UNITED STATES
                       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, 2003
                          -----------------
                                       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)

                Preferred Stock Purchase Rights, $0.01 par value
-------------------------------------------------------------------------------
                                (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  twelve (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 ninety (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. [ ]

     Indicate by check mark whether the registrant is an  accelerated  filer (as
defined in Exchange Act Rule 12b-2).

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

     The  aggregate  market value of the  registrant's  voting  shares of common
stock held by non-affiliates of the registrant on June 30, 2003, based on $13.26
per share,  the last reported sale price on the NASDAQ  National  Market on that
date, was $130.6 million.

     The number of shares  outstanding  of each of the  registrant's  classes of
common stock, as of March 11, 2004:

         Class                                Number of Shares
         -----                                ----------------

         Common Stock, $0.01 par value            14,121,677

     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 2004 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..................................................... 32
         3.  Legal Proceedings.............................................. 32
         4.  Submission of Matters to a Vote of Security Holders............ 34

PART II  5.  Market for the Company's Common Equity and Related
                 Stockholder Matters........................................ 35
         6.  Selected Consolidated Financial Data........................... 36
         7.  Management's Discussion and Analysis of Financial Condition
                 and Results of Operations.................................. 39
         7A. Quantitative and Qualitative Disclosures about Market Risk..... 56
         8.  Financial Statements and Supplementary Data.................... 57
         9.  Changes in and Disagreements with Accountants on Accounting
                and Financial Disclosure.................................... 57
         9A. Controls and Procedures........................................ 57

PART III 10. Directors and Executive Officers of the Registrant............. 58
         11. Executive Compensation......................................... 58
         12. Security Ownership of Certain Beneficial Owners and
                 Management and Related Stockholder Matters................. 58
         13. Certain Relationships and Related Transactions................. 58
         14. Principal Accountant Fees and Services......................... 58

PART IV  15. Exhibits, Financial Statement Schedules, and Reports on
                 Form 8-K................................................... 59

SIGNATURES.................................................................. 60

EXHIBIT INDEX............................................................... 62

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


                                      -i-

<PAGE>

                                     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  dental   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,  or
SRP, the most prevalent therapy for adult  periodontitis,  to promote attachment
level gain and to reduce  pocket  depth in  patients  with adult  periodontitis.
Adult periodontitis,  a chronic disease characterized by the progressive loss of
attachment  between the tooth root and the surrounding  periodontal  structures,
may result in tooth loss if untreated.

     We currently  market  Periostat  and other  pharmaceutical  products to the
dental and dermatology  communities through our own professional  pharmaceutical
sales force of approximately 115 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(R) and Atrisorb  FreeFlow(R),  and  Atrisorb-D(R),  to the United States
dental market. In May 2002, we executed a sublicense  agreement with Altana Inc.
to  market  and  distribute  Pandel(R),   a  prescription   mid-potency  topical
corticosteroid  product developed by Altana Inc. to dermatologists in the United
States and Puerto Rico. We distribute  Periostat and Pandel exclusively  through
drug  wholesalers  in  the  United  States.   Periostat  is  also  sold  through
wholesalers   and  direct  to  dentists  in  the  United  Kingdom   through  our
wholly-owned subsidiary, CollaGenex International, Ltd., and by distributors and
licensees in certain  other  overseas  markets.  The Atrix  dental  products are
distributed through a specialty distributor who sells these products directly to
dental practitioners in the United States and Puerto Rico.

     Research  has shown that certain  unique  properties  of the  tetracyclines
discovered  during the  development  of  Periostat  may be  applicable  to other
diseases  involving  inflammation  and/or  destruction of the body's  connective
tissues,  including acne,  rosacea,  meibomianitis and cancer metastasis,  among
others.  CollaGenex  is  further  evaluating  Periostat  and a series  of novel,
proprietary  compounds known as IMPACS(R)  (Inhibitors of Multiple Proteases and
Cytokines), to assess whether they are safe and effective in these applications.
Phase I clinical trials for Metastat(R),  our lead compound for the treatment of
metastatic  cancer,  were initiated under the sponsorship of the National Cancer
Institute,  or NCI. In Phase I clinical trials, Metastat demonstrated an overall
tumor  response rate of 44% in patients with  Kaposi's  sarcoma,  and the NCI is
sponsoring  a Phase II clinical  trial to  continue  to evaluate  the safety and
efficacy of Metastat in HIV-related  Kaposi's  sarcoma.  We anticipate  that the
results of this trial will be available during the second quarter of 2004.

     In 2003, we continued to implement our plans to expand into the dermatology
market.  A growing  number of studies  have shown the  safety  and  efficacy  of
Periostat to treat

<PAGE>


dermatological  conditions  and  diseases,  and two of these  studies  have been
published in peer-reviewed medical journals. There is no FDA or other regulatory
approval  for the use of  Periostat  to treat any  dermatological  condition  or
disease.   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  significant
improvement compared to the patients in the placebo group.

     During 2002 and 2003,  we conducted a  double-blinded,  placebo-controlled,
134-patient  Phase III  clinical  trial to evaluate  the safety and  efficacy of
Periostat in the treatment of rosacea,  a dermatological  condition that affects
approximately 15 to 20 million patients in the United States.  In February 2004,
we  announced  the positive  outcome of that study.  Preliminary  data  analysis
indicated that patients treated with Periostat  showed a continuous  improvement
during the 16-week course of the study  compared to patients on placebo.  In the
study, patients on Periostat had a significantly greater reduction in the number
of inflammatory  lesions (papules and pustules) compared to patients on placebo.
This  improvement  was both  clinically and  statistically  highly  significant.
Overall  clinical  disease  severity based on the  Clinician's  Global  Severity
Assessment  Scale declined  significantly  in the group of patients treated with
Periostat  compared to placebo,  with a greater  number of patients on Periostat
showing  a  complete  clearing  of the  disease  at 16 weeks  compared  to those
patients on placebo.  In addition,  the erythema,  or persistent  redness of the
skin,  in  patients  in the  Periostat  group  showed  a trend  towards  greater
improvement compared to patients in the placebo group.

     In  February  2002,  we  announced  that we had  licensed  a new dermal and
transdermal drug delivery technology called Restoraderm(TM),  which we intend to
develop  for  dermatological   applications.   Several  products  based  on  the
Restoraderm  technology have completed preliminary stability studies, and we are
developing  plans to  launch  two  products  based on this  technology  by 2007.
Manufacturing  arrangements  are currently  being pursued for the first of these
products,  which we expect to launch in 2005. We are actively seeking additional
product  licensing  opportunities  to augment  our  near-term  offerings  to the
dermatology market.

     In May 2002,  we executed a  sublicense  Agreement  with  Altana Inc.  with
respect to the marketing and  distribution  of Pandel.  Our sales force has been
promoting Pandel to the dermatological community since July 2002.

     Our core  IMPACS  technology  is  licensed  on a  perpetual  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.

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

                                      -2-
<PAGE>

     In this Annual Report on Form 10-K, the terms  "CollaGenex," "we," "us" and
"our" includes CollaGenex Pharmaceuticals, Inc. and its subsidiaries.

     Periostat(R),  Metastat(R),  Dermostat(R),   Nephrostat(R),   Osteostat(R),
Arthrostat(R),  Rheumastat(R), Corneostat(R), Gingistat(R), IMPACS(TM), PS20(R),
The  Whole  Mouth  Treatment(R),   Restoraderm(TM),   Dentaplex(R),   Lytra(TM),
Periostat-MR(TM)  and  Xerostat(TM)  are United States  trademarks of CollaGenex
Pharmaceuticals, Inc. Periostat(R),  Nephrostat(R), Optistat(R), Xerostat(R) and
IMPACS(TM) are European Community trademarks of CollaGenex Pharmaceuticals, Inc.
Periostat(R),  Nephrostat(R), Optistat(R), Xerostat(R), IMPACS(R), Dentaplex(R),
Restoraderm(R),  Periocycline(R),  Periostatus(R) and Periostat-SR(R) are United
Kingdom trademarks of our wholly-owned subsidiary, CollaGenex International Ltd.
CollaGenex(R),  PS20(R), Dermastat(R),  Periostan(R), "C" Logo(R) and "The Whole
Mouth Treatment" Logo(R) are European Community and United Kingdom trademarks of
CollaGenex    International   Ltd.    Periocycline(TM),    Restoraderm(TM)   and
Periostat-SR(TM) are European Community  Trademarks of CollaGenex  International
Ltd. All other trade names, trademarks or service marks appearing in this Annual
Report are the  property  of their  respective  owners and are not  property  of
CollaGenex Pharmaceuticals, Inc. or any of our subsidiaries.

Products and Product Agreements

Our Current Marketed Products

     Our current proprietary and licensed products are summarized below:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
<S>                    <C>                                      <C>
    Products           Territory Where Marketed                 Marketing Partner
-----------------------------------------------------------------------------------------------
    Periostat       United States and Puerto Rico                Not applicable
-----------------------------------------------------------------------------------------------
    Periostat               United Kingdom                CollaGenex International Ltd.
-----------------------------------------------------------------------------------------------
    Periostat                   Israel                      Taro Pharmaceuticals, Inc.
-----------------------------------------------------------------------------------------------
    Periostat                  Portugal                             ISDIN S.A.
-----------------------------------------------------------------------------------------------
    Periostat                  Austria             Willovonseder & Marchesani Ges.m.b.H & Co.
                                                                       KG
-----------------------------------------------------------------------------------------------
    Periostat                Switzerland                        Karr Dental, Inc.
-----------------------------------------------------------------------------------------------
    Periostat                   Canada                         Pharmascience, Inc.
-----------------------------------------------------------------------------------------------
     Atridox        United States and Puerto Rico           Atrix Laboratories, Inc.
-----------------------------------------------------------------------------------------------
Atrisorb FreeFlow   United States and Puerto Rico           Atrix Laboratories, Inc.
-----------------------------------------------------------------------------------------------
   Atrisorb-D       United States and Puerto Rico           Atrix Laboratories, Inc.
-----------------------------------------------------------------------------------------------
     Pandel         United States and Puerto Rico                 Altana, Inc.
-----------------------------------------------------------------------------------------------
</TABLE>
                                      -3-

<PAGE>

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 $6.0 billion,  primarily for procedures and surgeries performed by
a periodontist or a dental professional.

     The most  prevalent  therapy for adult  periodontitis  is SRP, a mechanical
procedure  that  removes  bacteria  deposits  called  plaque from tooth and root
surfaces  above  and  below  the  gum  line.   Periostat  is  the  first  orally
administered,  systemically delivered  pharmaceutical indicated as an adjunct to
SRP to promote attachment level gain and to reduce pocket depth in patients with
adult  periodontitis.  The Proceedings of the American Academy of Periodontology
2003  Workshop on  Contemporary  Sciences in  Clinical  Periodontics,  published
January 22,  2004,  set forth a detailed  report and  summary by leading  United
States  academic  and clinical  periodontology  experts who  concluded  that the
peer-reviewed  scientific  evidence strongly supports the use of Periostat as an
adjunct to  conventional  therapy,  such as SRP,  in the  management  of chronic
periodontitis.

     Periostat,   a  20  mg   dose  of   doxycycline   hyclate,   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, at higher  dosages,  for  approximately  35
years,  for  the  treatment  of  microbial  infections  and,  along  with  other
tetracyclines, has a well established safety record. Periostat is 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
SRP to promote  attachment  level gain and reduce  pocket depth in patients with
adult  periodontitis.  Periostat  was made  available  for  prescription  use in
November 1998 and was fully launched commercially in January 1999. Since January
1999, more than 3.0 million  Periostat  prescriptions  have been filled and over
40,000  dentists have written a Periostat  prescription.  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.

     We currently  actively  sell  Periostat in the United States and the United
Kingdom  and our  partners  have begun  initial  sales of  Periostat  in Israel,
Portugal,  Austria,  Switzerland  and Canada.  We also have other  marketing and
distribution   partnerships  for  the  sale  of  Periostat  in  various  foreign
countries, subject to regulatory approval.

                                      -4-
<PAGE>

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 periodontitis.

     Atridox is a locally-applied,  anti-microbial  therapy for the treatment of
chronic  adult  periodontitis.  Atridox  uses  Atrix's  patented  drug  delivery
technology, Atrigel(R), for the targeted delivery of 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,  or GTR, barrier product
used in the surgical treatment of periodontal defects to help regenerate tissue.
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,
which  has  been  shown  to  reduce  the  incidence  of  infections  during  GTR
procedures.

     Under the terms of our  License and  Marketing  Agreement  with  Atrix,  we
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, during which year we met this requirement;  (ii) maintain, for a period
of 24  months,  a force of no less  than 90 full  time  dental  consultants  and
divisional and regional managers to make sales and product  recommendation calls
on dental professionals (which requirement we have fulfilled);  and (iii) making
the Atrix  products  the  subject  of a specific  number of detail  calls in the
United  States  during  2002,  which we achieved.  We are also  required to make
certain annual minimum  expenditures for advertising and promotional  activities
over the term of the agreement  beginning  January 1, 2003,  including:  (i) the
lesser of $4.0  million  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 $2.0  million  or 30% of our  contribution  margin,  as defined in the
agreement,  relating to a separate  Atrix  product that we market.  These annual
requirements  were met by us in 2003.  In 2003,  we and  Atrix  agreed  to share
funding for  training and  maintaining  a corps of dental  hygienists  who would
serve as part-time,  professional sales associates in the dental market,  with a
specific  focus on the Atrix  products.  This 2003  addendum  will  terminate on
December 31, 2004, unless extended by Atrix and us.


                                      -5-
<PAGE>

     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 twelve (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.

Pandel

     On May 24, 2002, we executed a Sublicense  Agreement  with Altana Inc., the
United States  subsidiary of Altana Pharma AG, pursuant to which we were granted
the exclusive right to market, advertise,  promote,  distribute,  offer for sale
and sell,  in the United  States and Puerto Rico,  Pandel  Cream,  a mid-potency
topical  corticosteroid  that is  indicated  for the relief of  mild-to-moderate
inflammatory  disorders  of the skin in adults,  such as atopic  dermatitis  and
psoriasis.  We had detailed Pandel on a  co-promotional  basis with Altana since
October 2001. Altana currently  licenses such rights from Taisho  Pharmaceutical
Co., Ltd., a company organized and existing under the laws of Japan. Pursuant to
the terms of such agreement, we agreed to pay Altana an aggregate sublicense fee
of $1.7  million,  $800,000 of which was paid in June 2002 and $900,000 of which
was paid in May 2003. We purchase from Altana all Pandel products to be sold and
are required to pay Altana a royalty fee equal to a percentage  of the net sales
of Pandel.

Vioxx

     Pursuant to a  Co-Promotion  Agreement we executed  with Merck in September
1999,  we received the  exclusive  right to  co-promote  Vioxx,  a  prescription
strength  non-steroidal  anti-inflammatory  drug that was approved by the FDA on
May 20,  1999  to  relieve  osteoarthritis  and  manage  acute  pain in  adults,
including  dental pain. The agreement  provided for certain payments by Merck to
us upon  sales of Vioxx to the dental  community.  On  September  23,  2002,  we
executed an amendment,  extension and restatement of our Co-Promotion  Agreement
with Merck with respect to Vioxx. In accordance  with that amendment,  extension
and restatement,  our agreement with Merck automatically expired on December 31,
2003. We will continue to earn residual contract revenues under the co-promotion
agreement with Merck through December 2005.

AVAR

     In  March  2003,   we   executed   co-promotion   agreements   with  Sirius
Laboratories,  Inc.  pursuant  to which we  jointly  marketed  Sirius'  AVAR(TM)
product line and Pandel to dermatologists in the United States. These agreements
were  mutually  terminated  on  December  31,  2003.  We do not expect  contract
revenues from AVAR beyond this date.

Denavir

     Denavir is an FDA-approved  topical  antiviral cream used for the treatment
of recurrent cold sores in adults.  We marketed  Denavir to the dental community
under a Co-Promotion Agreement that we executed with SmithKline Beecham Consumer
Healthcare  in October 1998,  that  provided for certain  payments by SmithKline
Beecham to us. Following the acquisition of

                                      -6-
<PAGE>

SmithKline Beecham by Novartis Consumer Health,  Inc.,  Novartis terminated this
Co-Promotion Agreement effective April 13, 2001.

     On October 1, 2002,  we entered  into a Product  Detailing  Agreement  with
Novartis Consumer Health,  Inc. pursuant to which we co-promoted  Denavir to our
target dentists in the United States and received detailing fees and performance
incentives from Novartis  Consumer  Health,  Inc. Our agreement with Novartis to
co-promote  Denavir  expired on September 30, 2003, and we and Novartis  decided
not to renew our arrangement  with respect to Denavir.  We do not expect to earn
contract revenues for Denavir beyond 2003.

Sales and Marketing

     We market  and sell our dental and  dermatological  products  in the United
States  through a dedicated  sales force  comprised of  approximately  115 sales
representatives  and managers.  We currently market Periostat in certain foreign
markets, either through our wholly-owned  subsidiary,  CollaGenex  International
Ltd., or through marketing and distribution partnerships with companies in these
markets,  and we intend to market  Periostat in additional  foreign markets upon
receipt of all  requisite  regulatory  approvals.  We  currently  actively  sell
Periostat  in the United  States and the United  Kingdom and our  partners  have
begun initial sales of Periostat in Israel, Portugal,  Austria,  Switzerland and
Canada.  We currently have such  agreements with foreign  companies,  subject to
requisite regulatory approvals, covering Japan, Spain and Greece.

     Typically,  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 one  regional
manager,  eleven district managers and  approximately  103 full-time  equivalent
sales  representatives.   Each  full-time  equivalent  sales  representative  is
responsible  for covering a territory that includes  approximately  100 dentists
and periodontists  that are believed to be potential high volume  prescribers of
Periostat based on the estimated  number of scaling and root planings  performed
in  their  respective  practices.  Additionally,  each  representative  calls on
approximately  50 dermatology  offices that have high potential for  prescribing
Pandel.   In   accordance   with   legal  and   regulatory   requirements,   our
representatives  also  provide  peer-reviewed  scientific  literature  about the
safety and use of Periostat to treat dermatological conditions and diseases.

