<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                     . . . . . . . . . . . . . . . . . . . .

                                    FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                             OF 1934 For the fiscal
                            year ended June 30, 1997.
                                       or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                                   ACT OF 1934
                  For the transition period from ____ to _____.

                         Commission file number 0-18443

                       MEDICIS PHARMACEUTICAL CORPORATION
             (Exact name of registrant as specified in its charter)

              Delaware                                 52-1574808
(State of other jurisdiction              (I.R.S. Employer Identification No.)
of incorporation or organization)

4343 East Camelback Road, Suite 250, Phoenix, AZ                 85018-2700
(Address of principal executive office)                          (Zip Code)

Registrant's telephone number, including area code:           (602)  808-8800

Securities registered pursuant to Section 12(b) of the Act:         NONE

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

                     Class A Common Stock, $0.014 par value
                        Preference Share Purchase Rights
                              (Title of each Class)

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

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

The aggregate market value on September 16, 1997 of the voting stock held on
September 16, 1997 by non-affiliates of the registrant was $467,417,559
(calculated by excluding all shares held by executive officers, directors and
holders of five percent or more of the voting power of the registrant's Common
Stock, without conceding that such persons are "affiliates" of the Registrant
for purposes of the federal securities law).

As of September 16, 1997, there were outstanding 14,040,726 shares of Class A
Common Stock $0.014 par value and 281,974 shares of Class B Common Stock $0.014
par value.

Documents incorporated by reference:

         Portions of the Proxy Statement for the Registrant's 1997 Annual
Meeting of Stockholders are incorporated herein by reference in Part III of this
Form 10-K to the extent stated herein.
<PAGE>   2
                                     PART I


         This Report contains forward-looking statements which involve risks and
uncertainties. The actual results of Medicis Pharmaceutical Corporation
(together with its wholly-owned subsidiaries, the "Company" or "Medicis") could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including those set forth in this Annual Report on
Form 10-K and the Company's other Securities and Exchange Commission filings.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operation."

ITEM 1. BUSINESS

THE COMPANY

         Medicis is the leading independent pharmaceutical company in the United
States that offers prescription, over-the-counter ("OTC"), and cosmetic products
and procedures exclusively to treat dermatological conditions. Emphasizing the
clinical effectiveness, quality, affordability and cosmetic elegance of its
products, the Company has achieved a leading position in the treatment of acne,
acne-related conditions and psoriatic conditions, while also offering the
leading domestic OTC fade cream product. The Company has built its business
through the successful introduction of DYNACIN(R) and TRIAZ(R) products for the
treatment of acne and the acquisition of the LIDEX(R) and SYNALAR(R)
corticosteroid product lines, and the ESOTERICA(R) fade cream product line.

PRINCIPAL PRODUCTS AND PRODUCT LINES

         Medicis currently offers products in the following areas of
dermatology: acne, inflammatory skin conditions, therapeutic emollients and
moisturizers, hyperpigmentation and cosmetic dermatology. The Company addresses
these areas with a range of prescription products, dermatologist-dispensed
products and procedures and OTC products.

   PRESCRIPTION PHARMACEUTICALS

         Prescription pharmaceuticals accounted for 86.5% of the Company's net
sales in the fiscal year ended June 30, 1997 ("fiscal 1997"). Medicis currently
focuses its prescription pharmaceutical efforts primarily on treating acne,
inflammatory skin conditions, psoriasis and other related conditions. The
Company's branded pharmaceuticals are as follows:

DYNACIN(R) is an oral, systemic antibiotic prescribed for the treatment of
moderate to severe acne vulgaris, the most common form of acne, a condition that
resulted in over 10 million visits to dermatologists in 1995. The most commonly
prescribed systemic acne treatments are tetracycline and its derivatives,
doxycycline and minocycline. Minocycline, the active ingredient in DYNACIN(R)
products, is widely prescribed for the treatment of acne for several reasons. It
has a more convenient schedule of one or two doses per day as compared to other
forms of tetracycline, which can require up to four doses per day. Other forms
of tetracycline require ingestion on an empty stomach and often increase patient
sensitivity to sunlight, creating a greater risk of sunburn. Moreover, the other
forms of tetracycline, including doxycycline, often cause gastric irritation. In
addition, resistance to several commonly used antibiotics, including
erythromycin, clindamycin, doxycycline and tetracycline, by the primary
bacterial organism responsible for acne has been documented. Studies suggest
that bacterial resistance to erythromycin exceeds 60%, and resistance to
doxycycline and tetracycline exceeds 40%, while the bacteria showed virtually no
resistance to minocycline. Thus, although more expensive than other forms of
branded tetracycline and many times more expensive than generic tetracycline,
minocycline is documented to have clinical performance that is superior to other
forms of tetracycline, while avoiding many of its disadvantages. However, the
retail price of DYNACIN(R) is approximately 30% lower than the average reported
retail price of another branded minocycline product, Minocin, while selling at
approximately 25% to 30% higher than the average reported retail price of
generic minocycline. DYNACIN(R) is at least comparable in performance to Minocin
and is believed by the Company

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to enjoy certain performance characteristics that favorably distinguish it from
generic minocycline. DYNACIN(R) was launched in the second quarter of the fiscal
year ended June 30, 1993 ("fiscal 1993"). At June 30, 1997, DYNACIN(R) held
approximately 56% of total branded minocycline market sales and was the leading
branded minocycline in the United States. There can be no assurance that
DYNACIN(R) will not lose significant market share in the future, that it will
remain a competitive product, or that the Company will be able to compete
successfully in the acne treatment market through the sale of DYNACIN(R) or any
other product. The Company has entered into a manufacturing and supply agreement
with Schein Pharmaceuticals, Inc. ("Schein") for the supply of DYNACIN(R)
products. See "-- Manufacturing."

TRIAZ(R) is a topical therapy prescribed for the treatment of all forms and
varying degrees of acne, and is available as a gel in two concentrations and as
a cleanser. The combined domestic sales of topically-applied prescription acne
products were in excess of $500 million in 1996. The most frequently prescribed
topical acne treatments include Cleocin-T, generic topical clindamycin, and
Benzamycin. While these therapies are generally effective, TRIAZ(R) offers
advantages over each product, including improved stability, greater convenience
of use, reduced cost and fewer side effects. Benzamycin requires refrigeration
and mixing by a pharmacist and has a relatively short shelf life of three
months. TRIAZ(R) comes in a ready-mixed gel that does not require refrigeration
and has a two-year shelf life. In addition, TRIAZ(R) is aesthetically pleasing
and minimizes the extreme drying and scaling of skin often caused by competing
brands. The average reported retail price of TRIAZ(R) is less than that of
either Cleocin-T or Benzamycin. TRIAZ(R) products are manufactured using the
active ingredient benzoyl peroxide in a vehicle containing glycolic acid and
zinc lactate. Studies have shown that benzoyl peroxide is the most efficacious
agent available for eradicating the bacteria that cause acne. Glycolic acid is
believed by the Company to enhance the effectiveness of benzoyl peroxide by
exfoliating the outer layer of the skin (thereby providing direct access to the
bacteria), and zinc lactate is believed by the Company to act to reduce the
appearance of inflammation and irritation often associated with acne. TRIAZ(R)
was developed internally by the Company's formulation scientists and introduced
in the second quarter of the year ended June 30, 1996 ("fiscal 1996"). There can
be no assurance that the Company will be able to successfully market the
TRIAZ(R) product line or that the TRIAZ(R) product line will achieve or retain
market acceptance. The Company has certain licensed patent rights covering
varying aspects of TRIAZ(R). TRIAZ(R) products are manufactured to the Company's
specifications on a purchase order basis by Paco Laboratories, Inc. and Accupac,
Inc. See "--Manufacturing," "-- Trademarks" and "-- Patents and Proprietary
Rights."

LIDEX(R) is a high-potency topical corticosteroid brand prescribed for the
treatment of inflammatory and hyperproliferative skin diseases such as eczema,
psoriasis, atopic dermatitis, poison ivy, and other inflammatory skin
conditions. LIDEX(R) was introduced more than 20 years ago and is among the most
widely-accepted, efficacious and safe topical steroid treatments available.
Medicis acquired LIDEX(R) and SYNALAR(R) in the United States and Canada from
Syntex U.S.A., a division of F. Hoffman-LaRoche (Roche), in the third quarter of
fiscal 1997. The addition of the LIDEX(R) and SYNALAR(R) products broadens the
range of treatments the Company makes available to dermatologists and their
patients. The active ingredient in LIDEX(R), fluocinonide, works to alleviate
inflammations of the skin by reducing swelling and pain, relieving itching and
constricting blood vessels in the skin. The LIDEX(R) product line consists of
various strengths and cosmetically elegant formulations, including gels,
ointments, creams, solutions and emollient creams. This flexibility allows
dermatologists to prescribe the most appropriate product based on the severity
and location of a patient's condition, as well as the thickness of skin. The
various forms of LIDEX(R) are preservative-free, and the active ingredient is
fully dissolved in the vehicle of the medication (with the exception of the
LIDEX-E(R) Cream), resulting in better absorption of the medication into the
skin. Competing steroid brands in the high potency category include Halog,
Elocon, and Cyclocort. LIDEX(R) also competes with steroid brands in the
super-potency category such as Temovate, Diprolene and Psorcon; however, these
products have a time limitation on their usage, whereas there are no
restrictions on the length of treatment with LIDEX(R). LIDEX(R) is priced
comparably to other branded corticosteroid products. There can be no assurance
that the Company will be able to successfully market the LIDEX(R) product line
or that the LIDEX(R) product line will achieve or retain market acceptanceThe
Company has a manufacturing and supply agreement with Patheon, Inc., for the
production of LIDEX(R). See "--Manufacturing," "-- Trademarks" and "-- Patents
and Proprietary Rights."


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SYNALAR(R) is a mid- to low-potency topical corticosteroid brand prescribed for
the treatment of less severe forms of inflammatory and hyperproliferative skin
diseases such as eczema, psoriasis, poison ivy, atopic dermatitis and other
inflammatory skin conditions. The active ingredient in SYNALAR(R), fluocinolone
acetonide, works to alleviate inflammations of the skin by reducing swelling and
pain, relieving itching and constricting blood vessels in the skin. The
SYNALAR(R) product line consists of various strengths and cosmetically elegant
formulations, including ointments, creams, emollient creams and solutions. This
flexibility allows dermatologists to prescribe the most appropriate product
based on the severity and location of a patient's condition, as well as the
thickness of skin. Competing steroid brands in the mid- and low-potency
categories include Aristocort, Cutivate, and Valisone. There can be no assurance
that the Company will be able to successfully market the SYNALAR(R) product line
or that the SYNALAR(R) product line will achieve or retain market acceptance.
SYNALAR(R) is priced comparably to other branded corticosteroid products. The
Company has a manufacturing and supply agreement with Patheon, Inc., for the
production of SYNALAR(R). See "-- Manufacturing," "-- Trademarks" and "--
Patents and Proprietary Rights."

THERAMYCIN(TM) Z is a topical antibiotic therapy available as a lotion
prescribed for the treatment of acne. THERAMYCIN(TM) Z is erythromycin in a
solution containing zinc acetate, which acts to reduce the appearance of
inflammation and irritation often associated with acne. THERAMYCIN(TM) Z
competes with other topical acne treatments, including Cleocin-T, Erycette, ATS,
Emgel and other topical antibiotics. There can be no assurance that the Company
will be able to successfully market the THERAMYCIN(TM) Z product line or that
the THERAMYCIN(TM) Z product line will achieve or retain market acceptance. The
Company has an exclusive worldwide license to market this product from a
subsidiary of IVAX Corporation ("IVAX"). The Company purchases THERAMYCIN(TM) Z
from IVAX pursuant to a manufacturing and supply agreement. See
"--Manufacturing" and "-- Certain License and Royalty Agreements."

BENZASHAVE(R) products are shave creams marketed by the Company as topical
therapies for the treatment of pseudofolliculitis barbae ("PFB") and acne
associated with shaving. PFB, commonly called "razor bumps," is a painful
irritation aggravated by shaving. This condition affects millions of men in the
United States, particularly African Americans and others with relatively coarse
facial hair. However, medical treatment is often not sought, as many men
afflicted with PFB grow facial hair to avoid shaving, or use a variety of
nonprescription shaving products which claim to alleviate the condition. The
Company believes that BENZASHAVE(R) products are the only prescription shaving
products available for treatment of PFB and acne associated with shaving. There
can be no assurance that the Company will be able to successfully market
BENZASHAVE(R) products or that BENZASHAVE(R) will achieve or maintain market
acceptance. The Company entered into an exclusive worldwide license to market
BENZASHAVE(R) with IVAX in the fiscal year ended June 30, 1991 ("fiscal 1991"),
which includes a license of patent rights relating to the use of benzoyl
peroxide in the treatment of PFB. The Company purchases BENZASHAVE(R) pursuant
to a manufacturing and supply agreement. See "--Manufacturing," "--Certain
License and Royalty Agreements," "-- Trademarks" and "-- Patents and Proprietary
Rights."

   DERMATOLOGIST-DISPENSED COSMETIC DERMATOLOGY TREATMENTS

         In the third quarter of fiscal 1997, the Company introduced a new
business unit called TxSYSTEMS by MEDICIS(TM), to market cosmetic dermatology
treatments for sale directly to dermatologists nationwide for administration
and dispensing to patients. With more than 80 million Americans turning 50
between 1997 and 2010, demand for cosmetic procedures and products continues to
grow. Cosmetic dermatology has gained increasing importance as new therapies
and procedures have become available to effect significant improvement in the
appearance of skin and hair. Numerous non-prescription treatments are available
today, including glycolic acid in the form of creams and lotions to treat the
appearance of fine lines and improve skin texture, as well as various chemical
peels designed to rejuvenate the skin and correct scarring, discoloration and
textural irregularities. Furthermore, because cosmetic treatment is
discretionary and not covered by medical insurance, this market segment is not
subject to the impact of managed care seen in other areas of dermatology. Thus
the dispensing business is an important area for the continued growth and
success of the Company, and the Company will seek to become a leader in the
field of cosmetic dermatology through the timely introduction of innovative
products in this growing category. Initially, two products have been introduced
by the TxSYSTEMS by MEDICIS(TM) business unit:


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AFIRM(TM) is a line of topical creams containing the active ingredient retinol,
a vitamin-A derivative, to improve the texture and appearance of skin. AFIRM(TM)
works directly on the epidermis to exfoliate skin and restore and enhance the
natural cell renewal process. AFIRM(TM) reduces the appearance of fine lines,
superficial scars, and skin discoloration, helps to repair sun damaged skin, and
makes skin look and feel smoother and firmer. The cosmetically elegant
formulation of the creams makes AFIRM(TM) greaseless, non-comedogenic, and safe
for daily use. The product incorporates MICROSPONGE(R) technology developed by
Advanced Polymer Systems, Inc. ("APS") to maintain stability of the retinol
molecule and provide continuous delivery of retinol to the skin, simultaneously
providing improved bioavailability by absorption and reduced skin irritation.
AFIRM(TM)is available in three strengths of retinol for varying skin types.
There can be no assurance that the Company will be able to successfully market
the AFIRM(TM)product line or that the AFIRM(TM)product line will achieve or
retain market acceptance. The Company has a license and supply agreement with
APS for the manufacture of AFIRM(TM), which includes certain restrictions on the
ability of the Company to market this product directly to consumers. See "--
Manufacturing" and "-- Certain License and Royalty Agreements."

BETA-LIFTX(TM) is a five-minute peel procedure that stimulates cell turnover and
renewal through the application of salicylic acid in the form of microcrystals
using the MICROSPONGE(R) technology developed by APS. BETA-LIFTx(TM) works to
reduce the appearance of fine lines, skin discoloration, superficial scars, and
other signs of photodamaged skin. Unlike glycolic acid or other chemical peels,
the BETA-LIFTx(TM) product is self limiting or automatically shuts off after
approximately five minutes and does not damage the integrity of the skin's
function as a protective barrier, making the procedure easier and safer to
perform than similar in-office treatments. BETA-LIFTx(TM) is sold to
dermatologists in the form of a kit containing pre-cleanse pads, one application
of the salicylic acid, and a 1 oz. bottle of THERAPLEX HYDROLOTION(R) as an
after-care moisturizer. BETA-LIFTx(TM) was developed and patented by Dr. Albert
Kligman, the inventor of Johnson & Johnson's topical acne treatment Retin-A(R),
and Dr. Douglas Kligman. There can be no assurance that the Company will be able
to successfully market the BETA-LIFTx(TM) product line or that the
BETA-LIFTx(TM) product line will achieve or retain market acceptance. The
Company has a license and supply agreement with APS for the production of
BETA-LIFTx(TM), which includes certain restrictions on the ability of the
Company to market this product to certain specialties outside dermatology.
See "-- Manufacturing" and "-- Certain License and Royalty Agreements."

   OVER-THE-COUNTER PRODUCTS

         OTC pharmaceutical products accounted for 13.5% of the Company's net
sales in fiscal 1997. Medicis markets a variety of OTC skin care products to
treat hyperpigmentation, dry skin and certain inflammatory skin conditions. The
Company's OTC products are as follows:

ESOTERICA(R) is a line of topical creams used to treat minor skin discoloration
problems such as age spots, uneven skin tones, dark patches, blotches and
freckles. ESOTERICA(R) is the leading line of fade creams in the United States.
ESOTERICA(R) is available in five formulations, consisting of four creams
containing various concentrations of the active ingredient hydroquinone and a
body lotion. Hydroquinone is the only agent proven to reduce hyperpigmentation
and the only product legally sold in the United States for this purpose. Other
OTC products used to treat minor skin discoloration include Porcelana and AMBI,
which are sold in a variety of creams, gels and lotions. There can be no
assurance that the Company will be able to successfully market the ESOTERICA(R)
product line or that the ESOTERICA(R) product line will maintain market
acceptance. The Company acquired the ESOTERICA(R) product line from SmithKline
Beecham Consumer Healthcare L.P. ("SmithKline") in fiscal 1991, and assumed the
marketing of these products in the United States and Canada. The Company has a
manufacturing agreement for the ESOTERICA(R) products with Contract
Pharmaceuticals Limited on a purchase order basis. See "-- Manufacturing."


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THERAPLEX(R) is a line of moisturizers that are used for the treatment of dry
skin or certain inflammatory skin conditions, such as psoriasis, eczema or
ichthyosis. The THERAPLEX(R) line consists of three products, THERAPLEX(R)
EMOLLIENT, THERAPLEX(R) CLEARLOTION and THERAPLEX(R) HYDROLOTION, that combine
high molecular weight hydrocarbons, the active component of petrolatum, with
certain silicones. THERAPLEX(R) moisturizers do not contain the normally greasy,
sticky and odoriferous petrolatum components found in competitive products. Skin
care products containing the patented ingredient present in THERAPLEX(R)
moisturizers have been marketed by other companies under other trade names for
several years in certain European countries, and more recently in Canada.
THERAPLEX(R) moisturizers compete with a variety of other moisturizing products,
including Eucerin, Lubriderm and Keri-Lotion, as well as other mass marketed
moisturizers. There can be no assurance that the Company will be able to
successfully market the THERAPLEX(R) product line or that the THERAPLEX(R)
product line will achieve or retain market acceptance. The Company acquired a
license to the patent underlying the THERAPLEX(R) product line in 1990. The
Company has various agreements for the manufacture of the THERAPLEX(R) product
line on a purchase order basis and is obligated to pay certain royalties on its
product sales. See "-- Manufacturing" and "-- Certain License and Royalty
Agreements."

PRODUCTS IN DEVELOPMENT

         The Company has developed and obtained rights to certain dermatological
agents in various stages of development, and with potential applications,
including line extensions, new products and reformulations of existing products.
Medicis' strategy involves the rapid evaluation and formulation of new
therapeutics by obtaining preclinical safety and efficacy data (when possible),
followed by rapid safety and efficacy testing in humans. While development
periods may vary, the Company generally selects products for development with
the objective of proceeding from formulation to product launch within a two-year
period.

