SECURITIES AND EXCHANGE COMMISSION

                              Washington, DC 20549

                                    FORM 10-K
                        FOR ANNUAL AND TRANSITION REPORTS

                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

(Mark One)
|X|  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

For the fiscal year ended December 31, 1999
                          -----------------

                                       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 0-28308
                        COLLAGENEX PHARMACEUTICALS, INC.
                        --------------------------------
             (Exact Name of Registrant as Specified in Its Charter)

          Delaware                                    52-1758016
----------------------------------          ------------------------------------
(State or Other Jurisdiction of             (I.R.S. Employer Identification No.)
Incorporation or Organization)

41 University Drive, Newtown, Pennsylvania                               18940
--------------------------------------------------------------------------------
(Address of Principal Executive Offices)                              (Zip Code)

Registrant's telephone number, including area code (215) 579-7388
                                                   -------------

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

    Title of each class                Name of Each Exchange on Which Registered
    -------------------                -----------------------------------------

None
----------------------------           -----------------------------------------

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

                          Common Stock, $0.01 par value
--------------------------------------------------------------------------------
                                (Title of Class)

--------------------------------------------------------------------------------
                                (Title of Class)


<PAGE>


      Indicate by check mark whether the  registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.

                         Yes:   X                  No:
                             --------                 --------


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

      State the  aggregate  market  value of the  voting  common  stock  held by
non-affiliates of the registrant: $184,146,741 at February 15, 2000 based on the
last sales price on that date.

      Indicate  the  number of shares  outstanding  of each of the  registrant's
classes of common stock, as of February 15, 2000:

                 Class                              Number of Shares
                 -----                              ----------------
     Common Stock, $0.01 par value                      8,665,729


      The following  documents  are  incorporated  by reference  into the Annual
Report on Form 10-K: Portions of the registrant's definitive Proxy Statement for
its 2000 Annual Meeting of Stockholders  are incorporated by reference into Part
III of this Report.


<PAGE>


                                TABLE OF CONTENTS

              Item                                                      Page
              ----                                                      ----
PART I           1. Business......................................        1
                 2. Properties....................................       16
                 3. Legal Proceedings.............................       16
                 4. Submission of Matters to a Vote of                   16
                    Security Holders..............................
PART II          5. Market for the Company's Common Equity
                       and Related Stockholder Matters............       17
                 6. Selected Consolidated Financial Data..........       18
                 7. Management's Discussion and Analysis of
                       Financial Condition and Results of
                       Operations.................................       19
                7A. Quantitative and Qualitative Disclosures
                       About Market Risk..........................       25
                 8. Financial Statements and Supplementary Data          25
                 9. Changes in and Disagreements with
                       Accountants on Accounting and Financial
                       Disclosure.................................       25
PART III        10. Directors and Executive Officers of the
                    Company.......................................       26
                11. Executive Compensation........................       26
                12. Security Ownership of Certain Beneficial
                       Owners and Management......................       26
                13. Certain Relationships and Related
                    Transactions..................................       26
PART IV         14. Exhibits, Financial Statement Schedules,
                       and Reports on Form 8-K....................       27
SIGNATURES........................................................       28
EXHIBIT INDEX.....................................................       30
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULE................................................      F-1


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<PAGE>


                                     PART I

ITEM 1.   BUSINESS.


General
-------

      CollaGenex Pharmaceuticals,  Inc. and subsidiaries  ("CollaGenex",  or the
"Company") is a specialty pharmaceutical company focused on providing innovative
medical   therapies  to  the  dental  market.   The  Company's   first  product,
Periostat(R),  is a prescription pharmaceutical capsule that was approved by the
United States Food and Drug  Administration (the "FDA") in September 1998 and is
the first and only pharmaceutical to treat adult periodontitis by inhibiting the
enzymes that destroy periodontal  support tissues.  Periostat is indicated as an
adjunct to scaling and root  planing  ("SRP"),  the most  prevalent  therapy for
adult periodontitis, to promote attachment level gain and to reduce pocket depth
in patients with adult  periodontitis.  Adult  periodontitis,  a chronic disease
characterized by the progressive  loss of attachment  between the tooth root and
the surrounding periodontal  structures,  may result in tooth loss if untreated.
See " -- Periostat."

      The  Company  believes  that  it  is  the  only   pharmaceutical   company
specifically  focused  on  the  pharmaceutical  needs  of  dentists.  There  are
approximately  120,000 dentists in the United States, who write about 55 million
prescriptions per year. Most of these prescriptions are for drugs that treat the
symptoms  associated  with  dental  diseases,  such as  pain,  inflammation  and
infection.  Periostat is the first orally administered,  systemically  delivered
pharmaceutical developed and approved specifically to treat a dental disease.

      Research  has  shown  that the  enzyme-suppression  technology  underlying
Periostat may also be applicable to other diseases involving  destruction of the
body's   connective   tissues,   including  cancer   metastasis,   osteoporosis,
osteoarthritis,  rheumatoid  arthritis,  diabetes and acute lung injury. Phase I
clinical trials for  Metastat(R),  the Company's lead compound for the treatment
of metastatic  cancer,  were initiated in January 1998 under the  sponsorship of
the National  Cancer  Institute  (the "NCI").  Two Phase I clinical  trials were
completed in 1999,  and two additional  Phase I trials are ongoing.  The Company
and the NCI are currently  evaluating the preliminary results from the completed
trials  and the  further  clinical  development  of this  compound.  Preclinical
studies on  Nephrostat,  the  Company's  compound for the  treatment of diabetic
complications, were discontinued during 1999.

      The Company's core  technology is licensed on an exclusive  basis from the
Research Foundation of the State University of New York at Stony Brook ("SUNY").
SUNY also conducts  research and development on other potential  applications of
the core technology pursuant to a contract with the Company.

      Periostat is marketed to the  professional  dental community in the United
States  through  a  professional   pharmaceutical   sales  force   comprised  of
approximately 135 sales representatives and managers.  Currently,  the Company's
sales  force  is  also  marketing   Vioxx(R),   a   prescription   non-steroidal
anti-inflammatory  drug  developed  by  Merck  & Co.,  Inc.  ("Merck")  for  the


                                       1

<PAGE>


treatment of acute dental pain, and Denavir(R), a prescription drug developed by
SmithKline Beecham Consumer Healthcare, L.P. ("SmithKline") for the treatment of
cold  sores.  The Company is actively  seeking  other  products to market to the
professional dental community.

      The Company was  incorporated  in Delaware in January  1992 under the name
CollaGenex,  Inc. The Company's name was changed to CollaGenex  Pharmaceuticals,
Inc. in April 1996. The Company's executive offices are located at 41 University
Drive, Newtown, Pennsylvania 18940, and its telephone number is (215) 579-7388.

      "Periostat(R)"  and  "Metastat(R)"  are United  States  trademarks  of the
Company.  All other trade names,  trademarks or service marks  appearing in this
Annual Report on Form 10-K are the property of their  respective  owners and are
not property of the Company.


Periostat
---------

      Adult periodontitis is a chronic disease  characterized by the progressive
loss of attachment between the periodontal ligament and the surrounding alveolar
bone,  ultimately  resulting in tooth loss.  According to industry  data, in the
United States alone, an estimated  one-third of all adults,  or approximately 67
million people,  suffer from some form of periodontal disease.  Approximately 13
million people seek  professional  treatment  annually for periodontal  disease,
resulting in over 15 million  periodontal  procedures and annual expenditures of
approximately $6 billion,  primarily for procedures and surgeries performed by a
periodontist or a dental professional.

      The most prevalent  therapy for adult  periodontitis  is SRP, a mechanical
procedure  that  removes  hardened  bacteria  called  plaque from tooth and root
surfaces  above  and  below  the  gum  line.   Periostat  is  the  first  orally
administered,  systemically delivered  pharmaceutical indicated as an adjunct to
SRP to promote attachment level gain and to reduce pocket depth in patients with
adult periodontitis.

      Periostat,  a 20 mg dose of  doxycycline,  is a unique  sub-anti-microbial
dosage strength that suppresses the chronic and progressive  tissue  degradation
characteristic  of  periodontitis  without exerting any  anti-microbial  effect.
Doxycycline  is an active  ingredient of several FDA approved drugs and has been
in use for approximately 30 years for the treatment of microbial infections and,
along  with  other   tetracyclines,   has  a  well  established  safety  record.
Periostat's  mechanism of action is believed to be through the direct inhibition
of  collagenase,  an  enzyme  within a broad  class of  enzymes  known as matrix
metalloproteinases  ("MMPs")  that  is  excessively  produced  as a  result  of
inflammation  resulting  from  bacterial  infection  in the gums.  Periostat  is
intended to be taken orally by the patient  between dental visits.  In September
1998, the FDA granted the Company marketing approval for Periostat as an adjunct
to SRP to promote attachment level gain and reduce pocket depth in patients with
adult  periodontitis.  Periostat was made available for prescription in November
1998 and was fully launched commercially in January 1999.


                                       2

<PAGE>


Vioxx
-----

      Pursuant to a  Co-Promotion  Agreement  executed  with Merck in  September
1999, the Company received the exclusive right to co-promote Vioxx to the dental
community. Vioxx is a prescription strength non-steroidal anti-inflammatory drug
("NSAID")  that was  approved  by the FDA on May 20, 1999 for the  treatment  of
osteoarthritis,  the management of acute pain in adults,  including dental pain,
and the treatment of primary  dysmenorrhea.  Merck promotes Vioxx to the general
physician community. The agreement provides for certain payments by Merck to the
Company upon sales of Vioxx to the dental community.

      Vioxx  belongs  to a new  class of  NSAIDs  that are  believed  to work by
selectively  inhibiting the cyclooxygenase-2  (COX-2) enzyme, which plays a role
in pain and  inflammation.  Vioxx  spares a related  enzyme  (COX-1)  that helps
maintain the normal stomach lining and platelet  homeostasis.  In general,  most
NSAIDs block both enzymes. Such medications treat pain and inflammation, but may
damage the stomach lining,  potentially  leading to ulcers in some patients.  In
clinical  trials,  Vioxx was shown to be as effective  in relieving  pain as the
most  effective  NSAID,  with a much  lower  risk of the  gastrointestinal  side
effects and prolonged  bleeding  commonly  associated with NSAID pain relievers.
Prescribed as a once-a-day dose, Vioxx offers patients a convenient  alternative
to the multiple daily doses required for many other NSAIDs.

      Vioxx was launched to the dental community on September 23, 1999.


Denavir
-------

      Denavir is an FDA approved topical  antiviral cream used for the treatment
of cold  sores.  It is the first  and only  prescription-strength  medicine  for
treating  recurrent cold sores in healthy adults. The Company markets Denavir to
the  dental  community  under a  Co-Promotion  Agreement  with  SmithKline.  The
agreement provides for certain payments by SmithKline to the Company.


Sales and Marketing
-------------------

      The Company  markets and sells its products in the United States through a
direct sales force  comprised of  approximately  135 sales  representatives  and
managers.  Internationally,  the  Company  intends to market  Periostat  through
collaborations   with  foreign  marketing  partners  following  receipt  of  the
requisite  foreign  regulatory  approvals  and, in the United  Kingdom,  through
CollaGenex International Ltd. This strategy is intended to enable the Company to
gain rapid  market  acceptance  for its  products  and  establish  a  commercial
presence in the dental market.


      United States
      -------------

      In June of 1997,  the Company  hired a Vice  President of Marketing  and a
Vice President of Sales.  In January 1999,  under their  direction,  the Company
trained a sales force of approximately  125 sales  representatives  and managers
and began to promote  Periostat to the


                                       3

<PAGE>


dental  community.  Ten additional sales  representatives  were hired during the
first  quarter of 2000.  The sales  organization  is  comprised  of two regional
managers,  eleven district managers and  approximately 120 full-time  equivalent
("FTE") sales representatives.  Each FTE is responsible for covering a territory
that includes  approximately 250 dentists and periodontists that are believed to
be high volume potential  prescribers of Periostat based on the estimated number
of SRPs performed in their respective practices.

      The Company  believes  that its sales effort is  distinguished  from other
dental  sales  forces by its focus on  education  and the  clinical  benefits of
pharmaceutical   dentistry,   a  new  approach  to  treating  dental   diseases.
Accordingly,  the Company produces educational marketing materials,  detail aids
and product samples that are used  extensively by the  representatives  in their
presentations to dentists.  Clinical  reprints and video  presentations are also
provided.  The Company believes that  peer-to-peer  communications  are vital to
increasing the  acceptance of Periostat and arranges  speaking  engagements  and
teleconferences  where Periostat  advocates share their  experiences  with other
dental professionals.

      Sales  training  is an  important  component  of the  Company's  marketing
efforts. New representatives  receive four weeks of field training and two weeks
of  intensive  office  training in  periodontal  disease,  host  response,  pain
management,  territory  management  and selling  skills.  Training  continues at
district-level meetings throughout the year.

      In order to provide an  integrated  dental  product  line and leverage the
Company's sales and marketing  organization,  the Company is actively seeking to
in-license or acquire other high-quality therapeutic dental products.


      International
      -------------

      The Company is establishing  relationships with key partners to market and
sell Periostat internationally, upon receipt of the requisite foreign regulatory
approvals.  In 1996,  the  Company  executed a  manufacturing  and  distribution
agreement with Roche S.P.A.  (formerly  Boehringer  Mannheim Italia) pursuant to
which Roche S.P.A.  has the exclusive  right to market  Periostat in Italy,  San
Marino and The Vatican City pending requisite regulatory approval.  In 1997, the
Company  announced  that a Marketing  Authorization  for  Approval was filed for
Periostat by Roche S.P.A.  with the Italian  Ministry of Health.  The  Marketing
Authorization for Approval is currently under review.

      In July 1998, the Company executed a licensing agreement with Laboratoires
Pharmascience S.A. ("Laboratories Pharmascience") pursuant to which Laboratoires
Pharmascience  will market and  distribute  Periostat  following  the  requisite
regulatory approval on an exclusive basis in France, Morocco,  Algeria,  Tunisia
and other countries of French speaking Africa.

      In October  1998,  the Company  announced  that a Marketing  Authorization
Application had been filed with the United Kingdom  Medicine Control Agency (the
"UKMCA")  with  respect  to  Periostat.  Such  application  was filed  under the
European Mutual Recognition System in order to expedite the approval process for
the sale of Periostat in other European  countries.  In


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<PAGE>


February  2000,  the UKMCA  granted  marketing  approval for  Periostat  for the
adjunctive  treatment of chronic  adult  periodontitis.  The Company  intends to
launch a limited  test-marketing  effort for  Periostat  in the  United  Kingdom
through its subsidiary,  CollaGenex International,  Ltd., during 2000. There can
be no assurance that the Company will achieve other foreign regulatory approvals
or will  successfully  market  Periostat in the United Kingdom or other European
countries.

      The  Company  executed  a  licensing  agreement  with  Pharmascience  Inc.
("Pharmascience")  in June 1999 pursuant to which  Pharmascience will market and
distribute  Periostat in Canada pending requisite  regulatory  approval.  In the
fourth quarter of 1999,  Pharmascience  submitted an application to the Canadian
Therapeutic Products Program of Health Canada for Canadian marketing approval of
Periostat.


      Product Support
      ---------------

      Consistent  with the  Company's  strategy to outsource  certain  specialty
functions,  in September 1998, the Company entered into a Professional  Services
Agreement with Science Oriented  Solutions  ("SOS") pursuant to which SOS was to
establish and operate a medical  professional  inquiry  support  center to field
product  inquiries  regarding  Periostat from the professional  community.  This
agreement  was  terminated  during the first  quarter  of 2000 when the  Company
established an internal professional inquiry support center.


Manufacturing, Distribution and Suppliers
-----------------------------------------

      The Company has entered into a supply agreement with Hovione International
Limited  ("Hovione")  pursuant  to which the  active  ingredient  in  Periostat,
doxycycline,  is  supplied  by Hovione  from its  offshore  facilities.  Hovione
supplies a substantial portion of the doxycycline used in the United States from
two independent, FDA-registered and approved facilities, providing for a back-up
supply in the event that one facility is unable to manufacture. The initial term
of the supply agreement expired on January 25, 2000 and thereafter automatically
renewed and will continue to renew for successive  two-year  periods unless,  90
days prior to the  expiration of any such periods,  either party gives the other
party written  notice of  termination.  In addition,  in the event of a default,
uncured for 90 days, the non-defaulting party can terminate the supply agreement
effective  immediately at the end of such 90-day  period.  The Company relies on
Hovione as its sole supplier of doxycycline.