     Our field sales organization currently details Periostat, Atridox, Atrisorb
FreeFlow and Atrisorb-D,  to dental professionals,  and Pandel to dermatological
professionals.

     We believe  that our dental  sales  effort is  distinguished  from  typical
dental  promotion  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

                                      -7-
<PAGE>

arrange speaking engagements and teleconferences where Periostat advocates share
their experiences with other dental professionals.

     Sales  training  is an  important  component  of our  sales  and  marketing
efforts. New representatives  receive four weeks of field training and two weeks
of intensive office training in periodontal disease, host response, dermatology,
territory  management and selling skills.  Training  continues at district-level
meetings  throughout  the year.  In order to  provide an  integrated  dental and
dermatology product line and leverage our sales and marketing  organization,  we
are actively  seeking to in-license or acquire  other  high-quality  therapeutic
dental and dermatology products.

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.  had 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. withdrew the Marketing Authorization for Approval
in Italy,  and Italy was  included  under the  pan-European  Mutual  Recognition
Procedure,  which  we  filed  in  June  2001.  In  February  2002,  we  received
provisional  approval to market  Periostat in Italy.  In June 2002,  we received
final approval to market  Periostat in Italy.  Subsequent to this  approval,  we
were  notified by Roche that due to changes in Roche's  local  market  strategy,
Roche was not going to launch Periostat in the Italian market.  In January 2003,
we  attempted  to  reach  agreement  with  Roche  regarding   compensation   for
outstanding  milestone payments. In March 2003, we terminated our agreement with
Roche and notified  them of our intent to take the matter to  arbitration  as is
provided for in our agreement with Roche.  In June 2003 we received  $425,000 in
outstanding  milestone  payments which settled all  outstanding  obligations due
from Roche. We currently do not have a licensing partner for Periostat in Italy.

     In October 1998, we announced  that a Marketing  Authorization  Application
had been filed with the United Kingdom  Medicines Control Agency with respect to
Periostat. 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 United  Kingdom to dentists  through our United Kingdom
subsidiary,  CollaGenex  International  Limited.  Sales  of  Periostat  capsules
commenced in the United Kingdom in September  2000. 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.


                                      -8-
<PAGE>

     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.  In April 2002, we announced
that we received  the final  Marketing  Authorizations  from the  Ministries  of
Health in Austria and Finland.  In June 2002, we announced  that we had received
final Marketing  Authorizations from the Ministries of Health in the Netherlands
and Portugal.  In June 2002 we received  final  approval to market  Periostat in
Ireland and Italy.

     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.
In the fourth  quarter of 1999,  Pharmascience  submitted an  application to the
Canadian  Therapeutic  Products Program of Health Canada for Canadian  marketing
approval of a capsule formulation of Periostat which was approved in March 2003.
In August 2003,  Pharmascience launched Periostat in Canada and accordingly,  we
began  recognizing  royalty income on  Pharmascience  net product sales.  Future
milestones  fees  will be due  from  Pharmascience  upon  individual  provincial
formulary approval expected in 2004.

     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,  pending  requisite
regulatory  approval,  and  Portugal,  where we have  received  such  regulatory
approval and began recording sales in June 2003. Such agreement was subsequently
extended,  granting ISDIN S.A. the right to market and  distribute  Periostat in
Greece, pending requisite regulatory approval.

     On  June  9,  2000,  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. In April 2002, Periostat received regulatory approval
under the Mutual  Recognition  Procedure for  marketing in Austria.  In December
2002,  we made our  first  sales  of  Periostat  to  Willvonseder  &  Marchesani
Ges.m.b.H  and the  product was  launched in Austria by them in April 2003.  The
regulatory  authorities in  Switzerland  granted final approval for Periostat in
October  2003 and we have made our first  shipment  of product to Karr Dental in
January 2004.

     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.

     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. This agreement provides for the

                                      -9-

<PAGE>


payment of milestone  fees to us  associated  with the  regulatory  approvals of
Periostat.  In February 2002, the Israeli authorities notified Taro with respect
to the  provisional  approval of Periostat in Israel.  In May 2002, we announced
that the Israeli  Ministry of Health had  granted a Marketing  Authorization  to
Taro.  In October  2002,  we made initial  sales of Periostat  and Taro formerly
launched the product in Israel in January 2003. We have made additional sales to
Taro in 2003.

     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 January 2004, we informed Pharma Med that we
elected not to renew such arrangement.

     In November 2001, we terminated our  distribution  and marketing  agreement
for  Germany  with Hain  Diognostika  GmbH due to Hain's  failure to fulfill its
obligations under the agreement.  We signed a settlement  agreement with Hain in
November  2002 with  respect  to Hain's  non-payment  of  milestone  fees due to
CollaGenex.  We  currently  do not have a  licensing  partner for  Periostat  in
Germany.

     In February 2002, we announced that we had contracted with Dexcel-Dental, a
division of Dexcel-Pharma Limited, to promote Periostat to the dental profession
in the United  Kingdom  and,  upon  receipt of final  regulatory  approval,  the
Republic of Ireland.  In October 2002, we provided  Dexcel-Dental  with a formal
termination notice of our agreement. During 2003, we and Dexcel-Pharma commenced
non-binding  mediation to resolve their dispute regarding the termination of the
agreement. In March, 2004, we and Dexcel-Pharma agreed to settle the dispute and
resolve outstanding invoices from Dexcel-Pharma. We continue to market Periostat
in  the  United  Kingdom  through  our   wholly-owned   subsidiary,   CollaGenex
International Ltd.

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
hyclate,  is supplied to us by Hovione  from its  offshore  facilities.  Hovione
supplies a substantial portion of the doxycycline used in the United States from
two independent 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  that  remains  uncured  for 90 days,  the
non-defaulting party can terminate the supply agreement effective immediately at
the end of such  ninety-day  period.  We rely on Hovione as our sole supplier of
doxycycline, and have no back-up supplier at this time.

     On September 26, 2000, we entered into a Service and Supply  Agreement with
a contract manufacturer,  Pharmaceutical  Manufacturing Research Services, Inc.,
for  the  tablet  formulation  of  Periostat.   Our  current   arrangement  with
Pharmaceutical  Manufacturing  Research  Services  has been  extended  until the
earlier of March 30, 2007 or until a generic 20 mg doxycycline hyclate tablet is
available  on  the  market.  Currently,  Pharmaceutical  Manufacturing  Research
Services is

                                      -10-
<PAGE>

the sole  third-party  contract  manufacturer to supply a tablet  formulation of
Periostat to us. We intend to contract  with  additional  manufacturers  for the
commercial  manufacture  of  Periostat  tablets.   Pharmaceutical  Manufacturing
Research  Services  is  required  to  comply  with  current  good  manufacturing
practices, or cGMP, requirements.

     In  November  1998,  we executed a  Distribution  Services  Agreement  with
Cardinal Health Specialty Pharmaceutical Services, or SPS, pursuant to which SPS
acts as our exclusive  logistics provider for Periostat in the United States and
Puerto Rico. Under this agreement, SPS warehouses and ships Periostat and Pandel
from its central distribution facility near Nashville,  Tennessee to wholesalers
that  distribute  our products to  pharmacies  throughout  the United States for
prescription sale to patients.  SPS also provides 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 had an initial term of three years
with  automatic  renewal  for  successive  one-year  periods  unless  notice  of
termination  was  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.,  now known as Cardinal
Health Specialty Pharmaceutical Distribution, or SPD, pursuant to which SPD acts
as our non-exclusive  authorized  distributor of Atridox,  Atrisorb FreeFlow and
Atrisorb-D.  Under this  agreement,  SPD 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 90
days prior to expiration.

     We do not have the resources, facilities or capabilities to manufacture any
of our products or product  candidates.  We have no current plans to establish a
manufacturing  facility.  We expect that we will be dependent,  to a significant
extent,  on contract  manufacturers  for commercial  scale  manufacturing of our
products or product candidates in accordance with regulatory standards.

     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 hyclate or Periostat on commercially reasonable terms,
or in a timely  manner,  or if our suppliers  fail to comply with cGMP 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.

Customers/Backlog

     During 2003, net product sales to each of Cardinal Health,  Inc.,  McKesson
Corporation and  Amerisource-Bergen  Corporation accounted for 43%, 31% and 20%,
respectively,  of our aggregate net product sales.  As is common practice in the
pharmaceutical  industry,  wholesalers  may  become  very  speculative  in their
purchasing practices in anticipation of product price increases. Accordingly, we
may limit, fulfill or delay shipment of customer purchase orders


                                      -11-
<PAGE>


depending on the availability of product and other factors  necessary to operate
our  business  efficiently.  At  December  31,  2003,  there were open  customer
purchase orders with an aggregate value of approximately $800,000.  These orders
were shipped complete during January 2004.

Research and Development

Overview

     Our research and  development  activities are conducted  primarily by third
parties including  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.

     Major research  programs  currently being conducted by us include:  (i) the
clinical  development  of the  sub-antimicrobial  dose  of  doxycycline  for the
treatment of rosacea,  perioral  dermatitis (a skin condition  characterized  by
inflammatory lesions and redness around the mouth frequently associated with the
use of topical  steriods) and  meibomianitis  (a disorder  characterized by "dry
eye");  (ii)  the  development  of  a  "once-a-day"   formulation  of  Periostat
(Periostat MR); and (iii) limited support for the conduct of exploratory studies
in the utility of  Metastat  (COL-3) as a  treatment  for soft  tissue  sarcoma,
periodontitis and rosacea.

     As of December  31, 2003,  we had five  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.
Because of this, it is very  difficult to estimate the cost of completing  these
trials.  We continue to study Periostat in a series of clinical studies in order
to determine its  usefulness in certain  patient  types or in  conjunction  with
procedures other than SRP. For example, data on the use of Periostat in diabetic
patients was published in 2003 and suggested that the drug may provide  benefits
not only in improved periodontal outcomes but also in improved diabetic control.
Extensive  additional studies are required before this finding can be confirmed,
if at all. We intend to continue the Phase IV development of Periostat in 2004.

     If a particular  indication  proves  promising  during early stage clinical
development,  and the commercial opportunity justifies the investment,  the next
stage of  development  typically  involves  more  extensive  Phase II  trials to
determine the appropriate  dose and dosing  regimen.  Based on our assessment of
the data  obtained,  we may then  decide to conduct  Phase III  clinical  trials
involving the indication and use positive results from the Phase III trials,  if
any, to support a New Drug Application,  or NDA, to the FDA. 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  Metastat  with the NCI may also result in  variability  in our
development costs. We closely monitor our research

                                      -12-

<PAGE>


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 use of pharmaceutical  products to inhibit
the destruction of the connective  tissues of the body and to down-regulate  the
pathological  host  response to a variety of external and internal  mediators of
inflammation and tissue destruction.

     The  technology  works  in  part  by  modulating  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.

     Elements of our core  technology  are 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-antimicrobial
doses) was  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.

     Additional  research suggests that  tetracyclines  also have the ability to
stimulate  new  bone  protein  synthesis  by  a  variety  of  mechanisms.  These
properties, which are independent from the anticollagenoyltic  properties of the
compounds, are particularly important during the development of certain types of
bone deficiency  disorders,  including  periodontitis.  Particularly in patients
with  concomitant   disorders,   such  as  diabetic   osteopenia  and  peri-  or
post-menopausal  osteoporosis,   periodontitis  can  occur  in  the  absence  of
inflammatory-mediated  elevated  collagenolytic  activity  and  is  primarily  a
function of alterations  in the balance of osteoblast  and  osteoclast  mediated
resorption and bone formation (in particular a reduction of bone formation).  In
these  and  other   circumstances   during   development   of  the  bony  lesion
characterizing adult  periodontitis,  the property of tetracyclines to stimulate
new bone  formation is the means by which the compounds are able to  effectively
treat periodontitis.

                                      -13-
<PAGE>

     Other  commercially  available  antibiotic   tetracyclines  show  effective
anti-collagenolytic   and  independent   bone  protein   synthesis   stimulating
potential.  Long-term  administration  of these  compounds at normal  antibiotic
doses,  however,  can result in well-known  complications of antibiotic therapy,
such as  gastrointestinal  disturbance,  overgrowth of yeast and fungi,  and the
emergence of  antibiotic-resistant  bacteria. Our Phase III clinical trials with
Periostat  demonstrated that the  administration of  sub-antimicrobial  doses of
doxycycline over a twelve-month period exerted no anti-microbial  effects. Thus,
the use of this  dosage  strength  provides  the  anti-collagenolytic  and  bone
protein  synthesis  effects without the  complications  of long-term  antibiotic
therapies. In pharmacokinetic  studies,  Periostat MR, our once-daily,  modified
release formulation of Periostat, showed similar blood concentration levels (bio
availability) as Periostat, and we believe Periostat MR will show similar safety
and efficacy as Periostat.

     Our license  from SUNY also  covers the uses of a broad class of  compounds
(IMPACS)  that  have  been  chemically  modified  to retain  and  enhance  their
anti-collagenolytic  and other  properties  but  which  may have the  structural
elements responsible for their antibiotic activity removed. These compounds have
shown  potential  in a number of  pre-clinical  models of  excessive  connective
tissue  breakdown.  Our current  research and development  programs focus on the
potential  use of  Periostat  as well  as the use of  IMPACS  for a  variety  of
disorders characterized by inflammation and connective tissue destruction.

     Additional  research  has  been  conducted  to  identify,   synthesize  and
characterize  a new  generation  of IMPACS  compounds,  and we have filed patent
applications on these compounds. The first of these compounds,  called COL-1002,
recently issued in the United States. We have also filed patent  applications on
other IMPACS compounds, which are pending.

Periostat

     We  have  completed  various  clinical  trials  that  evaluate  the  use of
Periostat for other therapeutic indications.  Studies that evaluated Periostat's
ability to promote  attachment level,  decrease pocket depth and promote healing
in  patients  undergoing  periodontal  flap  surgery are  complete  and data are
awaiting final analysis, which is expected to be completed during the first half
of 2004. Preliminary data from this study were presented at the American Academy
of  Periodontology  meeting in 2002 and suggested that  Periostat  significantly
improved  certain  clinical  and  biochemical  parameters  that  are  key to the
successful  outcome of periodontal  surgery.  Other Phase IV clinical trials are
being  conducted  or are planned to evaluate  Periostat  as an adjunct to SRP in
institutionalized  geriatric  patients,  in  patients  with  Type I and  Type II
diabetes and in a population of smokers. Two of the studies in diabetic patients
reported  encouraging  preliminary  data at the American  Association for Dental
Research  meeting in March 2003,  suggesting that Periostat had the potential to
improve periodontal clinical outcomes and possibly contribute to improvements in
diabetic control in these patients. In January 2003, we announced that the first
patients had entered a multi-center, double-blinded, placebo-controlled Phase IV
clinical  study to  evaluate  the  combined  efficacy of  Periostat  and Atridox
(doxycycline hyclate) 10%, a locally-applied antimicrobial gel, in the treatment
of adult periodontitis. This study is fully enrolled and results are expected to
be reported during 2004. We have incurred  approximately $300,000 in expenses to
date for this  project  and expect to incur  approximately  $100,000  in 2004 to
complete the study.


                                      -14-
<PAGE>

     To extend the possible therapeutic use of Periostat beyond the oral cavity,
we and our  collaborators  are planning,  conducting or have completed  clinical
trials in other indications.  Of these studies,  only the study in meibomianitis
(dry eye) is being fully funded by us,  although we support  additional  studies
through the provision of active drug and placebo without charge.

     A study  carried  out in 2002  focused  on the use of  Periostat  to  treat
moderate  acne.   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  Medical 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.

     Rosacea

     In   May   2003,   we   announced   the   results   of  a   double-blinded,
placebo-controlled clinical study designed to evaluate the efficacy of Periostat
when combined with MetroLotion(R) (metronidazole) Topical Lotion, 0.75%, for the
treatment of rosacea. The study was conducted by Jorge Sanchez,  M.D., Professor
of Dermatology at the University of Puerto Rico.  Forty patients were randomized
to receive either  MetroLotion and Periostat  tablets or MetroLotion and placebo
tablets  for  12  weeks.  After  week  12,  patients  discontinued  the  use  of
MetroLotion and were maintained on either Periostat or placebo for an additional
4 weeks.  Lesion  counts,  along with an assessment  of erythema,  or persistent
redness,  and overall clinical  disease severity were recorded.  The project was
completed in 2003 at a total cost of approximately $50,000.

     At all points during the course of the study,  patients receiving Periostat
had significantly  fewer inflammatory  lesions than those on placebo. At week 12
there was a 59% reduction in lesion count in the group receiving MetroLotion and
Periostat,  compared with a 34% reduction in the group receiving MetroLotion and
placebo, a clinically  significant  difference.  The Clinician's Global Severity
Assessment Scale, which is a numerical scoring system that evaluates a patient's
overall  disease  severity,  was also  significantly  improved in the  Periostat
group,  and  there  was a trend  towards  improvement  in the  erythema  scores.
Patients  who  were  maintained  on  Periostat  for  an  additional  four  weeks
maintained  the  improvements  observed at week 12, which was not true for those
patients on placebo.

     In July 2003, we announced that the July/August  issue of the peer-reviewed
dermatology  journal,  Skin Med,  featured an article  describing  the  positive
outcome of a physician-sponsored clinical study of Periostat in the treatment of
rosacea.  This open-label,  50-patient  study was designed to determine  whether
monotherapy with Periostat improved the symptoms  associated with various stages
of rosacea. Joseph B. Bikowski,  M.D., Department of Dermatology,  University of
Pittsburgh  School of  Medicine,  and  author  of the  article,  concluded  that
treatment  with  Periostat  resulted in a significant  clearing of  inflammatory
lesions as well as a reduction in erythema and telangiectatic vessels.  Patients
were  treated  for up to eight  weeks with  Periostat.  After an average of four
weeks  treatment,  patients  experienced an 80% to 100% clearing of inflammatory
lesions and a 50%  reduction in erythema.  Periostat  was well  tolerated by the
patients in the study, with no reports of nausea, vomiting,  headache, diarrhea,
vaginitis or  photosensitivity,  effects often  observed with the chronic use of
higher doses of tetracycline antibiotics.

