entitled to be paid a proportionate share of U.S. net sales of Elestat based upon filled prescriptions written by ophthalmologists, optometrists and allergists. Under the terms of the agreement, Inspire is required to achieve certain performance minimums to receive some or all of co-promotion revenue contemplated.

The agreement will be in effect until the earlier of: (i) the approval and launch of the first generic epinastine product; or (ii) the approval and launch of the first over-the-counter epinastine product. The commercial exclusivity period for Elestat under the Hatch-Waxman Act will expire in October 2008, after which time Elestat could face generic competition if there is no other intellectual property protection covering Elestat. Either Allergan or Inspire may terminate the agreement in the event of a material breach of the agreement by the other or in the event of the other’s insolvency. Allergan can terminate the agreement if Inspire fails to meet a defined minimum of net sales in any given year, or upon a change of control where Inspire becomes an affiliate of a

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INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

direct competitor of Allergan’s as that term is defined in the agreement. Inspire can terminate the agreement in the event that Elestat is withdrawn from the market for more than ninety days.

In June 2001, the Company entered into a joint license, development and marketing agreement with Allergan to develop and commercialize our product candidate, Prolacria^TM. The agreement also provided the Company with a royalty on net sales of Allergan’s Restasis and granted the right to co-promote Restasis in the United States. This agreement was amended in December 2003, in connection with the execution of the co-promotion agreement for Elestat to reduce the co-promotion revenue rates due on net sales of Restasis. Under the terms of the amended agreement, Allergan obtained an exclusive license to develop and commercialize Prolacria worldwide, with the exception of Japan and nine other Asian countries covered by Inspire’s agreement with Santen Pharmaceutical Co., Ltd. (“Santen”). In return, Inspire received an up-front payment of $5,000 in 2001 on execution of the agreement and has received milestone payments of $3,000 in 2002 and $3,000 in 2003. Inspire is entitled to receive up to an additional $28,000 in milestone payments assuming the successful completion of all the remaining milestones. The Company is also entitled to receive co-promotion revenue from Allergan on sales of Prolacria, if any, and on worldwide sales of Allergan’s Restasis, excluding most larger Asian markets. The Company began receiving co-promotion revenue from net sales of Restasis in April 2004.

The Company is responsible for conducting, in collaboration with Allergan, the Phase 3 clinical trials for Prolacria for dry eye disease needed for potential approval and for filing the U.S. New Drug Application. Allergan is responsible for all other development activities under the agreement, including all development and regulatory activities needed for potential approval outside the United States and in its territories, and for ex-U.S. regulatory submissions, filings, and approvals relating to products. Allergan is responsible for all commercial costs except for the cost of Inspire’s sales force in the United States. Allergan is required to use commercially reasonable efforts to conduct these development activities, seek ex-U.S. regulatory approvals and market and sell Prolacria. Unless earlier terminated pursuant to other terms of the agreement, the agreement will expire as to each product (Restasis or Prolacria, as the case may be) in each applicable country on the later of (i) the 10th anniversary of the first commercial sale of such product in the applicable country, or (ii) the date on which the sale of such product ceases to be covered by any claim of any applicable Inspire or Allergan patent. The agreement will expire in its entirety upon the expiration of the agreement with respect to all products in all countries as described in the previous sentence.

Boehringer Ingelheim International GmbH

In February 2006, the Company entered into a development and license agreement with Boehringer Ingelheim International GmbH (“Boehringer Ingelheim”). The agreement grants Inspire certain exclusive rights to develop and market an intranasal dosage form of epinastine, in the United States and Canada, for the treatment or prevention of rhinitis. Under the terms of the agreement, Inspire has full responsibility for the epinastine nasal spray development program and regulatory filings in the United States and Canada. Upon the receipt of appropriate regulatory approvals for an epinastine nasal spray product, Inspire is responsible for the commercialization of such product in the United States and Canada. Boehringer Ingelheim has retained the rights to develop and commercialize an epinastine nasal spray product outside the United States and Canada, based on any future results of Inspire’s epinastine nasal spray development program.

In addition to funding all development activities under the terms of the agreement, Inspire paid Boehringer Ingelheim an upfront license fee of $2,500. Additionally, Inspire will owe Boehringer Ingelheim a high single digit royalty on net sales of an epinastine nasal spray product in the United States and Canada. If Boehringer Ingelheim commercializes Inspire’s epinastine nasal spray product outside of the United States and Canada, it will be obligated to pay royalties to Inspire on net sales of the product.

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INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

In general, the exclusive license granted to Inspire will expire and convert into a perpetual, fully paid-up, non-exclusive license on December 31, 2022. Certain other rights and royalty obligations will continue beyond such date. For a period of five years following December 31, 2022, Boehringer Ingelheim shall have the right, but not the obligation, to switch a product developed under the agreement from a prescription product to an over-the-counter (“OTC”) product. Following such a switch, Boehringer Ingelheim will have the right to commercialize such product in the United States and/or Canada. In connection with such a switch, Boehringer Ingelheim will be required to pay an OTC switch payment and ongoing royalties to the Company.

Cystic Fibrosis Foundation Therapeutics, Inc.

In October 2002, the Company entered into a study funding agreement with the Cystic Fibrosis Foundation Therapeutics, Inc. (“CFFT”), whereby the majority of the expenses for one Phase 2 clinical trial for denufosol for the treatment of cystic fibrosis were funded by the CFFT, but the Company also recorded the corresponding expenses and liabilities as the CFFT incurred these costs. This clinical trial was completed in 2004. If the Company receives FDA approval for denufosol for the treatment of cystic fibrosis, the Company will be obligated to pay a development milestone, and possibly a sales milestone, to the CFFT. The aggregate potential milestones under this agreement are approximately $16,000. The Company has recorded $1,915 of contingent liabilities in “Other long-term liabilities” associated with this agreement as of December 31, 2006 and 2005. If it does not receive FDA approval, the Company will have no financial obligation to the CFFT, including the Phase 2 clinical trial costs the CFFT funded on the Company’s behalf.

FAES Farma, S.A.

In October 2006, the Company entered into a licensing agreement with FAES Farma, S.A (“FAES”) for the U.S. and Canadian development and commercialization of bilastine, a Phase 3 oral antihistamine compound for the treatment or prevention of allergic rhinitis. Under the terms of the agreement, Inspire has acquired exclusive rights to further develop and commercialize formulations of bilastine in the United States and Canada, as well as the exclusive right to develop and commercialize the ocular formulation worldwide, excluding Spain, Portugal, Guatemala, Belize, El Salvador, Honduras, Nicaragua, Costa Rica, Panama and the countries of South America. Under the terms of the agreement, Inspire paid an upfront license fee of $7,000 and will owe FAES up to an additional $82,000 of payments, contingent upon achievement of various development, regulatory and sales-based milestone events. Inspire will also pay a royalty of either 14% or 16% based on the amount of annual net sales of the oral formulations of bilastine in the United States and Canada and 10% on ocular formulations of bilastine in the ocular territory described above, if approved by regulatory authorities. Under the terms of the agreement, Inspire’s obligation to pay royalties to FAES is subject to annual minimum royalty payments which commence on the first quarter start date that is at least one year after receipt of regulatory approval of the oral tablet formulation of bilastine for the treatment and prevention of allergic rhinitis. Additionally, Inspire granted to FAES a right of first negotiation for commercialization in Spain and Portugal of Inspire’s cystic fibrosis development compound, denufosol tetrasodium, if Inspire chooses to out-license the cystic fibrosis product on a regional basis. Unless terminated earlier upon mutual written consent, voluntary termination or material breach, the term of the agreement will expire upon the later to occur of the expiration of Inspire’s or FAES’ obligation to make royalty payments under the agreement. Inspire retains the right to terminate the agreement on a partial, product-by-product basis or entirely on the earlier of May 31, 2007 or upon receipt of results of certain studies, with a complete termination requiring 90 or 180 day advance written notice to FAES (depending upon whether Inspire has begun commercial sales of bilastine-based products).

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INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

Santen Pharmaceuticals Co, Ltd.

In December 1998, the Company entered into a development, license and supply agreement with Santen for the development of diquafosol tetrasodium for the therapeutic treatment of ocular surface diseases. Under the agreement, the Company granted Santen an exclusive license to develop and market diquafosol tetrasodium for ocular surface diseases in Japan, China, South Korea, the Philippines, Thailand, Vietnam, Taiwan, Singapore, Malaysia and Indonesia in the field. The Company is obligated to supply Santen with its requirements of diquafosol tetrasodium in bulk drug substance form for all preclinical studies, clinical trials and commercial requirements at agreed-upon prices.

Under the terms of the agreement, Inspire has received a total of $1,500 in equity and $1,750 in non-refundable milestone payments, including a $1,250 milestone payment received in March 2006. Depending on whether all milestones under the agreement are achieved, the Company could receive additional milestone payments of up to $3,000. In addition, the Company is entitled to receive royalties on net sales of diquafosol tetrasodium by Santen, if any.

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

Wisconsin Alumni Research Foundation

In November 2004, the Company executed an exclusive license agreement with the Wisconsin Alumni Research Foundation (“WARF”) under which WARF granted the Company an exclusive license under several patents, including three U.S. patents, for use in developing and commercializing new treatments for glaucoma. Under the terms of the agreement, Inspire will design and fund all future research, development, testing, regulatory filings and potential marketing activities related to any product candidate under development or product developed from the license. Inspire paid WARF an upfront licensing payment of $150 in 2004 on execution of the agreement, paid milestone payments of $50 in 2006, and will pay additional contingent payments of up to an aggregate of $1,750 upon the achievement of development milestones, and royalties on sales of any regulatory approved product utilizing the licensed patents. Unless terminated earlier, the agreement will expire on a country-by-country basis upon the expiration of the patents in such country. If the Company fails to pay the minimum annual payments under its license or commits any material breach of any other material covenant, as defined in the agreement, and fails to remedy such breach within 90 days of written notice, WARF may terminate the applicable license.

11. Commitments and Contingencies

Capital Leases

The Company is obligated under master capital lease agreements for furniture, equipment, and computers, for which the underlying furniture, equipment and computers serve as collateral. The lease terms under these master lease agreements expire 48 months from the date of inception and have interest rates ranging from 8.2% to 9.6%. The carrying value of the Company’s capital lease obligations at December 31, 2006 and 2005

F-27

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

approximate their fair value as the interest rates on these obligations approximate rates available in the financial market at such dates. The Company did not enter into any new capital leases during the years ended December 31, 2006 and 2005.

Operating Leases

The Company has entered into non-cancelable operating leases for its fleet of vehicles, facilities and office equipment that extend through 2008 and are subject to voluntary renewal options. In November 2006, the Company renewed the lease for its primary facilities located in Durham, North Carolina until January 2011. The Company leases vehicles for its commercial organization under a Master Lease Agreement that allows for individual vehicle leases to be cancelable after one year. The Master Lease Agreement requires the Company to maintain a Standby Letter of Credit in the amount of $515 during the term of the lease. The vehicle Master Lease Agreement also requires that the vehicles under lease serve as collateral for the obligation.

Total rent expense for operating leases during 2006, 2005 and 2004 was $1,428, $1,257 and $1,081, respectively. Future minimum lease payments under capital and non-cancelable operating leases with remaining lease payments as of December 31, 2006 are as follows:

Year Ending December 31,	Capital Leases		Operating Leases
2007	$	641	$	746
2008		272		616
2009		4		612
2010		—		631
2011		—		54
Total minimum lease payments		917	$	2,659
Less amount representing interest		62
Present value of net minimum capital lease payments		855
Less current portion of capital lease obligations		588
Capital lease obligations, excluding current portion	$	267

Other Commitments

The Company enters into contractual commitments or purchase arrangements with various clinical research organizations, manufacturers of active pharmaceutical ingredients and/or drug product as well as with others. The amount of these financial commitments which includes both cancelable and non-cancelable arrangements totaled approximately $14,307 at December 31, 2006. In addition, the Company has other contractual commitments outside of drug development under cancelable and non-cancelable arrangements which totaled approximately $3,065 at December 31, 2006. Many of these commitment amounts are dependent upon the results of underlying studies, the completion of studies and/or projects and certain other variable components of the agreements that may result in actual payments and the timing of those payments that differ from management’s estimate.

Contingencies

As of December 31, 2006, the Company’s existing license, collaboration and sponsored research agreements may require future cash payments upon the achievement of future milestones. In the aggregate, these agreements may require payments of up to $85,750 assuming the achievement of all development milestones and up to an

F-28

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

additional $14,000 assuming the achievement of all sales milestones. Amounts payable by the Company under these agreements are uncertain and are contingent on a number of factors, including the progress of its research, preclinical and development programs, its ability to obtain regulatory approvals, and the commercial success of its approved products. In addition, there is approximately $650 of development milestones under existing license agreements related to currently inactive development programs and management believes it is unlikely the milestones will be achieved and payments made. The Company is also obligated to pay royalties on net sales, if any, of certain product candidates currently in its portfolio. Some of the Company’s license agreements require minimum annual license preservation fees.

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. 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 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. Briefing on that motion is now complete and it is currently pending before the court.

The Company intends to defend the litigation vigorously. As with any legal proceeding, the Company cannot predict with certainty the eventual outcome of these pending 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 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

F-29

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

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 may seek a further meeting with 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.

12. Employee Benefit Plan

The Company adopted a 401(k) Profit Sharing Plan (“the 401(k) Plan”) covering all qualified employees on August 1, 1995. Participants may elect a salary reduction of 1% or more up to the IRS allowed maximum as a tax-deferred contribution to the 401(k) Plan. The 401(k) Plan permits discretionary employer contributions. If employer discretionary contributions are implemented, participants will begin vesting 100% immediately in such contributions. In 2006, 2005 and 2004, the Company elected a safe harbor contribution at 3.0% of annual compensation. These safe harbor contributions total $601, $578 and $455 for the years ended December 31, 2006, 2005 and 2004, respectively.

13. Co-promotion Revenue by Product Line

The Company operates its business as one business segment. The Company derives all of its co-promotion revenue for Elestat from product sales in the United States. Approximately 98% of co-promotion revenue for Restasis came from product sales in the United States in both 2006 and 2005.

	Year ended December 31,
	2006		2005		2004
Elestat	$	20,284	$	16,790	$	9,586
Restasis		15,525		6,476		1,482
	$	35,809	$	23,266	$	11,068

14. Quarterly Financial Data (unaudited)

2006	First			Second			Third			Fourth			Total
Revenue	$	5,468		$	13,437		$	9,702		$	8,452		$	37,059
Net loss available to common stockholders		(14,027	)		(5,377	)		(7,175	)		(15,536	)		(42,115	)
Net loss per common share—basic and diluted	$	(0.33	)	$	(0.13	)	$	(0.17	)	$	(0.37	)	$	(1.00	)
2005	First			Second			Third			Fourth			Total
Revenue	$	1,851		$	9,607		$	6,562		$	5,246		$	23,266
Net loss available to common stockholders		(13,342	)		(4,656	)		(6,752	)		(7,097	)		(31,847	)
Net loss per common share—basic and diluted	$	(0.32	)	$	(0.11	)	$	(0.16	)	$	(0.17	)	$	(0.76	)

15. Subsequent Events

On February 15, 2007, the Company signed an exclusive licensing agreement with InSite Vision Incorporated (“InSite Vision”) for the U.S. and Canadian commercialization of AzaSite^TM, a topical anti-infective

F-30

INSPIRE PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share amounts)

product candidate currently under review by the FDA for the treatment of bacterial conjunctivitis. The FDA’s review of the New Drug Application for AzaSite is expected to be completed the end of April 2007. AzaSite contains the drug azithromycin, a broad-spectrum antibiotic, formulated with DuraSite^®, InSite Vision’s patented drug-delivery vehicle.

Under the terms of the agreement, the Company has acquired from InSite Vision exclusive rights to commercialize AzaSite for ocular infections in the United States and Canada. Upon executing the agreement with InSite Vision, the Company paid InSite Vision an upfront licensing fee of $13,000. The Company will owe an additional $19,000 milestone payment, contingent upon regulatory approval of AzaSite by the FDA. Additionally, if approved by regulatory authorities, the Company will pay a royalty on net sales of AzaSite for ocular infections in the United States and Canada. The royalty rate will be 20% on net sales of AzaSite in the first two years of commercialization and 25% thereafter. The Company is obligated to pay royalties under the agreement for the longer of (i) eleven years from the launch of the subject product and (ii) the period during which a valid claim under a patent licensed from InSite Vision covers a subject product. Under the terms of the agreement, the Company’s obligation to pay royalties to InSite Vision is subject to annual minimum royalty payments which commence on the first quarter start date that is at least one year after the first commercial sale of any subject product, and may continue for a period of up to five years.

Under the terms of the agreement, InSite Vision is responsible for obtaining regulatory approval of AzaSite in the United States and Canada. The Company will be responsible for all the regulatory obligations and strategies relating to the further development and commercialization of products in the United States and Canada. The Company will also be responsible for all commercialization in the United States and Canada.

The license agreement can be terminated by the Company for convenience after the earlier of (i) the regulatory approval of the AzaSite product in the United States or (ii) April 27, 2008. The Company may also terminate the license agreement prior to the first commercial sale of a subject product upon 90 days notice to InSite Vision and after the first commercial sale of a subject product upon 180 days notice to InSite Vision.

The Company and InSite Vision have also entered into a supply agreement for the active pharmaceutical ingredient azithromycin. Previously, InSite Vision has entered into a third party supply agreement for the production of such active ingredient. Under the supply agreement, InSite Vision has agreed to supply Inspire’s requirements of active ingredient, pursuant to certain forecasting and ordering procedures. The initial term of the supply agreement is until 2012, subject to certain customary termination provisions, such as termination for material breach of the agreement. Either the Company or InSite Vision may terminate the supply agreement upon 180 days notice to the other party. After 2012, the supply agreement automatically renews for successive three-year periods unless terminated pursuant to such termination provisions. The supply agreement requires that InSite Vision produce for the Company a specified stockpile of active ingredient. The supply agreement also contains certain provisions regarding the rights and responsibilities of the parties with respect to manufacturing specifications, delivery arrangements, quality assurance, and regulatory compliance, as well as certain other customary matters.

F-31

Exhibit Index

Exhibit Number	Description
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	Certificate of Designations of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 3.3 to the Company’s Annual Report on Form 10-K filed March 7, 2003).
3.3	Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q filed on August 9, 2005).
4.1	Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
4.2	Rights Agreement, dated as of October 21, 2002, between the Company and Computershare Trust Company, which includes the form of Certificate of Designation of Series H Preferred Stock of Inspire Pharmaceuticals, Inc. as Exhibit “A”, the form of Rights Certificate as Exhibit “B” and the Summary of Rights to Purchase Preferred Stock as Exhibit “C” (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 22, 2002).
10.1†	Inspire Pharmaceuticals, Inc. Amended and Restated 1995 Stock Plan, as amended (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 21, 2005).
10.2†	Form of Incentive Stock Option. (Incorporated by reference to Exhibit 10.2 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.3†	Form of Non-statutory Stock Option. (Incorporated by reference to Exhibit 10.3 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.4*	Development, License and Supply Agreement between Inspire Pharmaceuticals, Inc. and Santen Pharmaceutical Co., Ltd., dated as of December 16, 1998. (Incorporated by reference to Exhibit 10.15 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.5†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Donald Kellerman dated February 3, 2000. (Incorporated by reference to Exhibit 10.24 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.6†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa dated February 4, 2000. (Incorporated by reference to Exhibit 10.26 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.7†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer dated February 10, 2000. (Incorporated by reference to Exhibit 10.28 to the Company’s registration statement on Form S-1 (Registration No. 333-31174) which became effective on August 3, 2000).
10.8†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Mary Bennett dated February 27, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2001).
10.9†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph Schachle dated April 3, 2001. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 10, 2001).

Exhibit Number	Description
10.10*	License, Development and Marketing Agreement between Inspire Pharmaceuticals, Inc. and Allergan, Inc., dated as of June 22, 2001. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 29, 2001).
10.11*	Study Funding Agreement, dated as of October 3, 2002, between Inspire Pharmaceuticals, Inc. and The Cystic Fibrosis Foundation Therapeutics, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 4, 2002).
10.12†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.13†	Form of Inspire Pharmaceuticals, Inc. Director Non-Statutory Stock Option Agreement. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 11, 2003).
10.14*	First Amendment to License, Development and Marketing Agreement, dated December 8, 2003, between Inspire Pharmaceuticals, Inc. and Allergan, Inc. and Allergan Sales, LLC and Allergan Pharmaceuticals Holdings (Ireland) Ltd. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 9, 2003).
10.15*	Elestat (Epinastine) Co-Promotion Agreement, entered into as of December 8, 2003, by and between Allergan Sales, LLC and Inspire Pharmaceuticals, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 1, 2004).
10.16†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II, dated May 16, 2003. (Incorporated by reference to Exhibit 10.35 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.17	Master Lease Agreement between GE Capital Fleet Services and Inspire Pharmaceuticals, Inc., dated as of November 18, 2003, and related documentation (Incorporated by reference to Exhibit 10.38 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.18	Master Security Agreement between General Electric Capital Corporation and Inspire Pharmaceuticals, Inc., dated as of November 12, 2003, and related documentation (Incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K filed March 12, 2004).
10.19†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between the Company and R. Kim Brazzell, dated August 5, 2004 (Incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q filed November 9, 2004).
10.20†	Amended and Restated Director Compensation Policy (Incorporated by reference to Exhibit 10.40 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.21*	Exclusive License Agreement between Inspire Pharmaceuticals, Inc. and the Wisconsin Alumni Research Foundation, effective November 2, 2004. (Incorporated by reference to Exhibit 10.44 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.22†	Inspire Pharmaceuticals, Inc. Change in Control Severance Benefit Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.23†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Christy L. Shaffer (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.24†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Mary B. Bennett (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed January 31, 2005).

Exhibit Number	Description
10.25†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Donald J. Kellerman (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.26†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Joseph K. Schachle (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.27†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Thomas R. Staab, II (Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.28†	Agreement regarding change in control, dated as of March 29, 2004, by and between Inspire Pharmaceuticals, Inc. and Benjamin R. Yerxa (Incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.29†	Agreement regarding change in control, dated as of August 2, 2004, by and between Inspire Pharmaceuticals, Inc. and R. Kim Brazzell (Incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed January 31, 2005).
10.30†	Form of Inspire Pharmaceuticals, Inc. Employee Stock Option Agreement (Incorporated by reference to Exhibit 10.56 to the Company’s Annual Report on Form 10-K filed March 11, 2005).
10.31†	Inspire Pharmaceuticals, Inc. 2005 Equity Compensation Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 21, 2005).
10.32†	Form of Incentive Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.33†	Form of Nonqualified Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.34†	Form of Director’s Nonqualified Stock Option Grant Agreement (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.35†	Form of Stock Appreciation Right Grant Agreement (Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.36†	Form of Stock Award Grant Agreement (Incorporated by reference to Exhibit 10.6 to the Company’s Current Report on Form 8-K filed on June 16, 2005).
10.37†	Agreement regarding change in control, dated as of March 2, 2006, by and between Inspire Pharmaceuticals, Inc. and Joseph M. Spagnardi (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 8, 2006).
10.38†	Consulting Agreement dated as of March 7, 2006, by and between Inspire Pharmaceuticals, Inc. and Barry G. Pea (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 10, 2006).
10.39**	Development and License Agreement between Inspire Pharmaceuticals, Inc. and Boehringer Ingelheim International GmbH, effective February 17, 2006. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed May 10, 2006)
10.40†	Form of Restricted Stock Unit Agreement (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 7, 2006).
10.41	Amended and Restated Lease Agreement, dated as of November 30, 2006, by and between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC with respect to certain premises located within the Royal Center I building at 4222 Emperor Blvd., Durham, North Carolina (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 6, 2006).

Exhibit Number	Description
10.42	Amended and Restated Lease Agreement, dated as of November 30, 2006, by and between Inspire Pharmaceuticals, Inc. and Royal Center IC, LLC with respect to certain premises located within the Royal Center II building at 4222 Emperor Blvd., Durham, North Carolina (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on December 6, 2006).
10.43†	Employee Confidentiality, Invention Assignment and Non-Compete Agreement between Inspire Pharmaceuticals, Inc. and Joseph M. Spagnardi, dated May 10, 2005.
10.44**	License Agreement by and between Inspire Pharmaceuticals, Inc. and FAES Farma, S.A, dated as of October 31, 2006.
10.45	Loan and Security Agreement, dated as of December 22, 2006, among Inspire Pharmaceuticals, Inc., Merrill Lynch Capital and Silicon Valley Bank.
23.1	Consent of PricewaterhouseCoopers LLP, independent registered public accounting firm.
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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

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

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

EX-10.43

EXHIBIT 10.43

EMPLOYEE CONFIDENTIALITY, INVENTION ASSIGNMENT

AND NON-COMPETE AGREEMENT

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

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

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

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

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

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

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

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

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

6. INVENTIONS.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

12. SEVERABILITY.

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

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

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

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

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

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

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

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

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

EMPLOYEE:	Joseph M Spagnardi
	(Print Name)
	/s/ Joseph M Spagnardi
	(Signature Here)

Date:	May 10, 2005
Address:	111 Pinecrest Road Durham, NC

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EX-10.44

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

Exhibit 10.44

LICENSE AGREEMENT

by and between

INSPIRE PHARMACEUTICALS, INC.

and

FAES FARMA, S.A.

Dated as of October 31, 2006

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

TABLE OF CONTENTS

ARTICLE 1 DEFINITIONS		1
ARTICLE 2 LICENSES, EXCLUSIVITY AND RELATED RIGHTS		12
2.1	License Grants	12
2.2	Use of Affiliates and Third Party Contractors	14
2.3	No Implied Licenses	15
2.4	Marks	15
2.5	Limitation on Sublicenses in Inspire Principal Territory	15
2.6	Faes Right of First Negotiation	15
2.7	Supply of Compound	16
ARTICLE 3 DEVELOPMENT AND COMMERCIALIZATION		16
3.1	Data and Materials Transfer and Right of Reference	16
3.2	Development	18
3.3	Commercialization	21
3.4	Records and Reports	22
3.5	Inspire Regulatory Matters; Faes Assistance	23
3.6	Faes Regulatory Matters; Inspire Assistance	24
3.7	Adverse Event Reporting	25
ARTICLE 4 INITIAL PAYMENT AND MILESTONE PAYMENTS		25
4.1	Initial Payment	25
4.2	Milestone Payments	25
ARTICLE 5 ROYALTIES		27
5.1	Inspire Royalty Payments	27
5.2	Faes Royalty Payments	28
5.3	Royalty Terms	28
5.4	Minimum Royalties	29
5.5	Reports and Payments	30
5.6	Taxes and Withholding	30
5.7	Currency Exchange; Manner and Place of Payment	31
5.8	Maintenance of Records; Audit	31
5.9	Interest on Late Payments	32
5.10	Reductions	32
ARTICLE 6 REPRESENTATIONS, WARRANTIES AND COVENANTS		34
6.1	Mutual Representations and Warranties	34
6.2	Additional Faes Representations and Warranties	35
6.3	Additional Inspire Representations, Warranties and Covenants	37
6.4	Additional Covenants	37
6.5	No Debarment	37
ARTICLE 7		38
7.1	Confidentiality	38
7.2	Authorized Disclosure	38
7.3	Scientific Publications	38
7.4	Public Announcements	39
7.5	Unauthorized Use	39
7.6	Return of Confidential Information	39
ARTICLE 8 INDEMNIFICATION		40
8.1	Inspire	40
8.2	Faes	40
8.3	Indemnification Procedures	40
8.4	Insurance Proceeds	42
8.5	Insurance	42
ARTICLE 9		42
9.1	Term	42
9.2	Voluntary Termination by Inspire	42
9.3	Material Breach	42

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

9.4	Bankruptcy or Insolvency	43
9.5	Continuing Rights of Sublicensees	43
9.6	Effect of Expiration or Termination of Agreement	44
9.7	Effect of Partial Termination	44
9.8	Consequences if QT Study Milestone Payment not Made	45
9.9	Change of Control	46
ARTICLE 10		46
10.1	Ownership of Inventions	46
10.2	Obligation to Inform	47
10.3	Prosecution of Faes Licensed Patents	47
10.4	Right to Consult	47
10.5	Abandonment of Prosecution of Faes Licensed Patent	48
10.6	Patent Term Extensions	48
10.7	Third Party Infringement	48
10.8	Infringement of Third Party Rights	50
ARTICLE 11		50
11.1	Assignment	50
11.2	Further Actions	51
11.3	Force Majeure	51
11.4	Notices	51
11.5	Amendment	51
11.6	Waiver	52
11.7	Counterparts; Facsimile Signatures	52
11.8	Descriptive Headings	52
11.9	Governing Law; Dispute Resolution	52
11.10	Severability	52
11.11	Entire Agreement of the Parties	53
11.12	Independent Contractors	53
11.13	Accrued Rights; Surviving Obligations	53
11.14	Expenses	53
11.15	No Third Party Beneficiaries	53
11.16	No Strict Construction	53
11.17	English Language	53
11.18	Rights and Remedies Cumulative, Certain Remedies, etc	53

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

LICENSE AGREEMENT

This LICENSE AGREEMENT (this “Agreement”), dated as of October 31, 2006 (the “Effective Date”), is made by and between INSPIRE PHARMACEUTICALS, INC., a Delaware corporation having its principal office at 4222 Emperor Blvd., Suite 200, Durham, NC 27703-8466, USA (“Inspire”), and FAES FARMA, S.A., a Spanish corporation having its principal office at Máximo Aguirre, 14, 48940 Leioa, Vizcaya, Spain (“Faes”). Inspire and Faes are each sometimes referred to individually as a “Party” and together as the “Parties.”

RECITALS

WHEREAS, Faes owns certain patents and know-how relating to the compound known as bilastine;

WHEREAS, Inspire is engaged in the research, development and commercialization of proprietary pharmaceutical products for the treatment of respiratory, ophthalmic and other indications;

WHEREAS, Inspire desires to obtain from Faes, and Faes desires to grant to Inspire, the exclusive rights in the Inspire Territory to certain patents and know-how for the development and commercialization of Inspire Licensed Products (each as defined below); and

WHEREAS, Faes desires to obtain from Inspire, and Inspire desires to grant to Faes, the exclusive rights in the Faes Territory to certain know-how and other intellectual property controlled by Inspire for the development and commercialization of Faes Licensed Ophthalmic Products and Faes Non-Ophthalmic Products (each as defined below);

NOW, THEREFORE, in consideration of the foregoing premises and the mutual representations, covenants and agreements contained herein, Inspire and Faes, intending to be legally bound, hereby agree as follows:

ARTICLE 1

DEFINITIONS

When used in this Agreement, whether in the singular or plural, each of the following capitalized terms shall have the meanings set forth in this Article 1.

1.1 “Acceptable Primary Label” means, for a particular Principal Product in a particular market, approved labeling for the relief of the nasal and non-nasal symptoms of allergic rhinitis, [C.I.] antihistamines existing as of the Effective Date in a manner that makes such Principal Product essentially unable to obtain significant sales in the applicable market for antihistamine products to treat the nasal and non-nasal symptoms of allergic rhinitis.

1

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

1.2 “Affiliate” means a corporation or non-corporate business entity that, directly or indirectly, controls, is controlled by, or is under common control with the Person specified. An entity will be regarded as in control of another entity if: (a) it owns, directly or indirectly, at least 50% of the voting securities or capital stock of such entity, or has other comparable ownership interest with respect to any entity other than a corporation; or (b) it possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the corporation or non-corporate business entity, as applicable, whether through the ownership or control of voting securities, by contract or otherwise.

1.3 “Breach Notice” has the meaning set forth in Section 9.3.

1.4 “Breaching Party” has the meaning set forth in Section 9.3.

1.5 “Business Day” means any day, except Saturday and Sunday, on which commercial banking institutions in New York are open for business. Any reference in this Agreement to “day” whether or not capitalized shall refer to a calendar day, not a Business Day.

1.6 “Combination Licensed Product” means an Inspire Licensed Product that: (a) consists of at least one active ingredient causing such product to be an Inspire Licensed Product in combination with one or more other therapeutically active compounds, or (b) is sold together with one or more other products that do not contain the Compound for a single invoiced price.

1.7 “Commercially Reasonable Efforts” means, with respect to the efforts of a particular Party to complete specific tasks or obligations under this Agreement, the efforts and resources that would be used, consistent with prevailing pharmaceutical industry standards, by a company of similar size and scope to such Party with respect to a product or potential product at a similar stage in its development or product life and of similar market potential taking into account efficacy, safety, the anticipated Regulatory Authority approved labeling, the competitiveness of alternative products in the marketplace or under development, the profitability of the product including the royalties payable to Third Party licensors, the patent and other proprietary position of the product, the likelihood of Regulatory Approval, the commercial value of the product and other relevant factors. Commercially Reasonable Efforts shall be determined on a market-by-market basis for a particular product, and it is anticipated that the level of effort will change over time, reflecting changes in the status of the product and the market involved.

1.8 “Compound” means the chemical compound known as bilastine, whose more specific chemical name is (F-96211-BM; 2-[4-(2-(1-2(-ethoxylethyl) benzimidazole-2-yl) piperidine-1-yl) ethyl) phenyl]-2-methylpropanoic acid, and any salts, esters, or hydrates of such compound.