      The Company  also relies on  third-party  contract  manufacturers  for the
commercial  manufacturing of Periostat. In June, 1998, the Company finalized its
manufacturing arrangements with Applied Analytical Industries,  Inc. ("AAI"), in
Wilmington,  North  Carolina for the  manufacture  of  Periostat.  The Company's
agreement with AAI terminates  three years from the date of the initial  product
launch and  automatically  extends for  consecutive  one-year  periods unless 12
months prior written notice is provided  before the expiration of the applicable
term.  AAI is  required  to comply  with Good  Manufacturing  Practices  ("GMP")
requirements.

      In November 1998, the Company executed a Distribution  Services  Agreement
with Cord Logistics, Inc. ("Cord"), pursuant to which Cord acts as the Company's
exclusive distribution


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<PAGE>


agent for Periostat in the United  States and Puerto Rico.  Cord is a subsidiary
of Cardinal Health, Inc., a leading wholesale  distributor of pharmaceutical and
related  healthcare  products.  Under this agreement,  Cord warehouses and ships
Periostat  from its  central  distribution  facility  to  wholesalers  and large
national  retail  chains  which  in  turn  distribute  Periostat  to  pharmacies
throughout  the  United  States for  prescription  sale to  patients.  Cord also
provides various  financial  support services to the Company,  including billing
and collections,  contract pricing  maintenance,  cash  application,  chargeback
processing and related reporting services.  Under this agreement,  Cord provides
certain customer service  functions and supply data for certain of the Company's
required  governmental  filings.  The  Distribution  Services  Agreement  has an
initial term of three years and will renew automatically for successive one-year
periods  unless notice of  termination is provided by either party 90 days prior
to expiration.

      In  1999,  the  Company  entered  into an  agreement  with  Pharmaceutical
Manufacturing  Research Services,  Inc. ("PMRS") to develop a tablet formulation
of  Periostat.  The Company  believes  that  tablets  will be less  expensive to
produce than the capsules  currently  being sold. The Company  expects to file a
New Drug Application  ("NDA") with the FDA for a tablet formulation of Periostat
during the first six months of 2000.

      There can be no  assurance  that the  Company  will be able to enter  into
additional,   or  maintain  existing   manufacturing,   distribution  or  supply
agreements  on  acceptable  terms,  if at all.  In the event that the Company is
unable  to  obtain   sufficient   quantities  of  doxycycline  or  Periostat  on
commercially  reasonable  terms,  or in a  timely  manner,  or if the  Company's
suppliers fail to comply with GMP, or if the Company's  distributors  are unable
to ship or support the Company's  products,  the Company's  business,  financial
condition and results of operations would be materially adversely affected.  See
"--Government Regulation."

Customers
---------

      During 1999, net product sales to each of McKesson Drug Company and Bergen
Brunswig Drug Company accounted for 30% and 14%, respectively,  of the Company's
aggregate net product sales.


Research and Development
------------------------

      The Company's  research and development  activities are conducted by third
parties,  primarily  contract  research  organizations,  academic and government
institutions.  The main  focus of these  activities  is the  identification  and
development of novel  tetracycline-based  compounds for application in a variety
of inflammatory and tissue-destructive disorders. Other than Periostat, the most
advanced  program  involves  Metastat,  the Company's lead compound for treating
metastatic cancer.

      Technology
      ----------

      The Company's core technology  involves the  pharmaceutical  modulation of
the activity of MMPs.  MMPs are  responsible for the normal turnover of collagen
and other  proteins  that are  integral  components  of a variety of  connective
tissues such as skin, bone, cartilage and ligaments.


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<PAGE>


      Under normal physiological  conditions,  the natural breakdown of collagen
is regulated by the interaction between the degradative properties of MMPs and a
group  of  naturally   occurring   biomolecules   called  tissue  inhibitors  of
metalloproteinases  ("TIMPs"), which modulate the level of MMP activity. In many
pathological  conditions,  however,  the balance between collagen production and
degradation  is  disrupted  resulting in excessive  loss of tissue  collagen,  a
process called collagenolysis.  One such example is the progressive  destruction
of the periodontal  ligament and alveolar bone in adult  periodontitis.  Similar
degradative  activity is associated  with other disorders and conditions such as
cancer metastasis,  wounds, osteoarthritis,  osteoporosis,  rheumatoid arthritis
and diabetic nephropathy.

      The Company's core  technology is licensed on an exclusive basis from SUNY
and results from the research of Drs.  Lorne M. Golub and Thomas F. McNamara and
their colleagues at SUNY. These researchers  demonstrated that tetracyclines can
significantly   reduce  the  pathologically   excessive   collagen   degradation
associated  with  periodontitis.  They also were able to  demonstrate  that this
result was unrelated to the antibiotic properties of tetracyclines. Furthermore,
they demonstrated that the  administration of doses of antibiotic  tetracyclines
well below the dosage  levels  necessary  to  destroy  microbes  (sub-antibiotic
doses) was still effective in preventing the loss of connective tissue in models
of  periodontitis.   Studies  published  in  scientific   journals  support  the
hypothesis  that the  mechanism  of action for this  activity is the result,  in
part,  of the direct  binding of  tetracyclines  to certain  metal binding sites
associated with the MMP structure.

      Although  commercially  available antibiotic  tetracyclines show effective
anti-collagenolytic  potential,  long-term  administration of these compounds at
normal  antibiotic  doses can result in  well-known  complications  of long-term
antibiotic therapy,  such as gastrointestinal  disturbance,  overgrowth of yeast
and fungi,  and the emergence of  antibiotic-resistant  bacteria.  The Company's
Phase III clinical trials using Periostat  demonstrated that the  administration
of  sub-antimicrobial  doses of  doxycycline  over a 12-month  period exerted no
anti-microbial  effects.  Thus,  the use of this dosage  strength  provides  the
anti-collagenolytic  effects without the  complications of long-term  antibiotic
therapies.  The Company is  currently  conducting  Phase IV clinical  studies to
support future marketing activities of Periostat.

      The  Company's  license from SUNY also covers a broad class of  chemically
modified tetracyclines ("CMTs") that have been chemically modified to retain and
enhance their  anti-collagenolytic  properties but which have had the structural
elements  responsible for their antibiotic  activity  removed.  These compounds,
which  lack any  antibiotic  activity,  have  shown  potential  in a  number  of
pre-clinical  models of excessive  connective  tissue  breakdown.  The Company's
current  research  and  development  programs  focus  on the use of CMTs in drug
therapies for potential  applications  where more potent doses of  tetracyclines
may enhance the  efficacy of the  treatment  as well as on the Phase IV clinical
studies for Periostat.

      Periostat
      ---------

      The Company is planning and  conducting  various Phase IV clinical  trials
that evaluate the use of Periostat for other therapeutic  indications.  Phase IV
studies being  conducted at SUNY and the  University of Michigan are  evaluating
Periostat's  ability to promote  attachment  level,


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<PAGE>


decrease  pocket depth and promote  healing in patients  undergoing  periodontal
flap  surgery.  Another  Phase IV study being  conducted  at the  University  of
Southern  California  was designed to study the use of Periostat to prevent root
resorption during orthodontic tooth movement. Other Phase IV clinical trials are
being  planned to  evaluate  the ability of  Periostat  to arrest or reverse the
degradation of the attachment apparatus that is sometimes associated with dental
implants,  the evaluation of Periostat as an adjunct to SRP in institutionalized
geriatric  patients,  and the  evaluation  of  Periostat as an adjunct to SRP in
patients  with Type I and Type II diabetes.  To extend the possible  therapeutic
use of Periostat beyond the oral cavity,  the Company and its  collaborators are
planning  clinical trials to evaluate whether Periostat can reduce the signs and
symptoms of acne,  decrease  bone loss in  postmenopausal  women and prevent the
growth and rupture of aortic aneurysms.


      Metastat
      --------

      Cancer  metastasis is the spread of cancer cells from a diseased  organ to
the lymphatic or circulatory  system,  where such cells then migrate  throughout
the body causing  cancer to develop in other  organs.  Tumor cell  invasion is a
complex  process that  involves the  destruction  of the basement  membrane,  or
structural  support  tissue,  of the lymphatic or  circulatory  system,  and the
migration of tumor cells to secondary sites,  followed by proliferation of these
cells.  Data from  pre-clinical  studies  sponsored  by the Company at two major
universities  suggest that several of the  Company's  CMT drug  candidates  have
potent activity in models of cancer invasion,  including prostate, breast, lung,
colon and melanoma.

      These  studies  also  demonstrated  that the  inhibition  of  certain  MMP
activity by conventional  tetracyclines  and CMTs results in a decreased ability
of tumor cells to invade the lung in models of  metastasis.  In  addition,  CMTs
have been shown to modulate  the specific  type of MMP isolated  from human lung
cancer  cells,  the activity of which has been  correlated  with the  metastatic
potential of tumors.  In animal models  involving a variety of human cancer cell
types, including prostate,  breast, lung, colon and melanoma,  CMTs developed by
the Company exhibited an ability to inhibit metastasis.

      In October  1996,  the Company and the NCI  executed a letter of intent to
formalize a collaborative  research and development  agreement pursuant to which
the NCI agreed to perform  pharmacology,  toxicology and Phase I clinical trials
using the  Company's  lead  compound for the  prevention  of cancer  metastasis,
Metastat.

      In June 1997,  the Company  announced  that it had  formally  extended its
Collaboration  Agreement  with  the  NCI  with  respect  to the  development  of
Metastat.  On December 5, 1997, the Company  announced that the NCI had filed an
investigational new drug application ("IND") for Metastat.  In January 1998, the
Company initiated Phase I clinical trials with respect to Metastat. Such studies
were sponsored by the NCI pursuant to the Company's Collaboration Agreement with
the NCI. In February 1999, the Company released initial findings related to such
studies.  Following oral  administration,  desired plasma  concentrations of the
compound were achieved and no  dose-limiting  side effects other than manageable
phototoxicity were encountered. In February 1999, the Company also announced the
allowance of a U.S. patent which provides  intellectual  property protection for
the use of Metastat for the inhibition of cancer metastasis.


                                       8

<PAGE>


Subsequently,  the NCI advised the  Company  that it believed  that the level of
photosensitivity,  although manageable,  could limit the commercial viability of
Metastat.  However, the NCI also advised the Company that it remained interested
in the  mechanism  of action  of this  class of  compounds  and it  intended  to
complete the current  clinical  trials to establish  "proof of  principal"  with
respect to a variety of  surrogate  markers.  Two Phase I clinical  trials  were
completed in 1999 and two additional  Phase I clinical  trials are ongoing.  The
Company and the NCI are currently evaluating the results of the completed trials
and the further clinical development of this compound.


      Preclinical Research and Development Activities
      -----------------------------------------------

      The Company  has an active  preclinical  program in place to identify  and
characterize  CMT  derivatives  that  exhibit  enhanced  biological   activities
compared to Periostat  and Metastat.  In  collaboration  with the  University of
Rochester,  the Company has  synthesized  over thirty new CMTs.  These are being
evaluated in a variety of in vitro and in vivo assay  systems under a three-year
research agreement with SUNY.

      The  Company  receives  certain   proprietary   rights  to  inventions  or
discoveries  that  arise as a result of this  research.  The  Company's  current
research and development  objective is to develop additional  products utilizing
its CMT technology.

      The Company's  research and development  expenditures  were  approximately
$4.2  million,   $4.7  million  and  $5.0  million  in  1997,   1998  and  1999,
respectively.


Patents, Trade Secrets and Licenses
-----------------------------------

      The  Company's  success  will  depend in part on patent  and trade  secret
protection for its technologies,  products and processes,  and on its ability to
operate without  infringement of proprietary rights of other parties both in the
United States and in foreign  countries.  Because of the  substantial  length of
time and expense  associated with bringing new products  through  development to
the marketplace,  the pharmaceutical  industry places considerable importance on
obtaining  and   maintaining   patent  and  trade  secret   protection  for  new
technologies, products and processes.

      The Company  depends on the license  from the Research  Foundation  of the
State of New York at Stony  Brook  for all of its  core  technology  (the  "SUNY
License"). The SUNY License grants the Company an exclusive worldwide license to
make and sell products employing  tetracyclines that are designed or utilized to
alter a biological  process.  Twenty-four United States patents and eight United
States  patent  applications  held by SUNY are licensed to the Company under the
SUNY  License.  One of the  twenty-four  patents  and  one of the  eight  patent
applications  have been  co-assigned  to the University of Miami,  Florida,  and
another patent has been co-assigned to Washington University. The primary United
States patent claims  methods of use of  conventional  tetracyclines  to inhibit
pathologically excessive collagenolytic activity (the "Primary Patent"), while a
related United States patent claims methods of use of  tetracyclines  which have
no antibiotic  activity (the "Secondary  Patent").  The twenty-two  other United
States   patents   relate   to   the   compositions   of   certain   CMTs   with
anti-collagenolytic  properties,  methods


                                       9

<PAGE>


of use of  tetracyclines to reduce bone loss and methods of use of tetracyclines
to enhance bone growth and inhibit protein glycosylation.  SUNY did not apply in
foreign  countries  for  patents  corresponding  to the  Primary  Patent but has
obtained  patents that correspond to the Secondary  Patent in Australia,  Canada
and certain European countries.  One of the Secondary Patents has also issued in
Japan. SUNY also has obtained patents in certain European countries,  Canada and
Japan and has pending  patent  applications  in certain other foreign  countries
which  correspond  to its United  States  patents  relating to methods of use of
tetracyclines to reduce bone loss. Sixty-one (61) patents have issued in foreign
countries.  All of SUNY's United States and foreign  patents expire between 2004
and 2018.  The  Company's  rights  under the SUNY License are subject to certain
statutory rights of the United States government  resulting from federal support
of  research  activities  at SUNY.  The  failure to obtain and  maintain  patent
protection  may mean that the Company  will face  increased  competition  in the
United States and in foreign  countries.  The SUNY License is terminable by SUNY
on 90 days prior notice only upon the Company's failure to make timely payments,
reimbursements or reports,  if the failure is not cured by the Company within 90
days. The termination of the SUNY License, or the failure to obtain and maintain
patent protection for the Company's technologies,  would have a material adverse
effect on the Company's business, financial condition and results of operations.

      One of the United  States  patents  and a  corresponding  Japanese  patent
application  licensed to the Company under the SUNY License are owned jointly by
SUNY and a Japanese  company.  These patent rights,  which expire in 2012, cover
particular  CMTs (the  "Jointly  Owned  CMTs")  that were  involved  in research
activities between SUNY and the Japanese company.  The Japanese company may have
exclusive rights to these Jointly Owned CMTs in Asia,  Australia and New Zealand
and may have a non-exclusive  right to exploit these Jointly Owned CMTs in other
territories.  These  Jointly  Owned  CMTs  are  not  involved  in the  Company's
Periostat  product but could,  in the future,  prove to be important  for one or
more of the Company's  other potential  applications  of its technology.  If the
Company does incorporate the Jointly Owned CMTs in any future product, it may be
precluded from marketing  these products in Asia,  Australia and New Zealand and
could experience increased competition in other markets from the joint owner.

      In consideration of the license granted to the Company,  the Company:  (i)
issued to SUNY 78,948  shares of common  stock;  and (ii) has agreed to pay SUNY
royalties  on the net sales of products  employing  tetracyclines,  with minimum
annual  royalty  payments  per year.  The term of the  license is: (i) until the
expiration  of the last to expire of the licensed  patents in each  country;  or
(ii)  until  20  years  from  the  first  commercial  sale  of  any  collagenase
inhibition-related  product  by the  Company  for  know-how,  at which  time the
Company has a fully paid, non-exclusive license.

      In  addition to the patents  and patent  applications  licensed  from SUNY
which represent the core technology,  the Company owns additional technology for
which  applications  for  United  States  patents  have been filed and have been
issued.  In this regard,  the Company  reports the existence of an issued patent
for  a   toothpaste/mouthwash   formulation  for  the   amelioration  of  dentin
hypersensitivity. Furthermore, the Company reports pending applications covering
new tetracycline derivatives having increased lipophilicity.