                                      -15-
<PAGE>


     In  February  2004,  we  announced  the  positive  outcome  of  a  Phase  3
double-blinded,  placebo-controlled  clinical  study  designed to  evaluate  the
safety and  efficacy  of  Periostat  for the  treatment  of  rosacea.  The study
enrolled  134  patients  and is the largest  clinical  trial ever  conducted  to
evaluate  a  systemic  therapy  for  rosacea.  The  detailed  study data will be
presented at the Skin Disease Education Foundation's Dermatology Open Seminar on
March 21, 2004.

     Preliminary  data analysis  indicated that patients  treated with Periostat
showed a continuous  improvement during the 16-week course of the study compared
to patients on placebo. In the study, patients that were administered  Periostat
had a  significantly  greater  reduction in the number of  inflammatory  lesions
(papules and pustules)  compared to patients on placebo.  This  improvement  was
both clinically and statistically significant.

     Overall clinical disease severity based on the Clinician's  Global Severity
Assessment  Scale declined  significantly  in the group of patients treated with
Periostat  compared to placebo,  with a greater  number of patients on Periostat
showing  a  complete  clearing  of the  disease  at 16 weeks  compared  to those
patients on placebo.  The erythema in patients in the  Periostat  group showed a
trend toward greater improvement  compared to patients in the placebo group. The
total  expenses  incurred to date on this  project were  $880,000.  We expect to
incur an additional $500,000 in 2004 to complete this trial.

     Periostat MR Once-A-Day Formulation

     The  development  of a  once-a-day  formulation,  Periostat  MR,  is  being
conducted through a development agreement with Shire Laboratories.  Formulations
arising from this research were administered to human volunteers during 2002 and
exhibited promising results,  leading to the selection of a formulation for more
complete  clinical  testing in 2003. In October  2003,  we announced  that these
tests had shown that we had a suitable  formulation  and  planned to enter Phase
III clinical  trials with this new once-a-day  formulation in the second quarter
of 2004.  We also expect to launch a Phase III clinical  trial in  periodontitis
patients and two Phase III clinical trials in roseacea patients by mid-2004.  We
have incurred  approximately $3.3 million in expenses through December 31, 2003.
The total anticipated  expenses,  through  commercialization,  including various
milestones to Shire, is estimated to be between $16.0 million and $18.0 million.

     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 tumor growth 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


                                      -16-
<PAGE>

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 2001, at their cost, the NCI initiated an open-label,  two-dose study to
establish  clinical  efficacy of Metastat in patients with HIV-related  Kaposi's
sarcoma.  This multi-center  Phase 2 study enrolled 77 patients with HIV-related
Kaposi's sarcoma by March 2003.  Patients received one of two different doses of
Metastat for six months.  The primary  objectives  of the study were to evaluate
the  tumor  response  rate and  duration  as well as to  evaluate  the  biologic
activity of Metastat by measuring serum levels of pro-angiogenic mediators.

     Due to the  unexpected  finding  that  patients  on Metastat  continued  to
improve over the course of their therapy, the AIDS Malignancy Consortium and the
NCI did not undertake an interim  analysis of this database  until January 2004.
We believe the analysis will be finalized in the second  quarter of 2004.  Early
reports  of  this  open-label  study  suggest  that  certain  patients  obtained
significant  relief (both  partial  responses  and complete  responses) of their
clinical symptoms during the course of the study, but we cannot be certain until
the data is formally analyzed.

COL-3

     A Phase I,  ascending  dose  trial with  COL-3 in normal  human  volunteers
succeeded in establishing the maximum  tolerated dose that could be supported in
investigational new drug, or IND-based, exploratory studies. During 2003, we set
up clinical  studies  with COL-3,  the active  ingredient  in  Metastat,  in the
treatment of adult periodontitis and rosacea. The rosacea study began recruiting
patients  in 2003 and the  periodontitis  study will begin  recruiting  patients
during 2004.  However,  we do not know whether the drug will exhibit  sufficient
efficacy  in the  treatment  of rosacea  or  periodontitis  to  justify  further
clinical investigation.

     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  currently  conducted
studies  with the NCI or other  sources of external  funding that the drug has a
tolerable  safety  profile  and a high  likelihood  of clinical  and  commercial
success.

Preclinical and Other Research and Development Activities

     A preclinical program has identified and characterized  IMPACS that exhibit
the  potential  for enhanced  biological  activities  compared to Periostat  and
Metastat. In collaboration with the University of Rochester, we have synthesized
a number of new IMPACS. These novel compounds underwent  preliminary  evaluation
in a variety of in vitro and in vivo assay systems.  In March 2003, we announced
the  issuance of the first United  States  patent  claiming a compound  that was
discovered as a result of these efforts.  Further patents for other compounds in
the series have issued in 2003, and we anticipate that others will issue in 2004
and beyond.


                                      -17-
<PAGE>


     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 October  2002,  we  announced  with  Discovery  Laboratories,  Inc.  the
formation of a research collaboration to evaluate the combination of Discovery's
platform   technologies  for  the  development  of  novel  respiratory   disease
therapeutics.  Due to  changed  priorities  at  Discovery,  this  agreement  was
terminated in September 2003.

     In October  2002, we also  announced  the execution of a license  agreement
with Medtronic, Inc. involving our IMPACS compounds, pursuant to which Medtronic
obtained an exclusive,  worldwide  license to technology  relating to the use of
the compounds to treat aortic aneurysms and other forms of vascular disease with
medical devices. This program is still underway.

     In February 2002 we announced that we had licensed a dermal and transdermal
drug delivery  technology named  Restoraderm  from its inventor.  Restoraderm is
designed to enhance the dermal  delivery of a variety of active  ingredients and
we  intend  to  develop   it  into  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  therapeutic  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 early
2005.  We have  acquired  exclusive  rights to the  technology  and 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.  To date, we have
spent $1.2 million in development  costs for the  Restoraderm  technology.  This
amount includes  $930,000 in milestone  payments to the inventor.  We anticipate
spending   approximately   $8.2   million  in   development   expenses   through
commercialization.

     Our research and development  expenditures were approximately $5.5 million,
$4.4  million  and $3.8  million  in  2003,  2002 and  2001,  respectively.  See
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Results of  Operations."  We expect to  significantly  increase our
investment in research and development in 2004.

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 SUNY for all of our core technology. The SUNY
License  grants us an  exclusive  worldwide  license  to make and sell  products
employing




                                      -18-
<PAGE>

tetracyclines  that are  designed  or utilized  to alter a  biological  process.
Thirty one United States patents and five United States patent applications held
by SUNY are licensed to us under the SUNY License.  Three of the 31 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 patent is co-owned with the Hospital for Joint Diseases in
New York City;  three patents are co-owned with the University of Helsinki;  and
one 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 29
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,  or 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.  Eighty seven
patents have been issued in foreign  countries.  All of SUNY's United States and
foreign  patents expire between 2004 and 2019. 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.

     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, we 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.

                                      -19-
<PAGE>

     In  consideration  of the  license  granted  to us,  we: (i) issued to SUNY
78,948  shares  of  common  stock in  1992;  and (ii)  have  agreed  to pay SUNY
royalties  on the net sales of products  employing  tetracyclines,  with minimum
annual  royalty  payments of $50,000  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.  A second  patent  was  issued  which  covers one of the novel
compounds  discovered  by us and its use to  treat  abdominal  aortic  aneurysm,
ulceration of the cornea,  periodontal  disease,  diabetes,  diabetes  mellitus,
scleroderma, progeria, lung disease (such as ARDS, cystic fibrosis, emphysema or
acute lung injury resulting from inhalation of toxicants),  cancer, graft versus
host  disease,  disease of  depressed  bone marrow  function,  thrombocytopenia,
prosthetic  joint  loosening,   spondyloarthropathies,   osteoporosis,   Paget's
disease,  autoimmune  disease,  systemic lupus  erythematosus,  acute or chronic
inflammatory   condition  (such  as  inflammatory   bowel  disease,   arthritis,
osteoarthritis,      rheumatoid     arthritis,     pancreatitis,      nephritis,
glomerulongephritis,  sepsis, septic shock,  lipopolysaccharide endotoxin shock,
multisystem  organ failure or  psoriasis),  renal disease (such as chronic renal
failure,  acute renal  failure,  nephritis  or  glomerulonephritis),  connective
tissue  disease,  and  neurological  or  neurodegenerative  condition  (such  as
Alzheimer's    disease,     Guillain-Barre    Syndrome,     Krabbe's    disease,
adrenoleukodystrophy,   Parkinson's  disease,   Huntington's  disease,  multiple
sclerosis, amyotrophic lateral sclerosis or an encephalopathy,  e.g., spongiform
encephalopathy).  Furthermore, we report pending applications covering other new
tetracycline  derivatives,  and,  among other things,  methods of treating acne,
rosacea, meibomianitis and Kaposi's sarcoma.

     On June 10, 2002, we executed a Development  and Licensing  Agreement  with
Shire  Laboratories,  Inc.  pursuant  to  which  we were  granted  an  exclusive
worldwide  license  (including the right to sublicense) to develop,  make,  have
made, use, supply, export, import,  register and sell products for the treatment
of various inflammatory  disorders.  In addition,  under the agreement,  certain
product  development  functions  shall  be  performed  for us.  Also  under  the
agreement,  we  have  committed  to  payments,  in  cash  or at  our  option,  a
combination  of cash and our  common  stock,  upon the  achievement  of  certain
clinical and regulatory  milestones in the event we pursue certain  applications
of the  technology  which  could  total  up to $7.9  million  in the  aggregate.
Pursuant  to the terms of such  agreement,  we shall  also pay a  percentage  of
certain net sales of products, if any, utilizing any part of the technology.  We
may terminate the agreement upon sixty days notice.

     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.

                                      -20-

<PAGE>


     During  2003,  we  announced  that we had settled  all pending  litigations
between CollaGenex and West-ward  Pharmaceutical  Corporation,  or West-ward,  a
generic  pharmaceutical  company that had filed an ANDA for a generic version of
Periostat.  We sued West-ward and other defendants in the United States District
Court for the Eastern  District of New York,  alleging that West-ward  infringes
our  patents  for  Periostat  for the  treatment  of  adult  periodontitis.  Our
complaint  also alleged that  West-ward  infringed  our patent  rights under the
Hatch-Waxman  act by  submitting  an ANDA with the FDA,  seeking FDA approval to
market a generic capsule version of Periostat.

     In a separate  action in the United States  District Court for the District
of  Columbia,  we sought  and,  on July 23,  2003,  were  granted a  preliminary
injunction  preventing  the FDA from  approving  generic  versions of Periostat,
including West-ward's version. West-ward intervened in that case.

     In the  settlement,  West-ward  agreed and  confessed to judgment  that our
Periostat  patents are valid and  infringed by the filing of  West-ward's  ANDA.
West-ward also agreed and confessed to judgment that our Periostat patents would
be  infringed by the  manufacture  and sale of a generic  version of  Periostat.
West-ward  consented to a judgment  enjoining  West-ward and any party acting in
concert with  West-ward  from making and selling a generic  version of Periostat
until our patents expire or are declared  invalid or unenforceable by a court of
competent jurisdiction.  Finally, West-ward agreed to withdraw from the FDA case
in the District of Columbia.  We agreed to pay a portion of  West-ward's  actual
legal expenses in the amount of $700,000.

     In  a   related   case,   we   have   separately   sued   United   Research
Laboratories/Mutual  Pharmaceutical  Company,  or Mutual,  in the United  States
District  Court for the  Eastern  District  of New York,  claiming  that  Mutual
infringes the claims of our Periostat patents.  Mutual has sued us in the United
States District Court for the Eastern District of Pennsylvania, alleging that we
engaged  in  tortious  and  anticompetitive  behavior  to  prevent  Mutual  from
commercializing  a generic  version of Periostat.  Mutual has also intervened in
the FDA action in the United States District Court for the District of Columbia.

     In addition,  on July 14, 2003 we  submitted a Citizen  Petition to the FDA
requesting that it refuse to approve any generic version of Periostat, submitted
by Mutual on the ground that the  bioequivalence  studies  Mutual  submitted are
insufficient to show that the Mutual product is bioequivalent to Periostat.  The
FDA has not reached a decision on our Citizen  Petition.  The  resolution of the
West-ward  cases does not  resolve  any of the  pending  Mutual  litigations  or
administrative proceedings. We cannot predict the outcome of these matters.

     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

                                      -21-
<PAGE>

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
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  CollaGenex.   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  Atridox,  Pandel,
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.

                                      -22-

<PAGE>


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

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

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

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

          -    submission to the FDA of an NDA for approval;

          -    satisfactory completion of an FDA inspection of the manufacturing
               facility  or  facilities  at which the drug is produced to assess
               compliance with cGMP; and

          -    FDA review and approval of the NDA.

     Pre-clinical  tests include  laboratory  evaluations of product  chemistry,
toxicity,  and  formulation,  as well as  animal  studies.  The  results  of the
pre-clinical tests,  together with manufacturing  information,  analytical data,
and a plan for studying the product in humans,  are submitted to the FDA as part
of an  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  is  placed on  clinical  hold and the
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 I 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 II 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
III 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 I, Phase II, or Phase III 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


                                      -23-
<PAGE>


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.

     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 cGMP 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 NDA for Periostat in
1998, however,  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 NDA 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. The FDA has not provided such protection to Periostat.

     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
current 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

                                      -24-
<PAGE>

products  we  market,  Atridox,  Atrisorb  FreeFlow,  Atrisorb-D  and Pandel 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.

     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.

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 a
variety of factors, including product efficacy, safety, cost-effectiveness, ease
of use, patient discomfort,  availability,  price, patent position and effective
product  promotion.  We  believe  that  Periostat  is  distinguished  from other
existing and known  periodontitis  treatments  in that it is the only  treatment
that is directed to suppression of the enzymes that degrade  periodontal support
tissues.  We believe  that all other  therapies  of which we are aware  focus on
temporarily removing the bacteria associated with periodontitis.  Periostat is a
prescription  pharmaceutical  tablet  indicated  as an adjunct to SRP to promote
attachment  level  gain and to  reduce  pocket  depth  in  patients  with  adult
periodontitis  that is taken by the patient  between dental  visits.  We believe
that the  following  chart  summarizes  the  pharmacotherapies  available in the
United States and indicated for the treatment of adult periodontitis:

<TABLE>
<CAPTION>
             Product                                      Patient
Product      Manufacturer/         Dental     Delivery    Adminis-   Treatment
Name         Marketer              Procedure  Route       tered      Focus        Indication
-----------  ----------------      ---------  ----------  ---------  ------------ -------------
<S>          <C>                      <C>     <C>           <C>       <C>          <C>
Periostat    CollaGenex               No      Systemic      Yes       Tissue       As an adjunct to SRP
             Pharmaceuticals,                                         degradation  to promote
             Inc.                                                                  attachment level gain
                                                                                   and to reduce pocket
                                                                                   depth in patients with
                                                                                   adult periodontitis

*Atridox     Atrix Laboratories/     Yes        Local       No        Bacteria     For treatment of
             CollaGenex                                                            chronic adult
             Pharmaceuticals, Inc.                                                 periodontitis for a
                                                                                   gain in clinical
                                                                                   attachment, reduction
                                                                                   in probing depth and
                                                                                   reduction in bleeding
                                                                                   on probing


                                      -25-
<PAGE>


Periochip    Vendent on behalf of    Yes        Local       No        Bacteria     As an adjunct to SRP
             Dexcel                                                                procedures for
                                                                                   reduction of pocket
                                                                                   depth in patients with
                                                                                   adult periodontitis

Arestin      Orapharma, a            Yes        Local       No        Bacteria     As an adjunct to SRP
             Division of Johnson                                                   procedures for
                                                                                   reduction of pocket
                                                                                   depth in patients with
                                                                                   adult periodontitis
</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.

     In addition,  we may face competition from generic  competitors.  If one or
more generic versions of Periostat are approved and marketed,  our revenues from
Periostat would significantly  decrease.  We cannot be certain that parties will
not  receive  FDA  approval  to  introduce  a  competitive  generic  version  of
Periostat.

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, 2003, we employed 156 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.

Additional Factors That May Affect Future Results

     We Rely on Periostat for Most of Our Revenue.

     During  the  years  ended  December  31,  2003,  2002 and  2001,  Periostat
accounted  for  approximately  82%,  82%  and  87% of our  total  net  revenues,
respectively.  Although we currently  derive  additional  revenue from marketing
and/or  selling other  products  (Atridox,  Atrisorb  FreeFlow,  Atrisorb-D  and
Pandel) and from licensing fees from foreign marketing


                                      -26-

<PAGE>

partners,  our revenue and  profitability  in the near future will depend on our
ability to successfully market and sell Periostat.

     Although  we  recently  settled  our  litigation  with  West-ward,   Mutual
submitted  an  application  to the FDA for  approval  of a  generic  version  of
Periostat.  Other companies may also have submitted applications for approval of
generic versions of Periostat.  We have filed suits to enforce our patent rights
and to compel the FDA to award  patent and  exclusivity  protections  that would
prevent a generic drug application from being approved now. On July 23, 2003, we
announced that the United States District Court for the District of Columbia had
granted a preliminary injunction temporarily  restraining the FDA from approving
any ANDAs  submitted for any generic  version of Periostat.  Until the Court has
made a final ruling on our  complaint,  the FDA cannot approve the ANDAs on file
for Mutual's 20 mg.  doxycycline  hyclate tablet or any other ANDA for a generic
version of  Periostat.  The Court could make a final ruling at any time.  If the
Court decides in favor of the FDA, the FDA could begin to approve  generic drugs
immediately thereafter.