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1.9 “Confidential Information” of a Party means all secret, confidential or proprietary information or data, whether provided in written, oral, graphic, video, computer or other form, provided by such Party (the “Disclosing Party”) to the other Party (the “Receiving Party”) pursuant to this Agreement (including information generated by or on behalf of such Party pursuant to this Agreement and disclosed to the other Party), which may include without limitation information relating to the Disclosing Party’s existing or proposed research, development efforts, patent applications, business or products and any other materials that have not been made available by the Disclosing Party to the general public. The terms of this Agreement shall also be deemed Confidential Information of each Party, except to the extent disclosed pursuant to Section 7.4 herein. Notwithstanding the foregoing sentences, the term “Confidential Information” shall not include any information or materials that the Receiving Party can demonstrate:

(a) were already known to the Receiving Party (other than under an obligation of confidentiality), at the time of disclosure by the Disclosing Party to the extent such Receiving Party has documentary evidence to that effect;

(b) were generally available to the public or otherwise part of the public domain at the time of its disclosure to the Receiving Party;

(c) became generally available to the public or otherwise part of the public domain after its disclosure or development, as the case may be, and other than through any act or omission of the Receiving Party in breach of its confidentiality obligations under this Agreement;

(d) were subsequently lawfully disclosed to the Receiving Party by a Third Party who had no obligation to the Disclosing Party not to disclose such information to others;

(e) were independently discovered or developed by or on behalf of the Receiving Party without the use of the Confidential Information belonging to the other Party and the Receiving Party has documentary evidence to that effect; or

(f) is approved for release by the Disclosing Party in writing.

1.10 “Control,” “Controls,” or “Controlled” means, with respect to specific materials, Know-How or Patent Rights, that the applicable Party owns or has a license under such materials, Know-How or Patent Rights and has the ability to grant to the other Party licenses or sublicenses thereto as contemplated under this Agreement without violating the terms of any agreement or other arrangement with, or the rights of, any Third Party existing as of the date on which such license or sublicense is granted.

1.11 “Definitive QT Study” means the currently ongoing definitive cardiovascular (QTc prolongation) study relating to the Compound being conducted on behalf of Faes under the Protocol No. BILA 459-09, entitled “A phase I, randomized, multiple-dose, double-blind, 5-way crossover study of the electrocardiographic effects of Bilastine in healthy adult subjects”.

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1.12 “Development Plan” means the plan describing the development of Subject Products in the Territory as described in Section 3.2.

1.13 “Development Program” means the activities undertaken by each of Inspire and Faes to develop Subject Products in the Territory in accordance with the Development Plan.

1.14 “Development Timeline” has the meaning set forth in Section 3.2(a)(i).

1.15 “Disclosing Party” has the meaning set forth in Section 1.9.

1.16 “Drug Master File” means the Drug Master File, as defined in the U.S. Federal Food, Drug, and Cosmetic Act, pursuant to 21 C.F.R. § 312.420 as amended, and the regulations promulgated thereunder (or the equivalent thereto as specified in any succeeding legislation), or any foreign equivalent thereto, with respect to manufacture of the Compound or an Inspire Licensed Product.

1.17 “Faes Development Activities” has the meaning set forth in Section 3.2(a)(i).

1.18 “Faes Know-How” means all Know-How related to the Compound (including information not covered by the Faes Licensed Patents) and any Inventions, in each case that are Controlled by Faes or its Affiliate as of the Effective Date and at any time during the Term and are necessary or useful to develop, manufacture or commercialize Inspire Licensed Products in the Inspire Territory.

1.19 “Faes Licensed Ophthalmic Product” means any product of Faes or its Affiliate or licensee (other than Inspire) incorporating the Compound and formulated and intended to be used in an Ophthalmic Indication by application to the eye, including any prescription or over-the-counter version of such product, in any dosage strength or size.

1.20 “Faes Licensed Patents” means all Patent Rights in the Inspire Territory that cover or claim the Compound or its manufacture or use or any Inventions, in each case that are Controlled by Faes or its Affiliate as of the Effective Date and at any time during the Term, and are necessary or useful to develop, manufacture or commercialize Inspire Licensed Products in the Inspire Territory. The Faes Licensed Patents owned by Faes as of the Effective Date, and the Faes Licensed Patents Controlled but not owned by Faes as of the Effective Date, are each set forth and identified as such in Schedule 1.20.

1.21 “Faes Non-Ophthalmic Product” means any product of Faes or its Affiliate or licensee (other than Inspire) incorporating the Compound and formulated to be used in an indication other than an Ophthalmic Indication, including any prescription or over-the-counter version of such product, in any dosage strength or size and for any mode of administration.

1.22 “Faes Ophthalmic OTC Product” means a Faes Licensed Ophthalmic Product that is sold to consumers without a prescription.

1.23 “Faes Ophthalmic Rx Product” means a Faes Licensed Ophthalmic Product that is sold to consumers under a prescription.

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1.24 “Faes Ophthalmic Territory” means Spain, Portugal, Guatemala, Belize, El Salvador, Honduras, Nicaragua, Costa Rica, Panama, and all the countries of South America, and their respective territories and possessions.

1.25 “Faes Royalties” has the meaning set forth in Section 5.2.

1.26 “Faes Royalty Term” has the meaning set forth in Section 5.3(b).

1.27 “Faes Technology” means, collectively, the Faes Licensed Patents and the Faes Know-How.

1.28 “Faes Territory” means, with respect to Faes Non-Ophthalmic Products, the entire world, excluding the Inspire Principal Territory, and with respect to Faes Licensed Ophthalmic Products, the Faes Ophthalmic Territory.

1.29 “FDA” means the United States Food and Drug Administration, or any successor agency thereof.

1.30 “Field” means the prevention, palliation or treatment of any condition, indication or disease in humans.

1.31 “First Commercial Sale” means (a) with regard to a particular Inspire Licensed Product in a country in the Inspire Territory, the first commercial sale by Inspire or its Affiliate or sublicensee of such Inspire Licensed Product to a Third Party for end use or consumption in the country after Inspire’s (or its Affiliate’s or sublicensee’s) receipt of Regulatory Approval for such Subject Product in such country, or (b) with regard to a Faes Licensed Ophthalmic Product in a country in the Faes Ophthalmic Territory, the first commercial sale by Faes or its Affiliate or sublicensee of such Faes Licensed Ophthalmic Product to a Third Party for end use or consumption in the country after Faes’ (or its Affiliate’s or sublicensee’s) receipt of Regulatory Approval for such Subject Product in such country. Use of Subject Products for promotional, sampling or compassionate use purposes or for use in clinical trials contemplated by this Agreement (but excluding post-approval clinical trials for which compensation is received by the selling party) shall not be considered a commercial sale hereunder.

1.32 “GAAP” means: (a) as to Inspire, United States generally accepted accounting principles as interpreted and accepted by the Financial Accounting Standards Board and the Securities and Exchange Commission, and (b) as to Faes, the generally accepted accounting principles applicable to Faes and consistently applied through its organization.

1.33 “Generic Competition” means, with respect to a particular Inspire Licensed Product or Faes Licensed Ophthalmic Product (as applicable), that one or more Third Parties is selling, for use in human beings, a Generic Equivalent of such Inspire Licensed Product or Faes Licensed Ophthalmic Product (as applicable) in the applicable country within the Inspire Territory or the Faes Ophthalmic Territory (as applicable).

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1.34 “Generic Equivalent” means a Third Party generic version of an Inspire Licensed Product being sold by Inspire in a particular country in the Inspire Territory, or Faes Licensed Ophthalmic Product being sold by Faes in a particular country in the Faes Ophthalmic Territory (as applicable), which generic version contains the Compound, has been approved by the FDA or by any foreign Regulatory Authority, and is being sold under such approval in such country.

1.35 “IND” means an Investigational New Drug Application, as defined in the U.S. Federal Food, Drug, and Cosmetic Act, pursuant to 21 C.F.R. § 312.3 as amended, and the regulations promulgated thereunder, or the equivalent thereto as specified in any succeeding legislation.

1.36 “Indemnitee” has the meaning set forth in Section 8.3(a).

1.37 “Indemnitor” has the meaning set forth in Section 8.3(a).

1.38 “Independent Sublicensees” has the meaning set forth in Section 9.5.

1.39 “Infringement Notice” has the meaning set forth in Section 10.7(a).

1.40 “Inspire Development Activities” has the meaning set forth in Section 3.2(a)(i).

1.41 “Inspire Know-How” means all Know-How related to the Compound (including information not covered by the Inspire Licensed Patents) and any Inventions, in each case that are Controlled by Inspire or its Affiliate at any time during the Term.

1.42 “Inspire Licensed Patents” means all Patent Rights in the Faes Territory that cover or claim the Compound or its manufacture or use or any Inventions, in each case that are Controlled by Inspire or its Affiliate at any time during the Term.

1.43 “Inspire Licensed Product” means any product of Inspire or its Affiliate or sublicensee (other than Faes or its Affiliates and other licensees) that contains the Compound, including any prescription or over-the-counter product, in any dosage strength or size and for any mode of administration, and whose development, manufacture, use, sale, distribution, importation or commercialization (a) is covered by a Valid Claim in a Faes Licensed Patent, and/or (b) materially uses or incorporates, or is materially based upon, Faes Know-How.

1.44 “Inspire Marks” has the meaning set forth in Section 2.4.

1.45 “Inspire Non-Ophthalmic Technology” means, collectively, the Inspire Licensed Patents and the Inspire Know-How that are necessary or useful to develop, manufacture or commercialize Faes Non-Ophthalmic Products outside the Inspire Principal Territory.

1.46 “Inspire Ophthalmic OTC Product” means an Inspire Licensed Product that is formulated and intended to be used in an Ophthalmic Indication by application to the eye, in any dosage strength or size, that is sold to consumers without a prescription.

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1.47 “Inspire Ophthalmic Product” means an Inspire Ophthalmic OTC Product or an Inspire Ophthalmic Rx Product.

1.48 “Inspire Ophthalmic Rx Product” means an Inspire Licensed Product that is formulated and intended to be used in an Ophthalmic Indication by application to the eye, in any dosage strength or size, that is sold to consumers under a prescription.

1.49 “Inspire Ophthalmic Technology” means, collectively, the Inspire Licensed Patents and the Inspire Know-How that are necessary or useful to develop, manufacture or commercialize Faes Licensed Ophthalmic Products in the Faes Ophthalmic Territory.

1.50 “Inspire Ophthalmic Territory” means the entire world, excluding the Faes Ophthalmic Territory.

1.51 “Inspire OTC Product” means a Principal OTC Product or an Inspire Ophthalmic OTC Product.

1.52 “Inspire Principal Territory” means the United States and Canada and their respective territories and possessions.

1.53 “Inspire Royalties” has the meaning set forth in Section 5.1.

1.54 “Inspire Royalty Term” has the meaning set forth in Section 5.3(a).

1.55 “Inspire Technology” means, collectively, the Inspire Ophthalmic Technology and the Inspire Non-Ophthalmic Technology.

1.56 “Inspire Territory” means with respect to Principal Products, the Inspire Principal Territory, and with respect to Inspire Ophthalmic Products, the Inspire Ophthalmic Territory.

1.57 “Inventions” means any and all Know-How, developments, inventions or discoveries conceived, reduced to practice, made or developed by or on behalf of a Party or its Affiliate or licensee during the Term.

1.58 “Joint Inventions” has the meaning set forth in Section 10.1(d).

1.59 “Joint Project Team” has the meaning set forth in Section 3.2(c).

1.60 “Know-How” means all non-public information, results and data of any type whatsoever, in any tangible or intangible form whatsoever, whether or not patentable, including databases, practices, methods, techniques, specifications, formulations, formulae, knowledge, skill, experience, data (including pharmacological, medicinal chemistry, biological, chemical, biochemical, toxicological and clinical study data), analytical and quality control data, stability data, studies and procedures, and manufacturing process and development information, results and data.

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1.61 “Knowledge” means, with respect to the applicable Party, the actual knowledge of such Party as of the given time (without any duty of investigation).

1.62 “Losses” has the meaning set forth in Section 8.1.

1.63 “Marks” means any trademarks, and goodwill associated therewith, for use in connection with the marketing and sale of Inspire Licensed Products, alone or accompanied by any logo or design and any foreign language equivalents in figure, sound or meaning, whether registered or not.

1.64 “Material Amendment” has the meaning set forth in Section 3.2(a)(ii).

1.65 “Milestone Payments” has the meaning set forth in Section 4.2.

1.66 “Minimum Royalty Date” means the first Quarter Start Date that is at least one year (365 days) after the date that Inspire (or its Affiliate or sublicensee) receives the first Regulatory Approval in the United States of a Principal Product comprising an oral tablet formulation for the Primary Indication.

1.67 “Minimum Royalty Period” means the one year period commencing on the Minimum Royalty Date or each yearly anniversary thereof.

1.68 “NDA” means a New Drug Application pursuant to 21 U.S.C. § 505(b)(1) or § 505(b)(2) submitted to the FDA or any successor application or procedure required for Regulatory Approval to commence sale of an Inspire Licensed Product.

1.69 “Net Sales” means the gross amounts invoiced by (i) Inspire, any of its Affiliates or any of its sublicensees for sales of Inspire Licensed Products to Third Parties or (ii) Faes, any of its Affiliates or any of its sublicensees for sales of Faes Licensed Ophthalmic Products to Third Parties, less the total of the following deductions to the extent actually allowed or incurred in connection with such sales:

(a) reasonable and customary trade, cash and quantity discounts off the invoiced price;

(b) excise, sales and other consumption taxes and custom duties to the extent included in the invoice price;

(c) freight, insurance and other transportation charges to the extent included in the invoice price;

(d) amounts repaid, credited or accrued, or allowances or adjustments made, by reason of returns, rejections, or recalls, or because of chargebacks, retroactive price reductions, or billing errors;

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(e) reasonable and customary rebates and chargebacks to pharmacy benefit managers, federal, state, or local governments (or their agencies or purchasers), and managed health organizations (including without limitation Medicaid rebates); and

(f) any amounts actually written off or specifically identified as uncollectible in accordance with GAAP;

solely to the extent the above deductions are taken in accordance with GAAP applicable to the particular Party.

Use of Subject Products for promotional, sampling or compassionate use purposes or for use in clinical trials contemplated under this Agreement (but excluding post-approval clinical trials for which compensation is received by the selling party) shall not be considered in determining Net Sales. In the case of any sale of a Subject Product between a Party and its Affiliates or sublicensees for resale, Net Sales shall be calculated as above only on the first arm’s length sale thereafter to a Third Party.

1.70 “Non-Breaching Party” has the meaning set forth in Section 9.3.

1.71 “Ophthalmic Indication” means the prevention or treatment of allergic conjunctivitis in the eye.

1.72 “OTC” means “over-the-counter,” as such term is typically understood in the pharmaceutical industry with reference to sales of drug products without a prescription.

1.73 “OTC Switch” means, with respect to a particular country of the Inspire Territory, the transfer of an Inspire Licensed Product from a prescription medicine to an OTC medicine in such country. An Inspire Licensed Product will be deemed to be transferred, and the OTC Switch deemed to be finalized, with respect to a given country of the Inspire Territory upon final approval of the sale of such Inspire Licensed Product as an OTC medicine by the Regulatory Authority in such country that has regulatory jurisdiction over such transfer.

1.74 “Partial Termination” means the termination of this Agreement solely with respect to particular Subject Product(s) and/or one or more countries, as provided in Section 9.2 or 9.3.

1.75 “Patent Rights” means the rights and interests in and to all issued patents and pending patent applications, including without limitation, all provisional applications, substitutions, continuations, continuations-in-part, divisions, and renewals, all letters patent granted thereon, and all patents-of-addition, reissues, reexaminations and extensions or restorations by existing or future extension or restoration mechanisms (including regulatory extensions), and all supplementary protection certificates, together with any foreign counterparts thereof anywhere in the Territory.

1.76 “Pediatric Indication” means the Primary Indication specifically for use in children as young as six (6) years of age and no older than twelve (12) years of age.

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1.77 “Person” or “person” means any individual, firm, corporation, partnership, limited liability company, trust, unincorporated organization or other entity or a government agency or political subdivision thereto, and shall include any successor (by merger or otherwise) of such Person.

1.78 “Phase 3 Clinical Trial” means a controlled clinical trial to confirm with statistical significance the efficacy and safety of a product in larger, targeted populations, performed to obtain Regulatory Approval, as more fully described in 21 C.F.R. § 312.21(c).

1.79 “Primary Indication” means the treatment of allergic rhinitis.

1.80 “Principal OTC Product” means an Inspire Licensed Product for any indication in the Field other than the Ophthalmic Indication that is sold to consumers without a prescription.

1.81 “Principal Product” means a Principal OTC Product or a Principal Rx Product.

1.82 “Principal Rx Product” means an Inspire Licensed Product for any indication in the Field other than the Ophthalmic Indication that is sold to consumers under a prescription.

1.83 “Prosecution” or “Prosecute” means the preparation, filing, prosecution, issuance and maintenance (including, without limitation, interference, opposition and similar third party proceedings before the relevant patent office) of any patent applications or patents.

1.84 “Publishing Party” has the meaning set forth in Section 7.3.

1.85 “Quarter Start Date” means January 1, April 1, July 1, and October 1 of any applicable year.

1.86 “Rate of Interest” means the interest rate equal to [C.I.] percentage points above the prime rate of interest published as of the applicable time in the Wall Street Journal as the prime rate; provided, however that if the Wall Street Journal does not publish such prime rate, then the term “Rate of Interest” shall mean [C.I.] percentage points above the rate of interest publicly announced as of the applicable time by Bank of America, N.A., as its Prime Rate, Base Rate, Reference Rate or the equivalent of such rate, whether or not such bank makes loans to customers at, above, or below said rate.

1.87 “Receiving Party” has the meaning set forth in Section 1.9.

1.88 “Regulatory Amendment” has the meaning set forth in Section 3.2(a)(ii).

1.89 “Regulatory Approval” means the issuance by the appropriate Regulatory Authority of an action letter indicating that an NDA or foreign equivalent, as applicable, is approved. For avoidance of doubt, Regulatory Approval does not mean that the Regulatory Authority issues an action letter indicating that an NDA or foreign equivalent is approvable.

1.90 “Regulatory Authority” means any national (e.g., the FDA), state, provincial or local regulatory agency, department, bureau, commission, council or other governmental entity

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involved in or responsible for regulation of medicinal products intended for human use in any country.

1.91 “Regulatory Dossier” means the technical, medical and scientific registrations, authorizations and approvals (including, without limitation, approvals of NDAs or foreign equivalents, supplements and amendments, pre- and post- approvals, pricing and Third Party reimbursement approvals, and labeling approvals) of any Regulatory Authority necessary for the development (including the conduct of clinical trials), manufacture, distribution, marketing, promotion, offer for sale, use, import, reimbursement, export or sale of a Subject Product in a regulatory jurisdiction, together with all related correspondence to or from any Regulatory Authority and all documents referenced in the complete regulatory chronology for each NDA or foreign equivalent, including the Drug Master File (if any), IND, NDA and supplemental new drug applications (sNDAs), or foreign equivalents.

1.92 “Reviewing Party” has the meaning set forth in Section 7.3.

1.93 “Rx Product” means a Principal Rx Product or an Inspire Ophthalmic Rx Product.

1.94 “Scientific Publication” has the meaning set forth in Section 7.3.

1.95 “Serious Adverse Drug Experience” means any of an “adverse drug experience,” a “life-threatening adverse drug experience,” a “serious adverse drug experience,” or an “unexpected adverse drug experience,” as those terms are defined at either 21 C.F.R. § 312.32 or 21 C.F.R. § 314.80 or relevant foreign regulation within the Territory.

1.96 “Subject Product” means any Faes Licensed Ophthalmic Product, any Faes Non-Ophthalmic Product, or any Inspire Licensed Product.

1.97 “Term” has the meaning set forth in Section 9.1.

1.98 “Territory” means, collectively, the Inspire Territory and the Faes Territory.

1.99 “Third Party(ies)” means any Person other than Faes, Inspire and their respective Affiliates.

1.100 “Third Party Claim” has the meaning set forth in Section 8.1.

1.101 “Third Party License” has the meaning set forth in Section 5.10(a).

1.102 “Urticaria Indication” means the treatment of chronic idiopathic urticaria.

1.103 “Valid Claim” means a claim of an issued and unexpired patent, or a claim of a pending patent application, within the Faes Licensed Patents, which claim has not been held invalid, unpatentable or unenforceable by a court or other government agency of competent jurisdiction from which no appeal can be further taken, and has not been held or admitted to be invalid, unpatentable or unenforceable through abandonment, re-examination or disclaimer, opposition

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procedure, nullity suit or otherwise, which claim covers or claims an Inspire Licensed Product or its manufacture or use; provided, however, that if a claim of a pending patent application shall not have issued within [CONFIDENTIAL] after the filing date from which such claim takes priority such claim shall not constitute a Valid Claim for the purposes of this Agreement unless and until such claim shall issue.

1.104 “Withholding Taxes” has the meaning set forth in Section 5.6.

ARTICLE 2

LICENSES, EXCLUSIVITY AND RELATED RIGHTS

2.1 License Grants.

(a) To Inspire.

(i) Faes hereby grants to Inspire a royalty-bearing, exclusive (even as to Faes and its Affiliates, except as otherwise provided in subsection (a)(iv) below) right and license, with the right to grant sublicenses (subject to Section 2.5), under the Faes Technology solely (i) to research, develop, make, have made, use, market, offer for sale, sell, and import Principal Products in the Field in the Inspire Principal Territory, and (ii) to research, develop, make, have made, and use Principal Products anywhere in the world solely for the purpose of marketing, commercialization and sale of Principal Products in the Field in the Inspire Principal Territory.

(ii) Faes hereby grants to Inspire a royalty-bearing, exclusive (even as to Faes and its Affiliates, except as otherwise provided in subsection (a)(iv) below) right and license, with the right to grant sublicenses, under the Faes Technology solely (i) to research, develop, make, have made, use, market, offer for sale, sell, and import Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory, and (ii) to research, develop, make, have made, and use Inspire Ophthalmic Products anywhere in the world solely for the purpose of marketing, commercialization and sale of Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory.

(iii) For the avoidance of doubt, the licenses and rights granted to Inspire under this Agreement shall not include a right to offer for sale, sell or have sold Principal Products, and Inspire expressly covenants that it and its Affiliates and sublicensees shall not sell any Principal Products, in the Inspire Principal Territory in circumstances in which Inspire knows or reasonably should know such Principal Products will be distributed or sold outside the Inspire Principal Territory. Further, the licenses and rights granted to Inspire under this Agreement shall not include a right to offer for sale, sell or have sold Inspire Ophthalmic Products, and Inspire expressly covenants that it and its Affiliates and sublicensees shall not sell any Inspire Ophthalmic Products, in the Inspire Ophthalmic Territory in circumstances

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in which Inspire knows or reasonably should know such Inspire Ophthalmic Products will be distributed or sold outside the Inspire Ophthalmic Territory or for any uses outside the Ophthalmic Indication.

(iv) Notwithstanding anything in this Agreement to the contrary, and for the avoidance of doubt, (1) Faes (and its Affiliates and other licensees) shall retain the rights under the Faes Technology to research, develop, make, have made, and use Faes Non-Ophthalmic Products in the Inspire Principal Territory solely for the purpose of sale of such products in the Field outside the Inspire Principal Territory; and (2) Faes (and its Affiliates and other licensees) shall retain the rights under the Faes Technology to research, develop, make, have made, and use Faes Licensed Ophthalmic Products in the Inspire Ophthalmic Territory solely for the purpose of sale of Faes Licensed Ophthalmic Products outside the Inspire Ophthalmic Territory; and (3) Faes (and its Affiliates and other licensees) shall retain the exclusive rights to research, develop, make, have made, use, offer for sale, sell, and import all Faes Non-Ophthalmic Products in the Field in all countries, territories and jurisdictions other than the Inspire Principal Territory; and (4) Faes (and its Affiliates and other licensees) shall retain the exclusive rights to research, develop, make, have made, use, market, offer for sale, sell, and import Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory.

(b) To Faes.

(i) Inspire hereby grants to Faes an exclusive (even as to Inspire and its Affiliates, except as otherwise provided in subsection (b)(iv) below) right and license, with the right to grant sublicenses, under the Inspire Non-Ophthalmic Technology solely to research, develop, make, have made, use, market, offer for sale, sell, and import Faes Non-Ophthalmic Products in the Field in all countries, territories and jurisdictions outside the Inspire Principal Territory.

(ii) Inspire hereby grants to Faes a royalty-bearing, exclusive (even as to Inspire and its Affiliates, except as otherwise provided in subsection (b)(iv) below) right and license, with the right to grant sublicenses, under the Inspire Ophthalmic Technology solely to research, develop, make, have made, use, market, offer for sale, sell, and import Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory.

(iii) For the avoidance of doubt, the licenses and rights granted to Faes under this Agreement shall not include a right to offer for sale, sell or have sold Faes Licensed Ophthalmic Products, and Faes expressly covenants that it and its Affiliates and sublicensees shall not sell any Faes Licensed Ophthalmic Products, in the Faes Ophthalmic Territory in circumstances in which Faes knows or reasonably should know such Faes Licensed Ophthalmic Products will be distributed or sold outside the Faes Ophthalmic Territory or for any uses outside the Ophthalmic Indication. Further, the licenses and rights granted to Faes under this

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Agreement shall not include a right to offer for sale, sell or have sold Faes Non-Ophthalmic Products, and Faes expressly covenants that it and its Affiliates and sublicensees shall not sell any Faes Non-Ophthalmic Products, in any country outside the Inspire Principal Territory in circumstances in which Faes knows or reasonably should know such Faes Non-Ophthalmic Products will be distributed or sold in the Inspire Principal Territory.

(iv) Notwithstanding anything in this Agreement to the contrary, and for the avoidance of doubt, (1) Inspire (and its Affiliates and other licensees) shall retain the rights under the Inspire Non-Ophthalmic Technology to research, develop, make, have made, and use Principal Products outside the Inspire Principal Territory solely for the purpose of sale of such products in the Field solely in the Inspire Principal Territory; and (2) Inspire (and its Affiliates and other licensees) shall retain the rights under the Inspire Ophthalmic Technology to research, develop, make, have made, and use Inspire Ophthalmic Products outside the Inspire Ophthalmic Territory solely for the purpose of sale of Inspire Ophthalmic Products in the Ophthalmic Indication solely in the Inspire Ophthalmic Territory; and (3) Inspire (and its Affiliates and other licensees) shall retain the exclusive rights to research, develop, make, have made, use, offer for sale, sell, and import Principal Products in the Field in the Inspire Principal Territory; and (4) Inspire (and its Affiliates and other licensees) shall retain the exclusive rights to research, have researched, develop, have developed, make, have made, use, market, have marketed, commercialize, have commercialized, offer for sale, sell, import and have imported Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory.

(c) With respect to each particular Inspire Licensed Product, on a country-by-country basis, upon the expiration of the Inspire Royalty Term applicable to such Inspire Licensed Product in a specific country, the licenses and rights granted to Inspire under Section 2.1(a) shall become fully paid up, royalty-free, perpetual and irrevocable solely with regards to such Inspire Licensed Product in such country. With respect to each particular Faes Licensed Ophthalmic Product, on a country-by-country basis, upon the expiration of the Faes Royalty Term applicable to such Faes Licensed Ophthalmic Product in a specific country, the licenses and rights granted to Faes under Section 2.1(b) shall become fully paid up, royalty-free, perpetual and irrevocable solely with regards to such Faes Licensed Ophthalmic Product in such country.

2.2 Use of Affiliates and Third Party Contractors. Without limiting the licenses and rights granted under Section 2.1, Inspire and Faes shall each have the right to engage their Affiliates and Third Party contractors (including but not limited to contract research organizations, clinical trial sites, contract manufacturers and distributors) to perform services to assist the respective Party in exercising its rights and in carrying out its respective activities or obligations under this Agreement, including for the purpose of development and commercialization of Principal Products in the Inspire Principal Territory and Inspire Ophthalmic Products in the Inspire Ophthalmic Territory on behalf of Inspire, or of Faes Licensed Ophthalmic Products in the Faes

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Ophthalmic Territory and Faes Non-Ophthalmic Products in all countries and jurisdictions outside the Inspire Principal Territory on behalf of Faes.

2.3 No Implied Licenses. Only the licenses expressly granted herein shall be of legal force and effect. No license rights shall be created hereunder by implication, estoppel or otherwise.

2.4 Marks. Inspire may market Principal Products in the Field in the Inspire Principal Territory, and Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory, under such Marks as Inspire shall select in its sole discretion (the “Inspire Marks”). Inspire shall own and control all such Inspire Marks. Inspire shall be responsible for filing, registering and maintaining the Inspire Marks in the Inspire Territory. Faes shall retain the exclusive rights to market Faes Non-Ophthalmic Products in the Field in all countries and jurisdictions outside the Inspire Principal Territory, and Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory, under such Marks as Faes (or its Affiliate or other licensee) shall select in its sole discretion (the “Faes Marks”). Faes (or its Affiliate or licensee, as applicable) shall own and control all such Faes Marks. Faes (or its Affiliate or licensee, as applicable) shall be responsible for filing, registering and maintaining the Faes Marks in all applicable countries.

2.5 Limitation on Sublicenses in Inspire Principal Territory. Faes shall have the right to approve, such approval not to be unreasonably withheld or delayed, the grant by Inspire of any sublicense to a proposed sublicensee of rights in the Inspire Principal Territory as to any Principal Product; such sublicensed rights would not be further sublicenseable by such sublicensee without Faes’ written approval, such approval not to be unreasonably withheld or delayed.

2.6 Faes Right of First Negotiation. Inspire hereby grants to Faes the right of first negotiation, as set forth below in this Section 2.6, in regards to the Inspire cystic fibrosis development product known as denufosol tetrasodium (the “CF Product”). If Inspire determines to undertake an initiative to out-license on an exclusive basis all or substantially of its intellectual property rights in the CF Product on a regional basis in Spain and Portugal (a “Business Opportunity”), then Inspire will notify Faes in writing of its intent to pursue such Business Opportunity. At the request of Faes, Inspire will afford Faes a reasonable opportunity to review scientific information relevant to the Business Opportunity and available to Inspire, and which has been approved by the Board of Directors of Inspire. Within fifteen (15) days of Faes’ receipt of the written notice, Faes will respond to Inspire in writing regarding Faes’ interest in the Business Opportunity. If Faes indicates interest in pursuing the Business Opportunity, the Parties will negotiate in good faith for a period of at least sixty (60) days to enter into a definitive agreement regarding such Business Opportunity. If, (i) Faes indicates no interest in the Business Opportunity or does not respond to Inspire’s notice of the Business Opportunity within such fifteen (15) day period, or (ii) Faes and Inspire do not enter into a definitive agreement within such sixty (60) day period, then Inspire will be free to pursue the Business Opportunity and will be deemed to have discharged its obligations under this Section 2.6 in full; provided, however, that if at the end of such sixty (60) day period the Parties are actively negotiating the terms of a definitive agreement, then such sixty (60) day period may be extended to a mutually acceptable time by the Parties in writing. For the avoidance of doubt, any Inspire initiative with respect to the CF Product that includes any country other than Spain and Portugal will not be deemed a Business Opportunity, and Inspire will have no obligation with respect to such an initiative, under this Section 2.6.

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2.7 Supply of Compound. The Parties acknowledge that it is the Parties’ intention, notwithstanding the license rights granted by Faes in Section 2.1(a), for Faes to supply to Inspire bulk Compound (as API) for Inspire’s use in manufacturing, developing and commercializing Inspire Licensed Products in final form. The Parties agree to initiate negotiation of a supply agreement in good faith promptly after the Effective Date, and to enter into a supply agreement as soon as practicable, which agreement shall contain commercially reasonable, mutually acceptable supply terms and provisions typical of similar supply arrangements, including forecasting and ordering provisions, delivery terms, transfer pricing, and back-up manufacturing rights. Inspire acknowledges that Faes’ right to supply to Inspire the Compound is a fundamental aspect of this Agreement for Faes, and thus Inspire agrees that Inspire shall not negotiate with any third party regarding any manufacturing relationship under which Faes would obtain supplies of Compound, so long as Faes is continuing to negotiate the terms of the supply agreement in good faith as above (and provided that Faes supplies to Inspire its interim requirements for Compound (for use in clinical development under the terms of this Agreement) as set forth in reasonable forecasts provided to Faes). It is understood that Inspire shall have sole responsibility for conducting (or having conducted on its behalf) all product formulation and packaging as needed to use the Compound supplied by Faes to make Inspire Licensed Products in final form.

ARTICLE 3

DEVELOPMENT AND COMMERCIALIZATION

3.1 Data and Materials Transfer and Right of Reference.

(a) In furtherance of the licenses granted by Faes to Inspire under this Agreement and the activities contemplated by this Article 3, Faes shall, or shall cause its Affiliates or Third Party contractors to, transfer promptly (but in all events within thirty (30) days following the Effective Date) to Inspire (i) the physical embodiments, to the extent available, of the Faes Technology that are needed or reasonably useful to Inspire in the development or commercialization of Inspire Licensed Products in the applicable countries of the Inspire Territory as contemplated by this Agreement, and (ii) a copy of the entire Regulatory Dossier in existence as of the Effective Date. Without limiting the foregoing, Faes shall provide to Inspire copies of all final audited study reports, prepared in accordance with applicable FDA guidelines, for all studies relating to the Compound.

