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, 2001
                          -----------------
                                               OR

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

For the transition period from             to
                               ----------     -----------

                         Commission File Number 0-28308

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


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

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


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

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

      Title of each class             Name of Each Exchange on Which Registered
-----------------------------      ---------------------------------------------
None

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

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


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


<PAGE>


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

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

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

     State  the  aggregate  market  value of the  voting  common  stock  held by
non-affiliates  of the  registrant:  $102,771,570 at March 15, 2002 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, 2002:

        Class                                    Number of Shares
        -----                                    ----------------
        Common Stock, $0.01 par value               11,110,019

     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 2002 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..............................................    31
          3.     Legal Proceedings.......................................    31
          4.     Submission of Matters to a Vote of Security Holders.....    31

PART II   5.     Market for the Company's Common Equity and Related
                    Stockholder Matters..................................    32
          6.     Selected Consolidated Financial Data....................    32
          7.     Management's Discussion and Analysis of Financial
                    Condition and Results of Operations..................    35
          7A.    Quantitative and Qualitative Disclosures about
                    Market Risk..........................................    51
          8.     Financial Statements and Supplementary Data.............    51
          9.     Changes in and Disagreements with Accountants on
                    Accounting and Financial Disclosure..................    52

PART III  10.    Directors and Executive Officers of the Registrant......    53
          11.    Executive Compensation..................................    53
          12.    Security Ownership of Certain Beneficial Owners and
                    Management...........................................    53
          13.    Certain Relationships and Related Transactions..........    53

PART IV   14.    Exhibits, Financial Statement Schedules, and Reports
                    on Form 8-K..........................................    54

SIGNATURES...............................................................    55

EXHIBIT INDEX............................................................    57

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


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                                     PART I

ITEM 1     BUSINESS.

GENERAL

     CollaGenex   Pharmaceuticals,   Inc.  and   subsidiaries   is  a  specialty
pharmaceutical   company  currently  focused  on  providing  innovative  medical
therapies  to  the  dental  and   dermatology   markets.   Our  first   product,
Periostat(R),  is an orally administered,  prescription  pharmaceutical  product
that was approved by the United States Food and Drug Administration in September
1998 and is the first and only  pharmaceutical  to treat adult  periodontitis by
inhibiting the enzymes that destroy  periodontal  support tissues.  Periostat is
indicated as an adjunct to scaling and root planing,  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."

     We market  Periostat  to the  professional  dental  community in the United
States  through  our  professional   pharmaceutical  sales  force  comprised  of
approximately  120 sales  representatives  and  managers.  Our sales  force also
markets Vioxx(R), a prescription  non-steroidal  anti-inflammatory  drug (NSAID)
developed by Merck & Co., Inc. In October 2001, pursuant to an exclusive License
and Marketing Agreement with Atrix  Laboratories,  Inc., we also began to market
and sell Atridox(R),  Atrisorb(R)  FreeFlow and Atrisorb(R)-D,  Atrix's products
for the treatment of adult periodontitis, to the United States dental market.

     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.  We are
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),  our lead compound for the treatment of
metastatic  cancer,  were initiated in January 1998 under the sponsorship of the
National Cancer Institute.  In Phase I clinical trials, Metastat demonstrated an
overall tumor  response rate of 44% in patients with Kaposi's  sarcoma,  and the
National Cancer Institute has opened enrollment for a Phase II clinical trial to
continue to evaluate the safety and efficacy of Metastat in HIV-related Kaposi's
sarcoma.

     In January  2002,  we  announced  our plans to expand into the  dermatology
market.   In  September   2001,  we  announced  the  results  of  a  59-patient,
double-blinded,  placebo-controlled  clinical  trial  designed to  evaluate  the
efficacy of Periostat to treat adult  patients with acne.  The results from this
trial revealed that the patients who were administered  Periostat  experienced a
greater than 50% reduction in the number of comedones,  inflammatory lesions and
total lesions relative to baseline lesion counts, a statistically greater number
than in the  placebo  group.  During  2002 we intend to  continue  the  clinical
development of Periostat for the treatment of inflammatory  acne and to initiate
a pilot  clinical  trial to evaluate the use of Periostat  to treat  rosacea,  a
related  dermatological  condition that affects  approximately  15 to 20 million
patients  in the  United  States.  We are  actively  seeking  product  licensing
opportunities to enhance our near-term  offerings to the dermatology  market and
in February 2002 we announced that we had



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<PAGE>

licensed  a  new  dermal  and  transdermal  drug  delivery   technology   called
Restoraderm(TM), which we intend to develop for dermatological applications.

     Our core  technology  is licensed on an  exclusive  basis from the Research
Foundation  of the State  University of New York at Stony Brook,  or SUNY.  SUNY
also conducts  research and development on other  potential  applications of the
core technology on a project basis.

     The Company  was  incorporated  in Delaware in January  1992 under the name
CollaGenex,  Inc. We changed  our name to  CollaGenex  Pharmaceuticals,  Inc. in
April 1996. Our executive offices are located at 41 University Drive, Suite 200,
Newtown, Pennsylvania 18940, and our telephone number is (215) 579-7388.

     Periostat(R),  Metastat(R),  Dermostat(R),   Nephrostat(R),   Osteostat(R),
Arthrostat(R), Rheumastat(R), Corneostat(R), Gingistat(R), IMPACS(TM), PS20(TM),
The Whole Mouth  Treatment(TM),  Restoraderm(TM)  and  Dentaplex(TM)  are United
States   trademarks   of   CollaGenex   Pharmaceuticals,    Inc.   Periostat(R),
Nephrostat(R), Optistat(R), and Xerostat(R) are European Community trademarks of
CollaGenex  Pharmaceuticals,  Inc.  Periostat(R),   Nephrostat(R),  Optistat(R),
Xerostat(R),  IMPACS(R) and  Dentaplex(R)  are United Kingdom  trademarks of our
wholly-owned  subsidiary,  CollaGenex  International Limited.  CollaGenex(R) and
PS20(R) are both European  Community and United Kingdom trademarks of CollaGenex
International  Limited.  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 CollaGenex  Pharmaceuticals,  Inc. or
any of our subsidiaries.

PRODUCTS

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 scaling and root
planing,  a mechanical  procedure that removes  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 scaling  and root  planing  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
is


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<PAGE>

intended to be taken orally by the patient  between dental  visits.  Periostat's
mechanism of action is believed in part to be through the down-regulation of the
activity of collagenases,  enzymes that belong to a broad class of enzymes known
as matrix metalloproteinases. Collagenase is excessively produced as a result of
inflammation  resulting from bacterial infection in the gums. In September 1998,
the FDA granted United States marketing  approval for Periostat as an adjunct to
scaling  and root  planing 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 1.5 million  Periostat  prescriptions  have
been filled and over 35,000 dentists have written a Periostat prescription.

     In December 2000 and February 2001, the United  Kingdom  Medicines  Control
Agency and the FDA,  respectively,  granted  marketing  approval  for our tablet
formulation of Periostat.  In July 2001, we launched a new tablet formulation of
Periostat.  The  Periostat  tablet  formulation  is easier to swallow and offers
manufacturing cost advantages over our capsule  formulation of Periostat,  which
has been  discontinued.  In August 2001,  we were advised by the  Department  of
Health in the United  Kingdom that  Periostat  tablets were placed on the Dental
Practitioners Formulary under the National Health Service,  allowing patients in
the United Kingdom to receive  Periostat via prescription by contributing only a
modest co-payment, or no co-payment at all.

     We have applied for the registration of Periostat tablets with the European
Union Member States and Norway under the Mutual Recognition Procedure,  with the
United Kingdom  Medicines  Control Agency acting as our Reference  Member State.
Under  the  Mutual  Recognition   Procedure,   once  marketing  approval  for  a
pharmaceutical  is granted by one European Member State, such state then acts as
a Reference  Member State and assists in  expediting  the review and approval of
the pharmaceutical in other European Member States.

     In February  2002,  we received  provisional  approval for the marketing of
Periostat from seven European Member States including Austria, Finland, Ireland,
Italy,  Luxembourg,  the  Netherlands  and Portugal.  We expect to receive final
approval to market  Periostat in these  countries  following  our  submission of
local language labeling based on the text approved under the Mutual  Recognition
Procedure.

     Submissions  for approval of Periostat  have also been made in  Switzerland
and Israel. The regulatory  authorities in Switzerland have requested additional
information.  The regulatory  authorities in Israel have approved  Periostat for
sale in  Israel  as of March  2002.  A  submission  was also made in 2001 to the
regulatory authorities in Oman.

     Periostat tablets are manufactured for us by  Pharmaceutical  Manufacturing
Research Services,  Inc., a contract  manufacturing company. We intend to supply
Periostat  tablets to our foreign  marketing  partners upon receipt of requisite
regulatory  approvals,  if at all, for  distribution in countries other than the
United States and the United Kingdom.



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<PAGE>

Vioxx

     Pursuant to a  Co-Promotion  Agreement we executed  with Merck in September
1999,  we  received  the  exclusive  right to  co-promote  Vioxx  to the  dental
community. Vioxx is a prescription strength non-steroidal anti-inflammatory drug
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 us
upon sales of Vioxx to the dental community.  The existing  agreement with Merck
expires  in 2002  and is  renewable  upon  mutual  agreement.  We are  currently
evaluating our options with respect to this agreement.

Atridox, Atrisorb FreeFlow and Atrisorb-D

     Pursuant to the terms of an exclusive License and Marketing  Agreement that
we executed with Atrix Laboratories,  Inc. in August 2001, we obtained the right
to market,  sell and distribute Atrix's  proprietary  dental products,  Atridox,
Atrisorb  FreeFlow and  Atrisorb-D  to the United States  dental  community.  We
believe that these products generally  complement  Periostat in the treatment of
adult periodontal disease.

     Pursuant to the terms of the License and Marketing  Agreement,  among other
things:  Atrix will  manufacture  the  products  for us; we paid to Atrix a $1.0
million  licensing fee to market such  products;  we have agreed to pay to Atrix
royalties  on future  net sales of the  products  each  calendar  year;  we have
committed  to no less than $2.0  million in  advertising  and  selling  expenses
related to the products  during the fiscal year  beginning  January 1, 2002;  we
have  agreed to  maintain,  for a period of 24 months,  a force of no fewer than
ninety (90) fulltime  dental  consultants,  divisional and regional  managers to
make sales and product recommendation calls on dental professionals; and we have
agreed  that the  products  will be the  subject of a specific  number of detail
calls in the United States during 2002. We will also be required to make certain
minimum  expenditures  for advertising and  promotional  activities  after 2002,
including:  (i) the lesser of $4,000,000 or 30% of our contribution  margin,  as
defined in the  agreement,  relating to a specific Atrix product that we market,
and (ii) the lesser of $2,000,000 or 30% of our contribution  margin, as defined
in the agreement, relating to a separate Atrix product that we market.

     In addition,  Atrix  purchased  330,556  unregistered  shares of our common
stock at a price of $9.08 per share.

     The License and Marketing Agreement  terminates  incrementally with respect
to each  Atrix  product,  upon each  successive  expiration  date of the  patent
protection  afforded to such product. We may terminate the License and Marketing
Agreement  at any time,  with or without  cause,  upon 12 months  prior  written
notice to Atrix. Furthermore,  either party may terminate the agreement upon the
occurrence  of certain  conditions,  as more fully set forth in the  License and
Marketing Agreement.

     Atridox is a  locally-applied  anti-microbial  therapy for the treatment of
adult  periodontitis.  Atridox uses Atrix's  patented drug delivery  technology,
Atrigel(R),  for the targeted delivery of the


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antibiotic doxycycline, which has been shown to reduce the levels of bacteria in
the  periodontal  pocket.  Atridox  is  a  gel  that  is  placed  into  affected
periodontal pockets by a dental professional and resorbs over a two week period.
In pivotal  double-blinded,  placebo-controlled  clinical  trials  conducted  by
Atrix,  the  administration  of Atridox was shown to increase  attachment  level
between the gums and the teeth and decrease periodontal pocket depth in patients
with adult periodontitis.

     Atrisorb  FreeFlow is a guided tissue  regeneration  (GTR) barrier  product
used in connection with gum surgeries.  In periodontal surgery, a section of the
gums called a flap is cut away from the  underlying  bone structure to allow the
periodontist  to repair  the  periodontal  support  structure.  When the flap is
subsequently repositioned,  a membrane barrier product such as Atrisorb FreeFlow
is placed  between the flap and the bone to prevent the downgrowth of epithelial
tissues,  which  interferes  with the  re-attachment  of the gums to the  teeth.
Atrisorb-D  is the first GTR  barrier  product  to  incorporate  an  antibiotic,
doxycycline,  which has been shown to reduce the incidence of infections  during
GTR procedures.

Dentaplex

     In June 2001, we launched Dentaplex, a nutritional supplement  specifically
formulated  to help  maintain  optimal oral  health.  Based upon a review of the
market  acceptance of Dentaplex,  by United States  retailers,  we are currently
evaluating the future marketability of the product.

Denavir

     Denavir is an FDA approved  topical  antiviral cream used for the treatment
of cold sores. We marketed  Denavir to the dental community under a Co-Promotion
Agreement  that we executed  with  SmithKline  Beecham  Consumer  Healthcare  in
October  1998,  which  agreement  provided  for certain  payments by  SmithKline
Beecham to us.  Following the  acquisition  of  SmithKline  Beecham by Novartis,
Novartis terminated this Co-Promotion  Agreement effective April 13, 2001. We no
longer co-promote Denavir.

SALES AND MARKETING

     We market and sell our  products in the United  States  through a dedicated
sales force comprised of approximately 120 sales  representatives  and managers.
We intend to market Periostat in foreign markets,  upon receipt of all requisite
regulatory approvals,  primarily through marketing and distribution partnerships
with companies in these markets.  We currently have such agreements with foreign
companies,  subject to requisite  regulatory  approvals,  covering Japan, Italy,
Canada, Spain, Portugal,  Greece,  Israel, Austria and Switzerland,  and have an
export  marketing  agreement for countries in the Middle East. In November 2001,
we terminated  our  distribution  and marketing  agreement for Germany with Hain
Diognostika  GmbH due to Hain's  failure  to fulfil  its  obligations  under the
agreement.  We are seeking  compensation  from Hain based on the  non-payment of
milestone  fees due to CollaGenex  according to the terms of the  agreement.  We
will  continue to seek  requisite  regulatory  approvals  in Germany and another
marketing partner to replace Hain.

     A capsule  formulation  of  Periostat  was  approved by the United  Kingdom
Medicines  Control  Agency in February  2000,  and we  launched a modest  direct
marketing effort in the


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<PAGE>

United  Kingdom to dentists  through our United Kingdom  subsidiary,  CollaGenex
International  Limited.  In December 2000 the United Kingdom  Medicines  Control
Agency  approved a tablet  formulation of Periostat and in June 2001, we applied
for the registration of Periostat  tablets with the European Union Member States
and  Norway  under the Mutual  Recognition  Procedure,  with the United  Kingdom
Medicines Control Agency acting as our Reference Member State.

     Under the Mutual  Recognition  Procedure,  once  marketing  approval  for a
pharmaceutical  is granted by one European Member State, such state then acts as
a Reference  Member State,  and assists in expediting the review and approval of
the pharmaceutical in other European Member States.

     In February  2002,  we received  provisional  approval for the marketing of
Periostat from seven European Member States including Austria, Finland, Ireland,
Italy,  Luxembourg,  the  Netherlands  and Portugal.  We expect to receive final
approval to market  Periostat in these  countries  following  our  submission of
local language labeling based on the text approved under the Mutual  Recognition
Procedure.

     Submissions  for approval of Periostat  have also been made in  Switzerland
and Israel. The regulatory  authorities in Switzerland have requested additional
information.  The regulatory  authorities in Israel have approved  Periostat for
sale in  Israel  as of March  2002.  A  submission  was also made in 2001 to the
regulatory authorities in Oman.

     In February  2002,  we announced  that we had  appointed  Dexcel-Dental,  a
division of Dexcel-Pharma  Limited,  to handle the field selling of Periostat to
the  dental  profession  in the  United  Kingdom  and,  upon  receipt  of  final
regulatory approval, the Republic of Ireland.

     Our 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.

     United States

     Our  field  sales  organization  is  currently  comprised  of two  regional
managers,  eleven district managers and  approximately 105 full-time  equivalent
sales  representatives.   Each  full-time  equivalent  sales  representative  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 scaling and root planings  performed
in their respective practices.

     Our field sales organization currently details Periostat, Atridox, Atrisorb
FreeFlow,  Atrisorb-D  and Vioxx.  Under the terms of our License and  Marketing
Agreement with Atrix, we have committed to: (i) expend no less than $2.0 million
in advertising  and selling  expenses  related to the Atrix products  during the
fiscal year beginning January 1, 2002; (ii) maintain, for a period of 24 months,
a force of no less than ninety (90) full time dental  consultants and divisional
and regional managers to make sales and product  recommendation  calls on dental
professionals;  and (iii)  making the Atrix  products  the subject of a specific
number  of  detail  calls in the  United  States  during  2002.  We will also be
required to make certain  minimum  expenditures  for advertising and promotional
activities after 2002, including: (i) the lesser of


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$4,000,000  or 30% of our  contribution  margin,  as defined  in the  agreement,
relating  to a specific  Atrix  product  that we market,  and (ii) the lesser of
$2,000,000  or 30% of our  contribution  margin,  as defined  in the  agreement,
relating to a separate Atrix product that we market.

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

     Sales  training is an important  component of our  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 and  medical  product  line and
leverage  our sales and  marketing  organization,  we are  actively  seeking  to
in-license  or  acquire  other  high-quality   therapeutic  dental  and  medical
products.

     United States Direct-to-Consumer Advertising Campaign

     Direct-To-Consumer,  or DTC,  advertising  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.
When we conducted certain market research during 2000, we 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.  Accordingly,
following the successful  completion in January 2001 of a three-month,  two-city
test to  evaluate  the  impact of DTC  advertising  on the  growth of  Periostat
prescriptions,  we expanded  our DTC  campaign to a number of cities  across the
country.  Approximately  60% of the prescribing  base we had at the beginning of
2001 was exposed to between two and six months of DTC  advertising  during 2001.
Prescription growth in the cities exposed to DTC advertising was markedly higher
than those  cities  that were not exposed to DTC  advertising,  and we intend to
continue DTC advertising during 2002.

     International

     We are  establishing  relationships  with key  partners  to market and sell
Periostat  internationally,  upon receipt of the  requisite  foreign  regulatory
approvals.  In 1996, we 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, we 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 withdrawn the Marketing  Authorization  for
Approval in Italy, and Italy was included under the


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<PAGE>

pan-European  Mutual  Recognition  Procedure,  which we filed in June  2001.  In
February 2002, we received provisional approval to market Periostat in Italy. As
with our other marketing and distribution  agreements with European partners, it
is our intent to supply Roche with finished  product and our existing  agreement
with Roche will be modified accordingly.

     In  July  1998,  we  executed  a  licensing   agreement  with  Laboratoires
Pharmascience  S.A. 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 we received notice from  Laboratories
Pharmascience  terminating the 1998 license agreement.  After  negotiation,  the
parties  mutually  agreed to  discontinue  their  relationship.  We are actively
seeking a partner to market and distribute  Periostat in France, upon receipt of
requisite regulatory approvals in such region.