                                       10

<PAGE>


      The  Company  intends to enforce  its patent  rights  against  third-party
infringers.  Due to the general availability of generic tetracyclines for use as
antibiotics,  the Company could become involved in infringement  actions,  which
could  entail  substantial  costs to the  Company.  Regardless  of the  outcome,
defense or  prosecution  of patent claims is expensive and time
consuming, and results in the diversion of substantial financial, management and
other resources from the Company's other activities.

      The patent positions of pharmaceutical  firms,  including the Company, are
generally   uncertain  and  involve   complex   legal  and  factual   questions.
Consequently,  as to the patent  applications  licensed  to it,  even though the
Company currently is prosecuting such patent applications with United States and
foreign  patent  offices,  the  Company  does  not  know  whether  any  of  such
applications  will result in the issuance of any  additional  patents or, if any
additional patents are issued, whether they will provide significant proprietary
protection or will be circumvented or invalidated.  Since patent applications in
the United  States are  maintained in secrecy  until  patents  issue,  and since
publication of discoveries in the scientific and patent  literature tends to lag
behind actual  discoveries by several months, the Company cannot be certain that
it was the first creator of inventions covered by pending patent applications or
that it was the first to file patent applications for such inventions.

      There can be no assurance  that patent  applications  to which the Company
holds rights will result in the issuance of patents,  that any patents issued or
licensed to the Company will not be challenged  and held to be invalid,  or that
any  such  patents  will  provide  commercially  significant  protection  to the
Company's  technology,  products and  processes.  In  addition,  there can be no
assurance that others will not independently  develop  substantially  equivalent
proprietary  information not covered by patents to which the Company owns rights
or obtain  access to the Company's  know-how,  or that others will not be issued
patents which may prevent the sale of one or more of the Company's products,  or
require  licensing  and the  payment of  significant  fees or  royalties  by the
Company to third parties in order to enable the Company to conduct its business.
In the event that any relevant claims of third-party patents are upheld as valid
and  enforceable,  the Company  could be prevented  from selling its products or
could be required to obtain licenses from the owners of such patents.  There can
be no assurance that such licenses would be available or, if available, would be
on terms  acceptable  to the  Company.  The  Company's  failure to obtain  these
licenses  would  have a  material  adverse  effect  on the  Company's  business,
financial condition and results of operations.

      The Company's success also is dependent upon know-how,  unpatentable trade
secrets,  and  the  skills,  knowledge  and  experience  of its  scientific  and
technical   personnel.   The  Company  requires  all  employees  to  enter  into
confidentiality   agreements   that  prohibit  the  disclosure  of  confidential
information to anyone outside the Company and require  disclosure and assignment
to the Company of their ideas,  developments,  discoveries  and  inventions.  In
addition,  the Company  seeks to obtain such  agreements  from its  consultants,
advisors and research  collaborators.  There can be no assurance  that  adequate
protection will be provided for the Company's  trade secrets,  know-how or other
proprietary information in the event of any unauthorized use or disclosure.  The
Company  occasionally  provides  information and chemical  compounds to research
collaborators  in academic  institutions,  and requests  that the  collaborators
conduct tests in order to investigate certain properties of the compounds. There
can be no


                                       11

<PAGE>


assurance that the academic  institutions will not assert intellectual  property
rights in the results of the tests conducted by the research  collaborators,  or
that the  academic  institutions  will grant  licenses  under such  intellectual
property  rights  to the  Company  on  acceptable  terms.  If the  assertion  of
intellectual  property rights by an academic  institution can be  substantiated,
failure of the academic institution to grant intellectual property rights to the
Company  could  have  a  material  adverse  effect  on the  Company's  business,
financial condition and results of operations.


Government Regulation
---------------------

      The Company's  activities and product  candidates are subject to extensive
and  rigorous  regulation  by a number of  governmental  entities  in the United
States,  primarily the FDA, and by comparable  regulatory  authorities  in other
countries.  These governmental entities regulate,  among other things,  research
and development  activities  including animal and human testing,  manufacturing,
safety, effectiveness, labeling, storage, record keeping, approval, advertising,
promotion,  distribution and sale of prescription drug products. Different types
of FDA regulation  apply to various drug  products,  depending upon whether they
are  marketed  only  upon  the  order of a  physician  (prescription  drugs)  or
over-the-counter,  are biological or antibiotic  drugs or are controlled  drugs,
such as  narcotics.  Product  development  and approval  within this  regulatory
framework  takes a number of years,  involves  the  expenditure  of  substantial
resources  and  approval is  uncertain.  Many  products  that  initially  appear
promising  ultimately  do not reach the market  because they are not found to be
safe and effective, as demonstrated by testing required by government regulation
during the development process. In addition, there can be no assurance that this
regulatory  framework  will not change or that  additional  regulation  will not
arise  at any  stage  of the  Company's  product  development  that  may  affect
approval, delay an application or require additional expenditure by the Company.
Moreover, even if approval is obtained, failure to comply with present or future
regulatory  requirements,  or new information adversely reflecting on the safety
or effectiveness of the approved drug, can lead to FDA withdrawal of approval to
market the product.  Failure to comply with applicable FDA and other  regulatory
requirements  can  result in  sanctions  being  imposed  on the  Company  or the
manufacturers of its products,  including  warning  letters,  product recalls or
seizures,  injunctions,  refusals  to permit  products  to be  imported  into or
exported  out of the  United  States,  refusals  of the FDA to grant  pre-market
approval  of drugs or to allow  the  Company  to enter  into  government  supply
contracts,   withdrawals  of  previously  approved  marketing  applications  and
criminal prosecutions.

      The activities  required  before a new drug product may be marketed in the
United States begin  primarily with  pre-clinical  testing.  Pre-clinical  tests
include laboratory evaluation of product chemistry and other characteristics and
animal  studies to assess the  potential  safety and  efficacy of the product as
formulated.  Many  pre-clinical  (toxicology)  studies are  regulated by the FDA
under  Good  Laboratory  Practice  ("GLP")  regulations.   Violations  of  these
regulations can, in some cases,  lead to invalidation of the studies,  requiring
such studies to be repeated.

      The entire body of pre-clinical  development  work necessary to administer
investigational  drugs to human  volunteers  or  patients  is provided in an IND
filed with the FDA. FDA regulations provide that human clinical trials may begin
30 days  following  receipt  of an IND,


                                       12

<PAGE>


unless  the  FDA  advises   otherwise   or  requests   additional   information,
clarification  or  additional  time to review  the IND  submission.  There is no
assurance  that the  submission  of an IND will  eventually  allow a company  to
commence  clinical  trials.  Once  trials have  commenced,  the FDA may stop the
trials,  or  particular  types of trials,  by placing a "clinical  hold" on such
trials because of concerns about,  for example,  the safety of the product being
tested or the  adequacy of the trial  design.  Such holds can cause  substantial
delay and, in some cases, may require abandonment of a product. Clinical testing
involves  the  administration  of the drug to  healthy  human  volunteers  or to
patients under the supervision of a qualified principal investigator,  usually a
physician, pursuant to a FDA reviewed protocol. Each clinical study is conducted
under the auspices of independent  Institutional  Review Boards  ("IRBs") at the
institutions at which the study will be conducted.  An IRB will consider,  among
other things,  ethical  factors,  the safety of human  subjects and the possible
liability of the  institution.  Human clinical trials typically are conducted in
three sequential phases,  but the phases may overlap.  Phase I trials consist of
testing  the  product  in a small  number  of  patients  or  normal  volunteers,
primarily  for  safety  and  tolerance,  in one or  more  dosages,  as  well  as
characterization of a drug's pharmacokinetic and/or pharmacodynamic  profile. In
Phase II, in addition to safety,  the  efficacy of the product is evaluated in a
patient  population.  Phase III trials typically involve  additional testing for
safety and  clinical  efficacy  with an expanded  population  at  geographically
dispersed sites. A clinical plan, or "protocol,"  accompanied by the approval of
an IRB,  must be submitted  to the FDA prior to  commencement  of each  clinical
trial. All patients involved in the clinical trial must provide informed consent
prior to their participation.

      A company  seeking FDA approval to market a new drug must file an NDA with
the FDA  pursuant to the Federal  Food,  Drug and  Cosmetic  Act. In addition to
reports of the pre-clinical and clinical trials conducted under the FDA-approved
IND, the NDA includes  information  pertaining  to the  preparation  of the drug
substance,  analytical  methods,  drug  product  formulation,   details  on  the
manufacture  of  finished  products as well as proposed  product  packaging  and
labeling.  Submission of an NDA does not assure FDA approval for marketing.  The
application  review  process  generally  takes one to three  years to  complete,
although  reviews of  treatments  for cancer and other rare or  life-threatening
diseases  may be  accelerated  or  expedited.  However,  the  process  may  take
substantially  longer if, among other things,  the FDA has questions or concerns
about the safety or efficacy of a product. In general, the FDA requires at least
two  properly   conducted,   adequate  and   well-controlled   clinical  studies
demonstrating   safety  and  efficacy  with  sufficient  levels  of  statistical
assurance. However, additional information may be required. For example, the FDA
also may request long-term toxicity studies or other studies relating to product
safety  or  efficacy.  Notwithstanding  the  submission  of such  data,  the FDA
ultimately  may decide that the  application  does not  satisfy  its  regulatory
criteria for approval.  Finally,  the FDA may require additional  clinical tests
following  NDA  approval  to further  delineate  safety and  efficacy  (Phase IV
clinical trials).

      The FDA has requested that a  post-approval,  post-marketing  animal study
related to  long-term  dosing and  carcinogenicity  of Periostat be conducted to
satisfy the regulatory  requirement  for a chronically  administered  drug. Such
studies are currently underway.

      The FDA may, in some  circumstances,  impose  restrictions on the use of a
drug,  compliance with which may be difficult and expensive.  Product  approvals
may be withdrawn if


                                       13

<PAGE>


compliance with  regulatory  requirements is not maintained or if problems occur
after the product  reaches the market.  After a product is approved  for a given
indication in an NDA, subsequent new indications or dosages for the same product
are reviewed by the FDA by the filing of an NDA  supplement.  The NDA supplement
is  much  more  focused  than  the NDA  and  deals  primarily  with  safety  and
effectiveness data related to the indication or dosage, and labeling information
for  the  new  indication.  Finally,  the  FDA  requires  reporting  of  certain
information that becomes known to a manufacturer of an approved drug.

      The FDA does not permit a manufacturer or distributor to market or promote
an approved  drug  product for an  unapproved  "off label" use or dosage  level.
Therefore,  any  company  that  markets or promotes  doxycycline  for use in the
treatment of adult  periodontitis in an unapproved dosage level (for example,  a
50 mg scored  tablet)  without  first  obtaining  FDA  approval for such use and
dosage would be subject to  regulatory  action.  Generally,  the FDA,  under its
"practice of medicine" policy,  does not prohibit a physician,  dentist or other
licensed   practitioner  from  prescribing  an  approved  drug  product  for  an
unapproved  use or dosage.  Nor does the FDA generally  regulate the practice of
pharmacy  where  the  pharmacist  fills  a  prescription  issued  by a  licensed
practitioner for an individual  patient.  There can be no assurance that the FDA
or a state agency regulating the practice of medicine would initiate  regulatory
action  against a  licensed  practitioner  for  prescribing  doxycycline  in the
currently available dosage for use in the treatment of adult periodontitis.

      The  Drug  Price  Competition  and  Patent  Term  Restoration  Act of 1984
provides for abbreviated  approval  requirements for generic drugs,  exclusivity
protection  for  innovative  products  that  prevents  FDA  approval  of generic
versions,  and patent  extension  for a certain  period of time that it takes to
obtain FDA approval.  Periostat is being treated by the FDA as an  "antibiotic."
Therefore,  the  Company  will have to rely solely on its patent  protection  as
Periostat will not be entitled to a three-year  period of marketing  exclusivity
before generic  versions can be approved by the FDA for commercial  sale, and no
patent-term  extension  will be  available.  In  addition,  the Company  will be
subject to certain  user fees that the FDA is  authorized  to collect  under the
Prescription  User  Fees Act of 1992 for  reviewing  NDAs  and  other  marketing
applications.

      Among the  requirements  for product  approval is the requirement that the
prospective  manufacturer conform to GMP regulations.  In complying with the GMP
regulations,  manufacturers  must  continue to expend time,  money and effort in
product,  record-keeping  and quality  control to assure that the product  meets
applicable specifications and other requirements.  The FDA periodically inspects
manufacturing facilities in the United States in order to assure compliance with
applicable GMP requirements. Foreign manufacturers also are inspected by the FDA
if their  drugs are  marketed  in the United  States.  Failure of the  Company's
foreign  supplier  of the  active  ingredient  used  in the  manufacture  of the
Company's  products or failure of the  Company's  manufacturer  of its  finished
dosage form products to comply with the GMP  regulations or other FDA regulatory
requirements  would have a material  adverse  effect on the Company's  business,
financial condition or results of operations.

      In  September  1998,  the FDA granted the Company  marketing  approval for
Periostat  as an  adjunct  to SRP to  promote  attachment  level gain and reduce
pocket  depth in patients  with adult


                                       14

<PAGE>


periodontitis.  The Company is subject to numerous continuing  requirements with
regard to such approval.  For example,  quality control and  manufacturing  must
conform to complex and  detailed  GMP  requirements.  In  addition,  the FDA may
require  post-marketing  testing and will  require  surveillance  to monitor the
record of the product and continued  compliance  with  regulatory  requirements.
Upon  approval,  a  prescription  drug may  only be  marketed  for the  approved
indications in the approved  dosage forms and at the approved  dosage.  Also, an
NDA holder is required to report  certain  adverse  reactions to the FDA, and to
comply with certain requirements  concerning  advertising and promotion labeling
for their  products.  There can be no assurance  that  approval  from the FDA to
market Periostat will not be withdrawn or that Periostat will never be recalled.
Withdrawal  of FDA  marketing  approval  or a recall of  Periostat  would have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

      In addition to the applicable FDA requirements,  the Company is subject to
foreign regulatory authorities governing clinical trials and drug sales. Whether
or not FDA approval has been obtained,  approval of a pharmaceutical  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.


Competition
-----------

      The pharmaceutical  industry is subject to intense  competition as well as
rapid  and  significant  technological  change.  The  Company  believes  that  a
significant  competitive factor is the relative speed with which the Company can
supply  commercial  quantities of the product to the market on an ongoing basis.
In addition,  the Company expects that  competition in the periodontal area will
be   based   on   other   factors,    including   product   efficacy,    safety,
cost-effectiveness,  ease of use, patient  discomfort,  availability,  price and
patent position.

      The Company believes that Periostat is  distinguished  from other existing
and known  periodontitis  treatments in that it is the only  treatment  which is
directed to suppression of the enzymes that degrade periodontal support tissues.
The Company believes that all other therapies focus on temporarily  removing the
bacteria   associated   with   periodontitis.   Periostat   is  a   prescription
pharmaceutical  capsule  indicated  as an adjunct  to SRP to promote  attachment
level gain and to reduce pocket depth in patients with adult  periodontitis that
is taken by the patient  between  dental visits.  The Company  believes that the
following chart summarizes the available forms of periodontitis treatment, other
than SRP and resective surgery:

                   Product
  Product        Manufacturer        Dental    Delivery     Patient    Treatment
   Name           Marketer          Procedure    Route   Administered   Focus
------------   -------------------  ---------  --------  ------------  ---------
Periostat(R)   CollaGenex              No      Systemic     Yes      Tissue
               Pharmaceuticals, Inc.                                 degradation

Atridox(TM)    Atrix Laboratories/     Yes      Local        No      Bacteria
               Block Drug

Actisite(R)    Alza/Proctor &          Yes      Local        No      Bacteria
               Gamble

Periochip(TM)  PerioProducts, Ltd./    Yes      Local        No      Bacteria
               Astra U.S.


                                       15

<PAGE>


      Many  of  the  companies   participating  in  the  periodontal  area  have
substantially greater financial,  technical and human resources than the Company
and may be better equipped to develop,  manufacture and market  products.  These
companies may develop and introduce  products and processes  competitive with or
superior to those of the Company.