         Medicis directs the efforts of contract laboratory research facilities
to perform formulation and research work on active ingredients as well as the
third-party conduct of preclinical studies and clinical trials. All products and
technologies under development will require significant commitments of personnel
and financial resources. Several products will require extensive clinical
evaluation and premarketing clearance by the United States Food and Drug
Administration ("FDA") and comparable agencies in other countries prior to
commercial sale. Certain of the products and technologies under development have
been licensed from third parties. The failure of the Company to meet its
obligations under one or more of these agreements could result in the
termination of the Company's rights under such agreements. In addition, the
Company regularly reevaluates its product development efforts. On the basis of
these reevaluations, the Company has in the past, and may in the future, abandon
development efforts for particular products. No assurance can be given that any
product or technology under development will result in the successful
introduction of any new product. Failure of the Company to introduce and market
new products, whether internally developed or acquired from third parties, could
have a material adverse effect on the Company's business, financial condition or
results of operation. See "-- Government Regulation."

         The Company's research and development costs for Company-sponsored and
unreimbursed co-sponsored pharmaceutical projects for fiscal 1997, fiscal 1996
and the fiscal year ended June 30, 1995 ("fiscal 1995") were $1,450,000,
$952,000 and $770,000, respectively. The Company has in the past supplemented,
and may in the future supplement, its research and development efforts by
entering into additional research and development agreements with other
pharmaceutical companies in order to defray the cost of product development.
There can be no assurance that the Company will enter into research and
development agreements acceptable to the Company, or at all.

         In June 1997, the Company signed an agreement with Abbott Laboratories,
Inc. ("Abbott") for the development and manufacture of a branded dermatologic
product. Abbott will be responsible for the development and eventual manufacture
of the product, which the Company will market exclusively to dermatologists. The
Company will pay certain costs with respect to certain product approvals
estimated to be approximately $1,000,000.


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MARKETING AND SALES

   PRESCRIPTION PHARMACEUTICALS

        The Company believes its marketing and sales organization to be of the
most productive in the dermatology sector. The marketing effort is focused on
assessing and meeting the needs of dermatologists. The Company's prescription
sales team, consisting of 33 members at September 16, 1997, regularly calls on
dermatologists. Those dermatologists responsible for a relatively higher volume
of prescriptions are visited more frequently than less busy practices. The
Company has created an incentive program based on aggressive goals in market
share growth, and believes its highest performing sales representatives to be
well compensated. The Company believes that its most effective promotion is
achieved by cultivating a relationship of trust and confidence with
dermatologists themselves. Medicis also uses a variety of marketing techniques
to promote its products, including sampling, journal advertising, promotional
material, specialty publications, rebate coupons, product guarantees, a
leadership position in educational conferences and exposure of its products on
the Internet.

   OVER-THE-COUNTER PRODUCTS

         The Company's OTC products are promoted to retailers and wholesalers by
manufacturers' representatives who also support a substantial number of products
of other manufacturers. The Company also markets its OTC products through trade
promotions, radio and print advertising, couponing and consumer awareness
programs.

   DERMATOLOGIST-DISPENSED COSMETIC DERMATOLOGY TREATMENTS

         The Company has a separate, specially-dedicated sales force of 13 field
representatives as of September 16, 1997, as part of the new TxSYSTEMS by
MEDICIS(TM) business unit to market cosmetic dermatology products for sale
directly to dermatologists. TxSYSTEMS(TM) representatives call on high-volume
dermatologists who are actively engaged in dispensing cosmetic products directly
to patients and who perform cosmetic procedures in their offices. The nature of
cosmetic products makes the selling method and message different for
TxSYSTEMS(TM) representatives than that of the prescription sales force.
TxSYSTEMS(TM) representatives conduct in-depth product demonstrations and
training, assist physicians and their office staffs with merchandising, and
provide consulting to dermatologists beginning in the dispensing business. The
Company also uses a variety of marketing techniques to support the field sales
force, including promotional and display materials, direct mail programs,
journal advertising, public relations efforts to obtain editorial coverage of
the product, and attendance at educational conferences and seminars.

WAREHOUSING AND DISTRIBUTION

         The Company utilizes an independent national warehousing corporation to
store and distribute its products from three central warehousing locations in
California, Kansas and Maryland. Upon the receipt of a purchase order through
electronic data input ("EDI"), phone, mail or facsimile, the order is processed
into the Company's inventory systems, at which time an inventory picking sheet
is automatically placed via EDI to the most efficient warehouse location for
shipment, usually within 24 hours, to the customer placing the order. Upon
shipment, the warehouse sends back to the Company via EDI the necessary
information to automatically process the invoice in a timely manner.

CUSTOMERS

         Medicis' customers include the nation's leading wholesale
pharmaceutical distributors, such as McKesson Drug Company ("McKesson"), Bergen
Brunswig Drug Company ("Bergen Brunswig"), Cardinal Health, Inc. ("Cardinal"),
Bindley Western Drug Company ("Bindley") and major drug chains. During fiscal
1997, McKesson, Cardinal and Bergen Brunswig accounted for approximately 20.6%,
16.3% and 10.9%, respectively, of the Company's sales. For fiscal 1996,
McKesson, Bergen Brunswig and Cardinal accounted for approximately 15.5%, 12.2%
and 11.8%, respectively, of the Company's sales. For fiscal 1995, McKesson and
Bergen Brunswig accounted for approximately 15.9% and 9.6%, respectively, of the
Company's sales. The distribution network for


                                      - 7 -
<PAGE>   8
pharmaceutical products has, in recent years, been subject to increasing
consolidation. As a result, a few large wholesale distributors control a
significant share of the market. In addition, the number of independent drug
stores and small chains has decreased as retail consolidation has occurred.
Further consolidation among wholesale distributors or retailers could result in
the combination or elimination of warehouses which may stimulate product returns
to the Company, cause a reduction in their inventory levels, or otherwise result
in reductions in purchases of the Company's products, any of which could result
in a material adverse impact upon the Company's business, financial condition or
results of operations.

MANUFACTURING

         The Company currently contracts for all of its manufacturing needs and
is permitted to contract only with manufacturers that comply with FDA current
Good Manufacturing Practices ("cGMP") regulations and other applicable laws and
regulations. The Company typically does not enter into long-term manufacturing
contracts with third-party manufacturers. Whether or not such contracts exist,
there can be no assurance that the Company will be able to obtain adequate
supplies of such products in a timely fashion, or at all.

         The Company's DYNACIN(R) products are manufactured by Schein in
compliance with the Company's stringent, internally developed specifications and
quality standards pursuant to a supply agreement that expires in December 1999.
Under the agreement, Schein manufactures minocycline for sale in the branded
market exclusively for the Company, but may manufacture and sell minocycline for
itself or others as a generic product. Schein currently manufactures minocycline
for the generic market under its own label. The Schein supply agreement is
subject to automatic renewal for successive two-year periods if neither party
gives timely notice of termination and may also be canceled without cause upon
12-months' notice. Schein may also terminate the exclusivity portion of the
agreement if its profit margin on sales of DYNACIN(R) products falls below a
specified level. Schein may terminate the agreement upon a material breach by
the Company, in the event that the Company becomes insolvent, or if any lawsuit
is commenced alleging a patent or a proprietary rights violation. The agreement
also provides that the Company will purchase all of its requirements for
minocycline from Schein but may purchase some of its requirements from another
manufacturer if Schein fails to meet certain cost standards or fails to provide
the Company with all of its requirements for two of four consecutive calendar
quarters. In addition, the Company may use alternative sources if Schein
terminates the Company's exclusive rights to purchase branded minocycline based
upon the Company's failure to meet the specified profit margins, as defined.
Either party may terminate the agreement in the event that one party cannot
perform under the agreement for a period of three months or longer for certain
reasons beyond its control, such as war, strike, fire, lockout or acts of God.
The Company believes that it has alternative sources of supply and that it would
be able to use these alternative sources to preserve an adequate supply of
DYNACIN(R). However, the inability of Schein to fulfill the Company's supply
requirements for DYNACIN(R), currently the Company's largest-selling product,
could have a material adverse effect on the Company's business, financial
condition or results of operations.

         The Company's LIDEX(R) and SYNALAR(R) products are manufactured
primarily by Patheon, Inc., in accordance with a manufacturing and supply
agreement assumed by the Company concurrent with the acquisition of the LIDEX(R)
and SYNALAR(R) products. Under the terms of the agreement, Roche shall continue
to supply, at cost, active ingredients necessary for manufacturing the LIDEX(R)
and SYNALAR(R) products. The Patheon manufacture and supply agreement is subject
to one-year automatic renewals subsequent to its current expiration in January
1999. Two stock-keeping units ("SKUs") of the LIDEX(R) products are manufactured
on a purchase order basis and in accordance with an indemnification agreement
with Paco Laboratories, Inc. The inability of Patheon, Inc., to fulfill the
Company's supply requirements for LIDEX(R) and SYNALAR(R) could have a material
adverse effect on the Company's business, financial condition or results of
operations.

         The Company's AFIRM(TM) and BETA-LIFTx(TM) products are manufactured by
APS pursuant to a license and supply agreement that expires on the later of the
expiration date of the last to expire patent relating to the AFIRM(TM) and
BETA-LIFTx(TM) products, or in October 2006, the tenth anniversary of the
effective date. Under the terms of the agreement, APS may manufacture and sell
similar products at specified strengths for itself or others to be marketed
outside the specialty of dermatology. In the event that APS fails to supply the
Company's requirements for either product, the Company is permitted to purchase
its requirements from third parties.


                                      - 8 -
<PAGE>   9
        The Company purchases THERAMYCIN(TM) Z and BENZASHAVE(R) products
exclusively from IVAX, pursuant to a manufacturing agreement expiring in July
2000. In the event that IVAX is prevented from completing performance of its
obligations under the agreement for specified reasons beyond its control, it is
excused from such performance until such time as the event preventing its
performance ceases. If IVAX is unable to supply the Company's requirements of
either product, the Company is permitted to purchase the unsatisfied
requirements from third parties.

        The remainder of the Company's products are produced on a purchase order
basis only, including its ESOTERICA(R) products, manufactured by Contract
Pharmaceuticals Limited; THERAPLEX(R) EMOLLIENT products, manufactured by ViFor,
S.A., a Swiss manufacturing company ("ViFor"); THERAPLEX(R) CLEARLOTION
products, manufactured by Accupac, Inc.; THERAPLEX(R) HYDROLOTION products,
manufactured by BeautiControl Cosmetics, Inc.; and TRIAZ(R) products,
manufactured by Paco Laboratories, Inc.

        There can be no assurance that the above manufacturers will continue to
meet the FDA's regulations or the Company's product specifications and standards
for the indicated products or that they can continue to meet product demand on a
consistent and timely basis. Schein, IVAX and ViFor are currently the sole
manufacturers of DYNACIN(R) products, THERAMYCIN(TM) Z and BENZASHAVE(R)
products, and THERAPLEX(R) EMOLLIENT products, respectively. The Company
believes that alternative sources of manufacturing are available for all of its
products. Because of the FDA requirement for cGMP validation of manufacturing
facilities for particular products, validation of a new facility to serve as a
replacement source of manufacturing requires a substantial period of time. Any
loss of a manufacturer or other manufacturing difficulties could have a material
adverse effect on the Company's business, financial condition or results of
operations. The Company has obtained business interruption insurance to insure
against the loss of income for up to 12 months due to the interruption of
manufacturing of the Company's five principal products due to certain causes.
While the Company believes that the policy provides substantial protection
against the covered events, there can be no assurance that the policy will cover
all manufacturing interruptions or that the amount of such insurance will be
adequate to fully protect the Company for losses associated with such
interruptions.

        The Company's third-party manufacturers rely on certain suppliers of key
raw materials. Certain of those materials are purchased from single sources and
others may be purchased from single sources in the future. Although the Company
has no reason to believe that it will be unable to procure adequate supplies of
such raw materials on a timely basis, disruptions in supplies, including delays
due to the inability of the Company or its manufacturers to procure raw
materials, would have a material adverse effect on the Company's business,
financial condition and results of operations.

        Any interruptions in the supply of any of the Company's products due to
shortages in raw materials, changes in manufacturing sources, regulatory changes
or other causes could delay or eliminate the Company's ability to supply such
products. In addition, the Company faces the risk that, upon expiration of the
term of any third-party manufacturing agreement, it may not be able to renew or
extend the agreement with the third-party manufacturer, to obtain an alternative
manufacturing source from other third parties or to develop internal
manufacturing capabilities on commercially viable terms, if at all. To manage
its resources effectively, the Company attempts to retain inventory levels that
are no greater than necessary to meet the currently projected needs of its
customers.

        There can be no assurance that the Company will not suffer future supply
insufficiencies or interruptions or that it will be able to obtain adequate
supplies of its products in a timely fashion, or at all. While the Company
believes that its inventory levels are generally adequate, the loss of a
manufacturer, the failure to obtain a replacement manufacturer on a timely
basis, other manufacturing problems or any interruption of supply could have a
material adverse effect on the Company's business, financial condition or
results of operations.

CERTAIN LICENSE AND ROYALTY AGREEMENTS

        In July 1990, the Company entered into two separate license agreements
with IVAX, as successor to Syosset Laboratories, Inc. ("Syosset"), under which
the Company acquired a 10-year exclusive, worldwide license to market and
sublicense the products Erythromycin 2%, which Medicis markets as
THERAMYCIN(TM)Z,


                                      - 9 -
<PAGE>   10
BENZASHAVE(R) 5% and 10% and certain other products. IVAX also manufactures the
licensed products for the Company pursuant to a manufacturing agreement. The
licensing agreements are subject to termination by IVAX upon a material failure
of the Company to perform its obligations under the agreements for 60 days, or
upon the Company's failure to perform under the payment provisions of the
agreements for 30 days, or upon the filing of a petition in bankruptcy by or
against the Company.

         In April 1989, the Company sublicensed a United States patent relating
to the THERAPLEX(R) line of products pursuant to a modified license agreement
among the Company, Dr. Hans Rudi Suess and H.R. Suess, A.G. (collectively,
"Suess") and Euromerican Trade Resources, Inc. ("Euromerican"). The Company was
granted an exclusive sublicense to market all products manufactured pursuant to
the patent in the United States, Mexico and Japan, until the patent expires in
October 1999. The agreement further grants the Company the right to otherwise
exploit the know-how embodied in the patent. The agreement requires that the
Company make annual payments of specified minimum royalties. The agreement is
subject to termination by Suess upon Euromerican's failure to perform its
obligations under the agreement for 45 days or by Suess or Euromerican upon the
Company's failure to perform its obligations under the agreement for 45 days or
upon the occurrence of other standard events of default. The Company has also
received a separate assignment from Dr. Eugene Gans and Dr. Suess of certain
patent rights relating to the Company's THERAPLEX(R) HYDROLOTION products.

         In October 1996, the Company entered into a license and supply
agreement with APS under which the Company has exclusive rights to market APS'
proprietary retinol product, which the Company markets as AFIRM(TM), to the
specialty of dermatology, and APS' proprietary salicylic acid product, which the
Company markets as BETA-LIFTx(TM). APS also manufactures the licensed products
for the Company pursuant to this license and supply agreement. The agreement
expires on the later of the expiration date of the last to expire patent
relating to the AFIRM(TM) and BETA-LIFTx(TM) products or on the tenth
anniversary of the effective date.

         There can be no assurance that the Company will fulfill its obligations
under any of the foregoing agreements. The failure to satisfy the requirements
of any agreement could result in the loss of the Company's rights under the
agreements and in other related agreements which could have a material adverse
affect upon the Company's business, financial condition or results of
operations.

TRADEMARKS

         The Company believes that trademark protection is significant in
establishing product recognition. The Company owns 51 federally registered
trademarks. The Company has filed United States applications for registration of
59 additional trademarks and service marks. United States federal registrations
for trademarks remain in force for 10 years and may be renewed every 10 years
after issuance provided the mark is still being used in commerce. There can be
no assurance that any such trademarks or service marks will afford the Company
adequate protection, or that the Company will have the financial resources to
enforce its rights under any such trademarks and service marks. The inability of
the Company to protect its trademarks or service marks from infringement could
result in injury to any goodwill which may be developed in such trademarks or
service marks. Moreover, the Company's inability to use one or more of its
trademarks or service marks because of successful third-party claims to such
marks could have a material adverse effect on the Company's business, financial
condition or results of operations.

         From time to time, the Company receives communications from parties who
allege that their trademark interests may be damaged either by the Company's use
of a particular trademark or its registration of such trademark. In general, the
Company seeks to resolve such conflicts before an actual opposition to
registration or suit for infringement is filed. There can, however, be no
assurance that such oppositions will not be filed or that, if filed, they will
not have a material adverse effect upon the Company's business, financial
condition or results of operations.


                                     - 10 -
<PAGE>   11
PATENTS AND PROPRIETARY RIGHTS

         The Company has licensed rights to products covered by certain United
States patents directed to aspects of the THERAPLEX(R), BENZASHAVE(R), AFIRM(TM)
and BETA-LIFTx(TM) compounds/formulations, and the Company has obtained patents
directed to aspects of several other compounds. The Company is also pursuing
several United States patent applications. No assurance can be given that
patents will be issued with respect to any of these applications. The Company
has acquired rights under certain patents and patent applications from
third-party licensors. The Company has also acquired from certain of its
consultants and principals an assignment of their rights to certain United
States patents or patent applications. Certain of such patents and patent
applications may be subject to claims of rights by third parties by reason of
existing relationships with the party who filed such patents or patent
applications. No assurance can be given that the Company will be able to obtain
any rights under such patents or patent applications as a result of such
conflicting claims, or that any rights which the Company may obtain will be
sufficient for the Company to market products which may be the subject of such
patents or patent applications. The Company may be required to obtain licenses
and/or pay royalties to obtain the rights it acquires under such patents or
patent applications, and no assurance can be given that the Company will be able
to obtain rights under such patents or patent applications on terms acceptable
to the Company, or at all.

         The Company believes that its success will depend in part on its
ability to obtain and maintain patent protection for its own inventions, and to
obtain and maintain licenses for the use of patents licensed or sublicensed by
third parties. No assurance can be given that any patent issued to, or licensed
by, the Company will provide protection that has commercial significance. In
this regard, the patent position of pharmaceutical compounds is particularly
uncertain. There can be no assurance that challenges will be not be instituted
against the validity or enforceability of any patent owned by or licensed to the
Company or, if instituted, that such challenges will not be successful. The
Company only conducts complete searches to determine whether its products
infringe upon any existing patents as it deems appropriate. The cost of
litigation to uphold the validity and prevent infringement of patents can be
substantial and require a significant commitment of management's time.
Furthermore, there can be no assurance that others will not independently
develop similar technologies or duplicate the technology owned by or licensed to
the Company or design around the patented aspects of such technology. There can
be no assurance that the products and technologies the Company currently
markets, or may seek to market in the future, will not infringe patents or other
rights owned by others. In the event of an adverse outcome of any dispute with
respect to patents or other rights, the Company may be required to license such
disputed rights or cease using such disputed rights. There can be no assurance
that a license would be on terms acceptable to the Company, or granted at all.

         The Company believes that obtaining foreign patents may be more
difficult than obtaining domestic patents because of differences in patent laws,
and recognizes that its patent position, therefore, may be stronger in the
United States than in Europe. In addition, the protection provided by foreign
patents once they are obtained may be weaker than that provided by domestic
patents.

         The Company relies and expects to continue to rely upon unpatented
proprietary know-how and continuing technological innovation in the development
and manufacture of many of its principal products. The Company's policy is to
require all its employees, consultants and advisors to enter into
confidentiality agreements with the Company. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's trade
secrets or proprietary know-how in the event of any unauthorized use or
disclosure of such know-how. In addition, there can be no assurance that others
will not obtain access to or independently develop these trade secrets or
know-how.

COMPETITION

         Competition is intense among manufacturers of prescription
pharmaceuticals, such as the DYNACIN(R), LIDEX(R), SYNALAR(R), TRIAZ(R),
THERAMYCIN(TM) Z, and BENZASHAVE(R) products for the treatment of dermatological
diseases, in the OTC market for dermatological products such as the ESOTERICA(R)
and THERAPLEX(R) product lines, and in the dermatologist-dispensed cosmetic
dermatology market for products such as AFIRM(TM) and BETA-LIFTx(TM), as well as
other products which the Company may develop and market in the future. Most of
the Company's competitors are large, well-established pharmaceutical, chemical,
cosmetic or health

                                     - 11 -
<PAGE>   12
care companies with considerably greater financial, marketing, sales and
technical resources than available to the Company. Additionally, many of the
Company's present and potential competitors have research and development
capabilities that may allow such competitors to develop new or improved products
that may compete with the Company's product lines. The pharmaceutical industry
is characterized by intense competition and rapid product development and
technological change. The Company's products could be rendered obsolete or made
uneconomical by the development of new products to treat the conditions
addressed by the Company's products, technological advances affecting the cost
of production, or marketing or pricing actions by one or more of the Company's
competitors. The Company's business, financial condition or results of
operations could be materially adversely affected by any one or more of such
developments. Each of the Company's products competes for a share of the
existing market with numerous products which have become standard treatments
recommended or prescribed by dermatologists. There can be no assurance that the
Company will be able to compete successfully against current or future
competitors or that competition will not have a material adverse effect on the
Company's business, financial condition and results of operations.

