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, 2000
                          -----------------

                                       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
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(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:  $40,406,361  at March 15, 2001 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 March 15, 2001:

Class                                    Number of Shares
-----                                    ----------------
Common Stock, $0.01 par value             10,550,638

      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 2001 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..............................................   24
           3.    Legal Proceedings.......................................   24
           4.    Submission of Matters to a Vote of Security Holders.....   24

PART II    5.    Market for the Company's Common Equity and Related
                    Stockholder Matters..................................   25
           6.    Selected Consolidated Financial Data....................   25
           7.    Management's Discussion and Analysis of Financial
                    Condition and Results of Operations..................   28
           7A.   Quantitative and Qualitative Disclosures about
                    Market Risk..........................................   35
           8.    Financial Statements and Supplementary Data.............   35
           9.    Changes in and Disagreements with Accountants on
                    Accounting and Financial Disclosure..................   35

PART III   10.   Directors and Executive Officers of the Company.........   36
           11.   Executive Compensation..................................   36
           12.   Security Ownership of Certain Beneficial Owners and
                    Management...........................................   36
           13.   Certain Relationships and Related Transactions..........   36

PART IV    14.   Exhibits, Financial Statement Schedules, and
                      Reports on Form 8-K................................   37

SIGNATURES...............................................................   38

EXHIBIT INDEX............................................................   40

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
  SCHEDULE..............................................................    F-1


                                       i


<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 an orally administered,  prescription  pharmaceutical  product
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.  In December  2000 and  February  2001,  the United  Kingdom  Medicines
Control  Agency  (the "UK MCA")  and the FDA,  respectively,  granted  marketing
approval for a new tablet  formulation of Periostat which is smaller,  easier to
swallow and offers manufacturing cost advantages.  This formulation will replace
the currently marketed capsule  formulation during 2001.  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 specialty  pharmaceutical company
specifically  focused  on the dental  market.  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.  The
Company is also  developing a series of novel,  proprietary  compounds  known as
IMPACS(R)  (Inhibitors  of Multiple  Proteases  and  Cytokines) to address other
applications.  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").  In Phase I
clinical trials,  Metastat demonstrated an overall tumor response rate of 44% in
patients  with  Kaposi's  sarcoma,  and the NCI has elected to continue  testing
Metastat in Phase II clinical trials.

      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 120 sales representatives


                                       1


<PAGE>


and managers. Currently, the Company's sales force is also marketing Vioxx(R), a
prescription  non-steroidal  anti-inflammatory drug (NSAID) developed by Merck &
Co., Inc.  ("Merck") that the Company promotes for the treatment of acute dental
pain,  and  Denavir(R),  a prescription  drug owned by Novartis  Pharmaceuticals
Corporation  ("Novartis") for the treatment of cold sores. Novartis notified the
Company  by letter  dated  March 14,  2001 of its  intention  to  terminate  its
co-promotion  agreement with the Company with respect to Denavir and the Company
and Novartis are discussing potential alternate partnering arrangements, if any.
The Company recently initiated a direct-to-consumer ("DTC") advertising campaign
to build patient  awareness of Periostat and to drive  prescription  and revenue
growth. The Company is actively pursuing other prescription and non-prescription
products to market to the  professional  dental  community  and  directly to the
consumer, and may enter directly into manufacturing  arrangements for additional
complementary products, such as dental neutraceuticals.

      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)", "Metastat(R)" and "IMPACS(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  bacteria and bacteria  deposits 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 35 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  in  part  to  be  through  the
down-regulation of the activity of collagenases,  enzymes which are members of a
broad  class of enzymes  known as matrix  metalloproteinases  ("MMPs")  that are
excessively  produced  as a result  of  inflammation  resulting


                                       2


<PAGE>

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.  Since January 1999, more
than 975,000 Periostat  prescriptions  have been filled and over 34,000 dentists
have written a Periostat prescription.

      In December 2000 and February 2001, the UK MCA and the FDA,  respectively,
granted  marketing   approval  for  the  Company's  new  tablet  formulation  of
Periostat.  Such tablets will be  manufactured by  Pharmaceutical  Manufacturing
Research Services, Inc. ("PMRS") a contract manufacturing company.  Tablets will
also be supplied to the  Company's  foreign  marketing  partners upon receipt of
requisite regulatory approvals, if at all, which will be applied for in 2001.

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 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
recent clinical trials,  Vioxx was shown to be more effective than acetominophen
plus  codeine,  a narcotic,  in  relieving  pain,  with a much lower risk of the
gastrointestinal  side effects and prolonged  bleeding commonly  associated with
NSAID pain relievers.  Vioxx may also now be promoted for  osteoarthritis of the
temporomandibular  joint  ("TMJ"),  a  painful  chronic  disorder  of  the  jaw.
Prescribed as a once-a-day dose, Vioxx offers patients a convenient  alternative
to the multiple daily doses required for many other NSAIDs.

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  has  marketed
Denavir to the dental  community  under a Co-Promotion  Agreement with Novartis,
since  October 13,  1998,  which  agreement  provided  for  certain  payments by
Novartis to the Company. Novartis notified the Company by letter dated March 14,
2001 of its intention to terminate its  co-promotion  agreement with the Company
with respect to Denavir,  and the Company and Novartis are discussing  potential
alternative partnering arrangements, if any.


                                       3


<PAGE>


SALES AND MARKETING
-------------------

      The Company  markets and sells its products in the United States through a
dedicated sales force comprised of approximately 120 sales  representatives  and
managers.  The Company  intends to market  Periostat  in foreign  markets,  upon
receipt of all requisite regulatory  approvals,  primarily through marketing and
distribution partnerships with companies in these markets. The Company currently
has such  agreements  with foreign  companies,  subject to requisite  regulatory
approvals,  covering Japan,  Germany,  Italy, Canada, Spain,  Portugal,  Greece,
Israel,  Austria and  Switzerland,  and has an export  marketing  agreement  for
countries in the Middle East. A capsule formulation of Periostat was approved by
the UK MCA in February 2000, and the Company  launched a modest direct marketing
effort in the United  Kingdom to dentists  through the Company's  United Kingdom
subsidiary  in  September  2000.  In December  2000 the UK MCA approved a tablet
formulation  of  Periostat  and  during  2001 the  Company  intends  to file for
regulatory  approvals  in  European  countries  through  the Mutual  Recognition
Procedure.  The Company's foreign marketing and distribution  agreements provide
for milestone payments upon the achievement of various regulatory and commercial
events as well as supply  agreements  for  manufactured  product.  The Company's
Swiss and Israeli  distributors  will also file for regulatory  approval  during
2001.

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

      The field  sales  organization  is  currently  comprised  of two  regional
managers,  eleven district managers and  approximately 105 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.


                                       4


<PAGE>


      United States Direct-to-Consumer Advertising Campaign
      -----------------------------------------------------

      DTC is a  relatively  new but  highly  effective  marketing  tool  used by
pharmaceutical companies to build patient awareness of prescription drugs and to
drive  prescription  and revenue  growth.  In conducting  market  research,  the
Company  learned that there was a greater than 90% awareness of Periostat  among
dentists but less than a 10%  awareness of Periostat  among  patients with adult
periodontitis.

      In October  2000,  the Company  initiated a test DTC campaign in Tampa and
St. Louis to evaluate the potential  effectiveness  of this tool for  increasing
Periostat  prescription  growth. The Company's  advertisements were developed by
Bozell Healthcare,  the fourth largest healthcare advertising firm in the world,
and were placed in both print and television  media in Tampa and St. Louis.  The
test campaign was conducted from October 8 through December 11, 2000 and resumed
again in January 2001 for one month.

      During the fourth quarter of 2000, new Periostat prescriptions in the test
cities  were 48%  higher  than the  third  quarter  of 2000  compared  to a 1.4%
increase  in new  Periostat  prescriptions  in the  rest of the  United  States.
Periostat is typically  prescribed  for 30 days with two or more refills.  Total
Periostat  prescriptions,  which  include  refills,  in the test  markets in the
fourth  quarter  of 2000  increased  32.4% over new  prescriptions  in the third
quarter compared to a 3.3% increase in the rest of the United States.

      Based on these  results,  in January  2001 the  Company  expanded  its DTC
campaign to include Philadelphia,  Washington,  Houston and Chicago. The Company
plans a further expansion of the campaign in up to eight additional  advertising
markets over the course of 2001.

      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.  Due to delays
incurred in the review of national filings,  Roche S.P.A. has agreed to withdraw
the Marketing  Authorization for Approval in Italy, and this country will now be
included under the pan-European Mutual Recognition  Procedure.  Such filing will
take place during 2001.

      In July 1998, the Company executed a licensing agreement with Laboratoires
Pharmascience S.A. ("Laboratories Pharmascience") pursuant to which Laboratoires
Pharmascience  was to 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.  On March 31, 2000 the Company
received  notice from  Laboratories  Pharmascience  terminating the 1998 license
agreement.  After negotiation,  the parties mutually agreed to discontinue their
relationship. The Company is actively seeking a partner to market and distribute
Periostat  in France,  upon receipt of  requisite  regulatory  approvals in such
region.


                                       5


<PAGE>


      In October  1998,  the Company  announced  that a Marketing  Authorization
Application ("MAA") had been filed with the UK MCA with respect to Periostat. In
February  2000,  the UK MCA granted  marketing  approval for  Periostat  for the
adjunctive treatment of chronic adult periodontitis. On May 2, 2000, the Company
announced  that it had  filed  another  MAA  with the UK MCA  seeking  marketing
approval  of  a   tablet-formulation   of  Periostat,   which   application  was
subsequently  granted in December 2000. Sales of Periostat capsules commenced in
the United Kingdom in September 2000. A new filing  incorporating data from both
the capsule and tablet MAAs was filed with the UK MCA in February 2001 and, when
approved, will form the basis for an application for approval of Periostat under
the European Mutual Recognition Procedure.  Such a filing will take place during
2001.  There can be no assurance  that the Company will  achieve  other  foreign
regulatory  approvals or will be successful in marketing 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. This application remains under review by the Canadian authorities.

      On May 2, 2000,  the Company  announced  that it had executed an exclusive
marketing and  distribution  agreement with ISDIN S.A., a joint venture  between
the Spanish companies Laboratorios del Dr. Esteve S.A. and Antonio Puig S.A, for
the  marketing  and  distribution  of Periostat  tablets in Spain and  Portugal,
pending requisite regulatory approval. Such agreement was subsequently extended,
granting  ISDIN S.A.  the right to market and  distribute  Periostat  in Greece,
pending requisite regulatory approval.

      On June 9, 2000, the Company announced that it had executed  marketing and
distribution  agreements  with  Willvonseder & Marchesani  Ges.m.b.H & Co. KG, a
Vienna based company and Karr Dental Ltd., a Zurich based company,  with respect
to  the  marketing  and  distribution  of  Periostat   tablets  in  Austria  and
Switzerland, respectively, pending requisite regulatory approval.

      On August 9, 2000, the Company announced that it had executed an exclusive
marketing  and supply  agreement  with Showa  Yakuhin  Kako Co. Ltd., a Japanese
company, with respect to the marketing and supply of Periostat tablets in Japan,
pending requisite regulatory approval.

      On  August  24,  2000,  the  Company  announced  that it had  executed  an
agreement for the marketing  and  distribution  of Periostat in Israel with Taro
International Ltd. ("Taro"),  a wholly-owned  subsidiary of Taro  Pharmaceutical
Industries Limited, an Israeli company,  pending requisite  regulatory approval.
Such  agreement  between  the  Company  and Taro  provides  for the  payment  of
milestone  fees to the  Company  associated  with the  regulatory  approvals  of
Periostat, if any.

      On  December  5,  2000,  the  Company  announced  that  it  had  signed  a
Distribution and Marketing Agreement with Hain Diagnostika GmbH ("Hain") for the
distribution and marketing of Periostat in Germany, pending requisite regulatory
approval  of  Periostat.  Hain  will pay  milestone  fees  associated  with such
regulatory approvals, if any.