     In October 1998, we announced  that a Marketing  Authorization  Application
had been filed with the United Kingdom  Medicines Control Agency with respect to
Periostat. In February 2000, the United Kingdom Medicines Control Agency granted
marketing  approval for Periostat for the adjunctive  treatment of chronic adult
periodontitis.  On May 2, 2000, we announced that we had filed another Marketing
Authorization  Application  with the United  Kingdom  Medicines  Control  Agency
seeking  marketing  approval  of our  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  Marketing  Authorization
Applications  was filed  with the United  Kingdom  Medicines  Control  Agency in
February 2001 and formed the basis for our application for approval of Periostat
under the European Mutual Recognition Procedure, which we filed in June 2001.

     In February  2002,  we received  provisional  approval for the marketing of
Periostat from seven European Member States including Austria, Finland, Ireland,
Italy,  Luxembourg,  the  Netherlands  and Portugal.  We expect to receive final
approval to market  Periostat in these  countries  following  our  submission of
local language labeling based on the text approved under the Mutual  Recognition
Procedure.

     We  cannot  be  certain  that  we will  achieve  other  foreign  regulatory
approvals or will be successful in marketing  Periostat in the United Kingdom or
other European countries.

     We  executed a licensing  agreement  with  Pharmascience  Inc. 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 active review by the Canadian authorities.

     On May 2, 2000,  we announced  that we 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


                                       8
<PAGE>

Greece,  pending  requisite  regulatory  approval.   Following  the  provisional
approval  of  Periostat  in  Portugal,  ISDIN  S.A.  continues  to work with the
Portuguese  authorities to complete the requisite final regulatory  approvals to
launch  Periostat  during  2002.  ISDIN S.A.  is also  providing  assistance  in
connection with the refiling of our regulatory submission in Spain.

     On  June  9,  2000,  we  announced  that  we  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. Periostat has
received  provisional  approval  under  the  Mutual  Recognition  Procedure  for
marketing  in  Austria,  and  Willvonseder  &  Marchesani  is  working to launch
Periostat  in 2002,  subject to the  receipt of final  regulatory  approval.  In
addition,  we are  working  with Karr  Dental to  provide  additional  requested
information to regulatory  authorities  in  Switzerland  in connection  with our
submission for regulatory approval in Switzerland.

     On August 9, 2000, we announced that we 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.  Showa  continues  to work with the  regulatory
authorities in Japan to establish the appropriate  clinical  development program
in order to gain  regulatory  approval  for  Periostat in Japan.  In  connection
therewith,  Showa  intends to conduct a study during 2002 to establish  that the
pharmacokinetics of Periostat are similar in Japanese and Caucasian populations.

     On August 24, 2000, we announced  that we had executed an agreement for the
marketing and distribution of Periostat in Israel with Taro International  Ltd.,
a wholly-owned subsidiary of Taro Pharmaceutical  Industries Limited, an Israeli
company,  pending requisite regulatory approval. Such agreement provides for the
payment of milestone  fees to us  associated  with the  regulatory  approvals of
Periostat,  if any. In February 2002, the Israeli authorities notified Taro with
respect to the provisional  approval of Periostat in Israel.  Final confirmation
of approval was obtained in March 2002.

     On January 30, 2001,  we announced  that we had signed an exclusive  Middle
East Export  Marketing  Agreement  with Pharma Med Inc. 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.  A regulatory
filing has been made with the authorities in Oman.

     On February 11, 2002, we announced that we have appointed Dexcel-Dental,  a
division  of  Dexcel-Parma  Limited,  to handle the field  selling of  Periostat
tablets to the  professional  dental  market in the  United  Kingdom  and,  upon
receipt of final regulatory approval, the Republic of Ireland.

MANUFACTURING, DISTRIBUTION AND SUPPLIERS

     In 1995,  we entered into a supply  agreement  with  Hovione  International
Limited pursuant to which the active  ingredient in Periostat,  doxycycline,  is
supplied  to us by Hovione  from its  offshore  facilities.  Hovione  supplies a
substantial portion of the doxycycline used in the United


                                       9
<PAGE>

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,
pursuant to an addendum to that agreement, the term was extended to May 14, 2006
and thereafter  automatically  renews 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.  We rely on Hovione as
our sole supplier of doxycycline, and have no back-up supplier at this time.

     We  historically  relied  on a single  third-party  contract  manufacturer,
Applied  Analytical  Industries,   Inc.,  to  produce  Periostat  in  a  capsule
formulation.  AAI served  notice of its intent to  terminate  its  agreement  to
supply Periostat  capsules to us as of November 2001. In an effort to capitalize
on certain  manufacturing  cost  advantages,  in July 2001,  we launched our new
tablet formulation of Periostat,  which has now replaced our capsule formulation
of Periostat.

     On September 26, 2000, we entered into a Service and Supply  Agreement with
a contract manufacturer,  Pharmaceutical  Manufacturing Research Services, Inc.,
for such tablet  formulation  for Periostat,  and we are,  therefore,  no longer
dependent  upon,  nor do we utilize,  AAI.  Our  agreement  with  Pharmaceutical
Manufacturing Research Services has an initial term of three years, during which
time  we  have   committed  to  certain   minimum  needs,   and   Pharmaceutical
Manufacturing  Research  Services  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.  We have
fulfilled our initial purchase orders with Pharmaceutical Manufacturing Research
Services and expect to make certain  purchases through 2002 to take advantage of
volume  price  discounts.  Pharmaceutical  Manufacturing  Research  Services  is
required to comply with good manufacturing practices, or GMP requirements.

     In November 1998, we executed a Distribution  Services  Agreement with Cord
Logistics, Inc., pursuant to which Cord acts as our 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 our sales force and various  customer
and  financial  support  services  to us,  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.  We  negotiated a  three-year  extension  of such  agreement  having
similar terms to the original agreement with an effective date of March 1, 2002.

     In  February  2002,  we executed a Wholesale  Service  Agreement  effective
November 2001 with National Specialty Services, Inc., pursuant to which National
Specialty Services acts as our non-exclusive  authorized distributor of Atridox,
Atrisorb FreeFlow and Atrisorb-D. Under this


                                       10
<PAGE>

agreement,  National  Specialty  Services will also provide  certain  additional
services,   including  marketing,  sales  detail  report  production,   contract
administration and chargeback processing. The Wholesale Service Agreement has an
initial  term of three  years  and  shall  renew  automatically  for  successive
one-year periods unless notice of termination is provided by either party ninety
(90) days prior to expiration.

     We cannot be  certain  that we 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  we are  unable  to  obtain  sufficient
quantities of doxycycline or Periostat on commercially reasonable terms, or in a
timely  manner,  or if our  suppliers  fail to comply  with  good  manufacturing
practices,  or GMP,  or if our  distributors  are unable to ship or support  our
products,  our business,  financial  condition and results of operations  may be
materially adversely affected. See "--Government Regulation."

CUSTOMERS

     During 2001, net product sales to each of the McKesson Drug Company, Bergen
Brunswig Drug Company,  Cardinal Health, Inc. and Walgreens,  Inc. accounted for
28%, 15%, 13% and 10%, respectively, of our aggregate net product sales.

RESEARCH AND DEVELOPMENT

     Our research and  development  activities are conducted  primarily by third
parties,  such as contract  research  organizations  and 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,  our lead compound for treating  metastatic
cancer.

     On October 18,  2000,  we  announced  that we had  received a Phase I Small
Business  Technology  Transfer  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 our  compounds  known as  IMPACS
(Inhibitors  of  Multiple  Proteases  and  Cytokines)  for  the  prevention  and
treatment of acute lung injury.

     Major research  programs  currently being conducted at CollaGenex  include:
(i) the  clinical  development  of the  sub-antimicrobial  dose  of  doxycycline
commercialized as Periostat for the treatment of inflammatory  acne, rosacea and
ocular rosacea (blepharitis); (ii) the development of a "once-a-day" formulation
of Periostat;  and (iii) limited support for the conduct of exploratory  studies
in the utility of Metastat  (COL-3) as a treatment  for soft tissue  sarcoma and
periodontitis.

     The clinical  development  of Periostat  in acne,  rosacea and  blepharitis
remains  exploratory  and  programs  will be  developed  during  2002  following
discussions  with the FDA  regarding  the  requirements  to be fulfilled for the
submission  of a  supplemental  new  drug  application  for  any  or  all of the
potential  clinical  indications.  No trials are  presently  underway;  however,
during 2002, we anticipate that the following activities will be initiated:  (i)
a pilot study in rosacea, utilizing approximately 120 patients; (ii) a Phase III
study in inflammatory acne, utilizing  approximately 200 patients;  and (iii) an
exploratory study in blepharitis, utilizing


                                       11
<PAGE>

approximately  60  patients.  It is  unlikely  that  these  studies  will  yield
meaningful  results  until 2003,  however,  based on  anecdotal  reports and the
results from the preliminary  clinical study in inflammatory acne carried out in
2000 and 2001, we anticipate that Periostat will demonstrate  clinical  efficacy
for all three  indications.  It is premature to determine  whether such efficacy
will be sufficient to achieve  statistical  significance or to provide the basis
for a regulatory filing.

     The  development  of the  once-a-day  formulation  of  Periostat  is  being
conducted  through a  development  agreement  with an  external  contractor.  We
anticipate  that the  first  formulations  arising  from this  research  will be
administered to human volunteers during 2002;  however,  because little is known
about the  absorption of doxycycline  from the  gastro-intestinal  tract,  these
studies  will be  experimental  in nature and the results of these  studies will
define the next phase of the  development  program.  We do not anticipate that a
final  formulation  will be available for clinical testing until 2003 or beyond,
if ever.

     Metastat,  our  antiangiogenesis  drug,  continues  development  under  the
auspices of a cooperative research and development agreement, or CRADA, with the
National Cancer Institute, which was extended in February 2002 for an additional
two years. We are responsible for providing a formulated,  encapsulated  version
of Metastat to support this clinical  study.  A sufficient  quantity of Metastat
was  produced in 2001 to support the  National  Cancer  Institute's  development
program  as it is  currently  proposed.  Two  studies  are  actively  recruiting
patients.  A Phase  I/II  study in  astrocytoma  and  glioblastoma  (both  brain
cancers) is currently recruiting patients. Such early studies are carried out in
patient  populations with severe refractory  disease and rarely provide evidence
of efficacy. Based on the positive results from the Phase I study carried out in
Kaposi's  sarcoma,  the  AIDS  Malignancy  Consortium  of  the  National  Cancer
Institute  is  sponsoring  a  randomized,  two-dose  Phase II study in  Kaposi's
sarcoma.   This  study  has  currently   recruited   approximately  50%  of  the
approximately 70 planned patients.  Initial indications suggest that the drug is
affording  disease  modifying  efficacy in some patients,  with early reports of
both partial and complete responses. However, the study is blinded and it is not
yet possible to determine  whether there is a dose response  and/or the drug has
sufficient efficacy to justify the conduct of a Phase III clinical study.

     During 2001, we submitted two  investigational new drug applications to the
FDA for the  conduct of  exploratory  clinical  studies  with COL-3 (the  active
ingredient in Metastat) in the treatment of cardiopulmonary  bypass patients and
the  treatment  of adult  periodontitis.  Both are on clinical  hold pending the
submission  to the FDA of additional  information.  In order to help provide the
requested  information,  we conducted a Phase I, ascending dose trial with COL-3
in normal human  volunteers  in order to establish  the maximum  tolerated  dose
which  could be  supported  in the  investigational  new drug  application-based
exploratory studies. While the National Cancer Institute is carrying out studies
with 50 mg and 100 mg of COL-3 per day as the  proposed  efficacious  dose,  our
Phase I study  suggested that the maximum  tolerated dose may be as low as 20 mg
per day. We anticipate  that the clinical hold will be released  during 2002 and
exploratory  clinical  studies  will  be  carried  out  by us  with  respect  to
periodontitis, soft-tissue sarcoma and possibly cardiopulmonary bypass patients.
We do not know  whether  the drug will  exhibit  significant  efficacy  in these
indications to justify further clinical investigation,  particularly if the dose
is significantly limited.



                                       12
<PAGE>

     We have not developed  forecasts for the sale of products  arising from the
commercialization of COL-3, nor do we anticipate spending significant  resources
on the development of COL-3 until it is clear from the studies being carried out
with National  Cancer  Institute or other  sources of external  funding that the
drug has a tolerable  safety  profile  and a high  likelihood  of  clinical  and
commercial success.

     As of December  31,  2001,  we had two  products or product  candidates  in
various  stages of  clinical  trials.  Completion  of  clinical  trials may take
several years or more, but the length of time can vary  substantially  according
to the type,  complexity,  novelty and intended use of a product  candidate.  In
2001, we completed a pilot trial of Periostat in inflammatory acne, and obtained
significant  results,  encouraging  us to  work  towards  the  development  of a
definitive  clinical  trial  plan  for an  indication  for  Periostat  for  this
application.  We  are  planning  to  initiate  additional  clinical  trials  for
Periostat  in acne  patients  during  2002,  pending  FDA review  and  agreement
regarding  protocols and  end-points.  We also  initiated and completed  several
Phase IV studies  of  Periostat  in dental  applications.  Phase IV studies  are
designed to help support  product  marketing and are not  typically  designed to
provide data  suitable for  submission to the FDA for a new  indication  for the
product. We intend to continue the Phase IV development of Periostat in 2002.

     Also in 2001, the National Cancer Institute  initiated Phase I/II trials of
COL-3  (Metastat) in patients with  astrocytoma and  glioblastoma and a Phase II
study in patients  with  HIV-related  Kaposi's  sarcoma.  These  studies  remain
ongoing in 2002. The clinical component of these studies is completely funded by
National  Cancer  Institute   funds,   except  for  a  nominal  payment  to  the
investigators from us to encourage  enrollment.  The time to completion of these
studies  will depend on the rate of patient  enrollment,  which is  difficult to
predict with any certainty. However, it is unlikely that either of these studies
will be completed during 2002.

     CMR International estimates that clinical trials in our franchise areas are
typically completed over the following timelines:

                                                             ESTIMATED
                                                            COMPLETION
                     CLINICAL PHASE                           PERIOD
                     --------------                           ------

                     Phase I                                1 - 2 years
                     Phase II                               2 - 3 years
                     Phase III                              2 - 3 years

     Upon successful  completion of the pilot and Phase II trials we will assess
the data  obtained and make a decision on whether to pursue Phase III trials for
any indication studied in Phase II or pilot studies.  Upon successful completion
of Phase III  trials,  we intend to submit  the  results  to the FDA to  support
regulatory  approval  of COL-3.  However,  we cannot be certain  that any of our
products will prove to be safe or effective,  will receive regulatory approvals,
or will be successfully commercialized.

     The  duration  and the cost  relating to  preclinical  testing and clinical
trials may vary significantly over the life of a project.  Our joint development
arrangement for COL-3 with the


                                       13
<PAGE>

National  Cancer  Institute may also result in  variability  in our  development
costs. We closely monitor our research and development  costs in order to ensure
that our investment is consistent with the return we predict from each project.

     Technology

     Our 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  us  to   pharmaceutically   modulate  the  activity  of  matrix
metalloproteinases.  Matrix  metalloproteinases  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
matrix metalloproteinases and a group of naturally occurring biomolecules called
tissue  inhibitors  of  metalloproteinases,  which  modulate the level of matrix
metalloproteinase  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.

     Our 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 matrix metalloproteinase 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.  Our 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.  We have conducted,  and are currently conducting,  Phase IV clinical
studies to support future marketing activities of Periostat.



                                       14
<PAGE>

     Our  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 potential in a number of pre-clinical models
of excessive  connective tissue breakdown.  Our 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

     We are  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 scaling and root planing in institutionalized geriatric patients, the
evaluation  of  Periostat  as an adjunct to scaling and root planing in patients
with Type I and Type II diabetes and the use of  Periostat  in a  population  of
smokers.  To extend the possible  therapeutic  use of Periostat  beyond the oral
cavity, we and our  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.   Of  these  studies  only  the  posterior
blepharitis study is being funded by us.

     A Phase IV clinical trial conducted at the University of Pittsburgh  Dental
School, the results of which were announced by us in October 2000,  demonstrated
significant  clinical benefit in patients with severe generalized  periodontitis
who were administered  Periostat in conjunction with a course of repeated dental
cleaning,  above and below the  gum-line  compared  to the same  therapy  plus a
placebo.

     In January 2002,  we announced  plans for  expansion  into the  dermatology
market.  On October 1, 2001,  we  announced  the  clinically  and  statistically
significant  results of a  six-month,  59-patient  clinical  trial  designed  to
evaluate the efficacy of Periostat  for the  treatment of patients with moderate
acne.

     The results showed that the patients receiving  Periostat  experienced more
than a 50% mean  reduction in comedones and  inflammatory  lesions from baseline
levels. Patent applications for Periostat to treat acne have been filed with the
U.S. Patent and Trademark Office.

     The Periostat acne clinical trial was a  multi-center,  placebo-controlled,
double-blind  study chaired by Dr. Robert Skidmore,  Chief of Dermatology at the
University of Florida


                                       15
<PAGE>

Medical  Center,  and  was  also  conducted  by  Dr.  Rodney  Kovach,  Chief  of
Dermatology at West Virginia  University  Health  Sciences  Center.  The results
revealed statistically and clinically significant benefits to patients receiving
Periostat  for all three of the  pre-established  primary  endpoints:  change in
total comedones, total inflammatory lesions and total lesion counts.

     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 us at two major universities
suggest  that  several of our 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   matrix
metalloproteinases  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 us exhibited an ability to inhibit
metastasis.

     In October  1996,  we executed a letter of intent with the National  Cancer
Institute  to  formalize a  collaborative  research  and  development  agreement
pursuant to which the National Cancer Institute agreed to perform  pharmacology,
toxicology  and  Phase  I  clinical  trials  using  our  lead  compound  for the
prevention of cancer metastasis, Metastat.

     In June 1997, we announced that we had formally  extended our Collaboration
Agreement with the National Cancer  Institute with respect to the development of
Metastat.  On December 5, 1997, we announced that the National Cancer  Institute
had filed an investigational new drug application for Metastat. In January 1998,
we initiated Phase I clinical trials with respect to Metastat. Such studies were
sponsored  by the  National  Cancer  Institute  pursuant  to  our  Collaboration
Agreement  with the National  Cancer  Institute.  In February  1999, we 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,
we 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 National Cancer Institute advised us that
it believed that the level of photosensitivity, although manageable, could limit
the commercial  viability of Metastat.  However,  the National Cancer  Institute
also advised us 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 was  initiated  in the first half of 2001.  Results from
the two  initial  Phase I studies of  Metastat in  refractory  solid  tumors and
refractory  metastatic cancer demonstrated


                                       16
<PAGE>

limited   disease   stabilization,   with  one   patient,   suffering   from  an
hemangioendothelioma  (an unusual type of lung tumor), remaining on Metastat for
over two years without  progressive  disease.  The studies established a maximum
tolerated dose, with phototoxicity proving to be the dose-limiting toxicity.

     On May 18,  2000,  we  announced  positive  findings  from  an  18-patient,
National Cancer Institute  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 National
Cancer  Institute has elected to continue  testing Metastat in Phase II clinical
trials.  This  trial is an  open-label,  two-dose  study to  establish  clinical
efficacy  in  patients  with  HIV-related  Kaposi's  sarcoma.  The  trial  began
recruitment in summer 2001 and presently is approximately 50% recruited.

     Preclinical and Other Research and Development Activities

     We have 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, we have 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
concluded in May 2001.