(b) Faes shall make reasonably available to Inspire at no cost to Inspire, during business hours and for reasonable amounts of time during the twelve (12) month period following the Effective Date, such of Faes’ employees as are appropriate (including key manufacturing and development personnel) for purposes of consulting with Inspire regarding the development, testing and manufacturing of Inspire Licensed Products, procuring of Regulatory Approval of Inspire Licensed Products, and to enable Inspire to use the Faes Know-How in connection with Inspire Licensed Products.

(c) Faes hereby grants to Inspire a “Right of Reference or Use” as that term is defined in 21 C.F.R. § 314.3(b), and any foreign equivalents, to any and all regulatory filings, data and information within the Faes Know-How relating to the Compound or Subject Products, including without limitation that related to pharmacology, toxicology, preclinical testing,

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clinical testing, chemistry, manufacturing and controls data, batch records, trials and studies, safety and efficacy, manufacturing information, analytical and quality control, and agrees to sign, and cause its Affiliates to sign, any instruments reasonably requested by Inspire in order to effect such grant, solely for the purposes of developing and seeking regulatory approval in the Inspire Principal Territory of Inspire Principal Products and in the Inspire Ophthalmic Territory of Inspire Ophthalmic Products and conducting such other activities as are contemplated by this Agreement. In addition, Faes hereby grants to Inspire the full right to use and refer to any Drug Master File for the Compound and will provide a copy thereof to Inspire upon Inspire’s request solely for the purposes of developing and seeking regulatory approval in the Inspire Principal Territory of Inspire Principal Products and in the Inspire Ophthalmic Territory of Inspire Ophthalmic Products and conducting such other activities as are contemplated by this Agreement.

(d) Faes hereby agrees to assign and hereby does assign to Inspire the regulatory documents in the Regulatory Dossier relating directly to the Compound in the Inspire Principal Territory. Within thirty (30) days after the Effective Date, Faes shall provide to Inspire a list of all of the documents in the Regulatory Dossier as of the Effective Date relating directly to the Compound in the Inspire Principal Territory. Within thirty (30) days after the Effective Date, the Parties shall execute and deliver to the FDA such documents as are required to notify the FDA of the transfer of the IND number 70,302 to Inspire. In addition, Faes promptly shall execute any and all other instruments, forms of assignment or other documents and take such further actions as Inspire may reasonably request in order to give effect to or evidence the foregoing assignment. Faes shall retain the full rights to use any and all information in the aspects of the Regulatory Dossier assigned to Inspire as above, and the right of reference to all such regulatory documents, solely for purposes relating to development and commercialization of Faes Non-Ophthalmic Products outside the Inspire Principal Territory and Faes Licensed Ophthalmic Products in the Faes Ophthalmic Territory.

(e) In furtherance of the licenses granted by Inspire to Faes under this Agreement and the activities contemplated by this Article 3, Inspire shall, or shall cause its Affiliates or Third Party contractors to, transfer to Faes upon Faes’s reasonable request made from time to time, to the extent available: (i) the physical embodiments of the Inspire Technology that are needed or reasonably useful to Faes in the development or commercialization of Faes Non-Ophthalmic Products in all applicable countries outside the Inspire Principal Territory or of the Faes Licensed Ophthalmic Products in the applicable countries of the Faes Ophthalmic Territory as contemplated by this Agreement, and (ii) a copy of the entire Regulatory Dossier with respect to the Inspire Licensed Products. In addition, Inspire hereby grants to Faes the foreign equivalents, in any country or jurisdiction outside the Inspire Principal Territory, to a “Right of Reference or Use” as that term is defined in 21 C.F.R. § 314.3(b) to any and all regulatory filings, data and information within the Inspire Technology relating to the Compound or Subject Products, including without limitation that related to pharmacology, toxicology, preclinical testing, clinical testing, chemistry, manufacturing and controls data, batch records, trials and studies, safety and efficacy, manufacturing information, analytical and quality control, and agrees to sign, and cause its Affiliates to sign, any instruments reasonably requested by Faes in order to effect such

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grant, solely for the purposes of developing and seeking regulatory approval outside the Inspire Principal Territory of Faes Non-Ophthalmic Products and/or of the Faes Licensed Ophthalmic Products in the applicable countries of the Faes Ophthalmic Territory as contemplated by this Agreement, and of conducting such other activities as are contemplated by this Agreement.

3.2 Development.

(a) Development Program and Plan.

(i) Inspire and Faes will perform the Development Program in accordance with the Development Plan. The Parties acknowledge and agree that the Development Plan sets forth the development activities to be performed by Inspire during the Term (the “Inspire Development Activities”) together with certain of the development activities to be performed by Faes during the Term (the “Faes Development Activities”). The Development Plan includes an overall timeline of the estimated target dates for completing the various development tasks described within the Development Plan (the “Development Timeline”). The initial Development Plan as agreed to by the Parties as of the Effective Date has been signed and acknowledged by each Party and copies of such signed document have been exchanged between the Parties.

(ii) The Parties will work together, through their participation on the Joint Project Team, to evaluate from time to time in light of then-current circumstances the status of the Development Program and progress compared to the Development Timeline. Either Inspire or Faes may propose modifications to the Development Plan, which will be discussed in good faith by the Joint Project Team. Any modification to the Development Plan proposed by either Party (except for Regulatory Amendments (defined below)) that will extend the Development Timeline for more than sixty (60) days or materially increase the costs associated with the development of a Principal Product for the Primary Indication (each, a “Material Amendment”) will require the requesting Party to demonstrate that the potential benefits (economic, commercial, or otherwise) to both Parties that may result from the proposed Material Amendment materially outweigh the potential adverse impact (economic, commercial, or otherwise) on both Parties (including without limitation the impact caused by a delay in launch and any increased development costs) associated with such proposed Material Amendment. Each Material Amendment will require the unanimous approval of the Joint Project Team prior to implementation and any dispute regarding a Material Amendment will be subject to the dispute resolution procedures set forth in Section 11.9; provided, however, that Inspire shall have final decision-making authority with respect to the development and commercialization of Principal Products in the Inspire Principal Territory and of Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, and Faes shall have final decision-making authority with respect to the development and commercialization of Faes Non-Ophthalmic Products outside the Inspire Principal Territory and of Faes Licensed Ophthalmic Products in the Faes Ophthalmic Territory, and compliance with the dispute

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resolution procedures set forth in Section 11.9 will not be required with respect to such matters. The Joint Project Team also will review and consider any modifications to the Development Plan suggested or required by any Regulatory Authority (each, a “Regulatory Amendment”), and the Parties will amend the Development Plan as necessary to incorporate feedback from any Regulatory authority on the Development Program and to comply with any legal requirement or formal action imposed by any Regulatory Authority.

(b) Development Activities.

(i) Inspire will be responsible for undertaking the Inspire Development Activities and will use Commercially Reasonable Efforts to perform the Inspire Development Activities in accordance with the Development Timeline. Faes will be responsible for undertaking the Faes Development Activities and will use Commercially Reasonable Efforts to perform the Faes Development Activities in accordance with the Development Timeline. The Joint Project Team will monitor each Party’s respective obligations and progress towards achieving the goals set forth in the Development Plan. Each Party acknowledges and agrees that the drug development process is a process of scientific discovery and as such is inherently unpredictable and delays to the Development Timeline may occur for reasons beyond a Party’s control as Subject Products are developed, and that the drug development process is subject to a high level of governmental regulation and the requirements of the regulatory process of seeking drug approval may result in delays beyond a Party’s control and that such delays or other similar delays beyond a Party’s control, without evidence of some other lack of Commercially Reasonable Efforts, are not a breach of this Section 3.2(b)(i).

(ii) Without limiting Section 3.2(b)(i), Inspire shall be responsible, at Inspire’s sole cost and expense, for conducting all Phase 3 Clinical Trials in the United States on the Compound as necessary to obtain Regulatory Approval in the United States of a Principal Product for the Primary Indication.

(iii) Without limiting Section 3.2(b)(i), Faes shall be responsible, at Faes’s sole cost and expense, for continuing and completing the Definitive QT Study in accordance with current good clinical practices and any comments received from the FDA. Promptly upon completion of the Definitive QT Study, Faes shall report the results thereof to Inspire. Faes shall prepare or cause to be prepared, at its sole cost and expense, a final, audited study report with respect to the Definitive QT Study in compliance with applicable guidelines and suitable for submission to the FDA, and Faes shall provide such report to Inspire within sixty (60) days after completion of such study. Inspire shall have the right to use and refer to the Definitive QT Study solely in connection with Inspire’s permitted activities under this Agreement.

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(c) Joint Project Team.

(i) Within ten (10) days after the Effective Date, the Parties will establish a project team to oversee the Development Program (the “Joint Project Team”). The Joint Project Team will be comprised of equal numbers of representatives of each Party, with each Party appointing four (4) representatives as members of the Joint Project Team. The Joint Project Team may change its size from time to time by mutual consent of its members; provided that each of Inspire and Faes at all times will have one (1) vote on any matter requiring the approval of the Joint Project Team. Each Party may replace its Joint Project Team representatives at any time upon written notice to the other Party. Each Party may, in its reasonable discretion, invite non-member representatives of such Party to attend meetings of the Joint Project Team as appropriate to provide input with respect to matters on the agenda; provided that such non-member representatives agree to comply with the non-use and non-disclosure obligations of Article 7 with respect to all information disclosed or exchanged in such meeting. Non-member representatives will not have the power to vote on matters before the Joint Project Team.

(ii) The Joint Project Team will perform the following functions:

(A) oversee and coordinate the Parties’ activities conducted in connection with the Development Program;

(B) review and approve the Development Plan and any updates and modifications thereto in accordance with Section 3.2(a)(ii);

(C) monitor progress towards achieving goals set forth in the Development Plan;

(D) address and attempt to resolve conflicts or disputes between the Parties that may arise during the course of performing the Development Plan; and

(E) serve as a forum for communication between the Parties for the activities performed pursuant to the Development Plan.

(iii) The Joint Project Team will meet in person (or by having certain representatives of the Parties participate by telephone where necessary) no less frequently than once every six (6) months, unless otherwise agreed by the Parties. The members of the Joint Project Team may also convene or be polled or consulted from time to time by means of telecommunications, video conferences, electronic mail or correspondence, as deemed necessary or appropriate. Meetings of the Joint Project Team that are held in person will alternate between the offices of the Parties, or such other place as the Parties may agree. The members of the Joint Project Team will designate one (1) representative at each meeting to serve as secretary for such meeting, who will promptly prepare and distribute to the Parties

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written minutes summarizing the matters discussed and actions taken, if any, at such meeting. The meeting minutes will be approved by each of Inspire and Faes promptly following the applicable Joint Project Team meeting and will reflect any agreement or disagreement of the Parties with regard to the matters therein. The first meeting of the Joint Project Team will take place at the offices of one of the Parties within thirty (30) days of the Effective Date.

(iv) The Joint Project Team will strive to reach consensus on matters over which it has authority; provided that any proposed amendments or modifications to the Development Plan will be made in accordance with Section 3.2(a)(ii). Subject to the foregoing and except as otherwise provided herein, if, at a meeting of the Joint Project Team, the Joint Project Team is unable to reach consensus on a particular issue, the members of the Joint Project Team will make good faith efforts to resolve such issue over the next thirty (30) days. If after thirty (30) days such effort is unsuccessful, either Party may proceed with the dispute resolution procedures set forth in Section 11.9; provided, however, that Inspire shall have final decision-making authority with respect to the development and commercialization of Principal Products in the Inspire Principal Territory and of Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, and Faes shall have final decision-making authority with respect to the development and commercialization of Faes Non-Ophthalmic Products outside the Inspire Principal Territory and of Faes Licensed Ophthalmic Products in the Faes Ophthalmic Territory, and compliance with the dispute resolution procedures set forth in Section 11.9 will not be required with respect to such matters.

(v) The Joint Project Team will have only such powers as are specifically delegated to it in this Agreement, and will have no power to amend this Agreement or waive a Party’s rights or obligations under this Agreement.

3.3 Commercialization.

(a) Inspire shall be solely responsible, using the efforts required in subsection (b) below, for commercialization of Principal Products in the Inspire Principal Territory and of Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, including without limitation with respect to:

(i) Regulatory Approval;

(ii) sales and marketing;

(iii) advertising, marketing and promotional materials;

(iv) sales representatives and sales force matters;

(v) distribution;

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(vi) regulatory compliance and communications;

(vii) additional required or appropriate clinical studies, such as Phase 4 trials; and

(viii) product inquiries and complaints.

(b) Inspire shall use Commercially Reasonable Efforts to commercialize a Principal Product in the Field in each country in the Inspire Principal Territory and an Inspire Ophthalmic Product in each country in the Inspire Ophthalmic Territory, promptly after obtaining Regulatory Approval for, and such other approvals (including without limitation reimbursement approvals) as are necessary for the marketing of, such Inspire Licensed Product in the applicable country.

(c) Faes shall have the right to recommend to Inspire specific companies that Faes believes would be appropriate as co-promotion or distribution partners for particular Inspire Licensed Products in applicable countries in the Inspire Territory. Inspire shall consider any such recommendations in good faith, and if requested by Faes will discuss such recommendations reasonably with Faes. If Faes and Inspire determine that it would be beneficial to the Parties to seek and enter into an agreement with one or more appropriate, capable co-promotion or distribution partners, such determination to be made reasonably and in good faith, then the Parties shall use Commercially Reasonable Efforts to enter into such agreements. Co-promotion proposals made by Faes or Inspire will not be rejected by the other Party unless such other Party shall have provided a written summary of the reasons that such other Party believes should justify not proceeding with such proposed arrangement, and such reasons are objective and clearly support not proceeding with such arrangement.

3.4 Records and Reports.

(a) Each Party shall maintain records, in sufficient detail and in good scientific manner appropriate for patent and regulatory purposes, which shall accurately reflect all work done and results achieved in the performance of the Development Program by such Party. All reports and other information provided or made available by a Party under this Section 3.4 shall constitute the Confidential Information of such Party and shall be subject to the provisions of Article 7.

(b) By Inspire. Every six (6) months following the Effective Date, Inspire shall provide Faes a written report summarizing the efforts and accomplishments of Inspire, its Affiliates and its sublicensees during the preceding six (6) month period in developing and commercializing Inspire Licensed Products. Such reports shall include, without limitation, summaries of scientific and clinical data obtained in furtherance of or based on Inspire’s (or its Affiliate’s or sublicensee’s) efforts to develop or commercialize Inspire Licensed Products.

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(c) By Faes. Every six (6) months following the Effective Date, Faes shall provide Inspire a written report summarizing the efforts and accomplishments of Faes, its Affiliates and sublicensees during the preceding six (6) month period in developing and commercializing Faes Licensed Ophthalmic Products. Such reports shall include, without limitation, summaries of scientific and clinical data obtained in furtherance of or based on Faes’s (or its Affiliate’s or sublicensee’s) attempts to develop or commercialize Faes Licensed Ophthalmic Products.

(d) Each Party shall have the right, during normal business hours and upon reasonable prior written notice, to inspect all such records of the other Party referred to in Section 3.4(a), and to obtain copies of such records to the extent reasonably needed by such Party in exercising its rights under this Agreement. Each Party shall maintain such records and the information disclosed therein in confidence in accordance with Article 7. Each Party shall have the right to arrange for its employees involved in the activities contemplated hereunder to visit the offices and laboratories of the other Party and any of its Affiliates, twice per calendar year during normal business hours and upon reasonable prior written notice, to discuss the Development Program work and its results in detail with the technical personnel and consultants of the other Party.

3.5 Inspire Regulatory Matters; Faes Assistance. From and after the Effective Date, the aspects of the Regulatory Dossier with respect to Principal Products in the Field in the Inspire Principal Territory and Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory, including without limitation any applicable NDA or foreign equivalents covering such products, shall be owned by Inspire and in Inspire’s name. Without limiting Inspire’s obligations set forth in Section 3.3, Inspire shall have exclusive control over, and authority and responsibility for, the regulatory strategies relating to the development and commercialization of all Principal Products in the Field in the Inspire Principal Territory and Inspire Ophthalmic Products in the Ophthalmic Indication in the Inspire Ophthalmic Territory including, without limitation: (a) the preparation of all documents submitted to Regulatory Authorities and the filing of all submissions relating to Regulatory Approval of Inspire Licensed Products in the applicable countries in the Inspire Territory; and (b) all regulatory actions, communications and meetings with any applicable Regulatory Authority with respect to any Inspire Licensed Product in the applicable countries in the Inspire Territory. Upon the request of Inspire, Faes shall use reasonable efforts to provide to Inspire on a timely basis such information in its possession and control relating to any Inspire Licensed Product as may be required for the foregoing regulatory activities, and otherwise provide reasonable assistance, at Inspire’s expense, to Inspire in complying with all regulatory obligations in the Inspire Territory relating to Inspire Licensed Products, including without limitation, reasonably assisting Inspire in its drafting the NDA or any foreign equivalent for any Inspire Licensed Product or providing reasonable assistance to Inspire relating to safety updates, amendments, annual reports, pharmacovigilance filings, investigator notifications, manufacturing facility inspections and certifications and product approvals. Inspire shall be responsible for interfacing, corresponding and meeting with all Regulatory Authorities in the applicable countries in the Inspire Territory with respect to any Inspire Licensed Product. Except as required by applicable law, Faes shall not communicate directly with the FDA or any other Regulatory Authority in the Inspire Principal Territory relating to any Principal Product or in the Inspire Ophthalmic Territory relating to any Inspire Ophthalmic

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Product, without the prior written consent of Inspire. In furtherance thereof, Faes shall refer all FDA and other Regulatory Authority communications relating to any Inspire Licensed Product to Inspire. Faes shall use reasonable efforts to cooperate with Inspire to provide, at Inspire’s expense, all reasonable assistance reasonably requested by Inspire that are necessary for Inspire to comply with any law applicable to any Inspire Licensed Product, including without limitation reporting of adverse drug experience reports (and serious adverse drug experiences) to Regulatory Authorities in the Inspire Territory.

3.6 Faes Regulatory Matters; Inspire Assistance. From and after the Effective Date, the aspects of the Regulatory Dossier with respect to Faes Non-Ophthalmic Products in the Field intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory, including without limitation any applicable foreign equivalent to an NDA covering such products, shall be owned by Faes (or its Affiliate or other licensee) and in such party’s name. Faes shall have exclusive control over, and authority and responsibility for, the regulatory strategies relating to the development and commercialization of Faes Non-Ophthalmic Products in the Field intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory including, without limitation: (a) the preparation of all documents submitted to Regulatory Authorities and the filing of all submissions relating to Regulatory Approval of Faes Non-Ophthalmic Products intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory; and (b) all regulatory actions, communications and meetings with any applicable Regulatory Authority with respect to Faes Non-Ophthalmic Products in the Field intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory. Upon the request of Faes, Inspire shall use reasonable efforts to provide to Faes on a timely basis such information in Inspire’s possession and control relating to any Faes Non-Ophthalmic Product and/or Faes Licensed Ophthalmic Product as may be required for the foregoing regulatory activities, and otherwise provide reasonable assistance, at Faes’ expense, to Faes in complying with all regulatory obligations in such countries relating to Faes Non-Ophthalmic Products in the Field intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory, including without limitation, reasonably assisting Faes in its drafting any application or registration for Regulatory Approval for any Faes Non-Ophthalmic Product or Faes Licensed Ophthalmic Product, or providing reasonable assistance to Faes relating to safety updates, amendments, annual reports, pharmacovigilance filings, investigator notifications, manufacturing facility inspections and certifications and product approvals. Faes shall be responsible for interfacing, corresponding and meeting with all Regulatory Authorities in the applicable countries with respect to Faes Non-Ophthalmic Products in the Field intended for Regulatory Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory. Except as required by applicable law, Inspire shall not communicate directly with any applicable Regulatory Authority relating to any Faes Non-Ophthalmic Product and/or Faes Licensed Ophthalmic Products, without the prior written consent of Faes. In furtherance thereof, Inspire shall refer to Faes all Regulatory Authority communications relating to Faes Non-Ophthalmic Products in the Field intended for Regulatory

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Approval and sale outside the Inspire Principal Territory and/or to Faes Licensed Ophthalmic Products in the Ophthalmic Indication in the Faes Ophthalmic Territory. Inspire shall use reasonable efforts to cooperate with Faes to provide, at Faes’ expense, all reasonable assistance reasonably requested by Faes that are necessary for Faes to comply with any law applicable to any Faes Non-Ophthalmic Product or Faes Licensed Ophthalmic Product, including reporting of adverse drug experience reports (and serious adverse drug experiences) to Regulatory Authorities in the applicable countries.

3.7 Adverse Event Reporting.

(a) Each Party shall, and shall require its respective Affiliates to:

(i) to the extent permissible under time constraints and reporting requirements, provide to the other Party in advance of initial or periodic submission to Regulatory Authorities any and all adverse event reports and Serious Adverse Drug Experience reports from clinical trials and commercial experiences with respect to the Compound and each Subject Product;

(ii) provide such adverse event reports and Serious Adverse Drug Experience reports to the other Party contemporaneously with the provision of such reports to the applicable Regulatory Authority; and

(iii) adhere to all requirements of applicable laws, rules and regulations that relate to the reporting and investigation of adverse events and Serious Adverse Drug Experiences and keep the other Party informed of such events.

(b) If a Party contracts with a Third Party for research to be performed by such Third Party on any of the Subject Products, that Party shall require such Third Party to report to the contracting Party the information set forth above.

ARTICLE 4

INITIAL PAYMENT AND MILESTONE PAYMENTS

4.1 Initial Payment. Within ten (10) Business Days after the Effective Date, Inspire shall pay Faes Seven Million U.S. Dollars ($7,000,000), by wire transfer, to the credit of such bank account as designated by Faes in writing, such sum shall be non-creditable and non-refundable.

4.2 Milestone Payments. Inspire shall pay the following non-creditable and non-refundable milestone payments (the “Milestone Payments”) within thirty (30) calendar days following the first occurrence of the specified event:

(a) Acceptable QT Study Results. Eight Million U.S. Dollars ($8,000,000) upon Faes providing to Inspire the final report of the completed Definitive QT Study and the results of such Definitive QT Study being acceptable to Inspire pursuant to the guidelines set forth in

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Schedule 4.2(a), such determination to be made by Inspire by the date thirty (30) days after Faes provides such report (the “QT Milestone Due Date”).

If Inspire does not pay the milestone payment under this Section 4.2(a) by the QT Milestone Due Date, then Inspire may proceed under the terms of Section 9.8(a), and Faes may proceed under the terms of Section 9.8(b).

(b) United States Phase 3 Clinical Trial Results. Two Million U.S. Dollars ($2,000,000) upon completion of the first Phase 3 Clinical Trial of a Principal Product comprising an oral tablet formulation for the Primary Indication conducted by or on behalf of Inspire in the United States in which the Principal Product’s results are significantly better than the results for placebo in such Phase 3 Clinical Trial.

[CONFIDENTIAL]

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For purposes of clarification, each of the foregoing Milestone Payments shall be made only once and upon the first occurrence of each milestone, regardless of the number of Inspire Licensed Products or occurrences of each milestone for Inspire Licensed Products.

ARTICLE 5

ROYALTIES

5.1 Inspire Royalty Payments. Inspire shall pay to Faes the following royalties in accordance with this Article 5 (“Inspire Royalties”) based on Net Sales of each Inspire Licensed Product in the Field in the Inspire Territory, as follows:

(a) For Net Sales of Principal Rx Products, the following percentages of Net Sales:

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(i) For Net Sales of such Principal Rx Products[C.I.] in a calendar year, fourteen percent (14%) of such Net Sales; and

(ii) For Net Sales of such Principal Rx Products [C.I.] in a calendar year, sixteen percent (16%) of such Net Sales.

(b) For Net Sales of Inspire Ophthalmic Rx Products, ten percent (10%) of such Net Sales.

(c) For Net Sales of Principal OTC Products, five percent (5%) of such Net Sales.

(d) For Net Sales of Inspire Ophthalmic OTC Products, three and one half percent (3.5%) of such Net Sales.

The obligation to pay Inspire Royalties under this Article 5 shall be imposed only once (i) with respect to any sale of the same unit of any Inspire Licensed Product, and (ii) with respect to a single unit of any Inspire Licensed Product.

5.2 Faes Royalty Payments. Faes shall pay to Inspire the following royalties in accordance with this Article 5 (“Faes Royalties”) based on Net Sales of each Faes Licensed Ophthalmic Product in the Field in the Faes Ophthalmic Territory, as follows:

(a) For Net Sales of Faes Ophthalmic Rx Products, ten percent (10%) of such Net Sales.

(b) For Net Sales of Faes Ophthalmic OTC Products, three and one half percent (3.5%) of such Net Sales.

The obligation to pay Faes Royalties under this Article 5 shall be imposed only once (i) with respect to any sale of the same unit of any Faes Licensed Ophthalmic Product, and (ii) with respect to a single unit of any Faes Licensed Ophthalmic Product.

5.3 Royalty Terms.

(a) Inspire Royalties. The Inspire Royalties set forth in Section 5.1 shall be payable for the applicable following period as to each particular Inspire Licensed Product sold in a particular country (such period, the “Inspire Royalty Term” as to the particular Inspire Licensed Product sold in the particular country):

(i) for each particular Principal Rx Product, on Subject Product-by-Subject Product and a country-by-country basis, for so long as there exists in the particular country of sale a Valid Claim within the Faes Technology covering such Principal Rx Product or its manufacture or use;

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(ii) for each particular Inspire Ophthalmic Rx Product, on a Subject Product-by-Subject Product and a country-by-country basis, until the tenth (10^th anniversary of the First Commercial Sale by Inspire, any of its Affiliates or any of its sublicensees of such Inspire Ophthalmic Rx Product in the particular country of sale, or, if longer, for so long as there exists in the particular country of sale a Valid Claim within the Faes Technology covering such Inspire Ophthalmic Rx Product or its manufacture or use; and

(iii) for each Inspire OTC Product, on a Subject Product-by-Subject Product basis and a country-by-country basis, until the tenth (10th) anniversary of the First Commercial Sale (after the OTC Switch) by Inspire, any of its Affiliates or any of its sublicensees of such Inspire OTC Product in the particular country of sale.

For the avoidance of doubt, Inspire shall have no obligation to pay any Inspire Royalties for a particular Inspire Licensed Product in a particular country under Section 5.1 above upon the expiration of the period in this Section 5.3(a) stated to be applicable to such Inspire Licensed Product in such country.

(b) Faes Royalties. The Faes Royalties set forth in Section 5.2 shall be payable as to each particular Faes Licensed Ophthalmic Product sold in a particular country, on a Subject Product-by-Subject Product basis and a country-by-country basis, until the tenth (10th) anniversary of the First Commercial Sale by Faes, any of its Affiliates or any of its sublicensees of such Faes Licensed Ophthalmic Product (such period, the “Faes Royalty Term” as to the particular Faes Licensed Ophthalmic Product sold in the particular country). For the avoidance of doubt, Faes shall have no obligation to pay any Faes Royalties for a particular Faes Licensed Ophthalmic Product in a particular country under Section 5.2 above upon the expiration of the period in this Section 5.3(b) stated to be applicable to such Faes Licensed Ophthalmic Product in such country.

5.4 Minimum Royalties.

(a) For each one year Minimum Royalty Period commencing on the Minimum Royalty Date and on each one year anniversary of such date, Inspire shall pay to Faes royalties in at least the amount of minimum royalties applicable to such one year period, as provided in this Section 5.4. On the date that is forty-five (45) days after the end of a particular Minimum Royalty Period, Inspire shall determine the total amounts of royalties accrued and payable for such Minimum Royalty Period under Section 5.1. If such total amount of royalties accrued is less than the minimum royalty amount owed for such Minimum Royalty Period as set forth in Schedule 5.4, then, in addition to the royalty payment Inspire shall make for the calendar quarter that just ended at the end of such Minimum Royalty Period, Inspire shall also pay Faes an amount equal to the difference between the such minimum royalty amount owed and such total amount of royalties accrued for such Minimum Royalty Period.

(b) Promptly after completion of a particular calendar year in which a Minimum Royalty Period ended, Inspire may conduct and complete a formal internal financial audit

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with respect to the total amounts of royalties accrued and payable under Section 5.1 for such Minimum Royalty Period. If such audit (combined with the applicable portions of an audit performed for the prior calendar year) shows that the total amount of royalties actually owed and paid to Faes, under Section 5.1, for such Minimum Royalty Period is different from the amount used in Section 5.4(a) above in calculating the amount (if any) that must be paid to Faes to meet the minimum royalty amount owed for such Minimum Royalty Period, then Inspire may provide to Faes a complete copy of the applicable portions of the written record of such audit that demonstrate such difference, and the consequential difference (if any) in the amount of the payment (if any) that Inspire should have made under Section 5.4(a) above for such Minimum Royalty Period in order to meet the minimum royalty amount owed for such Minimum Royalty Period (such difference, the “Reconciliation Amount”). If such audit, as reflected in the written record provided to Faes, demonstrates that there is a Reconciliation Amount that must be paid by one Party to the other, in order to make the payment made under Section 5.4(a) for the applicable Minimum Royalty Period accurate, then the applicable Party shall pay to the other Party such Reconciliation Amount shown to be owing by the audit, within thirty (30) days of Inspire providing such audit to Faes.

(c) Notwithstanding the foregoing, Inspire shall only be required to pay minimum royalties under this Section 5.4 during the period commencing on the Minimum Royalty Date and continuing for so long as there exists a Valid Claim within the Faes Technology covering a Principal Rx Product or its manufacture or use in the Inspire Principal Territory. If Inspire’s obligation to pay minimum royalties under this Section 5.4 expires pursuant to the previous sentence, or if this Agreement expires or is terminated, during any particular Minimum Royalty Period, then the minimum royalty amount owed for such Minimum Royalty Period shall be calculated within sixty (60) days of such expiration or termination and shall be based on a pro-rated amount (using a straight-line pro ration based on the number of days in such Minimum Royalty Period through the date of such expiration or termination) of the required minimum royalties owed for such Minimum Royalty Period under Schedule 5.4.

5.5 Reports and Payments. Each Party shall deliver to the other Party, within forty-five (45) days after the end of each calendar quarter, a report setting forth for such calendar quarter the following information for each Inspire Licensed Product (in the case of Inspire) or each Faes Licensed Ophthalmic Product (in the case of Faes): (i) Net Sales of such Subject Product by such Party, any of its Affiliates or any of its sublicensees on a country-by-country basis; (ii) the Inspire Royalties or Faes Royalties (as the case may be) due to the other Party in respect of such Net Sales; and (iii) the exchange rates used in calculating any of the foregoing. The total Inspire Royalties or Faes Royalties (as the case may be) due in respect of Net Sales of Subject Products during such calendar quarter shall be remitted at the time such report is made. All payments to be made by each Party under this Agreement shall be made by wire transfer of immediately available funds to a bank account as specified in writing by the other Party.

5.6 Taxes and Withholding. Any payments made by a Party to the other Party under this Agreement may be reduced by the amount of any taxes required to be paid or withheld with respect to such payments pursuant to any applicable law, including, but not limited to, United States

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federal, state or local tax law (“Withholding Taxes”). Any such Withholding Taxes required by law to be paid or withheld shall be an expense of, and borne solely by, the Party receiving the payment on which the Withholding Taxes are levied. Each Party, as applicable, shall submit to the other Party reasonable proof of payment of the Withholding Taxes, together with an accounting of the calculations of such taxes, within thirty (30) days after such Withholding Taxes are remitted to the proper authority. The Parties will cooperate reasonably in completing and filing documents required under the provisions of any applicable tax laws or under any other applicable law in connection with the making of any required tax payment or withholding payment, or in connection with any claim to a refund of or credit for any such payment.

5.7 Currency Exchange; Manner and Place of Payment. All payments hereunder shall be payable in U.S. Dollars. Inspire Royalties and Faes Royalties (as the case may be) shall be calculated based on Net Sales in each country’s currency in which Net Sales have occurred, and shall be converted (as applicable) to U.S. Dollars as follows. With respect to each calendar quarter, whenever conversion of payments from any foreign currency shall be required, such conversion shall be made using the arithmetic average of the spot rates on the last Business Day of each month of the calendar quarter in which Net Sales occurred. The spot rates published from time to time in the Wall Street Journal, or any other publication as agreed by the Parties, shall be used as the source of spot rates to calculate the average as defined in the preceding sentence. All payments shall be made by wire transfer in U.S. Dollars to the credit of such bank account as shall be designated at least ten (10) Business Days in advance by each Party in writing to the other Party.