     As a  result  of the  ruling  in the  District  Court  of the  District  of
Columbia,  we have  withdrawn our motion for a temporary  restraining  order and
preliminary injunction in our patent infringement suit against Mutual, which was
filed in the  District  Court of the  Eastern  District  of New  York.  Our suit
against Mutual, however,  remains on file and a motion for injunctive relief can
be filed  immediately  if  required.  We cannot  predict  the  outcome  of these
matters.  In addition,  we cannot be sure that one or more  generic  versions of
Periostat will not be approved and marketed.  If one or more generic versions of
Periostat  are  approved  and  marketed,   our  revenues  from  Periostat  would
significantly decrease and, as a result, our business, financial condition, cash
flows and results of operations would be materially adversely affected.

     We May Not Be Able to Maintain Profitability.

     From our  founding in 1992  through the  commercial  launch of Periostat in
November, 1998, we had no revenue from sales of our own products. As of December
31, 2003, we have an accumulated deficit of $69.9 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 and our
other products. Although we achieved net income of $6.4 million and $902,000 for
the years ended  December  31, 2003 and 2002,  respectively,  we expect to incur
significant  future  expenses,  particularly  with  respect  to  the  sales  and
marketing of our existing  products,  new products and  continuing  clinical and
manufacturing  development for other  indications and formulations of Periostat,
and  therefore,  we  cannot  be  certain  that we will be able to  maintain  our
profitability in the future, if at all.

     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.


                                      -27-
<PAGE>


     Our core  technology is licensed from SUNY, and other academic and research
institutions  collaborating with SUNY. Under the license agreement with SUNY, or
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  31  United   States   patents  and  six  United  States  patent
applications  that are  licensed  to us. The patents  licensed  from SUNY expire
between 2004 and 2019. 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,
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 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.

     We are currently enforcing our patent rights against Mutual, a generic drug
company. Mutual has submitted a request for listing a generic tablet replacement
for  Periostat  on  the  New  Jersey  Formulary.  In  keeping  with  our  patent
enforcement  policy,  we have  initiated  a patent  infringement  action  in the
Eastern  District  of New York to  prevent  Mutual  from  introducing  a generic
version of Periostat.  A motion for preliminary  injunction was filed and served
to  prevent  Mutual  from  introducing  a generic  version of  Periostat  to the
marketplace.  As a result of our  litigation  against the FDA, we have withdrawn
our motion for a temporary  restraining order and preliminary  injunction in our
patent  infringement suit against Mutual,  although our complaint against Mutual
remains  outstanding.  Mutual has filed  various  claims  against us relating to
these matters.  We cannot be certain that Mutual or other third parties will not
receive FDA approval and introduce a competitive  generic  version of Periostat.
Any  infringement  or related  action  involving  Mutual or any third party will
likely  result in  significant  expenditures,  even if such actions are settled,
require substantial management time and may not be resolved in our favor.

     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.


                                      -28-
<PAGE>

     If We  Lose  Our  Sole  Supplier  of  Doxycycline  Hyclate  or Our  Current
Manufacturer  of  Periostat,   Our   Commercialization   of  Periostat  Will  be
Interrupted, Halted or Less Profitable.

     We rely on a single supplier,  Hovione  International  Limited, or 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,  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
ninety-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  have  entered  into  an   agreement   with  a  contract   manufacturer,
Pharmaceutical  Manufacturing  Research Services,  Inc., or PMRS, for our tablet
formulation for Periostat.  Our current  arrangement with PMRS has been extended
until the earlier of March 30, 2007 or until a generic 20 mg doxycycline hyclate
tablet is  available  on the  market.  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. The introduction of a generic 20 mg
doxycycline  hyclate tablet could leave us without a manufacturer or force us to
negotiate a new  arrangement,  possibly on less  favorable  terms.  We intend to
contract  with  additional  manufacturers  for  the  commercial  manufacture  of
Periostat  tablets.  We believe,  however,  that it could take up to one 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,  Pandel and
Atridox have been approved by the FDA as drugs. Atrisorb FreeFlow and Atrisorb-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.  Also, we cannot market our approved products for
new indications  until FDA approves the product for that indication.  If the FDA
does not approve our products under  development or additional  indications  for
marketed  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.  If we or our partners
who manufacture our products fail to comply with regulatory requirements,

                                      -29-

<PAGE>

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 and approved for marketing in Austria,  Finland,
Switzerland,  Ireland, Israel, Italy, Luxembourg, the Netherlands,  Portugal and
Canada,  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.

     A Small  Number of  Wholesale  Customers  Account  for the  Majority of Our
Sales,  and the Loss of One of Them,  or Changes in Their  Purchasing  Patterns,
Could  Result in  Reduced  Sales,  Thereby  Adversely  Affecting  Our  Operating
Results.

     We  sell  most  of  our  products  to a  small  number  of  wholesale  drug
distributors.  For the year ended December 31, 2003,  sales to Cardinal  Health,
Inc.,  McKesson  Corporation  and  Amerisource-Bergen  Corporation,  represented
approximately  43%,  31% and 20%,  respectively,  of our  aggregate  net product
sales.  The small number of wholesale drug  distributors,  consolidation in this
industry or financial  difficulties  of these  distributors  could result in the
combination  or  elimination of  warehouses,  which could  temporarily  increase
returns  of our  products  or, as a result of  distributors  reducing  inventory
levels,  delay the  purchase  of our  products.  In  addition,  wholesalers  may
increase  purchase  levels in  anticipation  of future  price  increases  or may
capitalize  on  volume  discounts  to  acquire  inventory.  This  may  cause  an
unexpected  increase in the level of trade  inventories  normally  maintained by
wholesalers.  Although  we have  developed a plan to manage our  products  trade
inventory  level,  this plan may not be  effective.  If trade  inventory  levels
become  too high,  or if  prescription  growth of our  products  are lower  than
expected by the trade,  wholesalers  and large retail  chains could reduce their
orders for our products, which could result in reduced sales of our products and
adversely affect our operating results.

     We Cannot Assure You that Our Pursuit of Business in the Dermatology Market
will be Successful.

     During 2003, we began to implement our plans to expand into the dermatology
market.   We  have  completed  and  announced  the  preliminary   results  of  a
double-blind,   placebo-controlled  134-patient  Phase  III  clinical  trial  to
evaluate the safety and efficacy of Periostat to treat rosacea, we have licensed
a new dermal and transdermal drug delivery  technology called Restoraderm and we
executed a sublicense  Agreement  with Altana Inc. with respect to the marketing
and  distribution of Pandel.  In addition,  we continue to actively seek product
licensing  opportunities  to enhance our near-term  offerings to the dermatology
market.  Our future success will depend on, among other things,  our ability to:
(i)  achieve  market  acceptance  for  any of  these  or  future  dermatological
offerings;  (ii) hire and retain  personnel with  experience in the  dermatology
market; (iii) execute our business plan with respect to this market segment; and
(iv) adapt to technical or  regulatory  changes once  operational.  Furthermore,
while we have experience in the


                                      -30-
<PAGE>

sales and  marketing  of dental  products,  we have limited  experience  in this
market.  This  market  is very  competitive  and  some of our  competitors  have
substantially  greater  resources  than we have.  New product  development  is a
lengthy,  complex and uncertain process that will require significant  attention
and resources from management.  A product candidate can fail at any stage of the
development process due to, among other things, efficacy or safety concerns, the
inability to obtain necessary regulatory approvals,  the difficulty or excessive
cost to manufacture and/or the infringement of patents or intellectual  property
rights  of  others.  Furthermore,  the  sales of new  products  may  prove to be
disappointing and fail to reach  anticipated  levels. We therefore cannot assure
you that we will be  successful  in our pursuit of  business in the  dermatology
market, or that we can sustain any business in which we achieve initial success.

     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 an aggregate of $10.0 million in product liability insurance for
Periostat,  our product  candidates  and products for which we have licensing or
co-promotion  rights.  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.

     Because Our  Executive  Officers,  Directors  and  Affiliated  Entities Own
Approximately  23.3% of Our Capital Stock, They Could Influence 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  23.3% 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  influence
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.

     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  that may continue
indefinitely.


                                      -31-
<PAGE>


     The  following  table sets forth the high and low closing  market price per
share for our common  stock for each of the  quarters  in the  period  beginning
January 1, 2000 through  December 31, 2003,  as reported on the Nasdaq  National
Market:

              Quarter Ended                   High          Low
  -----------------------------------      -----------   ----------
  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
  March 31, 2002.....................        $12.00         $7.72
  June 30, 2002......................        $11.65         $5.75
  September 30, 2002.................         $7.34         $4.70
  December 31, 2002..................         $9.93         $4.05
  March 31, 2003.....................        $11.03         $6.66
  June 30, 2003......................        $13.27         $8.62
  September 30, 2003.................        $15.84        $10.50
  December 31, 2003..................        $11.82         $8.90

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.

     In November  2002,  we  commenced an action in the United  States  District
Court  for the  Eastern  District  of New  York  seeking  to  prevent  West-ward
Pharmaceutical  Corporation,  or  West-ward,  from  selling 20 mg.  capsules  of
doxycycline  hyclate  to  treat  periodontal  disease,  which we  believe  would
infringe  patents  covering our Periostat  product.  As discussed below, we have
settled all pending litigation with West-ward.

     In July 2003,  we commenced an action  against  Mutual in the United States
District  Court for the Eastern  District of New York seeking to prevent  Mutual
from  introducing 20 mg.  tablets of doxycycline  hyclate into the market in the
United  States.  Our suit  alleges  infringement  of patents to which we are the
exclusive licensee.

     In July 2003,  Mutual  commenced an action  against us in the United States
District Court for the Eastern District of Pennsylvania.  Mutual alleges that we
have  engaged  in an  overall  scheme to  monopolize  the  market  for  low-dose
doxycycline  products.  In  addition,  the suit  alleges that we have engaged in
exclusionary, unfair, and anticompetitive practices. Mutual seeks an

                                      -32-
<PAGE>

award of treble damages, injunctive relief, compensatory, punitive and exemplary
damages and  reasonable  attorneys'  fees. In January 2004, the Court stayed all
proceedings in this case.

     In June 2003,  we commenced an action and filed a motion for a  preliminary
injunction  in the United  States  District  Court for the  District of Columbia
challenging  FDA's  decision to treat  Periostat  as an  antibiotic  drug,  thus
denying Periostat certain protections  afforded  non-antibiotic  drugs under the
Food,  Drug,  and  Cosmetic  Act and against FDA  approval of generic  copies of
Periostat. West-ward and Mutual intervened in this action. On July 22, 2003, the
Court  granted a preliminary  injunction  temporarily  restraining  the FDA from
approving  any ANDA  submitted for a generic  version of Periostat  (doxycycline
hyclate) 20 mg.

     Until the United  States  District  Court for the  District of Columbia has
made a final  ruling on the  regulatory  status  of  Periostat,  the FDA  cannot
approve the ANDAs for West-ward's 20 mg. doxycycline  hyclate capsule,  Mutual's
20 mg.  doxycycline  hyclate  tablet or any other ANDA for a generic  version of
Periostat. Cross motions for summary judgment are pending.

     As a result  of the  ruling in the  United  States  District  Court for the
District  of  Columbia,  we  withdrew  our then  pending  motion for a temporary
restraining  order and preliminary  injunction in our patent  infringement  suit
against  Mutual,  which was filed in the United  States  District  Court for the
Eastern District of New York,  although our complaint  remains  outstanding.  In
November,  2003 the  proceedings  in the patent  infringement  case were  stayed
pending a determination  by the United States Patent and Trademark Office of its
re-examination of the patents-in-suit,  subject to the parties' right to conduct
limited  discovery  related to the potential  re-instatement of our motion for a
temporary  restraining order and preliminary  injunction.  We cannot predict the
outcome of these matters.

     On November  7, 2003,  we settled  all  pending  litigation  between us and
West-ward.  In the settlement,  West-ward  agreed and confessed to judgment that
our Periostat patents are valid and infringed by the filing of West-ward's ANDA.
West-ward also agreed and confessed to judgment that our Periostat patents would
be  infringed by the  manufacture  and sale of a generic  version of  Periostat.
West-ward  consented to a judgment  enjoining  West-ward and any party acting in
concert with  West-ward  from making and selling a generic  version of Periostat
until our patents expire or are declared  invalid or unenforceable by a court of
competent jurisdiction.  Finally, West-ward agreed to withdraw from the FDA case
in the District of Columbia.  In connection with this  settlement,  we agreed to
pay a portion of West-ward's actual legal expenses in the amount of $700,000.

     We  anticipate  that our future  legal costs in these  matters  relating to
patent  infringement  and defense  will be  reimbursed  by SUNY  pursuant to our
Technology  License  Agreement with SUNY to the extent that these legal expenses
do not exceed royalties earned by SUNY during that period. During 2002 and 2003,
we incurred $129,000 and $3.8 million respectively, in legal defense, litigation
and settlement costs for the aforementioned law suits with West-ward and Mutual,
$129,000 and $1.7 million  respectively,  of which were deducted from  royalties
payable to SUNY during those periods.  In the event such cumulative  legal costs
exceed in the amount of the  royalties  payable to SUNY,  we will not be able to
recover  such legal  costs from SUNY.  As of  December  31,  2003,  we have $1.7
million  in  previously  recorded  legal  expenses  available  to offset  future
royalties which may become payable to SUNY.

                                      -33-
<PAGE>


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

          Not applicable.

                                      -34-

<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 per share sales prices for
our common  stock for each of the  quarters in the period  beginning  January 1,
2002 through December 31, 2003 as reported on the Nasdaq National Market.

                Quarter Ended                        High           Low
    -----------------------------------          ------------    -----------
    March 31, 2002.....................             $12.00          $7.72
    June 30, 2002......................             $11.65          $5.75
    September 30, 2002.................              $7.34          $4.70
    December 31, 2002..................              $9.93          $4.05
    March 31, 2003.....................             $11.03          $6.66
    June 30, 2003......................             $13.27          $8.62
    September 30, 2003.................             $15.84         $10.50
    December 31, 2003..................             $11.82          $8.90

     As of March 11, 2004,  the  approximate  number of holders of record of our
common stock was 114 and the  approximate  number of  beneficial  holders of our
common stock was 4,406.

     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 had  certain
common stock dividend  obligations and continue to have certain  cumulative cash
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 for which we are  currently  negotiating  a
two-year renewal upon expiration.  See "Management's  Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."

     The following  information relates to all securities of the Company sold by
us during the year ended December 31, 2003 which were not  registered  under the
securities  laws at the time of grant,  issuance and/or sale (and which were not
previously reported on a Quarterly Report on Form 10-Q):


                                      -35-
<PAGE>


     Option Grants

     During the fourth quarter of 2003, we granted stock options pursuant to our
1996  Stock Plan and  outside  of our 1996 Stock Plan which were not  registered
under the Securities Act of 1933, as amended (the "Securities Act"). All of such
option  grants were granted at the then current fair value of the common  stock.
The following table sets forth certain information  regarding such grants during
the quarter:

           Number of Options          Weighted Average
               Granted                 Exercise Price
       --------------------------   ---------------------

               309,650                     $10.15

     We did not employ an  underwriter  in  connection  with the issuance of the
securities  described  above.  We believe  that the  issuance  of the  foregoing
securities  was exempt from  registration  under  either (i) Section 4(2) of the
Securities  Act as  transactions  not  involving  any public  offering  and such
securities  having  been  acquired  for  investment  and  not  with  a  view  to
distribution,  or (ii) Rule 701 under the  Securities Act as  transactions  made
pursuant  to a  written  compensatory  benefit  plan or  pursuant  to a  written
contract  relating  to  compensation.  All  recipients  had  adequate  access to
information about us. On February 6, 2004, we filed a registration  statement on
Form S-8  with the  Securities  and  Exchange  Commission  with  respect  to the
foregoing securities.

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, 2003, and with respect to the consolidated
balance  sheet data as of December  31,  2003 and 2002 are derived  from and are
qualified by reference to our audited consolidated  financial statements and the
related  notes  thereto  found  at  "Item  15.  Exhibits,   Financial  Statement
Schedules,  and  Reports on Form 8-K"  herein.  The  consolidated  statement  of
operations  data for the years ended December 31, 2000 and 1999 and with respect
to the  consolidated  balance sheet data as of December 31, 2001,  2000 and 1999
are derived from our 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 15. 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.