                                       6


<PAGE>


      On January 30, 2001, the Company announced that it had signed an exclusive
Middle East Export  Marketing  Agreement with Pharma Med Inc.  ("Pharma Med") to
distribute  and manage the  introduction  of Periostat in certain Middle Eastern
countries,  pending requisite regulatory approval.  In return for such services,
Pharma Med will be paid a fee contingent on Periostat sales to the distributors.

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   currently   relies  on  a  single   third-party   contract
manufacturer,  Applied Analytical Industries, Inc. ("AAI"), of Wilmington, North
Carolina,   for  the  commercial   manufacturing   of  Periostat  in  a  capsule
formulation.  This agreement with AAI,  which  initially had a three-year  term,
will terminate in November 2001 subject to AAI's limited  ongoing  commitment to
provide  product to the Company as  discussed  below.  AAI is required to comply
with Good Manufacturing Practices ("GMP") requirements.

      In October  2000,  AAI  notified  the Company of AAI's  belief that it was
commercially  impracticable  for AAI to continue  to  manufacture  Periostat  at
current pricing levels as a result of certain  manufacturing  specifications for
Periostat  that were  mandated by the FDA. AAI sought to recover  certain  costs
that  AAI  claims  it  incurred  since  beginning  commercial  manufacturing  of
Periostat in late 1998. The Company resolved this dispute with AAI and agreed to
pay a de minimus  amount to AAI and to incur certain  price  increases on future
quantities  of  Periostat  manufactured  for the  Company.  Concurrent  with the
resolution  of their  dispute,  AAI served notice of its intent to terminate the
agreement to supply as of November 2001. The agreement with AAI provides for AAI
to commit to an  additional  12 months  supply of  product  at a price  premium,
should  CollaGenex  be unable to qualify  an  alternative  manufacturing  source
subsequent to the termination of the AAI Agreement. The Company plans to convert
manufacturing  to the tablet  formulation  prior to the  termination  of the AAI
Agreement.

      The  Company  also  intends  to rely on PMRS as its sole  manufacturer  of
Periostat in a tablet  formulation.  CollaGenex  and PMRS entered into a Service
and Supply  Agreement on September 26, 2000 for Periostat  with an initial three
year term,  during which time CollaGenex has committed to certain minimum needs,
and PMRS has committed to certain  guaranteed supply terms. This agreement shall
be  automatically  extended for consecutive  one-year periods unless twelve (12)
months prior to the expiration of any such period,  either party gives the other
party written notice of termination.  The Company has placed an initial purchase
order with


                                       7


<PAGE>


PMRS and committed to certain minimum  purchases  through 2002 to take advantage
of volume price discounts. PMRS is required to comply with 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 logistics provider 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 sample fulfillment services for the Company's sales force and
various  customer  and  financial  support  services to the  Company,  including
billing  and  collections,   contract  pricing  maintenance,  cash  application,
chargeback processing and related reporting services.  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.

      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 may be materially  adversely  affected.  See
"--Government Regulation."

CUSTOMERS
---------

      During 2000, net product sales to each of McKesson Drug Company,  Cardinal
Health,  Inc., Bergen Brunswig and Walgreens,  Inc.  accounted for 31%, 17%, 14%
and 10%, respectively, of the Company's aggregate net product sales.

RESEARCH AND DEVELOPMENT
------------------------

      The Company's research and development  activities are conducted primarily
by  third  parties,  such  as  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.

      On October 18, 2000, the Company  announced that it had received a Phase I
STTR grant from the National Heart, Lung and Blood Institute,  a division of the
National Institute of Health.  The grant will support the potential  development
of one of the  Company's  compounds  known  as  IMPACS  for the  prevention  and
treatment of acute lung injury.


                                       8


<PAGE>


      Technology
      ----------

      The Company's core  technology  involves the prevention of the destruction
of the connective tissues of the body and the  down-regulation of a pathological
host  response to a variety of external and internal  mediators of  inflammation
and tissue destruction.

      One manifestation of this technology is the ability of the compounds under
development  by  CollaGenex to  pharmaceutically  modulate 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.

      Under normal physiological  conditions,  the natural breakdown of collagen
is in part 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  has  conducted  and 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 (IMPACS) 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


                                       9


<PAGE>


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 IMPACS 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  Boston  University,  SUNY at Stony  Brook and the
University of Michigan are evaluating  Periostat's ability to promote attachment
level,  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  conducted  or are 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 or  conducting  clinical  trials to
evaluate  whether  Periostat can manage  posterior  blepharitis,  prevent repeat
heart attack, decrease bone loss in postmenopausal women, prevent the growth and
rupture of aortic  aneurysms and prevent or reverse the clinical  manifestations
of disease secondary to diabetes.

      A Phase IV clinical trial conducted at the University of Pittsburgh Dental
School,  the results of which were  announced  by the  Company in October  2000,
demonstrated  significant  clinical  benefit in patients  who were  administered
Periostat in conjunction  with  traditional  mechanical  therapy compared to the
same therapy plus a placebo.

      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  IMPACS drug candidates have
potent activity in models of cancer invasion,  including prostate, breast, lung,
colon and melanoma.

      These studies also demonstrated that the  down-regulation  of the invasive
phenotype  by  conventional  tetracyclines  and IMPACS  results  in a  decreased
ability of tumor cells to invade the lung in models of metastasis.  For example,
IMPACS 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, IMPACS developed by
the Company exhibited an ability to inhibit metastasis.


                                       10


<PAGE>


      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  United  States  patent  which  provides  intellectual  property
protection  for the use of Metastat  for the  inhibition  of cancer  metastasis.
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,  one  Phase I  clinical  trial is  ongoing  and a fourth  is
currently planned to initiate in the first half of 2001.

      On  May  18,  2000,  the  Company  announced  positive  findings  from  an
18-patient,   NCI  sponsored   Phase  I   dose-escalating   study  of  Metastat,
administered  once daily to patients with Kaposi's  sarcoma,  a disfiguring  and
potentially deadly malignancy frequently associated with human  immunodeficiency
virus (HIV). In such Phase I clinical trials,  Metastat  demonstrated an overall
tumor  response rate of 44% in patients  with  Kaposi's  sarcoma and the NCI has
elected to continue testing Metastat in Phase II clinical trials.

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

      The Company  has an active  preclinical  program in place to identify  and
characterize  IMPACS that exhibit  enhanced  biological  activities  compared to
Periostat and Metastat.  In collaboration with the University of Rochester,  the
Company has synthesized  over thirty new IMPACS.  These are being evaluated in a
variety  of in vitro  and in vivo  assay  systems  under a  three-year  research
agreement with SUNY, which will conclude in May 2001.

      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 IMPACS technology, preferably in conjunction with development partners.

      The Company's  research and development  expenditures  were  approximately
$4.7  million,   $5.0  million  and  $3.1  million  in  1998,   1999  and  2000,
respectively.


                                       11


<PAGE>


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-eight (28) United States patents and four (4)
United States patent applications held by SUNY are licensed to the Company under
the SUNY License. Two (2) of the twenty-eight (28) patents have been co-assigned
to the University of Miami,  Florida, and another patent has been co-assigned to
Washington  University.  Other  institutions are co-owners with SUNY as follows:
one (1) patent is  co-owned  with the  Hospital  for Joint  Diseases in New York
City;  three (3) patents are co-owned with the  University of Helsinki;  and one
(1) patent is co-owned  with the  University of  Rochester.  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-six  (26) other
United  States  patents  relate  to  the   compositions  of  certain  CMTs  with
anti-collagenolytic  properties,  methods 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 been 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-nine  (69)  patents have been 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


                                       12


<PAGE>


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  November  18,  2018,  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.

      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


                                       13


<PAGE>


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,  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.  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 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
---------------------

      Government   authorities   in  the  United  States  and  other   countries
extensively regulate,  among other things, the research,  development,  testing,
manufacture,  labeling, promotion,  advertising,  distribution, and marketing of
the Company's  products.  In the United  States,  the FDA regulates our approved
product,  Periostat, and our products in development, as drugs under the Federal
Food,  Drug, and Cosmetic Act and  implementing  regulations.  Failure to comply
with FDA  requirements  may subject the  Company to  administrative  or judicial
sanctions,  such as the FDA's refusal to approve pending applications or warning
letters,  product  recalls,  product  seizures,  total or partial  suspension of
production  or  distribution,   withdrawal  of  approvals,   import  detentions,
injunctions, and/or criminal prosecution.

      The steps  required  before a drug may be  marketed  in the United  States
include:

      o     pre-clinical  laboratory  tests,  animal  studies,  and  formulation
            studies;

      o     submission to the FDA of an investigational  new drug exemption,  or
            IND, for human clinical testing,  which must become effective before
            human clinical trials may begin;


                                       14


<PAGE>


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

      o     submission  to the  FDA  of a new  drug  application,  or  NDA,  for
            approval;

      o     satisfactory  completion of an FDA  inspection of the  manufacturing
            facility  or  facilities  at which  the drug is  produced  to assess
            compliance with Good Manufacturing Practice, or GMP; and

      o     FDA review and approval of the NDA.

      Pre-clinical  tests include  laboratory  evaluations of product chemistry,
toxicity,  and  formulation,  as well as  animal  studies.  The  results  of the
pre-clinical tests,  together with manufacturing  information,  analytical data,
and a plan for studying the product in humans,  are submitted to the FDA as part
of an IND, which must become  effective  before human clinical trials may begin.
An IND automatically  becomes effective 30 days after receipt by the FDA, unless
before that time the FDA raises  concerns or questions  about issues such as the
conduct of the trials outlined in the IND. In that case, the IND sponsor and the
FDA must  resolve any  outstanding  FDA concerns or  questions  before  clinical
trials  can  proceed.  Submission  of an IND does not  always  result in the FDA
allowing clinical trials to commence.

      Clinical  trials involve  administration  of the  investigational  drug to
human  subjects  under  the  supervision  of  qualified  investigators  and  are
conducted under protocols  detailing the objectives of the study, the parameters
to be used in monitoring safety, and the effectiveness criteria to be evaluated.
Each protocol must be submitted to the FDA as part of the IND process,  and must
be reviewed and approved by an independent  Institutional Review Board before it
can begin.  Clinical trials typically are conducted in three sequential  phases,
but the phases may overlap or be combined.  Phase 1 usually involves the initial
introduction  of the  investigational  drug into people to evaluate  its safety,
dosage tolerance, phamacodynamics, and, if possible, to gain an early indication
of its  effectiveness.  Phase 2 usually  involves  trials  in a limited  patient
population  to  evaluate  dosage  tolerance  and  appropriate  dosage,  identify
possible  adverse  effects  and  safety  risks and  evaluate  preliminarily  the
efficacy of the drug for specific  indications.  Phase 3 trials usually  further
evaluate  clinical efficacy and test further for safety by using the drug in its
final form in an expanded patient population.  The Company cannot guarantee that
Phase 1, Phase 2, or Phase 3 testing  for its  products in  development  will be
completed  successfully  within any  specified  period of time,  if at all. Many
products that initially appear promising are found,  after clinical  evaluation,
not to be safe and effective.  Also, the Company or the FDA may suspend clinical
trials at any time on various grounds,  including a finding that the subjects or
patients are being exposed to an unacceptable health risk.