     We receive  certain  proprietary  rights to inventions or discoveries  that
arise as a  result  of this  research.  Our  current  research  and  development
objective is to develop  additional  products  utilizing our IMPACS  technology,
preferably in conjunction with development partners.

     In February 2002 we announced that we had licensed a dermal and transdermal
drug delivery technology, named Restoraderm(TM), from  its inventor. Restoraderm
is designed to enhance the dermal  delivery of a  variety of active  ingredients
and  we  intend  that it  will  form  the  basis  for  a  portfolio  of  topical
dermatological pharmaceuticals.

     The  Restoraderm  technology  is  based on the  ability  of  certain  lipid
compositions  to enhance the natural skin barrier and  facilitate the dermal and
transdermal delivery of known active ingredients.  The Restoraderm technology is
currently still under development,  and we anticipate that the first products to
be developed  using the  technology  will be available in late 2002. In exchange
for the rights to the technology,  we will pay the inventor  milestone fees upon
the  achievement  of certain  objectives as well as royalties on future sales of
products based on the technology.

     Our research and development  expenditures were approximately $5.0 million,
$3.1  million  and $3.8  million  in  1999,  2000 and  2001,  respectively.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Results of Operations."



                                       17
<PAGE>

PATENTS, TRADE SECRETS AND LICENSES

     Our success will depend in part on patent and trade secret  protection  for
our technologies,  products and processes, and on our 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.

     We depend on our license from the Research  Foundation  of the State of New
York at Stony Brook for all of our core  technology.  The SUNY License grants us
an exclusive worldwide license to make and sell products employing tetracyclines
that are designed or utilized to alter a biological process.  Thirty (30) United
States patents and three (3) United States patent  applications held by SUNY are
licensed to us under the SUNY License. Three (3) of the thirty (30) 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-eight  (28) other United States  patents  relate to  chemically  modified
tetracyclines,  or CMTs, and  compositions of certain CMTs with  anti-proteinase
properties,  including  anti-gelatinase,  anti-membrane-type  metalloproteinase,
anti-collagenase,   and   anti-elastase   properties   and  methods  of  use  of
tetracyclines  to reduce bone loss and skeletal muscle  wasting;  and methods of
use of  tetracyclines  to enhance bone growth and promote  synthesis in skeletal
muscle,   inhibit  protein   glycosylation,   inhibit  excess  phospholipase  A2
activity/production, inhibit endogenous production of nitric oxide (NO), enhance
endogenous  production of  interleukin  10, reduce dental plaque  adhesion,  and
inhibit or reduce pulmonary neutrophil infiltration (or accumulation).  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. Seventy six (76) patents
have been issued in foreign  countries.  All of SUNY's United States and foreign
patents  expire  between  2004 and 2018.  Our 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 we 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 our  failure to make  timely  payments,
reimbursements or reports, if the failure is not cured by us within 90 days. The
termination  of the SUNY License,  or the failure to obtain and maintain  patent
protection  for our  technologies,  would have a material  adverse effect on our
business, financial condition and results of operations.



                                       18
<PAGE>

     One of the  United  States  patents  and a  corresponding  Japanese  patent
application  licensed to us under the SUNY License are owned jointly by SUNY and
a Japanese company.  These patent rights, which expire in 2012, cover particular
CMTs (the  "Jointly  Owned  CMTs") that were  involved  in  research  activities
between SUNY and the Japanese  company.  The Japanese company may have exclusive
rights to these  Jointly  Owned CMTs in Asia,  Australia and New Zealand and may
have a  non-exclusive  right  to  exploit  these  Jointly  Owned  CMTs in  other
territories.  These Jointly Owned CMTs are not involved in our Periostat product
but could,  in the future,  prove to be  important  for one or more of our other
potential  applications of its  technology.  If we 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 us,  we: (i) issued to SUNY
78,948 shares of common stock; and (ii) have 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 we have a fully paid, non-exclusive license.

     In addition to the patents and patent applications licensed from SUNY which
represent  the  core  technology,   we  own  additional   technology  for  which
applications for United States patents have been filed and have been issued.  In
this   regard,   we  report   the   existence   of  an  issued   patent   for  a
toothpaste/mouthwash    formulation    for   the    amelioration    of    dentin
hypersensitivity.  Furthermore, we report pending applications covering: (i) new
tetracycline  derivatives  having increased  lipophilicity;  and (ii) methods of
treating acne.

     We intend to enforce our patent rights against third-party infringers.  Due
to the general availability of generic tetracyclines for use as antibiotics,  we
could become involved in infringement  actions,  which could entail  substantial
costs to us. 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 our other activities.

     Our  patent  positions,  like  those  of other  pharmaceutical  firms,  are
generally   uncertain  and  involve   complex   legal  and  factual   questions.
Consequently,  as to the patent  applications  licensed  to us,  even  though we
currently  prosecute  such patent  applications  with United  States and foreign
patent offices,  we do 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  published  or until  patents  issue,  and  since
publication of discoveries in the scientific and patent  literature tends to lag
behind actual  discoveries by several months,  we cannot be certain that we were
the first creator of inventions  covered by pending patent  applications or that
we were the first to file patent applications for such inventions.

     There can be no assurance that patent  applications to which we hold rights
will result in the issuance of patents,  that any patents  issued or licensed to
us will not be challenged and held to be invalid,  or that any such patents will
provide  commercially  significant  protection to our  technology,  products and
processes.  In  addition,  there  can  be no  assurance  that  others  will  not



                                       19
<PAGE>

independently  develop  substantially  equivalent  proprietary  information  not
covered by patents to which we own rights or obtain access to our  know-how,  or
that others will not be issued patents which may prevent the sale of one or more
of our products,  or require  licensing and the payment of  significant  fees or
royalties by us to third  parties in order to enable us to conduct our business.
In the event that any relevant claims of third-party patents are upheld as valid
and  enforceable,  we could be  prevented  from selling our 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 us. Our  failure  to obtain  these  licenses  would have a
material  adverse  effect on our  business,  financial  condition and results of
operations.

     Our success is also dependent upon know-how, trade secrets, and the skills,
knowledge and experience of our scientific and technical  personnel.  We require
all  employees  to enter  into  confidentiality  agreements  that  prohibit  the
disclosure  of  confidential  information  to anyone  outside  the  Company.  In
addition,  we seek to obtain such agreements from our consultants,  advisors and
research collaborators.  There can be no assurance that adequate protection will
be provided for our trade secrets,  know-how or other proprietary information in
the  event  of any  unauthorized  use or  disclosure.  We  occasionally  provide
information  and  chemical  compounds  to  research  collaborators  in  academic
institutions,  and  request  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 us 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 us could have a material
adverse effect on our 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 products we
develop and market.  In the United States,  the FDA regulates  Periostat and our
products in development as drugs under the Federal Food,  Drug, and Cosmetic Act
and implementing regulations. The FDA regulates Atrisorb FreeFlow and Atrisorb-D
as  medical  devices  under the Food,  Drug and  Cosmetic  Act and  implementing
regulations.  Failure  to  comply  with  FDA  requirements  may  subject  us  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.

     Our products in development are drugs. The steps required before a drug may
be marketed in the United States include:

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


                                       20
<PAGE>

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

     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 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; and

     o    FDA review and approval of the new drug application.

     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  investigational  new drug exemption,  which must become  effective before
human  clinical  trials  may  begin.  An  investigational   new  drug  exemption
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 investigational new drug exemption.  In that case,
the  investigational  new drug  exemption  sponsor and the FDA must  resolve any
outstanding  FDA  concerns or  questions  before  clinical  trials can  proceed.
Submission of an  investigational  new drug  exemption 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  investigational  new drug
exemption  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. We cannot
guarantee  that  Phase 1,  Phase  2, or  Phase 3  testing  for our  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, we, 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.



                                       21
<PAGE>

     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 a new drug
application   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 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 FDA approved our new drug application
for Periostat in 1998; we 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 we can market  Periostat for additional  indications  now being
evaluated, we will be required to obtain an additional FDA approval.

     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 new drug  application  for  Periostat,  the FDA has  requested  a
postmarket animal study related to long-term dosing and carcogenicity, which was
completed in 2000.

     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.

     Approved  and  cleared  drugs  and  medical   devices   remain  subject  to
comprehensive  regulation by the FDA while they are being marketed. The drug and
medical device  regulatory  schemes differ in detail,  but they are  essentially
similar.  For  example,  marketers  of approved  and  cleared  drugs and medical
devices  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.  Also, the FDA does not
permit a  manufacturer  to market or promote an approved or cleared drug product
or medical device for an unapproved or uncleared use. Also,  quality control and
manufacturing  procedures must continue to conform to the FDA's requirements for
Good  Manufacturing  Practices (for drugs) or Quality  Systems  Regulation  (for
medical  devices) after approval.  Accordingly,  manufacturers  must continue to
expend time,  money, and effort in the area of production and quality control to
maintain compliance with these and other aspects of regulatory  compliance.  The
FDA periodically inspects  manufacturers to assess compliance with manufacturing
and other  requirements.  We buy bulk active  ingredient  for  Periostat and our
products in  development  from third party  suppliers and finish the products in
third party  manufacturing  facilities.  The other  products  we market,  Vioxx,
Atridox,  Atrisorb  FreeFlow,  and  Atrisorb-D,  are provided by suppliers.  Our
failure, or the failure of our suppliers,  to comply with FDA requirements could
disrupt production and subject us to administrative or judicial sanctions.


                                       22
<PAGE>

     In addition to the applicable FDA  requirements,  we are 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.  We have filed for and subsequently
received  approval  from the United  Kingdom  Medicines  Control  Agency for the
marketing of Periostat tablets in the United Kingdom. Such application was filed
with the United  Kingdom acting as a Reference  Member State.  In June 2001, our
wholly-owned  subsidiary,   CollaGenex  International  Limited,   completed  the
official  filings for the  registration  of Periostat  tablets with the European
Union Member States and Norway.  Under the Mutual  Recognition  Procedure,  once
marketing approval for a pharmaceutical is granted by one European Member State,
such state then acts as a Reference  Member State, and assists in expediting the
review and approval of the pharmaceutical in other European Member States.

     In February  2002,  we received  provisional  approval for the marketing of
Periostat from seven European Member States including Austria, Finland, Ireland,
Italy,  Luxembourg,  the  Netherlands  and Portugal.  We expect to receive final
approval to market  Periostat in these  countries  following  our  submission of
local language labeling based on the text approved under the Mutual  Recognition
Procedure.

     Dentaplex,  our nutritional supplement,  is specifically formulated to help
maintain oral health, as a dietary supplement. Dietary supplements are regulated
by the FDA under the Food, Drug, and Cosmetic Act and implementing  regulations.
Although dietary supplements  generally do not require the FDA approval prior to
marketing,  the FDA  regulates  the safety,  promotion,  and labeling of dietary
supplements. To qualify as a dietary supplement, a product must meet a number of
requirements,  e.g., it must contain a dietary ingredient, it must be labeled as
a  dietary  supplement,  and it  must  meet  requirements  for  safety.  Dietary
supplements  may be marketed  with  claims that they are  intended to affect the
structure or function of the body, but, with narrow exceptions,  they may not be
marketed with claims that they will diagnose,  treat, prevent, cure, or mitigate
a disease.  The distinction  between claims that a product affects the structure
and  function of the body and claims that a product  diagnoses,  treats,  cures,
mitigates,  or prevents  disease can be difficult to apply in practice,  and the
FDA has been active in notifying  companies  that  because  their claims are not
acceptable,  their products are drugs rather than dietary supplement. We can not
be sure  that  the FDA  will  not  assert  that  Dentaplex  does  not  meet  the
requirements  for  dietary  supplement   status,   which  could  result  in  FDA
enforcement  action  or in our  having to make  changes  to the  product  or its
promotion or labeling, or withdraw it from the market.

COMPETITION

     The  pharmaceutical  industry is subject to intense  competition as well as
rapid and significant  technological  change.  We expect 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.



                                       23
<PAGE>

     We believe 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. We believe
that all other therapies focus on temporarily  removing the bacteria  associated
with periodontitis.  Periostat is a prescription pharmaceutical tablet indicated
as an adjunct to scaling and root planing to promote  attachment  level gain and
to reduce pocket depth in patients with adult periodontitis that is taken by the
patient between dental visits.  We believe that the following  chart  summarizes
the  available  forms of  periodontitis  treatment,  other than scaling and root
planing 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        CollaGenex                    No        Systemic         Yes         Tissue
                 Pharmaceuticals, Inc.                                                degradation

*Atridox         Atrix Laboratories/           Yes        Local           No          Bacteria
                 CollaGenex
                 Pharmaceuticals, Inc.

Periochip        Dexxon Ltd.                   Yes        Local           No          Bacteria

Arestin          Orapharma, Inc.               Yes        Local           No          Bacteria
</TABLE>


     * In August 2001,  we entered into a License and Marketing  Agreement  with
Atrix Laboratories,  Inc. pursuant to which we market Atridox, Atrisorb FreeFlow
and Atrisorb-D to the United States dental community. See -- "Item 1. Business"


     Many  of  the  companies   participating   in  the  periodontal  area  have
substantially  greater financial,  technical and human resources than we do, 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 ours.

EMPLOYEES

     We have historically  outsourced our  manufacturing,  clinical trials,  new
drug application preparation, warehousing, distribution and other activities. We
intend  to  continue  to  outsource  many  of  the  activities   which  we  have
historically outsourced.  As of December 31, 2001, we employed 155 persons. Each
of  our  management   personnel  has  had  extensive   prior   experience   with
pharmaceutical,  biotechnology  or  medical  products  companies.  We  cannot be
certain  that we will be able to recruit and retain  qualified  inside sales and
marketing  personnel,   additional  foreign  sub-licensees  or  distributors  or
marketing  partners or that our marketing and sales efforts will be  successful.
Currently,   none  of  our  employees  are  covered  by  collective   bargaining
agreements. In general, our employees are covered by confidentiality agreements.
We consider relations with our employees to be excellent.



                                       24
<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,  OUR SALES GROWTH WILL
SUFFER.

     Our growth and success  depends in large part on our 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,  our sales  efforts  are  largely  focused on
educating  dental  professionals  about an  entirely  new  approach  to treating
periodontitis.  Although over 35,000  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 we are unable to initiate
and/or expand usage of Periostat by dentists, our 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.  Our 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.

     WE RELY ON PERIOSTAT FOR MOST OF OUR REVENUE.

     During 1999, Periostat accounted for 95% of our total net revenues.  During
2000,  Periostat  accounted  for 84% of our total  net  revenues.  During  2001,
Periostat accounted for approximately 87% of our total net revenues. Although we
currently derive additional revenue from marketing and/or selling other products
(Vioxx(R),  Atridox,  Atrisorb  FreeFlow and Atrisorb-D) and from licensing fees
from  foreign  marketing  partners,  our revenue and  profitability  in the near
future will depend on our ability to successfully market and sell Periostat.

     WE ANTICIPATE FUTURE LOSSES.

     From our  founding in 1992  through the  commercial  launch of Periostat in
November,  1998,  we had no revenue from sales of our own  products.  During the
year ended  December 31, 2000, we experienced a net loss of  approximately  $8.8
million.  During the year ended  December 31, 2001, we experienced a net loss of
approximately  $8.1 million.  From inception  through December 31, 2001, we have
experienced an aggregate net loss of $69.5 million.  Our historical  losses have
resulted  primarily  from  the  expenses   associated  with  our  pharmaceutical
development program, clinical trials, the regulatory approval process associated
with  Periostat and sales and  marketing  activities  relating to Periostat.  We
expect to incur  significant  future expenses,  particularly with respect to the
sales and marketing of  Periostat.  As a result,  we anticipate  losses at least
through the second quarter of 2002.



                                       25
<PAGE>

     WE  HAVE A  LIMITED  MARKETING  AND  SALES  HISTORY  AND MAY NOT BE ABLE TO
SUCCESSFULLY MARKET OUR PRODUCT CANDIDATES.

     We  have  a  limited  history  of  marketing,   distributing   and  selling
pharmaceutical  products in the dental market. In January 1999, we first trained
a sales  force  of sales  representatives  and  managers  and  began to  promote
Periostat to the dental community. We market and sell our products in the United
States  through  this direct  sales  force.  Furthermore,  we have  entered into
agreements to market Periostat, upon receipt of the necessary foreign regulatory
approvals,  in certain countries in Europe, Israel, Japan, Canada and the Middle
East, and we continue to evaluate  partnering  arrangements  in other  countries
outside the United  States.  If we are unable to continue to recruit,  train and
retain sales and marketing  personnel,  we will be unable to successfully expand
our sales and marketing  efforts.  Furthermore,  if our foreign  partners do not
devote sufficient resources to perform their contractual obligations with us, we
may not achieve our foreign sales goals.  Pursuant to an exclusive Licensing and
Marketing  Agreement with Atrix  Laboratories,  Inc., we began marketing Atrix's
proprietary dental products, Atridox(R), Atrisorb(R) FreeFlow and Atrisorb(R)-D,
to the United States dental market in October 2001. It is too early to determine
whether  there will be  sufficient  acceptance  of these  products to achieve or
maintain profitability.

     OUR  COMPETITIVE  POSITION  IN THE  MARKETPLACE  DEPENDS ON  ENFORCING  AND
SUCCESSFULLY DEFENDING OUR 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  our  established  and new  technologies.  We  must  also  avoid
liability from infringing the proprietary rights of others.

     Our core  technology is licensed from The Research  Foundation of the State
University of New York ("SUNY"),  and other  academic and research  institutions
collaborating  with  SUNY.  Under the  license  agreement  with SUNY (the  "SUNY
License") we have 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 us and our failure to comply with
these  requirements  permits SUNY to  terminate  the SUNY  License.  If the SUNY
License  is  terminated,  we would lose our right to  exclude  competitors  from
commercializing  similar  products,  and we could be excluded from marketing the
same products if SUNY licensed the underlying  technology to a competitor  after
terminating the SUNY License.

     SUNY owns  thirty (30) United  States  patents and three (3) United  States
patent  applications  that are  licensed to us. The patents  licensed  from SUNY
expire  between 2004 and 2018.  Two 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 our patent rights cover new treatments  using  tetracyclines,
which are  generally  available  for their known use as  antibiotics,  we may be
required  to bring  expensive  infringement  actions to enforce  our patents and
protect  our  technology.  Although  federal  law  prohibits  making and selling
pharmaceuticals for infringing use, competitors and/or practitioners


                                       26
<PAGE>

may provide generic forms of tetracycline  for  treatment(s)  which infringe our
patents, rather than prescribe our Periostat product. Enforcement of patents can
be expensive and time consuming.

     Our success also  depends upon  know-how,  trade  secrets,  and the skills,
knowledge and experience of our scientific and technical personnel. To that end,
we require all of our 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 we provide for testing to collaborators in academic  institutions,  we
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 our commercial  position and,  consequently,  our
financial condition.

     IF WE LOSE OUR SOLE SUPPLIER OF DOXYCYCLINE OR OUR CURRENT  MANUFACTURER OF
PERIOSTAT,  OUR  COMMERCIALIZATION  OF  PERIOSTAT  WILL BE  INTERRUPTED  OR LESS
PROFITABLE.