5.8 Maintenance of Records; Audit. For a period of three (3) years from the end of the calendar quarter in which the particular sale occurred, each Party shall maintain, and shall require its respective Affiliates and sublicensees to maintain, complete and accurate books and records in connection with the sale of Subject Products hereunder by such Party, its Affiliates and sublicensees, as necessary to allow the accurate calculation consistent with GAAP of the Inspire Royalties due to Faes or the Faes Royalties due to Inspire (as the case may be), including any records required to calculate any royalty adjustments hereunder. Once per calendar year, each Party shall have the right to engage an independent accounting firm reasonably acceptable to the other Party, which shall have the right to examine in confidence the relevant records of the other Party as may be reasonably necessary to determine or verify the amount of royalty payments due hereunder. Such examination shall be conducted, and each such Party shall make its records available, during normal business hours, after at least fifteen (15) Business Days prior written notice to the Party to be audited, as applicable, and shall take place at the facility(ies) where such records are maintained. Each such examination shall be limited to pertinent books and records for any year ending not more than twenty-four (24) months prior to the date of request; provided that a Party shall not be permitted to audit the same period of time more than once. Before permitting such independent accounting firm to have access to such books and records, the Party to be audited may require such independent accounting firm and its personnel involved in such audit, to sign a confidentiality agreement (in form and substance reasonably acceptable to such Party) as to any confidential information which is to be provided to such accounting firm or to which such accounting firm will have access, while conducting the audit under this paragraph. The independent accounting firm will prepare and provide to each Party a written report stating whether the royalty reports submitted and royalties paid are correct or incorrect and the details

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concerning any discrepancies. Such accounting firm may not reveal to the auditing Party any information learned in the course of such audit other than the amount of any such discrepancies. The auditing Party agrees to hold in strict confidence all information disclosed to it by such accounting firm, except to the extent necessary for the auditing Party to enforce its rights under this Agreement or to the extent disclosure is required by law. In the event there was an underpayment by the audited Party of amounts owed under this Agreement, the audited Party shall promptly (but in no event later than thirty (30) days after the audited Party’s receipt of the independent auditor’s report so correctly concluding) make payment to the auditing Party of any shortfall together with interest as required under Section 5.9. In the event that there was an overpayment by the audited Party hereunder, the auditing Party shall promptly (but in no event later than thirty (30) days after the auditing Party’s receipt of the independent auditor’s report so correctly concluding) refund to the audited Party or credit to future royalties, at the audited Party’s election, the excess amount together with interest as required under Section 5.9. The auditing Party shall bear the full cost of such audit unless such audit discloses an underreporting by the audited Party of more than five percent (5%) of the aggregate amount of royalties in any twelve (12) month period, in which case, the audited Party shall bear the full cost of such audit.

5.9 Interest on Late Payments. In the event that any payment due hereunder is not made when due, each such payment shall accrue interest from the date due at the Rate of Interest per annum, calculated on the basis of a three hundred sixty five (365) day year, the interest period commencing on the due date and ending on the date payment is actually made.

5.10 Reductions.

(a) If Inspire, in its good faith judgment, determines that it is commercially necessary to obtain license rights in any country in the Inspire Territory from a Third Party (a “Third Party License”) under Patent Rights owned or controlled by such Third Party that claim or cover the Compound or its manufacture or use in such country and are required to develop, make, have made, use, commercialize, offer for sale, sell, and import a particular Inspire Licensed Product in the Field (“Third Party Patent Rights”), then if Inspire enters into such Third Party License, Inspire may:

(i) reduce the Inspire Royalties owed to Faes based on sales, in such country where such Third Party License grants Inspire license rights under the applicable Third Party Patent Rights, of an Inspire Licensed Product covered by such Third Party License by an amount equal to [C.I.] of the amounts of royalties Inspire pays to such Third Party based on such sales of such Inspire Licensed Product under such Third Party License during the applicable royalty period, but provided however that such reduction shall not reduce such Inspire Royalties owed to Faes based on such sales of the Inspire Licensed Product in such country (in the applicable royalty period) by more than [C.I.] of the amounts otherwise owed by Inspire as a result of application of this Section 5.10(a)(i).

(b) The Inspire Royalties payable by Inspire with respect to any particular Inspire Licensed Product in any particular country in the Inspire Territory pursuant to this Article 5 during a particular royalty period may be reduced by the following percentages effective

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during and after the calendar quarter when Generic Competition occurs at the following sales levels with respect to such Inspire Licensed Product in such country: Where the sales of the Generic Equivalent, as to such Inspire Licensed Product, during a calendar quarter are equal to or greater than either (w) [C.I.] of total sales of such Inspire Licensed Product sold in such country, expressed in units, or (x) [C.I.] of the total sales of such Inspire Licensed Product in such country, expressed in local currency, then the Inspire Royalties with respect to such particular Inspire Licensed Product shall be reduced, subject to the last sentence of this subsection (b), by [C.I.] of the amounts otherwise owed in such country. Where the sales of a Generic Equivalent, as to such Inspire Licensed Product, during a calendar quarter are equal to or greater than either (y) [C.I.] of total sales of such Inspire Licensed Product sold in such country, expressed in units, or (z) [C.I.] of the total sales of such Inspire Licensed Product in such country, expressed in local currency, then the Inspire Royalties with respect to such particular Inspire Licensed Product shall be reduced, subject to the last sentence of this subsection (b), by [C.I.] in such country (or such lesser percentage as applicable to comply with the last sentence of this subsection 5.10(b)). If such Generic Competition no longer continues at the specific sales levels required under subsection (w) or (x) above (as applicable), then, beginning with the first calendar quarter after such Generic Competition does not exist at such sales levels, the reduction of Inspire Royalties under the above subsection 5.10(b)(w) or (x) (as applicable) with respect to such particular Inspire Licensed Product shall no longer apply, and any reduction of Inspire Royalties (if any) under the above terms shall be limited to the reduction applicable under the above terms to such lower sales levels, if any, in such country until such time as Generic Competition may again exist at such sales levels with respect to such Inspire Licensed Product in such country. Notwithstanding the foregoing, in no event shall the Inspire Royalties payable by Inspire to Faes hereunder with regards to a particular Inspire Licensed Product be reduced to an amount that is below [C.I.] of applicable Net Sales in the applicable country as a result of application of this Section 5.10(b).

(c) The Faes Royalties payable by Faes with respect to any particular Faes Licensed Ophthalmic Product in any particular country in the Faes Ophthalmic Territory pursuant to this Article 5 during a particular royalty period may be reduced by the following percentages effective during and after the calendar quarter when Generic Competition occurs at the following sales levels with respect to such Faes Licensed Ophthalmic Product in such country: Where the sales of the Generic Equivalent, as to such Faes Licensed Ophthalmic Product, during a calendar quarter are equal to or greater than either (w) [C.I.] of total sales of such Faes Licensed Ophthalmic Product sold in such country, expressed in units, or (x) [C.I.] of the total sales of such Faes Licensed Ophthalmic Product in such country, expressed in local currency, then the Faes Royalties with respect to such particular Faes Licensed Ophthalmic Product shall be reduced, subject to the last sentence of this subsection (c), by [C.I.] of the amounts otherwise owed in such country. Where the sales of a Generic Equivalent, as to such Faes Licensed Ophthalmic Product, during a calendar quarter are equal to or greater than either (y) [C.I.] of total sales of such

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Faes Licensed Ophthalmic Product sold in such country, expressed in units, or (z) [C.I.] of the total sales of such Faes Licensed Ophthalmic Product in such country, expressed in local currency, then the Faes Royalties with respect to such particular Faes Licensed Ophthalmic Product shall be reduced, subject to the last sentence of this subsection (c), by [C.I.] in such country (or such lesser percentage as applicable to comply with the last sentence of this subsection 5.10(c)). If such Generic Competition no longer continues at the specific sales levels required under subsection (w) or (x) above (as applicable), then, beginning with the first calendar quarter after such Generic Competition does not exist at such sales levels, the reduction of Faes Royalties under the above subsection 5.10(c)(w) or (x) (as applicable) with respect to such particular Inspire Licensed Product shall no longer apply, and any reduction of Inspire Royalties (if any) under the above terms shall be limited to the reduction applicable under the above terms to such lower sales levels, if any, in such country until such time as Generic Competition may again exist at such sales levels with respect to such Inspire Licensed Product in such country. Notwithstanding the foregoing, in no event shall the Faes Royalties payable by Faes to Inspire hereunder with regards to a particular Faes Licensed Ophthalmic Product be reduced to an amount that is below [C.I.] of applicable Net Sales in the applicable country as a result of application of this Section 5.10(c).

(d) The Parties anticipate that Inspire, its Affiliates or its sublicensees may sell a Combination Licensed Product during the Inspire Royalty Term. In such event, the Parties shall determine Net Sales for the purpose of calculating royalty payments due on such Combination Licensed Product in a manner to be mutually agreed in good faith by the Parties based on the relative value contributed by each active ingredient of such Combination Licensed Product, such agreement not to be unreasonably withheld.

(e) If Inspire reasonably and in good faith believes that a lower royalty rate or minimum royalty amount is required in order to permit Inspire to commercialize the Inspire Licensed Products in a country in the Inspire Territory with a reasonable profit, Inspire may notify Faes of such belief and the basis therefor and, if such notification is made, the Parties shall meet as promptly as practicable to discuss in good faith whether a reduction to the royalty rate or minimum royalty amount for such Inspire Licensed Product in such country is appropriate, provided that nothing shall require Faes to agree to such a reduction.

ARTICLE 6

REPRESENTATIONS, WARRANTIES AND COVENANTS

6.1 Mutual Representations and Warranties. Each Party hereby represents and warrants to the other Party as of the Effective Date that:

(a) such Party is a corporation or entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has full corporate power and authority to execute and deliver this Agreement and to carry out the provisions hereof;

(b) such Party is duly authorized, by all requisite corporate action, to execute and deliver this Agreement and to carry out the provisions hereof, and the Person executing this

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Agreement on behalf of such Party is duly authorized to do so by all requisite corporate action;

(c) no consent, approval, order or authorization of, or registration, qualification, designation, declaration or filing with, any federal, state or local governmental authority is required on the part of such Party in connection with the valid execution, delivery and performance of this Agreement, except where the failure to obtain any of the foregoing would not have a material adverse impact on the ability of such Party to meet its obligations hereunder;

(d) this Agreement is a legal and valid obligation binding upon such Party and enforceable in accordance with its terms; and

(e) the execution, delivery and performance by it of this Agreement and its compliance with the terms and provisions of this Agreement does not and will not conflict with or result in a breach of any of the terms or provisions of (i) any other contractual or other obligations of such Party, (ii) the provisions of its charter, operating documents or bylaws, or (iii) any order, writ, injunction or decree of any court or governmental authority entered against it or by which it or any of its property is bound except where such breach or conflict would not have a material adverse impact on the Party’s ability to meet its obligations hereunder.

6.2 Additional Faes Representations and Warranties. Faes additionally represents and warrants to Inspire as of the Effective Date that:

(a) Faes has the full right, power and authority to grant, and is not prohibited by the terms of any agreement to which it is a party from granting, the licenses granted to Inspire under Article 2 hereof. Faes has not previously granted to any Third Party any rights under the Faes Technology that are in conflict with license rights granted to Inspire under this Agreement;

(b) Faes is the exclusive owner or licensee of all right, title and interest in the Faes Licensed Patents as set forth in Schedule 1.20, which is a complete and accurate list of all patents and patent applications included in the Faes Licensed Patents as of the Effective Date. Faes has no Knowledge that the issued claims in the patents included in the Faes Licensed Patents are invalid and/or unenforceable. The patent applications included in the Faes Licensed Patents have been duly filed;

(c) the patents and patent applications listed on Schedule 1.20 are the only Patent Rights Controlled by Faes and its Affiliates that claim or cover the Compound or its manufacture or use in the Field;

(d) Faes has obtained the assignment or exclusive licenses of all interests and all rights of any and all Third Parties (including but not limited to employees) with respect to the Faes Know-How. Faes has taken reasonable measures to protect the confidentiality of the Faes Know-How;

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(e) there are no pending claims, judgments or settlements against or owed by Faes pending with respect to any of the Faes Technology, and Faes has not received written notice of any threatened claims or litigation seeking to invalidate the Faes Licensed Patents;

(f) there are no investigations, inquiries, actions or other proceedings pending before or, to Faes’ Knowledge, threatened by any Regulatory Authority or other government agency with respect to the Compound, and Faes has not received written notice threatening any such investigation, inquiry, action or other proceeding;

(g) Faes has no Knowledge that the manufacture, use or sale of the Compound by Inspire as contemplated by this Agreement will infringe upon any Third Party’s patents or will constitute a misappropriation of a Third Party’s trade secrets or other intellectual property rights; neither Faes nor its Affiliates and, to Faes’ Knowledge, its Third Party contractors, have received any notice in writing, or otherwise have Knowledge of any facts, which have led Faes to believe that the manufacture, use or sale of the Compound infringes any rights of a Third Party;

(h) Faes has no Knowledge that any Third Party is infringing any of the Faes Licensed Patents or misappropriating or using Faes Know-How in derogation of the rights granted to Inspire in this Agreement;

(i) Faes has no Knowledge that the development, testing, manufacture, labeling, storage, and distribution, of the Compound have not been conducted by Faes, its Affiliates, and/or its Third Party contractors in compliance in all material respects with all applicable laws, rules and regulations, including with respect to investigational use, good clinical practices, good laboratory practices, good manufacturing practices, record keeping, security and filing of reports; and, as of the Effective Date, neither Faes nor its Affiliates, nor (to Faes’ Knowledge) its Third Party contractors, have received any notice in writing, or otherwise have Knowledge of any facts, which have led Faes to believe that any of the regulatory submissions of Faes or its Affiliate relating to the Compound are not currently in good standing with the FDA;

(j) Faes has no Knowledge that there are any facts that indicate the existence of any material side effect, toxicity effect, carcinogenicity effect, adverse effect or any instances of deleterious physical effects or reactions resulting from, or alleged to result from, the Compound, which are not identified in the Faes Know-How delivered to Inspire, or which has not been otherwise disclosed to Inspire by Faes;

(k) Faes has no Knowledge that any of the written statements and other writings furnished by Faes pursuant to or in connection with this Agreement or the transactions contemplated hereby is inaccurate, incomplete or untruthful; and

(l) Faes has no Knowledge that there are any metabolites of the Compound, and Faes is not directly or indirectly conducting, and has no current plans to conduct, any research or

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development on any compound that Faes knows to be an analog or derivative of the Compound.

6.3 Additional Inspire Representations, Warranties and Covenants. Inspire additionally represents, warrants and covenants to Faes as of the Effective Date that: (a) Inspire has the full right, power and authority to grant, and is not prohibited by the terms of any agreement to which it is a party from granting, the licenses granted to Faes under Article 2 hereof; (b) Inspire has not previously granted to any Third Party any rights under the Inspire Technology that are in conflict with the license rights granted to Faes under this Agreement; and (c) Inspire has no Knowledge that any of the written statements and other writings furnished by Inspire pursuant to or in connection with this Agreement or the transactions contemplated hereby is inaccurate, incomplete or untruthful.

6.4 Additional Covenants.

(a) Faes covenants that it will not grant to any Third Party any rights under the Faes Technology that are in conflict with license rights granted to Inspire under this Agreement.

(b) Each Party covenants to the other that it shall comply in all material respects with all laws, rules and regulations applicable to its performance under this Agreement.

(c) During the Term, Faes shall promptly notify Inspire in writing upon learning of any actual or threatened investigation, inquiry, action or proceeding by any Regulatory Authority or other government agency with respect to the Compound.

(d) During the Term, Faes shall promptly notify Inspire in writing upon learning of any actual claim, judgment or settlement against or owed by Faes with respect to any of the Faes Technology, or of any threatened claims or litigation seeking to invalidate the Faes Licensed Patents.

(e) Faes shall promptly notify Inspire upon learning that the manufacture, use or sale of the Compound or the practice of any of the inventions included in the Faes Licensed Patents or the use of the Faes Know-How may infringe any Patent Rights or other intellectual property rights of a Third Party.

(f) Inspire shall not grant to any Third Party any rights under the Inspire Technology that are in conflict with the license rights granted to Faes under this Agreement.

6.5 No Debarment. Neither Party shall employ, contract with, or retain any person directly or indirectly to perform any development work under this Agreement if such a person is under investigation by the FDA for debarment or is presently debarred by the FDA pursuant to 21 U.S.C. § 335a. In addition, each Party represents and warrants to the other Party that it has not engaged in any conduct or activity which could lead to debarment actions. If during the term of this Agreement a Party or any person employed or retained by it to perform development work under this Agreement (i) comes under investigation by the FDA for a debarment action, (ii) is debarred,

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or (iii) engages in any conduct or activity that could lead to a debarment action, such Party shall immediately notify the other Party of same.

ARTICLE 7

CONFIDENTIALITY, PUBLICATION AND PUBLIC ANNOUNCEMENTS

7.1 Confidentiality. The Parties agree that during the Term, and for a period of five (5) years after this Agreement expires or terminates, a Party receiving Confidential Information of the other Party shall (i) maintain in confidence such Confidential Information to the same extent such Party maintains its own proprietary information of similar kind and value (but at a minimum each Party shall use commercially reasonable efforts to maintain Confidential Information in confidence); (ii) not disclose such Confidential Information to any Third Party without prior written consent of the Disclosing Party, except for disclosures to its sublicensees and commercial partners for Subject Products who agree to be bound by obligations of non-disclosure and non-use at least as stringent as those contained in this Article 7; and (iii) not use such Confidential Information for any purpose except those purposes permitted by this Agreement.

7.2 Authorized Disclosure. Notwithstanding any other provision of this Agreement, the Receiving Party may disclose Confidential Information of the Disclosing Party to a Third Party: (i) to the extent and to the Persons as required by an applicable law, rule, regulation, legal process or court order, or an applicable disclosure requirement of any Regulatory Authority, the U.S. Securities and Exchange Commission (“SEC”), the Nasdaq market or any other securities exchange or market; or (ii) to the extent necessary to exercise the rights granted to or retained by the Receiving Party under this Agreement in filing or prosecuting patent applications, prosecuting or defending litigation or otherwise establishing rights or enforcing obligations under this Agreement, or conducting clinical trials or seeking Regulatory Approval with respect to Subject Products; provided, however, that the Receiving Party shall first have given prompt notice to the Disclosing Party to enable the Disclosing Party to seek any available exemptions from or limitations on any applicable disclosure requirement and shall reasonably cooperate in such efforts by the Disclosing Party.

7.3 Scientific Publications. Prior to making any formal scientific publication relating to Subject Products (a “Scientific Publication”), each Party (the “Publishing Party”) agrees to provide the other Party (the “Reviewing Party”) the opportunity to review: (a) any proposed Scientific Publication comprising a formal scientific paper for publication in any peer reviewed journal at least fifty (50) days prior to its intended publication, and (b) any proposed Scientific Publication comprising a formal scientific abstract or poster at least fourteen (14) days prior to its intended publication. The Reviewing Party shall have the right (i) to propose in good faith modification to the Scientific Publication for patent or other reasons, which modification the Publishing Party shall reasonably consider; (ii) to request in good faith a delay (for a reasonable period not to exceed 60 days) in the Scientific Publication in order to protect patentable information; and (iii) to require the Publishing Party to remove from the Scientific Publication the Reviewing Party’s Confidential Information. If the Reviewing Party requests a delay pursuant to clause (ii) of the preceding sentence, the Publishing Party shall delay the Scientific Publication for a period of forty-five (45) days from such request to enable patent applications to be filed

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protecting each Party’s rights in such information. Upon the expiration of the applicable fifty (50) day period or fourteen (14) day period specified above in this Section 7.3, the Publishing Party shall be free to proceed with the Scientific Publication as transmitted to the Reviewing Party, except to the extent that the Reviewing Party has exercised its rights under clause (ii) or (iii) of the second preceding sentence.

7.4 Public Announcements. The Parties agree that the existence of and the material terms of this Agreement shall be considered Confidential Information of both Parties, subject to the special authorized disclosure provisions set forth below in this Section 7.4 (in lieu of the authorized disclosure provisions set forth in Section 7.2, to the extent of any conflict) and without limiting the generality of the definition of Confidential Information set forth in Section 1.9. The Parties will mutually agree the text of a press release announcing the execution of this Agreement. Thereafter, if either Party desires to make a public announcement concerning this Agreement or the terms hereof, such Party shall give reasonable prior advance notice of the proposed text of such announcement to the other Party for its prior review and approval, such approval not to be unreasonably withheld. A Party shall not be required to seek the permission of the other Party to repeat any information as to the existence and terms of this Agreement that has already been publicly disclosed by such Party in accordance with the foregoing or by the other Party. Either Party may disclose the terms of this Agreement to such Party’s existing investors, directors and professional advisors and to potential investors, acquirors or merger partners and their professional advisors who are bound by written or professional obligations of non-disclosure and non-use that are at least as stringent as those contained in this Article 7 or are customary for such purpose. The Parties acknowledge that Inspire may be obligated to file a copy of this Agreement with the SEC with its next quarterly report on Form 10-Q, annual report on Form 10-K or current report on Form 8-K or with any registration statement filed with the SEC pursuant to the Securities Act of 1933, as amended, and that Faes may be obligated to file a copy of this Agreement with applicable securities exchanges, and Inspire and Faes shall be entitled to make such filings, provided that the filing Party requests (to the extent legally permitted) confidential treatment of the terms hereof for which confidential treatment is customarily sought, to the extent such confidential treatment is reasonably available to such Party under the circumstances then prevailing. In the event of any such filing, the filing Party will provide the other Party with an advance copy of the Agreement marked to show provisions for which the filing Party intends to seek confidential treatment (to the extent legally available in the applicable jurisdiction) and shall reasonably consider the other Party’s timely comments thereon.

7.5 Unauthorized Use. If either Party becomes aware or has knowledge of any unauthorized use or disclosure of the other Party’s Confidential Information, it shall promptly notify the other Party of such unauthorized use or disclosure.

7.6 Return of Confidential Information. Upon termination of this Agreement, subject to the royalty-free license described in Section 2.1(c), the Receiving Party shall promptly return all of the Disclosing Party’s Confidential Information, including all reproductions and copies thereof in any medium, except that the Receiving Party may retain one copy for its legal files.

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ARTICLE 8

INDEMNIFICATION

8.1 Inspire. Inspire shall indemnify, defend and hold harmless Faes and its Affiliates and their respective directors, officers, employees and agents (the “Faes Indemnitees”) from and against any and all losses, costs, damages, liabilities fees or expenses (including reasonable attorney’s fees and expenses) (“Losses”) incurred in connection with or arising out of any Third Party claim, suit, action or proceeding (a “Third Party Claim”) against any Faes Indemnitees in the Inspire Territory to the extent resulting from (i) the breach by Inspire of any of its representations, warranties, covenants or obligations pursuant to this Agreement, (ii) any negligence or willful misconduct of Inspire or its Affiliate or sublicensee in the exercise of any of rights granted by Faes or the performance of any of Inspire’s obligations under this Agreement, or (iii) the development, manufacture, sale, promotion, marketing or use of Inspire Licensed Products in the Inspire Territory by Inspire or its Affiliates or sublicensees.

8.2 Faes. Faes shall indemnify, defend and hold harmless Inspire and its Affiliates and their respective directors, officers, employees and agents (the “Inspire Indemnitees”) from and against any and all Losses incurred in connection with or arising out of any Third Party Claim against any Inspire Indemnitees to the extent resulting from (i) the breach by Faes of any of its representations, warranties, covenants or obligations pursuant to this Agreement, (ii) any negligence or willful misconduct of Faes or its Affiliate or sublicensee in the exercise of any of its rights or the performance of any of its obligations under this Agreement, or (iii) the development, manufacture, sale, promotion, marketing or use of the Compound, Faes Non-Ophthalmic Products or Faes Licensed Ophthalmic Products by Faes or its Affiliates or sublicensees.

8.3 Indemnification Procedures.

(a) In the case of a Third Party Claim made by any Person who is not a Party to this Agreement (or an Affiliate thereof) as to which a Party (the “Indemnitor”) may be obligated to provide indemnification pursuant to this Agreement, such Party seeking indemnification hereunder (“Indemnitee”) will notify the Indemnitor in writing of the Third Party Claim (and specifying in reasonable detail the factual basis for the Third Party Claim and, to the extent known, the amount of the Third Party Claim) reasonably promptly after becoming aware of such Third Party Claim; provided, however, that failure to give such notification will not affect the indemnification provided hereunder except to the extent the Indemnitor shall have been actually prejudiced as a result of such failure.

(b) If a Third Party Claim is made against an Indemnitee and the Indemnitor acknowledges in writing its obligation to indemnify the Indemnitee therefor, the Indemnitor will be entitled, within one hundred twenty (120) days after receipt of written notice from the Indemnitee of the commencement or assertion of any such Third Party Claim, to assume the defense thereof (at the expense of the Indemnitor) with counsel selected by the Indemnitor and reasonably satisfactory to the Indemnitee, for so long as the Indemnitor is conducting a good faith and diligent defense. Should the Indemnitor so elect to assume the defense of a Third Party Claim, the Indemnitor will not be liable to the Indemnitee for any legal or other expenses subsequently incurred by the Indemnitee in

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connection with the defense thereof; provided, that if under applicable standards of professional conduct a conflict of interest exists between the Indemnitor and the Indemnitee in respect of such claim, such Indemnitee shall have the right to employ separate counsel (which shall be reasonably satisfactory to the Indemnitor) to represent such Indemnitee with respect to the matters as to which a conflict of interest exists and in that event the reasonable fees and expenses of such separate counsel shall be paid by such Indemnitor; provided, further, that the Indemnitor shall only be responsible for the reasonable fees and expenses of one separate counsel for such Indemnitee. If the Indemnitor assumes the defense of any Third Party Claim, the Indemnitee shall have the right to participate in the defense thereof and to employ counsel, at its own expense, separate from the counsel employed by the Indemnitor. If the Indemnitor assumes the defense of any Third Party Claim, the Indemnitor will promptly supply to the Indemnitee copies of all correspondence and documents relating to or in connection with such Third Party Claim and keep the Indemnitee informed of developments relating to or in connection with such Third Party Claim, as may be reasonably requested by the Indemnitee (including, without limitation, providing to the Indemnitee on reasonable request updates and summaries as to the status thereof). If the Indemnitor chooses to defend a Third Party Claim, all Indemnitees shall reasonably cooperate with the Indemnitor in the defense thereof (such cooperation to be at the expense, including reasonable legal fees and expenses, of the Indemnitor). If the Indemnitor does not elect to assume control of the defense of any Third Party Claim within the one hundred twenty (120) day period set forth above, or if such good faith and diligent defense is not being or ceases to be conducted by the Indemnitor, the Indemnitee shall have the right, at the expense of the Indemnitor, after three (3) Business Days notice to the Indemnitor of its intent to do so, to undertake the defense of the Third Party Claim for the account of the Indemnitor (with counsel selected by the Indemnitee), and to compromise or settle such Third Party Claim, exercising reasonable business judgment.

(c) If the Indemnitor acknowledges in writing its obligation to indemnify the Indemnitee for a Third Party Claim, the Indemnitee will agree to any settlement, compromise or discharge of such Third Party Claim that the Indemnitor may recommend that by its terms obligates the Indemnitor to pay the full amount of Losses (whether through settlement or otherwise) in connection with such Third Party Claim and unconditionally and irrevocably releases the Indemnitee completely from all liability in connection with such Third Party Claim; provided, however, that, without the Indemnitee’s prior written consent, the Indemnitor shall not consent to any settlement, compromise or discharge (including the consent to entry of any judgment), and the Indemnitee may refuse in good faith to agree to any such settlement, compromise or discharge, that provides for injunctive or other non-monetary relief affecting the Indemnitee. If the Indemnitor acknowledges in writing its obligation to indemnify the Indemnitee for a Third Party Claim, the Indemnitee shall not (unless required by law) admit any liability with respect to, or settle, compromise or discharge, such Third Party Claim without the Indemnitor’s prior written consent (which consent shall not be unreasonably withheld).

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8.4 Insurance Proceeds. Any indemnification hereunder shall be made net of any insurance proceeds recovered by the Indemnitee (it being understood that an Indemnitee may simultaneously pursue an insurance claim and a claim for indemnification hereunder); provided, however, that if, following the payment to the Indemnitee of any amount under this Article 8, such Indemnitee recovers any insurance proceeds in respect of the claim for which such indemnification payment was made, the Indemnitee shall promptly pay an amount equal to the amount of such proceeds (but not exceeding the amount of such indemnification payment) to the indemnifying Party.

8.5 Insurance. Each Party agrees to obtain and maintain commercial general liability insurance, including clinical trials and products liability insurance, with reputable and financially secure insurance carriers, in such amounts and subject to such deductibles as are reasonable and customary in the pharmaceutical industry for companies of comparable size and activities. Each Party shall maintain such insurance for so long as Subject Products in the Territory continue to be developed, manufactured or sold and thereafter for so long as is necessary to cover any and all Third Party Claims which may arise from the development, manufacture or sale of a Subject Product in the Territory. Upon reasonable request by a Party, the other Party shall produce evidence that such insurance policies are valid, kept up to date and in full force and effect.

ARTICLE 9

TERM AND TERMINATION

9.1 Term. Except as set forth in Section 11.13, unless earlier terminated by mutual agreement of the Parties in writing or pursuant to the provisions of this Article 9, this Agreement will continue in full force and effect until the later of the following events: (a) the obligation to pay Inspire Royalties with respect to the sale of all Inspire Licensed Products expires throughout the Inspire Territory; or (b) the obligation to pay Faes Royalties with respect to the sale of all Faes Licensed Ophthalmic Products expires throughout the Faes Ophthalmic Territory (the “Term”).

9.2 Voluntary Termination by Inspire. Notwithstanding any other provision herein, commencing upon the earlier of (a) May 31, 2007 and (b) the date on which Inspire has received the results of the Definitive QT Study, Inspire may terminate this Agreement for its convenience either (i) on a country-by-country basis or Inspire Licensed Product-by-Inspire Licensed Product basis (such termination, a “Partial Termination”), or (ii) in its entirety, such termination requiring the following notice: (x) prior to the First Commercial Sale of an Inspire Licensed Product, upon ninety (90) days advance written notice to Faes, or (y) after the First Commercial Sale of an Inspire Licensed Product, upon one hundred eighty (180) days advance written notice to Faes.

9.3 Material Breach.

(a) Upon a material breach of its obligations under this Agreement by a particular Party (in such capacity, the “Breaching Party”), the other Party (in such capacity, the “Non-Breaching Party”) may provide written notice (a “Breach Notice”) to the Breaching Party specifying the material breach. If the Breaching Party fails to cure such material breach during the ninety (90) day period (or, if applicable, such longer period, but not to exceed one hundred and eighty (180) days, as would be reasonably necessary for a diligent

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party to cure such material breach, provided the Breaching Party has commenced and continues its diligent efforts to cure during the initial ninety (90) day period following the date on which the Breach Notice is provided), then the Non-Breaching Party may terminate this Agreement on written notice to the Breaching Party; but provided that the Non-Breaching Party may elect instead to terminate on a Subject Product-by-Subject Product and/or country-by-country basis (a “Partial Termination”), with respect to the particular Subject Product and country that was at issue in the uncured material breach.

(b) Notwithstanding the foregoing:

(i) the cure period for any failure by Inspire to make Milestone Payments or either Party to make Royalty payments due hereunder shall be thirty (30) days; provided, however, that the failure by a Party to make any such payment shall not be considered a breach to the extent that such payment is the subject of a good faith dispute by such Party, so long as such Party is using diligent, good faith efforts to resolve such dispute as promptly as practicable; and

(ii) to the extent a material breach of this Agreement by Inspire affects Inspire’s performance and Faes’ rights under this Agreement as they relate to the Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, but not the Principal Products in the Inspire Principal Territory, Faes may not terminate this Agreement in its entirety, but instead may effect only a Partial Termination with respect to the Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, and in such case this Agreement will remain in full force and effect with respect to all Principal Products in the Inspire Principal Territory.

9.4 Bankruptcy or Insolvency. Either Party may, subject to the provisions set forth herein, terminate this Agreement by giving the other Party written termination notice if, at any time, the other Party shall: (a) file in any court pursuant to any statute a petition for bankruptcy or insolvency, or for reorganization in bankruptcy, or for an arrangement or for the appointment of a receiver, trustee or administrator of such Party or of its assets; (b) be served with an involuntary petition against it, filed in any insolvency proceeding, and such petition shall not be dismissed within sixty (60) days after the filing thereof; (c) propose or be a party to any dissolution; or (d) make an assignment for the benefit of its creditors. Should Faes become a party to a bankruptcy proceeding and such proceeding is not dismissed within sixty (60) days then, to the extent permitted by applicable law, this Agreement and the licenses granted by Faes hereunder shall continue, subject to the terms and conditions set forth in this Agreement, and shall be adopted by any bankruptcy trustee or relevant Third Party charged with the disposition of same, and shall not be rejected by same, it being the Parties’ intent that, in such event, Inspire and its Affiliates and sublicensees shall be entitled to retain the rights granted to them hereunder by Faes.

9.5 Continuing Rights of Sublicensees. Upon any termination of this Agreement by Faes, or any Partial Termination by Faes, each sublicense previously granted by Inspire or any of its Affiliates, under license rights to Inspire that are terminated by such termination, to any Person that is not an Affiliate of Inspire (each, an “Independent Sublicensee”) shall survive such termination and remain in effect as a direct agreement between Faes and such Independent

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Sublicensee (by automatic assignment to Faes of the applicable sublicense agreement), and such rights shall become a direct license or sublicense, as the case may be, to such Independent Sublicensee of the applicable rights granted by Faes to Inspire, but subject to and provided that: (a) such Independent Sublicensee is not then in material breach of its obligations under the sublicense agreement with Inspire; and (b) Faes shall not be bound by any obligations to the Independent Sublicensee in such agreement that exceed Faes’ obligations under this Agreement (and such Independent Sublicensee shall not be obligated to pay any amounts that is in consideration of the performance of such obligations, if Faes elects not to perform such obligations).

9.6 Effect of Expiration or Termination of Agreement.

(a) Expiration or termination of this Agreement in its entirety pursuant to this Article 9 shall not (i) relieve a Party hereto of any obligation accruing to such Party prior to such termination, or (ii) result in the waiver of any right or remedy by a Party hereto accruing to such Party prior to such termination.