      Assuming  successful  completion  of the required  clinical  testing,  the
results of the preclinical  studies and of the clinical  studies,  together with
other  detailed  information,  including  information  on  the  manufacture  and
composition  of the  drug,  are  submitted  to the  FDA  in the  form  of an NDA
requesting  approval to market the product for one or more  indications.  Before
approving  an  application,  the FDA usually  will  inspect the  facility or the
facilities at which the drug is  manufactured,  and will not approve the product
unless  compliance  with  GMP  is  satisfactory.   If  the  FDA  determines  the
application and the manufacturing facilities are


                                       15


<PAGE>


acceptable,  the FDA will issue an approval  letter.  If the FDA  determines the
application or manufacturing facilities are not acceptable, the FDA will outline
the deficiencies in the submission and often will request  additional testing or
information.   Notwithstanding  the  submission  of  any  requested   additional
information, the FDA ultimately may decide that the application does not satisfy
the regulatory criteria for approval.  The Company received an NDA for Periostat
in 1998; it cannot be sure that any  additional  approvals  will be granted on a
timely  basis,  if at all.  After  approval,  certain  changes  to the  approved
product,  such as adding new indications,  manufacturing  changes, or additional
labeling  claims are subject to further FDA review and  approval.  For  example,
before the Company can market  Periostat for  additional  indications  now being
evaluated, it will be required to obtain an additional FDA approval.

      In  some  circumstances,  approved  drugs  are  provided  protection  from
competitive  versions of the  approved  drug for  specified  time  periods.  For
example,  the law provides for patent extension or market exclusivity in certain
circumstances. Periostat, however, is not eligible for such protection.

      After NDA approval is  obtained,  the Company is required to comply with a
number of post-approval requirements. For example, as a condition of approval of
an application,  the FDA may require  postmarketing  testing and surveillance to
monitor the drug's safety or efficacy. As part of the NDA for Periostat, the FDA
has  requested  a  postmarket  animal  study  related  to  long-term  dosing and
carcogenicity,  which was  completed in 2000.  It was found that up to 200 mg/kg
per day of doxycycline, the active ingredient in Periostat, produced no evidence
of carcinogenic activity in laboratory rats. In addition, holders of an approved
NDA are required to report certain adverse reactions and production problems, if
any, to the FDA,  and to comply with  requirements  concerning  advertising  and
promotional labeling for their products.  For example, the FDA does not permit a
manufacturer  to market or promote an approved  drug  product for an  unapproved
use. Also, quality control and manufacturing procedures must continue to conform
to GMP after approval. Accordingly,  manufacturers must continue to expend time,
money,  and effort in the area of  production  and  quality  control to maintain
compliance  with  GMP  and  other  aspects  of  regulatory  compliance.  The FDA
periodically  inspects  manufacturers  to assess  compliance  with GMP and other
requirements.  The Company buys bulk active  ingredient  for  Periostat  and the
Company's  products in development  from third party  suppliers and finishes the
products in third party manufacturing facilities.  Failure of either the Company
or its suppliers to comply with FDA  requirements  could disrupt  production and
subject the Company to enforcement sanctions.

      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. The Company has filed for
and  subsequently  received  approval  from  the UK MCA  for  the  marketing  of
Periostat  tablets in the United  Kingdom.  Such  application was filed with the
United Kingdom acting as a Reference  Member State,  thus providing a foundation
for the possible  submission of  applications,  later in 2001, to other European
Union countries through the Mutual Recognition Procedure.


                                       16


<PAGE>


COMPETITION
-----------

      The pharmaceutical  industry is subject to intense  competition as well as
rapid and significant technological change. 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, patent position and effective product promotion.

      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:


<TABLE>
<CAPTION>
Product          Product                   Dental     Delivery     Patient      Treatment
Name             Manufacturer/Marketer    Procedure    Route     Administered     Focus
------------     ---------------------    ---------   --------   ------------   ----------

<S>              <C>                        <C>       <C>            <C>        <C>
Periostat(R)     CollaGenex                  No       Systemic       Yes        Tissue
                 Pharmaceuticals,                                               degradation
                 Inc.

Atridox(TM)      Atrix Laboratories/        Yes       Local          No         Bacteria
                 Glaxo Smith Kline
                 Beecham

Periochip(TM)    Dexxon Ltd.                Yes       Local          No         Bacteria

Arestin(TM)      Orapharma, Inc.            Yes       Local          No         Bacteria

</TABLE>

      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, 2000,  the Company  employed  146 persons.  Each of its  management
personnel has had extensive prior experience with pharmaceutical,  biotechnology
or medical products  companies.  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.


                                       17


<PAGE>


ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
-------------------------------------------------

      IF  PERIOSTAT  IS NOT  ADOPTED  ROUTINELY  BY DENTAL  PROFESSIONALS  OR IF
MANAGED CARE  PROVIDERS DO NOT CONTINUE TO  REIMBURSE  PATIENTS,  THE  COMPANY'S
SALES GROWTH WILL SUFFER.

      The Company's  growth and success  depends in large part on its ability to
continue  to  demonstrate  the safety and  effectiveness  of  Periostat  for the
treatment  of gum  disease  to  dental  practitioners.  Periostat  is the  first
long-term  medical  therapy  for  any  dental  disease,  and  dentists  are  not
accustomed to prescribing  drugs for a minimum 90-day duration.  Periostat works
by suppressing  certain  enzymes  involved in the periodontal  disease  process,
which is a new concept for many  dentists  who believe that  removing  bacterial
plaque is the only way to treat this disease.  Accordingly,  the Company's sales
efforts are largely focused on educating dental  professionals about an entirely
new approach to treating  periodontitis.  Although  over 32,000  dentists in the
United States have written at least one prescription for Periostat,  a number of
dentists  have not adopted  Periostat  routinely  into their  treatment of adult
periodontitis.  Other  dentists have  prescribed  Periostat for only a subset of
their eligible  patients,  typically their most advanced or refractory cases. If
the Company is unable to initiate  and/or expand usage of Periostat by dentists,
its sales growth will suffer.

      Approximately 65% of the large managed care providers in the United States
(defined as those that cover 100,000 or more lives) reimburse their patients for
Periostat,  typically  requiring a modest  co-payment.  The Company's goal is to
achieve   reimbursement  from  approximately  75%  of  the  large  managed  care
providers,  since the remainder have policies that do not reimburse for drugs to
treat  dental  conditions.  Patients  who are not  reimbursed  by  managed  care
providers may choose not to accept  Periostat as a treatment.  In addition,  the
Company  has not yet  achieved  reimbursement  from  the  largest  managed  care
provider in  California,  thus  limiting  prescription  and sales growth in that
state.

      THE COMPANY RELIES ON PERIOSTAT FOR MOST OF ITS REVENUE.

      During 1999 and 2000,  Periostat accounted for 95% and 84%,  respectively,
of the Company's  total net  revenues.  Although the Company  currently  derives
revenues from  co-promoting two (2) other products (for one of which the Company
has received a notice of termination effective in April 2001) and from licensing
fees from foreign marketing partners, the Company's revenue and profitability in
the near future will depend on the Company's ability to successfully  market and
sell Periostat.

      THE COMPANY ANTICIPATES FUTURE LOSSES.

      From the  Company's  founding  in 1992  through the  commercial  launch of
Periostat  in November,  1998,  the Company had no revenue from sales of its own
products.  During  the years  ended  December  31,  1999 and 2000,  the  Company
incurred  net  losses  of   approximately   $14.6   million  and  $8.8  million,
respectively. From inception through December 31, 2000, the Company has incurred
an aggregate net loss of $61.3  million.  The Company's  historical  losses have
resulted  primarily  from  the  expenses   associated  with  its  pharmaceutical
development program, clinical trials, the regulatory approval process associated
with  Periostat and sales and marketing  activities  relating to Periostat.  The
Company expects to incur significant future


                                       18


<PAGE>


expenses,  particularly with respect to the sales and marketing of Periostat. As
a result, the Company  anticipates losses through at least the first nine months
of 2001.

      THE COMPANY HAS A LIMITED  MARKETING AND SALES HISTORY AND MAY NOT BE ABLE
TO SUCCESSFULLY MARKET ITS PRODUCT CANDIDATES.

      The Company has a limited history of marketing,  distributing  and selling
pharmaceutical products in the dental market. In January 1999, the Company first
trained a sales force of sales representatives and managers and began to promote
Periostat to the dental community. The Company markets and sells its products in
the United  States  through this direct sales  force.  Further,  the Company has
entered into  agreements  to market  Periostat,  upon  receipt of the  necessary
foreign regulatory approvals,  in certain countries in Europe, Israel, Japan and
Canada, and the Company continues to evaluate  partnering  arrangements in other
countries  outside  the United  States.  If the Company is unable to continue to
recruit,  train and retain sales and  marketing  personnel,  the Company will be
unable to successfully expand its sales and marketing efforts.  Furthermore,  if
the Company's  foreign  partners do not devote  sufficient  resources to perform
their  contractual  obligations,  the Company may not achieve its foreign  sales
goals.

      THE COMPANY'S COMPETITIVE POSITION IN THE MARKETPLACE DEPENDS ON ENFORCING
AND SUCCESSFULLY DEFENDING ITS INTELLECTUAL PROPERTY RIGHTS.

      In order to be competitive in the pharmaceutical industry, it is important
to  establish,   enforce,  and  successfully  defend  patent  and  trade  secret
protection for the Company's established and new technologies.  The Company must
also avoid liability from infringing the proprietary rights of others.

      The Company's core technology is licensed from SUNY and other academic and
research  institutions  collaborating  with  SUNY.  Under the SUNY  License  the
Company has an exclusive  worldwide  license to SUNY's rights in certain patents
and patent  applications to make and sell products  employing  tetracyclines  to
treat certain disease  conditions.  The SUNY License imposes various payment and
reporting  obligations  on the Company and the Company's  failure to comply with
these  requirements  permits SUNY to  terminate  the SUNY  License.  If the SUNY
License is terminated,  the Company would lose its right to exclude  competitors
from  commercializing  similar products,  and the Company could be excluded from
marketing  the same  products if SUNY  licensed the  underlying  technology to a
competitor after terminating the SUNY License.

      SUNY owns  twenty-eight  (28)  United  States  patents and four (4) United
States  patent  applications  that are  licensed  to the  Company.  The  patents
licensed  from SUNY  expire  between  2004 and 2018.  Two (2) of the patents are
related to Periostat  and expire in 2004 and 2007.  Technology  covered by these
patents becomes available to competitors as the patents expire.

      Since many of the  Company's  patent  rights  cover new  treatments  using
tetracyclines, which are generally available for their known use as antibiotics,
the Company may be required to bring expensive  infringement  actions to enforce
the Company's patents and protect its technology. Although federal law prohibits
making and  selling  pharmaceuticals  for  infringing  use,  competitors  and/or
practitioners  may provide generic forms of tetracycline for treatment(s)


                                       19


<PAGE>


which  infringe the  Company's  patents,  rather than  prescribe  the  Company's
Periostat product. Enforcement of patents can be expensive and time consuming.

      The Company's success also depends upon know-how,  trade secrets,  and the
skills,  knowledge and experience of its scientific and technical personnel.  To
that end, the Company requires all of its employees and, to the extent possible,
all   consultants,   advisors   and  research   collaborators,   to  enter  into
confidentiality agreements prohibiting unauthorized disclosure.  With respect to
information  and  chemical   compounds  the  Company  provides  for  testing  to
collaborators  in academic  institutions,  the Company cannot guarantee that the
institutions  will not assert  property  rights in the results of such tests nor
that a license can be reasonably  obtained from such  institutions  which assert
such  rights.  Failure to obtain the  benefit of such  testing  could  adversely
affect the  Company's  commercial  position  and,  consequently,  its  financial
condition.

      IF THE COMPANY  LOSES ITS SOLE  SUPPLIER OF  DOXYCYCLINE  OR THE COMPANY'S
CURRENT MANUFACTURER OF PERIOSTAT, THE COMPANY'S  COMMERCIALIZATION OF PERIOSTAT
WILL BE INTERRUPTED OR LESS PROFITABLE.

      The  Company  relies on a single  supplier  for  doxycycline,  the  active
ingredient in  Periostat.  There are  relatively  few  alternative  suppliers of
doxycycline and this supplier  produces the majority of the doxycycline  used in
the United States. If the Company is unable to procure a commercial  quantity of
doxycycline  from its  current  supplier  on an ongoing  basis at a  competitive
price,  or if the Company cannot find a replacement  supplier in a timely manner
or with favorable pricing terms, the Company's costs may increase  significantly
and the Company may experience delays in the supply of Periostat.