         DYNACIN(R) competes with Minocin, a branded minocycline product
marketed by American Home Products Corporation ("AHP"), Vectrin, marketed by
Warner-Chilcott Laboratories, Inc. ("Warner-Chilcott") and generic minocycline
products marketed by Schein, BioCraft Laboratories, Inc. ("BioCraft") and
Warner-Chilcott. Other oral antibiotics utilized for the treatment of acne
include erythromycin, doxycycline and tetracycline marketed in branded and
generic form by a variety of companies. LIDEX(R) and SYNALAR(R) compete with a
number of corticosteroid brands in the super-, high-, mid-, and low-potency
categories for the treatment of inflammatory and hyperproliferative skin
conditions. Competing brands include Halog, marketed by Westwood-Squibb; Elocon,
Diprolene, Diprosone and Valisone, marketed by Schering-Plough; Cyclocort,
marketed by Fujisawa; Temovate and Cutivate, marketed by Glaxo; Psorcon,
marketed by Rhone-Poulenc Rohrer; and Aristocort, marketed by AHP. The Company
believes that TRIAZ(R) competes with Cleocin-T and a generic topical
clindamycin, marketed by Pharmacia & Upjohn, Inc.; Benzac, marketed by Galderma,
Inc., a subsidiary of L'Oreal; and Benzamycin, marketed by a subsidiary of
Rhone-Poulenc Rorer. ESOTERICA(R) primarily competes with Porcelana, marketed by
Dep Corp. and AMBI, marketed by Kiwi Brands, a division of Sara Lee Corporation
("Kiwi"). In the category of dermatologist-dispensed cosmetic dermatology
products, AFIRM(TM) and BETA-LIFTx(TM) compete with various brands and
private-label products, as well as compounds which some dermatologists formulate
themselves in small quantities for their patients. Examples of competing brands
include the Glytone line marketed by C & M Pharmacal; the M.D. Formulations,
M.D. Forte and Aqua Glycolic lines marketed by Allergan; as well as various
product lines marketed by NeoStrata Company, the Gly Derm division of ICN
Pharmaceuticals, the Nova Skin Care Division of Glaxo, Obagi/NuDerm, and
Cellex-C Distribution Company.

         Several of the Company's products compete with generic (non-branded)
pharmaceuticals which claim to offer equivalent therapeutic benefits at a lower
cost. In some cases, insurers and other third-party payors seek to encourage the
use of generic products by paying or reimbursing a user or supplier of a branded
prescription product a lower portion of the purchase price than would be paid or
reimbursed for a generic product, making branded products less attractive, from
a cost perspective, to buyers. The aggressive pricing activities of the
Company's generic competitors and the payment and reimbursement policies of
third-party payors could have a material adverse impact on the Company's
business, financial condition or results of operations.

GOVERNMENT REGULATION

   DRUG AND COSMETIC REGULATION

         The manufacture and sale of cosmetics and drugs are subject to
regulation principally by the FDA and state and local authorities in the United
States, and by comparable agencies in certain foreign countries. The Federal
Trade Commission ("FTC") and state and local authorities regulate the
advertising of OTC drugs and cosmetics. The Federal Food, Drug and Cosmetic Act,
the regulations promulgated thereunder, and other federal and state statutes and
regulations, govern, among other things, the testing, manufacture, safety,
effectiveness, labeling, storage, recordkeeping, approval, advertising and
promotion of the Company's products. In general, products


                                     - 12 -
<PAGE>   13
falling within the FDA's definition of "new drugs" require premarketing
clearance by the FDA. Products falling within the FDA's definition of
"cosmetics" or of "drugs" that are not "new drugs" and that are generally
recognized as "safe and effective" do not require premarketing clearance.

         The steps required before a pharmaceutical compound may be marketed in
the United States include (i) preclinical laboratory and animal testing, (ii)
submission to the FDA of an Investigatory New Drug ("IND") application, which
must become effective before clinical trials may commence, (iii) adequate and
well-controlled clinical trials to establish the safety and efficacy of the
drug, (iv) submission to the FDA of a New Drug Application ("NDA") and (v) FDA
approval of the NDA prior to any commercial sale or shipment of the drug. In
addition to obtaining FDA approval for each product, each domestic drug
manufacturing establishment must be registered with, and approved by, the FDA.
Drug product manufacturing establishments located in California also must be
licensed by the State of California in compliance with separate regulatory
requirements.

         Preclinical testing is generally conducted in laboratory animals to
evaluate the potential safety and the efficacy of a drug. The results of these
studies are submitted to the FDA as a part of an IND, which must be approved
before clinical trials in humans can begin. Typically, clinical evaluation
involves a time consuming and costly three-phase process. In Phase I, clinical
trials are conducted with a small number of subjects to determine the early
safety profile, the pattern of drug distribution and metabolism. In Phase II,
clinical trials are conducted with groups of patients afflicted with a specific
disease in order to determine preliminary efficacy, optimal dosages and expanded
evidence of safety. In Phase III, large-scale, multi-center, comparative trials
are conducted with patients afflicted with a target disease in order to provide
enough data to demonstrate the efficacy and safety required by the FDA. The FDA
closely monitors the progress of each of the three phases of clinical trials and
may, at its discretion, re-evaluate, alter, suspend or terminate the testing
based upon the data which have been accumulated to that point and its assessment
of the risk/benefit ratio to the patient.

         In general, FDA approval is required before a new drug product may be
marketed in the United States. However, most OTC drugs are exempt from the FDA's
premarketing approval requirements. In 1972, the FDA instituted the ongoing OTC
Drug Review to evaluate the safety and effectiveness of OTC drugs then in the
market. Through this process, the FDA issues monographs that set forth the
specific active ingredients, dosages, indications and labeling statements for
OTC drugs that the FDA will consider generally recognized as safe and effective
and therefore not subject to premarket approval. OTC drug products are
classified by the FDA in one or more categories: Category I products, which are
deemed "safe and effective for OTC use," Category II products, which are deemed
"not generally recognized as safe and effective for OTC use," and Category III
products, which are deemed "possibly safe and effective with studies ongoing."
For certain categories of OTC drugs not yet subject to a final monograph, the
FDA usually will not take regulatory action against such a product unless
failure to do so will pose a potential health hazard to consumers. Drugs subject
to final monographs, however, are subject to various FDA regulations concerning,
for example, cGMP, general and specific OTC labeling requirements (including
warning statements), prohibitions against promotion for conditions other than
those stated in the labeling, and requirement that OTC drugs contain only
suitable inactive ingredients. OTC drug manufacturing facilities are subject to
FDA inspection, and failure to comply with applicable regulatory requirements
may lead to administrative or judicially imposed penalties.

         The active ingredient in DYNACIN(R) products (minocycline) and the
active ingredients in LIDEX(R) and SYNALAR(R) (fluocinonide and fluocinolone
acetonide, respectively) have been approved by the FDA. The active ingredient in
TRIAZ(R) and BENZASHAVE(R) products has been classified as a Category III
product under a tentative final FDA monograph for OTC distribution for use in
treatment of labeled conditions. The FDA has requested, and a task force of the
Non-Prescription Drug Manufacturers Association has undertaken, further studies
to confirm that benzoyl peroxide, an active ingredient in TRIAZ(R) and
BENZASHAVE(R) products, is not a tumor promoter when tested in conjunction with
UV light exposure. TRIAZ(R) and BENZASHAVE(R) products, which the Company sells
on a prescription basis, have the same ingredients at the same dosage levels as
the OTC products. In the Company's opinion, TRIAZ(R) and BENZASHAVE(R) products
would also be considered to be generally recognized as safe and effective for
their intended uses under the Food and Drug Act. There can be no assurance these
tests will confirm the status of benzoyl peroxide as generally recognized as
safe and effective or that adverse test results would not result in withdrawal
of TRIAZ(R) and BENZASHAVE(R) from marketing. An adverse decision by the FDA
with


                                     - 13 -
<PAGE>   14
respect to the safety of benzoyl peroxide could result in the assertion of
product liability claims against the Company and could otherwise have a material
adverse effect on the Company's business, financial condition or results of
operation.

          Certain ESOTERICA(R) products contain the active ingredient
hydroquinone, currently a Category I product. Independent expert dermatologists
have formally expressed the view that hydroquinone at a 2% concentration is
generally recognized as safe and effective for its intended use. However, in
1992, with the concurrence of the FDA, the industry initiated dermatological
metabolism and toxicity studies to fully support hydroquinone's continued
Category I status. Notwithstanding the pendency or results of these tests, which
may take up to three years to complete, the FDA may elect to classify
hydroquinone as a Category III OTC drug. The Company, in conjunction with the
Non-Prescription Drug Manufacturers Association and other manufacturers, is
responsible for 50% of the costs associated with these studies. An adverse
decision by the FDA on the safety of hydroquinone could result in the assertions
of product liability claims against the Company. Moreover, if hydroquinone is
not maintained as a Category I or Category III drug, the Company would be
required to cease marketing ESOTERICA(R) products containing hydroquinone, which
would have a material adverse effect on the Company's business, financial
condition and results of operations.

         The ESOTERICA(R), TRIAZ(R) and BENZASHAVE(R) products must meet the
composition and labeling requirements established by the FDA for products
containing their respective basic ingredients. The Company believes that
compliance with those established standards avoids the requirement for
premarketing clearance of these products. There can be no assurance that the FDA
will not take a contrary position.

         The Company believes its three THERAPLEX(R) moisturizers and the
AFIRM(TM) and BETA-LIFTx(TM) products, as they are promoted and intended by the
Company for use, fall within the FDA's definition of "cosmetics" and therefore
do not require premarketing clearance. There can be no assurance that the FDA
will not take a contrary position in the future or that an adverse determination
by the FDA would not result in withdrawal of the THERAPLEX(R) moisturizers or
the AFIRM(TM) and BETA-LIFTx(TM) products from the market. The Company believes
that such products are subject to regulations governing product safety, use of
ingredients, labeling and promotion, and methods of manufacture.

   CERTAIN FACTORS AFFECTING THE COMPANY'S PRODUCTS

         The Company believes that certain of its products, as they are promoted
and intended by the Company for use, are exempt from registration based on the
date of introduction of their active ingredients and therefore do not require
premarketing clearance. There can be no assurance that the FDA will not take a
contrary position. The Company believes that such products are subject to
regulations governing product safety, use of ingredients, advertising, labeling
and promotion and methods of manufacture.

         Clinical trials and the marketing and manufacturing of pharmaceutical
products are subject to the rigorous testing and approval processes of the FDA
and foreign regulatory authorities. The process of obtaining FDA and other
required regulatory approvals is lengthy and expensive. There can be no
assurance that the Company will be able to obtain the necessary approvals to
conduct clinical trials or for the manufacturing and marketing of products, that
all necessary clearances will be granted to the Company or its licensors for
future products on a timely basis, or at all, or that FDA review or other
actions will not involve delays adversely affecting the marketing and sale of
the Company's products. In addition, the testing and approval process with
respect to certain new products which the Company may develop or seek to
introduce is likely to take a substantial number of years and involve the
expenditure of substantial resources. There can be no assurance that
pharmaceutical products currently in development, or those products acquired or
licensed by the Company, will be cleared for marketing by the FDA. Failure to
obtain any necessary approvals or failure to comply with applicable regulatory
requirements could have a material adverse effect on the Company's business,
financial condition or results of operations. Further, future government
regulation could prevent or delay regulatory approval of the Company's products.

                                     - 14 -
<PAGE>   15
         There can be no assurance that any approval will be granted on a timely
basis, or at all; that the FDA will not require post-marketing testing and
surveillance to monitor the record of the product and continued compliance with
regulatory requirements; that the FDA will not require the submission of any lot
of any product for inspection and will not restrict the release of any lot that
does not comply with FDA standards; that the FDA will not otherwise order the
suspension of manufacturing, recall or seizure of products; or that the FDA will
not withdraw its marketing clearance of any product if compliance with
regulatory standards is not maintained or if problems concerning safety or
efficacy of the product are discovered following approval.

         From time to time, the FDA has issued correspondence to pharmaceutical
companies, including the Company, alleging that their advertising or promotional
practices are false, misleading or deceptive. The Company has resolved all such
complaints without any adverse findings by the FDA and without incurring
substantial expense. However, there can be no assurance that the Company will
not receive such correspondence from the FDA in the future, or that, if such
notices are received, they will not result in substantial cost, disruption or
expense (including fines and penalties), in material changes to the manner in
which the Company promotes its products, or in loss of sales of the Company's
products or other material adverse effects on the Company's business, financial
condition or results of operations.

         For both currently marketed and future products, failure to comply with
the applicable regulatory requirements could, among other things, result in
fines, suspensions of regulatory approvals; product recalls; operating
restrictions; criminal prosecution; relabeling costs; delays in product
distribution, marketing and sales; or seizure or cessation of manufacture of the
products and the imposition of civil or criminal sanctions. There can be no
assurance that the FDA will not change its position with regard to the safety or
effectiveness of the Company's current or future products or that the FDA will
agree with the Company's position regarding the regulatory status of its
products. In the event that the FDA takes a contrary position regarding any of
the Company's current or future products, the Company may be required to change
its labeling or formulation or possibly cease manufacture and marketing of such
products. In addition, even prior to any formal regulatory action, the Company
could decide voluntarily to cease distribution and sale or to recall any of its
products if concern about the safety or efficacy of any of its products were to
develop. Any such action could have a material adverse effect on the Company's
business, financial condition or results of operations.

         The Company also will be subject to foreign regulatory authorities
governing clinical trials and pharmaceutical sales if it seeks to market its
products outside the United States. Whether or not FDA approval has been
obtained, approval of a product by the comparable regulatory authorities of
foreign countries must be obtained prior to the commencement of marketing of the
product in those countries. The approval process varies from country to country
and the time required may be longer or shorter than that required for FDA
approval. There can be no assurance that any foreign regulatory agency will
approve any product submitted for review by the Company.

THIRD-PARTY REIMBURSEMENT

         The operating results of the Company will depend in part on the
availability of adequate reimbursement for the Company's products from
third-party payors, such as government entities, private health insurers and
managed care organizations. Third-party payors increasingly are seeking to
negotiate the pricing of medical services and products and to promote the use of
generic (non-branded) pharmaceuticals through payor-based reimbursement policies
designed to encourage their use. In some cases, third-party payors will pay or
reimburse a user or supplier of a prescription drug product only a portion of
the purchase price of the product. In the case of the Company's prescription
products, payment or reimbursement by third-party payors of only a portion of
the cost of such products could make such products less attractive, from a cost
perspective, to users, suppliers and prescribing physicians. There can be no
assurance that reimbursement, if available, will be adequate. Moreover, certain
of the Company's products are not of a type generally eligible for third-party
reimbursement. If adequate reimbursement levels are not provided by government
entities or other third-party payors for the Company's products, or if those
reimbursement policies increasingly favor the use of generic products, the
Company's business, financial condition and results of operations would be
materially adversely affected. In addition, managed care initiatives to control

                                     - 15 -
<PAGE>   16
costs have influenced primary care physicians to refer fewer patients to
dermatologists, resulting in a declining target market for the Company. Further
reductions in referrals to dermatologists could have a material adverse impact
upon the Company's business, financial condition or results of operations.

         In addition, a number of legislative and regulatory proposals aimed at
changing the nation's health care system have been proposed in recent years.
While the Company cannot predict whether any such proposals will be adopted, or
the effect that any such proposal may have on its business, such proposals, if
enacted, could have a material adverse effect on the Company's business,
financial condition or results of operations.

PRODUCT LIABILITY INSURANCE

         The Company faces an inherent risk of exposure to product liability
claims in the event that the use of its products is alleged to have resulted in
adverse effects. Such risk exists even with respect to those products that are
manufactured in licensed and regulated facilities or that otherwise possess
regulatory approval for commercial sale. There can be no assurance that the
Company will avoid significant product liability exposure. The Company currently
has product liability insurance in the amount of $5.0 million per claim and $5.0
million in the aggregate on a claims-made basis. Many of the Company's customers
require the Company to maintain product liability insurance coverage as a
condition to their conducting business with the Company. As the loss of such
insurance coverage could result in a loss of such customers, the Company intends
to take all reasonable steps necessary to maintain such insurance coverage,
although there can be no assurance that adequate insurance coverage will be
available in the future on commercially reasonable terms, or at all, or that
such insurance will be adequate to cover potential product liability claims, or
that the loss of insurance coverage or the assertion of a product liability
claim or claims would not materially adversely affect the Company's business,
financial condition and results of operations.

EMPLOYEES

         As of September 16, 1997, the Company had 89 full-time employees. The
Company believes its relationship with its employees is good. The Company
intends to hire personnel as needed during the next 12 months.

ITEM 2: PROPERTIES

         The Company presently leases approximately 12,000 square feet of office
space for its headquarters in Phoenix, Arizona, under a Lease Agreement which
expires in May 2005. Subsequent to fiscal 1997, the Company committed to lease
an additional 7,000 square feet at the same location under similar terms,
effective on or about November 1, 1997. The Company believes that these
facilities will be adequate to meet its needs for the foreseeable future.

ITEM 3: LEGAL PROCEEDINGS

         The Company and certain of its subsidiaries are parties to certain
actions and proceedings incident to their business. Liability in the event of
final adverse determinations in any of these matters is either covered by
insurance and/or established reserves, or, the Company believes, will not, in
the aggregate, have a material adverse effect on the business, financial
condition or results of operations of the Company.

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

         No matters were submitted to a vote of the security holders of the
Company during the fourth quarter of fiscal 1997.


                                     - 16 -
<PAGE>   17
                                     PART II


ITEM 5:   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
          STOCKHOLDER MATTERS

DIVIDEND POLICY

         The Company declared a 3-for-2 stock split in the form of a 50% stock
dividend paid on August 2, 1996 to holders of record on July 22, 1996. The
Company declared a 3-for-2 stock split in the form of a 50% stock dividend paid
on March 28, 1997 to holders of record on March 17, 1997. The Company has never
declared a cash dividend. The Company intends to retain any earnings to fund
future growth and the operation of its business and, therefore, does not
anticipate paying any cash dividends in the foreseeable future.

PRICE RANGE OF COMMON STOCK

         The Company's Class A Common Stock is traded on the Nasdaq National
Market under the symbol "MDRX." The following table sets forth for the fiscal
periods indicated, the range of high and low sales prices for the Class A Common
Stock of the Company on the Nasdaq National Market, as adjusted to reflect the
1-for-14 reverse stock split of the Company's Common Stock effected on October
23, 1995, as adjusted to the nearest 1/16 to reflect the 3-for-2 stock split in
the form of a 50% stock dividend paid on August 2, 1996 to holders of record as
of July 22, 1996, and as adjusted to reflect the 3-for-2 stock split in the form
of a 50% stock dividend paid on March 28, 1997 to holders of record as of March
17, 1997.
<TABLE>
<CAPTION>
                                                                              HIGH               LOW
                                                                          ----------          ----------
<S>                                                                       <C>                 <C>
                  FISCAL YEAR ENDED JUNE 30, 1997
                                    First Quarter.....................    $   33-1/2          $   16-1/2
                                    Second Quarter....................       40-3/16              26-2/3
                                    Third Quarter.....................        47-1/3                  28
                                    Fourth Quarter....................            51              23-1/4

                  FISCAL YEAR ENDED JUNE 30, 1996
                                    First Quarter.....................         3-1/2               1-1/2
                                    Second Quarter....................        7-1/16                   3
                                    Third Quarter.....................       14-1/16              6-1/16
                                    Fourth Quarter....................            21              10-1/3

                  FISCAL YEAR ENDED JUNE 30, 1995
                                    First Quarter.....................         3-1/3               1-3/8
                                    Second Quarter....................         3-1/2             1-15/16
                                    Third Quarter.....................         2-1/2               1-3/8
                                    Fourth Quarter....................         2-1/2              1-3/16
</TABLE>


         On September 16, 1997, the last reported sale price on the Nasdaq
National Market for the Company's Class A Common Stock was $47.13 per share. As
of such date, there were approximately 491 holders of record of Class A Common
Stock.