Employees
---------

      The  Company  historically  has  outsourced  its  manufacturing,  clinical
trials, NDA preparation and other activities. The Company intends to continue to
outsource many of the activities  which it historically  has  outsourced.  As of
December 31, 1999,  the Company  employed  142 persons.  Each of its  management
personnel has had extensive prior experience with pharmaceutical,  biotechnology
or medical products companies. The Company has increased its sales and marketing
staff  to  include   approximately  113  sales   representatives   and  managers
nationwide, of which 15 are part-time. In addition, the Company plans to recruit
additional sales  representatives  in 2000;  however,  there can be no assurance
that the Company will be able to recruit and retain  qualified  inside sales and
marketing  personnel,   additional  foreign  sub-licensees  or  distributors  or
marketing  partners or that the  Company's  marketing  and sales efforts will be
successful. Currently, none of the Company's employees are covered by collective
bargaining  agreements.  In  general,  the  Company's  employees  are covered by
confidentiality  agreements.  The Company considers relations with its employees
to be excellent.


ITEM 2.   PROPERTIES.

      The Company owns no real  property.  From January to May 1999, the Company
leased  3,500 square feet of office  space at 301 South State  Street,  Newtown,
Pennsylvania  under two leases.  In May 1999,  the Company  moved its  principal
executive  offices to 41  University  Drive,  Newtown,  Pennsylvania.  The newly
leased premises consist of approximately  14,204 square feet and the term of the
lease is one hundred and twenty-two (122) months.


ITEM 3.   LEGAL PROCEEDINGS.

      The Company is not a party to any material legal proceedings.

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

      Not applicable.


                                       16

<PAGE>


                                     PART II

ITEM 5.  MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

      Prior to June 1996,  there was no  established  market  for the  Company's
common  stock.  Since June 20,  1996,  the common stock has traded on the Nasdaq
National Market ("NNM") under the symbol "CGPI."

      The following  table sets forth the high and low bid  information  for the
common  stock for each of the quarters in the period  beginning  January 1, 1998
through  December  31,  1999  as  reported  on  NNM.  Such  quotations   reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions.

              Quarter Ended               High          Low
          ------------------------      -------       -------

          March 31, 1998..........      $ 13.13       $  5.50
          June 30, 1998...........      $ 10.75       $  7.25
          September 30, 1998......      $ 14.50       $  7.75
          December 31, 1998.......      $ 14.25       $  8.25
          March 31, 1999..........      $ 12.44       $  8.00
          June 30, 1999...........      $ 11.25       $  7.50
          September 30, 1999......      $ 23.94       $  9.13
          December 31, 1999.......      $ 24.56       $ 15.75

      As of February 15, 2000,  the  approximate  number of holders of record of
the common stock was 115 and the approximate number of beneficial holders of the
common stock was 3,400.

      The Company has never  declared or paid any cash  dividends  on its common
stock.  Except as set forth below,  the Company intends to retain  earnings,  if
any, to fund future growth and the  operation of its business.  On May 12, 1999,
the Company  consummated a $20.0 million  financing  through the issuance of its
Series D Cumulative  Convertible Preferred Stock. As a result of such financing,
the Company has  cumulative  cash and common stock  dividend  obligations to the
holders of the Series D Cumulative  Convertible  Preferred Stock. Such financing
arrangement also limits the Company's  ability to generally declare dividends to
its common stockholders.  See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."


                                       17

<PAGE>


ITEM 6.   SELECTED CONSOLIDATED FINANCIAL DATA.

      The selected  consolidated  financial data set forth below with respect to
the  Company's  statement  of  operations  data  for  each of the  years  in the
three-year  period ended December 31, 1999, and with respect to the consolidated
balance  sheet  data at  December  31,  1998 and 1999 are  derived  from and are
qualified by reference to the audited consolidated  financial statements and the
related  notes  thereto of the Company  found at "Item 14.  Exhibits,  Financial
Statement  Schedules,  and Reports on Form 8-K." The  consolidated  statement of
operations  data for the years ended December 31, 1995 and 1996 and with respect
to the  consolidated  balance sheet data as of December 31, 1995,  1996 and 1997
are derived from consolidated  audited financial statements not included in this
Annual Report on Form 10-K. The selected  consolidated  financial data set forth
below  should be read in  conjunction  with and is qualified in its entirety by,
the  Company's  audited  consolidated  financial  statements  and related  notes
thereto found at "Item 14. Exhibits,  Financial Statement Schedules, and Reports
on Form 8-K" and "Item 7.  Management's  Discussion  and  Analysis of  Financial
Condition and Results of Operations" which are included elsewhere in this Annual
Report on Form 10-K.

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                --------------------------------------------------------
                                  1995        1996        1997        1998        1999
                                --------    --------    --------    --------    --------
Consolidated Statement of                 (in thousands except for per share data)
  Operations Data:
<S>                             <C>         <C>         <C>         <C>         <C>
 Revenues:
 Product sales ..............   $   --      $   --      $   --      $  3,053    $ 15,211
 License revenues ...........       --           400         325         400         100
 Contract revenues ..........       --          --             9           8         770
                                --------    --------    --------    --------    --------
Total revenues ..............       --           400         334       3,461      16,081
                                --------    --------    --------    --------    --------
Operating expenses:
 Cost of product sales ......       --          --          --           745       3,139
 Research and development ...      3,635       4,436       4,200       4,670       5,005
 Selling, general and
 administrative .............      1,548       2,527       6,096      10,600      23,180
Operating loss ..............     (5,183)     (6,563)     (9,962)    (12,554)    (15,243)

Interest Income .............         59         645       1,338         988         851
Interest Expense ............       (144)       --          --          --          (199)
Net loss ....................     (5,269)     (5,918)     (8,624)    (11,566)    (14,591)

Net loss allocable to
 common stockholders ........   $ (6,028)   $ (6,638)   $ (8,624)   $(11,566)   $(15,683)
Net loss per share allocable
 to common stockholders(1):

 Basic ......................   $ (19.91)   $  (1.74)   $  (1.04)   $  (1.35)   $  (1.82)
 Diluted ....................     (14.60)      (1.72)      (1.04)      (1.35)      (1.82)
Shares used in computing
 net loss per share allocable
 to common stockholders(1):

 Basic ......................        303       3,809       8,291       8,579       8,598
 Diluted ....................        413       3,864       8,291       8,579       8,598
</TABLE>


                                       18

<PAGE>
<TABLE>
<CAPTION>

                                                  As of December 31,
                             --------------------------------------------------------
                                1995        1996       1997        1998        1999
                             --------    --------    --------    --------    --------
Balance Sheet Data:                                  (in thousands)

<S>                          <C>         <C>         <C>         <C>         <C>
Cash, cash equivalents and
  short-term investments..   $  5,806    $ 18,215    $ 22,771    $ 10,250    $ 14,367
Total assets .............      5,840      18,437      23,165      14,740      18,563
Mandatorily redeemable
  convertible preferred
  stock ..................     18,908        --          --          --          --
Accumulated deficit ......    (11,820)    (17,739)    (26,362)    (37,928)    (53,611)
Total stockholders'
  equity (deficit) .......    (13,581)     17,592      20,708       9,281      13,607
</TABLE>



(1)   See Note 2 of Notes to Consolidated  Financial  Statements for information
      concerning computation of net loss per share.


ITEM 7.   MANAGEMENT'S  DISCUSSION  AND ANALYSIS OF FINANCIAL  CONDITION AND
          RESULTS OF OPERATIONS.


Overview
--------

      CollaGenex  Pharmaceuticals,  Inc. and  subsidiaries  (the "Company") is a
specialty   pharmaceutical  company  focused  on  providing  innovative  medical
therapies to the dental market.  The Company's  first product,  Periostat,  is a
prescription  pharmaceutical capsule that was approved by the United States Food
and Drug  Administration  (the "FDA") in September 1998 as an adjunct to scaling
and root  planing,  the most  prevalent  therapy for  periodontitis,  to promote
attachment  level  gain and to  reduce  pocket  depth  in  patients  with  adult
periodontitis.  The  Company is  marketing  Periostat  to the  dental  community
through its own professional dental  pharmaceutical sales force of approximately
135 sales  representatives  and  managers.  This sales  force  also  co-promotes
Vioxx(R), a prescription non-sterodial anti-inflammatory drug developed by Merck
and  Denavir(R),  a prescription  cold sore  medication  developed by SmithKline
Beecham,  and the Company is actively  seeking  other  products to market to the
dental community.

      The Company began operations in January 1992 and functioned primarily as a
research and  development  company until 1998.  During this period,  the Company
operated  with  a  minimal   number  of   employees,   and   substantially   all
pharmaceutical  development  activities were contracted to independent  contract
research  and other  organizations.  Following  FDA  approval  of  Periostat  in
September  1998,  the Company  significantly  increased its number of employees,
primarily in the areas of sales and marketing. The Company continues to contract
its  research  and  development   activities  as  well  as   manufacturing   and
distribution.

      The  Company has  incurred  losses  each year since  inception  and had an
accumulated  deficit of $53.6 million at December 31, 1999. The Company  expects
to continue to incur losses in the foreseeable  future from expenditures on drug
development, marketing, manufacturing and administrative activities.

      Statements contained or incorporated by reference in this Annual Report on
Form 10-K that are not based on historical fact are "forward-looking statements"
within the meaning of


                                       19

<PAGE>


Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking
statements may be identified by the use of  forward-looking  terminology such as
"may," "will," "expect," "estimate," "anticipate," "continue," or similar terms,
variations of such terms or the negative of those terms. This Form 10-K contains
forward-looking  statements that involve risks and uncertainties.  The Company's
business of selling, marketing and developing pharmaceutical products is subject
to a number of significant risks, including risks relating to the implementation
of the Company's  sales and marketing  plans for  Periostat,  risks  inherent in
research and development  activities,  risks associated with conducting business
in a highly regulated environment and uncertainty relating to clinical trials of
products under development. The success of the Company depends to a large degree
upon the market acceptance of Periostat by periodontists,  dental practitioners,
other  health care  providers,  patients  and  insurance  companies.  Other than
Periostat, which has been FDA approved for marketing in the United States, there
can be no assurance that any of the Company's  other product  candidates will be
approved by any regulatory  authority for marketing in any  jurisdiction  or, if
approved,  that any such products or that Vioxx or Denavir will be  successfully
commercialized  by  the  Company.   The  Company's  actual  results  may  differ
materially  from  the  results  discussed  in  the  forward-looking   statements
contained herein.


Results of Operations
---------------------

      From its  founding  through the quarter  ended  September  30,  1998,  the
Company  had no  revenues  from  sales of its own  products.  During  the fourth
quarter  of 1998,  the  Company  achieved  net  product  sales  of $3.1  million
following the commercial  launch of Periostat in November 1998. Most of the 1998
sales represented  initial wholesale and retail stocking.  During the year ended
December 31, 1999, the Company  achieved net product sales of $15.2 million from
sales of  Periostat.  In  addition,  in 1999 the Company  generated  $770,000 in
contract revenues from its co-promotion  agreements and $100,000 in license fees
relating to the signing of a distribution agreement for Periostat in Canada.

      The Company  realized a net loss in 1999  resulting  primarily from higher
sales offset by higher planned  sales,  marketing and  administrative  expenses.
Total  operating  expenses  consist of the cost of product  sales,  research and
development expenses and selling,  general and administrative  expenses. Cost of
product sales consists primarily of direct manufacturing expenses and royalties.
Research and development  expenses  consist  primarily of funds paid to contract
research  organizations  for the  provision of services and  materials  for drug
development,  ongoing  manufacturing  and formulation  enhancements and clinical
trials.  Selling,  general and  administrative  expenses  consist  primarily  of
personnel  salaries and  benefits,  direct  marketing  costs,  professional  and
consulting fees, insurance and general office expenses.


Years Ended December 31, 1999 and December 31, 1998
---------------------------------------------------

      Revenues.  The Company  realized $16.1 million in net revenues during 1999
compared to $3.5 million during 1998. Revenues in 1999 included $15.2 million in
net sales of Periostat and $870,000 in licensing and contract revenues. The 1999
licensing  revenues of $100,000 were attributable to a licensing  agreement with
Pharmascience, Inc. pursuant to which Pharmascience, Inc., will market Periostat
in Canada pending  requisite  regulatory  approval.  Revenues in 1998


                                       20

<PAGE>


included a non-refundable $400,000 licensing fee from Laboratories Pharmascience
under a licensing  agreement pursuant to which  Laboratories  Pharmascience will
market Periostat in France pending requisite regulatory approval.

      Cost of product sales. Cost of product sales were $3.1 million or 20.6% of
net product sales in 1999 compared to $745,000, or 24.4% of net product sales in
1998. This improvement in gross margin resulted from the absence of launch trade
allowances  in 1999,  and lower  royalty  rates  applicable  to the higher sales
achieved in 1999 compared to 1998.

      Research  and  development  expenses.  Research and  development  expenses
increased to $5.0 million in 1999 from $4.7 million in 1998.  In 1999,  research
and development expenses were primarily for Phase IV clinical studies to support
the  future  marketing  activities  of  Periostat,   ongoing  manufacturing  and
formulation   development  work  for  Periostat  and  research  and  development
activities funded by the Company at SUNY. Research and development  expenses for
1998 consisted primarily of costs associated with the Company's amendment to its
NDA for  Periostat,  a Phase III  clinical  trial  intended  to  support  future
marketing  activities for Periostat and certain  pre-clinical  studies for other
potential compounds under development.

      Selling,  general  and  administrative  expenses.   Selling,  general  and
administrative expenses increased to $23.2 million in 1999 from $10.6 million in
1998.  This increase was due primarily to higher selling and marketing  expenses
for a full year of commercial activities for Periostat in 1999 and the hiring of
additional sales personnel as Periostat sales commenced in the fourth quarter of
1998.

      Other income/expenses.  Interest income decreased from $988,000 in 1998 to
$851,000 in 1999. This decrease was due to lower balances in cash and short-term
investments as a result of normal operating activities. Interest expense for the
year ended December 31, 1999 was $199,000. This expense was primarily due to the
interest on the $10.0  million  short term note executed by the Company in March
1999 which was repaid in connection with the Company's Financing (as hereinafter
defined) in May 1999.

     Preferred  stock  dividend.  Preferred  stock  dividends  increased to $1.1
million  during the year ended  December  31, 1999 as a result of the  Company's
obligations  in  connection  with  the  issuance  of  its  Series  D  Stock  (as
hereinafter defined) in May 1999.


Years Ended December 31, 1998 and December 31, 1997
---------------------------------------------------

      Revenues.  The Company  realized $3.5 million in net revenues  during 1998
compared to $334,000 during 1997.  Revenues in 1998 included $3.1 million in net
sales of Periostat  and $408,000 in licensing  and contract  revenues.  The 1998
licensing  revenues of $400,000 were attributable to a licensing  agreement with
Laboratories  Pharmascience  pursuant to which Laboratories  Pharmascience will,
following all requisite  regulatory  approvals,  market  Periostat in France and
certain other related  territories.  Revenues in 1997 included a  non-refundable
$300,000 licensing fee from Boehringer Mannheim Italia (now called Roche S.P.A.)
related to the achievement of the first  milestone  under a licensing  agreement
pursuant  to  which  Roche


                                       21

<PAGE>


S.P.A.  will,  following  all requisite  regulatory  approvals,  distribute  and
manufacture Periostat in Italy.

      Cost of product sales.  Cost of product sales were $745,000 in 1998, while
there were no cost of product  sales in 1997.  Such  increase  resulted from the
Company's initial sales of Periostat in 1998.

      Research  and  development  expenses.  Research and  development  expenses
increased  from $4.2  million  in 1997 to $4.7  million in 1998.  This  increase
resulted  primarily from expenses  relating to additional  costs associated with
the Company's  amendment to its NDA for Periostat  submitted to the FDA in March
1998, a Phase 3b clinical trial intended to support future marketing  activities
for Periostat,  the initiation of certain  pre-clinical  studies for Nephrostat,
the Company's compound for the treatment of diabetic  complications,  which were
discontinued  in 1999, and consulting and product  registration  fees associated
with the Marketing Authorization Application that the Company has filed with the
United Kingdom Medicine Control Agency with respect to potential Periostat sales
in the United Kingdom.

      Selling,  general  and  administrative  expenses.   Selling,  general  and
administrative  expenses increased from $6.1 million in 1997 to $10.6 million in
1998.  This  increase was due primarily to the  Company's  pre-launch  marketing
activities  related  to  Periostat  in 1998,  the  hiring  of  additional  sales
personnel  in 1998 and sales and  marketing  efforts in 1998  related to certain
contractual marketing arrangements entered into during 1997.