      The  Company  has  historically  relied on a single  third-party  contract
manufacturer,  Applied  Analytical  Industries,  Inc., to produce Periostat in a
capsule  formulation.  The Company's  previously  reported  dispute with Applied
Analytical  has been  resolved  and the  Company  has agreed to pay a de minimus
amount to Applied  Analytical  and to incur  certain  price  increases on future
quantities  of  Periostat  manufactured  for the  Company.  Concurrent  with the
resolution  of their  dispute,  AAI served notice of its intent to terminate the
agreement to supply as of November 2001. The agreement with AAI provides for AAI
to commit to an  additional  twelve  (12)  months  supply of  product at a price
premium,  should the Company be unable to qualify an  alternative  manufacturing
source  subsequent  to the  termination  of the AAI  agreement.  An inability to
maintain such arrangements with Applied Analytical could result in delays in the
supply of  Periostat.  The Company has entered  into an  agreement  with another
contract manufacturer,  PMRS, on a tablet formulation for Periostat. The Company
has placed an initial  purchase order with PMRS and committed to certain minimum
purchases   through  2002.  Upon  the  termination  of  the  Company's   current
arrangements   with  AAI,  PMRS  will  become  the  sole  third-party   contract
manufacturer  to supply  Periostat  to the  Company.  Any  inability  of PMRS to
produce and supply  product on agreed  upon terms could  result in delays in the
supply of  Periostat.  The  Company  also  intends to contract  with  additional
manufacturers for the commercial manufacture of Periostat.  The Company believes
that  it  could  take  up  to  one  year  to  successfully  transition  to a new
manufacturer.


                                       20


<PAGE>


      THE COMPANY IS SUBJECT TO EXTENSIVE GOVERNMENT  REGULATION,  INCLUDING THE
REQUIREMENT OF APPROVAL BEFORE ITS PRODUCTS MAY BE MARKETED.

      The FDA has approved only one of the Company's  products,  Periostat,  for
sale in the United States. The Company's other products are in development,  and
will have to be  approved  by the FDA before  they can be marketed in the United
States. If the FDA does not approve the Company's  products in a timely fashion,
or does not approve them at all, the Company's business and financial  condition
may be adversely affected.

      In addition,  the Company and its  products  are subject to  comprehensive
regulation by the FDA both before and after products are approved for marketing.
The FDA regulates, for example, research and development,  including preclinical
and  clinical   testing,   safety,   effectiveness,   manufacturing,   labeling,
advertising,  promotion,  export,  and marketing of its products.  The Company's
failure to comply with  regulatory  requirements  may result in various  adverse
consequences,  including FDA delay in approving or refusal to approve a product,
recalls, withdrawal of an approved product from the market and/or the imposition
of civil or criminal sanctions.

      The Company is, and will  increasingly be, subject to a variety of foreign
regulatory  regimes governing  clinical trials and sales of its products.  Other
than Periostat,  which has been approved by the Medicines Control Agency for the
marketing in the United Kingdom,  the Company's  products have not been approved
in any foreign country. Whether or not FDA approval has been obtained,  approval
of a product by the comparable regulatory  authorities of foreign countries must
be  obtained  prior to the  commencement  of  marketing  of the product in those
countries.  The  approval  process  varies from  country to  country,  and other
countries may also impose post-approval requirements.

      IF  THE  COMPANY'S   PRODUCTS  CAUSE  INJURIES,   THE  COMPANY  MAY  INCUR
SIGNIFICANT EXPENSE AND LIABILITY.

      The  Company's  business  may be adversely  affected by potential  product
liability  risks  inherent  in  the  testing,  manufacturing  and  marketing  of
Periostat  and other  products  developed  by or for us. The  Company  has $10.0
million in product  liability  insurance for Periostat.  This level of insurance
may not  adequately  protect  the  Company  against  product  liability  claims.
Insufficient  insurance coverage or the failure to obtain  indemnification  from
third  parties  for  their  respective  liabilities  may  expose  us to  product
liability  claims  and/or  recalls  and  could  cause  the  Company's  business,
financial condition and results of operations to decline.

      IF THE COMPANY NEEDS ADDITIONAL  FINANCING,  AND FINANCING IS UNAVAILABLE,
THE COMPANY'S ABILITY TO DEVELOP AND  COMMERCIALIZE  PRODUCTS AND ITS OPERATIONS
WILL BE ADVERSELY AFFECTED.

      The Company has  historically  financed its operations  through public and
private equity financings. The Company's capital requirements depend on numerous
factors,   including  its  ability  to  successfully   commercialize  Periostat,
competing technological and market developments,  the Company's ability to enter
into  collaborative  arrangements for the development,  regulatory  approval and
commercialization  of  other  products,  and the  cost of


                                       21


<PAGE>


filing,   prosecuting,   defending  and   enforcing   patent  claims  and  other
intellectual property rights. The Company anticipates that it may be required to
raise additional capital in order to conduct its operations. Additional funding,
if necessary,  may not be available on favorable  terms,  if at all. If adequate
funds are not  available,  the Company  may be  required  to curtail  operations
significantly  or  to  obtain  funds  through  arrangements  with  collaborative
partners or others that may require the Company to relinquish  rights to certain
of its  technologies,  product  candidates,  products or potential  markets.  At
December  31,  2000,  the  Company had cash,  cash  equivalents  and  short-term
investments  of  approximately  $5.4 million.  In March 2001, the Company raised
approximately  $6.9  million,  net of  offering  costs,  through the sale of its
Common Stock and Warrants to purchase  shares of its Common Stock in the future.
The Company  anticipates  that its  existing  working  capital,  including  such
additional  $6.9 million  raised by the Company will be  sufficient  to fund its
operations through at least the middle of 2002.

      DELAWARE LAW, THE COMPANY'S CERTIFICATE OF INCORPORATION AND THE COMPANY'S
BY-LAWS CONTAIN PROVISIONS THAT COULD DISCOURAGE A TAKEOVER OF THE COMPANY.

      Anti-takeover  provisions of Delaware law, the  Company's  Certificate  of
Incorporation and the Company's By-Laws could make it more difficult for a third
party to acquire control of the Company, even if such change would be beneficial
to the  Company's  stockholders.  The  Company's  Certificate  of  Incorporation
provides that the Company's  board of directors may issue  preferred  stock with
superior  rights  and  preferences  without  common  stockholder  approval.  The
issuance of  preferred  stock could have the effect of  delaying,  deterring  or
preventing  a change in  control.  The  Company's  board of  directors  has also
adopted a "poison  pill"  rights plan that may further  discourage a third party
from making a proposal to acquire the Company.  In addition,  in connection with
the  issuance of the  Company's  preferred  stock,  the rights of the  Company's
common  stockholders may be limited in certain instances with respect to divided
rights,  rights on  liquidation,  winding up and  dissolution  and certain other
matters submitted to a vote of the Company's common stockholders.

      BECAUSE  THE  COMPANY'S  EXECUTIVE  OFFICERS,   DIRECTORS  AND  AFFILIATED
ENTITIES OWN  APPROXIMATELY  43.1% OF THE COMPANY'S  CAPITAL STOCK, SUCH PERSONS
COULD  CONTROL  THE  COMPANY'S  ACTIONS  IN A  MANNER  THAT  CONFLICTS  WITH THE
COMPANY'S INTERESTS AND THE INTERESTS OF THE COMPANY'S OTHER STOCKHOLDERS.

      Currently,  the Company's  executive  officers,  directors and  affiliated
entities together beneficially own approximately 43.1% of the outstanding shares
of common stock or equity securities convertible into common stock. As a result,
these stockholders,  acting together,  or in the case of the Company's preferred
stockholders, in certain instances, as a class, will be able to exercise control
over corporate actions requiring stockholder approval, including the election of
directors.  This  concentration  of ownership may have the effect of delaying or
preventing a change in control,  including  transactions  in which the Company's
stockholders  might  otherwise  receive a premium  for  their  shares  over then
current market prices.


                                       22


<PAGE>


      THE COMPANY'S STOCK PRICE IS HIGHLY  VOLATILE,  AND THEREFORE THE VALUE OF
AN INVESTMENT IN THE COMPANY MAY FLUCTUATE SIGNIFICANTLY.

      The market price of the  Company's  common stock has  fluctuated  and will
continue to  fluctuate  as a result of  variations  in the  Company's  quarterly
operating  results.  These fluctuations may be exaggerated if the trading volume
of the Company's  common stock is low. In addition,  the stock market in general
has experienced  dramatic price and volume fluctuations from time to time. These
fluctuations may or may not be based upon any business or operating results. The
Company's  common stock may  experience  similar or even more dramatic price and
volume fluctuations which may continue indefinitely.


                                       23


<PAGE>


ITEM 2.   PROPERTIES.

      The Company owns no real  property.  From  January  1995 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.


                                       24


<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 (the "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, 1999
through  December  31,  2000 as  reported on the 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, 1999..........         $12.44          $8.00
         June 30, 1999...........         $11.25          $7.50
         September 30, 1999......         $23.94          $9.13
         December 31, 1999.......         $24.56         $16.19
         March 31, 2000..........         $30.38         $11.88
         June 30, 2000...........         $16.06          $7.50
         September 30, 2000......          $9.91          $6.44
         December 31, 2000.......          $8.00          $2.75

      As of March 15, 2001, the  approximate  number of holders of record of the
common stock was 119 and the  approximate  number of  beneficial  holders of the
common stock was 3,800.

      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. In addition, the Company's ability to generally declare
dividends  to its common  stockholders  is  further  limited by the terms of its
credit  facility with Silicon  Valley Bank.  See  "Management's  Discussion  and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources."

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, 2000, and with respect to the consolidated
balance  sheet  data at  December  31,  1999 and 2000 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" herein. The consolidated statement
of  operations  data for


                                       25


<PAGE>


the years ended December 31, 1996 and 1997 and with respect to the  consolidated
balance  sheet data as of December  31,  1996,  1997 and 1998 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,
                                               --------------------------------------------------------
                                                 1996        1997        1998        1999        2000
                                               --------    --------    --------    --------    --------
Consolidated Statement                                (in thousands  except for per share data)
  of Operations Data:                          --------------------------------------------------------

<S>                                            <C>         <C>         <C>         <C>         <C>
Revenues:
   Product sales ...........................   $   --      $   --      $  3,053    $ 15,211    $ 20,501
   License revenues ........................        400         325         400         100         530
   Contract revenues .......................       --             9           8         770       3,240
                                               --------    --------    --------    --------    --------
Total revenues .............................        400         334       3,461      16,081      24,271
Operating expenses:
   Cost of product sales ...................       --          --           745       3,139       4,070
   Research and development ................      4,436       4,200       4,670       5,005       3,128
   Selling, general and administrative .....      2,527       6,096      10,600      23,180      25,746
                                               --------    --------    --------    --------    --------
Operating loss .............................     (6,563)     (9,962)    (12,554)    (15,243)     (8,673)
Interest income ............................        645       1,338         988         851         613
Interest expense ...........................       --          --          --          (197)        (15)
Other income (expense) .....................       --          --          --            (2)          9
                                               --------    --------    --------    --------    --------
Loss before cumulative effect of
   change in accounting principle ..........     (5,918)     (8,624)    (11,566)    (14,591)     (8,066)
Cumulative effect of change in
   accounting principle(1) .................       --          --          --          --          (764)
Net loss ...................................     (5,918)     (8,624)    (11,566)    (14,591)     (8,830)
Net loss allocable to common
   stockholders ............................   $ (6,638)   $ (8,624)   $(11,566)   $(15,683)   $(10,519)

Netloss per share allocable to common
  stockholders  before cumulative effect
  of change in accounting principle:
   Basic ...................................   $  (1.74)   $  (1.04)   $  (1.35)   $  (1.82)   $  (1.12)
   Diluted .................................      (1.72)      (1.04)      (1.35)      (1.82)      (1.12)
Net loss per share allocable to common
  stockholders(2):
   Basic ...................................   $  (1.74)   $  (1.04)   $  (1.35)   $  (1.82)   $  (1.21)
   Diluted .................................      (1.72)      (1.04)      (1.35)      (1.82)      (1.21)
Shares used in computing per share
  amounts(2):
   Basic ...................................      3,809       8,291       8,579       8,598       8,712
   Diluted .................................      3,864       8,291       8,579       8,598       8,712
--------------------------------------------------------------------------------------------------------

</TABLE>

                                       26


<PAGE>


<TABLE>
<CAPTION>
                                                                     As of December 31,
                                              --------------------------------------------------------
                                                 1996        1997        1998        1999       2000
                                              --------    --------    --------    --------    --------
Balance Sheet Data:                                                    (in thousands)
                                              --------------------------------------------------------

<S>                                           <C>         <C>         <C>         <C>         <C>
Cash, cash equivalents and short-term
   investments ............................   $ 18,215    $ 22,771    $ 10,250    $ 14,367    $  5,448
Total assets ..............................     18,437      23,165      14,740      18,563      10,431
Note payable, less current portion ........       --          --          --           116          47
Accumulated deficit .......................    (17,739)    (26,362)    (37,928)    (53,611)    (64,130)
Total stockholders' equity ................     17,592      20,708       9,281      13,607       5,264

</TABLE>

(1)   See Note 7 of Notes to Consolidated  Financial  Statements for information
      concerning  the  cumulative  effect  of change  in  accounting  principle.