                                      -36-

<PAGE>

<TABLE>
<CAPTION>
                                                                  Years Ended December 31,
                                                                  ------------------------
                                               2003            2002             2001            2000           1999
                                               ----            ----             ----            ----           ----
                                                          (In thousands except for per share data)
                                                          ----------------------------------------
<S>                                        <C>             <C>              <C>             <C>             <C>
Consolidated Statement of Operations
   Data:
Revenues:
   Net product sales................       $   49,038      $   42,111       $   31,358      $   20,501      $   15,211
   Contract revenues................            3,122           2,332            3,386           3,240             770
   License revenues.................              699             176              488             530             100
                                           ----------      ----------       ----------      ----------      ----------
Total revenues......................           52,859          44,619           35,232          24,271          16,081
Operating expenses:
   Cost of product sales............            7,362           6,713            5,825           4,070           3,139
   Research and development.........            5,462           4,394            3,764           3,128           5,005
   Selling, general and administrative         33,668          32,699           34,010          25,746          23,180
                                           ----------      ----------       ----------      ----------      ----------
       Operating income (loss)......            6,367             813           (8,367)         (8,673)        (15,243)
Interest income.....................              148              77              232             613             851
Interest expense....................               --              (5)             (17)            (15)           (197)
Other (expense) income..............               (3)             17                8               9              (2)
                                           ----------      ----------       ----------      ----------      ----------
Income (loss) before income taxes and
   cumulative effect of change in
   accounting principle.............            6,512             902           (8,144)         (8,066)        (14,591)
Income taxes........................               85              --               --              --              --
Cumulative effect of change in
   accounting principle(1)..........               --              --               --            (764)             --
                                           ----------      ----------       ----------      ----------      ----------
Net income (loss)...................       $    6,427      $      902       $   (8,144)     $   (8,830)     $  (14,591)
                                           ==========      ==========       ==========      ==========      ==========
Net income (loss) allocable to common
   stockholders.....................       $    4,827      $     (727)      $   (9,824)     $  (10,519)     $  (15,683)
                                           ==========      ==========       ==========      ==========      ==========
Basic net income (loss) per share
   allocable to common stockholders
   before cumulative effect of change
   in accounting principle(1)(2)....       $     0.40      $    (0.06)      $    (0.94)     $    (1.12)     $    (1.82)
                                           ==========      ==========       ==========      ==========      ==========
Diluted net income (loss) per share
   allocable to common stockholders
   before cumulative effect of change
   in accounting principle(1)(2)....       $     0.38      $    (0.06)      $    (0.94)     $    (1.12)     $    (1.82)
                                           ==========      ==========       ==========      ==========      ==========
Basic net income (loss) per share
   allocable to common stockholders(2)     $     0.40      $    (0.06)      $    (0.94)     $    (1.21)     $    (1.82)
                                           ==========      ==========       ==========      ==========      ==========
Diluted net income (loss) per share
   allocable to common stockholders(2)     $     0.38      $    (0.06)      $    (0.94)     $    (1.21)     $    (1.82)
                                           ==========      ==========       ==========      ==========      ==========
Shares used in computing basic per
   share amounts(2).................       12,094,638      11,234,652       10,413,663       8,711,668       8,597,676
Shares used in computing diluted per
   share amounts(2).................       12,836,364      11,234,652       10,413,663       8,711,668       8,597,676
</TABLE>

                                      -37-

<PAGE>

<TABLE>
<CAPTION>
                                                                    As of December 31,
                                                                    ------------------
                                              2003             2002             2001            2000           1999
                                              ----             ----             ----            ----           ----
                                                                      (in thousands)
                                                                      --------------
<S>                                        <C>             <C>              <C>             <C>             <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and
   short-term investments...............   $   32,670      $   10,112       $    6,171      $    5,448      $   14,367
Working capital.........................       32,010           5,992            6,194           5,308          12,987
Total assets............................       43,305          17,634           14,698          10,431          18,563
Note payable, less current portion......           --              --               --              47             116
Accumulated deficit.....................      (69,854)        (74,681)         (73,954)        (64,130)        (53,611)
Total stockholders' equity..............       33,956           8,352            7,127           5,264          13,607
</TABLE>

(1)  Refers to the  Company's  adoption  of Staff  Accounting  Bulletin  No. 101
     during  2000 and the  corresponding  cumulative  effect  of the  change  in
     accounting principle.

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


                                      -38-
<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(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  dental   pharmaceutical   to  treat  adult
periodontitis  by  inhibiting  the  enzymes  that  destroy  periodontal  support
tissues.

     We are marketing Periostat and other pharmaceutical  products to the dental
and dermatology  communities through our own professional  pharmaceutical  sales
force of approximately 115 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(R) and Atrisorb  FreeFlow(R),  and  Atrisorb-D(R),  to the United States
dental market. In May 2002, we executed a sublicense  agreement with Altana Inc.
to, among other things,  market and distribute,  in the United States and Puerto
Rico,  Pandel(R),  a mid-potency  topical  corticosteroid  product  developed by
Altana  Inc.  We  distribute  Periostat  and  Pandel  exclusively  through  drug
wholesalers in the United States. Periostat is also sold through wholesalers and
direct to dentists in the United Kingdom  through our  wholly-owned  subsidiary,
CollaGenex  International  Ltd.,  and by  distributors  and licensees in certain
other  overseas  markets.  The Atrix  dental  products are  distributed  through
specialty  distributors who sell these products directly to dental practitioners
in the United States and Puerto Rico.

     For the years ended  December 31, 2003 and 2002,  we achieved net income of
approximately  $6.4  million  and  $902,000,  respectively.  We  have,  however,
incurred losses in each year from inception through 2002 and have an accumulated
deficit of $69.9 million at December 31, 2003.

     During  the  years  ended  December  31,  2003,  2002 and  2001,  Periostat
accounted  for  approximately  82%,  82%  and  87% of our  total  net  revenues,
respectively.  Although we currently  derive  additional  revenue from marketing
and/or  selling other  products  (Atridox,  Atrisorb  FreeFlow,  Atrisorb-D  and
Pandel) 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.

     Mutual has  submitted an  application  to the FDA for approval of a generic
version of  Periostat.  We have filed suits to enforce our patent  rights and to
compel the FDA to award patent and exclusivity  protections that would prevent a
generic drug  application from being approved now. We cannot predict the outcome
of these  matters.  In  addition,  we cannot  be sure  that one or more  generic
versions of Periostat will not be approved and marketed.  If one or more generic
versions of Periostat  are approved and marketed,  our revenues  from  Periostat
would  significantly  decrease  and,  as  a  result,  our  business,   financial
condition,  cash flows and results of operations  would be materially  adversely
affected.

                                      -39-
<PAGE>


     This  Annual  Report on Form  10-K and the  documents  incorporated  herein
contain  forward-looking  statements  within the  meaning of Section  21E of the
Securities  and  Exchange  Act of  1934,  as  amended.  For  this  purpose,  any
statements  contained  herein or incorporated  herein that are not statements of
historical fact may be forward-looking statements. For example, the words "may,"
"will,"   "continue,"   "believes,"   "expects,"    "anticipates,"    "intends,"
"estimates,"   "should"  and  similar   expressions  are  intended  to  identify
forward-looking  statements.  There are a number of important factors that could
cause  our  results  to  differ   materially   from  those   indicated  by  such
forward-looking statements. These factors include those set forth in the section
entitled  "Additional Factors That May Affect Future Results" included in Item 1
of this Annual  Report.  In particular,  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 enforcement of our intellectual
property rights, including risks relating to the outcome and consequences of our
patent litigation against Mutual, risks that the FDA will approve products, such
as Mutual's product,  that will compete with and limit the market for Periostat,
risks relating to our litigation with the FDA, 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.  There  can be no
assurance  that our  product  candidates  (other  than  the  FDA's  approval  of
Periostat  for  marketing in the United  States,  the United  Kingdom  Medicines
Control  Agency's  approval of Periostat for marketing in the United Kingdom and
Periostat's  marketing  approval  in  Austria,  Finland,  Switzerland,  Ireland,
Israel,  Italy,  Luxembourg,  the  Netherlands,  Portugal  and  Canada)  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  promote Pandel,
Atridox, Atrisorb-FreeFlow or Atrisorb-D. As a result of such risks, those risks
set forth in the section entitled "Additional Risks That May Affect Results" 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 or implied by the forward-looking  statements  contained herein. We
undertake  no  obligation  to update or revise any  forward-looking  statements,
whether as a result of new information, future events or otherwise.

     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. The preparation of these financial statements requires management
to make  judgments  and  estimates  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, stock compensation and deferred taxes.


                                      -40-
<PAGE>

     Revenue Recognition

     We recognize product 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  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.  Our contract  revenues are fee-based  arrangements
where revenue is earned as prescriptions are filled. Accordingly, since we never
take title to the product  being  promoted,  no  significant  obligations  exist
beyond the point that revenue is recognized.

     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.  The
expected  performance  period  is based on  management's  best  estimate  and is
subject  to  change  based  on  current  market  conditions.   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.

     Stock-Based Compensation

     It is our  policy to apply  Accounting  Principles  Board  Opinion  No. 25,
"Accounting  for Stock  Issued to  Employees,"  and related  interpretations  to
account  for  our  stock  option  grants  rather  than  Statement  of  Financial
Accounting  Standards No. 123,  "Accounting  for Stock-Based  Compensation."  As
such,  compensation expense is recorded on fixed stock option grants only if the
current market value of the  underlying  stock exceeds the exercise price of the
option at the date of grant and is recognized on a straight-line  basis over the
vesting  period.  Had we applied SFAS No. 123,  which requires  recording  stock
option  grants at their fair value,  our net income (loss) for each of the years
ended  December 31, 2003,  2002 and 2001 would have varied from the reported net
income (loss) as we would have recorded additional expenses in each period.

     Deferred Taxes

     In assessing the  realizability of deferred tax assets, we consider whether
it is more likely than not that some  portion or all of the  deferred tax assets
will  not  be  realized.  This  assessment  requires  significant  judgment  and
estimates. The ultimate realization of the deferred tax assets is dependent upon
the generation of future taxable income during the period in which those


                                      -41-
<PAGE>


temporary  differences  become  deductible.  We consider  our history of losses,
scheduled  reversal of deferred tax assets and liabilities and projected  future
taxable  income  over the  periods  in which the  deferred  tax asset  items are
deductible.  Should we continue to be profitable,  we will assess and may reduce
the valuation allowance. The Tax Reform Act of 1986 contains provisions that may
limit the net  operating  loss (NOL) and  research  and  experimentation  credit
carryforwards  available  to be used in any given  year upon the  occurrence  of
certain events,  including significant changes in ownership interest.  The rules
providing for the definition of an ownership change are complex.

Recently Issued Accounting Standards

     FASB Statement No. 150,  Accounting for Certain Financial  Instruments with
Characteristics  of both  Liabilities  and Equity,  was issued in May 2003. This
Statement  establishes  standards  for the  classification  and  measurement  of
certain  financial  instruments  with  characteristics  of both  liabilities and
equity.   The  Statement  also  includes  required   disclosures  for  financial
instruments   within  its  scope.  For  us,  the  Statement  was  effective  for
instruments entered into or modified after May 31, 2003. For certain mandatorily
redeemable  financial  instruments,  the Statement  will be effective at a later
date. The effective date has been deferred  indefinitely for certain other types
of mandatorily  redeemable financial  instruments.  We currently do not have any
financial instruments that are within the scope of this Statement.

Results of Operations

     We generated net income  allocable to common  stockholders of $4.8 million,
or $0.38 per diluted share,  for the year ended December 31, 2003 as compared to
a net loss of $727,000,  or $0.06 per diluted share for the year ended  December
31, 2002. The increase in profitability from 2002 to 2003 was primarily a result
of increases in net product sales,  contract revenues,  and licensing  revenues.
Product sales increased as a result of the increased volume in Periostat product
sales as well as  increases  in  Pandel  product  sales,  which we began to sell
direct  in  July  2002.   The  increase  in  contract   revenues  was  primarily
attributable to our co-promotion efforts related to the AVAR and Denavir product
lines,  partially  offset by the termination of other  co-promotion  agreements.
License revenues increased primarily as the result of milestones achieved by our
foreign partners in 2003 and the accelerated  recognition of previously deferred
up-front  payments  that were  recognized  as the result of  terminated  license
agreements.  These  increases  were partially  offset by increased  research and
development  expenditures  as well as  increases  in cost of  products  sold and
selling, general and administrative expenses.

     Our revenues are affected by a number of factors,  including our ability to
influence physician prescribing habits, managing the purchasing practices of the
United States drug wholesalers,  managing our sales professionals and delivering
our marketing message  effectively.  We believe future revenues will be affected
by our ability to maintain the current  business and expand the use of Periostat
for new indications.

     In order to effectively manage the wholesale channel, we executed Inventory
Management  Agreements with our major wholesalers in 2003. These agreements help
us manage the level of  inventory  of our  products  in the  wholesale  channel,
obtain weekly retail demand  information for our products and to make sales that
are consistent with end-user

                                      -42-
<PAGE>

prescription  demand for our  products.  In exchange for retail  demand data, we
allow our  wholesalers to purchase a specific amount of inventory from us at the
sales price in effect immediately prior to announced price increases.

     Periostat sales have historically been subject to seasonality in the United
States market based on holiday  schedules and vacation  patterns.  Our sales may
fluctuate on a quarterly basis based on such seasonal fluctuations.

         Years Ended December 31, 2003 and December 31, 2002

Revenues

Revenues
(dollars in thousands)           2003         Change                 2002
                                 ----         ------                 ----
-------------------------------------------------------------------------------
Net Product Sales           $   49,038         16.4%            $   42,111
-------------------------------------------------------------------------------
Contract Revenues                3,122         33.9                  2,332
-------------------------------------------------------------------------------
License Revenues                   699        297.2                    176
                            -----------                         -----------
-------------------------------------------------------------------------------
Total                       $   52,859        18.5%             $   44,619
-------------------------------------------------------------------------------

     Total revenues  during the year ended December 31, 2003 were $52.9 million,
an 18.5%  increase over total  revenues of $44.6  million  during the year ended
December 31, 2002. Such 2003 revenues  included  approximately  $49.0 million in
net product sales of  Periostat,  Atridox,  Atrisorb  FreeFlow,  Atrisorb-D  and
Pandel,  $3.1  million  in  contract  revenues,  which  were  derived  from  our
co-promotion of Vioxx, Denavir and AVAR, and $699,000 in international licensing
revenues. Our agreement with Novartis Consumer Health Inc. to co-promote Devavir
expired on September 30, 2003, and we and Novartis mutually decided not to renew
our arrangement with respect to Denavir.  Our agreement with Merck to co-promote
Vioxx expired on December 31, 2003 and the parties mutually decided not to renew
such  arrangement.   In  addition,   our  co-promotion   agreement  with  Sirius
Laboratories,  Inc. with respect to our joint  marketing  activities of the AVAR
product  line and Pandel was  mutually  terminated  on December  31,  2003.  Net
product sales increased $6.9 million,  or 16.4%,  during the year ended December
31,  2003 to $49.0  million  compared  to $42.1  million  during  the year ended
December 31, 2002,  mainly due to increased  volume of  prescriptions  and price
increases  relating to  Periostat  and the  addition of the Pandel  product line
which we began selling direct in July 2002. Total  international sales increased
to $558,000 in 2003 from $350,000 in 2002.

     Contract  revenues for the year ended December 31, 2003 increased  33.9% to
$3.1  million  from $2.3  million  during  the year  ended  December  31,  2002,
primarily  due to  increased  contract  revenues  relating  to our  co-promotion
activities  with  respect  to  Denavir  and the AVAR  product  line,  which were
partially offset by lower Pandel contract  revenues earned during 2003 following
our acquisition of a license to Pandel when we began selling Pandel directly and
recording  related product sales. We do not expect to earn contract revenues for
Denavir and AVAR in 2004. During 2003, our co-promotional agreements with Merck,
Novartis and Sirius  generated  approximately  $3.1 million in revenue.  We will
continue  to earn  nominal  residual  contract  revenues  through  2005 from our
expired agreement with Merck for Vioxx.


                                      -43-

<PAGE>

     We recorded  $52,000 and $59,000 in licensing  revenues for the years ended
December 31, 2003 and December 31, 2002, respectively,  that was attributable to
our  recognition of previously  received  up-front  license fees  recognized for
various  agreements  that were  deferred and are being  recognized  as licensing
revenue over the expected performance period of the agreements. We also recorded
licensing  revenues of $222,000 and $47,000  during the years ended December 31,
2003 and 2002, respectively, from previously deferred foreign up-front licensing
fees where the recognition of revenue was accelerated in connection with certain
licensing  agreements  that  were  mutually  terminated  during  the  respective
periods.  Additionally,  during  the years  ended  December  31,  2003 and 2002,
respectively,  we  recognized  $425,000  and $70,000 in license  milestone  fees
received  from  foreign  licensing  partners  upon the  achievement  of  certain
milestones.

Cost of Product Sales

-------------------------------------------------------------------------------
Cost of Product Sales             2003         Change           2002
(dollars in thousands)            ----         ------           ----
-------------------------------------------------------------------------------
Cost of Product Sales           $ 7,362         9.7%          $  6,713
-------------------------------------------------------------------------------
Percent of Net Product Sales       15.0%                          15.9%
-------------------------------------------------------------------------------

     Cost of product sales includes product  packaging,  third-party  royalties,
amortization  of  product  licensing  fees,  and the costs  associated  with the
manufacturing,  storage  and  stability  of  Periostat,  Pandel  and  the  Atrix
products.

     Cost of product sales were $7.4 million,  or 15.0% of net product sales for
the year ended  December 31,  2003,  compared to $6.7  million,  or 15.9% of net
product  sales during the year ended  December  31, 2002.  During the year ended
December  31, 2003,  cost of product  sales  increased in absolute  dollars as a
result of increased product sales. As a percentage of net product sales, cost of
product sales decreased during the year ended December 31, 2003, compared to the
year ended December 31, 2002, primarily due to product sales price increases for
Periostat  in  2003,  offset  in part by  higher  cost of  product  sales  (as a
percentage of net product sales) for the Pandel  product line,  launched in July
2002.

Research and Development

-------------------------------------------------------------------------------
Research and Development               2003        Change            2002
(dollars in thousands)                 ----        ------            ----
-------------------------------------------------------------------------------
Research and Development            $  5,462        24.3%         $  4,394
-------------------------------------------------------------------------------
Percentage of Total Revenue             10.3%                          9.8%
-------------------------------------------------------------------------------

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

     Research and development expenses increased $1.1 million, or 24.3%, to $5.5
million  during the year ended  December 31, 2003 from $4.4  million  during the
year ended December 31, 2002.

                                      -44-
<PAGE>

     Development  projects  conducted  during the year ended  December  31, 2003
included  our  continuing   formulation   development   work  for  a  once-a-day
formulation  of Periostat  and  formulation  and  stability  testing for several
potential  products  utilizing our licensed  Restoraderm(TM)  technology,  which
totaled  $2.0  million  and  $820,000,  respectively.  If all  of the  potential
products  are  successful,   additional  formulation  development  expenses  and
milestone fees could be as much as $11.1 million.