      Other income/expenses. Interest income decreased from $1.3 million in 1997
to  $988,000  in  1998.  This  decrease  was due to lower  balances  in cash and
short-term  investments  as a result of normal  operating  activities  since the
Company's follow-on public offering of common stock in April 1997.


Liquidity and Capital Resources
-------------------------------

      Since its origin in January 1992,  the Company has financed its operations
through  private  placements  of preferred  stock and common  stock,  an initial
public  offering  of  2,000,000  shares of common  stock,  which  generated  net
proceeds to the Company of approximately  $18.0 million after  underwriting fees
and related  expenses,  and a subsequent  public offering of 1,000,000 shares of
common stock, which generated net proceeds to the Company of approximately $11.6
million  after  underwriting  fees and related  expenses.  On May 12, 1999,  the
Company  consummated a $20.0 million  financing  (the  "Financing")  through the
issuance of its Series D Cumulative  Convertible  Preferred Stock (the "Series D
Stock"),  which  generated  net  proceeds to the Company of $18.5  million.  The
issuance  of the  Series D Stock was  approved  by a majority  of the  Company's
stockholders at the Company's  Annual Meeting of Stockholders on May 11, 1999. A
portion of the  proceeds of such  Financing  were used to repay a $10.0  million
Senior  Secured  Convertible  Note provided by one of the investors on March 19,
1999 in connection with the Financing. The remaining proceeds have been and will
be used for general working capital purposes.


                                       22

<PAGE>


      The Series D Stock is  convertible at any time into shares of common stock
of the Company at an initial  conversion  price of $11.00 per common share.  The
conversion  price is not  subject to reset  except in the event that the Company
should fail to declare and pay  dividends  when due or the Company  should issue
new equity securities or convertible securities at a price per share or having a
conversion  price per share lower than the then applicable  conversion  price of
the Series D Stock. During the first three years following issuance,  holders of
the Series D Stock will be  entitled to receive  dividends  payable in shares of
fully registered common stock at a rate of 8.4% per annum. Thereafter, dividends
will be payable in cash at a rate of 8.0% per annum.

      All or a portion of the shares of Series D Stock  shall,  at the option of
the  Company  (as  determined  by the  Board  of  Directors),  automatically  be
converted into fully paid, registered and non-assessable shares of common stock,
if the following two conditions are met: (i) the last sale price, or, in case no
such sale takes  place on such day,  the  average of the  closing  bid and asked
prices on the Nasdaq is at least 200% of the conversion price then in effect (as
of February 15, 2000, $11.00 per share) for forty consecutive  trading days; and
(ii) a shelf  registration  is in effect  for the  shares of common  stock to be
issued upon  conversion  of the Series D Stock.  Without  written  approval of a
majority  of the  holders of record of the Series D Stock,  the  Company,  among
other things,  shall not: (i) declare or pay any dividend or distribution on any
shares of capital  stock of the  Company  other than  dividends  on the Series D
Stock;   (ii)  make  any  loans,   incur  any   indebtedness  or  guarantee  any
indebtedness,  advance capital  contributions  to, or investments in any person,
issue or sell any  securities  or  warrants  or other  rights  to  acquire  debt
securities of the Company,  except that the Company may incur such  indebtedness
in any amount not to exceed $10.0  million in the aggregate  outstanding  at any
time for working capital  requirements  in the ordinary  course of business;  or
(iii) make research and  development  expenditures  in excess of $7.0 million in
any continuous twelve month period, unless the Company has reported positive net
income for four  consecutive  quarters  immediately  prior to such twelve  month
period.

      At  December  31,  1999,  the  Company  had  cash,  cash  equivalents  and
short-term  investments  of  approximately  $14.4  million,  an increase of $4.1
million from the $10.3 million balance at December 31, 1998.

      In accordance with investment  guidelines  approved by the Company's Board
of Directors,  cash balances in excess of those required to fund operations have
been invested in short-term  United States  Treasury  securities  and commercial
paper with a credit rating no lower than A1/P1. The Company's working capital at
December 31, 1999 was $13.0  million,  an increase of $4.0 million from December
31, 1998. This increase was primarily  attributable to the net proceeds received
from the Financing, offset in part by cash used in operations during 1999.

      In April 1999, the Company received $219,000 in proceeds from the issuance
of a note  payable.  The proceeds of such note were used to fund the purchase of
equipment,  fixtures and  furniture  for the  Company's  newly leased  corporate
offices in Newtown,  Pennsylvania.  The term of the note is three years at 9.54%
per annum, with monthly minimum payments of principal and interest.  The note is
secured by a third party irrevocable  standby letter of credit for an amount not
less than 90% of the financed property.


                                       23

<PAGE>


      The Company  anticipates that its existing working capital,  including the
proceeds from the Financing, will be sufficient to fund the Company's operations
through  at least  2000.  The  Company's  future  capital  requirements  and the
adequacy of its available funds will depend on many factors,  including the size
and scope of the Company's marketing effort and sales of Periostat, the terms of
agreements  entered  into with  corporate  partners,  if any, and the results of
research  and  development  and  pre-clinical  and  clinical  studies  for other
applications of the Company's core technology. Over the long-term, the Company's
liquidity is dependent on market acceptance of its products and technology.

      At December  31,  1999,  the Company had  approximately  $51.0  million of
Federal and $39.0 million of state net operating loss carryforwards available to
offset  future  taxable  income.  The  Federal  and  state  net  operating  loss
carryforwards  will  begin  expiring  in 2007  and  2005,  respectively,  if not
utilized. The Company also has research and development tax credit carryforwards
of approximately  $790,000  available to reduce Federal income taxes which begin
expiring in 2007.

     Section  382 of the  Internal  Revenue  Code of 1986  subjects  the  future
utilization of net operating  losses and certain other tax  attributes,  such as
research and  development  credits,  to an annual  limitation in the event of an
ownership change, as defined. Due to the Company's prior and current year equity
transactions,  a portion  of the net  operating  losses  and tax  credits of the
Company are subject to an annual  limitation of approximately  $3.8 million.  To
the extent that any single-year limitation is not utilized to the full amount of
the limitation,  such unused amounts are carried over to subsequent  years until
the earlier of its  utilization or the  expiration of the relevant  carryforward
period.  At December 31, 1999,  assuming there are no future ownership  changes,
approximately  $12.0 million is  immediately  available to offset future taxable
income. In addition to the Section 382 limitation,  the state net operating loss
carryforward is subject to a $2.0 million annual limitation.


Recently Issued Accounting Standards
------------------------------------

      In December  1999,  the staff of the  Securities  and Exchange  Commission
issued a Staff  Accounting  Bulletin  ("SAB") No. 101,  "Revenue  Recognition in
Financial  Statements"  ("SAB 101").  SAB 101 summarizes  certain of the staff's
views  in  applying   generally  accepted   accounting   principles  to  revenue
recognition in financial statements, including the recognition of non-refundable
fees  received  upon  entering  into  arrangements.  We are in  the  process  of
evaluating this SAB and the effect it will have in our financial  statements and
current revenue recognition policy.


Year 2000 Issues
----------------

      The Company  believes that material Year 2000  compliance  problems  would
have arisen on or immediately after January 1, 2000. As of the date hereof,  the
Company  is not  aware of any Year  2000-related  problems  associated  with its
internal systems or software or that of its vendors,  suppliers,  manufacturers,
distributors and marketing partners. It is possible,  however, that further Year
2000-related problems will arise in the future.


                                       24

<PAGE>


      Other than time spent by the Company's own personnel,  to date the Company
has not incurred any significant  costs in identifying and remediating Year 2000
problems.


European Monetary Union
-----------------------

      On January 1, 1999, eleven of the fifteen member countries of the European
Union set fixed  conversion  rates between their existing legacy  currencies and
the euro. At such time, these participating  countries adopted the euro as their
common  legal  currency.  The  eleven  participating  countries  will now  issue
sovereign debt exclusively in euro and will redenominate  outstanding  sovereign
debt.  The legacy  currencies  will continue to be used as legal tender  through
January 1, 2002, at which point the legacy  currencies will be canceled and euro
bills  and  coins  will be  used  for  cash  transactions  in the  participating
countries.

      The Company does not denominate its international  licensing agreements in
foreign  currencies.  The  Company  currently  does  not  believe  that the euro
conversion will have a material impact on the Company's results of operations or
financial condition.


ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

      The Company believes that it is not subject to a material Market Risk.


ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

      The financial  statements required to be filed pursuant to this Item 8 are
appended to this Annual Report on Form 10-K. A list of the financial  statements
filed herewith is found at "Item 14. Exhibits,  Financial  Statement  Schedules,
and Reports on Form 8-K."


ITEM 9.   CHANGES IN AND DISAGREEMENTS  WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE.

      Not applicable.


                                       25

<PAGE>


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.

      The information relating to the Company's directors, nominees for election
as directors and executive  officers under the headings "Election of Directors",
"Executive  Officers" and "Compliance with Section 16(a) of the Exchange Act" in
the  Company's  definitive  proxy  statement  for the  2000  Annual  Meeting  of
Stockholders is incorporated herein by reference to such proxy statement.


ITEM 11.  EXECUTIVE COMPENSATION.

      The discussion under the heading "Executive Compensation" in the Company's
definitive  proxy  statement  for the 2000  Annual  Meeting of  Stockholders  is
incorporated herein by reference to such proxy statement.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

      The discussion under the heading "Security Ownership of Certain Beneficial
Owners and Management" in the Company's  definitive proxy statement for the 2000
Annual Meeting of Stockholders is incorporated herein by reference to such proxy
statement.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

      The  discussion  under the  heading  "Certain  Relationships  and  Related
Transactions"  in the Company's  definitive  proxy statement for the 2000 Annual
Meeting  of  Stockholders  is  incorporated  herein by  reference  to such proxy
statement.


                                       26

<PAGE>


                                     PART IV

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

 (a)  (1)  Financial Statements.

           Reference is made to the Index to Consolidated  Financial  Statements
           and Schedule on Page F-1.

      (2)  Financial Statement Schedule.

           Reference is made to the Index to Consolidated  Financial  Statements
           and Schedule on Page F-1.

      (3)  Exhibits.

           Reference is made to the Index to Exhibits on Page 30.

 (b)       Reports on Form 8-K.

           No  Reports  on Form 8-K have been filed  during  the  quarter  ended
           December 31, 1999.  The Company filed a Current Report on Form 8-K on
           March 25, 1999  relating to its  issuance of a $10.0  million  Senior
           Secured  Convertible Note and its proposed  issuance of $20.0 million
           of  Series  D  Cumulative  Convertible  Preferred  Stock  to  certain
           investors.  The Company filed a Current Report on Form 8-K on May 26,
           1999  relating  to the  consummation  of a  $20.0  million  financing
           through the issuance of its Series D Cumulative Convertible Preferred
           Stock and prepayment of such $10.0 million Senior Secured Convertible
           Note.


                                       27

<PAGE>


                                   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 this 29th day of March,
2000.

                                    COLLAGENEX PHARMACEUTICALS, INC.

                                    By:/s/ Brian M. Gallagher
                                       --------------------------------------
                                       Brian M. Gallagher, Ph. D., President
                                       and Chief Executive Officer


                                       28

<PAGE>


      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 and in the capacities and on the dates indicated.

          Signature                        Title                       Date
---------------------------------  ---------------------------    --------------

/s/ Brian M. Gallagher, Ph.D.      President, Chief               March 29, 2000
---------------------------------  Executive Officer and
    Brian M. Gallagher, Ph.D.      Director (Principal
                                   Executive Officer)

/s/ Nancy C. Broadbent             Chief Financial Officer,       March 29, 2000
---------------------------------  Treasurer and Secretary
    Nancy C. Broadbent             (Principal Financial and
                                   Accounting Officer)

/s/ Helmer P.K. Agersborg, Ph. D.  Chairman of the Board and      March 29, 2000
---------------------------------  Director
    Helmer P.K. Agersborg, Ph.D.

/s/ Peter R. Barnett, D.M.D.       Director                       March 29, 2000
---------------------------------
    Peter R. Barnett, D.M.D.

/s/ Robert C. Black                Director                       March 29, 2000
---------------------------------
    Robert C. Black

                                   Director                       March   , 2000
---------------------------------
    James E. Daverman

/s/ Robert J. Easton               Director                       March 29, 2000
---------------------------------
    Robert J. Easton

/s/ Stephen A. Kaplan              Director                       March 29, 2000
---------------------------------
    Stephen A. Kaplan

/s/ Stephen W. Ritterbush, Ph.D.   Director                       March 28, 2000
---------------------------------
    Stephen W. Ritterbush, Ph.D.

/s/ Terence E. Winters, Ph.D.      Director                       March 25, 2000
---------------------------------
    Terence E. Winters, Ph.D.


                                       29

<PAGE>


                                  EXHIBIT INDEX

Exhibit No.                        Description of Exhibit
-----------                        ----------------------

   3.1(a)     Amended and Restated Certificate of Incorporation.

   3.2(a)     Amended and Restated Bylaws.

   4.1(a)     Registration  Rights  Agreement  dated  September  29, 1995 by and
              among the Company and certain investors, as supplemented.

   4.2(a)(b)  Letter dated  December 16, 1993 re:  certain rights of the Company
              with respect to certain  securities  of the Company owned by Brian
              M. Gallagher, Ph.D.

   4.3(a)     Fourth Investment  Agreement as of September 29, 1995 by and among
              the Company and certain Investors.

   4.4(d)     Shareholder Protection Rights Agreement, dated as of September 15,
              1997,  between  the Company and  American  Stock  Transfer & Trust
              Company which includes (i) the Form of Rights Certificate and (ii)
              the Certificate of Designation of Series A Participating Preferred
              Stock of the Company.

   4.5(j)     Amendment No. 1 to Shareholder Protection Rights Agreement,  dated
              as of March 16,  1999,  between  the Company  and  American  Stock
              Transfer & Trust Company.

   4.6(l)     Certificate  of  Designation.  Preferences  and Rights of Series D
              Cumulative    Convertible    Preferred    Stock   of    CollaGenex
              Pharmaceuticals, Inc.

 +10.1(a)     Assignment of,  Amendment to and  Restatement  of Agreement,  with
              all exhibits,  as amended,  and schedules,  dated January 13, 1992
              by and among the  Company,  Johnson & Johnson  Consumer  Products,
              Inc. and Research Foundation of State University of New York.

 +10.2(a)     Supply  Agreement  dated  January 23, 1995 between the Company and
              Hovione International Limited.

 +10.3(a)     Manufacturing  Agreement  as of April 12,  1996 by and between the
              Company and Applied Analytical Industries, Inc.

  10.4(a)     Form of  Non-Disclosure  Agreement  executed by all  Employees  as
              employed from time to time.

  10.5(a)(b)  Form of  Non-Competition  Agreement  executed  by each of Brian M.
              Gallagher, Ph.D., Nancy C. Broadbent and Robert A. Ashley.

  10.6(a)     Form  of  Mutual  Non-Disclosure  Agreement  executed  by  certain
              consultants  and research  collaborators  as retained from time to
              time.

  10.7(a)(b)  Form  of  Indemnification   Agreement  executed  by  each  of  the
              Company's directors and officers.

  10.8(a)     Forms of Consulting  Agreement  executed by each of Lorne M. Golub
              and Thomas F. McNamara.

  10.9(a)     Form of  Material  Transfer  Agreement  between  the  Company  and
              Researchers.


                                       30

<PAGE>


Exhibit No.                        Description of Exhibit
-----------                        ----------------------

  10.10(g)    Lease  Agreement  dated  September 5, 1995 between the Company and
              Stocking  Works  Associates  (incorporated  by  reference  to  the
              Company's   Registration   Statement  on  Form  S-1  (File  Number
              333-3582)  which became  effective on June 20,  1996),  as amended
              effective  January  1, 1997 (such  amendment  is  incorporated  by
              reference  to the  Company's  Registration  Statement  on Form S-1
              (File Number  333-24151) which became effective on April 2, 1997),
              as amended  effective  January 1, 1998  (such  Amendment  is filed
              herewith).

  10.11(a)    Master  Consulting  Agreement dated September 19, 1994 between the
              Company and Quintiles, Inc.

  10.12(a)(b) 1992 Stock Option Plan of the Company, as amended to date.

  10.13(a)(b) 1996 Stock Plan of the Company.