(b) Upon termination of this Agreement in its entirety by Inspire pursuant to Section 9.2 or 9.4 or by Faes pursuant to Section 9.3: (i) all licenses granted to Inspire by Faes under this Agreement will terminate, and all rights therein will revert to Faes; (ii) Inspire promptly shall assign to Faes the Inspire Marks under which any Inspire Licensed Product was marketed; (iii) Inspire shall be deemed automatically to grant to Faes the exclusive, worldwide, royalty-free license (with full rights to sublicense) under the Inspire Technology to research, develop, make, have made, use, offer for sale, sell, and import Subject Products in the Field in all countries, territories and jurisdictions of the world; and (iv) Inspire shall immediately assign and surrender to Faes the entire Regulatory Dossier. In addition, Inspire promptly shall execute any and all other instruments, forms of assignment or other documents and take such further actions as Faes may reasonably request in order to give effect to or evidence the foregoing assignments and grants.

(c) Upon termination of this Agreement in its entirety by Inspire pursuant to Section 9.3: (i) the licenses granted to Inspire by Faes under this Agreement will terminate, and all rights therein will revert to Faes; (ii) the licenses granted to Faes by Inspire under this Agreement will terminate, and all rights therein will revert to Inspire; and (iii) Inspire shall assign and surrender to Faes the entire Regulatory Dossier. In addition, Inspire promptly shall execute any and all other instruments, forms of assignment or other documents and take such further actions as Faes may reasonably request in order to give effect to or evidence the foregoing assignments.

9.7 Effect of Partial Termination.

(a) The Partial Termination of this Agreement pursuant to this Article 9 shall not (i) relieve a Party hereto of any obligation accruing to such Party prior to such termination, or (ii) result in the waiver of any right or remedy by a Party hereto accruing to such Party prior to such termination, or (iii) result in the termination or modification of any rights or obligations of a Party under the Agreement not involved in such Partial Termination.

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(b) Upon the Partial Termination of this Agreement with respect to any Inspire Licensed Product in any country of the Inspire Territory by Inspire pursuant to Section 9.2, 9.4 or 9.8(a), or by Faes pursuant to Section 9.3: (i) the licenses granted to Inspire by Faes under this Agreement solely with respect to such product in such country will terminate, and all such license rights will revert to Faes; (ii) Inspire promptly shall assign to Faes the Inspire Marks under which such product was marketed in such country; (iii) Inspire shall be deemed automatically to grant to Faes the exclusive, worldwide, royalty-free license (with full rights to sublicense) under the Inspire Technology to research, develop, make, have made, use, offer for sale, sell, and import such Inspire Licensed Product in the Field in such country that is the subject of the Partial Termination; and (iv) Inspire shall immediately assign and surrender to Faes the Regulatory Dossier directly related to such product in such country. In addition, Inspire promptly shall execute any and all other instruments, forms of assignment or other documents and take such further actions as Faes may reasonably request in order to give effect to or evidence the foregoing assignments and grants.

(c) Upon the Partial Termination of this Agreement with respect to any Faes Ophthalmic Product or Faes Non-Ophthalmic Product in any country of the Faes Territory by Inspire pursuant to Section 9.3: the licenses granted to Faes by Inspire under this Agreement solely with respect to such product in such country will terminate, and all such license rights will revert to Inspire.

9.8 Consequences if QT Study Milestone Payment not Made.

(a) If Inspire does not pay the milestone payment under Section 4.2(a) by the QT Milestone Due Date (the date that is thirty (30) days after Faes provides to Inspire the Definitive QT Study report in accordance with Section 4.2), then Inspire may make an election (such election to be at Inspire’s sole discretion) in writing provided to Faes to proceed under this Section 9.8(a). If Inspire provides Faes written notice that it makes such election prior to termination of this Agreement, then: (i) Inspire shall retain all its license and other rights under this Agreement relating to the Inspire Ophthalmic Products in the Inspire Ophthalmic Territory, and shall continue to have all of its applicable obligations with respect to such Inspire Ophthalmic Products under this Agreement; (ii) immediately upon such election there shall be deemed to occur a Partial Termination with respect to all Principal Products throughout the Inspire Principal Territory, and the Parties shall proceed under Section 9.7(b) as to all such products (including that all license and other rights granted to Inspire under this Agreement relating to the Principal Products and related obligations shall automatically terminate and such rights shall revert exclusively to Faes).

(b) If Inspire has not paid the milestone payment under Section 4.2(a) by the QT Milestone Due Date, and Inspire has not made an election as provided in Section 9.8(a) above, then thereafter Faes may provide a written termination notice to Inspire and, if Inspire does not pay such milestone or make such written election within thirty (30) days following the date on which such termination notice was provided, then this Agreement shall automatically terminate in its entirety at the end of such thirty (30) day period.

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9.9 Change of Control. If an entity, or a group of related entities, obtains control of Inspire (i.e., transaction, or series of related transactions occurs, under which the shareholders of Inspire just prior to such transaction(s) own or control after such transaction(s) less than 50% of the shareholder voting power entitle to elect directors), then within thirty (30) days of the closing of such transaction such entity (or entities) that then control Inspire shall deliver to Faes a written instrument agreeing to cause Inspire to perform its obligations under this Agreement, expressly including all of Inspire’s diligence obligations with respect to development and commercialization of Inspire Licensed Products, in accordance with the terms of this Agreement.

ARTICLE 10

INTELLECTUAL PROPERTY

10.1 Ownership of Inventions.

(a) Inventorship of any Inventions that, in the case of patentable Inventions, were conceived and reduced to practice, and in the case of non-patentable Inventions, were made or developed, in the course of performing activities under this Agreement, together with all Patent Rights therein, will be determined in accordance with the rules of inventorship under United States patent laws with respect to patentable Inventions, and in accordance with applicable United States federal or state law with respect to non-patentable Inventions, and ownership of such Inventions shall be as set forth in further detail in Section 10.1(b) through (d).

(b) Faes will own all right, title and interest in and to all Inventions that are conceived, reduced to practice, made or developed solely by or on behalf of Faes or its Affiliate or other licensee from the Effective Date until the expiration or termination of the Term (whether or not patentable), and all intellectual property rights appurtenant thereto, subject only to the license rights under the Faes Technology granted by Faes to Inspire under this Agreement.

(c) Inspire will own all right, title and interest in and to all Inventions that are conceived, reduced to practice, made or developed by or on behalf of Inspire or its Affiliate or sublicensee from the Effective Date until the expiration or termination of the Term (whether or not patentable), and all intellectual property rights appurtenant thereto, subject only to the license rights under the Inspire Technology granted by Inspire to Faes under this Agreement.

(d) All right, title and interest in and to Inventions made and reduced to practice during the Term jointly by employees or contractors of each Party (“Joint Inventions”), and all intellectual property rights appurtenant thereto, will be owned jointly by the Parties. Except to the extent either Party is restricted by the licenses granted to the other Party and covenants contained herein, each Party will be entitled to practice and license Joint Inventions without restriction or consent of the other Party or an obligation to account to the other Party, and each Party hereby waives any right it may have under the laws of any jurisdiction to require any such consent or accounting. The Parties will confer and

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cooperate in good faith with respect to the Prosecution of patents and patent applications that claim or cover Joint Inventions, with the Parties sharing equally all costs and expenses of such Prosecution (unless otherwise agreed). Each Party hereby agrees to take all actions and execute and deliver all documents reasonably necessary to Prosecute such patents and patent applications.

10.2 Obligation to Inform. Faes will promptly disclose to Inspire all Inventions owned or Controlled by Faes relating to the Compound or Subject Products that arise during the Term. Inspire will promptly disclose to Faes all Inventions owned or Controlled by Inspire relating to the Compound or Inspire Licensed Products that arise during the Term. Information provided by Inspire or Faes to the other Party with respect to such Inventions will be in reasonable detail but in no circumstance less than would be sufficient to permit an understanding of the nature of the Inventions by a practitioner reasonably skilled in the relevant technical or scientific area.

10.3 Prosecution of Faes Licensed Patents. Faes shall have the obligation, using its commercially reasonable efforts, to Prosecute the Faes Licensed Patents in the Inspire Territory, at its expense and through patent counsel selected by Faes, except as provided in the following. If Faes so elects by written notification to Inspire, Inspire shall have the obligation, using its commercially reasonable efforts, to Prosecute those Faes Licensed Patents existing as of the Effective Date in the Inspire Principal Territory that relate directly to the Compound or to Inspire Licensed Products, at its expense and through patent counsel selected by Inspire and reasonably acceptable to Faes. Faes shall provide Inspire reasonable opportunities to consult with Faes regarding such Prosecution by Faes, and Inspire shall cooperate with and assist Faes reasonably in such Prosecution of the Faes Licensed Patents. If Faes elects to have Inspire conduct Prosecution of particular Patent Rights in the Inspire Principal Territory, then Inspire shall provide Faes reasonable opportunities to consult with Inspire regarding such Prosecution by Inspire, and Faes shall cooperate with and assist Inspire reasonably in such Prosecution of the Faes Licensed Patents.

10.4 Right to Consult. During the Term, Faes shall copy Inspire, or have Inspire copied, on all material, substantive documents relating to Faes Licensed Patents received by or on behalf of Faes from or to be filed by or on behalf of Faes in any patent office in the Inspire Territory, promptly after receipt from the patent office and at least fifteen (15) days prior to filing with the patent office, respectively, including without limitation copies of each patent application, official action, response to official action, declaration, information disclosure statement, request for terminal disclaimer, request for patent term extension, and request for reexamination. Inspire shall have the right to comment on such documents, and Faes shall reasonably consider in good faith any reasonable comments timely received from Inspire. If Faes elects to have Inspire conduct Prosecution of particular Patent Rights in the Inspire Principal Territory pursuant to Section 10.3, then thereafter during the Term, Inspire shall copy Faes, or have Faes copied, on all material, substantive documents relating to Faes Licensed Patents received by or on behalf of Inspire from or to be filed by or on behalf of Inspire in any patent office in the Inspire Principal Territory, promptly after receipt from the patent office and at least fifteen (15) days prior to filing with the patent office, respectively, including without limitation copies of each patent application, official action, response to official action, declaration, information disclosure statement, request for terminal disclaimer, request for patent term extension, and request for reexamination. Faes shall

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have the right to comment on such documents, and Inspire shall reasonably consider in good faith any reasonable comments timely received from Faes.

10.5 Abandonment of Prosecution of Faes Licensed Patent. Faes shall notify Inspire in the event it for any reason elects to abandon the Prosecution of a particular patent application or maintenance of an issued patent within the Faes Licensed Patents in the Inspire Territory (other than in favor of a continuing application based on such parent application). Such notification shall specify the application to be abandoned or patent that will no longer be maintained by Faes and shall be given within a reasonable period (i.e., with sufficient time for Inspire to take action as may be necessary or desired) prior to the date on which such patent application(s) or patent(s) will lapse or go abandoned. Inspire shall then have the option, exercisable upon written notification to Faes, to assume full responsibility, at its discretion and its cost and expense, for Prosecution of the affected patent application(s) or maintenance of any of the affected patent(s) in such country or countries in the Inspire Territory. If Faes elects to have Inspire conduct Prosecution of particular Patent Rights in the Inspire Principal Territory pursuant to Section 10.3, then thereafter during the Term, Inspire shall notify Faes in the event it for any reason elects to abandon the Prosecution of a particular patent application or maintenance of an issued patent within the Faes Licensed Patents in the Inspire Principal Territory (other than in favor of a continuing application based on such parent application). Such notification shall specify the application to be abandoned or patent that will no longer be maintained by Inspire and shall be given within a reasonable period (i.e., with sufficient time for Faes to take action as may be necessary or desired) prior to the date on which such patent application(s) or patent(s) will lapse or go abandoned. Faes shall then have the option, exercisable upon written notification to Inspire, to assume full responsibility, at its discretion and its cost and expense, for Prosecution of the affected patent application(s) or maintenance of any of the affected patent(s) in such country or countries in the Inspire Principal Territory.

10.6 Patent Term Extensions. Inspire shall have the right to request that Faes file all applications and take actions necessary to obtain patent extension pursuant to 35 U.S.C. § 156 or similar foreign statutes for the Faes Licensed Patents in the Inspire Principal Territory, which extensions shall be owned by Faes. If Faes declines to pursue such patent extensions, then Inspire shall have the right (at Inspire’s cost and expense) on behalf of Faes to file all such applications and take all such actions necessary to obtain such patent extensions. Faes agrees to sign such further document and take such further actions (at Inspire’s cost and expense) as may be requested by Inspire in this regard.

10.7 Third Party Infringement.

(a) Suits for Infringement of the Faes Licensed Patents. If Faes or Inspire becomes aware of infringement of any patent included in the Faes Licensed Patents by a Third Party anywhere in the world, such Party shall promptly notify the other Party in writing to that effect and provide a summary of the relevant facts and circumstances known to such Party relating to such infringement (“Infringement Notice”). Promptly after receipt of an Infringement Notice, the Parties shall discuss in good faith the infringement and appropriate actions that could taken to cause it to cease. Faes shall have the right, at its sole discretion, on its own behalf, to institute, prosecute and control any action or proceeding to restrain infringement of any Faes Licensed Patents. Inspire shall provide all reasonable

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cooperation required to prosecute such litigation. Faes shall have sole control of any such suit and all negotiations for its settlement or compromise and shall have the sole right to settle or compromise any such suit, except that, with regards to a suit based on a Principal Infringement (as defined below), Faes shall not settle or compromise any such suit or enter into any consent order for the settlement or compromise of such suit based on a Principal Infringement without the prior written consent of Inspire, which consent shall not be unreasonably withheld or delayed.

(b) Step-in Right for Inspire. If, prior to the expiration of five (5) months from an Infringement Notice regarding infringement of any patent included in the Faes Licensed Patents in the Inspire Principal Territory by a Third Party (a “Principal Infringement”), Faes has not obtained a discontinuance of the alleged Principal Infringement by a Third Party in the Inspire Principal Territory or brought an infringement action or proceeding or otherwise taken appropriate action to abate such Principal Infringement, then Inspire shall have the right, but not be obligated, to institute, prosecute and control any action or proceeding to restrain such Principal Infringement. Faes agrees to be joined as a party plaintiff if necessary to prosecute the action or proceeding and shall provide all reasonable cooperation, at Inspire’s expense, required to prosecute such litigation. Faes shall have the right to join any such action using counsel of its own choosing and at its own expense. Inspire shall have sole control of any such suit brought by Inspire under this subsection (b) based on a Principal Infringement and all negotiations for its settlement or compromise, provided that Inspire shall not settle or compromise any such suit or enter into any consent order for the settlement or compromise thereof without the prior written consent of Faes, which consent shall not be unreasonably withheld or delayed.

(c) Costs and Recoveries from Infringement Action. Each Party shall assume and pay all of its own out-of-pocket costs incurred in connection with any litigation or proceedings described in this Section 10.7 including, without limitation, the fees and expenses of that Party’s counsel. Any recovery obtained by any Party as a result of any proceeding described in this Section 10.7, by settlement or otherwise, shall be applied in the following order of priority: (i) first, to reimburse each Party for all litigation costs in connection with such proceeding paid by that Party and not otherwise recovered (on a pro rata basis based on each Party’s respective litigation costs, to the extent the recovery was less than all such litigation costs); and (ii) second, the remainder of the recovery shall be retained by the Party that brought and prosecuted the suit.

(d) Declaratory Actions & Counterclaims Against Inspire or Faes. In the event that an action alleging invalidity or non-infringement of any of the Faes Licensed Patents shall be brought against Faes or Inspire, Faes, at its sole discretion, shall have the right, within thirty (30) days after the commencement of such action, to take or regain control of the action at its own expense. If Faes shall determine not to exercise this right, Inspire may take over or remain as lead counsel for the action at Inspire’s sole discretion. Any recovery obtained from such litigation, proceeding or settlement shall be shared in accordance with Section 10.7(c).

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10.8 Infringement of Third Party Rights.

(a) Infringement Claims. With respect to any and all claims instituted by Third Parties for patent infringement involving the manufacture, use, offer for sale or sale of an Inspire Licensed Product in the Inspire Territory during the Term, Inspire shall promptly notify Faes of such claim, and, except for any such claims for which Faes is obligated to indemnify Inspire under Section 8.2(i), Inspire shall have the right, at its sole discretion, to defend and control any action or proceeding with respect to such claim. Faes shall provide all reasonable cooperation, at Inspire’s expense, required to defend such litigation. Inspire shall have sole control of any such suit and all negotiations for its settlement or compromise, provided that, Inspire shall not settle or compromise any such suit or enter into any consent order for the settlement or compromise thereof in any manner that would materially negatively impact Faes, its rights in or to any Faes Technology, or its rights under this Agreement without the prior written consent of Faes, which consent shall not be unreasonably withheld.

(b) Step-in Right for Faes. If, prior to the expiration of three (3) months from said claim being brought, or such sooner period as may be necessary to appropriately respond to said claim, Inspire has not elected to defend such action or proceeding, or if Inspire shall notify Faes at any time prior thereto of its intention not to defend such action or proceeding, then Faes shall have the right, but not be obligated, to defend and control any action or proceeding. Inspire shall provide all reasonable cooperation, at Faes’ expense, required to defend such litigation. Faes shall have sole control of any such suit and all negotiations for its settlement or compromise, provided that Faes shall not settle or compromise any such suit or enter into any consent order for the settlement or compromise thereof in any manner that would materially negatively impact Inspire, its rights in or to any Inspire Technology, or its rights under this Agreement without the prior written consent of Inspire, which consent shall not be unreasonably withheld.

ARTICLE 11

MISCELLANEOUS

11.1 Assignment. This Agreement may not be assigned or otherwise transferred (in whole or in part, whether voluntarily, by operation of law or otherwise) by either Party without the prior written consent of the other Party (which consent shall not be unreasonably withheld); provided, however, that a Party may assign or transfer this Agreement in its entirety without such consent either (a) to an Affiliate of the Party; or (b) to its successor in interest (but subject to the other provisions of this Section 11.1) in connection with (i) the merger, consolidation, reorganization or acquisition of the Party, or (ii) the sale or transfer of all or substantially all of the voting stock or assets of the Party, provided that (A) such Affiliate or successor in interest (as applicable) delivers to the other Party a written instrument agreeing to be bound by this Agreement or (B) in the case of subsection 11.1(b), if the acquired Party becomes a subsidiary of another company, then the parent company delivers to the other Party a written instrument agreeing to cause the acquired Party to perform its obligations under this Agreement in accordance with the terms thereof. Notwithstanding the foregoing, any such assignment or transfer to an Affiliate shall not relieve the

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assigning Party of its responsibilities for performance of its obligations under this Agreement. The rights and obligations of the Parties under this Agreement shall be binding upon and inure to the benefit of the successors and permitted assigns of the Parties. Any assignment not in accordance with this Agreement shall be void.

11.2 Further Actions. Each Party agrees to execute, acknowledge and deliver such further instruments, and to do all such other acts, as may be necessary or appropriate in order to carry out the purposes and intent of this Agreement.

11.3 Force Majeure. Neither Party will be deemed to be in breach of this Agreement as a result of default, delay or failure to perform by such Party that results from any cause beyond the reasonable control of such Party that could not reasonably be foreseen by such Party, including without limitation, fire, earthquake, acts of God, acts of war, strikes, lockouts, or other labor disputes, riots, civil disturbances, actions or inactions of governmental authorities (except actions in response to a breach of applicable laws by such Party), or epidemics. In the event of any such force majeure, the Party affected will promptly notify the other Party, will use commercially reasonable efforts to overcome such force majeure and to perform its obligations under the Agreement notwithstanding the force majeure, and will keep the other Party informed with respect thereto.

11.4 Notices. Notices to Faes shall be addressed to:

Faes Farma, S.A.

Máximo Aguirre, 14

48940 Leioa, Vizcaya, Spain

Attention: General Manager

Facsimile No.: 00 34 94 46 49 103

Notices to Inspire shall be addressed to:

Inspire Pharmaceuticals, Inc.

4222 Emperor Boulevard, Suite 200

Durham, North Carolina 27703-8566, USA

Attention: General Counsel

Facsimile No.: 919-941-9797

Either Party may change the address to which notices shall be sent by giving notice to the other Party in the manner herein provided. Any notice required or provided for by the terms of this Agreement shall be in writing and shall be (i) sent via a reputable overnight courier service, or (ii) sent by facsimile transmission, in each case properly addressed in accordance with the paragraphs above. The effective date of any notice shall be the actual date of receipt by the Party receiving the same.

11.5 Amendment. No amendment, modification or supplement of any provision of this Agreement shall be valid or effective unless made in writing and signed by a duly authorized officer of each Party.

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11.6 Waiver. No provision of this Agreement shall be waived by any act, omission or knowledge of a Party or its agents or employees except by an instrument in writing expressly waiving such provision and signed by a duly authorized officer of the waiving Party.

11.7 Counterparts; Facsimile Signatures. This Agreement may be executed in counterparts and such counterparts taken together shall constitute one and the same agreement. This Agreement may be executed by facsimile signatures, which signatures shall have the same force and effect as original signatures.

11.8 Descriptive Headings. The descriptive headings of this Agreement are for convenience only, and shall be of no force or effect in construing or interpreting any of the provisions of this Agreement.

11.9 Governing Law; Dispute Resolution. This Agreement shall be governed and construed in accordance with the laws of the State of New York, USA, without giving effect to any choice of law provisions thereof. Each Party hereby [CONFIDENTIAL]. Prior to bringing a legal action against the other Party, such dispute shall be separately negotiated by the Parties hereto in good faith and all reasonable efforts undertaken to settle amicably such matters before resorting to further legal recourse, as follows: upon the occurrence of a dispute between the Parties, including, without limitation, any breach of this Agreement or any obligation relating thereto, or any dispute with respect to whether a product is a Subject Product, the matter shall be referred first to the officers of Faes and Inspire having responsibility for the subject matter of the dispute, or their designees. The officers, or their designees, as the case may be, shall negotiate in good faith to resolve such dispute in a mutually satisfactory manner for up to thirty (30) days. If such efforts do not result in mutually satisfactory resolution of the dispute, the matter shall be referred to the chief executive officers of Faes and Inspire, or their designees. The chief executive officers, or their designees, as the case may be, shall negotiate in good faith to resolve such dispute in a mutually satisfactory manner for up to thirty additional (30) days, or such longer period of time to which the chief executive officers may agree.

11.10 Severability. If any provision hereof should be held invalid, illegal or unenforceable in any respect in any jurisdiction, the Parties hereto shall use reasonable efforts to substitute, by mutual written consent, valid provisions for such invalid, illegal or unenforceable provisions which valid provisions in their economic effect are sufficiently similar to the invalid, illegal or unenforceable provisions that it can be reasonably assumed that the Parties would have entered into this Agreement with such valid provisions. In case such valid provisions cannot be agreed upon, the invalid, illegal or unenforceable provisions of this Agreement shall not affect the validity of this Agreement as a whole, unless the invalid, illegal or unenforceable provisions are of such essential importance to this Agreement that it is to be reasonably assumed that the Parties would not have entered into this Agreement without the invalid, illegal or unenforceable provisions.

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11.11 Entire Agreement of the Parties. This Agreement hereby, together with the Schedules and Exhibits hereto and thereto, constitutes and contains the complete, final and exclusive understanding and agreement of the Parties and cancels and supersedes any and all prior negotiations, correspondence, understandings and agreements whether oral or written, between the Parties respecting the subject matter hereof and thereof.

11.12 Independent Contractors. The relationship between the Parties created by this Agreement is one of independent contractors and neither Party shall have the power or authority to bind or obligate the other except as expressly set forth in this Agreement.

11.13 Accrued Rights; Surviving Obligations. Unless explicitly provided otherwise in this Agreement, termination, relinquishment or expiration of this Agreement for any reason shall be without prejudice to any rights that shall have accrued to the benefit to any Party prior to such termination, relinquishment or expiration, including damages arising from any breach hereunder. Such termination, relinquishment or expiration shall not relieve any Party from obligations or deprive a Party of any of its rights that are expressly indicated to survive termination or expiration of the Agreement. Without limiting the foregoing, the obligations and/or rights set forth in Sections 2.1(c) (solely in connection with the scheduled expiration of the Term as set forth in Section 9.1), 5.8, 5.9, 9.5, 9.6, and 10.1, and Articles 1 (to the extent required to enforce other surviving rights and/or obligations), 7, 8 and 11 shall survive the termination or expiration of this Agreement.

11.14 Expenses. Unless otherwise provided herein, all costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the Party that shall have incurred the same and the other Party shall have no liability relating thereto.

11.15 No Third Party Beneficiaries. No person or entity other than the Parties hereto and their respective Affiliates, successors and permitted assigns shall be deemed an intended beneficiary hereunder or have any right to enforce any obligation of this Agreement.

11.16 No Strict Construction. This Agreement has been prepared jointly and shall not be strictly construed against either Party.

11.17 English Language. The English language version of this Agreement shall be controlling on both Parties. All information, documents, reports, notices and communications to be provided by one Party to the other Party hereunder shall be provided in the English language.

11.18 Rights and Remedies Cumulative, Certain Remedies, etc.

(a) The enumeration of certain rights and remedies set forth in this Agreement is not intended to be to the exclusion of other applicable remedies, and the exercise by a Party of any specified right or remedy shall not preclude the exercise of any other applicable rights or remedies under the Agreement or that may now or hereafter exist at law or in equity. No delay or failure to take action on the part of a Party in exercising any right or remedy shall operate or be construed as a waiver thereof, nor shall any single or partial exercise of any such right or remedy preclude other or further exercise thereof or of any other right or

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remedy.

(b) Each Party acknowledges and agrees that the other Party may be irreparably damaged if any of the provisions of this Agreement (other than provisions involving the payment of money) are not performed by a Party in accordance with their specific terms, and that any breach of, or failure to perform or comply with, this Agreement by a Party may not be adequately compensated in all cases by monetary damages alone. Accordingly, in addition to any other right or remedy to which a Non-Breaching Party may be entitled at law or in equity, it shall be entitled to enforce any provision of this Agreement (other than provisions involving the payment of money) by a decree of specific performance and to temporary, preliminary and permanent injunctive relief to prevent breaches or threatened breaches of any of the provisions of this Agreement, without posting any bond or other undertaking.

(c) If any legal action or other legal proceeding is brought by a Party for the enforcement of this Agreement (including without limitation pursuant to Section 11.18(b)), or to recover damages or other applicable remedy based on the alleged dispute, breach or default in connection with the provisions of this Agreement, the successful or prevailing Party as to any specific and separable issue in such action or proceeding (in a final decision by the applicable court action or other legal proceeding, or by settlement or otherwise) shall be entitled to recover reasonable attorneys’ fees and other reasonable costs and expenses incurred in enforcing the specific obligation of the other Party under this Agreement that was the basis for such specific issue in such action or proceeding, in addition to any other relief to which it may be entitled, and such Party shall be entitled to offset such reasonable fees, costs and expenses (to the extent such amounts are determined to be awarded under this subsection (c) by a judgment in such action or proceeding) against any amounts payable to the other Party under this Agreement.

(d) Each Party shall be entitled to offset, against amounts payable to the other Party under this Agreement, any amounts of damages determined, in a final decision by the applicable court action or other legal proceeding, to be owed to such Party by the other Party based on the other Party’s breach or non-performance of its obligations under this Agreement.

(e) If the breach or non-performance by a Party of certain of its obligations under this Agreement causes the other Party to be unable to perform certain of its obligations under this Agreement, then such other Party shall not be obligated to perform such obligations that are prevented by such breach, until such breach is cured, but such other Party shall remain obligated to perform all its other obligations that are not affected by such breach, and shall immediately commence performing the affected obligations as soon as such breach is cured, or such Party otherwise is able to perform the obligation.

[Signature Page Immediately Follows]

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IN WITNESS WHEREOF, duly authorized representatives of the Parties have duly executed this Agreement as of the Effective Date.

FAES FARMA, S.A.
By:	/s/ Eduardo Fernández de Valderrama y Murillo
Name:	Eduardo Fernández de Valderrama y Murillo
Title:	Chairman and CEO
INSPIRE PHARMACEUTICALS, INC.
By:	/s/ Christy L. Shaffer
Name:	Christy L. Shaffer, Ph.D.
Title:	President & Chief Executive Officer

SIGNATURE PAGE TO LICENSE AGREEMENT

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

Schedule 1.20

Faes Licensed Patents

Bilastine: First patent

New benzimidaloze derivatives with antihistaminic activity

Country	Number	Application	Granted
Spain	9601236	04-06-96	16-06-99
Europe	0818454	03-06-97	14-04-04
Argentine	P-970102441	05-06-97
Australia	725700	02-06-97	01-02-01
Brazil	PI9703276.0	04-06-97
Canadá	2.206.754	03-06-97
Colombia	97030697	03-06-97
South Korea	0494448	04-06-97	01-06-05
Croacia	P970307	03-06-97	07-01-02
CzecRepublic	289278	04-06-97	23-10-01
Chile	40.509	03-06-97	22-05-00
China	ZL 97114905.4	04-06-97	16-04-03
USA.	5.877.187	04-06-97	02-03-99
Hungary	P-9700997	04-06-97
India	186.319	04-06-97	08-03-02
	1066/Del/2000*	28-11-00
	1067/Del/2000*	28-11-00
	1068/Del/2000*	28-11-00
	1069/Del/2000*	28-11-00
	1070/Del/2000*	28-11-00
	1071/Del/2000*	28-11-00
Japan	09-162010	04-06-97
Mexico	944127	04-06-97
Norway	313195	03-06-97	26-08-02
Pakistan	135858	03-06-97	03-10-99
Poland	188908	04-06-97	01-06-05
Russia	2182150	03-06-97	10-05-02
South Africa	97/4893	03-06-97	25-03-98
Taiwan	135814	22-07-97	30-10-01
Turkey	TR 1997 00464 B	04-06-97	21-10-02
Venezuela	1053-97	04-06-97

*: Divisional. Patent

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

Patente Polimorfos BILASTINA:

Bilastine: Polymorph patent

4-[2-[4-[1-(2-Ethoxyethyl)-1H-benzimidazol-2-yl]-1-piperidinyl]ethyl]-a,a-dimethyl-benzeneacetic acid polymorph.

PCT patent application

PAIS	NUMERO	SOLICITUD	CONCESION
Patente PCT	PCT/ES02/00194	19-04-02
Argentine	P030101325	14-04-03
Chile	0758-2003	14-04-03
Guatemala	PI-2003-0092	24-04-03
Honduras	PI-US2003/119	11-04-03
Panamá	85712	16-04-03	13-10-04
Pakistan	332/2003	17-04-03
Perú	00376-2003/OIN	14-04-03
Uruguay	27762	14-04-03
Venezuela	2003-000623	22-04-03
Europe	02 724 323.7	19-04-02(1)
Australia	2002255017	18-11-04
Belorussia	20041053	17-11-04
Brazil	PI 0215703-9	18-10-04
Bulgaria	108941	19-04-02(6)
Canadá	2.484.460	18-10-04
Colombia	04-114046	11-11-04
South Korea	2004-7016676	18-10-04
Croacia	P20041048A	09-11-04
Czec Republic	PV2004-1122	19-04-02(4)
China	02828987.0	19-04-02(5)
Ecuador	04-5415	08-11-04
USA	10/511,822	19-10-04
Slovakia	PV5020-2004S	19-04-02
Hungary		19-11-04
India	1735/KOLNP/2004	19-04-02(4)
Israel	164645	19-04-02(2)
Japan	2003-586146	16-11-04
Mexico	PA/a/2004/010313	19-04-02(3)
Norway	20044999	17-11-04
New Zealand	536551	19-04-02(8)
Poland	P-372982	22-02-05
Russia	2004133813	19-04-02(6)
South Africa	2004/9217	17-11-04	22-02-06
Ukraine	UA 20041109444	19-04-02(7)

As of the Effective Date, Faes owns all right, title and interest in and to all of the patents and patent applications set forth in this Schedule 1.20.

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

Schedule 4.2(a)

QT Study Results Guidelines

If the results of the Definitive QT Study show:

(a) an increase in QTc interval of [CONFIDENTIAL] and Inspire shall pay the milestone payment under Section 4.2(a);

(b) an increase in QTc interval of [CONFIDENTIAL] Inspire shall pay the milestone payment under Section 4.2(a).

If the results of the QT Study show an increase in QTc interval of [CONFIDENTIAL].

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

Schedule 5.4

Minimum Royalties

Minimum Royalty Period	Required Minimum Royalty for Period
First Minimum Royalty Period	[CONFIDENTIAL]
Second Minimum Royalty Period	[CONFIDENTIAL]
Third Minimum Royalty Period	[CONFIDENTIAL]
Fourth Minimum Royalty Period	[CONFIDENTIAL]
Fifth Minimum Royalty Period	[CONFIDENTIAL]
Sixth Minimum Royalty Period	[CONFIDENTIAL]
Seventh Minimum Royalty Period	[CONFIDENTIAL]
Eighth Minimum Royalty Period	[CONFIDENTIAL]
Ninth Minimum Royalty Period	[CONFIDENTIAL]
Tenth Minimum Royalty Period	[CONFIDENTIAL]]
Eleventh and each subsequent Minimum Royalty Period (for so long as royalties are owed on Principal Rx Products)	[C.I.] of the Minimum Royalty owed for the last most recent Minimum Royalty Period

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EX-10.45

Exhibit 10.45

LOAN AND SECURITY AGREEMENT

THIS LOAN AND SECURITY AGREEMENT (the “Agreement”) dated as of December 22, 2006 by and among MERRILL LYNCH CAPITAL, a division of Merrill Lynch Business Financial Services Inc. (“Merrill Lynch”), SILICON VALLEY BANK (“SVB”) (SVB and Merrill Lynch each individually a “Lender”, and collectively the “Lenders”), SVB in its capacity as agent for the Lenders (in such capacity, “Agent”), SVB and Merrill Lynch in their capacities as joint lead arrangers (in such capacity, the “Arrangers”), and INSPIRE PHARMACEUTICALS, INC., a corporation organized and in good standing under the laws of the State of Delaware (“Borrower”), provides the terms on which Lenders shall lend to Borrower and Borrower shall repay Lenders. The parties agree as follows:

1. ACCOUNTING AND OTHER TERMS

Accounting terms not defined in this Agreement shall be construed following GAAP. Calculations and determinations must be made following GAAP. The term “financial statements” includes the notes and schedules. The terms “including” and “includes” always mean “including (or includes) without limitation,” in this or any Loan Document. Capitalized terms in this Agreement shall have the meanings as set forth in Section 13. All other terms contained in this Agreement, unless otherwise indicated, shall have the meanings provided by the Code, to the extent such terms are defined therein.