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


                                       27
<PAGE>


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

Overview
--------

      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 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 120 sales representatives and managers.  This sales force
also  co-promotes  Vioxx, a prescription  non-sterodial  anti-inflammatory  drug
developed by Merck and Denavir,  a prescription  cold sore  medication  owned by
Novartis,  although Novartis has terminated its co-promotion  agreement with the
Company  effective  in April 2001,  and the Company is  actively  seeking  other
products to market to the dental community or directly to consumers.

      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
outsource its research and development  activities as well as its  manufacturing
and distribution functions.

      The  Company has  incurred  losses  each year since  inception  and had an
accumulated  deficit of $64.1 million at December 31, 2000. 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 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 and approved by
the Medicines  Control Agency for marketing in the United Kingdom,  there can be
no assurance that any of the Company's other product candidates will be approved
by any


                                       28


<PAGE>


regulatory authority for marketing in any jurisdiction or, if approved, that any
such products or Vioxx will be successfully  commercialized by the Company. As a
result of these risks,  and others  expressed from time to time in  CollaGenex's
filings  with the  Securities  and Exchange  Commission,  the  Company's  actual
results may differ  materially  from the results  discussed in or implied by 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,  the Company  generated  $770,000 in contract
revenues  from its two (2)  co-promotion  agreements  (one  (1) of  which  shall
terminate in April 2001) and $100,000 in license fees relating to the signing of
a distribution agreement for Periostat in Canada. During the year ended December
31, 2000, the Company  achieved net product sales of $20.5 million from sales of
Periostat.  In addition,  in 2000 the Company generated $3.2 million in contract
revenues  from its two (2)  co-promotion  agreements  (one  (1) of  which  shall
terminate in April 2001) and $530,000 in license and milestone fees from various
foreign  distribution  and  marketing  agreements  for  Periostat.  This  amount
included $397,000 of license revenues that were deferred upon the implementation
of Staff  Accounting  Bulletin  ("SAB") 101,  effective  January 1, 2000.  These
amounts were previously  recognized as license revenues in prior years under the
historical revenue recognition policy prior to the adoption of SAB 101.

      The Company  realized a net loss in 2000  resulting  primarily from higher
revenue offset by higher planned sales,  marketing and  administrative  expenses
incurred  during such period.  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, 2000 and December 31, 1999
      ---------------------------------------------------

      Revenues.  The Company  realized $24.3 million in net revenues during 2000
compared to $16.1 million  during 1999.  Revenues in 2000 included $20.5 million
in net sales of Periostat, $3.2 million in contract revenues, which were derived
from the Company's  co-promotion  of Vioxx and Denavir,  and $530,000 in foreign
license and milestone  revenues for Periostat.  Revenues from Denavir  accounted
for approximately $700,000 of such contract revenues. The Company has received a
thirty (30) day termination  notice by letter dated March 14, 2001 from Novartis
Pharmaceuticals Corporation, the owner of Denavir, with respect to the Company's
co-promotion  agreement with Novartis for Denavir.  In accordance  with SAB 101,
which  was  adopted  in 2000,  the 2000  licensing  revenues  of  $530,000  were
attributable,  in part, to the


                                       29


<PAGE>


recognition of up-front  license fees received for various  agreements which are
being recognized over the expected term of these agreements. License revenues in
2000 also  included  $397,000  that were  recorded in earlier years prior to the
adoption of SAB 101 which were deferred as a result of the cumulative  effect of
a change in accounting  principle as of January 1, 2000.  Licensing  revenues in
1999 included $100,000 in connection with an agreement with Pharmascience,  Inc.
pursuant to which  Pharmascience  Inc. will market  Periostat in Canada  pending
requisite  regulatory  approval.  However,  under  SAB 101,  licensing  revenues
recognized in 1999 would have been $58,000.

      Cost of product sales.  Cost of product sales were $4.1 million,  or 19.9%
of net product sales in 2000  compared to $3.1 million,  or 20.6% of net product
sales in 1999.  This  decrease in costs of product  sales as a percentage of net
product sales resulted  primarily from the absence of trade allowances and price
increases for Periostat during 2000.

      Research  and  development  expenses.  Research and  development  expenses
decreased  to $3.1  million  in 2000 from $5.0  million in 1999.  This  decrease
resulted  primarily from fewer expenses  related to Phase 3b clinical studies to
support future marketing activities for Periostat,  decreased  manufacturing and
formulation  development  work for  Periostat  tablets and reduced  research and
development  activities.  Such  decreases  were  partially  offset by a $324,000
non-cash  compensation  charge  incurred during the year ended December 31, 2000
related  to  accelerating  the  vesting  on stock  options  granted  to  certain
non-employees  in 1999.  In 2000,  the Company's  expenditures  for research and
development  included,  among  other  things,  regulatory  and  consulting  fees
associated with the Company's NDA for Periostat  tablets submitted to the FDA as
well as  applications  submitted  to the UK MCA for  marketing  approval  of the
tablet formulation of Periostat in the United Kingdom,  expenditures relating to
the ongoing  Phase IV marketing  studies of Periostat,  as well as  expenditures
incurred  relating  to a Phase I study of  Metastat.  Research  and  development
expenses for 1999 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.

      Selling,  general  and  administrative  expenses.   Selling,  general  and
administrative expenses increased to $25.7 million in 2000 from $23.2 million in
1999.  This  increase  was  mainly  due to higher  advertising  and  promotional
expenses for Vioxx pursuant to the Company's  co-promotion  agreement with Merck
and  the  initiation  of a  direct-to-consumer  advertising  test  campaign  for
Periostat which commenced in October 2000.

      Other  income/expenses.  Interest  income  decreased from $851,000 for the
year ended  December 31, 1999  compared to $613,000 for the year ended  December
31,  2000.  This  decrease  was due to lower  balances  in cash  and  short-term
investments  during the year  December 31, 2000.  Interest  expense for the year
ended  December  31, 2000 was  $15,000,  compared to $197,000 for the year ended
December 31, 1999.  This  decrease was primarily due to the repayment of a $10.0
million short term note executed in connection with the Company's  Financing (as
hereinafter  defined) in May 1999. Such decrease for 2000 was offset by interest
expense  related to the $219,000  note payable  executed by the Company in April
1999.


                                       30


<PAGE>


      Change in accounting  principle.  The Company recognized a $764,000 charge
during the year ended December 31, 2000 from the  cumulative  effect of a change
in accounting  principle,  effective as of January 1, 2000, upon the adoption of
SAB 101. This change in accounting principle primarily reflected the deferral of
up-front licensing  revenues  recognized in prior years. Under SAB 101, up-front
licensing fees must be recognized  over the expected  performance  period of the
relevant agreements. Accordingly, at December 31, 2000, the Company has recorded
approximately  $739,000  in  deferred  revenue  which will  recognized  over the
expected performance period of each respective agreement.

      Preferred  stock dividend.  Preferred stock dividends  increased from $1.1
million  during the year ended December 31, 1999 to $1.7 million during the year
ended December 31, 2000. Such preferred stock  dividends,  paid in shares of the
Company's  Common  Stock,  were  the  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, 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. Revenues
from Denavir accounted for approximately $511,000 of such contract revenues. The
Company has received a thirty (30) day termination  notice by letter dated March
14, 2001 from Novartis with respect to the Company's co-promotion agreement with
Novartis for Denavir.  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  included  a  non-refundable  $400,000
licensing  fee  from  Laboratories  Pharmascience  under a  licensing  agreement
pursuant to which  Laboratories  Pharmascience was to market Periostat in France
pending  requisite   regulatory   approval.   Such  agreement  was  subsequently
terminated.

      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 in


                                       31


<PAGE>


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 $197,000. 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, paid in shares of the
Company's Common Stock, 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.

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.

      The Series D Stock is  convertible at any time into shares of common stock
of the Company at a current  conversion  price of $9.94 per common share,  which
conversion price reflects a decrease from the initial conversion price of $11.00
per share as a result of the Company's  Common Stock  financing  consummated  on
March 12, 2001. 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


                                       32


<PAGE>


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 March  15,  2001,  $9.94  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,  2000,  the  Company  had  cash,  cash  equivalents  and
short-term investments of approximately $5.4 million, a decrease of $9.0 million
from the $14.4 million balance at December 31, 1999. This decrease was primarily
attributable to the cash used to fund operations during 2000. 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, 2000
was $5.3  million,  a decrease of $7.7  million from  December  31,  1999.  This
decrease was primarily  attributable to the cash used to fund operations  during
2000.

      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.

      On March 12, 2001, the Company  consummated a private  equity  offering of
1,500,000  shares  of  Common  Stock  for an  aggregate  purchase  price of $7.5
million,  which  generated  net  proceeds to the Company of  approximately  $6.9
million.   Such   proceeds   will  be   used   primarily   for   the   Company's
direct-to-consumer   advertising   campaign  and  for  general  working  capital
purposes.  In  addition,  the  investors in such  financing  were also issued an
aggregate of 400,000  warrants which are  exercisable  for up to three (3) years
into 400,000 shares of the Company's Common Stock at an exercise price per share
of $6.00.  The  consideration  received  for such  warrants  is  included in the
aggregate  proceeds  received in the  financing.  The Company also issued to its
financial advisor in such financing warrants to purchase an aggregate of 150,000
shares of the Company's Common Stock exercisable for up to three (3) years at an
exercise  price of $5.70  per  share,  as  partial  consideration  for  services
rendered  in  connection  with  this  financing.  These  warrants  may be deemed
automatically  exercised in certain circumstances based upon the Company's stock
price.  The  Company is  obligated  to file by April 11, 2001 and  maintain  the
effectiveness of a shelf registration  statement with respect to all such shares
of Common  Stock issued and shares  underlying  all such  warrants  beginning no
later than June 10,


                                       33


<PAGE>


2001.  Should the  Company  fail to obtain  effectiveness  of such  registration
statement by June 10, 2001 or to maintain the effectiveness of such registration
statement for a continuous  twenty-four (24) month period, the investors and the
financial  advisor shall  receive an  additional  27,500 shares of the Company's
Common Stock, in the aggregate, for no additional consideration.