  10.14(a)(b) 1996 Non-Employee Director Stock Option Plan of the Company.

 +10.15(c)    License  Agreement  dated July 18, 1996 by and between the Company
              and Boehringer Mannheim Italia.

  10.16(e)    Letter  Agreement  dated June 24, 1997 relating to CoreStates Bank
              N.A. line of credit,  together with Master  Commercial  Promissory
              Note.

  10.17(e)    Consulting and Contract  Service  Agreement dated February 1, 1997
              by and between the Company and Innovative Customer Solutions, Ltd.

  10.18(g)    Lease  Agreement  dated  August 22,  1997  between the Company and
              Stocking Works  Associates  which became effective on September 1,
              1997.

  10.19(h)    Contract between  Quintiles  Scotland Ltd. and the Company,  dated
              April 28, 1998.
 +10.20(i)    License  Agreement  dated as of June 30,  1998 by and  between the
              Company and Laboratories Pharmascience S.A.

 +10.21(i)    Exhibit A to the  Manufacturing  Agreement as of April 12, 1996 by
              and between the Company and Applied Analytical  Industries,  Inc.,
              filed with the Company's  Registration Statement on Form S-1 (File
              Number 333-3582) which became effective on June 20, 1996.

 +10.22(i)    Co-Promotion  Agreement dated October 13, 1998 between  SmithKline
              Beecham Consumer Healthcare, L.P. and the Company.

 +10.23(i)    Distribution  Services  Agreement  dated  August 15, 1998  between
              Cord Logistics, Inc. and the Company.

  10.24(j)    Convertible  Loan and  Security  Agreement  dated as of March  19,
              1999,  between OCM  Principal  Opportunities  Fund,  L.P.  and the
              Company.

  10.25(j)    Convertible  Note dated  March 19,  1999,  made by the  Company in
              favor of OCM Principal Opportunities Fund, L.P.

  10.26(j)    Stock  Purchase  Agreement  dated  March  19,  1999,  between  the
              Company,   OCM  Principal   Opportunities  Fund,  L.P.  and  other
              Purchasers set forth therein.

  10.27(k)    Lease  Agreement  dated  March 15,  1999  between  the Company and
              Newton Venture IV Associates, effective May 15, 1999.


                                       31

<PAGE>

Exhibit No.                        Description of Exhibit
-----------                        ----------------------

  10.27(l)    Stockholders and Registration  Rights  Agreement,  dated March 19,
              1999,  by  and  among   CollaGenex   Pharmaceuticals,   Inc.,  OCM
              Principal  Opportunities  Fund,  L.P. and the Purchasers set forth
              therein.

  21(f)       List of subsidiaries of the Registrant.

  23.1        Consent of KPMG LLP.

  27          Financial Data Schedule.

-------

+      Confidential  treatment  has been  requested and granted for a portion of
       this Exhibit.

(a)    Incorporated by reference to the Company's Registration Statement on Form
       S-1 (File Number 333-3582) which became effective on June 20, 1996.

(b)    A management contract or compensatory plan or arrangement  required to be
       filed as an exhibit pursuant to Item 14(c) of Form 10-K.

(c)    Incorporated by reference to the Company's  Quarterly Report on Form 10-Q
       for the  quarter  ended  September  30,  1996  which was  filed  with the
       Securities and Exchange Commission on October 29, 1996.

(d)    Incorporated  by reference to the Company's  Current  Report on Form 8-K,
       dated  September  16,  1997,  which was  filed  with the  Securities  and
       Exchange Commission on September 17, 1997.

(e)    Incorporated by reference to the Company's  Quarterly Report on Form 10-Q
       for the quarter ended June 30, 1997,  which was filed with the Securities
       and Exchange Commission on August 1, 1997.

(f)    Incorporated by reference to the Company's Annual Report on Form 10-K for
       the year ended December 31, 1996, which was filed with the Securities and
       Exchange Commission on March 28, 1997.

(g)    Incorporated by reference to the Company's Annual Report on Form 10-K for
       the year ended December 31, 1997, which was filed with the Securities and
       Exchange Commission on March 30, 1998.

(h)    Incorporated by reference to the Company's  Quarterly Report on Form 10-Q
       for the quarter ended June 30, 1998,  which was filed with the Securities
       and Exchange Commission on August 14, 1998.

(i)    Incorporated by reference to the Company's  Quarterly Report on Form 10-Q
       for the  quarter  ended  September  30,  1998,  which was filed  with the
       Securities and Exchange Commission on November 16, 1998.

(j)    Incorporated  by reference to the Company's  Current  Report on Form 8-K,
       dated March 19,  1999 which was filed with the  Securities  and  Exchange
       Commission on March 25, 1999.

(k)    Incorporated by reference to the Company's  Quarterly Report on Form 10-Q
       for the quarter ended March 31, 1999, which was filed with the Securities
       and Exchange Commission on May 7, 1999.

(l)    Incorporated  by reference to the Company's  Current  Report on Form 8-K,
       dated May 12,  1999,  which was filed with the  Securities  and  Exchange
       Commission on May 26, 1999.


                                       32

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

                        AND FINANCIAL STATEMENT SCHEDULE

                                                                      Page
                                                                      ----

Independent Auditors' Report.....................................     F-2

Consolidated Balance Sheets as of December 31, 1998 and 1999.....     F-3

Consolidated Statements of Operations for the years ended
  December 31, 1997, 1998, and 1999..............................     F-4

Consolidated Statements of Stockholders' Equity for the years
  ended December 31, 1997, 1998 and 1999.........................     F-5

Consolidated Statements of Cash Flows for the years ended
  December 31, 1997, 1998 and 1999...............................     F-6

Notes to Consolidated Financial Statements.......................     F-7

Financial Statement Schedule

  Valuation and Qualifying Accounts..............................     F-21


                                      F-1

<PAGE>


                          Independent Auditors' Report


The Board of Directors and Stockholders
CollaGenex Pharmaceuticals, Inc.:


We  have  audited  the   consolidated   financial   statements   of   CollaGenex
Pharmaceuticals,  Inc. and subsidiaries as listed in the accompanying  index. In
connection with our audits of the  consolidated  financial  statements,  we also
have  audited the  financial  statement  schedule as listed in the  accompanying
index. These consolidated  financial statements and financial statement schedule
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these  consolidated  financial  statements  and  financial
statement 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 consolidated  financial statements referred to above present
fairly,  in  all  material  respects,   the  financial  position  of  CollaGenex
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1998 and 1999, and the
results  of their  operations  and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally accepted
accounting  principles.  Also in our  opinion the  related  financial  statement
schedule,  when  considered  in  relation  to the basic  consolidated  financial
statements taken as a whole,  presents  fairly,  in all material  respects,  the
information set forth therein.

                                    /s/ KPMG LLP




Princeton, New Jersey
February 7, 2000


                                      F-2

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                           Consolidated Balance Sheets

                           December 31, 1998 and 1999
                  (dollars in thousands, except per share data)


                    Assets                                  1998         1999
                                                          --------     --------
Current assets:
   Cash and cash equivalents .........................    $  3,286     $  7,981
   Short term investments ............................       6,964        6,386
   Accounts receivable, net of allowance of
   $293 and $386 in 1998 and 1999, respectively ......       3,045        2,150
   Inventories .......................................         342          695
   Prepaid expenses and other current assets .........         823          615
                                                          --------     --------
         Total current assets ........................      14,460       17,827
Equipment and leasehold improvements, net ............         267          709
Other assets .........................................          13           27
                                                          --------     --------
         Total assets ................................    $ 14,740     $ 18,563
                                                          ========     ========

     Liabilities and Stockholders' Equity

Current liabilities:
   Current portion of note payable ...................    $   --       $     65
   Accounts payable ..................................       2,914        2,440
   Accrued expenses ..................................       2,545        2,335
                                                          --------     --------
         Total current liabilities ...................       5,459        4,840
                                                          --------     --------
Note payable, less current portion ...................        --            116
Stockholders' equity:
   Preferred stock, $0.01 par value,
     5,000,000 shares authorized, no shares
     and 200,000 shares of Series D cumulative
     convertible preferred stock issued and
     outstanding in 1998 and 1999, respectively
     (liquidation value $20,000) .....................        --              2
   Common stock, $0.01 par value; 25,000,000
     shares authorized, 8,587,204 and 8,622,091
     shares issued and outstanding in 1998 and
     1999, respectively ..............................          86           86
   Additional paid in capital ........................      47,317       67,206
   Deferred compensation .............................        (194)         (76)
   Accumulated deficit ...............................     (37,928)     (53,611)
                                                          --------     --------
         Stockholders' equity ........................       9,281       13,607
Commitments
                                                          --------     --------
         Total  liabilities and  stockholders'
           equity ....................................    $ 14,740     $ 18,563
                                                          ========     ========

          See accompanying notes to consolidated financial statements.


                                      F-3

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                      Consolidated Statements of Operations

                  Years ended December 31, 1997, 1998 and 1999
                  (dollars in thousands, except per share data)


                                          1997          1998           1999
                                      -----------    -----------    -----------
Revenues:
   Product sales ..................   $      --      $     3,053    $    15,211
   License revenues ...............           325            400            100
   Contract revenues ..............             9              8            770
                                      -----------    -----------    -----------
       Total revenues .............           334          3,461         16,081
                                      -----------    -----------    -----------
Operating expenses:
   Cost of product sales ..........          --              745          3,139
   Research and development .......         4,200          4,670          5,005
   Selling, general and
   administrative .................         6,096         10,600         23,180
                                      -----------    -----------    -----------
       Total operating expenses ...        10,296         16,015         31,324
                                      -----------    -----------    -----------
       Operating loss .............        (9,962)       (12,554)       (15,243)
Other income (expense):
   Interest income ................         1,338            988            851
   Interest expense ...............          --             --             (199)
                                      -----------    -----------    -----------
       Net loss ...................        (8,624)       (11,566)       (14,591)
                                      ===========    ===========    ===========

Preferred stock dividend ..........          --             --            1,092
                                      -----------    -----------    -----------
Net loss allocable to common
   stockholders ...................    $   (8,624)    $  (11,566)    $  (15,683)
                                      ===========    ===========    ===========
Basic and diluted net loss per
  share allocable to common
  stockholders ....................   $    (1.04)    $    (1.35)    $     (1.82)
                                      ===========    ===========    ===========
Shares used in computing basic
  and diluted net loss per share
   allocable to common
   stockholders ...................     8,291,167      8,579,054      8,597,676
                                      ===========    ===========    ===========

          See accompanying notes to consolidated financial statements.


                                      F-4

<PAGE>


<TABLE>
<CAPTION>
                                          COLLAGENEX PHARMACEUTICALS, INC.
                                                  AND SUBSIDIARIES

                                  Consolidated Statements of Stockholders' Equity

                                    Years ended December 31, 1997, 1998 and 1999
                                               (dollars in thousands)


                                                            Series D
                                                      cumulative convertible
                                                         preferred stock           Common stock
                                                       ---------------------   ---------------------    Additional
                                                       Number of      Par      Number of      Par        paid-in
                                                         shares      value      shares       value       capital
                                                       ---------   ---------   ---------   ---------   -----------
<S>                                                    <C>         <C>         <C>         <C>         <C>
Balance, December 31, 1996 .........................        --     $    --     7,535,533   $      75   $    35,551
    Exercise of common stock options ...............        --          --        32,046           1            52
    Issuance of common stock at $12.50 per share
      in conjunction with follow-on offering, net
      of issuance costs ............................        --          --     1,000,000          10        11,552
    Deferred compensation resulting from grant
      of options ...................................        --          --          --          --             142
    Amortization of deferred compensation ..........        --          --          --          --            --
    Net loss .......................................        --          --          --          --            --
                                                       ---------   ---------   ---------   ---------   -----------
Balance, December 31, 1997 .........................        --          --     8,567,579          86        47,297
    Exercise of common stock options ...............        --          --        19,625        --              20
    Amortization of deferred compensation ..........        --          --          --          --            --
    Net loss .......................................        --          --          --          --            --
                                                       ---------   ---------   ---------   ---------   -----------
Balance, December 31, 1998 .........................        --          --     8,587,204          86        47,317
    Exercise of common stock options ...............        --          --        13,575        --              44
    Issuance of Series D cumulative convertible
      preferred stock, net of issuance costs .......     200,000           2        --          --          18,448
    Common stock dividends on Series D
    cumulative convertible preferred stock .........        --          --        21,312        --           1,092
    Compensation expense resulting from options
      to non-employees .............................        --          --          --          --             305
    Amortization of deferred compensation ..........        --          --          --          --            --
    Net loss .......................................        --          --          --          --            --
                                                       ---------   ---------   ---------   ---------   -----------
Balance, December 31, 1999 .........................     200,000   $       2   8,622,091   $      86   $    67,206



                                                                                   Total
                                                       Deferred     Accumulated  stockholders'
                                                     compensation     deficit       equity
                                                       ---------    ---------    ---------

<S>                                                    <C>          <C>          <C>
Balance, December 31, 1996 .........................   $    (296)   $ (17,738)   $  17,592
    Exercise of common stock options ...............        --           --             53
    Issuance of common stock at $12.50 per share
      in conjunction with follow-on offering, net
      of issuance costs ............................        --           --         11,562
    Deferred compensation resulting from grant
      of options ...................................        (142)        --           --
    Amortization of deferred compensation ..........         125         --            125
    Net loss .......................................        --         (8,624)      (8,624)
                                                       ---------    ---------    ---------
Balance, December 31, 1997 .........................        (313)     (26,362)      20,708
    Exercise of common stock options ...............        --           --             20
    Amortization of deferred compensation ..........         119         --            119
    Net loss .......................................        --        (11,566)     (11,566)
                                                       ---------    ---------    ---------
Balance, December 31, 1998 .........................        (194)     (37,928)       9,281
    Exercise of common stock options ...............        --           --             44
    Issuance of Series D cumulative convertible
      preferred stock, net of issuance costs .......        --           --         18,450
    Common stock dividends on Series D
    cumulative convertible preferred stock .........        --         (1,092)        --
    Compensation expense resulting from options
      to non-employees .............................        --           --            305
    Amortization of deferred compensation ..........         118         --            118
    Net loss .......................................        --        (14,591)     (14,591)
                                                       ---------    ---------    ---------
Balance, December 31, 1999 .........................   $     (76)   $ (53,611)   $  13,607

                            See accompanying notes to consolidated financial statements.
</TABLE>


                                                        F-5

<PAGE>
<TABLE>
<CAPTION>


                              COLLAGENEX PHARMACEUTICALS, INC.
                                      AND SUBSIDIARIES

                           Consolidated Statements of Cash Flows

                    For the years ended December 31, 1997, 1998 and 1999
                                   (dollars in thousands)


                                                           1997         1998       1999
                                                         --------    --------    --------
<S>                                                      <C>         <C>         <C>
Cash flows from operating activities:
   Net loss ..........................................   $ (8,624)   $(11,566)   $(14,591)
   Adjustments  to  reconcile  net  loss  to net
   cash used in operating activities:
       Noncash compensation expense ..................        125         119         423
       Depreciation and amortization expense .........         31          66         151
       Change in assets and liabilities:
         Accounts receivable .........................       --        (3,045)        895
         Inventories .................................       --          (342)       (353)
         Prepaid expenses and other assets ...........       (125)       (545)        194
         Accounts payable ............................        505       2,363        (474)
         Accrued expenses ............................      1,107         639        (210)
                                                         --------    --------    --------
          Net cash used in operating activities ......     (6,981)    (12,311)    (13,965)
                                                         --------    --------    --------
Cash flows from investing activities:
   Capital expenditures ..............................        (78)       (230)       (593)
   Proceeds from the sale of short-term
     investments .....................................     25,402       6,880       7,464
   Purchase of short-term investments ................    (23,427)     (7,452)     (6,886)
                                                         --------    --------    --------
   Net cash provided by (used in) investing
     activities ......................................      1,897        (802)        (15)
                                                         --------    --------    --------
Cash flows from financing activities:

   Proceeds from issuance of note payable ............       --          --        10,000
   Repayment of note payable .........................       --          --       (10,000)
   Net proceeds from the issuance of preferred
     stock ...........................................       --          --        18,450
   Net proceeds from issuance of common stock ........     11,615          20          44
   Proceeds from issuance of long-term debt ..........       --          --           219
   Repayment of long-term debt .......................       --          --           (38)
                                                         --------    --------    --------
          Net cash provided by financing
            activities ...............................     11,615          20      18,675
                                                         --------    --------    --------
Net increase (decrease) in cash and cash
  equivalents ........................................      6,531     (13,093)      4,695

Cash and cash equivalents at beginning of year .......      9,848      16,379       3,286
                                                         --------    --------    --------
Cash and cash equivalents at end of year .............   $ 16,379    $  3,286    $  7,981
                                                         ========    ========    ========

Supplemental schedule of noncash financing activities:

   Deferred compensation .............................   $    142    $   --      $   --
                                                         ========    ========    ========
   Common stock dividends on preferred stock .........   $   --      $   --      $  1,092
                                                         ========    ========    ========

Supplemental disclosure of cash flow information:

   Cash paid during the year for interest ............   $   --      $   --      $    199
                                                         ========    ========    ========
</TABLE>

               See accompanying notes to consolidated financial statements.