     Clinical  projects  totaling  $832,000 were conducted during the year ended
December 31, 2003 and included several Phase IV studies for Periostat in various
dental indications and continued clinical development work relating to Periostat
in dermatological indications and including a Phase III trial in 134 patients to
evaluate  Periostat  for the  treatment  of rosacea.  Until the outcome of these
trials is  determined,  it is premature to estimate the future costs  associated
with the clinical development of Periostat for any indication.

     Other  research and  development  expenses  incurred  during the year ended
December  31, 2003  included  $108,000 in  regulatory  consulting  and legal and
filing fees under the Mutual  Recognition  Procedure  in Europe and $484,000 for
various  regulatory  costs,  including  annual FDA filing fees,  patent fees and
regulatory  expenses in the United States, and $335,000 in development costs for
Metastat and the IMPACS compounds.  Direct salaries and other personnel expenses
incurred  during the year ended December 31, 2003 were  $657,000.  Additionally,
during such period we incurred  $243,000 in consulting,  travel and other office
expenses.  We expect to  significantly  increase our  investment in research and
development in 2004.

     Development  projects  conducted  during the year ended  December  31, 2002
included  our  continuing   formulation   development   work  for  a  once-a-day
formulation  of Periostat  and  formulation  and  stability  testing for several
potential products utilizing our licensed Restoraderm technology,  which totaled
$1.3 million and $349,000, respectively.

     Clinical  projects  totaling  $1.1 million were  conducted  during the year
ended  December 31, 2002 and included  several Phase IV studies for Periostat in
various  dental  indications,  initiation  of a  70-patient  clinical  study  to
evaluate the efficacy of Periostat to treat meibomianitis,  clinical development
work  relating to  Periostat in  dermatological  indications,  limited  clinical
testing of Restoraderm  formulations  and initiation of a Phase III trial in 134
patients to  evaluate  Periostat  for the  treatment  of rosacea.  Additionally,
during 2002 we granted  $253,000 for research to various  academic  institutions
for conducting research related to our core technology.

     Other  research and  development  expenses  incurred  during the year ended
December 31, 2002  included  $247,000 in regulatory  consulting  and filing fees
under the Mutual  Recognition  Procedure  in Europe  and  $373,000  for  various
regulatory  costs,  including  annual FDA filing  fees,  legal,  and  regulatory
expenses in the United  States.  Direct  salaries and other  personnel  expenses
incurred  during the year ended December 31, 2002 were  $480,000.  Additionally,
during such period we incurred  $266,000 in consulting,  travel and other office
expenses.

                                      -45-
<PAGE>

Selling, General and Administrative

-------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands)                       2003         Change         2002
                                             ----         ------         -----
-------------------------------------------------------------------------------
Selling, General and Administrative        $ 33,668         3.0%      $ 32,699
--------------------------------------------------------------------------------
Percentage of Total Revenues                   63.7%                      73.3%
-------------------------------------------------------------------------------

     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  3.0% to  $33.7
million  during the year ended  December 31, 2003 from $32.7 million  during the
year ended December 31, 2002. This increase of $969,000 was primarily the result
of  approximately  $2.5 million in  increased  legal fees and  settlement  costs
relating to our ongoing  litigation,  net of  reimbursable  legal  expenses from
SUNY, additional personnel costs of $1.2 million,  approximately $1.9 million in
additional  promotional  expenses for AVAR and Pandel,  offset in part by a $4.7
million reduction in selling and marketing expenditures for Periostat, Vioxx and
the Atrix products.

     Significant  components  of selling,  general and  administrative  expenses
incurred  during the year ended  December  31, 2003  included  $15.7  million in
direct selling and sales training  expenses,  $8.8 million in marketing expenses
(including  advertising  and promotion  expenditures  for  Periostat,  the Atrix
products and Pandel and  co-promotion  expenses  relating to Vioxx and AVAR) and
$8.9 million in general and  administrative  expenses,  which  include  business
development, finance, legal and corporate activities.  Significant components of
selling,  general and  administrative  expenses  incurred  during the year ended
December 31, 2002 included  $15.7 million in direct  selling and sales  training
expenses,  $11.3  million in marketing  expenses  (including  direct to consumer
advertising  and promotion  expenditures  for Periostat,  the Atrix products and
co-promotion  expenses relating to Vioxx and Pandel) and $5.7 million in general
and administrative  expenses,  which include business  development,  finance and
corporate activities.

     Selling,  general and administrative expenses also included $251,000 during
the year ended December 31, 2003 which resulted from certain  modifications made
to stock  option  agreements  held by  Brian M.  Gallagher,  Ph.D.,  our  former
chairman, chief executive officer and president, in connection with a Transition
Agreement we executed with Dr. Gallagher on March 18, 2003.

Other Income/Expense

-------------------------------------------------------------------------------
Other Income/Expense
(dollars in thousands)              2003            Change              2002
                                    ----            ------              ----
-------------------------------------------------------------------------------
Interest Income                  $   148             92.2%            $   77
-------------------------------------------------------------------------------
Interest Expense                 $    --             (100%)           $    5
-------------------------------------------------------------------------------
Other Income (Expense)           $    (3)          (117.6%)           $   17
-------------------------------------------------------------------------------

     Interest income  increased to $148,000 for the year ended December 31, 2003
compared

                                      -46-
<PAGE>

to $77,000 for the year ended December 31, 2002. This increase was due to higher
average investment  balances in 2003,  partially offset by lower average yields.
There was no interest expense for the year ended December 31, 2003,  compared to
$5,000 for the year ended  December 31, 2002.  Other  expense was $3,000 for the
year ended  December  31, 2003  compared to other income of $17,000 for the year
ended December 31, 2002. Such other income (expense) was attributable to foreign
currency transaction gains (losses).

Income Taxes

     Income tax expense for the year ended December 31, 2003 consisted primarily
of a provision for current Federal alternative minimum tax.

Preferred Stock Dividend

     Preferred stock dividends included in net income (loss) allocable to common
stockholders  were $1.6 million during each of the years ended December 31, 2003
and 2002.  Such preferred  stock  dividends,  paid in shares of our common stock
through May 11, 2002, and thereafter in cash, are the result of our  obligations
in connection  with the issuance of our Series D preferred stock in May 1999. As
more fully set forth in the Amended Certificate of Designation,  Preferences and
Rights of the Series D Cumulative  Convertible  Preferred  Stock,  after May 11,
2002,  we no longer pay  dividends on the Series D preferred  stock in shares of
our  common  stock  at a rate of  8.4%,  and we  became  obligated  to pay  such
dividends in cash, at a rate equal to 8% per annum.

     Years Ended December 31, 2002 and December 31, 2001

     We incurred net losses  allocable to common  stockholders  of $727,000,  or
$0.06 per basic and  diluted  share,  and $9.8  million,  or $0.94 per basic and
diluted  share,  for the years ended  December  31, 2002 and  December 31, 2001,
respectively. The decrease in the net loss allocable to common stockholders from
2001 to 2002 was primarily a result of increased  product  sales,  including the
addition of Atrix dental product sales in 2002, and decreased  selling,  general
and   administrative   expenditures.   Selling,   general   and   administrative
expenditures  decreased  primarily  as a result  of a  decline  in  expenditures
related to a direct to consumer  campaign for Periostat.  These  contributors to
the decrease in the net loss allocable to common  stockholders from 2001 to 2002
were  partially  offset by a decrease in  contract  revenues as well as moderate
increases  in  the  cost  of  products   sold  and   research  and   development
expenditures.  Contract revenues  decreased  primarily due to the termination of
the Novartis  arrangement  to co-promote  Denavir and a decline in  co-promotion
revenues related to Vioxx.

                                      -47-
<PAGE>

Revenues

-------------------------------------------------------------------------------
Revenues
(dollars in thousands)           2002         Change          2001
                                 ----         ------          -----
-------------------------------------------------------------------------------
Net Product Sales             $   42,111      34.3%         $ 31,358
-------------------------------------------------------------------------------
Contract Revenues                  2,332     (31.1)            3,386
-------------------------------------------------------------------------------
License Revenues                     176     (63.9)              488
-------------------------------------------------------------------------------
Total                         $   44,619      26.6%         $ 35,232
-------------------------------------------------------------------------------

     Total revenues  during the year ended December 31, 2002 were $44.6 million,
representing  a 26.6%  increase over total  revenues of $35.2 million during the
year ended December 31, 2001. Such 2002 revenues  included  approximately  $42.1
million  in  net  product  sales  of  Periostat,   Atridox,  Atrisorb  FreeFlow,
Atrisorb-D and Pandel (since July 1, 2002),  $2.3 million in contract  revenues,
which were derived from our  co-promotion of Vioxx and Pandel (prior to June 30,
2002) and Denavir  (effective October 1, 2002), and $176,000 in deferred foreign
license and milestone revenues for Periostat.  Net product sales increased $10.8
million,  or 34.3%,  during the year ended  December  31, 2002 to $42.1  million
compared to $31.4 million during the year ended December 31, 2001, mainly due to
increased volume of prescriptions and price increases relating to Periostat, the
addition of the Atrix dental products, which we began marketing in October 2001,
and Pandel,  which we began selling on July 1, 2002. Total  international  sales
increased to $350,000 in 2002 from $35,000 in 2001.

     Contract  revenues for the year ended  December 31, 2002 declined  31.1% to
$2.3  million  from $3.4  million  during the year ended  December 31, 2001 as a
result of the  termination in April 2001 of our prior agreement with Novartis to
co-promote Denavir and a decline in contract revenues from Merck relating to our
co-promotion  of Vioxx.  Contract  revenues for the year ended December 31, 2001
included  $297,000 in co-promotion  revenues for Denavir.  Contract revenues for
the year ended December 31, 2002 included $100,000 in co-promotion  revenues for
Denavir,  pursuant to our Product Detailing  agreement with Novartis executed in
October  2002.  We were  compensated  at a higher rate for sales  growth for the
previous  year's  sales  of  Vioxx.  In  2001,  a  significant  portion  of  our
Vioxx-related compensation was attributed to sales growth. Vioxx sales, however,
were lower in 2002 compared to 2001,  and therefore we were paid at lower rates,
resulting in a decline in contract revenues.

     License  revenues for the year ended  December 31, 2002  declined  63.9% to
$176,000 from $488,000 for the year ended December 31, 2001. In accordance  with
SAB 101,  which we adopted in 2000,  $59,000 and $60,000 in licensing  revenues,
respectively, for the years ended December 31, 2002 and 2001 was attributable to
our  recognition of up-front  license fees received for various  agreements that
were  deferred in  accordance  with SAB 101 and is recognized as income over the
expected  performance  period of these  agreements.  We also recorded  milestone
revenues from our foreign licensing  partners of $70,000 and $425,000 during the
years ended  December  31,  2002 and 2001,  respectively,  related to  obtaining
regulatory approval in certain countries.


                                      -48-

<PAGE>

Cost of Product Sales

-------------------------------------------------------------------------------
Cost of Product Sales
(dollars in thousands)                    2002        Change         2001
                                          ----        ------         ----
-------------------------------------------------------------------------------
Cost of Product Sales                   $ 6,713       15.2%        $ 5,825
-------------------------------------------------------------------------------
Percent of Net Product Sales               15.9%                      18.6%
-------------------------------------------------------------------------------

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

     Cost of product  sales were $6.7  million,  or 15.9% of net  product  sales
during the year ended December 31, 2002,  compared to $5.8 million,  or 18.6% of
net product sales during the year ended December 31, 2001. Cost of product sales
increased in absolute dollars but decreased as a percentage of net product sales
during 2002 compared to 2001,  primarily due to  manufacturing  cost savings for
Periostat  tablets,  which we  launched  in July  2001,  compared  to  Periostat
capsules  and  product  price  increases.  Cost of  product  sales in 2001  also
included  a  $602,000  provision  for  obsolete  inventory;  there  was no  such
provision in 2002.  This  decrease in percent of Periostat  net product sales in
2002 was  slightly  offset by a higher  percent of  product  sales for the Atrix
products  and Pandel,  launched in  November  2001 and July 2002,  respectively,
which have lower margins than Periostat.


Research and Development

-------------------------------------------------------------------------------
Research and Development
(dollars in thousands)               2002         Change             2001
                                     ----         ------             -----
-------------------------------------------------------------------------------
Research and Development          $  4,394         16.7%           $ 3,764
-------------------------------------------------------------------------------
Percentage of Total Revenue            9.8%                          10.7%
-------------------------------------------------------------------------------

     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, report writing, regulatory compliance and internal payroll and related
costs.

     Research and  development  expenses  increased  $630,000,  or 16.7% to $4.4
million  during the year ended  December 31, 2002 from $3.8  million  during the
year ended December 31, 2001.

     Development  projects  conducted  during the year ended  December  31, 2002
included  our  continuing   formulation   development   work  for  a  once-a-day
formulation  of Periostat  and  formulation  and  stability  testing for several
potential products utilizing our licensed Restoraderm technology,  which totaled
$1.3 million and $349,000, respectively.

     Clinical  projects  totaling  $1.1 million were  conducted  during the year
ended  December 31, 2002 and included  several Phase IV studies for Periostat in
various  dental  indications,  initiation  of a  70-patient  clinical  study  to
evaluate the efficacy of Periostat to treat meibomianitis,  clinical development
work  relating to  Periostat in  dermatological  indications,  limited  clinical
testing of Restoraderm  formulations  and initiation of a Phase III trial in 134
patients to evaluate

                                      -49-
<PAGE>

Periostat  for the  treatment of rosacea.  Additionally,  during 2002 we granted
$253,000 for research to various academic  institutions for conducting  research
related to our core technology.

     Other  research and  development  expenses  incurred  during the year ended
December 31, 2002  included  $247,000 in regulatory  consulting  and filing fees
under the Mutual  Recognition  Procedure  in Europe  and  $373,000  for  various
regulatory  costs,  including  annual FDA filing  fees,  legal,  and  regulatory
expenses in the United  States.  Direct  salaries and other  personnel  expenses
incurred  during the year ended December 31, 2002 were  $480,000.  Additionally,
during such period we incurred  $266,000 in consulting,  travel and other office
expenses.

     Research and  development  expenses  incurred in 2001 included  $210,000 in
research 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.  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  through  2001  under this  agreement  were  approximately  $1.4
million.

     Development  projects  contracted in 2001  included an initial  feasibility
study  and  formulation   development  work  for  a  once-a-day  formulation  of
Periostat, which totaled $455,000 in 2001.

     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.

     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. During 2001 we incurred $535,000 in direct salaries and other
personnel and $164,000 in noncash compensation expense relating to the extension
of the  exercisability of certain stock options for one of our ex-board members.
Additionally,  we incurred $110,000 in ongoing manufacturing support relating to
our existing products and $194,000 in travel and other office expenses.

Selling, General and Administrative

-------------------------------------------------------------------------------
Selling, General and Administrative
(dollars in thousands)                       2002        Change         2001
                                             ----        ------        -----
-------------------------------------------------------------------------------
Selling, General and Administrative        $ 32,699      (3.9%)      $ 34,010
-------------------------------------------------------------------------------
Percentage of Total Revenues                   73.3%                     96.5%
-------------------------------------------------------------------------------

     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.


                                      -50-
<PAGE>

     Selling,  general  and  administrative  expenses  decreased  3.9% to  $32.7
million  during the year ended  December 31, 2002 from $34.0 million  during the
year ended December 31, 2001.  The decrease of $1.3 million in selling,  general
and administrative  expenses,  or 3.9%, from the year ended December 31, 2001 to
the year ended  December 31, 2002,  was the result of spending $3.8 million less
on our DTC  campaign in 2002  compared  to 2001.  This was  partially  offset by
incremental  promotional  expenses for the newly licensed Atrix dental products,
other  direct  professional  Periostat  promotion  expenses  and the  launch and
promotional expenses for Pandel, effective July 1, 2002.

     Significant  components  of selling,  general and  administrative  expenses
incurred  during the year ended  December  31, 2002  included  $15.7  million in
direct selling and sales training expenses,  $11.3 million in marketing expenses
(including  Periostat DTC advertising and promotion  expenditures for Periostat,
the Atrix products and co-promotion  expenses  relating to Vioxx and Pandel) and
$5.7 million in general and  administrative  expenses,  which  include  business
development,  finance  and  corporate  activities.   Significant  components  of
selling,  general and administrative expenses during the year ended December 31,
2001  included  $13.9  million in direct  selling and training  expenses,  $14.9
million in marketing expenses (including Periostat DTC advertising expenditures,
launch expenses for the Atrix products and Dentaplex and  co-promotion  expenses
related to Vioxx) and $5.2 million in general and administrative expenses.


Other Income/Expense

-------------------------------------------------------------------------------
Other Income/Expense
(dollars in thousands)           2002         Change              2001
                                 ----         ------              -----
-------------------------------------------------------------------------------
Interest Income                $  77          (66.8%)           $  232
-------------------------------------------------------------------------------
Interest Expense               $   5          (70.6%)           $   17
-------------------------------------------------------------------------------
Other Income                   $  17         (112.5%)           $    8
-------------------------------------------------------------------------------

     Interest  income  decreased to $77,000 for the year ended December 31, 2002
compared to $232,000 for the year ended December 31, 2001. This decrease was due
to  lower  average  balances  in  cash  and  short-term  investments  and  lower
investment yields during the year ended December 31, 2002.  Interest expense for
the year ended  December  31, 2002 was $5,000,  compared to $17,000 for the year
ended December 31, 2001 due to lower average  principle  amounts  outstanding on
our notes payable. Other income for the year ended December 31, 2002 was $17,000
compared to $8,000 for the year ended December 31, 2001. These amounts represent
foreign currency transaction gains and vary based on transaction volume.