      On March 19, 2001,  the Company  consummated a revolving  credit  facility
(the "Facility")  with Silicon Valley Bank (the "Bank").  The Company may borrow
up to the lesser of  $3,000,000  or 80% of  eligible  accounts  receivables,  as
defined under the Facility.  The amount available is also reduced by outstanding
letters of credit which may be issued under this Facility in amounts totaling up
to  $1,500,000.  The Company is not obligated to draw amounts under the Facility
and any such draws will bear interest,  payable monthly,  at the then prevailing
prime  rate  plus  1.5%  per  annum  and may be used  only for  working  capital
purposes.  The Company  intends to secure its  purchase  order  commitments  for
Periostat  from PMRS with a letter of credit  under the  Facility.  Without  the
consent of the Bank,  the Company,  among other  things,  shall not (i) merge or
consolidate with another entity; (ii) acquire assets outside the ordinary course
of business;  or (iii) pay or declare any cash dividends on the Company's Common
Stock. The Company must also maintain a certain tangible net worth and a minimum
of $2.0 million in cash,  net of  borrowings  under the  Facility,  at all times
during the term of the  Facility.  In  addition,  the  Company  has  secured its
obligations  under the Facility  through the granting of a security  interest in
favor of the Bank with respect to all of the  Company's  assets,  including  its
intellectual property.

      The Company  anticipates that its existing working capital,  including the
approximately $6.9 million received through the Company's Common Stock financing
consummated  on  March  12,  2001,  will be  sufficient  to fund  the  Company's
operations  through at least the middle of 2002.  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,  2000,  the Company had  approximately  $59.8  million of
Federal and $46.5 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  $840,000  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  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, 2000,  assuming there are no future ownership  changes,


                                       34


<PAGE>


and not giving effect, if any, to the March 2001 financing,  approximately $25.0
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.

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  impact to its
financial position or results of operations relating to market risk.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

      The  financial  statements  and  supplementary  data  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.


                                       35


<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  2001  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 2001  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 2001
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 2001 Annual
Meeting  of  Stockholders  is  incorporated  herein by  reference  to such proxy
statement.


                                       36


<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 40.

(b)   Reports on Form 8-K.

            No  Reports on Form 8-K have been filed  during  the  quarter  ended
            December 31, 2000.




                                       37


<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 26th day of March,
2001.

                                    COLLAGENEX PHARMACEUTICALS, INC.


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




                                       38


<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.       Chairman, Chief Executive    March 26, 2001
---------------------------------   Officer, Prisident and
   Brian M. Gallagher, Ph.D.        Director (Principal
                                    Executive Officer)

/s/ Nancy C. Broadbent              Chief Financial Officer,     March 26, 2001
---------------------------------   Treasurer and Secretary
   Nancy C. Broadbent               (Principal Financial and
                                    Accounting Officer)

/s/ Helmer P.K. Agersborg, Ph. D.   Director                     March 23, 2001
---------------------------------
   Helmer P.K. Agersborg, Ph.D.

/s/ Peter R. Barnett, D.M.D.        Director                     March 26, 2001
---------------------------------
   Peter R. Barnett, D.M.D.

/s/ Robert C. Black                 Director                     March 21, 2001
---------------------------------
   Robert C. Black

/s/ James E. Daverman               Director                     March 26, 2001
---------------------------------
   James E. Daverman

                                    Director
---------------------------------
   Robert J. Easton

/s/ Stephen A. Kaplan               Director                     March 26, 2001
---------------------------------
   Stephen A. Kaplan

/s/ W. James O'Shea                 Director                     March 20, 2001
---------------------------------
   W. James O'Shea


                                       39


<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(f)           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(h)           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.


                                       40


<PAGE>


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

   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.

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

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

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

  +10.13(c)          License  Agreement  dated July 18,  1996 by and between the
                     Company and Boehringer Mannheim Italia.

  +10.14(e)          License  Agreement dated as of June 30, 1998 by and between
                     the Company and Laboratories Pharmascience S.A.

  +10.15(e)          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.

  +10.16(e)          Co-Promotion  Agreement  dated  October  13,  1998  between
                     SmithKline  Beecham  Consumer  Healthcare,   L.P.  and  the
                     Company.

  +10.17(e)          Distribution  Services  Agreement  dated  August  15,  1998
                     between Cord Logistics, Inc. and the Company.

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

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


                                       41


<PAGE>


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

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

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

   10.22(h)          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.

   10.23(i)          Form of Common Stock  Purchase  Agreement,  dated March 12,
                     2001,  between  the  Company  and  the  Investors  set  for
                     therein,   together  with  form  of   Registration   Rights
                     Agreement  as an exhibit  thereto and form of Warrant as an
                     exhibit thereto.

   10.24             Loan and Security  Agreement dated March 19, 2001,  between
                     the Company and Silicon Valley Bank filed herewith.

   21                List of subsidiaries of the Registrant filed herewith.

   23.1              Consent of KPMG LLP filed herewith.

+  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  September  30,  1998,  which was  filed  with the
      Securities and Exchange Commission on November 16, 1998.
(f)   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.
(g)   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.
(h)   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.


                                       42


<PAGE>


(i)   Incorporated  by reference to the  Company's  Current  Report on Form 8-K,
      dated March 16,  2001,  which was filed with the  Securities  and Exchange
      Commission on March 16, 2001.




                                       43


<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, 1999 and
2000..........................................................          F-3

Consolidated Statements of Operations for the years
ended December 31, 1998, 1999, and 2000.......................          F-4

Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1998, 1999 and 2000..................          F-5

Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1999 and 2000........................          F-6

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

Financial Statement Schedule - Valuation and Qualifying
Accounts......................................................          F-27




                                      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 auditing standards generally accepted
in the  United  States of  America.  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, 1999 and 2000, and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended  December  31,  2000,  in  conformity  with  accounting
principles  generally  accepted  in the United  States of  America.  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.

As  discussed in Notes 2 and 7 to the  consolidated  financial  statements,  the
Company adopted the provisions of the Securities and Exchange Commission's Staff
Accounting  Bulletin No. 101, "Revenue  Recognition in Financial  Statements" in
2000.

                                  /s/ KPMG LLP



Princeton, New Jersey
January 31, 2001, except as to the first
   paragraph of note 14, which is as of
   March 12, 2001 and the second  paragraph
   of note 14, which is as of March 19, 2001


                                      F-2


<PAGE>
<TABLE>
<CAPTION>


                            COLLAGENEX PHARMACEUTICALS, INC.
                                    AND SUBSIDIARIES

                              Consolidated Balance Sheets

                               December 31, 1999 and 2000

                     (dollars in thousands, except per share data)


                      Assets                                       1999         2000
                                                                 --------     --------
<S>                                                              <C>          <C>
Current assets:
     Cash and cash equivalents ................................  $  7,981     $  3,709
     Short term investments ...................................     6,386        1,739
     Accounts receivable, net of allowance
     of $386 and $381 in 1999 and 2000, respectively ..........     2,150        3,038
     Inventories ..............................................       695          277
     Prepaid expenses and other current assets ................       615          989
                                                                 --------     --------
         Total current assets .................................    17,827        9,752
Equipment and leasehold improvements, net .....................       709          652
Other assets ..................................................        27           27
                                                                 --------     --------
         Total assets .........................................  $ 18,563     $ 10,431
                                                                 ========     ========
                  Liabilities and Stockholders' Equity
Current liabilities:
     Current portion of note payable ..........................  $     65     $     65
     Accounts payable .........................................     2,440        1,865
     Accrued expenses .........................................     2,335        2,514
                                                                 --------     --------
                  Total current liabilities ...................     4,840        4,444
                                                                 --------     --------
Note payable, less current portion ............................       116           47
Deferred revenue ..............................................      --            676
Commitments
Stockholders' equity:
     Preferred stock, $0.01 par value, 5,000,000 shares
         authorized,  200,000 shares of Series D cumulative
         convertible  preferred  stock issued and
         outstanding in 1999 and 2000, respectively
         (liquidation value $20,000) ..........................         2            2
     Common stock, $0.01 par value; 25,000,000 shares
         authorized, 8,622,091 and 8,775,176 shares
         issued and outstanding in 1999 and 2000,
         respectively .........................................        86           88
     Common stock to be issued (39,188 shares and
         275,462 shares in 1999 and 2000, respectively) .......       858          872
     Additional paid in capital ...............................    66,348       68,461
     Deferred compensation ....................................       (76)         (29)
     Accumulated deficit ......................................   (53,611)     (64,130)
                                                                 --------     --------
                  Stockholders' equity ........................    13,607        5,264
                                                                 --------     --------
Total liabilities and stockholders' equity ....................  $ 18,563     $ 10,431
                                                                 ========     ========
</TABLE>

             See accompanying notes to consolidated financial statements.


                                      F-3


<PAGE>
<TABLE>
<CAPTION>


                                  COLLAGENEX PHARMACEUTICALS, INC.
                                          AND SUBSIDIARIES

                                Consolidated Statements of Operations

                            Years ended December 31, 1998, 1999 and 2000

                            (dollars in thousands, except per share data)


                                                              1998           1999          2000
                                                          -----------    -----------    -----------
<S>                                                       <C>            <C>            <C>
Revenues:
     Product sales ....................................   $     3,053    $    15,211    $    20,501
     License revenues .................................           400            100            530
     Contract revenues ................................             8            770          3,240
                                                          -----------    -----------    -----------
         Total revenues ...............................         3,461         16,081         24,271
                                                          -----------    -----------    -----------
Operating expenses:
     Cost of product sales ............................           745          3,139          4,070
     Research and development .........................         4,670          5,005          3,128
     Selling, general and administrative ..............        10,600         23,180         25,746
                                                          -----------    -----------    -----------
         Total operating expenses .....................        16,015         31,324         32,944
                                                          -----------    -----------    -----------
         Operating loss ...............................       (12,554)       (15,243)        (8,673)
Other income (expense):
     Interest income ..................................           988            851            613
     Interest expense .................................          --             (197)           (15)
     Other income (expense) ...........................          --               (2)             9
                                                          -----------    -----------    -----------
         Loss before cumulative effect of change in
              accounting principle ....................       (11,566)       (14,591)        (8,066)
Cumulative effect of change in accounting principle ...          --             --             (764)
                                                          -----------    -----------    -----------
         Net loss .....................................       (11,566)       (14,591)        (8,830)
Preferred stock dividend ..............................          --            1,092          1,689
                                                          -----------    -----------    -----------
Net loss allocable to common stockholders .............   $   (11,566)   $   (15,683)   $   (10,519)
                                                          ===========    ===========    ===========
Basic and diluted net loss per share allocable to
     common stockholders before cumulative effect
     of change in accounting principle ................   $     (1.35)   $     (1.82)   $     (1.12)

Cumulative effect of change in accounting principle ...          --             --            (0.09)
                                                          -----------    -----------    -----------
Basic and diluted net loss per share allocable to
     common stockholders ..............................   $     (1.35)   $     (1.82)   $     (1.21)
                                                          ===========    ===========    ===========
Shares used in computing per share amounts:
     Basic and diluted ................................     8,579,054      8,597,676      8,711,668
                                                          ===========    ===========    ===========
Pro forma net loss assuming new accounting principle
     is applied retroactively .........................   $   (11,926)   $   (14,633)   $    (8,066)
                                                          ===========    ===========    ===========
Pro forma net loss allocable to common stockholders
     assuming new accounting principle is applied
     retroactively ....................................   $   (11,926)   $   (15,725)   $    (9,755)
                                                          ===========    ===========    ===========
Pro forma basic and diluted net loss per share
     allocable to common stockholders assuming new
     accounting principle is applied retroactively ....   $     (1.39)   $     (1.83)   $     (1.12)
                                                          ===========    ===========    ===========
</TABLE>

                    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, 1998, 1999 and 2000

                                                 (dollars in thousands)