     We rely on a single supplier,  Hovione  International  Limited ("Hovione"),
for doxycycline,  the active  ingredient in Periostat.  There are relatively few
alternative  suppliers of doxycycline  and Hovione  produces the majority of the
doxycycline used in the United States. Our current supply agreement with Hovione
expires on May 14,  2006 and  thereafter  automatically  renews  for  successive
two-year  periods  unless,  ninety (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  ninety  (90)  days,  the
non-defaulting party can terminate the supply agreement effective immediately at
the end of such  90-day  period.  We rely on  Hovione  as our sole  supplier  of
doxycycline  and have no  back-up  supplier  at this  time.  If we are unable to
procure a commercial quantity of doxycycline from Hovione on an ongoing basis at
a competitive  price,  or if we cannot find a  replacement  supplier in a timely
manner or with favorable pricing terms, our costs may increase significantly and
we may experience delays in the supply of Periostat.

     We  historically  relied  on a single  third-party  contract  manufacturer,
Applied Analytical  Industries,  Inc., ("AAI") to produce Periostat in a capsule
formulation.  AAI served  notice of its intent to  terminate  its  agreement  to
supply  Periostat  capsules to us as of November  2001.  The agreement  with AAI
provided for AAI to commit to an additional twelve (12) months supply of product
at a price premium, should we be unable to qualify an alternative  manufacturing
source  subsequent to the  termination of the AAI agreement.  As an alternative,
and in an effort to capitalize on certain manufacturing cost advantages, in July
2001, we launched our new tablet formulation of Periostat which has now replaced
our capsule  formulation  of  Periostat.  We believe that the change to a tablet
formulation  will  positively  impact our results of operations by improving our
gross margin on Periostat sales from  approximately  79% to approximately 88% of
Periostat  net  sales.  We  have  entered  into  an  agreement  with a  contract
manufacturer, Pharmaceutical Manufacturing Research Services, Inc. ("PMRS"), for
such  tablet  formulation  for  Periostat,  and we  are,  therefore,  no  longer
dependent upon, nor do we utilize,  AAI. We have fulfilled our initial  purchase
orders with PMRS and expect to make certain  purchases  from PMRS through  2002.
Currently, PMRS is the sole third-party contract manufacturer to supply a tablet
formulation  of  Periostat  to us. Any  inability  of PMRS to produce and supply
product on agreed upon terms could result in delays in the supply of  Periostat.
We also intend to contract


                                       27
<PAGE>

with  additional  manufacturers  for the  commercial  manufacture  of  Periostat
tablets.  We  believe,  however,  that  it  could  take  up to one  (1)  year to
successfully transition from PMRS to a new manufacturer.

     OUR PRODUCTS ARE SUBJECT TO EXTENSIVE REGULATION BY THE FDA.

     Drugs and medical devices  generally require approval or clearance from the
FDA before they can be marketed in the United States.  Periostat,  Vioxx(R), and
Atridox(R)  have been  approved by the FDA as drugs.  Atrisorb(R)  FreeFlow  and
Atrisorb(R)-D have been cleared by the FDA as medical devices. Our drug products
under development,  however, will have to be approved by the FDA before they can
be marketed in the United States.  If the FDA does not approve our products in a
timely fashion,  or does not approve them at all, our financial condition may be
adversely affected.

     In  addition,   drug  and  medical  device   products   remain  subject  to
comprehensive  regulation by the FDA while they are being marketed. The drug and
medical device  regulatory  schemes differ in detail,  but they are  essentially
similar. The FDA regulates,  for example, the safety,  manufacturing,  labeling,
and promotion of both drug and medical device products.  Although  Dentaplex,  a
dietary supplement,  did not require FDA approval prior to marketing, it is also
subject to  regulation  while it is being  marketed.  If we or our  partners who
manufacture  our products fail to comply with regulatory  requirements,  various
adverse consequences can result, including recalls, civil penalties,  withdrawal
of the  product  from the market  and/or  the  imposition  of civil or  criminal
sanctions.

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

     IF OUR  PRODUCTS  CAUSE  INJURIES,  WE MAY INCUR  SIGNIFICANT  EXPENSE  AND
LIABILITY.

     Our 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 or for which we have licensing or  co-promotion
rights. We have $10.0 million in product liability insurance for Periostat. This
level of  insurance  may not  adequately  protect us 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  our  business,  financial
condition and results of operations to decline.



                                       28
<PAGE>

     IF WE NEED ADDITIONAL FINANCING, AND FINANCING IS UNAVAILABLE,  OUR ABILITY
TO DEVELOP AND  COMMERCIALIZE  PRODUCTS  AND OUR  OPERATIONS  WILL BE  ADVERSELY
AFFECTED.

     We have  historically  financed our  operations  through public and private
equity  financings.   Our  capital  requirements  depend  on  numerous  factors,
including  our  ability  to  successfully  commercialize  Periostat,   competing
technological and market  developments,  our ability to enter into collaborative
arrangements for the development,  regulatory approval and  commercialization of
other  products,  and the cost of filing,  prosecuting,  defending and enforcing
patent claims and other intellectual  property rights. We anticipate that we may
be required  to raise  additional  capital in order to conduct  our  operations.
Additional funding, if necessary, may not be available on favorable terms, if at
all.  If  adequate  funds  are not  available,  we may be  required  to  curtail
operations   significantly  or  to  obtain  funds  through   arrangements   with
collaborative  partners or others that may  require us to  relinquish  rights to
certain of our technologies,  product candidates, products or potential markets.
At December 31, 2001 we had cash, cash equivalents and short-term investments of
approximately $6.2 million. In March 2001, we raised approximately $6.8 million,
net of  offering  costs,  through the sale of our common  stock and  warrants to
purchase  shares of our common stock.  In August 2001,  we raised  approximately
$3.0  million  through the sale of  unregistered  shares of our common  stock to
Atrix Laboratories,  Inc. in connection with our entering into certain licensing
arrangements with Atrix. We anticipate that our existing working capital will be
sufficient  to fund our  current  operations  through  at least the end of 2002.
However, we may seek additional funding to expand our current operations through
the acquisition of additional products or by investing in the development of our
research and development pipeline.

     BECAUSE OUR  EXECUTIVE  OFFICERS,  DIRECTORS  AND  AFFILIATED  ENTITIES OWN
APPROXIMATELY  34.5% OF OUR CAPITAL  STOCK,  THEY COULD CONTROL OUR ACTIONS IN A
MANNER  THAT  CONFLICTS  WITH  OUR  INTERESTS  AND THE  INTERESTS  OF OUR  OTHER
STOCKHOLDERS.

     Currently,  our  executive  officers,  directors  and  affiliated  entities
together  beneficially own approximately  34.5% of the outstanding shares of our
common stock or equity  securities  convertible  into common stock. As a result,
these  stockholders,   acting  together,   or  in  the  case  of  our  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 our stockholders
might  otherwise  receive a premium for their  shares over then  current  market
prices.

     WE  EXPECT TO SELL  SHARES OF OUR  COMMON  STOCK IN THE  FUTURE,  INCLUDING
SHARES ISSUED UNDER OUR EQUITY LINE WITH  KINGSBRIDGE  CAPITAL LIMITED AND THESE
SALES WILL DILUTE THE INTERESTS OF SECURITY HOLDERS AND DEPRESS THE PRICE OF OUR
COMMON STOCK.

     As of December 31, 2001,  there were 10,999,573  shares of our common stock
outstanding,  options to purchase  approximately  2,452,609 shares of our common
stock outstanding, and there were outstanding warrants to purchase approximately
550,000 shares of our common stock outstanding. There are also 924,880 shares of
common stock which, upon effectiveness of our shelf registration statement,  are
issuable under the equity line with Kingsbridge and 40,000 shares issuable under
the warrants which we granted to Kingsbridge in


                                       29
<PAGE>

connection with the equity line arrangement. We may also issue additional shares
in acquisitions,  financings or in connection with the grant of additional stock
options to our employees,  officers,  directors or  consultants  under our stock
option plans.

     The  issuance or even the  potential  issuance  of shares  under the equity
line, in connection with any other  additional  financing,  and upon exercise of
warrants,  options or rights will have a dilutive  impact on other  stockholders
and could have a negative  effect on the market  price of our common  stock.  In
addition,  if we draw down  under  the  equity  line,  we will  issue  shares to
Kingsbridge  at a discount to the daily volume  weighted  average  prices of our
common  stock  during the fifteen  (15)  trading  days after  notification  of a
drawdown. This will further dilute the interests of the other stockholders.

     If we draw down on the equity  line when share  prices are  decreasing,  we
will need to issue more  shares,  which will lead to  dilution  and  potentially
further price decrease.

     As we sell shares of our common stock to Kingsbridge  under the equity line
and then Kingsbridge  sells the common stock to third parties,  our common stock
price may decrease due to the additional  shares in the market.  If we decide to
draw down on the equity line as the price of our common stock decreases, we will
need to issue more shares of our common stock for any given  dollar  amount that
Kingsbridge  invests,  subject to the  minimum  selling  price we  specify.  The
perceived risk of dilution from sales of stock to Kingsbridge  may cause holders
of our common stock to sell their shares,  or it may encourage short sales. This
could contribute to a decline in our share price.  Kingsbridge has covenanted in
the equity line arrangement  that neither  Kingsbridge nor any of its affiliates
nor any entity managed by Kingsbridge  will ever be in a net short position with
respect to shares of our common  stock in any  accounts  directly or  indirectly
managed by any such  person or entity.  The more  shares that we issue under the
equity  line of credit,  the more  diluted  our shares  will be and the more our
stock price may  decrease.  This may  encourage  short sales,  which could place
further downward pressure on the price of our common stock.

     OUR  STOCK  PRICE IS  HIGHLY  VOLATILE,  AND  THEREFORE  THE  VALUE OF YOUR
INVESTMENT MAY FLUCTUATE SIGNIFICANTLY.

     The market  price of our common  stock has  fluctuated  and may continue to
fluctuate as a result of variations in our quarterly  operating  results.  These
fluctuations  may be  exaggerated  if the trading  volume of our 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.  Our common stock may  experience
similar or even more dramatic price and volume  fluctuations  which may continue
indefinitely.


                                       30
<PAGE>

     The  following  table sets forth the high and low closing  market price for
our common  stock for each of the  quarters in the period  beginning  January 1,
1999 through December 31, 2001 as reported on the Nasdaq National Market:

                QUARTER ENDED                  HIGH                LOW

       March 31, 1999...............           $12.19              $8.25
       June 30, 1999................           $11.25              $8.25
       September 30, 1999...........           $22.38              $9.50
       December 31, 1999............           $25.00             $15.75
       March 31, 2000...............           $27.13             $12.63
       June 30, 2000................           $15.50              $8.25
       September 30, 2000...........            $9.88              $8.06
       December 31, 2000............            $7.88              $3.13
       March 31, 2001...............            $6.00              $4.47
       June 30, 2001................            $8.80              $5.06
       September 30, 2001...........           $10.00              $7.25
       December 31, 2001............            $9.50              $7.50


ITEM 2.     PROPERTIES.

     We own no real property.  Our principal  executive  offices,  located at 41
University  Drive,  Suite 200, Newtown,  Pennsylvania,  consist of approximately
14,204 square feet. Our lease for such premises continues through April 2009.

ITEM 3.     LEGAL PROCEEDINGS.

     We are not a party to any material legal proceedings.

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

     Not applicable.



                                       31
<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 our common stock.
Since June 20, 1996, our common stock has traded on the Nasdaq  National  Market
under the symbol "CGPI."

     The  following  table sets forth the high and low bid  information  for our
common  stock for each of the quarters in the period  beginning  January 1, 2000
through  December  31,  2001 as  reported on the Nasdaq  National  Market.  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, 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
           March 31, 2001...............         $5.99          $4.00
           June 30, 2001................         $9.00          $4.88
           September 30, 2001...........        $10.40          $6.49
           December 31, 2001............         $9.49          $7.26

     As of March 15, 2002,  the  approximate  number of holders of record of our
common stock was 116 and the  approximate  number of  beneficial  holders of our
common stock was 3,466.

     We have never  declared  or paid any cash  dividends  on our common  stock.
Except as set forth below, we intend to retain earnings,  if any, to fund future
growth and the  operation of our  business.  On May 12, 1999,  we  consummated a
$20.0  million  financing  through  the  issuance  of our  Series  D  cumulative
convertible  preferred stock. As a result of such financing,  we have cumulative
cash and  common  stock  dividend  obligations  to the  holders  of the Series D
preferred stock. Such financing arrangement also limits our ability to generally
declare  dividends  to our common  stockholders.  In  addition,  our  ability to
generally declare dividends to our common stockholders is further limited by the
terms of our  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
our  consolidated  statement  of  operations  data for each of the  years in the
three-year  period ended December 31, 2001, and with respect to the consolidated
balance  sheet  data at  December  31,  2000 and 2001 are  derived  from and are
qualified by reference to our audited consolidated  financial statements and the
related  notes  thereto  found  at  "Item  14.  Exhibits,   Financial  Statement
Schedules, and


                                       32
<PAGE>

Reports on Form 8-K" herein.  The consolidated  statement of operations data for
the years ended December 31, 1997 and 1998 and with respect to the  consolidated
balance  sheet data as of December  31,  1997,  1998 and 1999 are  derived  from
audited consolidated  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 our  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,
                                    ----------------------------------------------------------------
                                       1997         1998          1999         2000         2001
                                    ------------  ----------    ----------   ----------   ----------
CONSOLIDATED STATEMENT OF                     (IN THOUSANDS EXCEPT FOR PER SHARE DATA)
 OPERATIONS DATA:

<S>                                <C>           <C>          <C>           <C>          <C>
Revenues:
  Product sales................    $      --     $   3,053    $  15,211     $  20,501    $  31,358
  License revenues.............          325           400          100           530          488
  Contract revenues............            9             8          770         3,240        3,386
                                       -----      --------     --------      --------     --------
Total revenues.................          334         3,461       16,081        24,271       35,232
Operating expenses:
  Cost of product sales........           --           745        3,139         4,070        5,825
  Research and development.....        4,200         4,670        5,005         3,128        3,764
  Selling, general and
    administrative.............        6,096        10,600       23,180        25,746       34,010
                                       -----      --------     --------      --------     --------
      Operating loss...........       (9,962)      (12,554)     (15,243)       (8,673)      (8,367)
Interest income................        1,338           988          851           613          232
Interest expense...............           --            --         (197)          (15)         (17)
Other income (expense).........           --            --           (2)            9            8
                                       -----      --------     --------      --------     --------
Loss before cumulative
  effect of change in
  accounting principle.........       (8,624)      (11,566)     (14,591)       (8,066)      (8,144)
Cumulative effect of change
  in accounting principle(1)...           --            --           --          (764)          --
                                       -----      --------     --------      --------     --------
Net loss.......................       (8,624)      (11,566)     (14,591)       (8,830)      (8,144)
Net loss allocable to common
  stockholders.................    $  (8,624)    $ (11,566)   $ (15,683)    $ (10,519)   $  (9,824)
Basic and diluted net loss
  per share allocable to
  common stockholders before
  cumulative effect of
  change in accounting
  principle....................    $   (1.04)    $   (1.35)   $   (1.82)    $   (1.12)   $   (0.94)
Basic and diluted net loss
  per share allocable to
  common stockholders(2).......    $   (1.04)    $   (1.35)   $   (1.82)    $   (1.21)   $   (0.94)
Shares used in computing
  basic and diluted per
  share amounts(2).............        8,291         8,579        8,598         8,712       10,414
</TABLE>



                                       33
<PAGE>

<TABLE>
<CAPTION>
                                                           AS OF DECEMBER 31,
                                    ----------------------------------------------------------------
                                       1997         1998          1999         2000         2001
                                    ------------  ----------    ----------   ----------   ----------
CONSOLIDATED BALANCE SHEET                                  (IN THOUSANDS)
  DATA:                             ----------------------------------------------------------------

<S>                                <C>           <C>          <C>           <C>          <C>
Cash, cash equivalents and
  short-term investments.......    $  22,771     $  10,250    $  14,367     $   5,448    $   6,171
Total assets...................       23,165        14,740       18,563        10,431       14,698
Note payable, less current
  portion......................           --            --          116            47           --
Accumulated deficit............      (26,362)      (37,928)     (53,611)      (64,130)     (73,954)
Total stockholders' equity.....       20,708         9,281       13,607         5,264        7,127
</TABLE>

(1)  See Note 9 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.



                                       34
<PAGE>

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

OVERVIEW

     CollaGenex   Pharmaceuticals,   Inc.  and   subsidiaries   is  a  specialty
pharmaceutical   company  currently  focused  on  providing  innovative  medical
therapies to the dental and dermatology markets.  Our first product,  Periostat,
is an orally administered, prescription pharmaceutical product that was approved
by the United States Food and Drug  Administration  in September 1998 and is the
first and only  pharmaceutical  to treat adult  periodontitis  by inhibiting the
enzymes that destroy  periodontal support tissues. We are marketing Periostat to
the dental community through our own professional  dental  pharmaceutical  sales
force of approximately 120 sales  representatives  and managers.  Pursuant to an
exclusive  License and Marketing  Agreement  with Atrix  Laboratories,  Inc., we
began, in October 2001, to actively market Atrix's  proprietary dental products,
Atridox,  Atrisorb FreeFlow and Atrisorb-D,  to the United States dental market.
We distribute  Periostat through drug wholesalers and large retail chains in the
United States and the United Kingdom.  The Atrix dental products are distributed
through a  specialty  distributor  who sells these  products  directly to dental
practitioners in the United States.  Our sales force also  co-promotes  Vioxx, a
prescription  non-steroidal,  anti-inflammatory  drug  developed by Merck & Co.,
Inc., in the United States.

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

     We have incurred  losses each year since  inception and have an accumulated
deficit of $74.0 million at December 31, 2001.

     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.  Our  business  of  selling,  marketing  and
developing  pharmaceutical products is subject to a number of significant risks,
including risks relating to the  implementation of our sales and marketing plans
for Periostat and other products that we market,  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.  Our  success  depends  to a large  degree  upon the  market
acceptance of Periostat by  periodontists,  dental  practitioners,  other health
care providers, patients and insurance companies. Periostat has been approved by
the FDA 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


                                       35
<PAGE>

our other product  candidates  will be approved by any regulatory  authority for
marketing in any  jurisdiction  or, if approved,  that any such products will be
successfully  commercialized by us. In addition,  there can be no assurance that
we  will  successfully  commercialize  Vioxx,  Atridox,  Atrisorb  FreeFlow  and
Atrisorb-D.  As a result of these risks,  and others expressed from time to time
in our filings with the Securities and Exchange  Commission,  our actual results
may  differ  materially  from  the  results  discussed  in  the  forward-looking
statements contained herein.

RESULTS OF OPERATIONS

     From our founding  through the quarter ended  September 30, 1998, we had no
revenues from sales of our own products.  During the fourth  quarter of 1998, we
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, we achieved net
product  sales of $15.2 million from sales of  Periostat,  contract  revenues of
$770,000 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,  we achieved net product sales of
$20.5  million from sales of  Periostat,  contract  revenues of $3.2 million and
license and milestone  fees of $530,000 from various  foreign  distribution  and
marketing  agreements for  Periostat.  Included in this $530,000 was $397,000 in
license revenues that were deferred upon the  implementation of Staff Accounting
Bulletin  SAB 101 ("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.

     During the year ended  December 31, 2001,  we achieved net product sales of
$31.4 million,  including  $30.6 million from the sale of Periostat and $732,000
from the sale of Atridox and Atrisorb  FreeFlow.  In  addition,  during the year
ended  December 31, 2001,  we  generated  $3.4 million in contract  revenues and
$488,000 in licensing revenue,  which included $63,000 in previously  recognized
up-front license fees that were deferred upon the adoption of SAB 101.

     CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     Management's  discussion and analysis of its financial position and results
of operations are based upon our consolidated  financial statements,  which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments  that affect the reported  amounts of
assets, liabilities,  revenues and expenses and related disclosure of contingent
assets and liabilities. Management believes the critical accounting policies and
areas that require the most  significant  judgments  and estimates to be used in
the  preparation of the  consolidated  financial  statements  pertain to revenue
recognition.

     We  recognize  sales  revenue  upon  shipment,  net of  estimated  returns,
provided  that  collection  is  determined  to be  probable  and no  significant
obligations  remain.  Sales  revenue from our customers is subject to agreements
allowing limited rights of return, rebates and price protection. Accordingly, we
reduce  revenue  recognized  for  estimated  future  returns,  rebates and price
protection  at the time the  related  revenue is  recorded.  The  estimates  for
returns are


                                       36
<PAGE>

adjusted  periodically based upon historical rates of returns,  inventory levels
in the  distribution  channel,  and  other  related  factors.  While  management
believes it can make reliable  estimates for these matters,  unsold  products in
these  distribution  channels may be exposed to expiration.  Accordingly,  it is
possible  that  these  estimates  will  change in the  future or that the actual
amounts  could vary  materially  from our estimates and that the amounts of such
changes  could impact our results of  operations,  financial  condition  and our
business.

     Since our  inception,  a portion of our  revenue  has been  generated  from
license and distribution agreements for our products. We recognize nonrefundable
signing or license fees that are not dependent on future performance under these
agreements as revenue when received and over the term of the  arrangement  if we
have continuing performance  obligations.  Any amounts deferred are amortized to
revenue  over the  expected  performance  period of each  underlying  agreement.
Deferred revenue  represents the portion of up front license  payments  received
that has not been earned.  Milestone  revenue  from  licensing  arrangements  is
recognized  upon  completion  of  the  milestone  event  or  requirement  if  it
represents the achievement of a significant step in the research, development or
regulatory process.

     YEARS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000

REVENUES

--------------------------------------------------------------------------------
Revenues
(dollars in thousands)          2001           CHANGE              2000
                                ----           ------              ----
--------------------------------------------------------------------------------
Product Sales               $   31,358           53%           $   20,501
--------------------------------------------------------------------------------
Contract Revenues                3,386            5                 3,240
--------------------------------------------------------------------------------
License Revenues                   488           (8)                  530
                            -----------                       ------------
--------------------------------------------------------------------------------
Total                       $   35,232           45%           $   24,271
--------------------------------------------------------------------------------

     Revenues in 2001 included $30.6 million in net sales of Periostat, $732,000
in net sales of Atridox and Atrisorb FreeFlow, $3.4 million in contract revenue,
which were derived from our  co-promotion of Vioxx and Denavir,  and $488,000 in
foreign  license and milestone  revenues for Periostat.  Product sales increased
$10.9  million,  or 53%,  in 2001  mainly  as a  result  of the DTC  advertising
campaign for  Periostat  that we launched in the United  States in January 2001.
The increase in product sales also included $732,000 in product sales of Atridox
and  Atrisorb  FreeFlow,  which were  launched in October  2001.  Revenues  from
Denavir  accounted  for  approximately   $297,000  of  2001  contract  revenues.
Novartis,  which acquired Denavir from SmithKline Beecham Consumer Healthcare in
early  2001,  terminated  our  Co-Promotion  Agreement  with  respect to Denavir
effective  April 13, 2001.  We have not  recognized  any revenue with respect to
sales of Denavir since April 2001.

     Revenues in 2000 included  $20.5  million in net sales of  Periostat,  $3.2
million in contract revenues,  which were derived from our 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. There were no sales of Atridox or Atrisorb FreeFlow in 2000.



                                       37
<PAGE>

     In accordance  with SAB 101, which we adopted in 2000,  $63,000 of our 2001
licensing   revenues  of  $488,000  were  attributable  to  our  recognition  of
previously recognized up-front license fees received for various agreements that
were  deferred  upon the adoption of SAB 101 and are being  recognized as income
over the expected  performance  period of these agreements.  License revenues in
2001  also  included  $425,000  in  milestone  fees  associated  with  obtaining
regulatory  approval  in  certain  countries.  Our 2000  licensing  revenues  of
$530,000  included  $410,000  of  up-front  license  fees  received  for various
agreements which are being  recognized as revenue over the expected  performance
period of these  agreements in accordance with SAB 101. We also recorded another
$120,000 in milestone  fees  associated  with obtaining  regulatory  approval in
certain countries.

COST OF PRODUCT SALES

--------------------------------------------------------------------------------
Cost of Product Sales
(dollars in thousands)          2001           CHANGE             2000
                                ----           ------             ----
--------------------------------------------------------------------------------
Cost of Product Sales         $  5,825           43%            $  4,070
--------------------------------------------------------------------------------
Percent of Product Sales         18.6%                             19.9%
--------------------------------------------------------------------------------

     Cost of product sales includes product  packaging,  third-party  royalties,
obsolete inventory  provisions,  amortization of new product licensing fees, and
the costs  associated  with the  manufacturing,  storage  and  stability  of our
products and the Atrix products.

     Cost of product sales were $5.8 million, or 18.6% of product sales in 2001,
compared to $4.1  million,  or 19.9% of product  sales in 2000.  Cost of product
sales  increased in absolute  dollars but  decreased as a percentage  of product
sales in 2001 compared to 2000,  primarily due to the manufacturing cost savings
for Periostat  tablets,  which we launched in July 2001. For Periostat,  cost of
product  sales as a percent  of sales,  declined  to 16.1% in 2001 from 19.9% in
2000. The cost of product sales for Atridox and Atrisorb FreeFlow were 38.0% for
the two  months of sales  recorded  during  2001.  In 2001,  we also  recorded a
provision  for obsolete  inventory of $602,000;  there was no such  provision in
2000.

RESEARCH AND DEVELOPMENT

--------------------------------------------------------------------------------
Research and Development
(dollars in thousands)          2001           CHANGE             2000
                                ----           ------             ----
--------------------------------------------------------------------------------
Research and Development      $  3,764           20%            $  3,128
--------------------------------------------------------------------------------
Percentage of Total Revenue      10.7%                             12.9%
--------------------------------------------------------------------------------

     Research and development  expenses consist primarily of funds paid to third
parties  for the  provision  of services  and  materials  for drug  development,
manufacturing  and  formulation  enhancements,   clinical  trials,   statistical
analysis and report writing and regulatory compliance costs.

     Research and  development  expenses  increased to $3.8 million in 2001 from
$3.1  million  in 2000.  Research  and  development  expenses  incurred  in 2001
included  $535,000  in  direct  salaries  and  benefits,   $164,000  in  noncash
compensation  expense relating to the extension of the exercisability of certain
stock options for one of our ex-board  members,  $210,000 in research


                                       38
<PAGE>

grants to various academic  institutions for conducting  research related to our
core  technology and $765,000 in contracted  clinical and  development  expenses
related to a completed safety and  pharmacokinetic  study for Metastat and other
IMPACs compounds that we are currently  developing.  During 2001, our three-year
evaluation  testing  agreement for such  compounds with SUNY expired and was not
renewed. The amount paid to SUNY in 2001 under this agreement was $168,000.  The
total cumulative costs incurred to date under this agreement were  approximately
$1.4 million.

     Development  projects  contracted  in 2001  include an initial  feasibility
study  and  formulation   development  work  for  a  once-a-day  formulation  of
Periostat, which totaled $455,000 in 2001. Future development of this technology
will be contingent on the outcome of the initial phase of the project,  which is
expected  to be  determined  by  mid  2002.  Additional  expenses  ranging  from
approximately  $1.0  million in 2002 to as much as $6.0  million  at  completion
could be incurred if the project is successful.

     Clinical projects  conducted during 2001 included the completion of several
Phase 3b studies for Periostat in various dental  indications and the initiation
of clinical trials for Periostat in dermatological indications. Clinical project
costs incurred in 2001 were $230,000.  We are currently in discussions  with the
FDA  regarding  protocols  for  additional  trials with  Periostat  for acne and
rosacea. Until these discussions are finalized,  it is premature to estimate the
future  costs  associated  with  the  continued  development  of  Periostat  for
dermatological indications.

     Other expenses incurred in 2001 included $400,000 in regulatory  consulting
and filing fees under the Mutual  Recognition  Procedure  in Europe and $535,000
for various  regulatory  costs,  including  annual FDA filing fees,  legal,  and
regulatory  expenses in the United States  related to obtaining FDA approval for
Periostat tablets.  Additionally,  we incurred $110,000 in ongoing manufacturing
support  relating  to our  existing  products  and  $194,000 in travel and other
office expenses.

     Research and development expenses incurred in 2000 consisted of $375,000 in
direct salaries and benefits,  $324,000 in noncash  compensation expense related
to the  acceleration  of the vesting of stock  options for certain  research and
development  consultants,  $255,000  in  research  grants  to  various  academic
institutions for conducting research related to our core technology and $356,000
to SUNY under an agreement we executed in 1998  relating to the  development  of
our IMPACS  technology.  We also incurred  $263,000 in  contracted  clinical and
development expenses related to Metastat and other IMPACs compounds.

     Development   projects  contracted  in  2000  also  included  $113,000  for
formulation development relating to Dentaplex.

     Clinical projects  conducted during 2000 included the initiation of several
Phase 3b studies for Periostat in various dental  indications.  Clinical project
costs incurred in 2000 were $250,000. These projects were completed in 2001.

     Other research and development  expenses  incurred in 2000 include $600,000
for FDA filing  fees,  legal,  and  regulatory  expenses  in the  United  States
relating  to  Periostat  capsules  and our New Drug  Application  for  Periostat
tablets.  We also  incurred  $237,000 in regulatory


                                       39
<PAGE>

consulting and filing fees related to obtaining marketing approval for Periostat
tablets in the United Kingdom.  Additionally,  during 2000, we incurred $188,000
in ongoing manufacturing  support for Periostat capsules,  stability studies and
manufacturing  validation costs for Periostat tablets and $167,000 in travel and
other office expenses.

SELLING, GENERAL AND ADMINISTRATIVE

--------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands)                    2001         CHANGE          2000
                                          ----         ------          ----
--------------------------------------------------------------------------------
Selling, General and Administrative    $ 34,010          32%         $ 25,746
--------------------------------------------------------------------------------
Percentage of Total Revenue               96.5%                        106.1%
--------------------------------------------------------------------------------

     Selling, general and administrative expenses consist primarily of personnel
salaries  and  benefits,  direct  marketing  costs,   professional,   legal  and
consulting fees, insurance and general office expenses.

     Selling,  general and administrative expenses increased to $34.0 million in
2001 from $25.7 million in 2000. Significant components of selling,  general and
administrative  expenses  incurred  in 2001  included  $13.9  million  in direct
selling  and sales  training  expenses,  $14.9  million  in  marketing  expenses
(including  Periostat DTC  advertising  expenditures,  Atridox and Atrisorb Free
Flow launch  expenditures and co-promotion  expenses relating to Vioxx) and $5.2
million  in  general  and  administrative   expenses,   which  include  business
development,  finance and corporate activities. The increase in selling, general
and administrative  expenses during 2001 was mainly due to the launch of our DTC
advertising campaign for Periostat;  during 2001 we incurred $6.8 million on DTC
advertising  compared  to $1.2  million in 2000.  Additionally,  direct  selling
expenses  increased  $1.3  million  as a result of salary  increases  and higher
incentive  compensation  and sales training costs for our 120-person field sales
force.  Corporate  administration  expenses also  increased  $1.4 million during
2001, as we began to develop our dermatological  business, and our corporate and
financial infrastructure both domestically and abroad.

     During 2000, we incurred $12.9 million in direct selling and sales training
expenses,  $9.0 million in marketing  expenses for Periostat and Vioxx, and $3.8
million in general and administrative expenses.

OTHER INCOME/EXPENSE

--------------------------------------------------------------------------------
Other Income / Expense                    2001         CHANGE          2000
                                          ----         ------          ----
--------------------------------------------------------------------------------
Interest Income                        $ 232,000        (62%)       $ 613,000
--------------------------------------------------------------------------------
Interest Expense                       $  17,000         13%        $  15,000
--------------------------------------------------------------------------------
Other Income                           $   8,000        (11%)       $   9,000
--------------------------------------------------------------------------------

     Interest income  decreased to $232,000 for the year ended December 31, 2001
compared to $613,000 for the year ended December 31, 2000. This decrease was due
to  lower  average  balances  in  cash  and  short-term  investments  and  lower
investment yields during the year


                                       40
<PAGE>

December 31,  2001.  Interest  expense for the year ended  December 31, 2001 was
$17,000,compared to $15,000 for the year ended December 31, 2000.

CHANGE IN ACCOUNTING PRINCIPLE

     We  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,  we had recorded  approximately  $739,000 in
deferred revenue which will be recognized over the expected  performance  period
of each  respective  agreement.  During 2001, we  recognized  $63,000 in revenue
previously recognized up-front license fees that were deferred upon the adoption
of SAB 101, and accordingly, at December 31, 2001 have approximately $677,000 in
deferred revenue which will be recognized over the expected  performance  period
of each respective agreement.

PREFERRED STOCK DIVIDEND

     Preferred  stock dividends were $1.7 million during each of the years ended
December 31, 2001 and December 31, 2000. Such preferred stock dividends, paid in
shares of our common  stock,  were the result of our  obligations  in connection
with the  issuance of our Series D  preferred  stock in May 1999.  Beginning  in
mid-2002,  as more fully set forth in the Amended  Certificate  of  Designation,
Preferences and Rights of the Series D Cumulative  Convertible  Preferred Stock,
we will no longer pay dividends on the Series D preferred stock in shares of our
common stock, and will become obligated to pay such dividends in cash, at a rate
equal to 8% per annum.

     YEARS ENDED DECEMBER 31, 2000 AND DECEMBER 31, 1999

REVENUES

--------------------------------------------------------------------------------
Revenues
(dollars in thousands)               2000             CHANGE            1999
                                     ----             ------            ----
--------------------------------------------------------------------------------
Product Sales                     $  20,501             35%           $  15,211
--------------------------------------------------------------------------------
Contract Revenues                     3,240            321                  770
--------------------------------------------------------------------------------
License Revenues                        530            430                  100
                                  ---------                           ---------
--------------------------------------------------------------------------------
Total                             $  24,271             51%           $  16,081
--------------------------------------------------------------------------------

     We recognized  $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 our
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. In accordance with SAB 101, which we adopted
in 2000, our 2000 licensing revenues of $530,000 were attributable,  in part, to
our recognition of up-front  license fees received for various  agreements which
are being recognized over the expected  performance  period of these agreements.
License revenues in 2000


                                       41
<PAGE>

also  included  $397,000 that we recorded in earlier years prior to the adoption
of SAB 101 which we  deferred  as a result of our change in revenue  recognition
policy.

     Revenues in 1999 included $15.2 million in net sales of Periostat, $770,000
in contract revenues from our co-promotion of Vioxx and Denavir, and $100,000 in
foreign  license  revenues for  Periostat.  Revenues from Denavir  accounted for
$511,000 of such contract revenues. 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
(dollars in thousands)             2000             CHANGE           1999
                                   ----             ------           ----
--------------------------------------------------------------------------------
Cost of Product Sales            $  4,070             30%           $ 3,139
--------------------------------------------------------------------------------
Percent of Product Sales            19.9%                              20.6%
--------------------------------------------------------------------------------

     Cost of product sales includes product packaging, third-party royalties and
the costs associated with the manufacturing,  storage and stability of Periostat
capsules.

     Cost of product sales were $4.1 million,  or 19.9% of product sales in 2000
compared to $3.1 million,  or 20.6% of product  sales in 1999.  This decrease in
cost of product  sales as a percentage of product sales was primarily due to the
absence of trade  allowances  in 2000 and the increase in the selling  price per
unit for  Periostat  in 2000,  which  resulted in a lower cost of product  sales
percentage.

RESEARCH AND DEVELOPMENT

--------------------------------------------------------------------------------
Research and Development
(dollars in thousands)             2000             CHANGE           1999
                                   ----             ------           ----
--------------------------------------------------------------------------------
Research and Development          $ 3,128            (38%)          $ 5,005
--------------------------------------------------------------------------------
Percentage of Total Revenue         12.9%                             31.1%
--------------------------------------------------------------------------------

     Research and development  expenses consist primarily of funds paid to third
parties  for the  provision  of services  and  materials  for drug  development,
manufacturing  and  formulation  enhancements,   clinical  trials,   statistical
analysis and report writing and regulatory compliance costs.

     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.



                                       42
<PAGE>

     Research and development expenses incurred in 2000 consisted of $375,000 in
direct salaries and benefits,  $324,000 in noncash compensation expense relating
to the  acceleration  of the vesting of stock  options for certain  research and
development  consultants,  $255,000  in  research  grants  to  various  academic
institutions for conducting research related to our core technology and $356,000
to SUNY under the  agreement  we executed in 1998 for  research  relating to our
IMPACS  technology.  We  also  incurred  $263,000  in  contracted  clinical  and
development expenses related to Metastat and other IMPACS compounds.

     Development  projects  contracted in 2000 included $113,000 for formulation
development expense for Dentaplex.

     Clinical projects  conducted during 2000 included the initiation of various
Phase 3b studies for  Periostat in dental  indications.  Clinical  project costs
incurred in 2000 were $250,000.

     Other expenses incurred in 2000 include $600,000 in FDA filing fees, legal,
and regulatory expenses in the United States for Periostat capsules and expenses
associated with our New Drug Application for Periostat tablets. We also incurred
$237,000 in  regulatory  consulting  and filing  fees in the United  Kingdom for
marketing  approval for  Periostat  tablets,  $188,000 in ongoing  manufacturing
support for Periostat capsules,  stability studies and manufacturing  validation
costs  for   Periostat   tablets  and   $167,000  in  travel  and  other  office
expenditures.

     Research and  development  expenses  incurred in 1999 included  $387,000 in
direct salaries and benefits,  $306,000 in noncash compensation expense relating
to stock options for certain research and development  consultants,  $542,000 in
non-recurring  research  grants  and  $541,000  to SUNY  under  our  contractual
obligation  entered  into in  1998.  We also  incurred  $172,000  in  contracted
clinical  and  development   expenses  related  to  Metastat  and  other  IMPACS
compounds.

     Development  projects  contracted  in 1999  included  $975,000  for ongoing
manufacturing validation and formulation development costs for Periostat tablets
which  began  in 1999  and  $261,000  for an  initial  feasibility  study  for a
once-a-day formulation for Periostat that failed during the year.

     Clinical  projects  conducted  during  1999  included  a Phase  IV study to
support the future marketing  activities for Periostat.  These costs incurred in
1999 were $1.1 million.

     Other expenses incurred in 1999 include $464,000 in FDA filing fees, legal,
and regulatory expenses in the United States for Periostat capsules and expenses
associated with our New Drug Application for Periostat tablets. We also incurred
$65,000 in  regulatory  consulting  and filing  fees in the United  Kingdom  for
marketing  approval  for  Periostat  capsules  and  $186,000 in travel and other
office expenditures.