                                     - 17 -
<PAGE>   18
ITEM 6:           SELECTED FINANCIAL DATA

         The following selected financial data have been derived from the
consolidated financial statements of Medicis Pharmaceutical Corporation for the
fiscal years 1997, 1996, 1995, 1994 and 1993.
<TABLE>
<CAPTION>
                                                                   YEAR ENDED JUNE 30,
                                                                   -------------------
                                                  1997       1996      1995(1)      1994(2)      1993(2)
                                                -------    -------    --------     --------     --------
                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                             <C>        <C>        <C>          <C>          <C>
STATEMENT OF OPERATIONS DATA:
Net sales                                       $41,159    $25,310    $ 19,132     $ 17,059     $ 11,088
Gross profit                                     31,797     18,354      13,282       11,239        7,215
Operating expenses:

         Selling, general and administrative     16,484     10,868      10,330        8,786       14,237(3)

         Research and development expenses        1,450        952         770        1,572        3,841(4)

         Depreciation and amortization              999        559         522          653          616
                                                -------    -------    --------     --------     --------


Total operating expenses                         18,933     12,379      11,622       11,011       18,694
                                                -------    -------    --------     --------     --------

Operating income (loss)                          12,864      5,975       1,660          228      (11,479)
Other:
         Minority share of losses of Dyad            --         --          --          677           --
         Gains on disposition of Dyad                --         --         107           --           --
         Net interest income (expense)            3,787         79         (94)        (249)        (175)
         Income tax benefit (expense)               694      1,826         (60)          --           --
                                                -------    -------    --------     --------     --------
Net income (loss)                               $17,345    $ 7,880    $  1,613     $    656     $(11,654)
                                                =======    =======    ========     ========     ========
Net income (loss) per share                     $  1.22    $  0.73    $   0.16     $   0.07     $  (1.41)
                                                =======    =======    ========     ========     ========
Shares used in computing per share amount        14,202     10,863       9,890        9,455        8,261
</TABLE>

<TABLE>
<CAPTION>
BALANCE SHEET DATA:                                             JUNE 30,
                                            1997       1996       1995       1994(2)      1993(2)
                                          -------    -------    --------    --------     --------
                                                             (IN THOUSANDS)
<S>                                      <C>         <C>        <C>        <C>          <C>
Cash, cash equivalents and short-term
  investments                            $ 85,132    $ 7,956    $   953    $    775     $    233
Working capital (deficiency)               94,803     12,401        619      (1,978)      (4,541)
Total assets                              140,537     26,313     13,850      12,726       11,993
Long-term debt                                111        117        694         899        1,264
Stockholders' equity                      131,565     19,460      7,387       5,263        2,937
</TABLE>


(1) Fiscal 1995 includes approximately $610,000 of charges associated with
    headquarters relocation; the Company had operating income of $2,270,000
    before relocation charges in fiscal 1995.

(2) Fiscal 1994 and fiscal 1993 include the operations of Dyad Pharmaceutical
    Corporation ("Dyad") which were divested in fiscal 1995.

(3) Included in selling, general and administrative were advertising costs
    associated with the launch of DYNACIN(R) products in November 1992.

(4) Research and development costs included the allocation of the purchase price
    of Dyad to research and development and the addition of Dyad's research and
    development expenses in fiscal 1993.


                                     - 18 -
<PAGE>   19
ITEM 7:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATION

         The following Management's Discussion and Analysis of Financial
Condition and Results of Operation contains forward-looking statements which
involve risk and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors. See "--Certain Factors Affecting Forward Looking
Statements - Safe Harbor Statement."

OVERVIEW

         Medicis was founded in 1987 to develop and market prescription and OTC
products to treat dermatological conditions. The Company has acquired rights to
manufacture and sell certain of its dermatological products pursuant to several
license and asset purchase agreements. The Company sells these products for use
in various segments of the dermatological market, including acne, inflammatory
skin conditions, therapeutic emollients and moisturizers, hyperpigmentation
segment and cosmetic dermatology. The Company has achieved increases in net
sales and net income through the acquisition of products, the licensing of
products, and the launch of internally-developed new products. Two of the
Company's primary prescription products, DYNACIN(R) products and TRIAZ(R)
products, were launched in fiscal 1993 and fiscal 1996, respectively; the
Company's LIDEX(R) and SYNALAR(R) products were acquired in February 1997; and
the Company's primary OTC products, the ESOTERICA(R) products, were acquired in
fiscal 1991. Prescription pharmaceuticals accounted for 86.5%, 83.2% and 70.6%
of net sales in fiscal 1997, 1996 and 1995, respectively. DYNACIN(R) products
accounted for a majority of the Company's total sales in fiscal 1997, 1996 and
1995.

         The Company believes that sales of DYNACIN(R) products will continue to
constitute a significant percentage of total net sales for the foreseeable
future. Accordingly, any factor adversely affecting the sale of DYNACIN(R)
products would have a material adverse effect on the Company's business,
financial condition and results of operations. DYNACIN(R) products could be
rendered obsolete or uneconomical by regulatory or competitive changes. The sale
of DYNACIN(R) products could also be affected adversely by other factors,
including manufacturing or supply interruptions, the development of new
competitive pharmaceuticals to treat the conditions addressed by DYNACIN(R)
products, technological advances, factors affecting the cost of production,
marketing or pricing actions by one or more of the Company's competitors,
changes in the prescribing practices of dermatologists, changes in the
reimbursement policies of third-party payors, product liability claims or other
factors. See Item 1, "Business -- Products in Development," "-- Manufacturing,"
"-- Certain License and Royalty Agreements," "-- Competition," and "--
Government Regulation."

         The Company's results of operations may vary from period to period due
to a variety of factors, including expenditures incurred to acquire, license and
promote pharmaceuticals, changes in prescribing practices of dermatologists, the
Company's level of research and development, the introduction of new products by
the Company or its competitors, supply interruptions, cost increases from
third-party manufacturers, the availability and cost of raw materials, the mix
of products sold by the Company, changes in marketing and sales expenditures,
market acceptance of the Company's products, competitive pricing pressures,
seasonal fluctuations and general economic and industry conditions that affect
customer demand. In addition, the Company's business historically has been
subject to seasonal fluctuations, with lower sales generally being experienced
in the first quarter of each fiscal year. As a result of customer buying
patterns, a substantial portion of revenues has been received in the last month
of each quarter. The Company schedules its inventory purchases to meet
anticipated customer demand. As a result, relatively small delays in the receipt
of manufactured products could result in revenues being deferred or lost. The
Company's operating expenses are based on anticipated sales levels, and a high
percentage of the Company's expenses are relatively fixed in the short-term;
variations in the timing of recognition of revenue could cause significant
fluctuations from period to period and may result in unanticipated periodic
earnings shortfalls or losses. There can be no assurance that the Company will
maintain or increase revenues, maintain profitability or avoid losses in any
future period.


                                     - 19 -
<PAGE>   20
         The Company recognizes revenues from sales upon shipment to its
customers. At the time of sale, the Company records reserves for returns based
on estimates using historical experience. Sales are reported net of actual and
estimated product returns and net of pricing adjustments and/or discounts. The
Company applies royalty obligations to the cost of sales in the period the
corresponding sales are recognized.

         Medicis' customers include the nation's leading wholesale
pharmaceutical distributors, such as McKesson, Bergen Brunswig, Cardinal,
Bindley and major drug chains. During fiscal 1997, McKesson, Cardinal and Bergen
Brunswig accounted for 20.6%, 16.3% and 10.9%, respectively, of the Company's
sales. During fiscal 1996, McKesson, Bergen Brunswig and Cardinal accounted for
15.5%, 12.2% and 11.8%, respectively, of the Company's sales. During fiscal
1995, McKesson and Bergen Brunswig accounted for 15.9% and 9.6%, respectively,
of the Company's sales. The loss of any of these customer accounts could have a
material adverse effect upon the Company's business, financial condition or
results of operations. See Item 1, "Business -- Customers."

         To enable Medicis to focus on its core marketing and sales activities,
the Company selectively out-sources certain non-sales and non-marketing
functions, such as laboratory research, manufacturing and warehousing. As the
Company expands its activities in these areas, additional financial resources
are expected to be utilized. The Company typically does not enter into long-term
manufacturing contracts with third-party manufacturers. Whether or not such
contracts exist, there can be no assurance that the Company will be able to
obtain adequate supplies of such products in a timely fashion, or at all. See
Item 1, "Business -- Manufacturing."

         The Company plans to spend substantial amounts of capital to continue
the research and development of its pharmaceutical products. Actual expenditures
will depend on the Company's financial condition, as well as the results of
clinical testing, delays or changes in government-required testing and approval
procedures, technological and competitive developments and strategic marketing
decisions. The Company may increase total expenditures for research and
development and expects that research and development expenditures as a
percentage of net sales will fluctuate from period to period. The Company can
give no assurance that the research and development projects will provide
technologies or products that will be patentable, commercially feasible or
acceptable to government agencies whose approval may be necessary. See Item 1,
"Business -- Products in Development."

         The Company intends to seek additional acquisitions of dermatology
products to leverage its existing distribution channels and marketing
infrastructure, and to market aggressively formulations of existing products.
The success of the Company's efforts is subject to a number of risks and
uncertainties including dependence upon key pharmaceuticals and integration of
new product acquisitions, reliance upon third-party manufacturers to produce
certain key products, the ability to effectively manage a changing business,
uncertainties related to pharmaceutical pricing and reimbursement and the
uncertainty of competitive forces within the pharmaceutical industry which
affect both the market for its products and the availability of product lines
for acquisition which meet the Company's acquisition criteria. The future
results of operations, both annually and from quarter to quarter, are subject to
a variety of factors applicable to the Company and to the industries and markets
in which it operates. See "Certain Factors Affecting Forward Looking Statements
-- Safe-Harbor Statement."

RESULTS OF OPERATIONS

         The following discussion and analysis should be read in conjunction
with the Consolidated Financial Statements and Notes to Consolidated Financial
Statements contained elsewhere herein. The following table sets forth certain
data as a percentage of net sales for the periods indicated.

                                     - 20 -
<PAGE>   21
                               PERCENTAGE OF SALES
<TABLE>
<CAPTION>
                                      YEAR ENDED JUNE 30,
                                 ----------------------------
                                  1997       1996       1995
                                 ------     ------     ------

<S>                              <C>        <C>        <C>   
Net sales                         100.0%     100.0%     100.0%

Gross profit                       77.3       72.5       69.4
Operating expenses                 46.0       48.9       60.8
Operating income                   31.3       23.6        8.6
Net interest income (expense)       9.2        0.3       (0.5)
Gains on disposition of Dyad         --         --        0.6
Income tax benefit (expense)        1.6        7.2       (0.3)
                                 ------     ------     ------
Net income                         42.1%      31.1%       8.4%
                                 ======     ======     ======
</TABLE>



                                      FISCAL 1997 AND 1996 QUARTERLY ANALYSIS
                                       (IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
                                                            1997                                   1996
                                         --------------------------------------   --------------------------------------

                                           SEPT     DEC.       MAR.       JUNE      SEPT.      DEC.      MAR.      JUNE
<S>                                      <C>       <C>       <C>        <C>        <C>       <C>       <C>       <C>   
Net sales                                $7,268    $8,508    $10,976    $14,407    $4,574    $6,449    $7,016    $7,271
Gross profit                              5,313     6,255      8,499     11,730     3,257     4,667     5,041     5,390
Operating expenses                        3,718     3,956      5,045      6,214     2,608     3,260     3,240     3,271
Operating income                          1,595     2,299      3,454      5,516       649     1,407     1,801     2,119
Net income                                3,604     3,251      4,337      6,153       646     1,404     1,759     4,071
Net income per share                     $ 0.31    $ 0.22    $  0.29    $  0.41    $ 0.06    $ 0.14    $ 0.16    $ 0.36
                                         ======    ======    =======    =======    ======    ======    ======    ======
</TABLE>


YEARS ENDED JUNE 30, 1997 AND 1996

      NET SALES

         Net Sales for fiscal 1997 increased 62.6%, or $15.9 million, to $41.2
million from $25.3 million for fiscal 1996. The Company's net sales increased in
fiscal 1997 primarily as a result of both unit and dollar sales growth
associated with an increase in market share of the existing prescription and OTC
products and the acquisition of a new prescription product line in February
1997. The Company's prescription products accounted for 86.5% of net sales in
fiscal 1997 and 83.2% in fiscal 1996. Net sales of the Company's prescription
products grew 68.9%, or $14.5 million, to $35.6 million in 1997 from $21.1
million in fiscal 1996, primarily due to the Company's acquisition of the
LIDEX(R) and SYNALAR(R) products in February 1997 and the continued growth in
units and dollars of the Company's DYNACIN(R) and TRIAZ(R) products. The
Company's OTC products and cosmetic division TxSYSTEMS by MEDICIS(TM) accounted
for 13.5% of net sales for fiscal 1997 and 16.8% in fiscal 1996. OTC sales
increased approximately 27.7%, primarily due to an increase in units and dollars
of the Company's ESOTERICA(R) products. The Company launched the TxSYSTEMS by
MEDICIS(TM) division in March 1997. The Company continues to invest a majority
of its marketing funds in the Company's prescription products.

      GROSS PROFIT

         Gross Profit during fiscal 1997 increased 73.2%, or $13.4 million, to
$31.8 million from $18.4 million in fiscal 1996. As a percentage of net sales,
gross margin grew to 77.3% in fiscal 1997 from 72.5% in fiscal 1996, primarily
as a result of the acquisition of the LIDEX(R) and SYNALAR(R) products, which
enjoy higher margins than the Company's other products, the increase in sales of
TRIAZ(R) products, which also enjoy margins in excess of aggregate corporate
gross profit margin percentages, manufacturing cost reductions for DYNACIN(R)
products and a change in sales mix toward the Company's prescription products,
which have higher gross margins.


                                     - 21 -
<PAGE>   22
      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

         Selling, General and Administrative Expenses in fiscal 1997 increased
51.7%, or $5.6 million, to $16.5 million from $10.9 million in fiscal 1996. This
increase was primarily attributable to an increase in promotional costs
attributable to the sampling and advertising of the Company's products, variable
costs commensurate with increased sales volumes, and an increase in personnel
costs attributable to an increase in the number of employees to 85 in fiscal
1997 from 58 in fiscal 1996 and yearly salary escalations for existing
employees. Selling, general and administrative expenses as a percentage of net
sales in fiscal 1997 decreased 2.8 percentage points to 40.1% from 42.9% in
fiscal 1996.

      RESEARCH AND DEVELOPMENT EXPENSES

         Research and Development Expenses in fiscal 1997 increased 52.3%, or
$0.5 million, to $1.5 million from $1.0 million in fiscal 1996, primarily due to
development efforts relating to new products and expenses associated with the
clinical support of the Company's existing products.

      DEPRECIATION AND AMORTIZATION EXPENSES

         Depreciation and Amortization Expenses in fiscal 1997 increased 78.8%,
or $0.4 million, to $1.0 million from $0.6 million in fiscal 1996. This increase
is primarily attributable to the amortization of the purchase price of the
LIDEX(R) and SYNALAR(R) products purchased by the Company in February 1997. The
Company is amortizing this purchase price over a 25-year period.

      OPERATING INCOME

         Operating Income during fiscal 1997 increased 115.3%, or $6.9 million,
to $12.9 million from $6.0 million in fiscal 1996 and increased as a percentage
of net sales to 31.3% from 23.6% in fiscal 1996. This increase was primarily as
a result of higher sales volume, coupled with an increase in the Company's gross
profit margin and the reduction in operating expenses as a percentage of net
sales.

      NET INTEREST INCOME (EXPENSE)

         Interest Income in fiscal 1997 increased $3.6 million, to $3.8 million
from $0.2 million in fiscal 1996, primarily due to higher cash, cash equivalent
and short-term investment balances during fiscal 1997, attributable to the
public offering completed by the Company in October 1996, raising $95.7 million
before related expenses or $90.1 million net of related expenses. Interest
expense in fiscal 1997 decreased 63.8%, or $48,000, to $27,000, from $76,000 in
fiscal 1996.

      INCOME TAX BENEFIT

         Income Tax Benefit, net, during fiscal 1997 decreased $1.1 million to a
benefit of $0.7 million from a benefit of $1.8 million in fiscal 1996. During
the fourth quarter of fiscal 1996 and the first quarter of fiscal 1997, the
Company reevaluated the estimated amount of valuation allowance required to
reduce deferred tax assets in accordance with Statement of Financial Accounting
Standard No. 109, "Accounting for Income Taxes" ("SFAS No. 109") to an amount
the Company believed appropriate. Accordingly, a credit to deferred income tax
benefit of $1.9 million in fiscal 1996 and $2.0 million in fiscal 1997 was
reflected in the consolidated income statement. The amount of net deferred tax
assets estimated to be recoverable was based upon the Company's assessment of
the likelihood of near term operating income coupled with uncertainties with
respect to the impact of future competitive and market conditions.



                                     - 22 -
<PAGE>   23
    NET INCOME

         Net Income during fiscal 1997 increased approximately 120.1%, or $9.4
million, to $17.3 million from $7.9 million in fiscal 1996. The increase was
primarily attributable to an increase in sales volume, an increase in gross
margin as a percentage of net sales, and a reduction of operating expenses as a
percentage of net sales.

YEARS ENDED JUNE 30, 1996 AND 1995

     NET SALES

         Net Sales for fiscal 1996 increased 32.3%, or $6.2 million, to $25.3
million from $19.1 million for fiscal 1995. The Company's net sales increased in
fiscal 1996 primarily as a result of both unit and dollar sales growth
associated with an increase in market share of the existing prescription
products and the launch of a new prescription product. The Company's
prescription products accounted for 83.2% of net sales in fiscal 1996 and 70.6%
in fiscal 1995. Net sales of the Company's prescription products grew 56.0%, or
$7.6 million, to $21.1 million in 1996 from $13.5 million in fiscal 1995,
primarily due to the Company's launch of TRIAZ(R) products in October 1995,
coupled with an increase in market penetration of DYNACIN(R) products. The
increase in sales of prescription products in fiscal 1996 was partially offset
by a decrease in unit sales of OTC products, primarily the ESOTERICA(R) product
line. The OTC products accounted for 16.8% of net sales in fiscal 1996 and 28.2%
in fiscal 1995. The Company continues to invest a majority of its marketing
funds in the Company's prescription products.

      GROSS PROFIT

         Gross Profit during fiscal 1996 increased 38.2%, or $5.1 million, to
$18.4 million from $13.3 million in fiscal 1995. As a percentage of net sales,
gross margin grew to 72.5% in fiscal 1996 from 69.4% in fiscal 1995 primarily as
a result of manufacturing cost reductions for DYNACIN(R) products and a change
in sales mix toward the Company's prescription products, which have higher gross
margins.

      SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

         Selling, General and Administrative Expenses in fiscal 1996 increased
5.2%, or $0.5 million, to $10.9 million from $10.3 million in fiscal 1995,
primarily due to a 22.2%, or $1.4 million, increase in selling expenses in
fiscal 1996. This increase was primarily attributable to an increase in
personnel costs commensurate with increased sales volume, yearly salary
escalations and an increase in promotional costs attributable to the launch of
TRIAZ(R) products. Selling, general and administrative expenses in fiscal 1995
included $0.6 million in nonrecurring expenses associated with the Company's
headquarters relocation to Phoenix, Arizona in fiscal 1995.

      RESEARCH AND DEVELOPMENT

         Research and Development Expenses in fiscal 1996 increased 23.7%, or
$0.2 million, to $1.0 million from $0.8 million in fiscal 1995 primarily due to
development efforts relating to the introduction in October 1995 of the
Company's TRIAZ(R) products.

      DEPRECIATION AND AMORTIZATION EXPENSES

         Depreciation and Amortization Expenses remained materially unchanged,
at $0.6 million in fiscal 1996 and $0.5 million in fiscal 1995.

       OPERATING INCOME

         Operating Income during fiscal 1996 increased 260.0%, or $4.3 million,
to $6.0 million from $1.7 million in fiscal 1995 and increased as a percentage
of net sales to 23.6% from 8.6% in fiscal 1995. This increase was primarily as a
result of higher sales volume, coupled with an increase in the Company's gross
profit margin and the absence of nonrecurring relocation expenses which were
incurred in fiscal 1995.