                                            F-6

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


(1)   BUSINESS

      CollaGenex  Pharmaceuticals,  Inc.  ("CollaGenex  Pharmaceuticals"  or the
      "Company") was  incorporated  in Delaware on January 10, 1992. The Company
      is a specialty  pharmaceutical  company  focused on  providing  innovative
      medical therapies to the dental market. The Company, through its own sales
      and marketing  force,  is currently  marketing  Periostat(R)  (doxycycline
      hyclate),  the Company's lead drug for the treatment of adult  periodontal
      disease which received  approval from the U.S. Food & Drug  Administration
      (the "FDA") in  September  1998.  The Company is also  co-marketing  other
      pharmaceutical products on a contract basis with two other companies.  The
      Company has other  internally  developed  compounds  in the  research  and
      development stage.

      The accompanying  consolidated financial statements include the results of
      operations  of  the  Company  and  its  wholly-owned   subsidiaries.   All
      intercompany   accounts  and   transactions   have  been   eliminated   in
      consolidation.

(2)   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      Cash and Cash Equivalents
      -------------------------

      The  Company  considers  all highly  liquid  investments  with an original
      maturity of three months or less when  purchased  to be cash  equivalents.
      All cash and cash  equivalents  are  invested in  obligations  of the U.S.
      Government and in commercial  paper which bears minimal risk. To date, the
      Company  has  not  experienced   any   significant   losses  on  its  cash
      equivalents.

      Short-Term Investments
      ----------------------

      Short-term   investments  consist  of  U.S.  Government   obligations  and
      corporate  debt  securities  with original  maturities  greater than three
      months. In accordance with Statement of Financial Accounting Standards No.
      115,  "Accounting for Certain  Investments in Debt and Equity Securities,"
      the Company  classifies its short-term  investments as available for sale.
      Available  for sale  securities  are  recorded at their fair value,  which
      approximates  cost,  of the  investments  based on quoted market prices at
      December 31, 1998 and 1999.  The Company  considers all of its  short-term
      investments to be available for sale.

      Inventories
      -----------

      Inventories  are stated at the lower cost or  market.  Cost is  determined
      using the first-in, first-out method.


                                      F-7

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Equipment
      ---------

      Equipment,  consisting of computer and office equipment, exhibit equipment
      and  leasehold   improvements  is  recorded  at  cost.   Depreciation  and
      amortization is provided using the straight-line method over the estimated
      useful  lives of the  assets  or the  related  lease  term,  whichever  is
      shorter,  generally  three to ten  years.  Expenditures  for  repairs  and
      maintenance are expensed as incurred.

      Segment Information
      -------------------

      The Company is managed and operated as one business.  The entire  business
      is managed by a single management team that reports to the chief executive
      officer.  The  Company  does not  operate  separate  lines of  business or
      separate  business entities with respect to any of its products or product
      candidates.  Accordingly,  the Company does not prepare discrete financial
      information with respect to separate product areas or by location and does
      not have  separately  reportable  segments  as  defined  by SFAS No.  131,
      "Disclosures about Segments of an Enterprise and Related Information".

      Financial Instruments
      ---------------------

      The carrying amounts of cash and cash equivalents, short-term investments,
      accounts  receivable,  accounts payable and accrued  expenses  approximate
      fair  value  because  of the  short  maturity  of these  instruments.  The
      interest rates on the note payable  approximate rates for similar types of
      borrowing  arrangements at December 31, 1999,  therefore the fair value of
      the note payable approximates the carrying value at December 31, 1999.

      Recent Pronouncement
      --------------------

      On December 3, 1999, the Securities and Exchange Commission ("SEC") issued
      Staff  Accounting  Bulletin No. 101 ("SAB 101"),  "Revenue  Recognition in
      Financial  Statements".  SAB 101  provides  the SEC  staff's  views on the
      recognition of revenue  including  non-refundable  technology  access fees
      received by registrants in connection  with research  collaborations  with
      third parties. SAB 101 states that in certain  circumstances the SEC staff
      believes that up-front fees,  even if  non-refundable,  should be deferred
      and recognized  systematically over the term of the research  arrangement.
      SAB 101 requires  registrants to adopt the accounting  guidance  contained
      therein by no later  than the first  fiscal  quarter  of the  fiscal  year
      beginning after December 15, 1999. The Company is currently  assessing the
      requirements  of SAB 101 and has not yet determined the impact of applying
      the accounting guidance of SAB 101 on its financial position or results of
      operations or current revenue recognition policy.


                                      F-8

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Product Sales
      -------------

      In September 1998, the Company  received  clearance from the FDA to market
      Periostat.  The Company has the exclusive right to market Periostat in the
      United States.  In November 1998, the Company began shipping  Periostat to
      wholesalers  throughout the United States.  The Company  recognizes  sales
      revenue upon shipment. Sales are reported net of allowances for discounts,
      rebates, chargebacks and product returns.

      License Revenues
      ----------------

      Revenue  from  license   arrangements   is  recognized  when  the  related
      milestones  are  met  by  the  Company  and  when  all  of  the  Company's
      significant  performance  obligations  under the terms of the  arrangement
      have been satisfactorily completed.

      Contract Revenues
      -----------------

      Contract revenues are earned and recognized according to the provisions of
      each collaborative agreement.

      Research and Development
      ------------------------

      Research and product development costs are expensed as incurred.

      Accounting for Income Taxes
      ---------------------------

      Deferred tax assets and  liabilities  are determined  based on differences
      between the financial  reporting  and tax bases of assets and  liabilities
      and are  measured  using  the  enacted  tax rates and laws that will be in
      effect when such  differences are expected to reverse.  The measurement of
      deferred tax assets is reduced, if necessary, by a valuation allowance for
      any tax  benefits  which are not  expected to be  realized.  The effect on
      deferred tax assets and liabilities of a change in tax rates is recognized
      in the period that such tax rate changes are enacted.

      Management Estimates
      --------------------

      The  preparation of consolidated  financial  statements in conformity with
      generally  accepted  accounting  principles  requires  management  to make
      estimates  and  assumptions   that  affect  the  amount  reported  in  the
      consolidated  financial  statements and accompanying notes. Actual results
      could differ from those estimates.


                                      F-9

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Stock-Based Compensation
      ------------------------

      As described in note 6,  Statement of Financial  Accounting  Standards No.
      123 ("SFAS 123"),  "Accounting for Stock-Based  Compensation,"  encourages
      but does not require companies to record compensation cost for stock-based
      employee  compensation  plans at fair  value.  The  Company  has chosen to
      continue to account for stock-based compensation using the intrinsic value
      method   prescribed  in  Accounting   Principles  Board  Opinion  No.  25,
      "Accounting for Stock Issued to Employees,"  and related  interpretations.
      Accordingly,  compensation  cost for stock options  issued to employees is
      measured as the excess, if any, of the market price of the Company's stock
      at the date  both the  number  of  shares  and  price  per share are known
      (measurement  date) over the exercise  price.  Such amounts are  amortized
      over the respective  vesting  periods of the option  grants.  Transactions
      with  non-employees,  in which  goods or  services  are the  consideration
      received for the issuance of equity  instruments,  are  accounted for on a
      fair value basis in accordance with SFAS 123 and related interpretations.

      Concentration of Credit and Other Risks
      ---------------------------------------

      The Company invests its excess cash in deposits with major U.S.  financial
      institutions,   money  market  funds,  U.S.  Government   obligations  and
      corporate debt securities. The Company has established guidelines relative
      to diversification  and maturities that maintain safety and liquidity.  To
      date, the Company has not experienced any significant losses.

      The Company  currently  contracts  with a single  source for the  domestic
      manufacturing  of Periostat  which is sold  throughout  the United  States
      exclusively  to  wholesale  and  retail  distributors.  During  1999,  two
      customers  accounted for 30% and 14%, of net product sales,  respectively.
      During  1998,  two  customers  accounted  for 28% and 27%,  of net product
      sales, respectively.

      The Company's business of selling, marketing and developing pharmaceutical
      products  is subject to a number of  significant  risks,  including  risks
      relating to the implementation of the Company's sales and marketing plans,
      risks inherent in research and development  activities,  risks  associated
      with   conducting   business  in  a  highly   regulated   environment  and
      uncertainties related to clinical trials of products under development.


                                      F-10

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Net Loss Per Share
      ------------------

      Basic earnings per share ("EPS") is calculated by dividing earnings (loss)
      allocable to common  stockholders by the weighted average shares of common
      stock  outstanding.  Net loss  allocable to common  stockholders  includes
      dividends  on the  preferred  stock.  Diluted  EPS would also  include the
      effect  of  dilution  to  earnings  of  convertible  securities  and stock
      options.  As of December 31,  1999,  the effect of dilution to earnings of
      convertible  securities  and stock  options.  As of December 31, 1999, the
      Company has certain  convertible  preferred  stock and stock options which
      have  not been  used in the  calculation  of  diluted  net loss per  share
      allocable to common stockholders  because to do so would be anti-dilutive.
      As such,  the numerator and  denominator  used in computing both basic and
      diluted net loss per share allocable to common stockholders are equal.

(3)   COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

      Inventories
      -----------

      Inventories at December 31, 1998 and 1999 consists of the following:


                                        1998     1999
                                       -----    -----
                Raw materials........  $ 124    $ 254
                Finished goods.......    218      441
                                       -----    -----
                                       $ 342    $ 695
                                       =====    =====

      Equipment and Leasehold Improvements
      ------------------------------------

      Equipment  and  leasehold  improvements  at  December  31,  1998  and 1999
      consists of the following:

                                                        1998     1999
                                                       -----    -----
                Computer and office equipment........  $ 198    $ 672
                Exhibit equipment....................    185      259
                Leasehold improvements...............     --       45
                                                       -----    -----
                                                         383      976
                Less accumulated depreciation........   (116)    (267)
                                                       -----    -----
                                                       $ 267    $ 709
                                                       =====    =====


                                      F-11

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Accrued Expenses
      ----------------

      Accrued expenses at December 31, 1998 and 1999 consists of the following:

                                                        1998      1999
                                                       ------    ------
                Contracted development and
                  manufacturing costs................  $  984     $  441
                Sales and marketing costs............     637        144
                Payroll and related costs............     421      1,237
                Professional and consulting fees.....     268        221
                Royalties............................     163        215
                Miscellaneous taxes..................      29         32
                Other................................      43         45
                                                       ------     ------
                                                       $2,545     $2,335
                                                       ======     ======

(4)   NOTE PAYABLE

      In April 1999, the Company  received $219 in proceeds from the issuance of
      a note  payable.  The proceeds of such note were used to fund the purchase
      of  equipment,  fixtures  and  furniture  for the  Company's  newly leased
      corporate office in Newtown,  Pennsylvania.  The term of the note is three
      years with interest at 9.54% per annum,  with monthly minimum  payments of
      principal and interest.  The note is secured by a third party  irrevocable
      standby  letter of credit for an amount not less than 90% of the  financed
      property.

(5)   STOCKHOLDERS' EQUITY

      The  Company's  Board of  Directors  may,  without  further  action by the
      Company's  stockholders,  from time to time, direct the issuance of shares
      of preferred  stock in series and may, at the time of issuance,  determine
      the rights,  preferences  and  limitations of each series.  The holders of
      preferred stock would normally be entitled to receive a preference payment
      in the event of any liquidation,  dissolution or winding-up of the Company
      before any payment is made to the holders of the common stock.

      On April 8, 1997, the Company completed a follow-on  offering of 1,000,000
      shares  of its  common  stock  at a price of  $12.50  per  share.  The net
      proceeds for the offering after underwriting fees and all related expenses
      was $11,562.

      On May 12, 1999,  the Company  consummated a $20.0 million  financing (the
      "Financing")  through  the  issuance  of  200,000  shares of its  Series D
      Cumulative  Convertible  Preferred  Stock (the "Preferred


                                      F-12

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Stock"),  which  generated  net  proceeds to the Company of  approximately
      $18.5 million.  OCM Principal  Opportunities  Fund,  L.P.  ("OCM") led the
      investor group,  which also included  certain current  stockholders of the
      Company.

      The  issuance  of the  Preferred  Stock was  approved by a majority of the
      Company's  stockholders at the Company's Annual Meeting of Stockholders on
      May 11, 1999. A portion of the proceeds of the Financing were used for the
      repayment of a $10.0 million Senior Secured Convertible Note with interest
      at 12% per annum provided by OCM on March 19, 1999 in connection  with the
      financing.  During the first three years following issuance, the Preferred
      Stock  pays  dividends  in  common  stock  at a rate  of 8.4%  per  annum.
      Thereafter,  the Preferred  Stock pays dividends in cash at a rate of 8.0%
      per annum.  The Preferred  Stock is convertible  into common shares of the
      Company at an  initial  conversion  price of $11.00 per share,  subject to
      adjustment,  at any time by the holder and under certain conditions by the
      Company.  The  conversion  price is subject to adjustment in the event the
      Company fails to declare or pay  dividends  when due or should the Company
      issue new equity securities or convertible securities at a price per share
      or  having  a  conversion  price  per  share  lower  than  the  applicable
      conversion  price of the Preferred Stock.  Dividends  totaling $1,092 were
      paid and/or declared in 1999.

      The holders of the  Preferred  Stock are entitled to vote with the holders
      of the  Company's  common  stock  on all  matters  to be  voted  on by the
      Company's  stockholders on an as converted to common stock basis,  subject
      to  adjustment.  The  holders  of the  Preferred  Stock  are  entitled  to
      liquidation   preferences  equal  to  the  original  purchase  price  plus
      dividends   accrued   and   unpaid   plus  other   dividends   in  certain
      circumstances. In connection with the issuance of the Preferred Stock, the
      rights of the  holders  of the  Company's  common  stock may be limited in
      certain instances with respect to dividend rights,  rights on liquidation,
      winding  up and  dissolution  of the  Company,  and the  right  to vote in
      connection with certain matters submitted to the Company's stockholders.

      Without  written  approval  of a majority  of the holders of record of the
      Preferred Stock, the Company,  among other things,  shall not: (i) declare
      or pay any dividend or  distribution on any shares of capital stock of the
      Company other than dividends on the Preferred Stock;  (ii) make any loans,
      incur any  indebtedness  or guarantee any  indebtedness,  advance  capital
      contributions  to,  or  investments  in any  person,  issue  or  sell  any
      securities  or warrants or other rights to acquire debt  securities of the
      Company, except that the Company may incur such indebtedness in any amount
      not to exceed $10.0 million in the aggregate  outstanding  at any time for
      working capital requirements in the ordinary course of business;  or (iii)
      make research and  development  expenditures  in excess of $7.0 million in
      any  continuous  twelve  month  period,  unless the Company  has  reported
      positive net income for four  consecutive  quarters  immediately  prior to
      such twelve month period.