                                       43
<PAGE>


SELLING, GENERAL AND ADMINISTRATIVE

--------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands)                   2000           CHANGE           1999
                                         ----           ------           ----
--------------------------------------------------------------------------------
Selling, General and Administrative    $ 25,746           11%          $ 23,180
--------------------------------------------------------------------------------
Percentage of Total Revenue               106.1%                         144.1%
--------------------------------------------------------------------------------

     Selling, general and administrative expenses consist primarily of personnel
salaries  and  benefits,  direct  marketing  costs,   professional,   legal  and
consulting fees, insurance and general office expenses.

     Selling,  general and administrative expenses increased to $25.7 million in
2000 from $23.2 million in 1999. Significant components of selling,  general and
administrative  expenses  incurred  in 2000  included  $12.9  million  in direct
selling and sales  training  expenses,  $9.0 million in  marketing  expenses for
Periostat and Vioxx,  and $3.8 million in general and  administrative  expenses,
which include business  development,  finance and corporate  activities.  Direct
selling  expenses  increased $1.8 million as a result of annual salary increases
and recruiting  costs for our sales force.  Other increases in selling,  general
and  administrative  expenses during 2000 were mainly due to an incremental $1.2
million in promotional expenses for Vioxx pursuant to our co-promotion agreement
with  Merck  and an  additional  $1.2  million  for  the  initiation  of our DTC
advertising test campaign for Periostat,  which commenced in October 2000. These
increases  were  partially  offset by a $2.5  million  decrease  in  traditional
marketing programs for Periostat.

     During 1999, we incurred  $10.3 million in direct  selling  expenses,  $9.3
million in marketing  expenses,  primarily  for  Periostat,  and $3.6 million in
general and administrative expenses.

OTHER INCOME/EXPENSE

--------------------------------------------------------------------------------
Other Income /(Expense)                  2000           CHANGE           1999
                                         ----           ------           ----
--------------------------------------------------------------------------------
Interest Income                        $ 613,000        (28%)       $ 851,000
--------------------------------------------------------------------------------
Interest Expense                       $  15,000        (92%)       $ 197,000
--------------------------------------------------------------------------------
Other Income (Expense)                 $   9,000          N/A       $  (2,000)
--------------------------------------------------------------------------------

     Interest  income  decreased  from $851,000 for the year ended  December 31,
1999 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 our financing  consummated in May 1999.  Such decrease for 2000
was partially  offset by interest  expense  related to the $219,000 note payable
executed by us in April 1999.


                                       44
<PAGE>

CHANGE IN ACCOUNTING PRINCIPLE

     We  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 our  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.

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 our common stock,  were the result
of our  obligations  in  connection  with the issuance of our Series D preferred
stock in May 1999.

LIQUIDITY AND CAPITAL RESOURCES

     Since our origin in January 1992, we have financed our  operations  through
private placements of our preferred and common stock, an initial public offering
of  2,000,000  shares of common  stock,  which  generated  net proceeds to us 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 us of approximately  $11.6 million after  underwriting  fees and
related  expenses.  On May 12, 1999, we  consummated  a $20.0 million  financing
through the issuance of our Series D  cumulative  convertible  preferred  stock,
which generated net proceeds to us of $18.5 million.  The issuance of the Series
D preferred  stock was approved by a majority of our  stockholders at our Annual
Meeting  of  Stockholders  on May 11,  1999.  A portion of the  proceeds  of the
preferred  stock  financing  consummated  in May 1999 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 such financing.  The remaining  proceeds have
been and will be used for general working capital purposes.

     The Series D preferred  stock is convertible at any time into shares of our
common stock at a current  conversion price of $9.91 per share, which conversion
price reflects a decrease from the initial  conversion price of $11.00 per share
as a  result  of both a common  stock  financing  in March  2001 and the sale of
shares of our common stock to Atrix in August 2001. Such conversion price is not
subject  to reset  except in the event that we should  fail to  declare  and pay
dividends  when due or we 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  preferred  stock.
During  the first  three  years  following  issuance,  holders  of the  Series D
preferred  stock are  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 preferred  stock  shall,  at our
option (as  determined by our board of  directors),  automatically  be converted
into fully paid,  registered and  non-assessable  shares of common stock, if the
following two conditions  are met: (i) the last sale price,  or, in case no such
sale takes place on such day, the average of the closing bid and asked


                                       45
<PAGE>

prices on the Nasdaq  National  Market is at least 200% of the conversion  price
then in effect (as of December 31,  2001,  such  conversion  price was $9.91 per
share)  for  forty  consecutive  trading  days;  and  (ii) a shelf  registration
statement  is in  effect  for the  shares  of  common  stock to be  issued  upon
conversion  of the Series D  preferred  stock.  Without  written  approval  of a
majority  of the holders of record of the Series D preferred  stock,  we,  among
other things,  shall not: (i) declare or pay any dividend or distribution on any
shares of our  capital  stock  other than  dividends  on the Series D  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 our debt
securities,  except  that we 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 we have reported  positive net income for four consecutive
quarters immediately prior to such twelve month period.

     In April 1999, we received $219,000 in proceeds from our issuance of a note
payable.  We used the proceeds of such note to fund the  purchase of  equipment,
fixtures and furniture for our 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, we  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 us of  approximately  $6.8 million.  We are using such
proceeds  primarily  for our DTC  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
from the date of such  financing  into 400,000  shares of our 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 such financing. We also issued
to our financial advisor in such financing  warrants to purchase an aggregate of
150,000 shares of our 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  the  financing.  Such  warrants  may  be  deemed
automatically  exercised in certain circumstances based upon our stock price. In
connection  with the March 2001  financing,  we are  obligated  to maintain  the
effectiveness of a shelf registration  statement with respect to all such shares
of common stock issued and shares  underlying all such warrants for a continuous
twenty-four (24) month period,  or we will be required to issue to the investors
and the financial  advisor an additional  27,500 shares of our common stock,  in
the aggregate, for no additional consideration.

      On March 19, 2001, we consummated a revolving credit facility with Silicon
Valley Bank, which was subsequently  amended in March 2002. The credit facility,
as amended,  extends  through  March 15, 2004. We may borrow up to the lesser of
$4.0 million or 80% of eligible accounts receivable, as defined under the credit
facility.  The amount available to us is also reduced by outstanding  letters of
credit which may be issued under the credit  facility in amounts  totaling up to
$1.5 million.  We are not obligated to draw amounts and any such borrowings bear
interest,  payable  monthly,  currently  at the prime  rate plus 1.0 to 1.5% per
annum and may be used only for working capital purposes. In 2002, we secured our
expected   purchase  order   commitments   for  Periostat  from   Pharmaceutical
Manufacturing Research Services, Inc., a


                                       46
<PAGE>

contract  manufacturing  company,  with a letter  of  credit  under  the  credit
facility  for  approximately  $1.3  million.  Without the consent of the Silicon
Valley Bank,  we, 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 our  common  stock.  We must also
maintain a certain  tangible  net worth and a minimum of $2.0 million in cash at
Silicon Valley Bank, net of borrowings under the credit  facility,  at all times
during the term thereto. In addition,  we have secured our obligations under the
credit facility through the granting of a security interest in favor of the bank
with respect to all of our assets,  including our intellectual  property.  As of
December 31, 2001, we had no outstanding letters of credit issued.  There are no
current borrowings outstanding against the credit facility.

     On August 24, 2001, we signed a License and Marketing  Agreement with Atrix
Laboratories,  Inc. to market  Atrix's  proprietary  dental  products,  Atridox,
Atrisorb FreeFlow and Atrisorb-D,  to the United States dental market.  Pursuant
to the terms of this agreement,  among other things:  (i) Atrix will manufacture
the dental  products  for us at an agreed upon  transfer  price and will receive
royalties on future net sales of the products each calendar  year;  (ii) we paid
to Atrix a $1.0 million  licensing  fee to market such  products;  (iii) we have
committed  to no less than $2.0  million in  advertising  and  selling  expenses
related to the Atrix products during the fiscal year beginning  January 1, 2002;
(iv) we have agreed to maintain,  for a period of 24 months,  a force of no less
than  ninety (90) full time  dental  consultants  and  divisional  and  regional
managers to make sales and product recommendation calls on dental professionals;
and (v) we have agreed that the Atrix products will be the subject of a specific
number  of  detail  calls in the  United  States  during  2002.  We will also be
required to make certain  minimum  expenditures  for advertising and promotional
activities  after 2002,  including:  (i) the lesser of  $4,000,000 or 30% of our
contribution  margin  relating to a specific  Atrix product that we market,  and
(ii) the lesser of $2,000,000 or 30% of our  contribution  margin  relating to a
separate Atrix product that we market.

     In addition,  pursuant to the terms of a Stock  Purchase  Agreement that we
executed with Atrix, dated August 24, 2001, Atrix purchased 330,556 unregistered
shares of our common stock for an aggregate purchase price of approximately $3.0
million.  As a result of the sale of such shares to Atrix,  the conversion price
of our Series D preferred stock was reduced from $9.94 to $9.91 per share.

     On February 14, 2002, we entered into an equity line arrangement  under the
terms of a common stock purchase  agreement with  Kingsbridge  Capital  Limited.
Pursuant to this agreement, we may, at our sole discretion and from time to time
over the next 12 months,  sell shares of our common  stock to  Kingsbridge  at a
discount  to  market  price,  as  determined  prior to each such  sale.  We have
committed to: (i) draw down on this equity line, an amount  aggregating at least
$1.5 million in registered shares of common stock,  prior to August 14, 2002; or
(ii) if, prior to August 14, 2002, we have not drawn down an amount  aggregating
at least $1.5 million in registered shares of common stock, we will be obligated
to pay Kingsbridge,  in cash, an amount equal to 10% of the amount by which $1.5
million  exceeds the  aggregate of all amounts drawn down by us under the equity
line up to that  date.  The  equity  line  provides  for the  sale of up to $8.5
million in registered shares of our common stock to Kingsbridge.



                                       47
<PAGE>

     Additionally,  in connection  with the  consummation of the equity line and
pursuant  to  the  terms  of a  warrant  agreement  executed  by us,  we  issued
Kingsbridge  a warrant  to  purchase  40,000  shares of our  common  stock at an
exercise  price  of $9.38  per  share.  The  conversion  price  of our  Series D
preferred stock was not reduced as a result of such issuance.  Such warrant will
not become  exercisable  until August 14, 2002,  and will  thereafter  expire on
August 13, 2007.  We intend to register the shares of our common stock which may
be issued by us upon the sale and issuance of our common  stock to  Kingsbridge,
and upon any  exercise of the  warrant by  Kingsbridge,  under our recent  shelf
registration  statement on Form S-3,  which  registered  an aggregate of 964,880
shares of our common stock and was  declared  effective  by the  Securities  and
Exchange Commission on February 14, 2002.

     At  December  31,  2001,  we had  cash,  cash  equivalents  and  short-term
investments of approximately $6.2 million, an increase of $723,000 from the $5.4
million balance at December 31, 2000.  This increase was primarily  attributable
to the net proceeds of $6.8 million  from the 2001  financing,  and $3.0 million
from the sale of shares of the our common stock to Atrix, less cash used to fund
operating  activities for the year ended  December 31, 2001. In accordance  with
investment  guidelines  approved  by our 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. Our working capital at December 31, 2001 was $6.3 million,  an
increase of $1.0 million from $5.3 million at December 31, 2000.  This  increase
was  primarily  attributable  to the net proceeds of $6.8 million from our March
2001  financing  and $3.0 million from the sale of shares of our common stock to
Atrix,  less cash used to fund  operations  during the year ended  December  31,
2001.

     We anticipate that our existing  working capital will be sufficient to fund
our current  operations  through at least the end of 2002 and that existing cash
and  cash  equivalents,  internally  generated  funds  from  operations  and the
anticipated  cash inflows  from both our equity line of credit with  Kingsbridge
and our revolving credit facility with Silicon Valley Bank will be sufficient to
support our  operations  through  2003.  Our actual  future  cash  requirements,
however,  will  depend  on many  factors,  including  market  acceptance  of our
products and technology.

     We  believe  that other key  factors  that could  affect our  internal  and
external sources of cash are:

     o    Revenues and margins from sales of  Periostat  and other  products and
          contracted services;

     o    The success of our dermatology franchise;

     o    The success of our pre-clinical, clinical and development programs;

     o    The receptivity of the capital markets to future financings;

     o    Our ability to enter into additional  strategic  collaborations and to
          maintain  existing  and new  collaborations  and the  success  of such
          collaborations; and

     o    Our  ability to meet the  covenant  requirements  under our  revolving
          credit facility.



                                       48
<PAGE>

CONTRACTUAL OBLIGATIONS

     Our major outstanding  contractual  obligations relate to cash dividends on
our Series D preferred stock outstanding,  operating leases for our office space
and other  contractual  commitments  with our  marketing  partners  for  certain
selling and promotional  expenses  associated with the products we are currently
detailing. Additionally, we also expect to make certain inventory purchases from
our contract manufacturer of Periostat,  guaranteed by our irrevocable Letter of
Credit with Silicon Valley Bank.

     Our Series D preferred  stock currently pays dividends in common stock at a
rate of 8.4%  per  annum  through  March  19,  2002.  Thereafter,  the  Series D
preferred stock pays dividends in cash at a rate of 8.0% per annum. The Series D
preferred  stock is  convertible  into our common stock at a current  conversion
price of $9.91 per share,  subject to adjustment,  at any time by the holder and
under certain  conditions by us. The conversion  price of the Series D preferred
stock is subject to  adjustment in the event we fail to declare or pay dividends
when due or should we 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 Series D preferred stock.

     In May 1999, we entered into a lease agreement relating to our office space
in Newtown,  Pennsylvania.  The lease has an initial  term of 10 years.  Rent is
expected  to be  approximately  $318,000  per  year  and is  subject  to  market
adjustments at the end of the 5th year.

     In August of 1999, we entered into a three-year co-promotion agreement with
Merck for Vioxx under which we are committed to spend up to $1 million  annually
for promotional expenses, unless the agreement is earlier terminated.

     Pursuant to our License and Marketing Agreement with Atrix Laboratories, we
have  committed  to: (i) expend no less than $2.0  million  in  advertising  and
selling  expenses related to the Atrix products during the fiscal year beginning
January 1, 2002;  (ii) maintain,  for a period of 24 months,  a force of no less
than  ninety (90) full time  dental  consultants  and  divisional  and  regional
managers to make sales and product recommendation calls on dental professionals;
and (iii) making the Atrix  products the subject of a specific  number of detail
calls in the United States during 2002. We will also be required to make certain
minimum  expenditures  for advertising and  promotional  activities  after 2002,
including:  (i) the lesser of $4,000,000 or 30% of our contribution  margin,  as
defined in the  agreement,  relating to a specific Atrix product that we market,
and (ii) the lesser of $2,000,000 or 30% of our contribution  margin, as defined
in the agreement, relating to a separate Atrix product that we market.




                                       49
<PAGE>

     Below is a table which presents our contractual  obligations and commercial
commitments as of December 31, 2001:
<TABLE>
<CAPTION>

------------------------------------------------------------------------------------------------------------
                                                    PAYMENTS DUE BY PERIOD
                         -----------------------------------------------------------------------------------
   CONTRACTUAL                               LESS
   OBLIGATIONS                               THAN 1            2 - 3             4 - 5           AFTER 5
                             TOTAL            YEAR             YEARS             YEARS            YEARS
------------------------------------------------------------------------------------------------------------
<S>                      <C>             <C>               <C>                <C>              <C>
LONG-TERM DEBT(1)        $     35,000    $    35,000            $0                $0               $0
------------------------------------------------------------------------------------------------------------

OPERATING LEASES(2)      $  2,532,000    $   335,000       $   667,000        $   668,000      $   862,000
------------------------------------------------------------------------------------------------------------

UNCONDITIONAL                            $   293,000(3)
PURCHASE                                 $ 1,000,000(4)
OBLIGATIONS              $  3,293,000    $ 2,000,000(5)          (5)                 (5)              (5)
------------------------------------------------------------------------------------------------------------

CASH DIVIDEND ON
SERIES D PREFERRED
STOCK                    $  7,600,000(6) $ 1,200,000(6)    $ 3,200,000(6)    $  3,200,000(6)          (6)
------------------------------------------------------------------------------------------------------------
TOTAL CONTRACTUAL
OBLIGATIONS              $ 13,460,000    $ 4,863,000       $ 3,867,000       $  3,868,000      $   862,000

------------------------------------------------------------------------------------------------------------
</TABLE>


(1)  Balance payable on April 1999 $219,000 note.

(2)  Such amounts primarily include minimum rental payments for our office lease
     in Newtown, Pennsylvania.

(3)  Such amount represents  committed  inventory  purchases on a purchase order
     under the terms of our Agreement with Pharmaceutical Research Manufacturing
     Services, Inc.

(4)  Such amount  represents the maximum  amounts payable under the terms of our
     Co-Promotion Agreement with Merck & Co., Inc. for Vioxx.

(5)  Such  amounts  are  payable  under the terms of our  Agreement  with  Atrix
     Pharmaceuticals.  We will be required to expend  $2,000,000 in  advertising
     and selling  expenses  related to the Atrix  products in 2002,  and to make
     certain minimum  expenditures  for  advertising and promotional  activities
     after  2002,  including:  (i)  the  lesser  of  $4,000,000  or  30%  of our
     contribution  margin (as defined in the  agreement)  relating to a specific
     Atrix  product that we market,  and (ii) the lesser of $2,000,000 or 30% of
     our  contribution  margin  (as  defined  in the  agreement)  relating  to a
     separate Atrix product that we market.

(6)  Pursuant  to the terms of our  Series D  Cumulative  Convertible  Preferred
     Stock  issued in May 1999,  and unless  earlier  converted  pursuant to its
     terms,  the  holders  of the  Series D  preferred  stock  are  entitled  to
     dividends  payable in our common  stock at a rate of 8.4% per annum for the
     first three years and dividends payable in cash at a rate of 8.0% per annum
     thereafter.

                                       50
<PAGE>

     At  December  31,  2001,  the Company had  approximately  $64.5  million of
Federal and $35.9 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  $850,000  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.  As  of  December  31,  2001,  assuming  no  future  ownership  changes,
approximately  $34.0 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 $2,000,000 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 were used as legal tender through December 31, 2001.
On January 1, 2002, the legacy currencies were canceled and euro bills and coins
began to be used for cash transactions in the participating countries.

     We do not  denominate  our  international  licensing  agreements in foreign
currencies. The euro conversion did not have a material impact on our results of
operations or financial condition.

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

     We believe  that we are not subject to a material  impact to our  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."



                                       51
<PAGE>

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

     Not applicable.




                                       52
<PAGE>

                                    PART III

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The  information  relating  to our  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
our definitive  proxy  statement for the 2002 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 our definitive
proxy  statement for the 2002 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 our definitive  proxy  statement for the 2002 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 our definitive  proxy statement for the 2002 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.



                                       53
<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 57.

(b)       Reports on Form 8-K.

               We filed two current reports on Form 8-K during the quarter ended
          December 31, 2001.

               On October 18, 2001,  we filed a current  report on Form 8-K with
          the Securities and Exchange  Commission with respect to the filing of:
          (i) the Amended Certificate of Designation,  Preferences and Rights of
          the Series D  Cumulative  Convertible  Preferred  Stock of  CollaGenex
          Pharmaceuticals,  Inc.; (ii) Amendment No. 1 to the  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;  (iii)  Amendment No. 2 to
          the 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;  and
          (iv) Amendment No. 2 to the Shareholder  Protection  Rights Agreement,
          dated September 15, 1997, between CollaGenex Pharmaceuticals, Inc. and
          American Stock Transfer & Trust Company, as amended.