                                     - 23 -
<PAGE>   24
      NET INTEREST INCOME (EXPENSE)

         Interest Income in fiscal 1996 increased 167.7%, or $96,000, to
$154,000 from $58,000 in fiscal 1995, primarily due to higher cash and cash
equivalent balances in fiscal 1996. Interest expense in fiscal 1996 decreased
49.9%, or $75,000, to $76,000, from $151,000 in fiscal 1995, primarily due to
the repayment of a substantial portion of the Company's debt.

      INCOME TAXES

         Income Tax Benefit (Expense) during fiscal 1996 increased $1.9 million
to a benefit of $1.8 million from an expense of $0.1 million in fiscal 1995.
During the fourth quarter of fiscal 1996, the Company reevaluated the estimated
amount of valuation allowance required to reduce deferred tax assets in
accordance with SFAS No. 109 to an amount the Company believed appropriate.
Accordingly, a credit to income tax benefit of $1.9 million was reflected in the
consolidated income statement. The amount of net deferred tax assets estimated
to be recoverable was based upon the Company's assessment of the likelihood of
near term operating income coupled with uncertainties with respect to the impact
of future competitive and market conditions. No such income tax benefit was
recorded in fiscal 1995.

      NET INCOME

         Net Income during fiscal 1996 increased approximately 388.5%, or $6.3
million, to $7.9 million from $1.6 million in fiscal 1995. The increase was
primarily attributable to an increase in sales volume, an increase in gross
margin as a percentage of net sales, and the recording of the income tax benefit
in fiscal 1996.

LIQUIDITY AND CAPITAL RESOURCES

         At June 30, 1997 and June 30, 1996, the Company had cash, cash
equivalents and short-term investments of approximately $85.1 million and $8.0
million, respectively. The Company's working capital was $94.8 million at June
30, 1997 and $12.4 million at June 30, 1996.

         In fiscal 1997, the Company increased its cash position through a
public offering yielding $95.7 million before related expenses, through $13.8
million cash provided by operations and $3.5 million generated from the exercise
of stock options. During fiscal 1997, the Company paid $28.0 million for the
purchase of the LIDEX(R) and SYNALAR(R) products. During fiscal 1996, the
Company retired two notes with payments aggregating $750,000.

         In May 1996, the Company obtained a $5.0 million credit facility from
Norwest Bank Arizona, N.A. ("Norwest") that expires in September 1997. This
credit facility replaced a $2.0 million credit facility obtained from Norwest
Business Credit, Inc., an affiliate of Norwest, in August 1995. The credit
facility is secured by substantially all of the assets of the Company. The
Company is required to comply with certain covenants and restrictions, including
covenants relating to the Company's financial condition and results of
operations. If the Company is unable or fails to comply with the covenants and
restrictions, the lender would have the right not to make loans under the credit
facility and to require early repayment of any outstanding loans. The credit
facility, as amended, is no longer subject to a 0.5% per annum fee on the unused
portion of the credit facility. Although the Company has yet to draw down on the
credit facility, the lack of availability of loans or the requirement to make
early repayment of loans or the inability of the Company to renew the credit
facility could have a material adverse effect on the Company, depending on its
liquidity and working capital at such time.

         In November 1996, the Company increased its credit facility with
Norwest from $5 million to $25 million. The credit facility is secured by
principal assets of the Company. The Company is required to comply with certain
covenants and restrictions, including covenants relating to the Company's
financial condition and result of operations. This credit facility has not been
accessed by the Company.


                                     - 24 -
<PAGE>   25
         At June 30, 1997 and June 30, 1996, the Company had inventories of $3.0
million and $2.1 million, respectively. The increase in inventory is related
primarily to increased sales levels and the acquisition of approximately 30 SKUs
of LIDEX(R) and SYNALAR(R) products in February 1997. Inventories also include
finished goods held at manufacturers. The Company's inventory balances are
subject to the manufacturers' scheduling of production in order to meet future
demand as conveyed to the manufacturer by the Company. Inventories at
manufacturers recorded on the consolidated balance sheets of the Company have no
effect on working capital.

         During the fourth quarter of fiscal 1996 and the first quarter of
fiscal 1997, the Company reevaluated the estimated amount of valuation allowance
required to reduce deferred tax assets available in accordance with SFAS No. 109
to an amount the Company believed appropriate. Accordingly, a deferred tax asset
of $6.3 million was reflected in the consolidated balance sheet with a
corresponding credit to equity of $1.2 million for 1997 tax deductions related
to stock option exercises and a credit to deferred tax benefit of $2.0 million
in the consolidated income statement. The Company has deferred tax assets
available at June 30, 1997 of $6.3 million, which are comprised principally of
the tax effect of the Company's $11.0 million net operating loss carryforward.
The amount of net deferred tax assets available that are estimated to be
recoverable was based upon the Company's assessment of the likelihood of
near-term operating income coupled with the uncertainties with respect to the
impact of future competitive and market conditions. The amount of deferred tax
asset available that ultimately will be realized will depend upon future events
which are uncertain.

         In accordance with various manufacturing agreements, the Company is
required to provide manufacturers with pro forma estimated production
requirements by SKU and in accordance with minimum production runs. From time to
time, the Company may not take possession of all merchandise which has been
produced by the manufacturer. However, the Company records its obligation to the
manufacturer at the time production is completed.

         On October 2, 1996, the Company completed a public offering for
approximately 2.8 million primary shares of the Company's Class A Common Stock
at a price of $30.00 per share. The underwriters also exercised the
over-allotment option of approximately 0.4 million shares at a price of $30.00
per share. Gross proceeds from the offering before related expenses totaled
approximately $95.7 million. The Company has used and anticipates using the
proceeds from the offering for marketing expenses associated with new product
introductions; the licensing or acquisition of formulations, technologies,
products or businesses; research and development; expansion of marketing and
sales capabilities; and general corporate purposes.

         On March 7, 1997, the Company announced that its Board of Directors had
approved a 3-for-2 stock split to be effected in the form of a 50% stock
dividend. The dividend was paid to holders of record of the Class A and Class B
Common Stock and all stock option holders on March 17, 1997, i.e., the record
date. Holders of the Company's Class A and Class B Common Stock received one
additional share of Common Stock for each two shares held. Similar adjustments
were made under the Company's Rights Agreement, dated as of August 15, 1995 (as
amended from time to time) between the Company and Norwest Bank Minnesota, N.A.,
so that one additional right shall be issued to accompany each share of Common
Stock issued pursuant to the dividend.

         Adequate additional funds, whether from the financial markets or from
other sources, may not be available on a timely basis, on terms acceptable to
the Company, or at all. Insufficient funds may cause the Company to delay, scale
back, or abandon some or all of its product acquisition, licensing, marketing or
research and development programs or opportunities.

OTHER MATTERS

         In January 1997, the Company agreed to acquire the United States and
Canadian dermatology assets of Syntex USA, Inc., from various affiliates of
Syntex and its parent company, F. Hoffman-La Roche, Ltd. The Company, using cash
reserves, paid $28 million, and will pay an additional $3 million in $1 million
installments on the anniversary of the purchase for each over the next three
years unless certain market conditions do not obtain. Medicis entered into four
separate Asset Purchase Agreements with various Roche affiliates (the "Purchase
Agreements") for the acquisition of the intellectual property rights, know-how,
and all finished goods inventory specifically associated with Syntex's topical
corticosteroid dermatology products ("the Purchased Products") in the


                                     - 25 -
<PAGE>   26
United States and Canada. The Purchased Products include the prescription
topical steroid brands LIDEX(R) and SYNALAR(R). These topical corticosteroids
combat inflammatory and hyperproliferative skin diseases by reducing swelling
and pain, relieving itching, and constricting blood vessels in the skin. The
product lines consist of various potencies and cosmetically elegant
formulations, allowing dermatologists to prescribe the most appropriate product
based on the severity and location of a patient's condition. Prior to the
acquisition, the Company did not market any products in this category of
dermatological care.

         During June 1997, the Company entered into a joint product development
and distribution agreement with an unrelated third party whereby the Company
will pay certain costs with respect to certain product approvals estimated to be
approximately $1 million.

         Inflation did not have a significant impact upon the results of the
Company during fiscal 1997, 1996 or 1995.

CERTAIN FACTORS AFFECTING FORWARD LOOKING STATEMENTS - SAFE HARBOR
STATEMENT.

         The foregoing Management's Discussion and Analysis of Financial
Condition and Results of Operations, as well as other portions of this Annual
Report, contain forward-looking statements that involve risks and uncertainties.
The actual results of Medicis could differ materially from those anticipated in
these forward-looking statements. In evaluating the Company and its performance,
investors should take into consideration the risks and uncertainties discussed
in the other Securities and Exchange Commission filings of the Company, as well
as under the captions "Business" and "Management's Discussion and Analysis of
Financial Condition and Results of Operation," herein, as well as the following:

DEPENDENCE ON SALES OF DYNACIN(R) PRODUCTS

         The Company derives a significant portion of its revenue from sales of
DYNACIN(R) products. The Company believes that sales of DYNACIN(R) products will
continue to constitute a significant portion of net sales for the foreseeable
future. Accordingly, any factor adversely affecting the sale of DYNACIN(R)
products would have a material adverse effect on the Company's business,
financial condition and results of operations. DYNACIN(R) products could be
rendered obsolete or uneconomical by regulatory or competitive changes. The sale
of DYNACIN(R) products could also be affected adversely by other factors,
including manufacturing or supply interruptions, the development of new
competitive pharmaceuticals to treat the conditions addressed by DYNACIN(R)
products, technological advances, factors affecting the cost of production,
marketing or pricing actions by one or more of the Company's competitors,
changes in the prescribing practices of dermatologists, changes in the
reimbursement policies of third-party payors, product liability claims or other
factors. See Item 1, "Business -- Products in Development," "-- Manufacturing,"
"-- Certain License and Royalty Agreements," "-- Competition" and "-- Government
Regulation."

UNCERTAINTY OF FUTURE FINANCIAL RESULTS; FLUCTUATIONS IN OPERATING RESULTS

         The Company's results of operations may vary from period to period due
to a variety of factors, including expenditures incurred to acquire, license and
promote pharmaceuticals, changes in prescribing practices of dermatologists, the
level of research and development, the introduction of new products by the
Company or its competitors, cost increases from third-party manufacturers,
supply interruptions, the availability and cost of raw materials, the mix of
products sold by the Company, changes in marketing and sales expenditures,
market acceptance of the Company's products, competitive pricing pressures, and
general economic and industry conditions that affect customer demand. In
addition, the Company's business has historically been subject to seasonal
fluctuations, with lower sales generally being experienced in the first quarter
of each fiscal year. As a result of customer buying patterns, a substantial
portion of the Company's revenues have been in the last month of each quarter.
The Company schedules its inventory purchases to meet anticipated customer
demand. As a result, relatively small delays in the receipt of manufactured
products could result in revenues being deferred or lost. The Company's
operating expenses are based on anticipated sales levels, and a high percentage
of the Company's

                                     - 26 -
<PAGE>   27
expenses are relatively fixed in the short term. Consequently, variations in the
timing of recognition of revenue could cause significant fluctuations in
operating results from period to period and may result in unanticipated periodic
earnings shortfalls or losses. There can be no assurance that the Company will
maintain or increase revenues or profitability or avoid losses in any future
period.

INTENSE COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE

         The manufacture and sale of pharmaceuticals is highly competitive. Most
of the Company's competitors are large, well-established pharmaceutical,
chemical, cosmetic or health care companies with considerably greater financial,
marketing, sales and technical resources than those available to the Company.
Additionally, many of the Company's present and potential competitors have
research and development capabilities that may allow such competitors to develop
new or improved products that may compete with the Company's product lines. The
pharmaceutical industry is characterized by intense competition and rapid
product development and technological change. The Company's products could be
rendered obsolete or made uneconomical by the development of new products to
treat the conditions addressed by the Company's products, technological advances
affecting the cost of production, or marketing or pricing actions by one or more
of the Company's competitors. The Company's business, financial condition or
results of operations could be materially adversely affected by any one or more
of such developments.

         DYNACIN(R) competes principally with Minocin, a branded minocycline
product marketed by AHP, and generic minocycline products marketed by BioCraft,
Schein, and Warner-Chilcott. Other oral antibiotics utilized for the treatment
of acne include erythromycin, doxycycline and tetracycline marketed in branded
and generic form by a variety of companies. LIDEX(R) and SYNALAR(R) compete
with a number of corticosteroid brands in the super-, high-, mid-, and
low-potency categories for the treatment of inflammatory and hyperproliferative
skin conditions. Competing brands principally include Halog and Ultravate,
marketed by Westwood-Squibb; Elocon, Diprolene, Diprosone and Valisone,
marketed by Schering-Plough; Cyclocort, marketed by Fujisawa; Temovate and
Cutivate, marketed by Glaxo; Psorcon, marketed by Rhone-Poulenc Rohrer, and
Aristocort, marketed by AHP. The Company believes that TRIAZ(R) competes with
Cleocin-T and a generic topical clindamycin, manufactured by Pharmacia &
Upjohn; Benzac, manufactured by Galderma, Inc.; and Benzamycin, manufactured by
Rhone-Poulenc Rorer. ESOTERICA(R) primarily competes with Porcelana, marketed
by Dep Corp., and AMBI, marketed by Kiwi.

         Several of the Company's products compete with generic (non-branded)
pharmaceuticals which purport to offer equivalent therapeutic benefits at a
lower cost. In some cases, insurers and other third-party payors seek to
encourage the use of generic products by paying or reimbursing a user or
supplier of a branded prescription product a lower portion of the purchase price
than would be paid or reimbursed for a generic product, making branded products
less attractive, from a cost perspective, to buyers. The aggressive pricing
activities of the Company's generic competitors and the payment and
reimbursement policies of third-party payors could have a material adverse
effect on the Company's business, financial condition or results of operations.
See Item 1, "Business --Competition."

DEPENDENCE ON NEW PRODUCT INTRODUCTIONS AND ACQUISITION STRATEGY

         The Company's strategy for growth is substantially dependent upon its
continued ability to acquire products targeted at the dermatology market. The
Company engages in limited proprietary research and development of new products
and must rely upon the willingness of other companies to sell or license product
lines. Other companies, including those with substantially greater financial,
marketing and sales resources, compete with the Company to acquire such
products. There can be no assurance that the Company will be able to acquire
rights to additional products on acceptable terms, or at all. The failure of the
Company to acquire additional products or successful products could have a
material adverse effect on the Company's business prospects. Further, the market
conditions, distribution channels and levels and bases of competition with
respect to internally developed or acquired products may be different than those
of the Company's current products, and there can be no assurance that the
Company will be able to compete favorably and attain market acceptance in any
new product category or


                                     - 27 -

<PAGE>   28
successfully integrate any acquired products or business. Failure of the Company
to successfully introduce and market new products, whether internally developed
or acquired from third parties, could have a material adverse effect on the
Company's business, financial condition or results of operations.

MANAGING CHANGING BUSINESS

         The Company's business strategy includes potential acquisitions of
products and businesses and introductions of new products. The Company
anticipates that the integration of new businesses or potential products, if
any, would require significant management time and attention. The Company's
ability to manage change will require it to continue to implement and improve
its operational, financial and management information systems and to motivate
and effectively manage an increasing number of employees. Failure to manage such
change effectively would have a material adverse effect on the Company's
business, financial condition and results of operations. See Item 1, "Business
-- Principal Products and Product Lines" and "-- Products in Development."

RISK OF PRODUCT RECALL; PRODUCT RETURNS

         Product recalls may be issued at the discretion of the Company, the
FDA, or other government agencies having regulatory authority for product sales
and may occur due to disputed labeling claims, manufacturing issues, quality
defects or other reasons. No assurance can be given that product recalls will
not occur in the future. Any product recall could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company's policy is to accept for return only damaged and expired products in
accordance with its Return Goods Policy and procedures. There can be no
assurance that the Company will not grant such exceptions in the future. The
Company maintains financial reserves for the anticipated amount of product
returns based upon historical experience. There can be no assurance that future
recalls or returns would not have a material adverse affect upon the Company's
business, financial condition and results of operations.
See Item 1, "Business -- Government Regulation."

DEPENDENCE ON KEY PERSONNEL

         The Company is dependent on certain management personnel for the
operation and development of its business. The Company has entered into an
Employment Agreement providing for full-time services with Mr. Jonah Shacknai,
the founder, Chairman and Chief Executive Officer of the Company. The current
term of the agreement expires on June 30, 2001, subject to automatic renewal for
periods of five years unless either party gives timely notice of an intention
not to renew the agreement. Mr. Shacknai may also terminate the agreement prior
to the end of the term. Presently, the Company carries key man insurance on Mr.
Shacknai's life in the amount of $1.0 million with the Company as named
beneficiary. Subject to the control and oversight of the Company's Board of
Directors, Mr. Shacknai exercises control over substantially all policy-making
functions of the Company. In addition, the Company is dependent upon its
scientific consultants, particularly with respect to the commercial development
of discoveries and technologies to which they have special expertise. Certain of
such consultants are employed on a full-time basis by employers other than the
Company, and some have consulting or other advisory arrangements with other
entities which may conflict or compete with their obligations to the Company.
The loss of any key person, or a reduction in the amount of time Mr. Shacknai
devotes to the Company, could have an adverse effect on the Company's business,
financial condition or results of operations.

DEPENDENCE ON LICENSES FROM OTHERS

         The Company has acquired rights to manufacture, use or market certain
of its products, as well as many of its other proposed products and
technologies, pursuant to license agreements with third parties. Such agreements
contain provisions requiring the Company to use its best efforts or otherwise
exercise diligence in pursuing market development for the subject products in
order to maintain the rights granted under the agreements and may be canceled
upon the Company's failure to perform its payment obligations. There can be no
assurance that the Company will fulfill its obligations under one or more of
such agreements due to insufficient resources, lack of successful product
development, lack of product acceptance or other reasons. The failure to satisfy
the requirements of any such agreements may result in the loss of the Company's
rights under that agreement or under related


                                      -28-
<PAGE>   29
agreements and have a material adverse effect on the Company. In addition, the
Company's licensing agreements with Suess and Euromerican for the exclusive
rights to market the THERAPLEX(R) line of products will terminate in October
1999 with the expiration of the related patent. See Item 1, "Business --
Manufacturing," "-- Certain License and Royalty Agreements," "-- Trademarks" and
"-- Patents and Proprietary Rights."

RISK OF DEBT COVENANT DEFAULT

         The Company has a Credit Facility from Norwest that expires in November
1998. The Credit Facility is secured by substantially all of the assets of the
Company. The Company is required to comply with certain covenants and
restrictions, including covenants relating to the Company's financial condition
or results of operations. If the Company is unable or fails to comply with the
covenants and restrictions, the lender would have the right not to make loans
under the Credit Facility and to require early repayment of any outstanding
loans. The lack of availability of loans or the requirement to make early
repayment of loans or the inability of the Company to renew the Credit Facility
could have a material adverse effect on the Company's business, financial
condition or results of operations. See "-- Liquidity and Capital Resources."

UNCERTAINTY OF ACCESS TO CAPITAL

         During a portion of fiscal 1995 and prior years, the Company's cash
flow from operations was insufficient to cover its operating expenses, and the
Company relied on external financings to meet its needs for operating cash flow.
As a result of increased sales beginning in the latter half of 1995, the Company
experienced an increase in accounts receivable. The Company expects that its
current cash and cash equivalents, together with additional cash from operations
and cash available from its Credit Facility and the proceeds of the offering
completed in October 1996, will be sufficient to meet its current liquidity
requirements at least through the fiscal year ending June 30, 1998. However,
depending upon the Company's acquisition and licensing activity and results of
operations, there can be no assurance that such resources will be sufficient. If
they are not, the Company would need to obtain additional financing. There is no
assurance that such financing would be on terms advantageous to the Company.
Adequate additional funds, whether from the financial markets or from other
sources, may not be available on a timely basis, on terms acceptable to the
Company, or at all. Insufficient funds may cause the Company to delay, scale
back, or abandon some or all of its product acquisition, licensing, marketing or
research and development programs or opportunities.