                                                    Series D cumulative
                                                    convertible
                                                    preferred stock           Common stock
                                                    -------------------   ---------------------
                                                    Number                Number                  Common       Additional
                                                    of        Par         of          Par         Stock to     paid-in
                                                    shares    value       shares      value       be issued    capital
                                                    -------   ---------   ---------   ---------   ---------    ---------
<S>               <C> <C>                                     <C>         <C>         <C>         <C>          <C>
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        --           858          234
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         858    $  66,348
Exercise of common stock options ..............        --          --        21,325        --            32           84
Common stock dividends on Series D
      cumulative convertible preferred
      stock ...................................        --          --       131,760           2        (858)       1,705
Common stock dividends declared on Series
      D cumulative convertible preferred
      stock ...................................        --          --          --          --           840         --
Compensation expense resulting from
      options to non-employees ................        --          --          --          --          --            324
Amortization of deferred compensation .........        --          --          --          --          --           --
Net loss ......................................        --          --          --          --          --           --
                                                    -------   ---------   ---------   ---------   ---------    ---------
Balance, December 31, 2000 ....................     200,000   $       2   8,775,176   $      88   $     872    $  68,461
                                                    =======   =========   =========   =========   =========    =========


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

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
Exercise of common stock options ..............        --           --            116
Common stock dividends on Series D
      cumulative convertible preferred
      stock ...................................        --           (849)        --
Common stock dividends declared on Series
      D cumulative convertible preferred
      stock ...................................        --           (840)        --
Compensation expense resulting from
      options to non-employees ................        --           --            324
Amortization of deferred compensation .........          47         --             47
Net loss ......................................        --         (8,830)      (8,830)
                                                  ---------    ---------    ---------
Balance, December 31, 2000 ....................   $     (29)   $ (64,130)   $   5,264
                                                  =========    =========    =========

                               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, 1998, 1999 and 2000

                                       (dollars in thousands)

                                                                   1998        1999        2000
                                                                 --------    --------    --------
<S>                                                              <C>         <C>         <C>
Cash flows from operating activities:
     Net loss ................................................   $(11,566)   $(14,591)   $ (8,830)
     Adjustments to reconcile net loss to net cash used
         in operating activities:
           Noncash compensation expense ......................        119         423         371
           Depreciation and amortization expense .............         66         151         226
           Cumulative effect of change in
               accounting principle ..........................       --          --           764
           Change in assets and liabilities:
               Accounts receivable ...........................     (3,045)        895        (888)
               Inventories ...................................       (342)       (353)        418
               Prepaid expenses and other assets .............       (545)        194        (342)
               Accounts payable ..............................      2,363        (474)       (575)
               Accrued expenses ..............................        639        (210)        116
               Deferred revenue ..............................       --          --           (25)
                                                                 --------    --------    --------
                  Net cash used in operating activities ......    (12,311)    (13,965)     (8,765)
                                                                 --------    --------    --------
Cash flows from investing activities:
     Capital expenditures ....................................       (230)       (593)       (169)
     Proceeds from the sale of short-term investments ........      6,880       7,464       6,871
     Purchase of short-term investments ......................     (7,452)     (6,886)     (2,224)
                                                                 --------    --------    --------
                  Net cash provided by (used in)
                     investing activities ....................       (802)        (15)      4,478
                                                                 --------    --------    --------
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        --
     Proceeds from issuance of common stock ..................         20          44          84
     Proceeds from issuance of long-term debt ................       --           219        --
     Repayment of long-term debt .............................       --           (38)        (69)
                                                                 --------    --------    --------
                  Net cash provided by financing activities ..         20      18,675          15
                                                                 --------    --------    --------
Net increase (decrease) in cash and cash equivalents .........    (13,093)      4,695      (4,272)
Cash and cash equivalents at beginning of year ...............     16,379       3,286       7,981
                                                                 --------    --------    --------
Cash and cash equivalents at end of year .....................   $  3,286    $  7,981    $  3,709
                                                                 ========    ========    ========
Supplemental schedule of noncash financing activities:
     Common stock dividends issued or to be issued on
         preferred stock .....................................   $   --      $  1,092    $  1,689
                                                                 ========    ========    ========
     Common stock to be issued on exercise of common
         stock options .......................................   $   --      $   --      $     32
                                                                 ========    ========    ========
Supplemental disclosure of cash flow information:
     Cash paid during the year for interest ..................   $   --      $    199    $      6
                                                                 ========    ========    ========
</TABLE>

                    See accompanying notes to consolidated financial statements.


                                                F-6


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (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.
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,  1999 and  2000.  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, 1998, 1999 and 2000

                  (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 and 2000,  therefore  the fair value of the note  payable
approximates the carrying value at December 31, 1999 and 2000.

      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 1999,  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.

      Revenue Recognition
      -------------------

      Milestone revenue from license  arrangements is recognized upon completion
of the milestone event or requirement.  Payments, if any, received in advance of
performance  under a contract  are  deferred  and  recognized  when  earned.  As
described  in note 7, as of  January  1, 2000,  upfront  license  fees where the
Company  has  continuing  involvement,  (which  prior to  January  1,  2000 were
recorded as license revenues when received) are now deferred and recognized over


                                      F-8


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


the  estimated  performance  period of each  individual  licensing  agreement in
accordance  with the SEC's  Staff  Accounting  Bulletin  No.  101  ("SAB  101").
Accordingly,  effective  January 1, 2000, the Company has recorded a $764 charge
as a cumulative  effect of change in accounting  principle  for certain  upfront
license revenues recognized prior to January 1, 2000.

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

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

      Advertising Costs
      -----------------

      The Company incurs advertising costs from print  advertisements in various
periodicals  and  television  advertisements.  The Company  records  advertising
expense when incurred.  Such amounts charged to the  consolidated  statements of
operations  for 1998,  1999 and 2000 were $0.8  million,  $1.6  million and $2.1
million, respectively.

      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.

      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


                                      F-9


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


to record compensation cost for stock-based employee  compensation plans at fair
value. The Company has chosen 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 on a straight-line basis 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  capsules which are sold throughout the United States
exclusively to wholesale and retail distributors. In addition, the Company has a
supply  agreement  with a single  company  to supply the  active  ingredient  in
Periostat.  A single  company also  provides all  warehousing  and  distribution
services to the Company. During 2000, four customers accounted for 31%, 17%, 14%
and  10%,  of net  product  sales,  respectively.  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.

      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, 2000,
the Company has certain convertible preferred stock and stock options which have
not been included in the  calculation of diluted net loss per share allocable to
common


                                      F-10


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


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.

      Reclassification
      ----------------

      Certain amounts in the 1999  consolidated  financial  statements have been
reclassified to conform to the 2000 presentation.

(3)   COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

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

      Inventories at December 31, 1999 and 2000 consists of the following:

                                               1999                2000
                                            ---------            ---------
      Raw materials................         $     254            $      60
      Finished goods...............               441                  217
                                            ---------            ---------
                                            $     695            $     277
                                            =========            =========

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

      Equipment  and  leasehold  improvements  at  December  31,  1999  and 2000
consists of the following:

                                               1999                2000
                                            ---------            ---------
      Computer and office equipment....     $     673            $     792
      Exhibit equipment................           259                  309
      Leasehold improvements...........            45                   45
                                            ---------            ---------
                                                  977                1,146
      Less accumulated
        depreciation and
        amortization...................          (268)                (494)
                                            ---------            ---------
                                            $     709            $     652
                                            =========            =========


                                      F-11


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


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

      Accrued expenses at December 31, 1999 and 2000 consists of the following:

                                               1999                2000
                                            ---------            ---------
      Contracted development and
        manufacturing costs...........      $     441            $     314
      Sales and marketing costs.......            144                  597
      Payroll and related costs.......          1,237                1,061
      Professional  and  consulting
       fees...........................            221                  204
      Royalties.......................            215                  201
      Deferred revenue................             --                   63
      Miscellaneous taxes.............             32                   52
      Other...........................             45                   22
                                            ---------            ---------
                                            $   2,335            $   2,514
                                            =========            =========

(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.

(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 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  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


                                      F-12


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


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 (see note 14), 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  (see note 14).  Dividends  totaling  $1,092  and  $1,689  were
declared in 1999 and 2000, respectively. At December 31, 1999 and 2000, declared
dividends of 39,188 and 259,462 shares of common stock,  respectively,  have not
been issued,  and have  accordingly been classified as common stock to be issued
in the accompanying consolidated balance sheet.

      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-


                                      F-13


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


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, 2000, the Rights were neither  exercisable nor traded
separately from the Company's  common stock,  and become  exercisable  only if a
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 1,500,000  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. 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.


                                      F-14


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      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.

      During  1999,  192,500  options  were  granted to employees at fair market
value with an exercise price of $10.06 per share.  During 2000,  237,750 options
were granted to  employees at fair market value with an exercise  price of $5.00
per share.  These  grants  were not  issued  under the terms of any of the above
Plans.

      At December 31, 2000,  there were 278,670 shares available for grant under
the 1996 Plan and 105,000 under the Non-Employee Director Plan.

      Deferred compensation had been recorded in years prior to 1998 for options
granted  where the fair 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 ($119,  $118 and
$47 in 1998, 1999 and 2000, respectively).

      In 1999, the Company granted options to certain  non-employees to purchase
60,000 shares of common stock.  Such options were  originally  scheduled to 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
periods  following the grant are 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  completed
performance  under the  option  agreement  and the  options  vest.  The  Company
recorded total  compensation  expense of $305 in 1999, based on the market value
of the options at the grant date and at December 31, 1999 as determined  using a
Black-Scholes  option pricing model.  In 2000, the Company elected to accelerate
the vesting on the remaining unvested options. Accordingly, the Company recorded
total compensation  expense,  including that related to the accelerated vesting,
of $324 in 2000,  based on the market value of the options at the grant date and
at the  vesting  dates in 2000 as  determined  using  the  Black-Scholes  option
pricing model. No future  compensation  expense will be recorded on these 60,000
options.


                                      F-15


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      The  following  table  summarizes  stock option  activity for 1998 through
2000:

                                                             Weighted average
                                                              exercise price
                                              Shares             per share
                                            ---------        ----------------
      Balance December 31, 1997....           725,954            $  7.06
        Granted....................           315,000               8.08
        Exercised..................           (19,625)              1.00
        Cancelled..................            (3,000)              6.75
                                            ---------            -------
      Balance December 31, 1998....         1,018,329               7.49
        Granted....................           475,150              11.36
        Exercised..................           (13,575)              3.24
        Cancelled..................           (42,000)             10.72
                                            ---------            -------
      Balance December 31, 1999....         1,437,904               8.72
        Granted....................           721,880              13.17
        Exercised..................           (37,325)              3.11
        Cancelled..................           (99,450)             12.97
                                            ---------            -------
      Balance December 31, 2000....         2,023,009              10.20

      Amounts  exercised in 2000 include 16,000 options to purchase common stock
at $2.00 per share which were not issued until January 2001, and accordingly are
classified  as common stock to be issued in the  accompanying  balance  sheet at
December 31, 2000.


                                      F-16


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      As of December 31,  2000,  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 of   contractual    price per    Number of     price per
    prices       shares        life         share         shares       share
------------    ---------   -----------    ---------    ---------    ----------
 $0.20- 2.00    189,954       4.7 years     $  0.95      189,954       $  0.95
  4.50-10.00    739,050       7.3 years        7.18      278,025          8.61
 10.06-12.00    444,275       7.4 years       10.29      201,624         10.46
 12.19-13.56    198,950       8.0 years       12.42      124,287         12.44
 14.06-22.88    450,780       8.5 years       17.96       18,925         17.12
               2,023,009      7.4 years     $ 10.20      812,815       $  8.06

      Had the  Company  elected to  recognize  compensation  cost for options as
prescribed  by the fair value  method  under 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:

                                        1998            1999            2000
                                      --------        --------        --------
      Net loss allocable to
        common stockholders:
          As reported...........      $ 11,566        $ 15,683        $ 10,519
          Pro forma.............        12,487          17,338          13,802
      Basic and diluted net loss
        per share allocable to
        common stockholders::
          As reported...........      $   1.35        $   1.82        $   1.21
          Pro forma.............          1.46            2.02            1.58

      Pro forma net loss allocable to common stockholders  reflects only options
granted in 1995  through  2000.  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.