      The Company maintains a Shareholder Rights Plan (the "Rights Plan"). Under
      the Rights  Plan,  each common  stockholder  receives one "Right" for each
      share of common stock held.  Each Right,  once  exercisable,  entitles the
      holder to purchase  from the Company one  one-hundredth  of a share of the
      Company's  Series A Participating  Preferred Stock at an exercise price of
      $65. All Rights expire on September 26, 2007 unless earlier  redeemed.  At
      December  31,  1999,  the  Rights  were  neither
      a


                                      F-13

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      exercisable  nor traded  separately from the Company's  common stock,  and
      become  exercisable  only if person or a group of affiliated or associated
      persons  has  acquired,  or  obtained  the  right to  acquire,  beneficial
      ownership of 20% or more of the voting power of all outstanding  shares of
      the Company's  common stock and in certain  other  limited  circumstances.
      Upon separation from the common stock, each Right will entitle the holder,
      other than the acquiring  person that has triggered  such  separation,  to
      effectively purchase certain shares of the Company's common stock equal in
      market value to two times the then applicable exercise price of the Right.
      If the  Company  is  acquired  in a merger or other  business  combination
      transaction,  or 50% or more of the Company's  assets or earning power are
      sold in one or more related transactions, the Rights will entitle holders,
      upon  exercise of the  Rights,  to receive  shares of common  stock of the
      acquiring  or  surviving  company  with a market  value equal to twice the
      exercise price of each Right. In 1999, the Company amended its Rights Plan
      to specifically exclude an initial issuance of the Preferred Stock.

(6)   STOCK OPTION PLANS

      The Company has three stock-based compensation plans (the "Plans") and has
      adopted the disclosure-only  provisions of SFAS 123. The Company continues
      to apply APB Opinion No. 25 in accounting  for its stock option plans and,
      accordingly,   no   compensation   expense  has  been  recognized  in  the
      consolidated financial statements for stock options issued to employees at
      exercise prices equal to the market value on the measurement date.

      The 1992 Stock Option Plan, as amended, (the "1992 Plan") provided for the
      granting of incentive and nonstatutory options to directors, employees and
      consultants to purchase up to 291,000 shares of the Company's common stock
      at a price, for the incentive options, not less than the fair market value
      on the  measurement  date. Such options are exercisable for a period of 10
      years from the grant date and generally vest over a four year period.  All
      such 291,000  options  available under the 1992 Plan were granted by March
      31, 1996.

      The 1996 Stock Option Plan (the "1996 Plan")  provides for the granting of
      incentive  and  nonstatutory  options  to  employees  and  consultants  to
      purchase up to 750,000  (increased  to 1,500,000  in 1999),  shares of the
      Company's  common stock at a price,  for the incentive  options,  not less
      than  the  fair  market  value  on the  measurement  date.  Incentive  and
      nonstatutory  options  granted to individuals  owning more than 10% of the
      voting  power of all  classes  of stock at the time of grant  must have an
      exercise  price no less than 110% of the fair market  value on the date of
      grant.  Such  options  are  exercisable  for a period of 10 years from the
      grant date and generally  vest over a two to five year period,  and may be
      accelerated for certain grants in certain circumstances.

      In March 1996, the Board of Directors approved a nonqualified plan for the
      issuance of stock options to non-employee directors under the Non-Employee
      Director Stock Option Plan (the "Non-Employee  Director Plan"). Under this
      plan,  300,000  shares of common  stock are  reserved  for  issuance at an
      exercise  price equal to the fair market value on the date of grant.  Such
      options vest 20% per annum commencing one year from the grant date.


                                      F-14

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      During 1996, 11,000 options were granted to employees at an exercise price
      of $2.00 per share. During 1999, 192,500 options were granted to employees
      at fair  market  value with an exercise  price of $10.06 per share.  These
      grants were not issued under the terms of any of the above Plans.

      Deferred  compensation  of $142 was recorded in 1997 and other  amounts of
      deferred compensation had been recorded in prior years for options granted
      where the market  value of the  Company's  stock on the  measurement  date
      exceeded the exercise  price of such  options.  Deferred  compensation  is
      being amortized to compensation  expense in the accompanying  consolidated
      statement of operations over the respective vesting periods of such grants
      ($125, $119 and $118 in 1997, 1998 and 1999, respectively).

      In 1999, the Company granted options to certain  non-employees to purchase
      60,000 shares of common  stock.  Such options vest over a four year period
      based upon future  service  requirements.  In  accordance  with EITF Issue
      96-18, the amount of compensation expense to be recorded in future periods
      related to the 1999 grant is subject to change each reporting period based
      upon changes in the market value of the Company's common stock,  estimated
      volatility and risk free interest rates until the  non-employee  completes
      performance  under the option  agreement and the options vest. At December
      31, 1999,  60,000 options subject to this treatment remain  unvested.  The
      Company recorded total compensation  expense of $305 in 1999, based on the
      market  value at the grant date and at  December  31,  1999 as  determined
      using a Black-Scholes option pricing model.

      At December 31, 1999,  there were 654,100 shares available for grant under
      the 1996 Plan and 115,000 under the Non-Employee Director Plan.


                                      F-15

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      The  following  table  summarizes  stock option  activity for 1997 through
      1999:

                                                               Exercise price
                                                   Shares        per share
                                                  ----------      --------------
           Balance, December 31, 1996...........     410,250      $ 0.20 - 10.00
             Granted............................     348,750        9.00 - 13.50
             Exercised..........................     (32,046)       0.20 - 2.00
             Cancelled..........................      (1,000)      0.335 - 1.20
                                                  ----------
           Balance, December 31, 1997...........     725,954        0.20 - 13.50
             Granted............................     315,000        6.25 - 13.25
             Exercised..........................     (19,625)      0.355 - 2.00
             Cancelled..........................      (3,000)           6.75
                                                  ----------
           Balance, December 31, 1998...........   1,018,329        0.20 - 13.50
             Granted............................     475,150        8.56 - 22.88
             Exercised..........................     (13,575)       0.20 - 9.69
             Cancelled..........................     (42,000)       6.75 - 17.75
                                                  ----------
           Balance, December 31, 1999...........   1,437,904      $ 0.20 - 22.88
                                                  ==========      ==============

      As of December 31,  1999,  the  following  options  were  outstanding  and
      exercisable by price range as follows:

                           Outstanding                   Exercisable
                 ----------------------------------  ----------------------
                              Weighted    Weighted                 Weighted
                              average     average                  average
     Range of                remaining    exercise                 exercise
     exercise     Number     contractual   price      Number        price
      prices     of shares      life      per share  of shares     per share
    -----------  ----------  -----------  ---------  ----------    --------
 $   0.20- 2.00    218,704   5.7 years  $     1.02     203,954  $     0.94
     6.25-10.00    499,900   7.5 years        8.29     192,275        8.85
    10.06-12.00    464,600   8.6 years       10.31     107,975       10.61
    12.19-13.50    214,750   8.9 years       12.49      44,925       12.87
    14.06-22.88     39,950   9.5 years       17.45       6,800       17.22
                 ----------  -----------  ---------  ----------    --------
                 1,437,904      7.9 year$     8.72     555,929  $     6.72
                 ==========  ===========  =========  ==========    ========


                                      F-16

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Had the  Company  elected to  recognize  compensation  cost for options as
      prescribed  by SFAS  123,  the  Company's  net loss  allocable  to  common
      stockholders  and basic and  diluted  loss per share  allocable  to common
      stockholders would have been reflected as set forth below:

                                                1997        1998        1999
                                              --------   ---------   ---------
      Net loss allocable to
          common stockholders:
            As reported .................     $  8,624   $  11,566   $  15,683
            Pro forma ...................        9,267      12,487      17,338
      Basic and diluted net loss
          per share allocable to
          common stockholders:
            As reported .................     $   1.04   $    1.35   $    1.82
            Pro forma ...................         1.12        1.46        2.02



      Pro forma net loss allocable to common stockholders  reflects only options
      granted in 1995 through 1999. Consequently, the full impact of calculating
      compensation cost for stock options under SFAS 123 is not reflected in the
      pro forma net loss  allocable  to common  stockholders  amounts  presented
      above  because  compensation  cost is  incurred  under  SFAS  123 over the
      respective  vesting  period of such  options,  and options  granted by the
      Company  prior to January 1, 1995 are not  reflected  in the pro forma net
      loss allocable to common stockholders figures above.

      The  weighted  average fair values of stock  options  granted to employees
      during  1997,  1998 and 1999 were  $5.93,  $4.64  and  $11.24  per  share,
      respectively,  on the date of grant.  The weighted  average fair values of
      stock options granted to nonemployees during 1999 were $12.19 per share on
      the  date  of  grant.   Such  fair  values  were   determined   using  the
      Black-Scholes  option  pricing  model  and  are  based  on  the  following
      assumptions:

                                    1997    1998    1999
                                   ------  ------  ------
      Expected life in years.....     5       5       5
      Risk-free interest rate....   6.25%   6.25%   6.25%
      Volatility.................    60%     60%     80%
      Dividend yield.............     0%      0%      0%


(7)   INCOME TAXES

      The Company  utilizes the asset and  liability  method of  accounting  for
      income  taxes in  accordance  with SFAS No.  109,  "Accounting  for Income
      Taxes".  Under  the  asset  and  liability  method,   deferred  taxes


                                      F-17

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      are determined  based on the differences  between the financial  statement
      and tax bases of assets and liabilities using currently enacted tax rates.

      The tax effects of  temporary  differences  that give rise to  significant
      portions of the deferred tax assets and deferred tax liability at December
      31, 1998 and 1999 are presented below:

                                                           1998          1999
                                                         --------      --------
      Deferred tax assets:
          Capitalized start up costs ...............     $    677      $    423
          Net operating loss carryforwards .........       14,145        19,543
          Tax credit carryforward ..................          500           790
          Accrued expenses .........................          134           348
                                                         --------      --------
            Total gross deferred tax assets ........       15,456        21,104
          Less valuation allowance .................      (15,450)      (21,069)
                                                         --------      --------
            Total deferred tax assets ..............            6            35
      Deferred tax liability:
          Depreciation .............................           (6)          (35)
                                                         --------      --------
            Net deferred 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.  In
      assessing the realizability of deferred tax assets,  management  considers
      whether  it is more  likely  than  not  that  some  portion  or all of the
      deferred tax assets will not be  realized.  The  ultimate  realization  of
      deferred tax assets is dependent  upon the  generation  of future  taxable
      income during the periods in which  temporary  differences  are deductible
      and carryforwards  are available.  Due to the uncertainty of the Company's
      ability to  realize  the  benefit  of the  deferred  tax  assets,  the net
      deferred tax assets are fully offset by a valuation  allowance at December
      31, 1998 and 1999.

      The net change in the valuation allowance for the years ended December 31,
      1998  and  1999  were  increases  of  approximately   $6,067  and  $5,619,
      respectively,   related  primarily  to  additional  net  operating  losses
      incurred by the Company.

      At December 31, 1999, the Company had approximately $51,000 of Federal and
      $39,000 of state net  operating  loss  carryforwards  available  to offset
      future  taxable   income.   The  Federal  and  state  net  operating  loss
      carryforwards will begin expiring in 2007 and 2005,  respectively,  if not
      utilized.  The


                                      F-18

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


      Company also has  research and  development  tax credit  carryforwards  of
      approximately  $790  available to reduce  Federal income taxes which begin
      expiring in 2007.

     Section  382 of the  Internal  Revenue  Code of 1986  subjects  the  future
     utilization of net operating losses and certain other tax attributes,  such
     as research and development  credits,  to an annual limitation in the event
     of an ownership change, as defined.  Due to the Company's prior and current
     year equity  transactions,  a portion of the net  operating  losses and tax
     credits of the Company are subject to an annual limitation of approximately
     $3,800.  To the extent that any  single-year  limitation is not utilized to
     the full amount of the limitation,  such unused amounts are carried over to
     subsequent  years until the earlier of its utilization or the expiration of
     the relevant  carryforward period. At December 31, 1999, assuming there are
     no future  ownership  changes,  approximately  $12,000,000  is  immediately
     available to offset future taxable  income.  In addition to the Section 382
     limitation,  the state net  operating  loss  carryforward  is  subject to a
     $2,000 annual limitation.

(8)   TECHNOLOGY LICENSE

      At the  time  of its  formation  in  1992,  the  Company  entered  into an
      agreement  with SUNY  whereby the Company  received an option to acquire a
      certain  technology  license.  The Company's option to acquire the license
      was  exercised in 1995 and remains in effect for a period not to exceed 20
      years  from  the  date of the  first  sale of  product  incorporating  the
      technology  under license or the last to expire of the licensed patents in
      each country.  The Company is liable to SUNY for annual royalty fees based
      on net  sales,  if any,  as  defined in the  agreement.  A minimum  annual
      royalty is  required  for the  duration  of the  technology  license.  The
      Company  incurred  royalty expense of $50, $200 and $711 in 1997, 1998 and
      1999, respectively.

      In addition,  the Company is required to reimburse SUNY for certain patent
      related costs, as well as to support certain additional research efforts.


                                      F-19

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1997, 1998 and 1999

                  (dollars in thousands, except per share data)


(9)   COMMITMENTS

      The Company  maintains  various  operating  leases,  primarily  for office
      space.  As of December  31,  1999,  future  minimum  rent  payments  under
      noncancellable operation leases are as follows:

                                2000          $   318
                                2001              318
                                2002              318
                                2003              318
                                2004              318
                                Thereafter      1,480
                                              -------
                                    Total     $ 3,070
                                              =======


      Rent expense for the years ended December 31, 1997,  1998 and 1999 totaled
      $70, $86 and $204, respectively.

      The Company has entered into a  three-year  Co-Promotion  Agreement  under
      which the  Company is  committed  to spend up to $1 million  annually  for
      promotional  expenses,  unless the agreement is earlier terminated per the
      terms of the agreement.

(10)  401(K) SALARY REDUCTION PLAN

      In January 1995, the Company  adopted a 401(k) Salary  Reduction Plan (the
      "401(k)  Plan")  available to all employees  meeting  certain  eligibility
      requirements. The 401(k) Plan permits participants to contribute up to 15%
      of their  annual  salary  not to  exceed  the  limits  established  by the
      Internal  Revenue  Code.  All  contributions  made  by  participants  vest
      immediately  in the  participant's  account.  The Company did not make any
      "matching  contributions"  in 1997,  1998 or 1999 in  accordance  with the
      terms of the 401(k) Plan.

(11)  CONTRACT RESEARCH AGREEMENT

      In May 1998,  the Company  entered  into a three year  evaluation  testing
      agreement with SUNY pursuant to which SUNY will evaluate certain compounds
      supplied  by the  Company  under  which  the  Company  will pay SUNY up to
      $1,570.  Either  party may  terminate  the  agreement  at any time.  Costs
      incurred during 1998 and 1999 were $333 and $541, respectively.

      The Company has entered into several  contract  research  agreements  with
      another  research  company to provide certain  clinical  monitoring,  data
      management,  statistical analysis and regulatory services on behalf of the
      Company.  The Company is billed as research services are performed.  Costs
      incurred under these agreements  aggregated  approximately  $1,064, $1,837
      and $396 for 1997, 1998 and 1999, respectively.


                                      F-20

<PAGE>


                                                                     SCHEDULE II

                 CollaGenex Pharmaceuticals, Inc. and Subsidiary
                          Financial Statement Schedule
                        Valuation and Qualifying Accounts
                     Years Ended December 31, 1998 and 1999
                                 (in thousands)


     Col A         Col B            Col C           Col D         Col E
--------------   ----------  -------------------  ----------  --------------
  Description    Balance at       Additions       Deductions  Balance at the
                    the                                       End of Period
                 Beginning
                 of Period
--------------   ----------  -------------------  ----------  --------------
                             Charged      Other
                             to
                             Statement
                             of
                             Operations
--------------               ----------  -------
   Accounts
  Receivable
  Allowance:

     1998                --        $293       --          --            $293
     1999              $293        $554       --        $461            $386


                                      F-21

<PAGE>


                                  Exhibit 23.1

                               Consent of KPMG LLP



<PAGE>


                              ACCOUNTANTS' CONSENT

The Board of Directors
CollaGenex Pharmaceuticals, Inc.:

We consent to  incorporation  by reference  in the  registration  statement  No.
333-31229  on Form S-8 of  CollaGenex  Pharmaceuticals,  Inc.  and  registration
statement No. 333-88697 on Form S-3 of CollaGenex  Pharmaceuticals,  Inc. of our
report dated February 7, 2000,  relating to the  consolidated  balance sheets of
CollaGenex  Pharmaceuticals,  Inc. and  subsidiaries as of December 31, 1998 and
1999,  and the related  consolidated  statements  of  operations,  stockholders'
equity  and cash  flows for each of the  years in the  three-year  period  ended
December 31, 1999 and the related schedule, which report appears in the December
31, 1999, Annual Report on Form 10-K of CollaGenex Pharmaceuticals, Inc.




                                  /s/ KPMG LLP



Princeton, New Jersey
March 24, 2000