VOLATILITY OF COMMON STOCK PRICE

         The market price for the stocks of many publicly traded pharmaceutical
companies and marketers of dermatological products, including the Company, is
highly volatile. A variety of events, both concerning and unrelated to the
Company and the markets in which it participates, may have a significant
negative impact on the market price of the Common Stock. These factors include
regulatory developments in the health care field generally, the performance of
and product announcements by other pharmaceutical companies, manufacturing or
supply disruptions, product recalls, the loss of key personnel, and other
matters affecting the Company's products, acquisitions and financial
performance. Although the Company's Common Stock trades on the Nasdaq National
Market, trading volume, size of institutional holdings and the number of
marketmakers has fluctuated and, in the past, has been quite low. Both the price
and volume of trading has been sensitive to the number of analysts reporting on
the Company and such analysts' comments concerning the Company and the industry
in which it participates. The realization of any of the risks described in these
"Certain Factors Affecting Forward Looking Statements" could have a material
adverse effect on the price of the Company's Common Stock.

CONTROL BY DIRECTORS AND OFFICERS

         As of September 16, 1997, the Company's directors and officers
beneficially own 777,730 shares of Class A Common Stock, which have one vote per
share, and 252,677 shares of Class B Common Stock, which have 10 votes per
share, representing approximately 7.0% of the Company's outstanding capital
stock and 19.1% of the total voting power. Accordingly, such individuals, if
they vote together, are able to exercise substantial power in the election of
directors and thereby influence the policies of the Company.


                                      -29-
<PAGE>   30
     MARKET RISK OF SHARES ELIGIBLE FOR FUTURE SALES

         Subject to certain specified exceptions relating to charitable gifts,
estate planning transfers and sales relating to the exercise of expiring
options, directors and executive officers of the Company hold in the aggregate,
as of September 16, 1997, 653,362 shares of Common Stock representing 4.6% of
the shares outstanding. Sales by such officers and directors are generally
subject to the provisions of Rule 144 under the Securities Act.

         The sale of a significant number of restricted securities, the exercise
of a significant number of options, or the offer or sale of a significant number
of shares of Common Stock acquired upon exercise of options at any one time
could materially adversely affect the market price of the Company's Common
Stock.

     ANTI-TAKEOVER EFFECT OF CHARTER PROVISIONS, RIGHTS PLAN, DELAWARE LAW

         The Company's Certificate of Incorporation and Bylaws authorized the
Board of Directors to designate and issue, without stockholder approval,
Preferred Stock with voting, conversion and other rights and preferences that
could differentially and adversely affect the voting power or other rights of
the holders of Common Stock. The issuance of Preferred Stock or of rights to
purchase Preferred Stock could be used to discourage an unsolicited acquisition
proposal. Moreover, the Company has granted a dividend of one Preference Stock
Purchase Right ("Right") on each outstanding share of Class A Common Stock and
Class B Common Stock. Under certain circumstances, after a person has acquired
beneficial ownership of a certain percentage of the Common Stock, each Right
will entitle the holder to purchase, at the Right's then-current exercise price,
stock of the Company or its successor at a discount. In addition, certain
provisions of Delaware law applicable to the Company and certain provisions of
the Company's Certificate of Incorporation and Bylaws could also delay or make
more difficult a merger, tender offer or proxy contest involving the Company,
including Section 203 of the Delaware Business Corporation Law, which prohibits
a Delaware corporation from engaging in any business combination with any
interested stockholder for a period of three years unless certain conditions are
met. All of the Company's stock option plans provide for the acceleration of
vesting in the event of a change in control in the Company, and Mr. Shacknai's
Employment Agreement provides for certain payments upon a change in control, as
well as an acceleration of vesting of options previously granted to him. The
possible issuance of Preferred Stock, the rights granted to stockholders under
the Rights Plan, Delaware law, provisions of the Certificate of Incorporation
and Bylaws and the Company's stock option plans and Mr. Shacknai's Employment
Agreement could each have the effect of delaying, deferring or preventing a
change in control of the Company including, without limitation, discouraging a
proxy contest, making more difficult the acquisition of a substantial block of
the Company's Common Stock or limiting the price that investors might in the
future be willing to pay for shares of the Common Stock. Under certain
circumstances, Mr. Shacknai's Employment Agreement requires the Company to make
payments that would constitute excess parachute payments under the Internal
Revenue Code of 1986, as amended. In the event that the Company was required to
make payments constituting excess parachute payments, payments to Mr. Shacknai
would not be deductible by the Company, and Mr. Shacknai would be required to
pay an excise tax.

LACK OF CASH DIVIDENDS

         The Company has never paid any cash dividends on its capital stock and
does not anticipate that any cash dividends will be declared or paid in the
foreseeable future.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
         MARKET RISK

         Not applicable

                                      -30-
<PAGE>   31
ITEM 8:  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The Company's financial statements and schedule at June 30, 1997 and
1996 and for each of the three years in the period ending June 30, 1997 and the
Independent Auditors' Report thereon and contained on pages F-1 through F-17 and
S-1 of this Form 10-K.

ITEM 9:  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCING DISCLOSURE

        Not applicable.


                                    PART III


ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

ITEM 11: EXECUTIVE COMPENSATION

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information called for by Items 10, 11, 12 and 13 are incorporated
by reference to the Company's definitive proxy statement for the 1997 Annual
Meeting of Stockholders to be filed pursuant to Regulation 14A.

                                      -31-
<PAGE>   32
                                     PART IV

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
                                                                                   PAGE
                                                                                   ----
<S>                                                                                <C>
    (a)  Documents filed as a part of this Report
         (1)     Financial Statements:
                  Index to Consolidated Financial Statements.....................   F-1
                  Report of Ernst & Young LLP, Independent Auditors..............   F-2
                  Consolidated balance sheets at June 30, 1997 and 1996..........   F-3
                  Consolidated statements of income for the years ended
                  June 30, 1997, 1996 and 1995...................................   F-5
                  Consolidated statements of stockholders' equity for the years
                  ended June 30, 1995, 1996 and 1997.............................   F-6
                  Consolidated statements of cash flows for the years ended June
                  30, 1997, 1996 and 1995........................................   F-7
                  Notes to consolidated financial statements.....................   F-8
         (2)    Financial Statement Schedules:
                  Schedule II - Valuation and Qualifying Accounts................   S-1
                   The financial statement schedule should be read in conjunction
                   with the consolidated financial statements. Financial
                   statement schedules not included in this Annual Report on Form
                   10-K have been omitted because they are not applicable or the
                   required information is shown in the financial statements or
                   notes thereto.
         (3)    Exhibits filed as part of this Report:
</TABLE>

<TABLE>
<CAPTION>
   EXHIBIT NO.         DESCRIPTION
   -----------         -----------
<S>                    <C>
       3.1       -     Certificate of Incorporation of the Company, as amended(11)
       3.3       -     By-Laws of the Company(1)
       4.1       -     Rights Agreement dated as of August 17, 1995 between the Company and American
                       Stock Transfer & Trust Company, as Rights Agent(11)
       4.1b      -     Amendment No. 2 to Rights Agreement dated as of March 17, 1997 between the
                       Company and Norwest Bank Minnesota N.A.(16)
       4.3       -     Form of specimen certificate representing Class A Common Stock(2)
       10.1      -     License Agreement among Euromerican Trade Resources, Inc., Dr.  H. R. Suess and
                       H. R. Suess A.G. dated as of September 24, 1987(3)
       10.2      -     Modification to License Agreement among the Company, Euromerican Trade
                       Resources, Inc., Dr. H. R. Suess and H. R. Suess A.G. dated as of April 6, 1989(3)
       10.3      -     Letter Agreement between the Company and Euromerican Trade Resources, Inc.
                       dated as of April 6, 1989, relating to Modification to License Agreement among
                       the Company, Euromerican Trade Resources, Inc., Dr. H. R. Suess and
                       H. R.  Suess A.G. dated as of April 6, 1989(3)
       10.8      -     Medicis Pharmaceutical Corporation 1995 Stock Option Plan (incorporated by
                       reference to Exhibit C to the definitive Proxy Statement for the 1995 Annual
                       Meeting of Stockholders previously filed with the SEC, File No. 0-18443)
       10.9      -     Employment Agreement between the Company and Jonah Shacknai dated as of
                       July 24, 1996(15)
       10.10     -     Medicis Pharmaceutical Corporation 1988 Stock Option Plan, as amended(4)
       10.12     -     License Agreement between the Company and Dr. H. R. Suess dated March 1, 1990(3)
       10.13     -     License Agreement between Syosset Laboratories, Inc. and Medicis Dermatologics,
                       Inc., dated as of July 25, 1990, and the Guaranty of the Company(5)
       10.14     -     Non-Exclusive License Agreement between Syosset Laboratories, Inc. and Medicis
                       Dermatologics, Inc., dated as of July 25, 1990, and the Guaranty of the Company(5)
       10.15     -     Manufacturing Agreement between Syosset Laboratories, Inc. and Medicis
                       Dermatologics, Inc., dated as of July 25, 1990, and the Guaranty of the Company(5)
</TABLE>

                                      -32-
<PAGE>   33
<TABLE>
<S>                    <C>
       10.16     -     Sales Agency Agreement between Syosset Laboratories, Inc. and Medicis
                       Dermatologics, Inc., dated as of July 25, 1990, and the Guaranty of the Company(5)
       10.18     -     Medicis Pharmaceutical Corporation 1990 Stock Option Plan, as amended(4)
       10.49     -     Option to Purchase Class A Common Stock granted to Stephen B. Booke(4)
       10.50     -     Option to Purchase Class A Common Stock granted to Gerald Amato(4)
       10.58     -     Medicis Pharmaceutical Corporation 1992 Stock Option Plan(8)
       10.59     -     Supply Agreement, dated as of October 21, 1992 between Schein and the Company(7)
       10.70     -     Amendment to Manufacturing and Supply Agreement, dated March 2, 1993 between
                       Schein and the Company(10)
       10.72(a)  -     Credit and Security Agreement, dated as of August 3, 1995 between the Company and
                       Norwest Business Credit, Inc.(12)
       10.72(b)  -     First Amendment to Credit and Security Agreement, dated as of May 29, 1996
                       between the Company and Norwest Bank Arizona, N.A.(15)
       10.72(c)  -     Second Amendment to Credit and Security Agreement dated November 22, 1996
                       by and between the Company and Norwest Bank Arizona, N.A. as successor-in-interest
                       to Norwest Business Credit, Inc.(17)
       10.73(a)  -     Patent Collateral Assignment and Security Agreement, dated as of August 3, 1995 by
                       the Company to Norwest Business Credit, Inc.(13)
       10.73(b)  -     First Amendment to Patent Collateral Assignment and Security Agreement, dated as
                       of May 29, 1996 by the Company to Norwest Bank Arizona,
                       N.A.(15)
       10.74(a)  -     Trademark Collateral Assignment and Security Agreement, dated as of August 3,
                       1995 by the Company to Norwest Business Credit, Inc.(14)
       10.74(b)  -     First Amendment to Trademark Collateral Assignment and Security Agreement,
                       dated as of May 29, 1996 by the Company to Norwest Bank Arizona, N.A.(15)
       10.75     -     Assignment and Assumption of Loan Documents, dated as of May 29, 1996 from
                       Norwest Business Credit, Inc., to and by Norwest Bank Arizona, N.A.(15)
       10.76     -     Multiple Advance Note, dated May 29, 1996 from the Company to Norwest Bank
                       Arizona, N.A.(15)
       10.77     -     Securities Account Pledge and Security Agreement dated November 22, 1996 by
                       and between the Company and Norwest Bank Arizona, N.A.(17)
       10.78     -     Acknowledgment of Control of Pledged Securities Account dated November 22, 1996
                       by and among Norwest Bank Arizona and the Company and Norwest Bank Minnesota(17)
       10.79     -     Asset Purchase Agreement dated January 21, 1997 between the Company and
                       Syntex (U.S.A.) Inc.(16)
       10.80     -     Asset Purchase Agreement dated January 21, 1997 between the Company and
                       Syntex (U.S.A.), Inc.(16)
       10.81     -     Asset Purchase Agreement dated January 21, 1997 between the Company and
                       F. Hoffman-La Roche Limited(16)
       10.82     -     Asset Purchase Agreement dated January 21, 1997 between the Company and
                       Syntex Pharmaceuticals International Limited(16)
       10.83     -     Transition Services Agreement dated January 21, 1997 between the Company and
                       F. Hoffman-La Roche, Inc.(16)
       10.84     -     Transition Services Agreement dated January 21, 1997 between the Company and
                       F. Hoffman-La Roche Limited(16)
       10.85     -     Supply Agreement (Fluocinolone Acetonide and Fluocinonide) dated January 21,
                       1997 between the Company and Syntex Pharmaceuticals International Limited(16)
       10.86     -     License Agreement dated March 28, 1997 between the Company and Platinum(R)
                       Software Corporation(16)
       10.87     -     Master Software License Agreement dated March 28, 1997 between the Company
                       and FocusSoft, Inc.(16)
       11.1      -     Statements re:  Computation of Per Share Earnings
       21.1      -     Subsidiaries(18)
       23.1      -     Consent of Ernst & Young LLP(18)
       24.1      -     Power of Attorney(18)  (See page 35)
       27.1      -     Financial Data Schedule(18)
</TABLE>

----------


                                      -33-
<PAGE>   34
    (1)  Incorporated by reference to the exhibit with the same number in the
         Company's Quarterly Report on Form 10-Q for the quarter ended December
         31, 1992, File No. 0-18443, previously filed with the Securities and
         Exchange Commission (the "SEC")

    (2)  Incorporated by reference to the exhibit with the same number in the
         Registration Statement on Form S-1 of the Registrant, File No.
         33-32918, filed with the SEC on January 16, 1990

    (3)  Incorporated by reference to the exhibit with the same number in
         Amendment No. 1 to the Registration Statement on Form S-1 of the
         Company, File No. 33-32918, filed with the SEC on March 6, 1990

    (4)  Incorporated by reference to the exhibit with the same number in the
         Company's Annual Report on Form 10-K for the fiscal year ended June 30,
         1992, as amended, File No. 0-18443 previously filed with the SEC

    (5)  Incorporated by reference to the exhibit with the same number in
         Amendment No. 2 to the Registration Statement on Form S-1 of the
         Company, File No. 33-34041, filed with the SEC on August 2, 1990

    (6)  Incorporated by reference to the exhibit with the same number in
         Amendment No. 1 to the Registration Statement on Form S-1 of the
         Company, File No. 33-46913, filed with the SEC on April 29, 1992

    (7)  Incorporated by reference to the exhibit with the same number in
         Registration Statement on Form S-1 of the Company, File No. 33-54276,
         filed with the SEC on June 11, 1993

    (8)  Incorporated by reference to Exhibit B to the Company's definitive
         Proxy Statement for its 1992 Annual Meeting of Stockholders, previously
         filed with the SEC, File No. 0-18443

    (9)  Incorporated by reference to the exhibit with the same number in
         Amendment No. 1 to the Registration Statement on Form S-1 of the
         Company, File No. 33-54276, filed with the SEC on May 25, 1993

    (10) Incorporated by reference to the exhibit with the same number in the
         Company's Annual Report on Form 10-K for the fiscal year ended June 30,
         1993, File No. 0-18443, filed with the SEC on October 13, 1993

    (11) Incorporated by reference to the exhibit with the same number in the
         Company's Annual Report on Form 10-K for the fiscal year ended June 30,
         1995, File No. 0-18443, filed with the SEC on September 27, 1995 ("1995
         Form 10-K")

    (12) Incorporated by reference to exhibit number 4.2 in the 19 Form 10-K

    (13) Incorporated by reference to exhibit number 4.4 in the 19 Form 10-K

    (14) Incorporated by reference to exhibit number 4.5 in the 19 Form 10-K

    (15) Incorporated by reference to the exhibit with the same number in the
         Company's Annual Report on Form 10-K for the fiscal year ended June 30,
         1996, File No. 0-18443, filed with the SEC on September 24, 1996

    (16) Incorporated by reference to the exhibit with the same number in the
         Company's Quarterly Report on Form 10-Q for the quarter ended March 31,
         1997, File No. 0-18443, previously filed with the SEC

    (17) Incorporated by reference to the exhibit with the same number in the
         Company's Quarterly Report on Form 10-Q for the quarter ended December
         31, 1996, File No. 0-18443, previously filed with the SEC

    (18) Filed herewith

(b) No reports on Form 8-K were filed with the SEC for the quarter end June 30,
    1997.

(c) The exhibits to this Form 10-K follow the Company's Financial Statement
    Schedule included in this Form 10-K.

(d) The Financial Statement Schedule to this Form 10-K appears on page S-1 of
    this Form 10-K.


                                      -34-
<PAGE>   35
                                POWER OF ATTORNEY

         KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Jonah Shacknai and Mark A. Prygocki, Sr.,
or either of them, as his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Annual Report on Form 10-K and any documents related to this report and filed
pursuant to the Securities and Exchange Act of 1934, and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof.

                                   SIGNATURES

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

Date:  September 25, 1997

                                     MEDICIS PHARMACEUTICAL CORPORATION

                                     By:   /s/ JONAH SHACKNAI
                                           -----------------------------------
                                           Jonah Shacknai
                                           Chairman of the Board of Directors
                                           and Chief Executive Officer

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

<TABLE>
<CAPTION>
                 SIGNATURE                                          TITLE                                 DATE
---------------------------------------------   ---------------------------------------------     ---------------------
<S>                                             <C>                                               <C>
/s/ JONAH SHACKNAI                              Chairman of the Board of Directors                September 25, 1997
--------------------------------------------    and Chief Executive Officer
Jonah Shacknai                                  (Principal Executive Officer)

/s/ MARK A. PRYGOCKI, SR.                       Chief Financial Officer                           September 25, 1997
--------------------------------------------     (Principal Financial and Accounting Officer)
Mark A. Prygocki, Sr.

/s/ ARTHUR G. ALTSCHUL, JR.                     Director                                          September 25, 1997
--------------------------------------------
Arthur G. Altschul, Jr.

/s/ RICHARD L. DOBSON, M.D.                     Director                                          September 25, 1997
--------------------------------------------
Richard L. Dobson, M.D.

/s/ PETER S. KNIGHT, ESQ.                       Director                                          September 25, 1997
--------------------------------------------
Peter S. Knight, Esq.

/s/ MICHAEL A. PIETRANGELO                      Director                                          September 25, 1997
--------------------------------------------
Michael A. Pietrangelo

/s/ PHILIP S. SCHEIN, M.D.                      Director                                          September 25, 1997
--------------------------------------------
Philip S. Schein, M.D.

/s/ LOTTIE SHACKELFORD                          Director                                          September 25, 1997
--------------------------------------------
Lottie Shackelford
</TABLE>

                                      -35-
<PAGE>   36
                       MEDICIS PHARMACEUTICAL CORPORATION

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<TABLE>
<CAPTION>
                                                                                              PAGE
                                                                                              ----
<S>                                                                                           <C>
          Report of Ernst & Young LLP, Independent Auditors............................        F-2

          Consolidated Balance Sheets..................................................        F-3

          Consolidated Statements of Income............................................        F-5

          Consolidated Statements of Stockholders' Equity..............................        F-6

          Consolidated Statements of Cash Flows........................................        F-7

          Notes to Consolidated Financial Statements...................................        F-8
</TABLE>




                                      F-1
<PAGE>   37
                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Medicis Pharmaceutical Corporation

         We have audited the accompanying consolidated balance sheets of Medicis
Pharmaceutical Corporation and subsidiaries as of June 30, 1997 and 1996, and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended June 30, 1997. Our audits
also included the financial statement schedule listed in the Index at Item
14(a). These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. 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 includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial condition of
Medicis Pharmaceutical Corporation and subsidiaries at June 30, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended June 30, 1997, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

                                   /s/ ERNST & YOUNG LLP

Phoenix, Arizona
August 1, 1997




                                      F-2
<PAGE>   38
                       MEDICIS PHARMACEUTICAL CORPORATION

                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS


<TABLE>
<CAPTION>
                                                                    JUNE 30,
                                                           ---------------------------
                                                               1997           1996
                                                           ------------    -----------
<S>                                                        <C>             <C>
ASSETS
  Current assets:
    Cash and cash equivalents .........................    $ 33,623,397    $ 7,956,050
    Short-term investments ............................      51,508,611             --
    Accounts receivable, less allowances:
      1997: $1,150,000;  1996: $680,000 ...............       6,352,840      5,210,704
    Inventories .......................................       2,981,877      2,080,014
    Deferred tax assets ...............................       6,257,000      3,000,000
    Other current assets ..............................       2,818,505        738,911
                                                           ------------    -----------
         Total current assets .........................     103,542,230     18,985,679
Property and equipment:
  Furniture and equipment .............................         755,905        336,544
  Leasehold improvements ..............................         170,000        170,000
                                                           ------------    -----------
                                                                925,905        506,544
    Less accumulated depreciation .....................         213,764        100,897
                                                           ------------    -----------
         Net property and equipment ...................         712,141        405,647
Intangible assets:
  Intangible assets related to product acquisitions ...      36,999,644      9,168,853
  Other intangible assets .............................       1,608,762        203,326
                                                           ------------    -----------

                                                             38,608,406      9,372,179
    Less accumulated amortization .....................       3,325,621      2,450,705
                                                           ------------    -----------
         Net intangible assets ........................      35,282,785      6,921,474

Other non-current assets ..............................       1,000,000             --
                                                           ------------    -----------
                                                           $140,537,156    $26,312,800
                                                           ============    ===========
</TABLE>


                             See accompanying notes.