2. LOANS AND TERMS OF PAYMENT

2.1 Promise to Pay.

Borrower hereby unconditionally promises to pay Lenders the unpaid principal amount of all Term Loan Advances hereunder with all interest, fees and finance charges due thereon as and when due in accordance with this Agreement.

2.1.1 Term Loan Facility.

(a) Availability. Subject to the terms and conditions of this Agreement, Lenders agree, severally and not jointly, to lend to Borrower, prior to the expiration of the Draw Period, advances (each a “Term Loan Advance” and collectively, the “Term Loan Advances”) in an aggregate amount equal to the Term Loan Commitment according to each Lender’s pro rata share of the Term Loan Commitment (based upon the respective Commitment Percentage of each Lender). The first Term Loan Advance shall be made on the Closing Date, and shall be in the amount of Twenty Million Dollars ($20,000,000) (the “Closing Date Advance”). Subject to the following sentence, the balance of the Term Loan Commitment shall be available during the Draw Period if at the time of the request for each such Term Loan Advance (i) no Default or Event of Default has occurred and is continuing and (ii) Borrower has satisfied the Draw Conditions. In the event Borrower satisfies the Draw Conditions solely by virtue of satisfying the R&D Condition, then Borrower may only request additional Term Loan Advances in an amount equal to the cumulative cash payments made by Borrower with respect to the R&D Condition, which exceed Twenty Million Dollars ($20,000,000). Each Term Loan Advance shall be in a minimum amount of One Million Dollars ($1,000,000). When repaid, a Term Loan Advance may not be re-borrowed.

(b) Borrowing Procedure. To obtain a Term Loan Advance, unless otherwise agreed by Agent and Lenders, Borrower must notify Agent by facsimile by 12:00 p.m. Eastern Time three (3) Business Days prior to the date the Term Loan Advance is to be made by delivering to Agent a completed Payment/Advance Form signed by two Responsible Officers in the form attached as Exhibit B (a “Payment Advance Form”). On the Funding Date, each Lender shall credit and/or transfer (as applicable) to Borrower’s deposit account with SVB, an amount equal to its Commitment Percentage multiplied by the amount of the Term Loan Advance. Each Lender may make the Term Loan Advance under this Agreement based on instructions from a Responsible Officer or his or her designee or without instructions if the Term Loan Advance is necessary to meet Obligations which have become due. Each Lender may rely on any facsimile notice given by a person whom such Lender believes is a Responsible Officer or designee. Borrower shall indemnify each Lender and Agent for any loss Lender or Agent suffers due to such reliance.

2.2 Termination of Commitment to Lend.

Without limiting Lenders’ other rights hereunder, each Lender’s obligation to lend the undisbursed portion of the Term Loan Commitment shall terminate if, in such Lender’s good faith business judgment, there has been a Material Adverse Change.

2.3 Repayment of Credit Extensions.

(a) Principal and Interest Payments on Payment Dates.

(i) Each Term Loan Advance is payable in monthly installments of interest only for six (6) months, commencing on the first (1^st) Business Day of the first month after the Funding Date and continuing on the first (1^st ) Business Day of each month thereafter (each a “Payment Date”) until the Conversion Date. Commencing on the seventh (7^th) month after each Funding Date (the “Conversion Date”), on each Payment Date, Borrower shall repay the unpaid principal amount of each Term Loan Advance in equal monthly payments of principal and interest which would fully amortize the amount of such Term Loan Advance from the Conversion Date until the Maturity Date at the applicable Basic Rate. All unpaid principal and accrued interest is due and payable in full on the Maturity Date. A Term Loan Advance may only be prepaid in accordance with Sections 2.3(d) and 2.3(e).

(ii) Payments received after 12:00 noon Eastern Time are considered received at the opening of business on the next Business Day.

(b) Interest Rate.

(i) Borrower shall pay interest on each Payment Date on the unpaid principal amount of each Term Loan Advance until the Term Loan Advance has been paid in full, at the per annum rate of interest equal to the Basic Rate determined by Agent as of the Funding Date for each Term Loan Advance in accordance with the definition of the Basic Rate. Interest is computed on the basis of a 360 day year for the actual number of days elapsed.

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(ii) Any amounts outstanding during the continuance of an Event of Default shall bear interest at a per annum rate equal to three percent (3%) above the highest interest rate otherwise applicable thereto (the “Default Rate”).

(iii) In no event shall the interest charged hereunder, with respect to the notes (if any) or any other obligations of Borrower under any Loan Documents exceed the maximum amount permitted under the laws of the State of New York or of any other applicable jurisdiction. Notwithstanding anything to the contrary herein or elsewhere, if at any time the rate of interest payable hereunder or under any note or other Loan Document (the “Stated Rate”) would exceed the highest rate of interest permitted under any applicable law to be charged (the “Maximum Lawful Rate”), then for so long as the Maximum Lawful Rate would be so exceeded, the rate of interest payable shall be equal to the Maximum Lawful Rate; provided, however, that if at any time thereafter the Stated Rate is less than the Maximum Lawful Rate, Borrower shall, to the extent permitted by law, continue to pay interest at the Maximum Lawful Rate until such time as the total interest received is equal to the total interest which would have been received had the Stated Rate been (but for the operation of this provision) the interest rate payable. Thereafter, the interest rate payable shall be the Stated Rate unless and until the Stated Rate again would exceed the Maximum Lawful Rate, in which event this provision shall again apply. In no event shall the total interest received by any Lender exceed the amount which it could lawfully have received had the interest been calculated for the full term hereof at the Maximum Lawful Rate. If, notwithstanding the prior sentence, any Lender has received interest hereunder in excess of the Maximum Lawful Rate, such excess amount shall be applied to the reduction of the principal balance of the Loans or to other amounts (other than interest) payable hereunder, and if no such principal or other amounts are then outstanding, such excess or part thereof remaining shall be paid to Borrower. In computing interest payable with reference to the Maximum Lawful Rate applicable to any Lender, such interest shall be calculated at a daily rate equal to the Maximum Lawful Rate divided by the number of days in the year in which such calculation is made.

(c) Final Payment. On the Maturity Date or at the time of any mandatory or permitted prepayment of any Term Loan Advance, Borrower shall pay, in addition to the unpaid principal and accrued interest and all other amounts due on such date with respect to such Term Loan Advance, an amount equal to the Final Payment.

(d) Mandatory Prepayment upon an Acceleration. If the Term Loan is accelerated following the occurrence of an Event of Default or otherwise, Borrower shall immediately pay to Lenders an amount equal to the sum of: (i) all payments of principal plus accrued interest due and owing on such date and not yet paid, plus (ii) all remaining payments of principal, plus (iii) the Final Payment, plus (iv) all other sums, if any, that shall have become due and payable, including interest at the Default Rate with respect to any past due amounts.

(e) Permitted Prepayment of Loans. Borrower shall have the option to prepay Term Loan Advances in whole or in part from time to time advanced by any Lender under this Agreement, without penalty or premium, in minimum incremental amounts of One Million Dollars ($1,000,000), provided Borrower (i) provides written notice to Agent of its election to prepay Term Loan Advances at least fifteen (15) days prior to such prepayment, and (ii) pays, on the date of such prepayment (A) the principal amount of such prepayment, plus

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accrued interest due and owing thereon on such date, plus (B) the Final Payment, plus (C) all other sums, if any, that shall have become due and payable, including interest at the Default Rate with respect to any past due amounts.

(f) Debit of Accounts. After the occurrence and during the continuance of a Default, Agent may debit any of Borrower’s deposit accounts including Account Number                      maintained with SVB for principal and interest payments or any amounts Borrower owes Agent or Lenders which have not been paid as and when due, including any grace period. Agent will promptly notify Borrower when it debits Borrower’s accounts.

(g) Payments. All payments to be made by Borrower hereunder or under any other Loan Document, including payments of principal and interest made hereunder and pursuant to any other Loan Document, and all fees, expenses, indemnities and reimbursements, shall be made without set-off; recoupment or counterclaim, in lawful money of the United States and in immediately available funds.

2.4 Fees.

Borrower will pay to Agent:

(a) Commitment Fee. A fully earned, non-refundable commitment fee as provided in the Commitment Letter.

(b) Final Payment. One or more Final Payments, as provided in Sections 2.3(c), (d) and (e) when due.

(c) Agent Expenses. All Agent and Lenders’ Expenses (including reasonable attorneys’ fees and reasonable expenses) incurred through and after the Closing Date, when due in accordance with the Commitment Letter.

(d) Unused Commitment Fee. On the day the Draw Period expires, Borrower shall pay to Agent for the ratable benefit of the Lenders, a fee (the “Unused Facility Fee”), in an amount equal to one percent (1.00%) of the unused portion of the Term Loan Commitment, as determined by Agent.

(e) Good Faith Deposit. A good faith deposit of Twenty Thousand Dollars ($20,000), which has already been paid to Agent by Borrower and will be applied against Agent Expenses and Lenders’ Expenses. Any portion of the deposit not utilized to pay Agent Expenses and Lender Expenses will be refunded to Borrower.

2.5 Additional Costs.

If any new law or regulation increases any Lender’s costs or reduces its income for any loan, Borrower shall pay the increase in cost or reduction in income or additional expense; provided, however, that Borrower shall not be liable for any amount attributable to any period before one hundred eighty (180) days prior to the date such Lender notifies Borrower of such increased costs. Each Lender agrees that it shall allocate any increased costs among its customers similarly affected in good faith and in a manner consistent with such Lender’s customary practice.

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3. CONDITIONS OF LOANS

3.1 Conditions Precedent to Closing Date Advance.

The Lenders’ agreement to make the Closing Date Advance is subject to the condition precedent that Agent shall have received, in form and substance satisfactory to Agent, such documents and completion of such other matters, as Agent may reasonably deem necessary or appropriate, including, without limitation, subject to the condition precedent that Agent shall have received in form and substance satisfactory to Agent the following:

(a) This Agreement;

(b) A certificate of the Secretary of Borrower with respect to articles, by-laws, incumbency, specimen signature and corporate resolutions authorizing the execution, delivery and performance of this Agreement;

(c) Perfection Certificate by Borrower;

(d) Intercreditor Agreement between the Lenders;

(e) Financing statement (Form UCC-1);

(f) Deposit Account Control Agreements/Securities Account Control Agreements (SVB and other financial institutions);

(g) Evidence of insurance;

(h) Payment of the fees and Agent Expenses and Lenders’ Expenses then due specified in Section 2.4 hereof;

(i) Certificate of Foreign Qualification from the State of North Carolina;

(j) Certificate of Good Standing from the State of Delaware;

(k) Legal opinion issued to Agent and Lenders by counsel to Borrower, in form and substance satisfactory to Agent; and

(l) Such other documents, and completion of such other matters, as Agent may reasonably deem necessary or appropriate.

3.2 Conditions Precedent to all Term Loan Advances.

The obligations of Lenders to make each Term Loan Advance, including the Closing Date Advance, is subject to the following:

(a) Satisfaction of the provisions of Section 3.1;

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(b) Timely receipt of any Payment/Advance Form; and

(c) The representations and warranties in Section 5 shall be true, correct and complete in all material respects on the date of the Payment/Advance Form and on the effective date of each Term Loan Advance; provided, that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all respects as of that date, and no Event of Default shall have occurred and be continuing, or result from the Term Loan Advance. Each Credit Extension is Borrower’s representation and warranty on that date that the representations and warranties in Section 5 remain true in all material respects.

4. CREATION OR SECURITY INTEREST

4.1 Grant of Security Interest.

Borrower hereby grants Agent, for the ratable benefit of the Lenders, and to each Lender, to secure the payment and performance in full of all of the Obligations and the performance of each of Borrower’s duties under the Loan Documents, a continuing security interest in, and pledges and assigns to Agent, for the ratable benefit of the Lenders, and to each Lender the Collateral, wherever located, whether now owned or hereafter acquired or arising, and all proceeds and products thereof. Borrower warrants and represents that the security interest granted herein shall be a first priority security interest in the Collateral, subject only to Permitted Liens.

Except as noted on Borrower’s Perfection Certificate, Borrower is not a party to, nor is bound by, any material license or other similar agreement with respect to which Borrower is the licensee that prohibits or otherwise restricts Borrower from granting a security interest in Borrower’s interest in such license or agreement or any other property. If Borrower enters into any license or agreement that is reasonably likely to have a material impact on Borrower’s business or financial condition and such license or agreement prohibits or otherwise restricts Borrower from granting a security interest in Borrower’s interest in such license or agreement or any other property, Borrower will request the prior written consent of Agent with respect to Borrower’s entry into such license or agreement, which consent will not be unreasonably withheld; provided, however, if such license or agreement contains assignment terms or provisions which are materially consistent with (or less restrictive with respect to the prohibition on assignments than) the terms set forth in Bilastine License Agreement or the Allergan Contract, Borrower shall not be required to first obtain Agent’s consent to Borrower’s entry into such license or agreement, but will provide Agent with prompt notice of such license or agreement and provide Agent with a copy thereof. If such licenses or other agreements meet the definition of Collateral set forth in Section 13 of this Agreement, Borrower shall take such steps as Agent reasonably requests to obtain the consent of, or waiver by, any Person whose consent or waiver is necessary for such licenses or other agreements to be deemed “Collateral” and for Agent to have a security interest in it that might otherwise be restricted or prohibited by law or by the terms of any such Collateral, whether now existing or entered into in the future.

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Borrower agrees that any disposition of the Collateral in violation of this Agreement, by either Borrower or any other Person, shall be deemed to violate the rights of the Lenders under the Code. If the Agreement is terminated, Lenders’ and Agent’s lien and security interest in the Collateral shall continue until Borrower fully satisfies its Obligations. If Borrower shall at any time, acquire a commercial tort claim (as defined in the Code) or Letter-of-Credit Right, Borrower shall promptly notify Agent in a writing signed by Borrower of the brief details thereof and grant to Agent and Lenders in such writing a security interest therein and in the proceeds thereof, all upon the terms of this Agreement, with such writing to be in form and substance satisfactory to Agent.

4.2 Authorization to File Financing Statements.

Borrower hereby authorizes Agent to file financing statements, without notice to Borrower, with all appropriate jurisdictions, in order to perfect or protect Agent’s and Lenders’ interest or rights hereunder.

5. REPRESENTATIONS AND WARRANTIES

Except as set forth in the Perfection Certificate or any Schedule, Borrower represents and warrants to Agent and each Lender as follows:

5.1 Due Organization and Authorization.

Each of Borrower and its Subsidiaries is duly organized, validly existing and in good standing in its state of incorporation and duly qualified to do business in, and in good standing in, each jurisdiction in which the nature of the business conducted by it or its ownership of property requires that it be qualified, except where the failure to be or do so could not reasonably be expected to cause a Material Adverse Change. In connection with this Agreement, Borrower delivered to Agent a certificate signed by Borrower and entitled “Perfection Certificate”. The Borrower represents and warrants to Agent and each Lender that: (a) Borrower’s exact legal name is that indicated on the Perfection Certificate and on the signature page hereof; (b) Borrower is an organization of the type, and is organized in the jurisdiction, set forth in the Perfection Certificate; (c) the Perfection Certificate accurately sets forth Borrower’s organizational identification number; (d) the Perfection Certificate accurately sets forth Borrower’s place of business where at any time it keeps Collateral having a value in excess of $15,000, or, if more than one, its chief executive office as well as Borrower’s mailing address if different; and (e) all other information set forth on the Perfection Certificate pertaining to Borrower is accurate and complete in all material respects.

The execution, delivery and performance of the Loan Documents have been duly authorized, and do not conflict with Borrower’s organizational documents, nor constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which or by which it is bound, in which the default could reasonably be expected to cause a Material Adverse Change.

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5.2 Collateral.

Borrower has good title to the Collateral, free of Liens except Permitted Liens. Borrower has no deposit account, other than the deposit accounts with Lenders and deposit accounts described in the Perfection Certificate delivered to Agent in connection herewith. The Accounts are bona fide, existing obligations, of the account debtors. The Collateral is not in the possession of any third party bailee (such as a warehouse). Except as hereafter disclosed to the Lenders in writing by Borrower, none of the components of the Collateral shall be maintained at locations other than as provided in the Perfection Certificate. In the event that Borrower, after the date hereof; intends to store or otherwise deliver any portion of the Collateral to a bailee, then Borrower will first receive the written consent of Lenders and such bailee must acknowledge in writing that the bailee is holding such Collateral for the benefit of Agent and Lenders. All Inventory (other than R&D Inventory) is in all material respects of good and marketable quality, free from material defects.

5.3 Accounts Receivable.

Borrower has no knowledge of any actual or imminent Insolvency Proceeding of any Account Debtor whose accounts are an Eligible Account. To the best of Borrower’s knowledge, all signatures and endorsements on all documents, instruments, and agreements relating to all Eligible Accounts are genuine, and all such documents, instruments and agreements are legally enforceable in accordance with their terms.

5.4 Intellectual Property.

Borrower and its Subsidiaries solely own, or have rights to use and otherwise exercise and exploit and license all Intellectual Property necessary or material for use in connection with their respective businesses as currently being conducted. Neither Borrower nor any of its Subsidiaries has received any notice that any current activities of any of them may violate or infringe upon the Patent rights of any Person. Except as set forth on Borrower’s Perfection Certificate, to the knowledge of Borrower, each Patent owned or licensed by Borrower or its Subsidiaries that is necessary or material for use in its business as currently conducted is enforceable and there is no existing and Borrower has no notice (written or otherwise) of any expected infringement (or challenge) by another Person of (or to) any of the Intellectual Property of Borrower or its Subsidiaries that could reasonably be expected to cause a Material Adverse Change. The Perfection Certificate sets forth, as of the Closing Date, (i) all domestic and foreign registered Patents and Patent applications of Borrower and (ii) all domestic and foreign registered and applied for Trademarks, trade names and service marks of Borrower. Borrower has no domestic or foreign Copyrights or Copyright registrations, nor does Borrower use any material unregistered Copyrights in the ordinary course of its business.

5.5 Litigation.

Except as shown in the Perfection Certificate, there are no actions or proceedings pending or, to the knowledge of Borrower, threatened by or against Borrower or any Subsidiary in which an adverse decision could reasonably be expected to cause a Material Adverse Change.

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5.6 No Material Deterioration in Financial Statements.

All consolidated financial statements for Borrower and its Subsidiaries, delivered to Agent were prepared in accordance with GAAP consistently applied during the periods involved (except in the case of unaudited interim statements, to the extent that they may not include footnotes, may be condensed or summary statements or may conform to the SEC’s rules and instructions for Reports on Form 10-Q) and fairly present in all material respects Borrower’s consolidated financial condition as of the dates thereof and Borrower’s consolidated results of operations and cash flows for the periods then ended (subject, in the case of unaudited statements, to normal year-end adjustments). There has not been any material deterioration in Borrower’s consolidated financial condition since the date of the most recent financial statements submitted to Agent.

5.7 Solvency.

Based on the financial condition of Borrower: (a) the fair salable value of Borrower’s assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; (b) Borrower will have reasonably adequate capital after the consummation of the transactions in this Agreement; and (c) Borrower is able to pay its debts (including trade debts) as they mature.

5.8 Regulatory Compliance.

Borrower is not an “investment company” or a company “controlled” by an “investment company”, or a “subsidiary” of an “investment company” under the Investment Company Act of 1940. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Borrower has not violated any Laws, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower’s or any Subsidiary’s properties or assets has been used by Borrower or any Subsidiary or, to Borrower’s knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each Subsidiary has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP. Borrower and each Subsidiary has obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all Government Authorities that are necessary to continue its business as currently conducted, except where the failure to do so would not reasonably be expected to cause a Material Adverse Change.

Neither Borrower, nor to the knowledge of Borrower, any of its Affiliates or agents acting on behalf of Borrower in any capacity in connection with the transactions contemplated by this Agreement is (a) in violation of any Anti-Terrorism Law, (b) engages in or conspires to engage in any transaction that evades or avoids, or has the purpose of evading or avoiding, or attempts to violate, any of the prohibitions set forth in any Anti-Terrorism Law, or (c) is a Blocked Person. Neither Borrower nor; to the knowledge of Borrower, any of its Affiliates or agents acting on behalf of Borrower in any capacity in connection with the transactions contemplated by this Agreement, (x) conducts any business or engages in making or receiving

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any contribution of funds, goods or services to or for the benefit of any Blocked Person, or (y) deals in, or otherwise engages in any transaction relating to, any property or interest in property blocked pursuant to Executive Order No. 13224, any similar executive order or other Anti-Terrorism Law.

5.9 Subsidiaries.

Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments. In the event Borrower creates any Subsidiary after the Closing Date, upon request of Agent, Borrower shall cause such Subsidiary to execute and deliver to Agent for the benefit of the Lenders, in a form reasonably acceptable unconditional guaranty on Agent’s customary form, together with such additional documents as Agent may reasonably require in connection therewith.

5.10 Full Disclosure.

No written representation, warranty or other statement of Borrower in any certificate or written statement given to Agent or any Lender (taken together with all such written certificates and written statements given to Agent or any Lender) contains any untrue statement of a material fact or omits to state a material fact necessary to make any representation, warranty or other statement contained in the certificates or written statements, in light of the circumstances under which they were made, not misleading as of the date such written representation, warranty or other statement was made, it being recognized by Agent and Lenders that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected or forecasted results.

6. AFFIRMATIVE COVENANTS

Borrower shall do all of the following for so long as Agent or any Lender has an obligation to make any Term Loan Advance, or there are outstanding Obligations:

6.1 Government Compliance.

Borrower shall maintain its and any Subsidiary’s legal existence and good standing as a Registered Organization and maintain qualification in each jurisdiction in which the failure to so qualify would reasonably be expected to have a material adverse effect on Borrower’s business or operations. Borrower shall comply, and have each Subsidiary comply, with all Laws to which it is subject, noncompliance with which could have a material adverse effect on Borrower’s business or operations or would reasonably be expected to cause a Material Adverse Change.

6.2 Financial Statements, Reports, Certificates.

(a) Borrower shall deliver to Agent: (i) as soon as available, but no later than thirty (30) days after the last day of each month, a Borrower prepared unaudited consolidated and consolidating financial statements, consisting of a balance sheet and income statement covering Borrower’s consolidated operations for the monthly period ending the last day of such month, together with a Compliance Certificate signed by a Responsible Officer in

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the form of Exhibit C or in a form reasonably acceptable to Agent; (ii) as soon as available, but no later than one hundred twenty (120) days after the last day of Borrower’s fiscal year, or within five (5) days of filing with the SEC, if earlier, audited consolidated and consolidating financial statements prepared under (GAAP, consistently applied, together with the unqualified report of an independent registered accounting firm with respect to Borrower’s financial statements issued in connection therewith; (iii) within five (5) days of filing, copies of all reports on Form 10-K Form 10-Q and Form 8-K filed with the SEC; (iv) Borrower’s annual budget approved by Borrower’s board of directors for each fiscal year not later than thirty (30) after such approval; (v) all material revisions to Borrower’s financial projections and business plans within thirty (30) days after such revisions; (vi) prompt written notice of any material revisions, amendments to, or notices received under, the Bilastine License or the Allergan Contract (subject to confidentiality restrictions contained in the Bilastine License or the Allergan Contract); and (vii) other financial information reasonably requested by Agent. Borrower may comply with the delivery requirements of clauses (ii) and (iii) above by maintaining an electronic link to its SEC reports on Borrower’s website.

(b) Borrower will keep proper books of record and accounts in accordance with GAAP in which full, true and correct entries shall be made of all material dealings and transactions in relation to its business and activities. Borrower shall allow, at the sole cost of Borrower (except as provided below), Agent to visit and inspect any of its properties, to examine and make abstracts or copies from any of their respective books and records, to conduct a collateral audit and analysis of its operations and the Collateral, to verify the amount and age of the accounts, the identity and credit of the respective account debtors, to review the billing practices of Borrower and to discuss its respective affairs, finances and accounts with their respective officers, employees and independent public accountants as often as may reasonably be requested. Notwithstanding the foregoing, (i) such audits shall be conducted at Agent’s expense if Covenant Level One is in effect and (ii) at all other times, such audits shall be conducted at Borrower’s expense (not to exceed $10,000 per audit) which prior to the occurrence and continuance of an Event of Default may not be conducted more often than once every twelve (12) months.

(c)(i) Borrower will give prompt written notice to Agent of any litigation or governmental proceedings pending or threatened (in writing) against Borrower which would reasonably be expected to result in a Material Adverse Change with respect to Borrower; (ii) without limiting or contradicting any other more specific provision of this Agreement, promptly (and in any event within three (3) Business Days) upon Borrower becoming aware of the existence of any Event of Default or event which, with the giving of notice or passage of time, or both, would constitute an Event of Default, Borrower shall give written notice to Agent of such occurrence, which such notice shall include a reasonably detailed description of such Event of Default or event which, with the giving of notice or passage of time, or both, would constitute an Event of Default.

6.3 Inventory; Returns.

Borrower shall keep all Inventory (other than R&D Inventory) in good and marketable condition, free from material defects. Returns and allowances between Borrower and its account debtors shall follow Borrower’s customary practices as they exist at the Closing Date. Borrower

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must promptly notify Agent of all returns, recoveries, disputes and claims with respect to Borrower’s Inventory, outside of the ordinary course of business, that involve more than One Hundred Thousand Dollars ($100,000).

6.4 Taxes.

Borrower shall make, and cause each Subsidiary to make, timely payment of all material federal, state, and local taxes or assessments (other than taxes and assessments which Borrower is contesting in good faith, with adequate reserves maintained in accordance with GAAP) and will deliver to Agent, on demand, appropriate certificates attesting to such payments.

6.5 Insurance.

Borrower shall keep its business and the Collateral insured for risks and in amounts, customary for similarly situated companies in Borrower’s industry as Lenders and Agent may reasonably request. Insurance policies shall be in a form, with companies, and in amounts that are satisfactory to Agent in Agent’s reasonable discretion. All property policies shall have a lenders’ loss payable endorsement showing each Lender as an additional loss payee and all of Borrower’s liability policies (other than officer and directors liability coverage and those liability policies which neither Agent nor the Lenders can have an insurable interest in) shall show the Lenders and Agent as an additional insured and all policies shall provide that the insurer must give Agent on behalf of Lenders (unless otherwise agreed to by Agent) at least twenty (20) days notice before canceling its policy. At Agent’s request, Borrower shall deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy shall, at Agent’s option, be payable to Agent on behalf of Lenders on account of the Obligations. Notwithstanding the foregoing, so long as no Event of Default has occurred and is continuing, Borrower shall have the option of applying the proceeds of any casualty policy toward the replacement or repair of destroyed or damaged property provided that (i) such replaced or repaired property (a) shall be of equal or like value as the replaced or repaired Collateral, and (b) shall be deemed Collateral in which Agent has been granted a first priority security interest pursuant to the terms hereunder.

6.6 Primary Accounts.

(a) In order to permit Agent to monitor Borrower’s financial performance and condition, Borrower, and all Borrower’s Subsidiaries, shall maintain Borrower’s, and such Subsidiaries’, primary depository and operating accounts and securities accounts with SVB or SVB’s Affiliates, which accounts shall represent at least (i) forty percent (40%) of Borrower’s unrestricted cash, cash equivalents and marketable securities (“Cash Balances”) held at any financial institution when Borrower’s total cash and investments is greater than or equal to One Hundred Million Dollars ($100,000,000), (ii) fifty percent (50%) of Borrower’s Cash Balances held at any financial institution when Borrower’s total cash and investments is greater than or equal to Eighty Million Dollars ($80,000,000) but less than One Hundred Million Dollars ($100,000,000), (iii) fifty seven percent (57%) of Borrower’s Cash Balances held at any financial institution when Borrower’s total cash and investments is greater than Seventy Million Dollars ($70,000,000) but less than Eighty Million Dollars ($80,000,000), (iv) sixty-five percent (65%) of Borrower’s Cash Balances held at any financial institution when

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Borrower’s total cash and investments is greater than or equal to Sixty Million Dollars ($60,000,000), but less than Seventy Million Dollars ($70,000,000), and (v) sixty-five percent (65%) of Borrower’s Cash Balances held at any financial institution when Borrower’s total cash and investments is less than Sixty Million Dollars ($60,000,000).

(b) Borrower shall identify to Agent, in writing, any bank or securities account opened by Borrower or any Guarantor with any institution other than Agent. In addition, for each such account that Borrower or any Guarantor at any time opens or maintains, Borrower shall, at Agent’s request, cause the depository bank or securities intermediary to agree that such account is the Collateral of Agent, on behalf of Lenders, pursuant to the terms of a control agreement in form and substance reasonably acceptable to the Lenders, Agent and such depository bank or securities intermediary. The provisions of the previous sentence shall not apply to deposit accounts exclusively used for payroll, payroll taxes and other employee wage and benefit payments to or for the benefit of Borrower’s employees.

6.7 Registration of Intellectual Property Rights.

Borrower shall with respect to all Intellectual Property owned by Borrower or licensed by Borrower and pursuant to which Borrower has “step-in” rights: (i) protect, defend and maintain the validity and enforceability of the Intellectual Property material to Borrower’s business; (ii) promptly advise Lenders in writing of material infringements of the Intellectual Property; and (iii) not allow any Intellectual Property material to Borrower’s business to be abandoned, forfeited or dedicated to the public without Lenders’ written consent;

6.8 Financial Covenant.

Borrower shall maintain at all times, minimum Liquidity of not less than 1.35 times the outstanding Term Loan Advances.

6.9 Use of Proceeds.

Borrower shall use the Term Loan to fund the payments under the in-license by Borrower of Bilastine, the in-license of other drugs, for further drug development, working capital needs and to fund its general business requirements. No portion of the Term Loan will be used for personal, family, agricultural or household use.

6.10 Notice of Management Change.

Borrower shall notify Agent of the separation of any of the following parties from employment at Borrower within ten (10) days of such separation: any “officer” as defined in Rule 16a-1(f) promulgated under the Securities Exchange Act of 1934, as amended.

6.11 Public Company, Ownership.

Borrower shall be and remain until the Obligations are repaid in full, a company whose equity securities are registered and traded on a public stock exchange.

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6.12 Further Assurances.

Borrower shall execute any further documents, instruments and agreements and take further action as Agent reasonably requests to perfect or continue Agent’s for the benefit of Lenders security interest in the Collateral or to effect the purposes of this Agreement.

7. NEGATIVE COVENANTS

Borrower shall not do any of the following without Agent’s prior written consent for so long as Agent or any Lender has an obligation to make Term Loan Advances or there are any outstanding Obligations:

7.1 Dispositions.

Convey, sell, lease, transfer or otherwise dispose of (collectively a “Transfer”), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, except for Transfers (a) of Inventory (other than R&D Inventory) in the ordinary course of business; (b) of non-exclusive licenses, “grant-back” licenses and assignments and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business and licenses Borrower may now or hereafter be obligated to grant pursuant to licenses and agreements to which Borrower is a party as of the Closing Date and which have been disclosed on the Perfection Certificate; (c) of worn-out or obsolete Equipment; (d) related to the out-licensing by Borrower of its intellectual property relating to INS50589 antiplatelet compound for acute cardiac care, INS37217 respiratory for the treatment of cystic fibrosis or BB Inhalation Delivery Technology acquired by Borrower pursuant to an exclusive license agreement dated August 22, 2000 among Borrower, University College Cardiff Consultants Limited, and Cardiff Scintigraphics Limited; and (e) in connection with Permitted Liens and Permitted Investments.

7.2 Changes in Business, Ownership, Management or Locations of Collateral.

Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower or reasonably related thereto, or consummate any offering of equity securities, whether in a single transaction or a series of related transactions, following which the shareholders of Borrower who were shareholders immediately preceding such securities offering would, on a fully diluted basis, beneficially own less than fifty percent (50%) of the common stock of Borrower immediately after giving effect to such transaction or transactions. Borrower shall not, without at least thirty (30) days prior written notice to Agent: (a) relocate its chief executive office, or add any new offices or business locations, including warehouses (unless such new offices or business locations contain less than One Hundred Thousand Dollars ($100,000) in Borrower’s assets or property), or (b) change its jurisdiction of organization, or (c) change its status as a registered organization (within the meaning of the Code) in the State of Delaware, or (d) change its legal name, or (e) change any organizational number (if any) assigned by its jurisdiction of organization.

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7.3 Mergers or Acquisitions.

Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person, or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person, except where (a) no Default or Event of Default has occurred and is continuing or would result from such action during the term of this Agreement; (b) Borrower is the surviving entity after such transaction is consummated (to the extent Borrower was a party thereto); and (c) no material adverse change in financial position or outlook of the combined entity is reasonably likely to result. A Subsidiary may merge or consolidate into another Subsidiary or into Borrower.

7.4 Indebtedness.

Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary to do so, other than Permitted Indebtedness.

7.5 Encumbrance.

Create, incur, or allow any Lien on any of its property, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, or permit any Collateral not to be subject to the first priority security interest granted herein, except that the Collateral may be subject to Permitted Liens. In addition, except as permitted by Section 7.1 of this Agreement, Borrower shall not sell, transfer, assign, mortgage, pledge, lease, grant a security interest in, or encumber, or enter into any agreement, document, instrument or other arrangement (except with or in favor of Agent and Lenders) with any Person which directly or indirectly prohibits or has the effect of prohibiting Borrower from selling, transferring, assigning, mortgaging, pledging, leasing, granting a security interest in or upon, or encumbering any of Borrower’s Intellectual Property.

7.6 Distributions; Investments.

(i) Directly or indirectly acquire or own any Person, or make any Investment in any Person, other than Permitted Investments, or permit any of its Subsidiaries to do so; or (ii) pay any dividends, distributions, rentals and management fees to Affiliates, or make any distribution or payment or redeem, retire or purchase any capital stock.

7.7 Transactions with Affiliates.

Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for (a) transactions that are in the ordinary course of Borrower’s business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm’s length transaction with a non-affiliated Person, and (b) transactions with Subsidiaries not otherwise prohibited hereunder, including Permitted Investments in Subsidiaries and Permitted Indebtedness to and from Subsidiaries.

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7.8 Subordinated Debt.

Make or permit any payment on any Subordinated Debt except (a) Permitted Payments or (b) under the terms of the Subordinated Debt, or amend any material provision in any document relating to the Subordinated Debt in a manner materially adverse to Lenders.

7.9 Compliance with Anti-Terrorism Laws.

Agent hereby notifies Borrower that pursuant to the requirements of Anti-Terrorism Laws, and Agent’s policies and practices, Agent is required to obtain, verify and record certain information and documentation that identifies Borrower and its principals, which information includes the name and address of Borrower and its principals and such other information that will allow Agent to identify such party in accordance with Anti-Terrorism Laws. Borrower will not, nor will Borrower permit any Subsidiary or Affiliate to, directly or indirectly, knowingly enter into any documents, instruments, agreements or contracts with any Person listed on the OFAC Lists. Borrower shall immediately notify Agent if Borrower has knowledge that Borrower or any Subsidiary or Affiliate is listed on the OFAC Lists or (a) is convicted on, (b) pleads nolo, contendere to, (c) is indicted on, or (d) is arraigned and held over on charges involving money laundering or predicate crimes to money laundering. Borrower will, nor will Borrower permit any Subsidiary or Affiliate to, directly or indirectly, (i) conduct any business or engage in any transaction or dealing with any Blocked Person, including, without limitation, the making or receiving of any contribution of funds, goods or services to or for the benefit of any Blocked Person, (ii) deal in, or otherwise engage in any transaction relating to, any property or interests in property blocked pursuant to Executive Order No. 13224, any similar executive order or other Anti-Terrorism Law, or (iii) engage in or conspire to engage in any transaction that evades or avoids, or has the purpose of evading or avoiding, or attempts to violate, any of the prohibitions set forth in Executive Order No. 13224 or other Anti-Terrorism Law.

7.10 Compliance.

Become an “investment company” or a company controlled by an “investment company,” under the Investment Company Act of 1940 or undertake as one of its important activities extending credit to purchase or carry margin stock, or use the proceeds of any Term Loan Advance for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other Law, if such failure or violation could reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so.

8. EVENTS OF DEFAULT

Any one of the following is an event of default (each an “Event of Default”):

8.1 Payment Default.

Borrower fails to pay any of the Obligations within three (3) Business Days after their due date. During the additional three (3) Business Day period the failure to cure the payment default shall not constitute an Event of Default (but no Credit Extension shall be made during such cure period).

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8.2 Covenant Default.

(a) If Borrower fails to perform any obligation under Sections 6.2(a)(ii), 6.2(b), 6.2(c), 6.6, 6.8 or 6.9 or violates any of the covenants contained in Section 7 of this Agreement, or

(b) If Borrower fails or neglects to perform, keep, or observe any other term, provision, condition, covenant, or agreement contained in this Agreement, in any of the Loan Documents, or in any other present or future agreement between Borrower and any Lender (other than occurrences described in other provisions of this Article 8 for which a different grace or cure period is specified or for which no grace or cure period is specified and thereby constitute immediate Events of Default) and such default is not remedied by Borrower within fifteen (15) days following receipt by Borrower of notice from Agent of the occurrence of such default; provided, however, that (i) if the default cannot by its nature be cured within the fifteen (15) day period or cannot after diligent attempts by Borrower be cured within such fifteen (15) day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional reasonable period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to have cured such default shall not be deemed an Event of Default (provided that no Credit Extensions will be made during such cure period) and (ii) if the default cannot by its nature be cured, then Borrower shall have a reasonable period (which shall not in any case exceed fifteen (15) days) to minimize the impact of the default such that the default is not material, and within such reasonable time period the default shall not be deemed an Event of Default (provided that no Credit Extensions will be made during such period).

8.3 Material Adverse Change.

A Material Adverse Change occurs.

8.4 Attachment.

(a) Any material portion of Borrower’s assets is attached, seized, levied on, or comes into possession of a trustee or receiver and the attachment, seizure or levy is not removed in ten (10) days; (b) the service of process upon Borrower seeking to attach, by trustee or similar process, any funds of Borrower on deposit with the Lenders and/or Agent, or any entity under the control of Lenders and/or Agent (including a subsidiary); (c) Borrower is enjoined, restrained, or prevented by court order from conducting a material part of its business; (d) a judgment or other claim becomes a Lien on a material portion of Borrower’s assets; or (e) a notice of lien, levy, or assessment is filed against any of Borrower’s assets by any government agency and not paid within ten (10) days after Borrower receives notice. These are not Events of Default if stayed or if a bond is posted pending contest by Borrower (but no Credit Extensions shall be made during the cure period).

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8.5 Insolvency.

(a) Borrower is unable to pay its debts (including trade debts) as they become due; (b) Borrower begins an Insolvency Proceeding; or (c) an Insolvency Proceeding is begun against Borrower and not dismissed or stayed within sixty (60) days (but no Credit Extensions shall be made before any Insolvency Proceeding is dismissed).

8.6 Other Agreements.

If there is a default in any agreement to which Borrower is a party with a third party or parties resulting in a right by such third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of (a) Two Million Dollars ($2,000,000) during any period when Covenant Level One is in effect, or (b) Four Hundred Thousand Dollars ($400,000) if Covenant Level Two is in effect, or (c) that could result in a Material Adverse Change.

8.7 Allergan Contract.

If there is a breach by Borrower under the Allergan Contract which would permit Allergan to terminate the Allergan Contract which breach is not cured or waived by Allergan.

8.8 Bilastine License.

If there is a breach by Borrower under the Bilastine License which permits Faes Farma, S.A. to terminate the Bilastine License, which event is not cured or waived by Faes Farma, S.A.

8.9 Judgments.

If a judgment or judgments for the payment of money is rendered against Borrower in an amount, individually or in the aggregate, of at least (a) Two Million Dollars ($2,000,000) during any period when Covenant Level One is in effect or (b) Four Hundred Thousand Dollars ($400,000) if Covenant Level Two is in effect, shall remain unsatisfied and unstayed for a period of ten (10) Business Days (provided that no Credit Extensions will be made prior to the satisfaction or stay of such judgment).

8.10 Misrepresentations.

If Borrower or any Person acting for Borrower now or later makes any material misrepresentation or material misstatement in any warranty or representation in this Agreement or in any writing delivered to Agent and/or Lenders or to induce Agent and/or Lenders to enter this Agreement or any Loan Document.

8.11 Criminal Proceeding.

The institution by any Governmental Authority of criminal proceedings against Borrower which are reasonably likely to result in a Material Adverse Change.

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8.12 Subordinated Debt.

Any Person holding any Subordinated Debt terminates the applicable subordination agreement or asserts that it is terminated.

8.13 Lien Priority.

Any Lien created hereunder or by any other Loan Document shall at any time fail to constitute a valid and perfected Lien on all of the Collateral purported to be secured thereby, subject to no prior or equal Lien except Permitted Liens, or any Borrower shall so assert.

8.14 Guaranty.

(a) Any guaranty of any Obligations terminates or ceases for any reason to be in full force and effect, (b) any Guarantor does not perform any obligation or covenant under any guaranty of the Obligations and such failure to perform continues unremedied for ten (10) days, (c) any circumstance described in Sections 8.3, 8.5 or 8.10 occurs with respect to any Guarantor, (d) the liquidation, winding up, or termination of existence of any Guarantor not otherwise permitted by the terms of the Loan Documents, or (e) a material impairment in the value of the collateral provided by Guarantor or in the perfection or priority of Agent’s Lien in such collateral continues unremedied for ten (10) days; provided, however, that (i) if the defaults described in clauses (b) and (d) cannot by their nature be cured within the ten (10) day period or cannot after diligent attempts by Borrower be cured within such ten (10) day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional reasonable period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to have cured such default shall not be deemed an Event of Default (provided that no Term Loan Advances will be made during such cure period) and (ii) if the default cannot by its nature be cured, then Borrower shall have a reasonable period (which shall not in any case exceed ten (10) days) to minimize the impact of the default such that the default is not material, and within such reasonable time period the default shall not be deemed an Event of Default (provided that no Credit Extensions will be made prior to the satisfaction or stay of such judgment).

9. RIGHTS AND REMEDIES

9.1 Rights and Remedies.

When an Event of Default occurs and continues Agent may, without notice or demand, do any or all of the following:

(a) Declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Agent and/or Lenders);

(b) Stop advancing money or extending credit for Borrower’s benefit under this Agreement or under any other agreement between Borrower and Agent and/or Lenders;

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(c) Settle or adjust disputes and claims directly with account debtors for amounts, on terms and in any order that Agent considers advisable and notify any Person owing Borrower money of Agent’s for the benefit of Lenders’ security interest in such funds and verify the amount of such account. Borrower shall collect all payments in trust for Agent for the benefit of Lenders and, if requested by Agent, immediately deliver the payments to Lenders in the form received from the account debtor, with proper endorsements for deposit;

(d) Make any payments and do any acts it considers necessary or reasonable to protect its security interest in the Collateral. Borrower shall assemble the Collateral if Agent requests and make it available as Agent designates. Agent may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Agent for the benefit of Lenders a license to enter and occupy any of its premises, without charge, to exercise any of Agent’s rights or remedies;

(e) Apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Agent or Lenders owing to or for the credit or the account of Borrower;

(f) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral. Agent is hereby granted a non-exclusive, royalty-free license or other right to use, without charge, Borrower’s labels, Patents, Copyrights, rights of use of any name, trade secrets, trade names, Trademarks, service marks, and advertising matter, or any similar property solely to the extent required in completing production of; advertising for sale, and selling any Collateral and, in connection with Agent’s exercise of its rights under this Section, Borrower’s rights under all licenses and all franchise agreements inure to Agent’s for benefit of Lenders;

(g) Only after and during the continuance of any Event of Default : (i) place a “hold” on any account maintained with Agent, (ii) deliver a notice of exclusive control, or deliver any entitlement order or other directions or instructions pursuant to any control agreement or similar agreements providing control of any Collateral;

(h) Dispose of the Collateral according to the Code or exercise any other right or remedy permitted hereunder, under any other Loan Document or under applicable Law.

9.2 Power of Attorney.

Borrower hereby irrevocably appoints Agent as its lawful attorney-in-fact, to be effective only upon the occurrence and during the continuance of an Event of Default, to: (a) endorse Borrower’s name on any checks or other forms of payment or security; (b) sign Borrower’s name on any invoice or bill of lading for any Account or drafts against account debtors, (c) settle and adjust disputes and claims about the Accounts directly with account debtors, for amounts and on terms Agent determines reasonable; (d) make, settle, and adjust all claims under Borrower’s insurance policies; and (e) transfer the Collateral into the name of Agent for the benefit of

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Lenders or a third party as the Code permits. Borrower hereby appoints Agent as its lawful attorney-in-fact to sign Borrower’s name on any documents necessary to perfect or continue the perfection of any security interest regardless of whether an Event of Default has occurred until all Obligations have been satisfied in full and Agent and Lenders are under no further obligation to make Credit Extensions hereunder. Agent’s foregoing appointment as Borrower’s attorney in fact, and all of Agent’s rights and powers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and Lenders and Agent’s obligation to provide Credit Extensions terminates.

9.3 Accounts, Notification and Collection.

In the event that an Event of Default occurs and is continuing, Agent may notify any Person owing Borrower money of Agent’s security interest in the funds and verify and/or collect the amount of the Account. Upon the occurrence and during the continuation of an Event of Default, any amounts received by Borrower shall be held in trust by Borrower for Agent, and, if requested by Agent, Borrower shall immediately deliver such receipts to Agent in the form received from the account debtor, with proper endorsements for deposit.

9.4 Agent Expenses.

Any amounts paid by Agent as provided herein are Agent Expenses and are immediately due and payable and shall bear interest at the then applicable rate and be secured by the Collateral. No payments by Agent shall be deemed an agreement to make similar payments in the future or Agent’s and Lenders’ waiver of any Event of Default.

9.5 Agent’s Liability for Collateral.

So long as Agent and Lenders comply with reasonable banking practices regarding the safekeeping of Collateral, Agent and Lenders shall not be liable or responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other Person. Subject to the preceding sentence, Borrower bears all risk of loss, damage or destruction of the Collateral.

9.6 Application of Proceeds.

Notwithstanding anything to the contrary contained in this Agreement, upon the occurrence and during the continuance of an Event of Default, (a) Borrower irrevocably waives the right to direct the application of any and all payments at any time or times thereafter received by Agent from or on behalf of Borrower or any Guarantor of all or any part of the Obligations, and, as between Borrower on the one hand and Agent and Lenders on the other, Agent shall have the continuing and exclusive right to apply and to reapply any and all payments received against the Obligations in such manner as Agent may deem advisable notwithstanding any previous application by Agent, and (b) the proceeds of any sale of, or other realization upon, all or any part of the Collateral shall be applied: first, to Agent Expenses; second, to Lenders’ Expenses; third, to accrued and unpaid interest on the Obligations (including any interest which, but for the provisions of the United States Bankruptcy Code, would have accrued on such amounts); fourth, to the principal amount of the Obligations outstanding; and fifth to any other indebtedness or

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obligations of Borrower owing to Agent or any Lender under the Loan Documents. Any balance remaining shall be delivered to Borrower or to whoever may be lawfully entitled to receive such balance or as a court of competent jurisdiction may direct. In carrying out the foregoing, (x) amounts received shall be applied in the numerical order provided until exhausted prior to the application to the next succeeding category, and (y) each of the Persons entitled to receive a payment in any particular category shall receive an amount equal to its pro rata share of amounts available to be applied pursuant thereto for such category.

9.7 Remedies Cumulative.

Agent’s rights and remedies under this Agreement, the Loan Documents, and all other agreements are cumulative. Agent has all rights and remedies provided under the Code, by law, or in equity. Agent’s exercise of one right or remedy is not an election, and Agent’s waiver of any Event of Default is not a continuing waiver. Agent’s delay is not a waiver, election, or acquiescence. No waiver hereunder shall be effective unless signed by Agent and each Lender and then is only effective for the specific instance and purpose for which it was given. Agent and Lenders shall have no obligation to marshal any assets in favor of Borrower or any Guarantor, or against or in payment of any of the other Obligations or any other obligation owed to Agent or Lenders by Borrower or any Guarantor.

9.8 Demand Waiver.

Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Agent on which Borrower is liable.

10. NOTICES

Notices or demands by either party about this Agreement must be in writing and personally delivered or sent by an overnight delivery service or by telefacsimile at the addresses listed below. A party may change its notice address by written notice to the other party.

If to Borrower:	Inspire Pharmaceuticals, Inc.
	4222 Emperor Boulevard, Suite 200
	Durham, North Carolina 27703
	Attn: Thomas R. Staab II, Chief Financial Officer and Treasurer
	Telecopier: (919) 941-9797
	Email: tstaab@inspirepharm.com
With copy to:	Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, LLP
	2500 Wachovia Capitol Center
	Raleigh, North Carolina 27601
	Attn: Christopher B. Capel
	Telecopier: (919) 821-6800
	Email: ccapel@smithlaw.com

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If to Agent or SVB:	Silicon Valley Bank
	5915 Farrington Road, Suite 201
	Chapel Hill, NC 27517
	Attn: Dan Allred
	Telecopier: (919) 442-2155
	email: dallred@svbank.com
If to Merrill:	Merrill Lynch Capital
	222 N. LaSalle Street, 16th Floor
	Chicago, Illinois 60601
	Attn: Account Manager for MLC/SVB/Inspire
	Fax: (866)231-8408

11. CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER

New York law governs the Loan Documents without regard to principles of conflicts of law. Borrower, Lenders and Agent each submit to the jurisdiction of the State and Federal courts in New York; provided, however, if for any reason Agent and Lenders can not avail themselves of the courts in New York, Borrower accepts jurisdiction of the courts in California and venue in Santa Clara County, California. NOTWITHSTANDING THE FOREGOING, AGENT SHALL HAVE THE RIGHT TO BRING ANY ACTION OR PROCEEDING AGAINST THE BORROWER OR ITS PROPERTY IN THE COURTS OF ANY OTHER JURISDICTION WHICH AGENT DEEMS NECESSARY OR APPROPRIATE IN ORDER TO REALIZE ON THE COLLATERAL OR TO OTHERWISE ENFORCE THE LENDERS’ OR AGENT’S RIGHTS AGAINST THE BORROWER OR ITS PROPERTY.

BORROWER, AGENT AND LENDERS EACH WAIVES ITS RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL WITHOUT INTENDING IN ANY WAY TO LIMIT ITS AGREEMENT TO WAIVE ITS RESPECTIVE RIGHT TO A TRIAL BY JURY. If the above waiver of the right to a trial by jury is not enforceable, the parties hereto agree that any and all disputes or controversies of any nature between them arising at any time shall be decided by a reference to a private judge, mutually selected by the parties (or, if they cannot agree, by the Presiding Judge of the Santa Clara County, California Superior Court) appointed in accordance with California Code of Civil Procedure Section 638 (or pursuant to comparable provisions of federal law if the dispute falls within the exclusive jurisdiction of the federal courts), sitting without a jury, in Santa Clara County, California and the parties hereby submit to the jurisdiction of such court. The referenced proceedings shall be conducted pursuant to and in accordance with the provisions of California Code of Civil Procedure §§ 638 through 645.1, inclusive. The

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private judge shall have the power, among others, to grant provisional relief, including without limitation, entering temporary restraining orders, issuing preliminary and permanent injunctions and appointing receivers. All such proceedings shall be closed to the public and confidential and all records relating thereto shall be permanently sealed. If during the course of any dispute, a party desires to seek provisional relief; but a judge has not been appointed at that point pursuant to the judicial reference procedures, then such party may apply to the Santa Clara County, California Superior Court for such relief. The proceeding before the private judge shall be conducted in the same manner as it would be before a court under the rules of evidence applicable to judicial proceedings. The parties shall be entitled to discovery which shall be conducted in the same manner as it would be before a court under the rules of discovery applicable to judicial proceedings. The private judge shall oversee discovery and may enforce all discovery rules and order applicable to judicial proceedings in the same manner as a trial court judge. The parties agree that the selected or appointed private judge shall have the power to decide all issues in the action or proceeding, whether of fact or of law, and shall report a statement of decision thereon pursuant to the California Code of Civil Procedure § 644(a). Nothing in this paragraph shall limit the right of any party at any time to exercise self-help remedies, foreclose against collateral, or obtain provisional remedies. The private judge shall also determine all issues relating to the applicability, interpretation, and enforceability of this paragraph.

12. GENERAL PROVISIONS

12.1 Successors and Assigns.

This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights or Obligations under it without Agent’s prior written consent which may be granted or withheld in Agent’s discretion. Lenders and Agent have the right, without the consent of or notice to Borrower, to sell, transfer, assign, negotiate, or grant participation in all or any part of, or any interest in, Lenders’ obligations, rights and benefits under this Agreement, the Loan Documents or any related agreement, including, without limitation, an assignment to any Affiliate or related party.

12.2 Indemnification.

Borrower hereby indemnifies, defends and holds Agent and the Lenders and their respective officers, employees, and agents (collectively called the “Indemnitees”) harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including the reasonable fees and disbursements of counsel for such Indemnitee) in connection with any investigative, response, remedial, administrative or judicial matter or proceeding, whether or not such Indemnitee shall be designated a party thereto and including any such proceeding initiated by or on behalf of Borrower, and the reasonable expenses of investigation by engineers, environmental consultants and similar technical personnel and any commission, fee or compensation claimed by any broker (other than any broker retained by Agent or Lenders) asserting any right to payment for the transactions contemplated hereby, which may be imposed on, incurred by or asserted against such Indemnitee as a result of or in connection with the transactions contemplated hereby and the use or intended use of the proceeds of the Term Loan,

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except that Borrower shall not have any obligation hereunder to an Indemnitee with respect to any liabilities, obligations, losses, damages, penalties, claims, costs, expenses and disbursements caused by or resulting from the gross negligence or willful misconduct of any Indemnitee, as determined by a final non-appealable judgment of a court of competent jurisdiction. To the extent that the undertaking set forth in the immediately preceding sentence may be unenforceable, Borrower shall contribute the maximum portion which it is permitted to pay and satisfy under applicable law to the payment and satisfaction of all such indemnified liabilities incurred by the Indemnitees or any of them.

12.3 Expenses.

Borrower hereby agrees to promptly pay (a) all reasonable costs and expenses of Agent (including, without limitation, reasonable fees and costs of independent appraisers and consultants retained by Agent) in connection with the examination, review, due diligence investigation, documentation, negotiation, and closing of the transactions contemplated by this Agreement and the Loan Documents, in connection with the performance by Agent of its rights and remedies under this Agreement and under the Loan Documents and in connection with the continued administration of this Agreement and under the Loan Documents including: (i) any amendments, modifications, consents and waivers to and/or under this Agreement or any and all Loan Documents and (ii) any periodic public record searches conducted by or at the request of Agent (including, without limitation, title investigations, UCC searches, fixture filing searches, judgment, pending litigation and tax lien searches and searches of applicable corporate, limited liability, partnership and related records concerning the continued existence, organization and good standing of certain Persons); (b) without limitation of the preceding clause (a), all reasonable costs and expenses of Agent (including recordation and transfer taxes) in connection with the creation, perfection and maintenance of Liens pursuant to this Agreement and the Loan Documents; (c) without limitation of the preceding clause (a), all reasonable costs and expenses of Agent in connection with (i) protecting, storing, insuring, handling, maintaining or selling any Collateral, (ii) any litigation, dispute, suit or proceeding relating to this Agreement and any Loan Document, and (iii) any workout, collection, bankruptcy, insolvency and other enforcement proceedings under this Agreement and any and all of the Loan Documents; and (d) all reasonable costs and expenses incurred by Lenders in connection with any litigation, dispute, suit or proceeding relating to this Agreement and any Loan Document and in connection with any workout, collection, bankruptcy, insolvency and other enforcement proceedings under this Agreement or under any and all Loan Documents; provided, however, that to the extent the costs and expenses referred to in this clause (d) consist of fees, costs and expenses of counsel, Borrower shall be obligated to pay such fees, costs and expenses for counsel to Agent and for only one counsel acting for all Lenders (other than Agent) and provided further that, in all cases and notwithstanding any other provision in this Agreement or the Loan Documents to the contrary, if Borrower obtains a final, non-appealable judgment against Agent and Lenders for breach of this Agreement or any Loan Documents, Borrower shall be entitled to recover from Agent and Lenders all attorneys fees and other costs and expenses incurred, in addition to any other relief to which it may be entitled.

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12.4 Right of Set-Off.

Borrower and any guarantor hereby grant to Agent for the ratable benefit of Lenders, a lien, security interest and right of set-off as security for all Obligations to Agent and each Lender, hereunder, whether now existing or hereafter arising upon and against all deposits, credits, collateral and property, now or hereafter in the possession, custody, safekeeping or control of Agent or any entity under the control of Agent (including an Agent subsidiary) or in transit to any of them. At any time after the occurrence and during the continuance of an Event of Default without demand or notice, Agent may set-off the same or any part thereof and apply the same to any liability or obligation of Borrower and any guarantor even though unmatured and regardless of the adequacy of any other collateral securing the Obligations. ANY AND ALL RIGHTS TO REQUIRE AGENT TO EXERCISE ITS RIGHTS OR REMEDIES WITH RESPECT TO ANY OTHER COLLATERAL WHICH SECURES THE OBLIGATIONS, PRIOR TO EXERCISING ITS RIGHT OF SETOFF WITH RESPECT TO SUCH DEPOSITS, CREDITS OR OTHER PROPERTY OF THE BORROWER OR ANY GUARANTOR, ARE HEREBY KNOWINGLY, VOLUNTARILY AND IRREVOCABLY WAIVED.

12.5 Time of Essence.

Time is of the essence for the performance of all Obligations in this Agreement.

12.6 Severability of Provision.

Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

12.7 Amendments in Writing, Integration.

All amendments to this Agreement must be in writing signed by Agent, each Lender and Borrower. This Agreement and the Loan Documents represent the entire agreement about this subject matter, and supersede prior negotiations or agreements. All prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement and the Loan Documents merge into this Agreement and the Loan Documents.

12.8 Counterparts.

This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.9 Survival.

All covenants, representations and warranties made in this Agreement continue in full force while any Obligations remain outstanding. The obligation of Borrower in Section 12.2 to indemnify each Lender and Agent shall survive until the statute of limitations with respect to such claim or cause of action shall have run.

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12.10 Administrative Agent.

(a) Each Lender hereby irrevocably appoints and authorizes Agent to enter into each of the Loan Documents to which it is a party (other than this Agreement) on its behalf and to take such actions as Agent on its behalf and to exercise such powers under the Loan Documents as are delegated to Agent by the terms thereof; together with all such powers as are reasonably incidental thereto. Subject to the terms of the other Loan Documents, Agent is authorized and empowered to amend, modify, or waive any provisions of this Agreement or the other Loan Documents on behalf of Lenders. The provisions of this Section 12.10 are solely for the benefit of Agent and Lenders and neither Borrower nor any Guarantor shall have any rights as a third party beneficiary of any of the provisions hereof. In performing its functions and duties under this Agreement, Agent shall act solely as agent of Lenders and does not assume and shall not be deemed to have assumed any obligation toward or relationship of agency or trust with or for Borrower or any Guarantor. Agent may perform any of its duties hereunder, or under the Loan Documents by or through its agents or employees.

The duties of Agent shall be mechanical and administrative in nature. Agent shall not have by reason of this Agreement a fiduciary relationship in respect of any Lender. Nothing in this Agreement or any of the Loan Documents is intended to or shall be construed to impose upon Agent any obligations in respect of this Agreement or any of the Loan Documents except as expressly set forth herein or therein. Agent may consult with legal counsel, independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken by it in good faith in accordance with the advice of such counsel, accountants or experts.

Neither Agent nor any of its directors, officers, agents or employees shall be liable to any Lender for any action taken or not taken by it in connection with this Agreement or the Loan Documents, except that Agent shall be liable with respect to its specific duties set forth hereunder but only to the extent of its own gross negligence or willful misconduct in the discharge thereof as determined by a final non-appealable judgment of a court of competent jurisdiction. Neither Agent nor any of its directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into or verify (a) any statement warranty or representation made in connection with this Agreement or the Loan Documents or any borrowing hereunder; (b) the performance or observance of any of the covenants or agreements specified in this Agreement or the Loan Documents; (c) the satisfaction of any condition specified in this Agreement or the Loan Documents; (d) the validity, effectiveness, sufficiency or genuineness of this Agreement or the Loan Documents, any Lien purported to be created or perfected thereby or any other instrument or writing furnished in connection therewith; (e) the existence or non-existence of any Event of Default; or (f) the financial condition of Borrower. Agent shall not incur any liability by acting in reliance upon any notice, consent certificate, statement, or other writing (which may be a bank wire, telex, facsimile or electronic transmission or similar writing) believed by it to be genuine or to be signed by the proper party or parties. Agent shall not be liable for any apportionment or distribution of payments made by it in good faith and if any such apportionment or distribution is subsequently determined to have been made in error the sole recourse of any Lender to whom payment was due but not made, shall be to recover from other Lenders any payment in excess of the amount to which they are determined to be entitled (and such other Lenders hereby agree to return to such Lender any such erroneous payments received by them).

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Each Lender shall, in accordance with its pro rata share of the Obligations, indemnify Agent (to the extent not reimbursed by Borrower) upon demand against any cost, expense (including counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from Agent’s gross negligence or willful misconduct as determined by a final non-appealable judgment of a court of competent jurisdiction) that Agent may suffer or incur in connection with this Agreement or the Loan Documents or any action taken or omitted by Agent hereunder or thereunder. If any indemnity furnished to Agent for any purpose shall, in the opinion of Agent, be insufficient or become impaired, Agent may call for additional indemnity and cease, or not commence, to do the acts indemnified against even if so requested by Lenders until such additional indemnity is furnished.

Each Lender acknowledges that it has, independently and without reliance upon Agent or any other Lender, and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon Agent or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking any action under this Agreement and the Loan Documents.

Lenders irrevocably authorize Agent, at its option and in its discretion, to release any Lien granted to or held by Agent under this Agreement or any Loan Document (i) upon payment in full of all Obligations; or (ii) constituting property sold or disposed of as part of or in connection with any disposition permitted under this Agreement (it being understood and agreed that Agent may conclusively rely without further inquiry on a certificate of a responsible officer of Borrower as to the sale or other disposition of property being made in full compliance with the provisions of this Agreement).

Agent shall not be deemed to have knowledge or notice of the occurrence of any Event of Default or event which, with the giving of notice or passage of time, or both, would constitute an Event of Default except with respect to defaults in the payment of principal, interest and fees required to be paid to Agent for the account of Lenders, unless Agent shall have received written notice from a Lender or Borrower referring to this Agreement, describing such event and stating that such notice is a “notice of default”. Agent will notify each Lender of its receipt of any such notice. Agent shall take such action with respect to such event in accordance with the terms hereof. Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Event of Default or event which, with the giving of notice or passage of time, or both, would constitute an Event of Default as it shall deem advisable or in the best interests of Lenders.

(b) Agent may retire or be retired as Agent as follows: (i) Agent may at any time give notice of its resignation to the Lenders and Borrower and upon receipt of any such notice of resignation, the Lenders shall have the right to appoint a successor Agent and (ii) following the occurrence of any Event of Default, Agent may be replaced and succeeded as Agent by any other Lender if so provided for under any intercreditor agreement among Lenders

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so long as such Lender shall give notice to Borrower promptly upon becoming such successor Agent. Upon the acceptance of a successor’s appointment as Agent hereunder (or, in the case of the replacement of Agent by any other Lender as contemplated in clause (ii) of the preceding sentence, immediately upon such Lender becoming Agent), such successor shall succeed to and become vested with all of the rights, powers, privileges and duties of the retiring Agent, the retiring Agent’s resignation shall become immediately effective and the retiring Agent shall be discharged from all of its duties and obligations hereunder and under the other Loan Documents. The provisions of this Loan Agreement and the other Loan Documents shall continue in effect for the benefit of any retiring Agent and its sub-agents after the effectiveness of its resignation hereunder and under the other Loan Documents in respect of any actions taken or omitted to be taken by any of them while the retiring Agent was acting or was continuing to act as Agent.

12.11 Arrangers.

Notwithstanding the provisions of this Agreement or any of the Loan Documents, the Arrangers shall have no powers, rights, duties, responsibilities or liabilities with respect to this Agreement and the other Loan Documents.

12.12 Confidentiality.

In handling any confidential information, Lenders and Agent shall exercise the same degree of care that it exercises for its own proprietary information, but disclosure of information may be made (a) to Lenders’ and Agent’s subsidiaries or affiliates in connection with their business with Borrower; (b) to prospective transferees or purchasers of any interest in the Term Loan Advances (provided, however, Lenders and Agent shall use commercially reasonable efforts in obtaining such prospective transferee’s or purchaser’s agreement to the terms of this provision); (c) as required by law, regulation, subpoena, or other order, (d) as reasonably required in connection with Lenders’ and Agent’s examination or audit; and (e) as Agent in its good faith business judgment deems necessary in exercising remedies under this Agreement. Confidential information does not include information that either: (a) is in the public domain or in Lenders’ and/or Agent’s possession when disclosed to Lenders and/or Agent, or becomes part of the public domain after disclosure to Lenders and/or Agent; or (b) is disclosed to Lenders and/or Agent by a third party, if Lenders and/or Agent does not know that the third party is prohibited from disclosing the information.

12.13 Publicity.

Except with the prior written consent of Agent and further subject to the following sentence, Borrower will not directly or indirectly publish, disclose or otherwise use in any public disclosure, advertising material, promotional material, press release or interview, any reference to the name, logo or any Trademark of Agent or any Lender or any of their Affiliates or any reference to this Agreement or the financing evidenced hereby, in any case except as required by Law, subpoena or judicial or similar order. Agent and each Lender hereby acknowledge that Borrower is a public company subject to the reporting and disclosure requirements under federal and state securities laws and the NASDAQ Marketplace Rules, which Laws require public disclosure and discussion of the material terms of this transaction and the filing with the SEC of this Agreement and certain of the Loan Documents at and after the Closing Date.