                                      F-17


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      The  weighted  average fair values of stock  options  granted to employees
during 1998, 1999 and 2000 were $4.64, $7.81 and $10.72 per share, respectively,
on the date of grant.  The weighted average fair values of stock options granted
to nonemployees during 1999 were $9.21 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:

                                        1998            1999            2000
                                      --------        --------        --------
      Expected life in years....         5               5              7
      Risk-free interest rate...       6.25%           6.25%          6.20%
      Volatility................        60%             80%            90%
      Expected dividend yield...        --%             --%            --%

(7)   CHANGE IN ACCOUNTING PRINCIPLE

      In the fourth  quarter of 2000,  the  Company  adopted  SAB 101,  "Revenue
Recognition  in  Financial   Statements",   implementing  a  change  in  revenue
recognition  policy for  certain  upfront  payments  received  in  international
licensing  arrangements  for  Periostat.  Effective  January  1,  2000,  upfront
payments received from licensees,  where the Company has continuing involvement,
are now being  deferred and  recognized  as license  revenue over the  estimated
performance  period of the individual  license  agreements.  In previous  years,
prior to the Company's  adoption of SAB 101, the Company recognized revenue when
the  upfront  payments  were  received,  generally  upon the  execution  of each
agreement.  During 2000, the Company would have recognized approximately $505 in
license revenues under its historical  revenue  recognition  policy prior to the
adoption of SAB 101. In addition,  during  2000,  the Company  recorded  $397 in
license  revenues which were deferred upon the  implementation  of SAB 101 as of
January 1, 2000 and which were previously  recognized as license  revenues under
the historical revenue recognition policy prior to the adoption of SAB 101.

      The consolidated statement of operations in 2000 has been presented in the
accompanying   financial   statements   based  on  this  newly  adopted  revenue
recognition  policy.  The change increased revenue and decreased net loss by $25
during 2000,  excluding the cumulative  effect of the change.  The pro forma net
loss allocable to common stockholders and the related per share amounts for 1998
and 1999 as if the new accounting  principle had been applied  retroactively are
also presented in the accompanying consolidated statements of operations. During
2000, the Company recorded a $764 charge as a result of the cumulative effect of
the change in accounting  principle for revenue  recognized  prior to January 1,
2000 and, accordingly, has recorded approximately $739 in deferred revenues from
upfront  license  payments  received  from  licensees,  of  which  $63 has  been
classified as a current liability in the accompanying consolidated balance sheet
at December 31, 2000.


                                      F-18


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


(8)   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 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,
1999 and 2000 are presented below:

                                                     1999              2000
                                                  ---------         ---------
      Deferred tax assets:
        Capitalized start up costs...........     $     423         $     170
        Net operating loss carryforwards.....        19,543            23,530
        Tax credit carryforward..............           790               840
        Accrued expenses.....................           348                58
        Deferred revenue.....................            --               251
                                                  ---------         ---------
           Total gross deferred tax assets...        21,104            24,849
        Less valuation allowance.............       (21,069)          (24,830)
                                                  ---------         ---------
           Total deferred tax assets.........            35                19
      Deferred tax liability:
        Depreciation.........................           (35)              (19)
                                                  ---------         ---------
           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, 1999 and 2000.

      The net change in the valuation allowance for the years ended December 31,
1999 and 2000 were increases of approximately  $5,619 and $3,761,  respectively,
related primarily to additional net operating losses incurred by the Company.


                                      F-19


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      At December 31, 2000, the Company had approximately $59,800 of Federal and
$46,500 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  $840
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  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. As of December 31, 2000, assuming no future ownership changes (including
the  financing  in March  2001 - see note  14),  approximately  $25  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 $2,000 annual limitation.

(9)   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 $200, $711 and $940 in 1998, 1999 and
2000, 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-20


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


(10)   COMMITMENTS

      The Company  maintains  various  operating  leases,  primarily  for office
space.   As  of  December  31,  2000,   future   minimum  rent  payments   under
noncancellable operation leases are as follows:

                     2001............     $  337
                     2002............        335
                     2003............        335
                     2004............        332
                     2005............        334
                     Thereafter......      1,195
                                          ------
                          Total......     $2,868
                                          ======
      Rent expense for the years ended December 31, 1998,  1999 and 2000 totaled
$86, $204 and $326, respectively.

      During 1999, the Company 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.

      Subsequent to December 31, 2000, the Company  entered into an agreement to
purchase approximately $1,500 of inventory from its supplier.

(11)   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
1998, 1999 or 2000 in accordance with the terms of the 401(k) Plan.

(12)   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, 1999 and 2000 were $333, $541 and $356, respectively.


                                      F-21


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


(13)   QUARTERLY FINANCIAL DATA (UNAUDITED)

      The tables below  summarize the Company's  unaudited  quarterly  operating
results for 1999 and 2000.  The first three  quarters of 2000 have been restated
pursuant to the adoption of SAB 101 in the fourth  quarter of 2000, as described
in note 7.

                                               Three months ended
                                   ------------------------------------------
                                   March 31,  June 30,   Sept. 30,   Dec. 31,
                                     1999       1999        1999       1999
                                   ---------  ---------  ----------  --------

     Total revenues ...........    $ 2,418    $ 3,438    $ 4,345     $ 5,880
     Gross margin on product
       sales ..................      1,867      2,500      3,359       4,346
     Net loss .................     (5,089)    (4,142)    (3,286)     (2,074)
     Net loss allocable to
       common stockholders ....     (5,089)    (4,377)    (3,715)     (2,502)
     Basic and diluted net
       loss per share
       allocable to common
       stockholders ...........      (0.59)     (0.51)     (0.43)      (0.29)


                                      F-22


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


                                               Three months ended
                                   ------------------------------------------
                                   March 31,  June 30,   Sept. 30,   Dec. 31,
                                     2000       2000        2000       2000
                                   ---------  ---------  ----------  --------

     Total revenues............    $ 6,530    $ 6,612     $ 5,259     $ 5,870
     Gross margin on product
       sales...................      4,340      4,596       3,436       4,059
     Net loss..................     (2,837)    (1,990)     (2,052)     (1,951)
     Net loss allocable to
       common stockholders
       before cumulative
       effect of change in
       accounting principle....     (2,496)    (2,416)     (2,481)     (2,362)
     Net loss allocable to
       common stockholders.....     (3,260)    (2,416)     (2,481)     (2,362)
     Basic and diluted net
       loss per share
       allocable to common
       stockholders before
       cumulative effect of
       change in accounting
       principle...............       (0.29)     (0.28)      (0.28)     (0.27)
     Basic and diluted net
       loss per share
       allocable to common
       stockholders............       (0.38)     (0.28)      (0.28)     (0.27)


                                      F-23


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      The table below reflects the effect of the change in accounting  principle
on net loss allocable to common  stockholders and basic and diluted net loss per
share allocable to common  stockholders  under the Company's  historical revenue
recognition  policy as a result of the adoption of SAB 101 in the fourth quarter
of 2000.

                                               Three months ended
                                   ------------------------------------------
                                   March 31,  June 30,   Sept. 30,   Dec. 31,
                                     2000       2000        2000       2000
                                   ---------  ---------  ----------  --------

     Net loss allocable to
       common stockholders
       under historical
       revenue recognition
       policy...................    (2,866)    (2,327)     (2,276)     (2,311)
     Effect of change in
       accounting principle.....       370        (89)       (205)        (51)
     Cumulative effect of
       change in accounting
       principle................      (764)        --          --          --
                                    -------    -------     -------     -------
     Net loss allocable to
       common stockholders
       after effect of
       change in accounting
       principle, as restated ..   $(3,260)   $(2,416)    $(2,481)    $(2,362)
                                   ========    =======     =======     =======


                                      F-24


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


                                               Three months ended
                                   ------------------------------------------
                                   March 31,  June 30,   Sept. 30,   Dec. 31,
                                     2000       2000        2000       2000
                                   ---------  ---------  ----------  --------

      Basic and diluted net
        loss per share
        allocable to common
        stockholders under
        historical revenue          $  (0.33)  $  (0.27)   $  (0.26)   $ (0.27)
        recognition policy......
      Effect of change in
        accounting principle....        0.04      (0.01)      (0.02)       --
      Cumulative effect of
        change in accounting
        principle...............       (0.09)       --          --         --
                                    --------   -------     -------     ------
      Basic and diluted net
        loss per share
        allocable to common
        stockholders after
        effect of change in
        accounting principle,
        as restated.............    $  (0.38)  $  (0.28)   $  (0.28)   $  (0.27)
                                    ========   ========    ========    ========
(14)   SUBSEQUENT EVENTS

      On March 12, 2001, the Company  consummated a private  equity  offering of
1,500,000  shares of Common  Stock for an  aggregate  purchase  price of $7,500,
which  generated  net  proceeds  to the  Company  of  approximately  $6,900.  In
addition,  the  investors  in this  financing  were also issued an  aggregate of
400,000  warrants which are  exercisable  for up to three (3) years into 400,000
shares of the  Company's  Common Stock at an exercise  price per share of $6.00.
The  consideration  received  for such  warrants is  included  in the  aggregate
proceeds  received in the  financing.  The Company also issued to its  financial
advisor in this  financing,  warrants to purchase an aggregate of 150,000 shares
of the Company's  Common  Stock,  exercisable  for up to three (3) years,  at an
exercise price of $5.70 per share.  These  warrants may be deemed  automatically
exercised in certain  circumstances  based on the  Company's  stock  price.  The
Company  is  obligated  to  file  and  maintain  the  effectiveness  of a  shelf
registration  statement  with  respect to all such shares of Common Stock issued
and shares  underlying all such warrants  beginning no later than June 10, 2001.
Should the Company fail to obtain  effectiveness of such registration  statement
by June  10,  2001,  or to  maintain  the  effectiveness  of  such  registration
statement for a continuous  twenty-four (24) month period, the investors and the
financial  advisor shall  receive an  additional  27,500 shares of the Company's
Common Stock, in the aggregate, for no additional consideration.  As a result of
this  financing,  the  conversion  price  paid on the  Preferred  Stock has been
reduced to $9.94 per share.


                                      F-25


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1998, 1999 and 2000

                  (dollars in thousands, except per share data)


      On March 19, 2001,  the Company  consummated a revolving  credit  facility
(the "Facility")  with Silicon Valley Bank (the "Bank").  The Company may borrow
up to the lesser of $3,000 or 80% of eligible accounts  receivable,  as defined.
The amount available is also reduced by outstanding  letters of credit which may
be issued under this agreement in amounts totaling up to $1,500.  The Company is
not  obligated to draw  amounts  under the Facility and any such draws will bear
interest, payable monthly, at the then prevailing prime rate plus 1.5% per annum
and may be used only for working  capital  purposes.  Without the consent of the
Bank, the Company,  among other things,  shall not (i) merge or consolidate with
another entity; (ii) acquire assets outside the ordinary course of business;  or
(iii) pay or declare any cash  dividends  on the  Company's  Common  Stock.  The
Company must also maintain a certain  tangible net worth and a minimum of $2,000
in cash, net of borrowings  under the Facility,  at all times during the term of
the Facility.  In addition,  the Company has secured its  obligations  under the
Facility  through the granting of a security  interest in favor of the Bank with
respect to all of the Company's assets, including its intellectual property.




                                      F-26


<PAGE>


                                                                     SCHEDULE II

                 COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARY
                          FINANCIAL STATEMENT SCHEDULE

                        Valuation and Qualifying Accounts

                   Years Ended December 31, 1998 1999 and 2000
                                 (in thousands)


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

      1998          $   --        $  293      $--       $   --        $  293

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

      2000          $  386        $  824      $--       $  829        $  381
--------------------------------------------------------------------------------


                                      F-27