                                      F-3
<PAGE>   39
                       MEDICIS PHARMACEUTICAL CORPORATION

                           CONSOLIDATED BALANCE SHEETS

                      LIABILITIES AND STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                                                           JUNE 30,
                                                                                ------------------------------
                                                                                     1996             1997
                                                                                -------------     ------------
<S>                                                                             <C>               <C>
LIABILITIES
  Current liabilities:
    Accounts payable .......................................................    $   4,128,370     $  3,371,184
    Accrued officer's salaries .............................................               --          204,750
    Accrued royalties ......................................................          712,432          552,952
    Notes payable ..........................................................            5,245           10,000
    Accrued incentives .....................................................        1,671,103        1,184,111
    Accrued contract costs .................................................          600,000               --
    Other accrued liabilities ..............................................        1,622,093        1,262,134
                                                                                -------------     ------------
         Total current liabilities .........................................        8,739,243        6,585,131
  Long-term liabilities:
    Notes payable ..........................................................          111,335          116,580
    Other non-current liabilities ..........................................          121,761          151,437
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred Stock, $0.01 par value; shares authorized: 5,000,000;
  no shares issued .........................................................               --               --
Class A Common Stock, $0.014 par value; shares authorized: 50,000,000;
  issued and outstanding: 13,978,714 and 10,224,477 at June 30, 1997 and
  1996, respectively .......................................................          195,702          143,143
Class B Common Stock, $0.014 par value; shares authorized: 1,000,000;
  issued and outstanding:  281,974 at June 30, 1997 and 1996 ...............            3,948            3,948
Additional paid-in capital .................................................      138,973,208       44,202,441
Accumulated deficit ........................................................       (7,608,041)     (24,889,880)
                                                                                -------------     ------------
         Total stockholders' equity ........................................      131,564,817       19,459,652
                                                                                -------------     ------------
                                                                                $ 140,537,156     $ 26,312,800
                                                                                =============     ============
</TABLE>


                             See accompanying notes.




                                      F-4
<PAGE>   40
                       MEDICIS PHARMACEUTICAL CORPORATION

                        CONSOLIDATED STATEMENTS OF INCOME



<TABLE>
<CAPTION>
                                                                       YEAR ENDED JUNE 30,
                                                                       -------------------
                                                              1997             1996             1995
                                                          ------------     ------------     ------------
<S>                                                       <C>              <C>              <C>
Net sales ............................................    $ 41,158,860     $ 25,309,743     $ 19,131,665
Operating costs and expenses:
 Cost of sales .......................................       9,361,383        6,955,685        5,849,886
 Selling, general and administrative .................      16,484,329       10,867,979       10,330,162
 Research and development ............................       1,449,620          951,888          769,577
 Depreciation and amortization .......................         999,113          558,802          522,221
                                                          ------------     ------------     ------------
    Operating costs and expenses .....................      28,294,445       19,334,354       17,471,846
                                                          ------------     ------------     ------------
Operating income .....................................      12,864,415        5,975,389        1,659,819
Gain on disposition of Dyad ..........................              --               --          106,640
Interest income ......................................       3,814,435          154,023           57,543
Interest expense .....................................         (27,403)         (75,670)        (150,895)
                                                          ------------     ------------     ------------
Income before taxes ..................................      16,651,447        6,053,742        1,673,107
Income tax benefit (expense) .........................         693,467        1,826,000          (60,000)
                                                          ------------     ------------     ------------
Net income ...........................................    $ 17,344,914     $  7,879,742     $  1,613,107
                                                          ============     ============     ============
Net income per common and common equivalent share ....    $       1.22     $       0.73     $       0.16
                                                          ============     ============     ============
Shares used in computing net income per common and
    common equivalent share ..........................      14,202,074       10,863,243        9,889,746
                                                          ============     ============     ============
</TABLE>


                             See accompanying notes.




                                      F-5
<PAGE>   41
                       MEDICIS PHARMACEUTICAL CORPORATION

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY




<TABLE>
<CAPTION>
                                           CLASS A               CLASS B
                                        COMMON STOCK           COMMON STOCK             ADDITIONAL
                                        ------------           ------------              PAID-IN      ACCUMULATED
                                     SHARES      AMOUNT    SHARES        AMOUNT          CAPITAL        DEFICIT          TOTAL
                                     ------      ------    ------        ------          -------        -------          -----
<S>                                <C>          <C>        <C>           <C>          <C>            <C>             <C>
Balance at June 30, 1994 .......    9,394,694   $131,526   281,974       $3,948       $ 39,510,698   $(34,382,729)   $   5,263,443
 Shares issued in
   connection with private
   offering ....................      353,571      4,950        --           --            505,494             --          510,444
 Net income ....................           --         --        --           --                 --      1,613,107        1,613,107
                                   ----------   --------   -------       ------       ------------   ------------    -------------
Balance at June 30, 1995 .......    9,748,265    136,476   281,974        3,948         40,016,192    (32,769,622)       7,386,994
 Exercise of stock options
   and warrants, net ...........      476,212      6,667        --           --          3,099,249             --        3,105,916
 Tax effect of stock options
   exercised ...................           --         --        --           --          1,067,000             --        1,067,000
 Options issued in lieu of
   payment for services
   rendered ....................           --         --        --           --             20,000             --           20,000
 Net income ....................           --         --        --           --                 --      7,879,742        7,879,742
                                   ----------   --------   -------       ------       ------------   ------------    -------------
Balance at June 30, 1996 .......   10,224,477    143,143   281,974        3,948         44,202,441    (24,889,880)      19,459,652
 Exercise of stock options .....      563,681      7,892        --           --          3,482,765             --        3,490,657
 Tax effect of stock
   options exercised ...........           --         --        --           --          1,165,000             --        1,165,000
 Options issued in lieu of
   payment for services
   rendered ....................           --         --        --           --             59,500             --           59,500
Public offering ................    3,190,556     44,667        --           --         90,063,502             --       90,108,169
Net unrealized losses on
  available-for-sale
  securities ...................           --         --        --           --                 --        (63,075)         (63,075)
Net income .....................           --         --        --           --                 --     17,344,914       17,344,914
                                   ----------   --------   -------       ------       ------------   ------------    -------------
Balance at June 30, 1997 .......   13,978,714   $195,702   281,974       $3,948       $138,973,208   $ (7,608,041)   $ 131,564,817
                                   ==========   ========   =======       ======       ============   ============    =============
</TABLE>


                             See accompanying notes.




                                      F-6
<PAGE>   42
                       MEDICIS PHARMACEUTICAL CORPORATION

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                            YEAR ENDED JUNE 30,
                                                                    1997             1996            1995
                                                                ------------     -----------     -----------
<S>                                                             <C>              <C>             <C>
OPERATING ACTIVITIES:
 Net income ................................................    $ 17,344,914     $ 7,879,742     $ 1,613,107
 Adjustments to reconcile net income to net cash
   provided by operating activities:
    Depreciation and amortization ..........................         999,113         558,802         522,221
    Gain on sale of available-for-sale investments .........         (37,591)             --              --
    Non-cash interest ......................................              --          13,100          49,602
    Other non-cash expenses ................................          59,500          20,000              --
    Deferred income tax benefit ............................      (2,092,000)     (1,933,000)             --
    Provision for doubtful accounts and returns ............         470,000         160,000         120,000
    Accretion of discount on investments ...................        (422,032)             --              --
    Changes in operating assets and liabilities:
      Accounts receivable ..................................      (1,612,136)     (1,156,280)     (1,154,922)
      Inventories ..........................................        (901,863)     (1,281,058)       (370,929)
      Other current assets .................................      (1,579,594)       (487,825)        (48,013)
      Accounts payable .....................................         757,186         144,011       1,282,949
      Accrued officer's salaries ...........................        (204,750)             --              --
      Accrued royalties ....................................         159,480          84,770          70,601
      Interest payable .....................................              --              --        (250,016)
      Accrued incentives ...................................         486,992         552,880         222,711
      Other accrued liabilities
                                                                     359,959         334,891        (307,792)
                                                                ------------     -----------     -----------
         Net cash provided by operating activities .........      13,787,178       4,890,033       1,749,519

INVESTING ACTIVITIES:
 Purchase of property and equipment ........................        (430,691)       (181,911)       (140,754)
 Payments for intangible assets ............................     (28,636,227)             --              --
 Purchase of available-for-sale investments ................     (75,297,924)             --              --
 Sale of available-for-sale investments ....................       9,685,861              --              --
 Maturity of available-for-sale investments ................      14,500,000              --              --
 Escrow deposit ............................................      (1,500,000)        (71,772)         (7,885)
                                                                ------------     -----------     -----------
         Net cash used in investing activities .............     (81,678,981)       (253,683)       (148,639)

FINANCING ACTIVITIES:
 Proceeds from the sale of common equity securities, net ...      90,108,169              --         510,444
 Proceeds from issuance of note payable ....................              --           9,143         107,437
 Payment of notes payable ..................................         (10,000)       (748,797)     (2,040,000)
 Decrease in other non-current liabilities .................         (29,676)             --              --
 Proceeds from the exercise of options/warrants ............       3,490,657       3,105,916              --
                                                                ------------     -----------     -----------
         Net cash provided by (used in) financing
           activities ......................................      93,559,150       2,366,262      (1,422,119)
                                                                ------------     -----------     -----------
 Net increase in cash and cash equivalents .................      25,667,347       7,002,612         178,761
 Cash and cash equivalents at beginning of year ............       7,956,050         953,438         774,677
                                                                ------------     -----------     -----------
 Cash and cash equivalents at end of year ..................    $ 33,623,397     $ 7,956,050     $   953,438
                                                                ============     ===========     ===========
</TABLE>


                             See accompanying notes.




                                      F-7
<PAGE>   43
                       MEDICIS PHARMACEUTICAL CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                  JUNE 30, 1997

NOTE 1.  FORMATION AND DEVELOPMENT OF THE COMPANY

         Medicis Pharmaceutical Corporation and its wholly owned subsidiaries
("Medicis" or the "Company") is an independent pharmaceutical company in the
United States offering prescription and non-prescription (over-the-counter)
products exclusively to treat dermatological conditions. The Company has
acquired rights to manufacture and sell certain of its dermatological products
pursuant to several license and asset purchase agreements. The Company sells
these products for use in various segments of the dermatological market,
including acne, inflammatory skin conditions, therapeutic emollients and
moisturizers, pigmentation disorders and cosmetic dermatology.

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

         The accompanying consolidated financial statements include the accounts
of Medicis and all wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform to the current period
presentation.

CASH AND CASH EQUIVALENTS

        At June 30, 1997, cash equivalents include highly liquid investments
invested in money market accounts consisting of government securities and
high-grade commercial paper. These investments are stated at cost which
approximates fair value. The Company considers all highly liquid investments
purchased with a remaining maturity of three months or less to be cash
equivalents.

INVESTMENTS

         The Company accounts for investments under Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The Company's debt securities are classified as
available-for-sale. Available-for-sale securities are carried at fair value with
the unrealized gains and losses reported in stockholders' equity. The amortized
cost of debt securities in this category is adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Realized gains and losses, interest, and dividends on
securities are included in interest income. The cost of securities sold is based
on the specific identification method.

INVENTORIES

         The Company utilizes third parties to manufacture and package
inventories held for sale, takes title to certain inventories once manufactured,
and warehouses such goods until packaged for final distribution and sale.
Inventories consist of salable dermatological products held at the Company's
warehouses as well as at the manufacturers' facilities and are valued at the
lower of cost or market using the first-in, first-out method.




                                      F-8
<PAGE>   44
         Inventories are as follows:

<TABLE>
<CAPTION>
                                                                JUNE 30,
                                                        ------------------------
                                                           1997          1996
                                                        ----------    ----------
<S>                                                     <C>           <C>
                            Raw materials ..........    $  557,520    $   72,633
                            Work in progress .......            --        23,749
                            Finished goods .........     2,424,357     1,983,632
                                                        ----------    ----------

                              Total inventories ....    $2,981,877    $2,080,014
                                                        ==========    ==========
</TABLE>

PROPERTY AND EQUIPMENT

         Property and equipment are stated at cost. Depreciation is calculated
on the straight-line basis over the estimated useful lives of property and
equipment (three to five years). Leasehold improvements are amortized over the
shorter of their estimated useful lives or the remaining lease term.

INTANGIBLE ASSETS

         Legal fees and other direct costs incurred in obtaining and protecting
patents and trademarks are capitalized as incurred. When patent applications are
approved or trademarks are registered, these costs are amortized over the
shorter of the useful life of the patent or trademark, or the related product on
the straight-line basis. The costs are expensed if and when it is concluded that
nonapproval is probable or, in the Company's opinion, the patent or trademark
should be abandoned.

         Intangible assets resulting from the LIDEX(R), SYNALAR(R) and
ESOTERICA(R) product acquisitions principally consist of the excess of the
acquisition cost over the fair value of the net assets acquired and are being
amortized on a straight-line basis over a twenty to twenty-five year period. The
Company assesses the recoverability of intangible assets resulting from the
LIDEX(R), SYNALAR(R) and ESOTERICA(R) product acquisitions based upon expected
future undiscounted cash flows and other relevant information.

REVENUE RECOGNITION

         Revenue from product sales are recognized upon shipment net of
discounts, rebates and estimated allowances for chargebacks and returns. The
Company principally authorizes returns for damaged and expired products in
accordance with its Return Goods Policy and procedures. The Company has not
experienced significant returns of damaged or expired products.

ADVERTISING

         The Company expenses advertising as incurred. Advertising expenses for
the fiscal years ended June 30, 1997 ("fiscal 1997"), June 30, 1996 ("fiscal
1996") and June 30, 1995 ("fiscal 1995") were approximately $3,806,000,
$1,887,000 and $1,525,000, respectively.

STOCK BASED COMPENSATION

         The Company grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. The Company accounts for stock option grants to employees in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25").

         The Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock Based Compensation" ("SFAS No. 123") in fiscal 1997,
related to stock options granted to non-employees. Expense equal to either the
fair value of the consideration received, if such fair value is reliably
measurable, or the SFAS No. 123 fair value of the options granted to
non-employees is recorded. The adoption of SFAS No. 123 did not have a material
impact on the consolidated operations of the Company.



                                      F-9
<PAGE>   45
RESEARCH AND DEVELOPMENT COSTS

         All research and development costs, including payments related to
products under development and research consulting agreements, are expensed as
incurred.

INCOME TAXES

         Income taxes have been provided using the liability method in
accordance with SFAS No. 109.

NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE

         Net income per common and common equivalent share have been computed by
using the weighted average number of shares outstanding and common equivalent
shares. Net income per share has been adjusted to reflect the 3-for-2 stock
splits described in Note 7.

STATEMENTS OF CASH FLOWS

         Non-cash investing and financing activities were as follows:

<TABLE>
<CAPTION>
                                                                              YEAR ENDED JUNE 30,
                                                                     -------------------------------------
                                                                        1997           1996         1995
                                                                     ----------    -----------    --------
<S>                                                                  <C>           <C>            <C>
          Tax benefit of stock options exercised ................    $1,165,000    $ 1,067,000          --
          Intangibles acquired under accrued contract costs .....       600,000             --          --
          Property and equipment acquired under capital lease
            obligations .........................................            --             --    $170,234
</TABLE>

USE OF ESTIMATES

         The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates based upon future events, which could include, among other
risks, changes in the regulations governing the manner in which the Company
sells its products, changes in the health care environment and the reliance on
contract manufacturing services.

FAIR VALUE OF FINANCIAL INSTRUMENTS

         The carrying amount of cash and cash equivalents, short-term
investments, accounts receivable, accounts payable, and long-term debt reported
in the consolidated balance sheets approximate their fair value.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

         In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share," ("SFAS No. 128") which is required to
be adopted in the second quarter of fiscal 1998 ended December 31, 1997. At that
time, the Company will be required to change the method currently used to
compute earnings per share and to restate all prior periods. Under the new
requirements for calculating basic earnings per share, the dilutive effect of
stock options will be excluded. The impact is expected to result in an increase
in basic earnings per share for the year ended June 30, 1997 of $0.09 to $1.31.
The impact for the year ended June 30, 1996, is expected to increase $0.05 to
$0.78 per share. The impact of SFAS No. 128 on the calculation of fully diluted
earnings per share for the quarter and year end June 30, 1997, and June 30,
1996, is not expected to be material.




                                      F-10
<PAGE>   46
PRODUCT ACQUISITIONS

         In February 1997, the Company acquired the United States and Canadian
dermatology assets of Syntex USA, Inc., ("Syntex") from various affiliates of F.
Hoffmann-La Roche, Ltd. ("Roche"). The Company paid $28,000,000 for the
purchased assets. The Company will pay an additional $3,000,000 in $1,000,000
installments on the anniversary of the purchase for each of the next three years
unless certain market conditions are not obtained. Half of the remaining
payments are held in escrow and included in the Company's other assets. Medicis
entered into four separate Asset Purchase Agreements with various Roche
affiliates for the acquisition of the intellectual property rights, know-how,
and all finished goods inventory specifically associated with Syntex's topical
corticosteroid dermatology products ("the Purchased Products") in the United
States and Canada. The purchased products include the prescription topical
steroid brands LIDEX(R) and SYNALAR(R). Prior to the acquisition, the Company
did not market any products in this category of dermatological care.

NOTE 3.  DEBT

         Upon the Company's relocation to Arizona, the Company entered into a
note from the Commerce and Economic Development Commission in the amount of
approximately $131,000 bearing interest at a rate of 6.5% due in installments
through June 2, 2000. At June 30, 1997, $116,580 was outstanding on the note.

         The Company has a revolving line of credit facility of up to $25
million from Norwest Bank Arizona, N.A. The facility may be drawn upon by the
Company at its discretion and is secured by principal assets of the Company. The
outstanding balance of the credit facility bears interest at a floating rate of
150 basis points in excess of the 30-day London Interbank offered rate, and
expires in November 1998. The agreement requires the Company to comply with
certain covenants, including covenants relating to the Company's financial
condition and results of operation. The Company has not drawn on this credit
facility.

NOTE 4.  SHORT-TERM INVESTMENTS

         The Company's short-term investments are intended to establish a high
quality portfolio which preserves principal, meets liquidity needs, avoids
inappropriate concentrations and delivers an appropriate yield in relationship
to the investment guidelines and market conditions.

         The following is a summary of available-for-sale securities at June 30,
1997:

<TABLE>
<CAPTION>
                                                              AVAILABLE-FOR-SALE SECURITIES
                                                    ------------------------------------------------
                                                                   GROSS       GROSS      ESTIMATED
                                                                 UNREALIZED  UNREALIZED     FAIR
                                                        COST       GAINS       LOSSES       VALUE
                                                    -----------  ----------  ----------  -----------
<S>                                                 <C>          <C>         <C>          <C>
    U.S. corporate securities ..................    $22,542,389    $1,811     $22,188    $22,522,012
    U.S. Treasury securities and obligations ...     19,030,792       494      38,626     18,992,660
      of  U.S. government agencies
    Other debt securities ......................      9,998,505        --       4,566      9,993,939
                                                    -----------    ------     -------    -----------
      Total debt securities ....................    $51,571,686    $2,305     $65,380    $51,508,611
                                                    ===========    ======     =======    ===========
</TABLE>

         The gross realized gains on sales of available-for-sale securities
totaled $64,361, and the gross realized losses totaled $26,770. The net
adjustment to unrealized losses on available-for-sale securities included in
stockholders' equity totaled $63,075. The amortized cost and estimated fair
value of the available-for-sale securities at June 30, 1997, by maturity, are
shown below. Expected maturities will differ from contractual maturities because
the issuers of the securities may have the right to prepay obligations without
prepayment penalties and the Company views its available-for-sale securities as
available for current operations.