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Each Lender and Borrower hereby authorizes Merrill Lynch to publish the name of such Lender and Borrower, the existence of the financing arrangements referenced under this Agreement, the primary purpose and/or structure of those arrangements, the amount of credit extended under each facility, the title and role of each party to this Agreement, and the total amount of the financing evidenced hereby in any “tombstone”, comparable advertisement or press release which Merrill Lynch elects to submit for publication. In addition, each Lender and Borrower agrees that Merrill Lynch may provide lending industry trade organizations with information necessary and customary for inclusion in league table measurements after the Closing Date. With respect to any of the foregoing, Merrill Lynch shall provide Borrower with an opportunity to review and confer with Merrill Lynch regarding the contents of any such tombstone, advertisement or information, as applicable, prior to its submission for publication and, following such review period, Merrill Lynch may, from time to time, publish such information in any media form desired by Merrill Lynch until such time that Borrower shall have requested Merrill Lynch cease any such further publication.

12.14 No Strict Construction.

The parties hereto have participated jointly in the negotiation and drafting of this Agreement. In the event an ambiguity or question of intent or interpretation arises, this Agreement shall be construed as if drafted jointly by the parties hereto and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Agreement. The headings in this Agreement are for convenience of reference only, are not part of this Agreement and do not affect its interpretation.

12.15 SAS 70 Report.

The parties acknowledge that as a condition precedent to Borrower’s entering into this Agreement and the other Loan Documents to which Borrower is a party, that SVB delivered to Borrower a SAS 70 Report for SVB Asset Management prior to the date hereof regarding SVB Asset Management’s services in connection with Borrower’s deposit accounts and securities accounts maintained at SVB Asset Management and certain related matters. SVB agrees that Borrower may provide the SAS 70 Report to Borrower’s auditors for use by such auditors in the preparation of Borrower’s annual financial statements and for other directly related purposes. Borrower shall not provide, and shall prohibit its auditors from providing, the SAS 70 Report to any other Person without SVB’s prior written consent.

12.16 Effective Date.

Notwithstanding anything set forth in this Agreement or any Loan Document to the contrary, this Agreement and all of the Loan Documents shall not be effective until the date on which Agent and each Lender executes this Agreement as indicated on the signature page to this Agreement.

13. DEFINITIONS

13.1 Definitions.

In this Agreement:

“Accounts” shall mean all existing and later arising accounts, contract rights, and other obligations owed Borrower in connection with its sale or lease of goods (including licensing software and other technology) or provision of services, all credit insurance, guaranties, other security and all merchandise returned or reclaimed by Borrower and Borrower’s Books relating to any of the foregoing, as such definition may be amended from time to time according to the Code.

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“Account Debtor” is any “account debtor” as defined in the Code with such additions to such term as may hereafter be made.

“Affiliate” shall mean a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person’s senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person’s managers and members.

“Agent” shall mean, SVB, not in its individual capacity, but solely in its capacity as agent on behalf of and for the benefit of the Lenders.

“Agent Expenses” shall mean all audit fees and expenses and reasonable costs or expenses (including reasonable attorneys’ fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings).

“Agreement” shall have the meaning set forth in the opening paragraph.

“Allergan” shall mean Allergan, Inc., a Delaware corporation, and its Affiliates.

“Allergan Contract” shall mean the collective reference to (a) the Elestat (Epinastine) Co-Promotion Agreement dated December 8, 2003 by and between Allergan Sales, LLC and Borrower, (b) the License, Development and Marketing Agreement dated June 22, 2001 by and between Allergan and Borrower, as amended by that certain First Amendment to License, Development and Marketing Agreement dated December 8, 2003 by and between Allergan and Borrower, as any of the same may be amended from time to time.

“Anti-Terrorism Laws” shall mean any Laws relating to terrorism or money laundering, including Executive Order No. 13224 (effective September 24, 2001) the USA PATRIOT Act, the Laws comprising or implementing the Bank Secrecy Act, and the Laws administered by OFAC.

“Arrangers” shall have the meaning set forth in the opening paragraph.

“Basic Rate” shall mean, as of the Funding Date the per annum rate of interest (based on a year of 360 days) equal to the sum of (a) U.S. Treasury note yield to maturity for a term equal to sixty (60) months as quoted in the Wall Street Journal on the Funding Date, plus (b) the Loan Margin.

“Bilastine” shall mean the exclusive rights acquired by Borrower pursuant to a License Agreement dated October 31, 2006, with FAES Farma, S.A. to develop and commercialize

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formulations of bilastine, a Phase 3 oral antihistamine compound for the treatment or prevention of allergic rhinitis, in the United States and Canada and to develop ocular formulations of bilastine worldwide, excluding various countries.

“Bilastine License Agreement” shall mean that certain license agreement dated as of October 31, 2006 by and between Faes Farma, S.A., as licensor and Borrower, as licensee, as the same may be amended from time to time.

“Blocked Person” shall mean any Person: (a) listed in the annex to, or is otherwise subject to the provisions of, Executive Order No. 13224, (b) a Person owned or controlled by, or acting for or on behalf of, any Person that is listed in the annex to, or is otherwise subject to the provisions of, Executive Order No. 13224, (c) a Person with which any Lender is prohibited from dealing or otherwise engaging in any transaction by any Anti-Terrorism Law, (d) a Person that commits, threatens or conspires to commit or supports “terrorism” as defined in Executive Order No. 13224, or (e) a Person that is named a “specially designated national” or “blocked person” on the most current list published by OFAC or other similar list.

“Borrower” shall have the meaning set forth in the opening paragraph of this Agreement.

“Borrower’s Books” shall mean all Borrower’s books and records including ledgers, records regarding Borrower’s assets or liabilities, the Collateral, business operations or financial condition and all computer programs or discs or any equipment containing the information.

“Business Day” shall mean any day that is not a Saturday, Sunday or a day on which Agent is closed.

“Cash Balances” shall have the meaning set forth in Section 6.6(a).

“Closing Date” shall mean the date of this Agreement.

“Closing Date Advance” shall have the meaning set forth in Section 2.1.1.

“Code” shall mean the Uniform Commercial Code as adopted in New York as amended and in effect from time to time.

“Collateral” shall mean the property described on Exhibit A.

“Commitment Letter” shall mean that certain commitment letter dated October 31, 2006 from Agent and Lenders to Borrower.

“Commitment Percentage” shall mean with respect to (a) SVB, fifty percent (50%), and (b) Merrill Lynch, fifty percent (50%).

“Contingent Obligation” shall mean, for any Person, any direct or indirect liability, contingent or not, of that Person for (a) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly

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liable; (b) any obligations for undrawn letters of credit for the account of that Person, and (c) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but “Contingent Obligation” does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under the guarantee or other support arrangement.

“Conversion Date” shall have the meaning set forth in Section 2.3(a).

“Copyrights” shall mean all copyright rights, applications or registrations and like protections in each work of authorship or derivative work, whether published or not (whether or not it is a trade secret) now or later existing, created, acquired or held.

“Covenant Level One” shall mean any period in which Agent for the benefit of Lenders has a first lien perfected security interest in deposit and security accounts that hold unrestricted cash, cash equivalents and marketable securities with an aggregate value at least equal Ten Million Dollars ($10,000,000) in excess of the outstanding Obligations at such time.

“Covenant Level Two” shall mean any and all periods in which (a) an Event of Default has occurred and is continuing or (b) Covenant Level One is not in effect. Covenant Level Two shall take place immediately upon such occurrence, without any prior notice.

“Credit Extension” shall mean the Term Loan Advance, or any other extension of credit by any Lender for Borrower’s benefit.

“Default” shall mean an event which, with the giving of notice or lapse of time, or both, reasonably could or would constitute an Event of Default under the provisions of this Agreement.

“Default Rate” shall have the meaning set forth in Section 2.3(b)(ii).

“Draw Conditions” shall mean Agent has received and reviewed from Borrower either (a) evidence that Borrower either has received notification from the FDA that pivotal trials conducted outside the United States are acceptable for submission in a new drug application for Bilastine or upon the completion of a Phase 3 trial in which Bilastine’s results are significantly better than the results of placebo in such trial, or (b) evidence that Borrower has made cumulative cash payments (including internal research and development trials) exceeding Twenty Million Dollars ($20,000,000) for Bilastine and/or another in-licensed drug candidate, or (c) evidence of FDA approval of a product owned or in-licensed by Borrower. Draw Condition (b) being called the “R&D Condition”.

“Draw Period” shall mean the period of time from the Closing Date through the earliest to occur of (a) June 30, 2007, (b) an Event of Default, or (c) the existence of any Default, provided, however, that Borrower may upon written request and payment to Agent, for the ratable benefit of the Lenders, of a non refundable fee in the amount of Forty Thousand Dollars ($40,000) received prior to June 30, 2007, extend the Draw Period to the earliest to occur of (a) December 31, 2007, (b) an Event of Default, or (c) the existence of any Default.

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“Elestat” shall mean Allergen’s proprietary ophthalmic anti-allergy product epinastine ophthalmic solution 0.05% in finished pharmaceutical form, in any formulation, packaged for sale to third parties.

“Eligible Accounts” shall mean Accounts which arise in the ordinary course of Borrower’s business that meet all of Borrower’s representations and warranties in Section 5.3. Agent reserves the right at any time and from time to time after the Effective Date, to adjust any of the criteria set forth below and to establish new criteria in its good faith business judgment. Unless Agent agrees otherwise in writing, Eligible Accounts shall not include:

(a) Accounts for which the Account Debtor has not been invoiced;

(b) Accounts that the Account Debtor has not paid within ninety (90) days of invoice date;

(c) Accounts owing from an Account Debtor, fifty percent (50%) or more of whose Accounts have not been paid within ninety (90) days of invoice date;

(d) Credit balances over ninety (90) days from invoice date;

(e) Accounts owing from an Account Debtor, including Affiliates, whose total obligations to Borrower exceed twenty-five percent (25%) of all Accounts, for the amounts that exceed that percentage, unless Agent approves in writing;

(f) Accounts owing from an Account Debtor which does not have its principal place of business in the United States unless Agent approves in writing, except for Account Debtors in Canada if at Borrower’s cost and expense, Agent’s Lien for the benefit of the Lenders is a first priority Lien perfected in accordance with the Code and Canadian law and Agent receives such documents in connection with such Lien as Agent and its counsel deem necessary or prudent, including, without limitation, opinions of Canadian counsel;

(g) Accounts owing from an Account Debtor which is a federal, state or local government entity or any department, agency, or instrumentality thereof, except for Accounts of the United States, if Borrower has assigned its payment rights to Agent and the assignment has been acknowledged under the Federal Assignment of Claims Act of 1940, as amended;

(h) Accounts owing from an Account Debtor to the extent that Borrower is indebted or obligated in any manner to the Account Debtor (as creditor, lessor, supplier or otherwise—sometimes called “contra” accounts, accounts payable, customer deposits or credit accounts), with the exception of customary credits, adjustments and/or discounts given to an Account Debtor by Borrower in the ordinary course of its business;

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(i) Accounts for demonstration or promotional equipment, or in which goods are consigned, or sold on a “sale guaranteed”, “sale or return”, “sale on approval”, “bill and hold”, or other terms if Account Debtor’s payment may be conditional;

(j) Accounts for which the Account Debtor is Borrower’s Affiliate, officer, employee, or agent;

(k) Accounts in which the Account Debtor disputes liability or makes any claim (but only up to the disputed or claimed amount), or if the Account Debtor is subject to an Insolvency Proceeding, or becomes insolvent, or goes out of business;

(l) Accounts owing from an Account Debtor with respect to which Borrower has received deferred revenue (but only to the extent of such deferred revenue);

(m) Accounts for which Agent in its good faith business judgment determines collection to be doubtful; and

(n) other Accounts Agent deems ineligible in the exercise of its good faith business judgment.

Notwithstanding the foregoing, provided Allergan continues to remit without offset (other than offsets which are treated as deferred revenue by Borrower) or defense payment in full on royalty receivables to Borrower within sixty (60) days of each quarter end, “Eligible Accounts” shall include Accounts which are not excluded from Eligible Accounts by virtue of the criteria set forth in (m) and (n) above, but are the result of royalties generated in the ordinary course of business from sales of Restasis and Elestat.

“Equipment” shall have the meaning described in the Code as in effect from time to time.

“Event of Default” shall have the meaning set forth in the first sentence of Article 8.

“FDA” shall mean the United States Food and Drug Administration or any successor agency thereof.

“Final Payment” shall mean a payment (in addition to and not in substitution for the regular monthly payments of principal plus accrued interest) due on the Maturity Date or date of any mandatory or optional prepayment of any Term Loan Advance, or part thereof, equal to the amount of such Term Loan Advance subject to payment multiplied by the Final Payment Percentage.

“Final Payment Percentage” shall mean two percent (2.0%).

“Funding Date” shall mean any date on which a Term Loan Advance is made to or on account of Borrower.

“GAAP” shall mean generally accepted accounting principles.

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“Governmental Authority” shall mean any nation or government, any state or other political subdivision thereof, and any agency, department or Person exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government and any corporation or other Person owned or controlled (through stock or capital ownership or otherwise) by any of the foregoing, whether domestic or foreign.

“Guarantor” shall mean any present or future guarantor of the Obligations, including, without limitation, and any and all Subsidiaries designated by Agent after the Closing Date as a Guarantor.

“Indebtedness” shall mean (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations and (d) Contingent Obligations.

“Indemnitees” shall have the meaning set forth in Section 12.2.

“Insolvency Proceeding” shall mean any proceeding by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

“Intellectual Property” shall mean:

(a) Copyrights, Trademarks and Patents including amendments, renewals, extensions, and all licenses, options to license or other rights to use and all license fees and royalties from the use;

(b) Any trade secrets, including any inventions, and any intellectual property rights, including all licenses, options to license or other rights to use and those for computer software and computer software products, now or later existing, created, acquired or held by Borrower; and

(c) All design rights which may be available to Borrower now or later created, acquired or held by Borrower.

“Inventory” shall mean present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or later owned by or in the custody or possession actual or constructive, of Borrower, including inventory temporarily out of its custody or possession or in transit and including returns on any accounts or other proceeds (including insurance proceeds) from the sale or disposition of any of the foregoing and any documents of title.

“Investment” shall mean any beneficial ownership of (including stock, partnership interest or other securities) any Person, or any loan, advance or capital contribution to any Person.

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“Law” shall mean any and all federal, state, local and foreign statutes, laws, judicial decisions, regulations, guidances, guidelines, ordinances, rules, judgments, orders, decrees, codes, plans, injunctions, permits, concessions, grants, franchises, governmental agreements and governmental restrictions, whether now or hereafter in effect which are applicable to Borrower in any particular circumstance.

“Lender” shall have the meaning set forth in the opening paragraph.

“Lenders’ Expenses” shall mean all audit fees and expenses and reasonable costs or expenses (including reasonable attorneys’ fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings).

“Letter-of-Credit Right” shall have the meaning set forth in the Code.

“Lien” shall mean a mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance.

“Liquidity” shall mean Borrower’s unrestricted cash, cash equivalents and marketable securities, plus eighty percent (80%) of Borrower’s Eligible Accounts.

“Loan Amount” shall mean the original principal amount of the Term Loan Advance.

“Loan Documents” shall mean, collectively, this Agreement, any note or notes or guaranties executed by Borrower or any Guarantor, and any other present or future document, instruments or agreement by or from any Borrower for the benefit of Lenders and Agent in connection with this Agreement all as amended, extended or restated.

“Loan Margin” shall mean three percentage (3.0%) points.

“Material Adverse Change” shall mean: (a) a material impairment in the perfection or priority of Lenders’ security interest in the Collateral or in the value of’ such Collateral; (b) a material adverse change in the business, operations, or condition (financial or otherwise) of Borrower and any consolidated Subsidiaries taken as a whole; or (c) a material impairment of the prospect of repayment of any portion of the Obligations.

“Maturity Date” shall mean March 1, 2011.

“Maximum Lawful Rate” shall have the meaning set forth in Section 2.3(b)(iii).

“Merrill Lynch” shall have the meaning set forth in the opening paragraph.

“Obligations” shall mean debts, principal, interest, Final Payment, Agent’s Expenses, Lenders’ Expenses, and other amounts Borrower owes Lenders and/or Agent now or later and including interest accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Lenders and/or Agent.

“OFAC” shall mean the U.S. Department of Treasury Office of Foreign Assets Control.

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“OFAC Lists” shall mean, collectively, the Specially Designated Nationals and Blocked Persons List maintained by OFAC pursuant to Executive Order No. 13224, 66 Fed. Reg. 49079 (Sept. 25, 2001) and/or any other list of terrorists or other restricted Persons maintained pursuant to any of the rules and regulations of OFAC or pursuant to any other applicable Executive Orders.

“Patents” shall mean patents, patent applications and like protections, including improvements, divisions, continuations, renewals, reissues, extensions and continuations in part of the same.

“Payment Advance Form” shall have the meaning set forth in Section 2.1(b).

“Payment Date” shall have the meaning set forth in Section 2.3(a).

“Perfection Certificate” shall have the meaning set forth in Section 5.1.

“Permitted Indebtedness” shall mean:

(a) Borrower’s indebtedness to Lenders and Agent under this Agreement or the Loan Documents;

(b) Indebtedness existing on the Closing Date and shown on the Perfection Certificate;

(c) Indebtedness payable by Borrower in the ordinary course of business under inbound licenses;

(d) Subordinated Debt;

(e) Indebtedness to trade creditors incurred in the ordinary course of business;

(f) Indebtedness secured by Permitted Liens;

(g) Indebtedness of Borrower to any Subsidiary and Contingent Obligations of any Subsidiary with respect to obligations of Borrower (provided that the primary obligations are not prohibited hereby), and Indebtedness of any Subsidiary to any other Subsidiary and Contingent Obligations of any Subsidiary with respect to obligations of any other Subsidiary (provided that the primary obligations are not prohibited hereby);

(h) Other Indebtedness not otherwise permitted by Section 7.4 and not exceeding (a) Two Million Dollars ($2,000,000) if Covenant Level One is in effect or (b) Four Hundred Thousand Dollars ($400,000) if Covenant Level Two is in effect, in the aggregate outstanding at any time; and

(i) Extensions, refinancings, modifications, amendments and restatements of any items of Permitted Indebtedness (a) through (h) above, provided that the principal amount thereof is not increased or the terms thereof are not modified to impose more burdensome terms upon Borrower or its Subsidiary, as the case may be.

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“Permitted Investments” shall mean:

(a) Investments shown on the Perfection Certificate and existing on the Closing Date;

(b) Investments permitted by Borrower’s investment policy as approved by Borrower’s board of directors, as the same may be amended from time to time, provided that any such amendment to Borrower’s investment policy has been approved by Agent;

(c) Investments consisting of the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of Borrower;

(d) Investments accepted in connection with Transfers permitted by Section 7.1;

(e) Investments of Subsidiaries in or to other Subsidiaries or Borrower and Investments by Borrower in Subsidiaries not to exceed in any fiscal year (i) Four Hundred Thousand Dollars ($400,000) if Covenant Level One is in effect or (ii) if Covenant Level Two is in effect, not to exceed One Hundred Thousand Dollars ($100,000);

(f) Investments consisting of (i) travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business, and (ii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower or its Subsidiaries pursuant to employee stock purchase plans or agreements approved by Borrower’s Board of Directors;

(g) Investments (including debt obligations) received in connection with the bankruptcy or reorganization of customers or suppliers and in settlement of delinquent obligations of, and other disputes with, customers or suppliers arising in the ordinary course of business;

(h) Investments consisting of notes receivable of; or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates, in the ordinary course of business; provided that this paragraph (h) shall not apply to Investments of Borrower in any Subsidiary;

(i) Investments in connection with Transfers permitted by Section 7.1 or in connection with a transaction approved by Borrower’s board of directors, a significant purpose of which is to in-license, receive an option to in-license or develop technology with a third party;

(j) Investments permitted by Section 7.3; and

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(k) Other Investments not otherwise permitted by Section 7.6 not exceeding (i) Two Million Five Hundred Thousand Dollars ($2,500,000) if Covenant Level One is in effect or (ii) Two Hundred Fifty Thousand Dollars ($250,000) if Covenant Level Two is in effect, in the aggregate outstanding at any time.

“Permitted Liens” shall mean:

(a) Liens existing on the Closing Date and shown on the Perfection Certificate or arising under this Agreement or other Loan Documents;

(b) Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, if (i) they have no priority over any of Agent’s or any Lender’s security interests or (ii) such Liens having priority over any of Agent’s or any Lender’s security interests do not, in an aggregate amount exceed Four Hundred Thousand Dollars ($400,000);

(c) Purchase money Liens (i) on Equipment acquired or held by Borrower incurred for financing the acquisition of the Equipment, or (ii) existing on Equipment when acquired, if the lien is confined to the Equipment and the Proceeds of the Equipment;

(d) Leases or subleases (including leases and subleases of real property) and licenses or sublicenses (including licenses and sublicenses of Intellectual Property) granted in the ordinary course of Borrower’s business or pursuant to Section 7.1 of this Agreement and any interest or title of a lessee licensee or licensor under such leases, licenses or sublicenses;

(e) Statutory Liens securing claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other persons imposed without action of such persons incurred in the ordinary course of business, if (i) they have no priority over any of Agent’s or any Lender’s security interests or (ii) such Liens having priority over any of Agent’s or any Lender’s security interests do not, in an aggregate amount, exceed Four Hundred Thousand Dollars ($400,000);

(f) Liens to secure workers’ compensation, employment insurance, old-age pensions, social security and other like obligations incurred in the ordinary course of business;

(g) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (d), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase;

(h) Liens arising from judgments, decrees or attachments in circumstances not constituting an Event of Default under Section 8.4 or 8.7; and

(i) Liens in favor of other financial institutions arising in connection with Borrower’s deposit accounts held at such institutions, provided that Agent has a perfected security interest in the amounts held in such deposit accounts.

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“Permitted Payments” shall mean any payments in an aggregate amount not to exceed One Million Dollars ($1,000,000) with respect to Subordinated Debt during any time Covenant Level One is in effect and at all other times shall mean Zero Dollars ($0).

“Person” shall mean any individual, sole proprietorship, partnership, limited liability company, joint venture, company association, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

“Proceeds” shall have the meaning described in the Code as in effect from time to time.

“R&D Condition” shall have the meaning set forth in the definition of “Draw Conditions”.

“R&D Inventory” shall mean all Inventory of the Borrower that (i) is not presented as inventory in Borrower’s financial statements in accordance with GAAP and (ii) is used for research and development purposes.

“Registered Organization” shall mean an organization organized solely under the law of a single state or the United States and as to which the state or the United States must maintain a public record showing the organization to have been organized.

“Responsible Officer” shall mean each of the Chief Executive Officer, the Chief Financial Officer, Treasurer, Senior Vice President, General Counsel and Secretary, and the Principal Accounting Officer of Borrower.

“Restasis” shall mean all human ophthalmic formulations of cyclosporine owned by Allergan.

“Schedule” shall mean any attached schedule of exceptions.

“SEC” shall mean the U.S. Securities and Exchange Commission.

“Stated Rate” shall have the meaning set forth in Section 2.3(b)(iii).

“Subordinated Debt” shall mean debt incurred by Borrower subordinated to Borrower’s debt to Lenders (pursuant to a subordination agreement entered into between Agent, Borrower and the subordinated, creditor), on terms acceptable to Agent.

“Subsidiary” shall mean any Person, corporation, partnership, limited liability company, joint venture, or any other business entity of which more than fifty percent (50%) of the voting stock or other equity interests is owned or controlled, directly or indirectly, by the Person or one or more Affiliates of the Person.

“Supporting Obligation” shall mean a letter-of-credit right, secondary obligation or obligation of a secondary obligor or that supports the payment or performance of an account, chattel paper, a document, a general intangible, an instrument or investment property.

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“SVB” shall have the meaning set forth in the opening paragraph.

“Term Loan” shall mean Term Loan Advances in an aggregate amount not to exceed Forty Million Dollars ($40,000,000).

“Term Loan Advance” or “Term Loan Advances” shall have the meaning set forth in Section 2.1.1(a).

“Term Loan Commitment” shall mean with respect to each Lender, the total amount of the Term Loan Advances which may be made hereunder. With respect to SVB this means an amount of up to Twenty Million Dollars ($20,000,000), with respect to Merrill Lynch this means an amount of up to Twenty Million Dollars ($20,000,000).

“Trademarks” shall mean trademark and service mark rights, registered or not, applications to register and registrations and like protections, and the entire goodwill of the business of Borrower connected with the trademarks.

“Transfer” shall have the meaning set forth in Section 7.1.

“Unused Facility Fee” shall have the meaning set forth in Section 2.4(d).

“USA Patriot Act” shall mean United States Public Law 107-56, Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA) PATRIOT ACT) Act of 2001, as amended from time to time, and the rules and regulations promulgated thereunder from time to time in effect.

(Signatures are on the following page)

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written.

	INSPIRE PHARMACEUTICALS, INC.
	By:	/s/ Thomas R. Staab, II
	Name:	Thomas R. Staab, II
	Title:	CFO & Treasurer
	AGENT:
	SILICON VALLEY BANK
	By:	/s/ Daniel G. Allred
	Name:	Daniel G. Allred
	Title:	Deal Team Leader
	LENDERS:
	MERRILL LYNCH CAPITAL, a division of Merrill Lynch Business Financial Services Inc.
	By:	/s/ Chris York
	Name:	Chris York
	Title:	VP
	SILICON VALLEY BANK
	By:	/s/ Daniel G. Allred
	Name:	Daniel G. Allred
	Title:	Deal Team Leader
Effective as of                     , 2006

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EXHIBIT A

The Collateral consists of all right, title and interest of Borrower in and to the following:

All goods, equipment, inventory, contract rights or rights to payment of money, license agreements, franchise agreements, general intangibles (including payment intangibles), accounts (including health-care receivables), documents, instruments (including any promissory notes), chattel paper (whether tangible or electronic), cash, deposit accounts, fixtures, letters of credit rights (whether or not the letter of credit is evidenced by a writing), commercial tort claims, securities, and all other investment property, financial assets, whether now owned or hereafter acquired, wherever located; all Supporting Obligations and all of Borrower’s Books relating to the foregoing and any and all claims, rights and interests in any of the above and all substitutions for, additions and accessions to and Proceeds thereof.

All Letter-Of-Credit Rights (whether or not the letter of credit is evidenced by a writing); and

All Borrower’s Books relating to the foregoing and any and all claims, rights and interests in any of the above and all substitutions for, additions, attachments, accessories, accessions and improvements to and replacements, products, proceeds and insurance proceeds of any or all of the foregoing.

Provided, however, the Collateral does not include any Intellectual Property.

Notwithstanding the foregoing, the Collateral shall include all accounts, license and royalty fees and other revenues, proceeds, or income arising out of or relating to any of the foregoing Intellectual Property. To the extent a court of competent jurisdiction holds that a security interest in any Intellectual Property is necessary to have a security interest in any accounts, license and royalty fees and other revenues, cash proceeds, or income arising out of or relating to any of the foregoing Intellectual Property, then the Collateral shall, effective as of the Closing Date, include the Intellectual Property, to the extent (and only to the extent) necessary to permit perfection of the Lenders’ security interest in such accounts, license and royalty fees and other revenues, cash proceeds, or income arising out of or relating to any of the Intellectual Property.

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EXHIBIT B

Loan Payment /Advance Request Form

Fax To:                                                                                             Date:                                                                                            

LOAN PAYMENT:

Inspire Pharmaceuticals, Inc. (Borrower)

From Account #                                                                                             

(Deposit Account #)                                                                                      

Principal $                                                                                                        

To Account #                                                                                                  

(Loan Account #)                                                                                           

and/or Interest $                                                                                              

All Borrower’s representation and warranties in the Loan and Security Agreement are true, correct and complete in all material respects on the date of the transfer request for an advance, but those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date:

Authorized Signature:                                                                            

Phone Number:                                                                                         

2nd Authorized Signature :                                                                  

LOAN ADVANCE:

Complete Outgoing Wire Request section below if all or a portion of the funds from this loan advance are for an outgoing wire.

From Account #                                                                                        

(Loan Account #)                                                                                     

Amount of Advance $                                                                             

To Account #                                                                                             

(Deposit Account #)                                                                                

All Borrower’s representation and warranties in the Loan and Security Agreement are true, correct and complete in all material respects on the date of the transfer request for an advance, but those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of such date:

Authorized Signature:                                                                            

Phone Number:                                                                                         

2nd Authorized Signature :                                                                  

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OUTGOING WIRE REQUEST

Complete only if all or a portion of funds from the loan advance above are to be wired.

Deadline for same day processing is 12:00pm, E.S.T.

Beneficiary Name:                                                                                   

Beneficiary Bank:                                                                                    

Amount of Wire: $                                                                                   

Account Number:                                                                                     

City and State:                                                                                                                                                                                                                                          

Beneficiary Bank Transit (ABA) #:                                                  

Intermediary Bank:                                                                                  

Beneficiary Bank Code (Swift, Sort, Chip, etc.):                         

(For International Wire Only) Transit (ABA) #:                     

For Further Credit to:                                                                                                                                                                                                                             

Special Instruction:                                                                                                                                                                                                                                 

By signing below, I (we) acknowledge and agree that my (our) funds transfer request shall be processed in accordance with and subject to the terms and conditions set forth in the agreements(s) covering funds transfer service(s), which agreements(s) were previously received and executed by me (us).

Authorized Signature:                                                                            

Print Name Title:                                                                                      

Telephone #                                                                                               

2nd Authorized Signature :                                                                  

Print Name/Title:                                                                                      

Telephone #                                                                                               

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EXHIBIT C

Compliance Certificate

TO: SILICON VALLEY BANK as Agent

FROM: INSPIRE PHARMACEUTICALS, INC.

The undersigned authorized officer of Inspire Pharmaceuticals, Inc. certifies that under the terms and conditions of the Loan and Security Agreement among Borrower, Lenders and Agent (the “Agreement”), (i) Borrower is in compliance for the period ending with all required covenants except as noted below and no Default or Event of Default has occurred and is continuing and (ii) all representations and warranties in the Agreement are true and correct in all material respects on this date (except for those representations and warranties expressly referring to a specific date, which were true and correct in all respects as of that date). Attached are the required documents supporting the certification. In addition, the undersigned certifies that (1) Borrower has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP and (2) no liens have been levied or claims made against Borrower relating to unpaid employee payroll or benefits which Borrower has not previously notified in writing to Agent. The Officer certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) consistently applied from one period to the next except as explained in an accompanying letter or footnotes. The Officer acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and that compliance is determined not just at the date this certificate is delivered.

Please indicate compliance status by circling Yes/No under “Complies” column.

Reporting Covenant	Required	Complies
Monthly financial statements with Compliance Certificate.	Monthly within 30 days	Yes        No
Annual (CPA Audited)	FYE within earlier of 120 days or 5 days after filing with SEC	Yes        No
Financial Projections approved by Board	Annually at least 30 days prior to fiscal year end	Yes        No
Financial Covenant	Required	Complies
Unrestricted cash, cash equivalents and marketable securities with Agent	40% when total cash and investments is greater than or equal to $100,000,000	Yes        No

47

	50% when total cash and investments greater than $80,000,000 but less than $100,000,000 57% when total cash and investments greater than or equal to $70,000,000 but less than $80,000,000 65% when total cash and investments greater than or equal to $60,000,000 but less than $70,000,000 75% when total cash and investments is less than $60,000,000
Minimum cash and cash equivalents, marketable securities and 80% of Eligible Accounts, measured at the end of each month	1.35x Outstandings	Yes        No

Comments Regarding Exceptions: See Attached.   Sincerely,   Signature   Title   Date BANK USE ONLY   Received by:                                                                                                         AUTHORIZED SIGNER   Date:                                                                                                                           Verified:                                                                                                                 AUTHORIZED SIGNER   Date:                                                                                                                         Compliance Status:    Yes  ¨    No  ¨

48

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (333-114517), Form S-3 (333-141169), Form S-8 (333-130496) and Form S-8 (333-56360) of Inspire Pharmaceuticals, Inc. of our report dated March 15, 2007 relating to the financial statements, management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which appears in this Annual Report on Form 10-K.

/s/ PricewaterhouseCoopers LLP

Raleigh, North Carolina

March 15, 2007

EX-31.1

Exhibit 31.1

INSPIRE PHARMACEUTICALS, INC.

CERTIFICATIONS

I, Christy L. Shaffer, certify that:

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

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

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

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

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

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

Date: March 15, 2007	/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 annual report on Form 10-K of Inspire Pharmaceuticals, Inc.;

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

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

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

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

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

Date: March 15, 2007	/s/    THOMAS R. STAAB, II
	Thomas R. Staab, II Chief Financial Officer (principal financial officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the annual report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-K for the year ending December 31, 2006, as filed with the Securities and Exchange Commission (the “Report”), I, Christy L. Shaffer, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

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

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

Date: March 15, 2007	/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 annual report of Inspire Pharmaceuticals, Inc. (the “Company”) on Form 10-K for the year ending December 31, 2006, as filed with the Securities and Exchange Commission (the “Report”), I, Thomas R. Staab, II, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

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

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

Date: March 15, 2007	/s/    THOMAS R. STAAB, II
	Thomas R. Staab, II Chief Financial Officer (principal financial officer)