               On December 10, 2001, we also filed a current  report on Form 8-K
          announcing  the execution of an addendum to our Supply  Agreement with
          Hovione  International  Limited.  Hovione  is  our  sole  supplier  of
          doxycycline hyclate, the active ingredient in our Periostat product.




                                       54
<PAGE>

                                   SIGNATURES

     Pursuant to the  requirements  of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized this 29th day of March,
2002.

                                   COLLAGENEX PHARMACEUTICALS, INC.



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




                                       55
<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            Chairman, Chief Executive       March 29, 2002
------------------------------    Officer, President and Director
    Brian M. Gallagher, Ph.D.     (Principal Executive Officer)


/s/ Nancy C. Broadbent           Chief Financial Officer,         March 29, 2002
------------------------------   Treasurer and Secretary
    Nancy C. Broadbent           (Principal Financial and
                                 Accounting Officer)

/s/ Peter R. Barnett                Director                      March 29, 2002
------------------------------
    Peter R. Barnett, D.M.D.

/s/ Robert C. Black                 Director                      March 29, 2002
------------------------------
    Robert C. Black

/s/ James E. Daverman               Director                      March 31, 2002
------------------------------
    James E. Daverman

/s/ Robert J. Easton                Director                      March 31, 2002
------------------------------
    Robert J. Easton

/s/ Stephen A. Kaplan               Director                      March 29, 2002
------------------------------
    Stephen A. Kaplan

/s/ W. James O'Shea                 Director                      March 28, 2002
------------------------------
    W. James O'Shea




                                       56
<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.

   4.7(m)      Amended Certificate of Designation, Preferences and Rights of the
               Series D Cumulative  Convertible  Preferred  Stock of  CollaGenex
               Pharmaceuticals, Inc. dated as of October 15, 2001.

   4.8(m)      Amendment No. 2 to Shareholder Protection Rights Agreement, dated
               as of May 10,  2001,  between  the  Company  and  American  Stock
               Transfer & Trust Company.

 +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.



                                       57
<PAGE>

EXHIBIT NO.    DESCRIPTION OF EXHIBIT
-----------    ----------------------

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

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

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

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

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

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

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

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

  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.

                                       58
<PAGE>

EXHIBIT NO.    DESCRIPTION OF EXHIBIT
-----------    ----------------------

  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.

  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(j)     Loan and Security  Agreement  dated March 19,  2001,  between the
               Company and Silicon Valley Bank.

 +10.25(k)     Services and Supply  Agreement  dated as of September 26, 2000 as
               amended by letter  agreement dated as of December 1, 2000, by and
               between  the Company and  Pharmaceutical  Manufacturing  Research
               Services, Inc.

  10.26(l)     Letter  Agreement  dated as of June 26,  2001 by and  between the
               Company and Pharmaceutical Manufacturing Research Services, Inc.

  10.27(m)     Amendment  No.  1  to  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.

  10.28(m)     Amendment  No.  2  to  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.

 +10.29(n)     License Agreement dated August 24, 2001 by and between CollaGenex
               Pharmaceuticals, Inc. and Atrix Laboratories, Inc.

                                       59
<PAGE>

EXHIBIT NO.    DESCRIPTION OF EXHIBIT
-----------    ----------------------

 +10.30(n)     Stock  Purchase  Agreement  dated  August 24, 2001 by and between
               CollaGenex Pharmaceuticals, Inc. and Atrix Laboratories, Inc.

 +10.31(o)     First Addendum  December 10, 2001 to the Supply  Agreement  dated
               January  23,  1995 by and between  CollaGenex,  Inc.  and Hovione
               International Limited.

  10.32(p)     Common Stock  Purchase  Agreement  dated February 14, 2002 by and
               between CollaGenex Pharmaceuticals,  Inc. and Kingsbridge Capital
               Limited.

  10.33(p)     Warrant  dated  February 14, 2002 issued to  Kingsbridge  Capital
               Limited.

  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.



                                       60
<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.

(j)     Incorporated  by reference to the  Company's  Annual Report on Form 10-K
        for the  year  ended  December  31,  2000,  which  was  filed  with  the
        Securities  and  Exchange  Commission  on March 26,  2001.  The  Company
        amended such Form 10-K by filing a Form 10-K/A on January 2, 2002.

(k)     Incorporated by reference to the Company's Quarterly Report on Form 10-Q
        for the  quarter  ended  March  31,  2001,  which  was  filed  with  the
        Securities and Exchange Commission on May 15, 2001.

(l)     Incorporated by reference to the Company's Quarterly Report on Form 10-Q
        for the quarter ended June 30, 2001, which was filed with the Securities
        and Exchange Commission on August 14, 2001.

(m)     Incorporated  by reference to the Company's  Current Report on Form 8-K,
        dated October 15, 2001, which was filed with the Securities and Exchange
        Commission on October 18, 2001.

(n)     Incorporated by reference to the Company's Quarterly Report on Form 10-Q
        for the  quarter  ended  September  30,  2001,  which was filed with the
        Securities  and Exchange  Commission  on November 14, 2001.  The Company
        amended such Form 10-Q by filing a Form 10-Q/A on February 14, 2002.

(o)     Incorporated  by reference to the Company's  Current Report on Form 8-K,
        dated  December  10,  2001,  which was  filed  with the  Securities  and
        Exchange Commission on December 10, 2001.

(p)     Incorporated  by reference to the Company's  Current Report on Form 8-K,
        dated  February  14,  2002,  which was  filed  with the  Securities  and
        Exchange Commission on February 15, 2002.



                                       61
<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, 2000 and 2001...........    F-3

Consolidated Statements of Operations for the years ended
December 31, 1999, 2000, and 2001......................................    F-4

Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1999, 2000 and 2001.................................    F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 2000 and 2001.......................................    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,  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, 2000 and 2001, and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended  December  31,  2001,  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 9 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 30,  2002,  except as to the first  paragraph of note 16, which is as of
February  14,  2002,  the second  paragraph  of note 16 which is as of March 22,
2002, and the third paragraph of note 16 which is as of March 26, 2002.



                                      F-2
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                           Consolidated Balance Sheets

                           December 31, 2000 and 2001

                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                           ASSETS                                    2000          2001
                                                                  ---------     ---------
<S>                                                               <C>           <C>
Current assets:
    Cash and cash equivalents................................     $   3,709     $   6,171
    Short term investments...................................         1,739            --
    Accounts receivable, net of allowance of $381 and $950
        in 2000 and 2001, respectively.......................         3,038         4,478
    Inventories..............................................           277         1,402
    Prepaid expenses and other current assets................           989         1,200
                                                                  ---------     ---------
        Total current assets.................................         9,752        13,251
Equipment and leasehold improvements, net....................           652           537
Other assets.................................................            27           910
                                                                  ---------     ---------
        Total assets.........................................     $  10,431     $  14,698
                                                                  =========     =========

            LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Current portion of note payable..........................     $      65     $      35
    Accounts payable.........................................         1,865         3,769
    Accrued expenses.........................................         2,514         3,153
                                                                  ---------     ---------
               Total current liabilities.....................         4,444         6,957
                                                                  ---------     ---------

Note payable, less current portion...........................            47            --
Deferred revenue.............................................           676           614

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 2000 and 2001, respectively (liquidation value
       $20,000)..............................................             2             2
    Common stock, $0.01 par value; 25,000,000 shares
       authorized, 8,775,176 and 10,999,573 shares issued
       and outstanding in 2000 and 2001, respectively........            88           110
    Common stock to be issued (275,462 shares and 103,196
       shares in 2000 and 2001, respectively)................           872           840
    Additional paid in capital...............................        68,461        80,129
    Deferred compensation....................................           (29)           --
    Accumulated deficit......................................       (64,130)     (73,954)
                                                                  ---------     ---------
        Stockholders' equity.................................         5,264         7,127
                                                                  ---------     ---------
        Total liabilities and stockholders' equity...........     $  10,431     $  14,698
                                                                  =========     =========
</TABLE>


           See accompanying notes to consolidated financial statements

                                      F-3
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                      Consolidated Statements of Operations

                  Years ended December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                 1999              2000             2001
                                                            -------------      ------------     ------------
<S>                                                         <C>                <C>              <C>
Revenues:
     Product sales....................................      $      15,211      $     20,501     $     31,358
     Contract revenues................................                770             3,240            3,386
     License revenues.................................                100               530              488
                                                            -------------      ------------     ------------
         Total revenues...............................             16,081            24,271           35,232
                                                            -------------      ------------     ------------
Operating expenses:
     Cost of product sales............................              3,139             4,070            5,825
     Research and development.........................              5,005             3,128            3,764
     Selling, general and administrative..............             23,180            25,746           34,010
                                                            -------------      ------------     ------------
         Total operating expenses.....................             31,324            32,944           43,599
                                                            -------------      ------------     ------------
         Operating loss...............................            (15,243)           (8,673)          (8,367)

Other income (expense):
     Interest income..................................                851               613              232
     Interest expense.................................               (197)              (15)             (17)
     Other income (expense)...........................                 (2)                9                8
                                                            -------------      ------------     ------------
         Loss before cumulative effect of
              change in accounting principle..........            (14,591)           (8,066)          (8,144)

Cumulative effect of change in accounting principle...                 --              (764)              --
                                                            -------------      ------------     ------------
         Net loss.....................................            (14,591)           (8,830)          (8,144)

Preferred stock dividend..............................              1,092             1,689            1,680
                                                            -------------      ------------     ------------
Net loss allocable to common stockholders.............      $     (15,683)     $    (10,519)    $     (9,824)
                                                            =============      ============     ============
Basic and diluted net loss per share allocable
     to common stockholders before cumulative
     effect of change in accounting principle.........      $       (1.82)     $      (1.12)    $      (0.94)

Cumulative effect of change in accounting
     principle........................................                 --             (0.09)              --
                                                            -------------      ------------     ------------
Basic and diluted net loss per share allocable
     to common stockholders...........................      $       (1.82)     $      (1.21)    $      (0.94)
                                                            =============      ============     ============
Shares used in computing per share amounts:
     Basic and diluted................................          8,597,676         8,711,668       10,413,663
                                                            =============      ============     ============
Pro forma net loss assuming new accounting principle is
     applied retroactively............................      $     (14,633)     $     (8,066)
                                                            =============      ============
Pro forma net loss allocable to common stockholders
     assuming new accounting principle is applied
     retroactively....................................      $     (15,725)     $     (9,755)
                                                            =============      ============
Pro forma basic and diluted net loss per share allocable
     to common stockholders assuming new accounting
     principle is applied retroactively...............      $       (1.83)     $      (1.12)
                                                            =============      ============
</TABLE>


          See accompanying notes to consolidated financial statements.

                                      F-4
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 1999, 2000 and 2001
                             (Dollars in thousands)
<TABLE>
<CAPTION>

                                         SERIES D CUMULATIVE
                                         CONVERTIBLE
                                         PREFERRED
                                         STOCK                   COMMON STOCK
                                         -------------------  -------------------
                                                                                    COMMON STOCK   ADDITIONAL
                                         NUMBER OF    PAR      NUMBER OF     PAR       TO BE         PAID-IN        DEFERRED
                                          SHARES     VALUE      SHARES      VALUE      ISSUED        CAPITAL      COMPENSATION
                                        ----------  --------- ----------  ---------  -----------    ---------     ------------


<S>                                     <C>         <C>         <C>       <C>         <C>           <C>           <C>
Balance, December 31, 1998 .........           --   $     --   8,587,204  $     86    $     --      $  47,317     $    (194)
  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 ...................           --         --          --        --          --             --           118
  Net loss .........................           --         --          --        --          --             --            --
                                        ----------  --------- ----------  ---------  ----------     ----------    -----------
Balance, December 31, 1999 .........      200,000          2   8,622,091        86         858         66,348           (76)
  Exercise of common stock options..           --         --      21,325        --          32             84            --
  Common stock dividends issued 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 ...................          --          --          --        --          --             --            47
  Net loss .........................          --          --          --        --          --             --            --
                                        ----------  --------- ----------  ---------  ----------     ----------    -----------
Balance, December 31, 2000 .........      200,000          2   8,775,176        88         872         68,461           (29)
  Issuance of common stock for
    common stock options previously
    exercised ......................          --          --      16,000        --         (32)            32             --
  Issuance of common stock, net of
    issuance costs .................          --          --   1,830,556        18          --          9,796             --
  Common stock dividends issued on
    Series D cumulative convertible
    preferred stock ................          --          --     377,841         4        (840)         1,676             --
  Common stock dividends declared on
    Series D cumulative convertible
    preferred stock ................          --          --          --        --         840             --             --
  Compensation expense resulting
    from modifications of options ..          --          --          --        --          --            164             --
  Amortization of deferred
     compensation ..................          --          --          --        --          --             --             29
  Net loss .........................          --          --          --        --          --             --             --
                                        ----------  --------- ----------  ---------  ----------     ----------     ----------
Balance, December 31, 2001 .........     200,000    $      2  10,999,573  $    110    $    840      $  80,129      $
                                        ==========  ========= ==========  =========  ==========     ==========     ==========

                                                       TOTAL
                                       ACCUMULATED STOCKHOLDERS'
                                         DEFICIT      EQUITY
                                       -----------  ---------
Balance, December 31, 1998 .........   $  (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
  Net loss .........................      (14,591)   (14,591)
                                       -----------  ---------
Balance, December 31, 1999 .........      (53,611)    13,607
  Exercise of common stock options .         --          116
  Common stock dividends issued 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
  Net loss .........................       (8,830)    (8,830)
                                       ----------   ---------
Balance, December 31, 2000 .........      (64,130)     5,264
  Issuance of common stock for
    common stock options previously
    exercised ......................           --         --
  Issuance of common stock, net of
    issuance costs .................           --      9,814
  Common stock dividends issued on
    Series D cumulative convertible
    preferred stock ................         (840)        --
  Common stock dividends declared on
    Series D cumulative convertible
    preferred stock ................         (840)        --
  Compensation expense resulting
    from modifications of options ..           --        164
  Amortization of deferred
     compensation ..................           --         29
  Net loss .........................       (8,144)    (8,144)
                                       ----------   --------
Balance, December 31, 2001 .........   $  (73,954)  $  7,127
                                       ==========   =========
</TABLE>






          See accompanying notes to consolidated financial statements.


                                      F-5
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows

                  Years ended December 31, 1999, 2000 and 2001

                             (Dollars in thousands)
<TABLE>
<CAPTION>
                                                                      1999         2000         2001
                                                                -------------   ----------  -----------
<S>                                                            <C>             <C>          <C>
Cash flows from operating activities:
    Net loss................................................    $  (14,591)     $  (8,830)   $  (8,144)
    Adjustments to reconcile net loss to net cash used
    in operating activities:
         Noncash compensation expense.......................           423            371          193
         Depreciation and amortization expense..............           151            226          246
         Cumulative effect of change in accounting
             principle......................................            --            764           --
         Change in assets and liabilities:
            Accounts receivable.............................           895           (888)      (1,440)
            Inventories.....................................          (353)           418       (1,125)
            Prepaid expenses and other assets...............           194           (342)      (1,094)
            Accounts payable................................          (474)          (575)       1,904
            Accrued expenses................................          (210)           116          639
            Deferred revenue................................            --            (25)         (62)
                                                                   ----------    ----------   ----------
               Net cash used in operating activities........       (13,965)        (8,765)      (8,883)
Cash flows from investing activities:
    Capital expenditures....................................          (593)          (169)        (131)
    Proceeds from the sale of short-term investments........         7,464          6,871        2,035
    Purchase of short-term investments......................        (6,886)        (2,224)         296
                                                                   ----------    ----------   ----------
               Net cash provided by (used in)
                   investing activities.....................           (15)         4,478         1,608
                                                                   ----------    ----------   ----------
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..................            44             84         9,814
    Proceeds from issuance of long-term debt................           219             --            --
    Repayment of long-term debt.............................           (38)           (69)          (77)
                                                                   ----------    ----------   ----------
           Net cash provided by financing
                   activities...............................        18,675             15         9,737
                                                                   ----------    ----------   ----------
               Net increase (decrease) in cash
                   and cash equivalents.....................         4,695         (4,272)        2,462
Cash and cash equivalents at beginning of year..............         3,286          7,981         3,709
                                                                   ----------    ----------   ----------
Cash and cash equivalents at end of year....................     $   7,981      $   3,709     $   6,171
                                                                 ============   ===========   ==========
Supplemental schedule of noncash financing activities:
    Common stock dividends issued or to be
        issued on preferred stock...........................     $   1,092      $   1,689     $   1,680
                                                                 ============   ===========   ==========
    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     $      17
                                                                 ============   ===========   ==========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                      F-6
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (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 and dermatology markets. The Company,  through its
      own sales and marketing group, is currently  marketing  Periostat(R),  the
      Company's lead drug for the treatment of adult  periodontal  disease,  and
      Atridox,   Atrisorb  and  Atrisorb-D  under  an  exclusive  licensing  and
      marketing agreement with Atrix Laboratories,  Inc. ("Atrix").  The Company
      also co-promotes VIOXX(R) to dental professionals on a contract basis with
      Merck and Co.  The  Company  has other  internally  developed  proprietary
      compounds for cancer metasteses and a broad range of inflammatory diseases
      that are currently 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, 2000. The Company considers all of its short-term investments
      to be available for sale.

      INVENTORIES

      Inventories are stated at the lower of 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, 1999, 2000 and 2001

                  (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, 2000 and 2001,  therefore the fair
      value of the note payable  approximates the carrying value at December 31,
      2000 and 2001.

      PRODUCT SALES

      The Company  received  clearance  from the FDA to market  Periostat in the
      capsule  and  tablet   forms  in  September   1998  and   February   2001,
      respectively. In 2001, the Company entered into an exclusive licensing and
      marketing  agreement with Atrix  Laboratories,  Inc.  "Atrix" for Atridox,
      Atrisorb,  and  Atrisorb  D. The  Company  recognizes  sales  revenue  for
      Periostat  and its  licensed  Atrix  products  upon  shipment.  Sales  are
      reported  net  of  allowances  for  discounts,   rebates,  wholesaler  and
      distributor chargebacks and product returns.

      REVENUE RECOGNITION

      Milestone revenue from license  arrangements is recognized upon completion
      of the milestone  event or requirement if it represents the achievement of
      a significant step in the research and development or regulatory  process.
      Payments,  if any, received in advance of performance under a contract are
      deferred and recognized when earned. As described in note 9, as of January
      1,  2000,   upfront   license  fees  where  the  Company  has   continuing



                                      F-8
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      involvement,  (which  prior to  January 1, 2000 were  recorded  as license
      revenues when received) are now deferred and recognized over 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 1999,  2000 and 2001 were  $1,598,  $2,089 and $6,190,
      respectively.

      RESEARCH AND DEVELOPMENT

      Research and development expenses consist primarily of funds paid to third
      parties for the provision of services and materials for drug  development,
      manufacturing and formulation enhancements,  clinical trials,  statistical
      analysis and report writing and regulatory  compliance costs. 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
      accounting  principles  generally accepted in the United States of America
      requires  management  to make  estimates and  assumptions  that affect the
      amount reported in the consolidated  financial statements and accompanying
      notes. Actual results could differ from those estimates.