Preferred Stock Dividend

     Preferred stock dividends were $1.6 million for the year ended December 31,
2002 and $1.7 million for the year ended December 31, 2001. Such preferred stock
dividends,  paid in  shares  of our  common  stock  through  May 11,  2002,  and
thereafter in cash,  were the result of our  obligations in connection  with the
issuance of our Series D preferred stock in May 1999. As more fully set forth in
the Amended  Certificate of Designation,  Preferences and Rights of the Series D
Cumulative Convertible preferred stock, after May 11, 2002, we no longer pay


                                      -51-
<PAGE>


dividends on the Series D preferred stock in shares of our common stock,  and we
became obligated to pay such dividends in cash, at a rate equal to 8% per annum.
Cash  dividends  incurred  for the period May 12, 2002 to December 31, 2002 were
approximately $1.0 million.

Liquidity and Capital Resources

     On October 3, 2003, we announced  that we had entered into  agreements  for
the sale of 2,000,000 shares of our common stock registered under a registration
statement  on  Form  S-3 to  certain  institutional  investors,  at a per  share
purchase price of $10.00 for aggregate  gross  proceeds of $20.0 million,  which
generated net proceeds to us of approximately  $18.7 million,  after the payment
of placement agent fees and related expenses.

     Our Series D preferred  stock is convertible at any time into shares of our
common stock at a current  conversion price of $9.89 per share, which conversion
price reflects a decrease from the initial  conversion price of $11.00 per share
as a result of certain  subsequent equity issuances by us. 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 received  dividends payable in shares of fully registered common
stock at a rate of 8.4% per annum. Thereafter, and beginning on May 12, 2002, we
began paying such dividends 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 prices on
the  Nasdaq  National  Market is at least 200% of the  conversion  price then in
effect (as of December 31, 2003, such conversion  price was $9.89 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.

     We have a revolving  credit facility with Silicon Valley Bank which expires
on March 15, 2004. We are currently negotiating to renew the credit facility for
a two-year term upon expiration.  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

                                      -52-
<PAGE>

to $1.5  million.  On April 1, 2003,  we secured  our  expected  purchase  order
commitments for the next twelve months with a letter of credit for approximately
$1.1 million.  As of December 31, 2003, the letter of credit had been reduced to
$124,000.  As we continue to pay down  amounts  under the letter of credit,  the
amount available to us under the Facility will increase. 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.  Without the consent of 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 of $5.0 million,  subject to certain  upward  adjustments,  as a result of
profitable  operations or additional debt or equity  financings and a minimum of
$2.0 million in cash at Silicon Valley Bank, net of borrowings  under the credit
facility. 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, 2003,
we had no 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
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
(which  requirement  we met during  2002);  (iv) we agreed to maintain,  through
August  2003,  a force of no less than ninety full time dental  consultants  and
divisional and regional managers to make sales and product  recommendation calls
on dental professionals (which requirement we have fulfilled); and (v) we agreed
that the Atrix  products  would be the  subject of a  specific  number of detail
calls in the United States during 2002, which we achieved.  We are also required
to make certain annual minimum  expenditures  for  advertising  and  promotional
activities over the term of the agreement beginning January 1, 2003,  including:
(i) the lesser of $4.0 million 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 $2.0  million  or 30% of our  contribution  margin,  as defined in the
agreement,  relating to a separate  Atrix  product that we market.  These annual
requirements were met by us during 2003.

     During 2003, our co-promotional  agreements with Merck, Novartis and Sirius
generated  approximately  $3.1 million in revenue and approximately $1.6 million
in positive cash-flows.  As of December 31, 2003, all of these agreements either
expired or were  mutually  terminated.  We do not expect any future  revenues or
cash  in-flows  from Merck,  Novartis  and Sirius  other than  nominal  residual
contract revenues through 2005 from our expired agreement with Merck for Vioxx.

     On February 11, 2002, we executed a Co-operation, Development and Licensing
Agreement  pursuant  to  which we were  granted  an  exclusive,  sublicenseable,
transferable  license with  respect to the  Restoraderm  topical  drug  delivery
system which we intend to develop for dermatological  applications.  Pursuant to
the terms of such agreement,  upon the occurrence of certain events,  we will be
required to pay certain future consulting, royalty and milestone

                                      -53-
<PAGE>

payments in the aggregate amount of up to approximately  $3.2 million,  of which
no more than $2.2 million could be payable prior to January 1, 2004 and of which
no more than an  additional  $1.0 million  shall be payable  prior to January 1,
2005. We paid $600,000 under this agreement in the year ended December 31, 2003.
The term of such  agreement  is for the life of any patent that may be issued to
us for the first product we develop  utilizing  such  technology,  or, if such a
patent fails to issue, seven years.

     At December 31, 2003,  we had cash and cash  equivalents  of  approximately
$32.7  million,  an increase of $22.6 million from the $10.1 million  balance at
December 31, 2002.  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 money market funds.  Our working  capital at December 31,
2003 was $32.0  million,  an  increase  of $26.0  million  from $6.0  million at
December 31, 2002.  This  increase was primarily  attributable  to the operating
profitability  experienced  during  2003,  the  addition of $1.8 million in cash
proceeds  from  the  exercise  of stock  options  and  warrants  and the sale of
2,000,000  shares of our common stock,  at a per share purchase price of $10.00,
which generated net proceeds to us of  approximately  $18.7 million.  During the
year  ended  December  31,  2003,  we  generated  $4.8  million in cash from our
operating activities principally from net income of $6.4 million less changes in
certain  assets and  liabilities.  During the year ended  December 31, 2003,  we
invested $305,000 in capital  expenditures,  made $900,000 in licensing payments
to Altana Inc.  and paid $1.6  million in cash  dividends  to the holders of our
Series D preferred stock.

     We  currently  believe  that our working  capital at December 31, 2003 will
allow  us to fund our  operations,  capital  expenditures  and  preferred  stock
dividend requirements for at least the forseeable future and we do not anticpate
requiring  additional capital to fund our operations.  Our line of credit is due
to expire on March  15,  2004.  While it is our  intention  to renew the  credit
facility for an  additional  two-year  term, we believe our current cash balance
along with our cash flows from  operations is adequate to fund our operations in
the event  that the line of credit is not  renewed.  At this time,  however,  we
cannot accurately  predict the effect of certain  developments on future product
sales such as the degree of market  acceptance  of our products and  technology,
competition,  the  effectiveness  of our sales  and  marketing  efforts  and the
outcome of our research and  development to demonstrate the utility of Periostat
in  indications  beyond those  already  included in the FDA approved  label.  We
expect to  significantly  increase our investment in research and development in
2004.   Contract  and  license  revenues  include  receipts  from   co-promotion
agreements  and  performance  milestones.  The  continuation  of  any  of  these
agreements is subject to the  achievement of certain  milestones and to periodic
review by the parties involved.

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

     -    Revenues and profits from sales of  Periostat  and other  products and
          contracted services;

     -    The success of our dermatology franchise;

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

                                      -54-
<PAGE>


     -    The receptivity of the capital markets to future financings;

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

     -    The  outcome  and  consequences  of  our  patent  litigation  and  our
          litigation with the FDA.

Contractual Obligations

     Our major outstanding  contractual  obligations relate to cash dividends on
our outstanding Series D preferred stock, operating leases for our office space,
operating  leases  for our sales  force,  computer  equipment,  and  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.

     Below is a table which presents our contractual  obligations and commercial
commitments as of December 31, 2003:

<TABLE>
<CAPTION>
                           -------------------------------------------------------------------------------------------
                                                             PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------------------------------------------------------
 CONTRACTUAL OBLIGATIONS          TOTAL                2004         2005 AND 2006     2007 AND 2008    2009 AND AFTER
----------------------------------------------------------------------------------------------------------------------
<S>             <C>             <C>                  <C>              <C>                <C>              <C>
Operating Leases(1)......       $2,528,000           $530,000         $1,108,000         $694,000         $196,000
----------------------------------------------------------------------------------------------------------------------
Unconditional Purchase
   Obligations...........       $1,139,000(2)      $1,139,000(2)          --                --               --
----------------------------------------------------------------------------------------------------------------------
Co-Promotional
   Commitments...........          (3)                  (3)               (3)              (3)              (3)
----------------------------------------------------------------------------------------------------------------------
Cash Dividends on
   Series D Preferred
   Stock.................       $8,000,000(4)      $1,600,000(4)      $3,200,000(4)    $3,200,000(4)        (4)
----------------------------------------------------------------------------------------------------------------------
Consulting Payments......         $628,000(5)        $324,000(5)         304,000(5)         --               --
----------------------------------------------------------------------------------------------------------------------
Total Contractual
   Obligations...........      $12,295,000         $3,593,000         $4,612,000       $3,894,000         $196,000
----------------------------------------------------------------------------------------------------------------------
</TABLE>

     (1)  Such amounts  primarily include minimum rental payments for our office
          lease in Newtown,  Pennsylvania,  as well as payments  for sales force
          computer equipment leases.

     (2)  Such  amount  represents  purchase  order  commitments  for  inventory
          purchases and clinical supplies with various vendors.

     (3)  We will be required to make certain  annual minimum  expenditures  for
          advertising and promotional activities amounting to: (i) the lesser of
          $4.0  million 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 $2.0 million or 30% of our contribution  margin (as
          defined in the agreement) relating to a separate Atrix product that we
          market. See further information regarding the

                                      -55-
<PAGE>

          Atrix License and Marketing Agreement under the heading "Liquidity and
          Capital Resources."

     (4)  Pursuant to the terms of our Series D Cumulative Convertible preferred
          stock and unless earlier converted  pursuant to its terms, the holders
          of the Series D preferred  stock are entitled to dividends  payable in
          cash at a rate of 8.0% per annum,  which are  declared  and paid every
          six months. See further  information  regarding our Series D preferred
          stock under the heading "Liquidity and Capital Resources."

     (5)  Such  amount  represents  consulting  payments  to be made to Brian M.
          Gallagher, our former chief executive officer and president,  upon his
          separation  from the Company and pursuant to the terms of a consulting
          agreement executed March 18, 2003.

     In May 1999, we entered into a lease agreement relating to our office space
in Newtown,  Pennsylvania.  The lease has an initial term of ten years.  Rent is
expected  to be  approximately  $318,000  per  year  and is  subject  to  market
adjustments in 2004.

     On February 11, 2002, we executed a Co-operation, Development and Licensing
Agreement  pursuant  to  which we were  granted  an  exclusive,  sublicenseable,
transferable  license with  respect to the  Restoraderm  topical  drug  delivery
system which we intend to develop for dermatological  applications.  Pursuant to
the terms of such agreement,  upon the occurrence of certain events,  we will be
required to pay certain future consulting, royalty and milestone payments in the
aggregate amount of up to $3.2 million, of which no more than $2.2 million could
be payable prior to January 1, 2004 and of which no more than an additional $1.0
million shall be payable  prior to January 1, 2005. We paid $600,000  under this
agreement in the year ended December 31, 2003. The term of such agreement is for
the life of any patent that may be issued to us for the first product we develop
utilizing such technology, or, if such a patent fails to issue, seven years.

     On June 10, 2002, we executed a Development  and Licensing  Agreement  with
Shire  Laboratories,  Inc.  pursuant  to  which  we were  granted  an  exclusive
worldwide  license  (including the right to sublicense) to develop,  make,  have
made, use, supply, export, import,  register and sell products for the treatment
of various inflammatory  disorders.  In addition,  under the agreement,  certain
product  development  functions shall be performed for us. Pursuant to the terms
of such  agreement,  we will pay to Shire a  percentage  of certain net sales of
products,  if any,  utilizing  any part of  Shire's  technology.  Also under the
agreement,  we have  committed  to  payments  in  cash,  or,  at our  option,  a
combination  of cash and our  common  stock,  upon the  achievement  of  certain
clinical and regulatory  milestones in the event we pursue certain  applications
of the technology which could total up to $7.9 million in the aggregate.

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

     We had cash  equivalents  at  December  31,  2003 which are  exposed to the
impact of  interest  rate  changes and our  interest  income  fluctuates  as our
interest rates change.  Due to the short-term nature of our investments in money
market funds, the carrying values of our cash equivalents approximate their fair
value at December 31, 2003.

                                      -56-
<PAGE>


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 15.  Exhibits,
Financial Statement Schedules, and Reports on Form 8-K."

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

         Not applicable.

Item 9A. Controls and Procedures.

     Our management,  with the  participation of our chief executive officer and
chief financial officer,  evaluated the effectiveness of our disclosure controls
and procedures (as defined in Rules  13a-15(e) and 15d-15(e)  under the Exchange
Act) as of December  31,  2003.  In  designing  and  evaluating  our  disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated,  can provide only reasonable assurance
of achieving their objectives and management necessarily applied its judgment in
evaluating the  cost-benefit  relationship of possible  controls and procedures.
Based on this  evaluation,  our chief  executive  officer  and  chief  financial
officer  concluded  that, as of December 31, 2003, our  disclosure  controls and
procedures were (1) designed to ensure that material information relating to us,
including our  consolidated  subsidiaries,  is made known to our chief executive
officer  and  chief   financial   officer  by  others  within  those   entities,
particularly  during the period in which this report was being  prepared and (2)
effective,  in that they provide reasonable  assurance that information required
to be  disclosed  by us in our reports that we file or submit under the Exchange
Act is recorded,  processed,  summarized  and  reported  within the time periods
specified in the SEC's rules and forms.

     No change in our internal  control over financial  reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal
quarter  ended as of  December  31,  2003 that has  materially  affected,  or is
reasonably  likely to materially  affect,  our internal  control over  financial
reporting.



                                      -57-
<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  "Section  16(a)  Beneficial   Ownership   Reporting
Compliance"  in our  definitive  proxy  statement for the 2004 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.

     We have adopted a written code of business  conduct and ethics that applies
to our  directors,  officers and  employees,  including our principal  executive
officer,   principal   financial  officer,   principal   accounting  officer  or
controller,  or persons performing similar functions. We will make available our
code of business  conduct and ethics free of charge through our website which is
located at  www.collagenex.com.  We intend to  disclose  any  amendments  to, or
waivers  from,  our code of business  conduct and ethics that are required to be
publicly disclosed  pursuant to rules of the Securities and Exchange  Commission
and the Nasdaq  National  Market by filing  such  amendment  or waiver  with the
Securities and Exchange Commission and by posting it on our website.

Item 11. Executive Compensation.

     The discussion under the heading "Executive Compensation" in our definitive
proxy  statement for the 2004 Annual  Meeting of  Stockholders  is  incorporated
herein by reference to such proxy statement.

Item 12.  Security  Ownership of Certain  Beneficial  Owners and  Management and
Related Stockholder Matters.

     The discussion under the heading "Security  Ownership of Certain Beneficial
Owners and Management and Related  Stockholder  Matters" in our definitive proxy
statement for the 2004 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 2004 Annual Meeting of
Stockholders is incorporated herein by reference to such proxy statement.

Item 14. Principal Accountant Fees and Services.

     The  discussion  under the  heading  "Independent  Auditors  Fees and Other
Matters"  in our  definitive  proxy  statement  for the 2004  Annual  Meeting of
Stockholders is incorporated herein by reference to such proxy statement.

                                      -58-

<PAGE>


                                    PART IV

Item 15. 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 62.

(b)  Reports on Form 8-K.

          On October 8, 2003,  we filed a Current  Report on Form 8-K under Item
          5,  announcing  that we had entered  into  agreements  for the sale of
          2,000,000  shares of our common stock  registered under a registration
          statement on Form S-3 to certain institutional investors.

          On October 28, 2003,  we furnished a Current  Report on Form 8-K under
          Item 9, containing a copy of our earnings release for the period ended
          September 30, 2003 (including financial  information) pursuant to Item
          12 (Results of Operations and Financial Condition).

          On November 10, 2003, we filed a Current Report on Form 8-K under Item
          5,  relating  to our  settlement  of all  pending  litigation  between
          West-ward Pharmaceutical Corporation and us.

          On December 8, 2003, we filed a Current  Report on Form 8-K under Item
          5,  relating to the  appointment  of Colin W. Stewart as our president
          and chief executive officer.

          On December 8, 2003, we filed a Current  Report on Form 8-K under Item
          5,  relating  to our grant of  inducement  stock  options  to Colin W.
          Stewart in accordance with NASDAQ Marketplace Rule 4350.

          On February 24, 2004, we furnished a Current  Report on Form 8-K under
          Item 9, containing a copy of our earnings  release for the quarter and
          year  ended  December  31,  2003  (including  financial   information)
          pursuant to Item 12 (Results of Operations and Financial Condition).


                                      -59-
<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 15th day of March,
2004.

                                COLLAGENEX PHARMACEUTICALS, INC.



                             By: /s/ Colin W. Stewart
                                 ----------------------------------------------
                                 Colin W. Stewart, Chief Executive Officer and
                                 President


                                      -60-
<PAGE>

<TABLE>
<CAPTION>

     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>                            <C>                                        <C>
/s/ Colin W. Stewart           President, Chief Executive Officer         March 15, 2004
-----------------------------  and Director (Principal Executive
Colin W. Stewart               Officer)

/s/ Nancy C. Broadbent         Chief Financial Officer, Treasurer and     March 15, 2004
-----------------------------  Secretary (Principal Financial and
Nancy C. Broadbent             Accounting Officer)

/s/ Brian M. Gallagher         Director                                    March 8, 2004
-----------------------------
Brian M. Gallagher, Ph.D.

/s/ Peter R. Barnett, D.M.D.   Director                                   March 15, 2004
-----------------------------
Peter R. Barnett, D.M.D.

/s/ Robert C. Black            Director                                   March 15, 2004
-----------------------------
Robert C. Black

/s/ James E. Daverman          Chairman of the Board and Director         March 15, 2004
-----------------------------
James E. Daverman

/s/ Robert J. Easton           Director                                   March 15, 2004
-----------------------------
Robert J. Easton

/s/ Stephen A. Kaplan          Director                                   March 15, 2004
-----------------------------
Stephen A. Kaplan

/s/ W. James O'Shea            Director                                    March 8, 2004
-----------------------------
W. James O'Shea
</TABLE>


                                      -61-

<PAGE>


                                  EXHIBIT INDEX

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

  3.1(a)      Amended and Restated Certificate of Incorporation.