                                      F-11
<PAGE>   47
<TABLE>
<CAPTION>
                                                                               ESTIMATED
                                                                   COST       FAIR VALUE
                                                               -----------    -----------
<S>                                                            <C>            <C>
                 AVAILABLE-FOR-SALE
                   Due in one year or less ................    $20,408,747    $20,390,555
                   Due after one year through two years ...     26,162,939     26,136,638
                   Due after two years ....................      5,000,000      4,981,418
                                                               -----------    -----------
                                                               $51,571,686    $51,508,611
                                                               ===========    ===========
</TABLE>

NOTE 5.  COMMITMENTS AND CONTINGENCIES

OCCUPANCY ARRANGEMENTS

         The Company presently occupies approximately 12,150 square feet of
office space, at an average annual expense of $191,007 per annum, under a lease
agreement which expires in May 2005. The lease contains certain rent escalation
clauses and upon expiration can be renewed for a period of five years. Rent
expense was approximately $203,000, $207,000 and $188,000 for fiscal 1997, 1996
and 1995, respectively.

RESEARCH AND DEVELOPMENT AND CONSULTING CONTRACTS

         The Company has in the past and may in the future enter into agreements
with various research organizations and individuals under which the Company
acquires certain patent and marketing rights for therapeutics developed under
such agreements in exchange for providing funding for collaborative research. It
is also anticipated that, before any commercial marketing can be commenced, the
Company will be required to secure certain regulatory approvals on the
technological processes involved.

         The Company has various consulting agreements with certain scientists
in exchange for the assignment of certain rights and consulting services. In
addition, the Company has granted options to purchase shares of Class A Common
Stock which are included in the stock option plan described in Note 8. These
options vest annually over the commitment periods. At June 30, 1997, the Company
had approximately $870,000 (solely attributable to the Chairman of the Central
Research Committee of the Company) of commitments payable over the remaining
five years under an agreement, which is cancelable by either party under certain
conditions.

LICENSING, MARKETING AND MANUFACTURING AGREEMENTS

         The Company has entered into licensing and marketing agreements under
which it has obtained rights to market certain existing and future
pharmaceutical products. Generally, the terms of such agreements vary, but range
from 10 to 20 years from the date of the first sale of the related product or
until the expiration of the patent applicable to the product. The agreements
provide for varying royalties with certain stated minimum annual amounts, which
vary by agreement from $25,000 to, for one such agreement, $55,000. A commitment
to pay a minimum annual royalty of $160,000 commences twelve months after the
United States Food and Drug Administration grants approval to market the product
governed by an agreement. Total minimum royalties required to be paid on
products currently being sold approximate $80,000 per year.

         During June 1997, the Company entered into a joint product development
and distribution agreement with an unrelated third party whereby the Company
will pay certain costs with respect to certain product approvals estimated to be
approximately $1,000,000.

OTHER

         The Company and certain of its subsidiaries are parties to other
actions and proceedings incident to their business. Liability in the event of
final adverse determinations in any of these matters is either covered by
insurance and/or established reserves, or, in the opinion of management, after
consultation with counsel, should not, in the aggregate, have a material adverse
effect on the consolidated financial condition or results of operations of the
Company.



                                      F-12
<PAGE>   48
NOTE 6.  INCOME TAXES

         Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's net deferred tax assets are as follows:


<TABLE>
<CAPTION>
                                                                                      JUNE 30,
                                                                           -----------------------------
                                                                               1997             1996
                                                                           ------------     ------------
<S>                                                                        <C>              <C>
          Deferred tax assets:
            Net operating loss carryforwards ..........................    $  4,550,000     $ 10,500,000
            Reserves ..................................................       1,497,000          700,000
            Research and experimentation credits ......................         580,000          450,000
            Alternative Minimum Tax credits ...........................         325,000           70,000
                                                                           ------------     ------------
                                                                              6,952,000       11,720,000
          Deferred tax liabilities:
            Tax over book amortization of intangible assets related
               to product acquisitions ................................        (695,000)        (120,000)
                                                                           ------------     ------------
          Net deferred tax assets available ...........................       6,257,000       11,600,000
          Less valuation allowance ....................................              --        8,600,000
                                                                           ------------     ------------
          Deferred tax assets .........................................    $  6,257,000     $  3,000,000
                                                                           ============     ============
</TABLE>

         The valuation allowance decreased by $8,600,000 and $5,360,000 during
fiscal 1997 and 1996, respectively. The decrease in fiscal 1997 related to
changes in estimate with respect to deferred tax assets that management believes
are more likely than not expected to be recovered through future income
("Changes in Estimate"). Of the decrease in fiscal 1996, approximately
$4,000,000 related to Changes in Estimate, and an additional $1,000,000 related
to lower estimated deferred tax rates based upon the Company's relocation. The
amount of net deferred tax assets estimated to be recoverable was based upon
management's assessment of the likelihood of near-term operating income.

         At June 30, 1997, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $11,000,000 and research and
experimentation credits of approximately $580,000, which begin expiring in
varying amounts in the years 2005 through 2011 if not previously utilized.
During fiscal 1997 and 1996, the Company incurred approximately $255,000 and
$70,000, respectively, in Alternative Minimum Tax, which is available as a
future tax credit. The Alternative Minimum Tax credits do not expire for income
tax purposes.

         During fiscal 1997, 1996 and 1995, the Company made tax payments of
$1,133,000, $132,000 and $80,000, respectively.

         Components of the provision for income taxes (benefit) are as follows:

<TABLE>
<CAPTION>
                                                       YEAR ENDED JUNE 30,
                                             ---------------------------------------
                                                 1997            1996         1995
                                             -----------     -----------     -------
<S>                                          <C>             <C>             <C>
                  Current
                    Federal .............    $   272,000     $    70,000     $35,000
                    State ...............      1,127,533          37,000      25,000
                                             -----------     -----------     -------
                                               1,399,533         107,000      60,000
                  Deferred
                    Federal .............     (1,830,000)     (1,500,000)         --
                    State ...............       (262,000)       (433,000)         --
                                                             -----------     -------
                                              (2,092,000)     (1,933,000)         --
                                                             -----------     -------

                           Total ........    $  (692,467)    $(1,826,000)    $60,000
                                             ===========     ===========     =======
</TABLE>

         Income tax expense (benefit) for the three years ended June 30, 1997,
1996, and 1995 differs from the amount computed applying the federal statutory
rates as follows:




                                      F-13
<PAGE>   49
<TABLE>
<CAPTION>
                                                        YEAR ENDED JUNE 30,
                                                   ---------------------------
                                                    1997       1996       1995
                                                   -----      -----      -----
<S>                                                <C>        <C>        <C>
          Statutory federal income tax rate ...     35.0%      34.0%      34.0%
          State tax rate ......................      5.0        6.0       10.0
          Change in valuation allowance .......    (44.2)     (70.0)     (43.2)
          Other ...............................       --         --        2.8
                                                   -----      -----      -----
          Expense (benefit) ...................     (4.2%)    (30.0%)      3.6%
                                                   =====      =====      =====
</TABLE>


NOTE 7.  STOCK TRANSACTIONS

         Class A Common Stock has one vote per share and Class B Common Stock
has ten votes per share. Each share of Class B Common Stock may be converted
into one share of Class A Common Stock at the option of the holder or, in some
circumstances, may automatically be converted upon a vote of the Board of
Directors and the majority of the Class B Common Stockholders.

         Pursuant to a Subscription Agreement, dated as of November 17, 1994,
(the "Subscription Agreement") with Frost Nevada Limited Partnership, a Nevada
limited partnership ("Frost Nevada"), the Company issued 353,571 shares of its
Class A Common Stock, $0.014 par value to Frost Nevada for a purchase price of
$600,600. The 353,571 shares of Class A Common Stock issued by the Company were
sold to Frost Nevada as part of a two-part transaction in which Frost Nevada
purchased an aggregate of 514,284 shares of Class A Common Stock. Pursuant to a
Stock Purchase Agreement dated as of November 17, 1994, (the "Stock Purchase
Agreement") between the Chairman of the Company and Frost Nevada, Frost Nevada
purchased from the Chairman 160,713 shares of Class A Common Stock.

         On August 17, 1995, the Board of Directors adopted a Preferred Stock
Purchase Rights plan and declared a dividend of one preference share purchase
right for each outstanding share of Class A Common Stock and Class B Common
Stock. Under certain circumstances, after a person has acquired beneficial
ownership of 15% of the Class A Common Stock, each Preference Stock Purchase
Right will entitle the holder to purchase, at the Right's then-current exercise
price, stock of the Company or its successor at a discount.

         On August 29, 1995, the Board of Directors declared a one-for-fourteen
reverse stock split which was approved by shareholders on October 23, 1995. Per
share amounts and the average number of shares outstanding at that date were
retroactively revised for all periods presented.

         On July 23, 1996, the Board of Directors declared a three-for-two stock
split effected in the form of a 50% stock dividend payable August 2, 1996, to
common shareholders of record at the close of business on July 22, 1996. Per
share amounts and the weighted average number of shares outstanding at that date
have been retroactively revised for all periods presented.

         On October 2, 1996, the Company completed a secondary public offering
for approximately 2,800,000 primary shares of the Company's Class A Common Stock
at a price of $30.00 per share. The underwriters also exercised the
over-allotment option of approximately 400,000 primary shares at a price of
$30.00 per share. Gross proceeds from the offering before related expenses
totaled approximately $95.7 million. The Company is using the proceeds for
marketing expenses associated with new product introductions, the licensing or
acquisition of formulations, technologies, products or businesses, research and
development, expansion of marketing and sales capabilities, and general
corporate purposes.

         On March 7, 1997, the Board of Directors declared a three-for-two stock
split effected in the form of a 50% stock dividend payable March 28, 1997 to
common shareholders of record at the close of business on March 17, 1997. Per
share amounts and the weighted average number of shares outstanding have been
retroactively revised for all periods presented.




                                      F-14
<PAGE>   50
NOTE 8.  STOCK OPTION PLANS

         The Company has five Stock Option Plans (the 1996, 1995, 1992, 1990,
and 1988 Plans or, collectively, the "Plans"). The 1996, 1995, 1992, 1990, and
1988 Plans have the following options outstanding: 88,576, 400,923, 421,247,
60,524, and 236,418, respectively. The Board of Directors authorized the
granting of 1,950,000 shares to employees and consultants at fair market value
for the 1996 Stock Option Plan and has placed limitations on the granting of
options on the remaining Plans. The Plans allow the Company to designate options
as qualified incentive or non-qualified on an as-needed basis. Qualified and
non-qualified stock options vest over a period determined at the time the
options are granted ranging from one to five years. Options are granted at the
fair market value on the grant date. Options outstanding at June 30, 1997, vary
in price from $1.55 to $46.25, with a weighted average of $10.22 outlined in the
chart below:

<TABLE>
<CAPTION>
                                                    WEIGHTED      WEIGHTED                        WEIGHTED
                                                     AVERAGE       AVERAGE                        AVERAGE
               RANGE OF            NUMBER          CONTRACTUAL    EXERCISE        NUMBER          EXERCISE
           EXERCISE PRICES       OUTSTANDING         LIFE          PRICE       EXERCISABLE         PRICE
           ---------------       -----------         ----          -----       -----------         -----
<S>                              <C>               <C>            <C>          <C>                <C>
         $ 1.55 -    $ 2.33        165,129           2.30          $ 1.96         60,922           $ 1.90
         $ 2.36 -    $ 3.50        496,056           3.20          $ 2.90        407,755           $ 2.93
         $ 3.67 -    $ 4.22          9,480           1.24          $ 4.04          8,190           $ 4.05
         $ 6.22 -    $ 9.33         43,495           2.89          $ 6.80         37,582           $ 6.68
         $10.14 -    $13.66         54,737           3.43          $11.52         37,775           $11.33
         $18.16 -    $27.16        326,260           8.89          $18.52            -0-           $ 0.00
         $27.44 -    $36.42        108,431           9.40          $31.35            -0-           $ 0.00
         $42.00 -    $46.25          4,100           9.80          $43.41            -0-           $ 0.00
</TABLE>

         The weighted average fair value of options granted during fiscal 1997
and 1996 was $13.79 and $2.00, respectively.

         A summary of stock option activity granted within the Plans and related
information for the years ended June 30, 1997, 1996 and 1995 is as follows:

<TABLE>
<CAPTION>
                                                                                               WEIGHTED
                                                                                                AVERAGE
                                             QUALIFIED     NON-QUALIFIED        TOTAL            PRICE
                                             ---------     -------------        -----            -----
<S>                                           <C>             <C>             <C>              <C>
          Balance at June 30, 1994 ...        490,221         717,576         1,207,797        $    7.20

          Granted ....................        273,125         487,006           760,131        $    4.02
          Terminated/expired .........       (350,456)       (336,383)         (686,839)       $    5.69
                                              -------         -------         ---------
          Balance at June 30, 1995 ...        412,890         868,199         1,281,089        $    6.12

          Granted ....................        316,827         447,992           764,819        $    3.48
          Exercised ..................        (38,503)       (176,815)         (215,318)       $   13.38
          Terminated/expired .........       (197,938)       (332,960)         (530,898)       $    6.98
                                              -------         -------         ---------
          Balance at June 30, 1996 ...        493,276         806,416         1,299,692        $    4.32

          Granted ....................        284,593         168,427           453,020        $   21.99
          Exercised ..................       (157,622)       (341,607)         (499,229)       $    5.62
          Terminated/expired .........        (40,974)         (4,821)          (45,795)       $    9.44
                                              -------         -------         ---------

          Balance at June 30, 1997 ...        579,273         628,415         1,207,688        $   10.22
                                              =======         =======         =========
</TABLE>


         During fiscal 1997, 60,423 non-qualified stock options not subject to
the Plans have been exercised by outside parties at $9.71. An additional 6,250
non-qualified stock options not subject to the Plans are issued and outstanding
to outside parties at June 30, 1997, with an exercise price of $9.71.




                                      F-15
<PAGE>   51
         The Company elected the adoption of the disclosure-only provisions of
SFAS No. 123 in fiscal 1997. In accordance with the provisions of SFAS No. 123,
the Company applies APB 25 and related interpretations in accounting for option
grants to employees under its stock option plans. If the Company had elected to
recognize compensation cost based on the fair value of the options granted at
grant date as prescribed by SFAS No. 123, net income and earnings per share
would have been reduced to the pro forma amounts indicated in the table below:

<TABLE>
<CAPTION>
                                                        1997                   1996
                                                    ------------          -------------
<S>                                                 <C>                   <C>
             Net Income - As Reported               $ 17,344,914          $   7,879,742

             Net Income - Pro Forma                 $ 15,742,000          $   6,982,000

             Earnings Per Share - As Reported       $       1.22          $        0.73

             Earnings Per Share - Pro Forma         $       1.11          $        0.64
</TABLE>

         Because SFAS No. 123 is applicable to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until
approximately June 30, 2002. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over the options'
vesting periods.

         The fair value of these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions:

<TABLE>
<CAPTION>
                                                              1997        1996
                                                            -------     -------
<S>                                                         <C>         <C>
             Expected Dividend Yield                            0.0%        0.0%

             Expected Stock Price Volatility                    .70         .70

             Risk-Free Interest Rate                            5.7%        6.0%

             Expected Life of Options                       5 Years     4 Years
</TABLE>

         The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options which, unlike options granted by the
Company, have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions,
including the expected stock price volatility. Because the Company's stock
options have characteristics significantly different from options traded on an
exchange, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its stock
options.

NOTE 9.  SIGNIFICANT CUSTOMERS

         For fiscal 1997, three customers accounted for approximately 20.6%,
16.3%, and 10.9% of sales. For fiscal 1996, three customers accounted for
approximately 15.5%, 12.2%, and 11.8% of sales.

NOTE 10. FINANCIAL INSTRUMENTS -- CONCENTRATIONS OF CREDIT RISK

         Financial instruments which potentially subject the Company to
significant concentrations of credit risk consist principally of cash, cash
equivalents, short-term investments and accounts receivable.

         The Company maintains cash, cash equivalents and short-term investments
primarily with two financial institutions that invest funds in short-term,
interest bearing, investment grade, marketable securities. The Company performs
periodic evaluations of the relative credit standing of these financial
institutions.

         At June 30, 1997 and 1996, three and five customers, respectively,
comprised approximately 50.0% and 55.2%, respectively, of accounts receivable.
The Company does not require collateral from its customers but performs periodic
credit evaluations of its customers' financial condition. Management does not
believe significant credit risk exists at June 30, 1997.



                                      F-16
<PAGE>   52
NOTE 11. DEFINED CONTRIBUTION PLAN

         The Company has a defined contribution plan (the "Contribution Plan")
that is intended to qualify under Section 401(k) of the Internal Revenue Code.
All employees, except those who have not attained the age of 21, are eligible to
participate in the Contribution Plan. Participants may contribute, through
payroll deductions, up to 20% of their basic compensation, not to exceed
Internal Revenue Code limitations. Although the Contribution Plan provides for
profit sharing contributions by the Company, the Company has not made any such
contributions since its inception.

NOTE 12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

         In the table below is the quarterly financial information for fiscal
1997 and 1996. All figures are in thousands except per share data, and certain
amounts do not total to the annual amounts due to rounding.


<TABLE>
<CAPTION>
                                                    FISCAL YEAR ENDED JUNE 30, 1997
                                                        (FOR THE QUARTERS ENDED)
                                                        ------------------------
                             SEPTEMBER 30, 1996       DECEMBER 31, 1996      MARCH 31, 1997   JUNE 30, 1997
                             ------------------       -----------------      --------------   -------------
<S>                          <C>                      <C>                    <C>              <C>
Net sales..............          $   7,268                $    8,508           $   10,976       $   14,407
Gross profit...........              5,313                     6,255                8,499           11,730
Net income.............              3,604                     3,251                4,337            6,153
Net income per share...               0.31                      0.22                 0.29             0.41
</TABLE>

<TABLE>
<CAPTION>
                                                      FISCAL YEAR ENDED JUNE 30, 1996
                                                          (FOR THE QUARTERS ENDED)
                                                          ------------------------
                             SEPTEMBER 30, 1995        DECEMBER 31, 1995        MARCH 31, 1996   JUNE 30, 1996
                             ------------------        -----------------        --------------   -------------
<S>                          <C>                       <C>                      <C>              <C>
Net sales..............          $   4,574                 $   6,449              $   7,016        $   7,271
Gross profit...........              3,257                     4,667                  5,041            5,390
Net income.............                646                     1,404                  1,759            4,071
Net income per share...               0.06                      0.14                   0.16             0.36
</TABLE>

         The quarterly net income per share data disclosed above does not agree
with the amounts reported in the Company's Quarterly Reports on Form 10-Q filed
with the Securities and Exchange Commission as the amounts have been revised to
reflect the stock splits discussed in Note 7. The net income for the quarter
ended June 30, 1996 includes a fourth quarter adjustment to record deferred
income tax benefits of $1,933,000 as described in Note 6.




                                      F-17
<PAGE>   53
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
                                  Balance at    Charged to   
                                 beginning of   costs and    Charged to                   Balance at
        Description                 year         expenses   other accounts  Deductions    end of year
-------------------------------  ------------  -----------  --------------  -----------   -----------
<S>                              <C>           <C>          <C>             <C>           <C> 
Year Ended June 30, 1997
 Deducted from Asset Accounts:
 Accounts Receivable:
  Allowances                     $   680,000   $       --    $   470,000    $       --    $ 1,150,000
 Deferred tax assets:
  Valuation allowance              8,600,000           --     (8,600,000)           --             --

Year Ended June 30, 1996
 Deducted from Asset Accounts:
 Accounts Receivable:
  Allowances                         520,000           --        160,000            --        680,000
 Deferred tax assets:
  Valuation allowance             13,960,000           --     (5,360,000)           --      8,600,000

Year Ended June 30, 1995
 Deducted from Asset Accounts:
 Accounts Receivable:
  Allowances                         400,000           --        120,000            --        520,000
 Deferred tax assets:
  Valuation allowance             14,500,000           --       (540,000)           --     13,960,000
</TABLE>