                                      F-9
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      STOCK-BASED COMPENSATION

      As described in note 8,  Statement of Financial  Accounting  Standards No.
      123 (SFAS 123), "Accounting for Stock-Based  Compensation," encourages but
      does not require  companies to record  compensation  cost for  stock-based
      employee  compensation  plans at fair  value.  The  Company  has chosen to
      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  nonemployees,  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(R). A single company also provides all warehousing
      and  distribution  services to the Company.  During 2001,  four  customers
      accounted for 28%, 15%, 13% and 10%, of net product  sales,  respectively.
      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.  Substantially  all product
      sales are in the United States.

      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



                                      F-10
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      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, 2001, the
      Company has certain convertible  preferred stock,  stock options and stock
      warrants which have not been  included in the  calculation  of diluted net
      loss per share allocable to common stockholders  because to do so would be
      anti-dilutive.  As such, the numerator and  denominator  used in computing
      both basic and diluted net loss per share allocable to common stockholders
      are equal.

(3)   COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

      INVENTORIES

      Inventories at December 31, 2000 and 2001 consists of the following:

                                                 2000             2001
                                             ----------     -----------
               Raw Materials                 $       60     $       174
               Work-in-process                       --              66
               Finished goods                       217           1,162
                                             ----------     -----------
                                             $      277     $     1,402
                                             ==========     ===========


      EQUIPMENT AND LEASEHOLD IMPROVEMENTS

      Equipment  and  leasehold  improvements  at  December  31,  2000  and 2001
      consists of the following:

                                                 2000            2001
                                             -----------    -----------
               Computer and office equipment   $      792    $       923
               Exhibit equipment                      309            309
               Leasehold improvements                  45             45
                                             ------------     ----------
                                                    1,146          1,277
               Less accumulated depreciation
                  and amortization                  (494)           (740)
                                             -----------     -----------
                                               $     652     $       537
                                             ===========     ===========


                                      F-11
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      ACCRUED EXPENSES

      Accrued expenses at December 31, 2000 and 2001 consists of the following:

<TABLE>
<CAPTION>
                                                            2000                2001
                                                        -------------        -----------
<S>                                                     <C>                 <C>
                Contracted development
                   and manufacturing costs              $         314       $        398
                Sales and marketing costs                         597                210
                Payroll and related costs                       1,061              1,563
                Professional and consulting fees                  204                291
                Royalties                                         201                434
                Deferred revenue                                   63                 63
                Miscellaneous taxes                                52                122
                Other                                              22                 72
                                                        -------------       ------------
                                                        $       2,514       $      3,153
                                                        =============       ============
</TABLE>


(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 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



                                      F-12
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      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 below and note 6),
      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 below and note 6). Dividends  totaling $1,689 and
      $1,680 were declared in 2000 and 2001, respectively.  At December 31, 2000
      and 2001,  declared  dividends  of 259,462  and  103,196  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 sheets.

      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.



                                      F-13
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      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
      $6,800.  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 for a continuous 24-month period.  Should the
      Company fail to maintain the effectiveness of such registration statement,
      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.  Such conversion
      price was further  reduced to $9.91 per share in connection  with the sale
      of shares of the Company's common stock to Atrix (see note 6).

      The Company maintains a Shareholder  Rights Plan (the Rights Plan).  Under
      the Rights  Plan,  each common  stockholder  receives one "Right" for each
      share of common stock held.  Each Right,  once  exercisable,  entitles the
      holder to purchase  from the Company one  one-hundredth  of a share of the
      Company's  Series A Participating  Preferred Stock at an exercise price of
      $65. All Rights expire on September 26, 2007 unless earlier  redeemed.  At
      December  31,  2001,  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.


                                      F-14
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


(6)   LICENSING AND MARKETING AGREEMENT

      On August 24, 2001, the Company signed an exclusive License Agreement (the
      "Atrix License Agreement") with Atrix to market Atrix's proprietary dental
      products,  Atridox(R),  Atrisorb(R)  FreeFlow  and  Atrisorb(R)-D,  to the
      United States dental  markets.  Pursuant to the terms of the Atrix License
      Agreement,  among other things, Atrix will manufacture the dental products
      for the  Company  at an  agreed  upon  transfer  price  and  will  receive
      royalties  on future net sales of the products  each  calendar  year.  The
      Company paid a $1,000  licensing  fee to Atrix to market such  products in
      the United  States.  The Company has also committed to no less than $2,000
      in  advertising  and selling  expenses  related to the  licensed  products
      during 2002, and the lesser of $4,000 or 30% of the Company's contribution
      margin, as defined in the agreement,  relating to a specific Atrix product
      that the Company  markets and the lesser of $2,000 or 30% of the Company's
      contribution  margin, as defined in the agreement,  relating to a separate
      Atrix product that the Company  markets  commencing with fiscal year 2003.
      Additionally,  the  Company  must  maintain a minimum  amount of full time
      sales professionals and make a specific amount of sales presentations over
      the first 24 months of the  agreement.  The $1,000 license fee payment has
      been  capitalized and is being amortized to cost of product sales over the
      ten year estimated term of the license on a straight-line basis.

      In addition,  pursuant to the terms of a Stock  Purchase  Agreement  dated
      August 24, 2001 by and between  the  Company  and Atrix,  Atrix  purchased
      330,556 unregistered shares of the Company's common stock for an aggregate
      purchase price of  approximately  $3,000.  As a result of the sale of such
      shares to Atrix,  the conversion price of the Company's Series D Preferred
      Stock was reduced $9.91 per share.

(7)   LINE OF CREDIT

      On March 19, 2001,  the Company  consummated a one-year  revolving  credit
      facility  (the  Facility)  with  Silicon  Valley Bank (the Bank) which was
      amended  subsequent  to December  31, 2001 (See Note 16).  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



                                      F-15
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      Bank with  respect  to  all  of  the  Company's   assets,   including  its
      intellectual  property.  At December  31,  2001 there  were no  borrowings
      against the Facility or outstanding letters of credit (see note 16).

(8)   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 2,000,000  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.

      In March 1996, the board of directors approved a nonqualified plan for the
      issuance of stock options to nonemployee  directors  under the Nonemployee
      Director Stock Option Plan (the  Nonemployee  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.  During  2001,  360,000  options were granted to
      employees at fair market value with an exercise  price of $5.19 per share.
      These grants were not issued under the terms of any of the above Plans.




                                      F-16
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001


                  (Dollars in thousands, except per share data)

      At December 31, 2001,  there were 679,820 shares available for grant under
      the 1996 Plan and 100,000 under the Nonemployee 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
      has  been   amortized  to   compensation   expense  in  the   accompanying
      consolidated  statement of operations over the respective  vesting periods
      of such grants ($118, $47 and $29 in 1999, 2000 and 2001, respectively).

      In 2001, the Company extended  through the remaining  contractual life the
      exercisability  of certain  vested  options for an ex-board  member of the
      Company. Accordingly, $164 was recognized as compensation expense in 2001,
      based  on the fair  value of the  options  on the date the  extension  was
      granted as determined using a Black-Scholes pricing model.

      In 1999, the Company granted  options to certain  nonemployees 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
      nonemployee  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-17
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      The  following  table  summarizes  stock option  activity for 1999 through
2001:

                                                               WEIGHTED AVERAGE
                                                                EXERCISE PRICE
                                           SHARES                 PER SHARE
                                         ---------              ----------------

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

    Granted                                  570,100                    5.85
    Cancelled                               (140,500)                  10.87
                                     ---------------           -------------

Balance, December 31, 2001                 2,452,609           $        9.15
                                     ===============           =============


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.

As of December 31, 2001, the following  options were outstanding and exercisable
by price range as follows:

<TABLE>
<CAPTION>
                                  OUTSTANDING                       EXERCISABLE
                     ---------------------------------------    -----------------------
                                    WEIGHTED       WEIGHTED                    WEIGHTED
                                     AVERAGE       AVERAGE                     AVERAGE
      RANGE OF                      REMAINING      EXERCISE                    EXERCISE
      EXERCISE         NUMBER      CONTRACTUAL      PRICE         NUMBER        PRICE
       PRICES        OF SHARES        LIFE         PER SHARE     OF SHARES     PER SHARE
    ------------     ---------    --------------  ---------     ----------     ---------
<S>                  <C>            <C>            <C>            <C>         <C>
  $ 0.20 - 2.00        189,954      3.7 years      $    0.95       189,954    $    0.95
   4.50 - 10.00      1,250,475      7.7 years           6.62       527,735         7.45
  10.06 - 12.00        412,900      6.1 years          10.28       270,950        10.40
  12.19 - 13.56        193,950      7.0 years          12.42       149,600        12.46
  14.06 - 22.63        405,330      7.9 years          18.07       108,964        18.03
                    ----------      ---------      ---------     ---------    ---------

                     2,452,609      7.1 years      $    9.15     1,247,203    $    8.63
                    ==========      =========      =========     =========    =========
</TABLE>


                                      F-18
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      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:


                                           1999          2000         2001
                                        ----------    ----------   ----------
        Net loss allocable to
            common stockholders:
                As reported           $   15,683      $  10,519     $   9,824
                Pro forma                 17,338         13,802        13,693

        Basic and diluted net loss
            per share allocable to
            common stockholders:
                As reported           $     1.82      $   1.21      $    0.94
                Pro forma                   2.02          1.58           1.31

      The  weighted  average fair values of stock  options  granted to employees
      during  1999,  2000 and 2001 were  $7.81,  $10.72  and  $4.57  per  share,
      respectively,  on the date of grant.  The weighted  average fair values of
      stock options granted to nonemployees  during 2000 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:

                                           1999          2000          2001
                                        ----------    ----------   ----------
        Expected life in years               5              7             7
        Risk-free interest rate           6.25 %         6.20 %        4.88 %
        Volatility                          80 %           90 %          95 %
        Expected dividend yield             -- %           -- %          -- %


(9)   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(R).  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



                                      F-19
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


     its historical revenue recognition policy prior to the adoption of SAB 101.
     In addition,  during 2001 and 2000, respectively,  the Company recorded $63
     and $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
     amount  for  1999 as if the  new  accounting  principle  had  been  applied
     retroactively is 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  approximately
     $739 recorded as deferred  revenue 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. As of
     December 31, 2001, the Company has approximately  $677 recorded as deferred
     revenue,  $63 of which has  been  classified as a  current liability in the
     accompanying consolidated balance sheet as of December 31, 2001.

(10) 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.



                                      F-20
<PAGE>
                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      The tax effects of  temporary  differences  that give rise to  significant
      portions of the deferred tax assets and deferred tax liability at December
      31, 2000 and 2001 are presented below:

                                                           2000           2001
                                                        ---------      ---------
      Deferred tax assets:
        Capitalized start up costs.......              $      170      $      --
        Net operating loss carryforwards........           23,530         24,765
        Tax credit carryforward.................              840            850
        Accrued expenses........................               58            800
        Deferred revenue........................              251            275
                                                       ----------      ---------
            Total gross deferred tax assets.....           24,849         26,690
        Less valuation allowance................         (24,830)       (26,681)
                                                       ----------      ---------
            Total deferred tax assets...........               19              9
      Deferred tax liability:
        Depreciation............................             (19)            (9)
                                                       ----------      ---------
            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, 2000 and 2001.

      The net change in the valuation allowance for the years ended December 31,
      2000  and  2001  were  increases  of  approximately   $3,761  and  $1,851,
      respectively,   related  primarily  to  additional  net  operating  losses
      incurred by the Company.

      At December 31, 2001, the Company had approximately $64,500 of Federal and
      $35,900 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  $850  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,


                                      F-21
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      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, 2001, assuming no future ownership changes,  approximately
      $34,000 is immediately  available  to offset  future  taxable  income.  In
      addition  to the section  382  limitation,  the state net  operating  loss
      carryforward is subject to a $2,000 annual limitation.

(11)  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 Periostat  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 for this  technology of $711, $940 and
      $1,348 in 1999, 2000 and 2001, respectively.

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

(12)  COMMITMENTS

      The Company  maintains  various  operating  leases,  primarily  for office
      space.  As of December  31,  2001,  future  minimum  rent  payments  under
      noncancellable operation leases are as follows:

                     2002...............             $      335
                     2003...............                    335
                     2004...............                    332
                     2005...............                    334
                     2006...............                    334
                     Thereafter.........                    862
                                                     -----------
                           Total........             $     2,532
                                                     ===========


      Rent expense for the years ended December 31, 1999,  2000 and 2001 totaled
      $204, $326 and $337, respectively.

                                      F-22
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


      During 1999, the Company entered into a three-year  co-promotion agreement
      under which the Company is  committed  to spend up to $1,000  annually for
      promotional  expenses,  unless the agreement is earlier terminated per the
      terms of the agreement.

      Pursuant  to the terms of the Atrix  License  Agreement  (see note 6), the
      Company  has  committed  to spend no less than $2,000 in  advertising  and
      selling  expenses  related to the licensed  products  during 2002, and the
      lesser of $4,000 or 30% of the Company's  contribution  margin, as defined
      in the  agreement,  relating to a specific  Atrix product that the Company
      markets  and the  lesser of $2,000  or 30% of the  Company's  contribution
      margin, as defined in the agreement,  relating to a separate Atrix product
      that the Company markets  commencing with fiscal year 2003.  Additionally,
      the  Company   must   maintain  a  minimum   amount  of  full  time  sales
      professionals and make a specific amount of sales  presentations  over the
      first 24 months of the agreement.

      During 2001,  the Company  entered into and  fulfilled  an  obligation  to
      purchase approximately $1,500 of inventory from a supplier.

(13)  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 1999,  2000 or 2001 in  accordance  with the
      terms of the 401(k) Plan.

(14)  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  would pay SUNY up to
      $1,570.  In May 2001, the agreement  expired.  Costs incurred during 1999,
      2000 and 2001 were $541, $356 and $168, respectively.

(15)  QUARTERLY FINANCIAL DATA (UNAUDITED)

      The tables below  summarize the Company's  unaudited  quarterly  operating
      results  for 2000 and 2001.  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 9.



                                      F-23
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>

                                                           THREE MONTHS ENDED
                                          ----------------------------------------------------
                                            MARCH 31,      JUNE 30,      SEPT. 30,    DEC. 31,
                                              2000           2000          2000         2000
                                          ------------ ------------- ------------- -----------


<S>                                      <C>           <C>           <C>           <C>
      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)
</TABLE>

                                      F-24
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)
<TABLE>
<CAPTION>

                                                           THREE MONTHS ENDED
                                           --------------------------------------------------
                                           MARCH 31,     JUNE 30,     SEPT. 30,      DEC. 31,
                                             2001          2001         2001           2001
                                           ----------- ------------- -----------  -----------
<S>                                        <C>          <C>           <C>           <C>
      Total revenues.....................   $   7,024    $    8,711    $    9,249    $  10,248
      Gross margin on product sales......       4,747         5,751         7,046        7,989
      Net loss...........................     (2,691)       (2,681)       (1,546)      (1,226)
      Net loss allocable to common
        stockholders.....................     (3,111)       (3,101)       (1,966)      (1,646)
      Basic and diluted net loss per
        share allocable to common
        stockholders.....................      (0.33)       (0.29)         (0.18)       (0.15)
</TABLE>

      The table below reflects the effect of the change in accounting  principle
      on  net  loss  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.


<TABLE>
<CAPTION>

                                                             THREE MONTHS ENDED
                                                 ---------------------------------------------
                                                  MARCH 31,   JUNE 30,    SEPT. 30,   DEC. 31,
                                                    2000        2000        2000        2000
                                                 ----------  ----------  ----------  ---------
<S>                                              <C>           <C>         <C>        <C>
      New 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)
                                                 =========   ==========  =========  =========


                                                               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 recognition policy... $  (0.33)    $  (0.27)  $  (0.26)  $   (0.27)
      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)
                                                 =========    =========  =========  ==========
</TABLE>


                                      F-25
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 1999, 2000 and 2001

                  (Dollars in thousands, except per share data)

(16)  SUBSEQUENT EVENT

      On February 14, 2002, the Company  entered into an equity line (the Equity
      Line)  arrangement  under the terms of a Common Stock  Purchase  Agreement
      (the Agreement) with Kingsbridge Capital Limited (Kingsbridge).  Under the
      terms of the Agreement,  the Company may, at its sole  discretion and from
      time to time over the next 12 months,  sell shares of its common  stock to
      Kingsbridge  at a discount  to market  price of up to 10%,  as  determined
      prior to each such sale. The maximum amounts of individual  draws is based
      on the  Company's  market  capitalization  and may not  exceed  $3,000 and
      availability  is  subject  to  certain  representations,   warranties  and
      covenants of the Company.  The Company has  committed to: (i) draw down on
      the Equity Line an amount  aggregating at least $1.5 million in registered
      shares of common stock,  prior to August 14, 2002 (the Minimum  Commitment
      Amount);  or (ii) if the Company has not satisfied such Minimum Commitment
      Amount,  pay to  Kingsbridge an amount equal to 10% of the amount by which
      the Minimum  Commitment  Amount exceeds the aggregate of all amounts drawn
      down under the Equity Line in respect of the shares of common stock issued
      and sold thereunder,  except if the price of the Company's common stock is
      below certain levels during this period.  The Equity Line provides for the
      sale of up to an  aggregate  $8.5 million in  registered  shares of common
      stock. In connection with the consummation of the Equity Line, the Company
      issued to Kingsbridge, a warrant to purchase 40,000 shares of common stock
      at an  exercise  price of $9.38 per  share.  The  conversion  price of the
      Series D  preferred  stock was not  reduced as a result of such  issuance.
      Such warrant will not become  exercisable  until August 14, 2002, and will
      expire on August 13, 2007.

      On March 22, 2002,  the Company  amended its Facility with Silicon  Valley
      Bank (see note 7). Accordingly the amount the Company may borrow under the
      Facility was increased to the lesser of $4,000 or 80% of eligible accounts
      receivable, as defined in the amendment. Any such draws under the Facility
      will bear interest at the then prevailing  prime rate plus 1.0 to 1.5% per
      annum,  dependent  upon  achieving  two  consecutive  fiscal  quarters  of
      profitability,  as defined.  The Company must also maintain (i) a tangible
      net worth of $5,000,  subject to certain upward  adjustments as defined in
      the amendment,  as a result of profitable  operation or additional debt or
      equity  financings and (ii) a minimum of $2,000 in cash, net of borrowings
      under the facility,  at all times during the term of the  Facility,  which
      expires  March  15,  2004.

      On March 26,  2002,  the Company  issued an  irrevocable  letter of credit
      under the  Facility  for  $1,343.  This  letter of credit  will be used to
      secure future purchases of inventory that the Company expects to make from
      a supplier.



                                      F-26
<PAGE>





                 COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          FINANCIAL STATEMENT SCHEDULE

                        Valuation and Qualifying Accounts

                  Years Ended December 31, 1999, 2000 and 2001
                                 (in thousands)
<TABLE>
<CAPTION>

--------------------------------------------------------------------------------------------------------------------
       COL A                COL B                       COL C                        COL D              COL E
--------------------------------------------------------------------------------------------------------------------
     Description        Balance at the                 Additions                   Deductions       Balance at the
                        Beginning of                                                                End of Period
                           Period
--------------------------------------------------------------------------------------------------------------------
Accounts Receivable                         Charged to            Other
     Allowance:                            Statement of
                                            Operations
--------------------------------------------------------------------------------------------------------------------
        <S>                 <C>               <C>                 <C>               <C>                <C>
        1999                $ 293              $ 554              $ --               $ 461              $ 386

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

        2001                $ 381             $1,906              $ --              $1,337              $ 950
--------------------------------------------------------------------------------------------------------------------
</TABLE>


                                      F-27