  3.2(v)      Amended and Restated Bylaws.

  3.3(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.

  3.4(t)       Amended  Certificate  of  Designation  of Series A  Participating
               Preferred  Stock,  as filed  with the  Secretary  of State of the
               State of Delaware on June 5, 2002.

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

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

  4.3(t)       Amended and Restated  Shareholder  Protection  Rights  Agreement,
               dated   as  of  May  29,   2002,   by  and   between   CollaGenex
               Pharmaceuticals,   Inc.  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.

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

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

 10.4(a)(b)    Form of  Non-Competition  Agreement  executed by each of Nancy C.
               Broadbent and Robert A. Ashley.

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

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

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

                                       62
<PAGE>


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

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

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

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

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

 +10.12(e)     Distribution  Services  Agreement  dated  August 15, 1998 between
               Cord Logistics, Inc. and the Company.

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

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

  10.15(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.

  10.16(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.

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

 +10.18(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.

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

  10.20(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.

                                        63

<PAGE>


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

 10.21(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.

 +10.22(n)     License Agreement dated August 24, 2001 by and between CollaGenex
               Pharmaceuticals, Inc. and Atrix Laboratories, Inc.

 +10.23(n)     Stock  Purchase  Agreement  dated  August 24, 2001 by and between
               CollaGenex Pharmaceuticals, Inc. and Atrix Laboratories, Inc.

 +10.24(o)     First Addendum  December 10, 2001 to the Supply  Agreement  dated
               January  23,  1995 by and between  CollaGenex,  Inc.  and Hovione
               International Limited.

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

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

 +10.27(r)     Wholesale Service Agreement  effective as of November 1, 2001, by
               and  between  CollaGenex   Pharmaceuticals,   Inc.  and  National
               Specialty Services, Inc.

 +10.28(r)     First Amendment to Wholesale  Service  Agreement  effective as of
               November 12,  2001,  by and between  CollaGenex  Pharmaceuticals,
               Inc. and National Specialty Services, Inc.

 +10.29(r)     Exclusive  Distribution  Agreement  dated as of March 1, 2002, by
               and between CollaGenex Pharmaceuticals,  Inc. and CORD Logistics,
               Inc.

  10.30(r)     First Loan  Modification  Agreement dated as of March 22, 2002 by
               and between CollaGenex  Pharmaceuticals,  Inc. and Silicon Valley
               Bank.

  10.31(r)     Second Loan Modification  Agreement dated as of March 27, 2002 by
               and between CollaGenex  Pharmaceuticals,  Inc. and Silicon Valley
               Bank.

 +10.32(u)     Agreement   by   and   between   Altana   Inc.   and   CollaGenex
               Pharmaceuticals, Inc., dated May 24, 2002.

  10.33(v)     Form of Change of Control  Agreement  executed with each of Nancy
               C. Broadbent, Robert Ashley, David Pfeiffer and Douglas Gehrig.


                                       64
<PAGE>

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

 +10.34        Letter  Agreement  dated as of September  12, 2002 by and between
               the Company and Pharmaceutical  Manufacturing  Research Services,
               Inc.

  10.35(w)     Transition  Agreement  and  Release  dated  March 18, 2003 by and
               between Brian Gallagher and CollaGenex Pharmaceuticals, Inc.

  10.36(w)     Consulting  Agreement  dated March 18, 2003 by and between  Brian
               Gallagher and CollaGenex Pharmaceuticals, Inc.

  10.37(x)     Form of Incentive Bonus Agreement  executed with each of David F.
               Pfeiffer and Robert A. Ashley.

  10.38(y)     Severance  Agreement by and between  CollaGenex  Pharmaceuticals,
               Inc. and Paul Lubetkin.

     21*       List of subsidiaries of the Registrant.

   23.1*       Consent of KPMG LLP.

   31.1*       Certification  Pursuant to Rule  13a-14(a)  and  15d-14(a) of the
               Exchange  Act,  as  Adopted   Pursuant  to  Section  302  of  the
               Sarbanes-Oxley Act of 2002 (Chief Executive Officer).

   31.2*       Certification  Pursuant to Rule  13a-14(a)  and  15d-14(a) of the
               Exchange  Act,  as  Adopted   Pursuant  to  Section  302  of  the
               Sarbanes-Oxley Act of 2002 (Chief Financial Officer).

   32.1*       Certification Pursuant to 18 U.S.C. Section 1350.

     * 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 Current Report on Form 8-K,
          dated  September  16, 1997,  which was filed with the  Securities  and
          Exchange Commission on September 17, 1997.

     (d)  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.


                                       65
<PAGE>

     (e)  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.

     (f)  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.

     (g)  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.

     (h)  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.

     (i)  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.

     (j)  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.

     (k)  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.

     (q)  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.

     (r)  Incorporated  by reference to the Company's  Quarterly  Report on Form
          10-Q for the quarter  ended March 31,  2002,  which was filed with the
          Securities and Exchange Commission on May 15, 2002.

                                       66

<PAGE>

     (s)  Incorporated by reference to the Company's Current Report on Form 8-K,
          dated May 15, 2002,  which was filed with the  Securities and Exchange
          Commission on May 20, 2002.

     (t)  Incorporated by reference to the Company's Current Report on Form 8-K,
          dated May 29, 2002,  which was filed with the  Securities and Exchange
          Commission on June 5, 2002.

     (u)  Incorporated  by reference to the Company's  Quarterly  Report on Form
          10-Q for the  quarter  ended June 30,  2002,  which was filed with the
          Securities and Exchange Commission on August 14, 2002.

     (v)  Incorporated  by reference to the Company's  Quarterly  Report on Form
          10-Q for the quarter ended  September  30, 2002,  which was filed with
          the Securities and Exchange Commission on November 14, 2002.

     (w)  Incorporated by reference to the Company's Current Report on Form 8-K,
          dated March 18, 2003, which was filed with the Securities and Exchange
          Commission on March 19, 2003.

     (x)  Incorporated  by reference to the Company's  Quarterly  Report on Form
          10-Q for the quarter ended  September  30, 2003,  which was filed with
          the Securities and Exchange Commission on November 14, 2003.

     (y)  Incorporated  by reference to the Company's  Quarterly  Report on Form
          10-Q for the quarter ended  September  30, 2003,  which was filed with
          the Securities and Exchange Commission on November 14, 2003.


                                       67

<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, 2003 and 2002.............   F-3

Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001........................................   F-4

Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001.........................................   F-5

Consolidated Statements of Cash Flows for the years
ended December 31, 2003, 2002 and 2001...................................   F-6

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

Financial Statement Schedule - Valuation and Qualifying Accounts
for the years ended December 31, 2003, 2002 and 2001.....................   F-31



                                      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, 2003 and 2002, and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended  December  31,  2003,  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.

                                  /s/ KPMG LLP



Princeton, New Jersey
February 20, 2004

                                      F-2

<PAGE>

<TABLE>
<CAPTION>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                           Consolidated Balance Sheets

                           December 31, 2003 and 2002

                  (Dollars in thousands, except per share data)


                                 Assets                                             2003          2002
                                                                                 ----------     ---------
Current assets:
<S>                                                                             <C>           <C>
     Cash and cash equivalents............................................      $   32,670    $   10,112
     Accounts receivable, net of allowances of $1,308 and $1,412
         in 2003 and 2002, respectively...................................           4,959         2,142
     Inventories..........................................................           1,672         1,415
     Prepaid expenses and other current assets............................           1,732         1,044
                                                                                ----------    ----------
         Total current assets.............................................          41,033        14,713
Equipment and leasehold improvements, net.................................             496           559
Acquired product rights, net..............................................           1,749         2,335
Other assets..............................................................              27            27
                                                                                ----------    ----------
         Total assets.....................................................      $   43,305    $   17,634
                                                                                ==========    ==========
                  Liabilities and Stockholders' Equity
Current liabilities:
     Accounts payable.....................................................           3,273         3,616
     Accrued expenses.....................................................           4,950         4,305
     Preferred dividends payable..........................................             800           800
                                                                                ----------    ----------
                  Total current liabilities...............................           9,023         8,721
                                                                                ----------    ----------
Deferred revenue..........................................................             326           561
                                                                                ----------    ----------
Commitments and contingencies (Note 11)

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 2003 and 2002, (liquidation
         value $20,800); 150,000 shares of Series A participating
         preferred stock, $0.01 par value, designated and no shares
         issued and outstanding in 2003 and 2002..........................               2             2
     Common stock, $0.01 par value; 25,000,000 shares authorized,
         13,842,200 and 11,377,631 shares issued and outstanding in
         2003 and 2002, respectively......................................             138           114
     Additional paid in capital...........................................         103,670        82,917
     Accumulated deficit..................................................         (69,854)      (74,681)
                                                                                ----------    ----------
         Stockholders' equity.............................................          33,956         8,352
                                                                                ----------    ----------
         Total liabilities and stockholders' equity.......................          43,305        17,634
                                                                                ==========    ==========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-3

<PAGE>

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

                      Consolidated Statements of Operations

                  Years ended December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


                                                                 2003              2002              2001
                                                              -----------       ----------        ----------
Revenues:
<S>                                                           <C>              <C>               <C>
     Net product sales................................        $   49,038       $   42,111        $   31,358
     Contract revenues................................             3,122            2,332             3,386
     License revenues.................................               699              176               488
                                                              ----------       ----------        ----------
         Total revenues...............................            52,859           44,619            35,232
                                                              ----------       ----------        ----------
Operating expenses:
     Cost of product sales............................             7,362            6,713             5,825
     Research and development.........................             5,462            4,394             3,764
     Selling, general and administrative..............            33,668           32,699            34,010
                                                              ----------       ----------        ----------
         Total operating expenses.....................            46,492           43,806            43,599
                                                              ----------       ----------        ----------
         Operating income (loss)......................             6,367              813            (8,367)
Other income (expense):
     Interest income..................................               148               77               232
     Interest expense.................................                --               (5)              (17)
     Other............................................                (3)              17                 8
                                                              ----------       ----------        ----------
         Income (loss) before income taxes............             6,512              902            (8,144)
     Income taxes.....................................                85               --                --
                                                              ----------       ----------        ----------
         Net income (loss)............................             6,427              902            (8,144)
Preferred stock dividends.............................             1,600            1,629             1,680
                                                              ----------       ----------        ----------
Net income (loss) allocable to common stockholders....        $    4,827       $     (727)       $   (9,824)
                                                              ==========       ==========        ==========
Basic net income (loss) per share allocable to common
     stockholders.....................................        $     0.40       $    (0.06)       $    (0.94)
                                                              ==========       ==========        ==========
Diluted net income (loss) per share allocable to common
     stockholders.....................................        $     0.38       $    (0.06)       $    (0.94)
                                                              ==========       ==========        ==========
Weighted average shares used in computing per share
     amounts:
     Basic............................................        12,094,638       11,234,652        10,413,663
                                                              ==========       ==========        ==========
     Diluted..........................................        12,836,364       11,234,652        10,413,663
                                                              ==========       ==========        ==========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-4

<PAGE>

<TABLE>
<CAPTION>
                COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                 Consolidated Statements of Stockholders' Equity
                  Years ended December 31, 2003, 2002 and 2001
                             (Dollars in thousands)

                                                        Series D
                                                 cumulative convertible
                                                    preferred stock                Common stock
                                                 ----------------------      -----------------------
                                                                                                          Common
                                                  Number of                   Number of                 stock to be
                                                    shares     Par value        shares     Par value      issued
                                                 ----------    ---------     ----------    ---------    -----------
<S>                                              <C>           <C>           <C>           <C>          <C>
Balance, December 31, 2000......................    200,000    $       2      8,775,176    $      88    $     872
  Issuance of common stock for common
     stock options previously exercised.........         --           --         16,000           --           (32)
  Issuance of common stock, net of issuance
     costs......................................         --           --      1,830,556           18            --
  Common stock dividends issued on Series D
     cumulative convertible preferred stock.....         --           --        377,841            4          (840)
  Common stock dividends declared on Series D
     cumulative convertible preferred stock.....         --           --             --           --           840
  Compensation expense resulting from
     modifications of options...................         --           --             --           --            --
  Amortization of deferred compensation ........         --           --             --           --            --
  Net loss......................................         --           --             --           --            --
                                                 ----------    ---------     ----------    ---------    ----------
Balance, December 31, 2001 .....................    200,000            2     10,999,573          110           840
Exercise of common stock options and
  warrants......................................         --           --         35,704           --            --
Issuance of common stock, net of issuance
  cost..........................................         --           --        151,522            2            --
Common stock dividends declared on Series D
  cumulative convertible preferred stock........         --           --             --           --           611
Common stock dividends issued on Series D
      cumulative convertible preferred
      stock ....................................         --           --        190,832            2        (1,451)
Cash dividends declared on Series D cumulative
  convertible preferred stock ..................         --           --             --           --            --
Net income......................................         --           --             --           --            --
                                                 ----------    ---------     ----------    ---------    ----------
Balance, December 31, 2002......................    200,000            2     11,377,631          114            --
Exercise of common stock options and
  warrants .....................................         --           --        464,569            4            --
Issuance of common stock, net of issuance
  cost..........................................         --           --      2,000,000           20            --
Cash dividends declared on Series D cumulative
  convertible preferred stock ..................         --           --             --           --            --
Compensation expense resulting from the
      modification of options ..................         --           --             --           --            --
Net income......................................         --           --             --           --            --
                                                 ----------    ---------     ----------    ---------    ----------
Balance, December 31, 2003......................    200,000    $       2     13,842,200    $     138    $       --
                                                 ==========    =========     ==========    =========    ==========

                                                 Additional                                   Total
                                                  paid-in      Deferred      Accumulated   stockholders'
                                                  capital     compensation     deficit        equity
                                                 ----------   ------------   -----------   -------------

Balance, December 31, 2000...................... $   68,461    $     (29)    $  (64,130)   $   5,264
  Issuance of common stock for common
     stock options previously exercised.........         32           --             --           --
  Issuance of common stock, net of issuance
     costs......................................      9,796           --             --        9,814
  Common stock dividends issued on Series D
     cumulative convertible preferred stock.....      1,676           --           (840)         --
  Common stock dividends declared on Series D
     cumulative convertible preferred stock ....         --           --           (840)         --
  Compensation expense resulting from
     modifications of options ..................        164           --             --          164
  Amortization of deferred compensation ........         --           29             --           29
  Net loss .....................................         --           --         (8,144)      (8,144)
                                                 ----------   ------------   -----------   ---------
Balance, December 31, 2001 .....................     80,129           --        (73,954)       7,127
Exercise of common stock options and
  warrants .....................................        165           --             --          165
Issuance of common stock, net of issuance
  cost .........................................      1,174           --             --        1,176
Common stock dividends declared on Series D
  cumulative convertible preferred stock .......         --           --           (611)          --
Common stock dividends issued on Series D
      cumulative convertible preferred
      stock ....................................      1,449           --             --           --
Cash dividends paid on Series D cumulative
  convertible preferred stock ..................         --           --           (218)        (218)
Cash dividends declared on Series D cumulative
  convertible preferred stock ..................         --           --           (800)        (800)
Net income .....................................         --           --            902          902
                                                 ----------   ------------   -----------   ---------
Balance, December 31, 2002 .....................     82,917           --        (74,681)       8,352
Exercise of common stock options and
  warrants .....................................      1,819           --             --        1,823
Issuance of common stock, net of issuance
  cost .........................................     18,683           --             --       18,703
Cash dividends declared on Series D cumulative
  convertible preferred stock ..................         --           --         (1,600)      (1,600)
Compensation expense resulting from the
      modification of options ..................        251           --             --          251
Net income .....................................         --           --          6,427        6,427
                                                 ----------   ------------   -----------   ---------
Balance, December 31, 2003 ..................... $  103,670    $      --     $  (69,854)   $  33,956
                                                 ==========    =========     ==========    =========
</TABLE>


          See accompanying notes to consolidated financial statements.

                                      F-5
<PAGE>

<TABLE>
<CAPTION>
                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows

                  Years ended December 31, 2003, 2002 and 2001

                             (Dollars in thousands)

                                                                                     2003              2002              2001
Cash flows from operating activities:
<S>                                                                              <C>               <C>              <C>
     Net income (loss)...................................................        $   6,427         $     902        $  (8,144)
     Adjustments to reconcile net income (loss) to net cash
         provided by (used in) operating activities:
           Noncash compensation expense..................................              251                --              193
           Depreciation and amortization expense.........................              954               524              263
           Accounts receivable provisions................................             (104)              462              569
           Change in assets and liabilities:
               Accounts receivable.......................................           (2,713)            1,874           (2,009)
               Inventories...............................................             (257)              (13)          (1,125)
               Prepaid expenses and other assets.........................             (688)              156             (111)
               Accounts payable..........................................             (343)             (153)           1,904
               Accrued expenses..........................................            1,545               252              639
               Deferred revenue..........................................             (235)              (53)             (62)
                                                                                 ---------         ---------        ---------
                  Net cash provided by (used in) operating activities....            4,837             3,951           (7,883)
                                                                                 ---------         ---------        ---------
Cash flows from investing activities:
     Capital expenditures................................................             (305)             (298)            (131)
     Acquisition of product rights.......................................             (900)             (800)          (1,000)
     Proceeds from the sale of short-term investments....................               --                --            2,035
     Purchase of short-term investments..................................               --                --             (296)
                                                                                 ---------         ---------        ---------
                  Net cash provided by (used in) investing activities....           (1,205)           (1,098)             608
                                                                                 ---------         ---------        ---------
Cash flows from financing activities:
     Net proceeds from issuance of common stock..........................           20,526             1,341            9,814
     Payment of preferred dividends......................................           (1,600)             (218)              --
     Repayment of long-term debt.........................................               --               (35)             (77)
                                                                                 ---------         ---------        ---------
                 Net cash provided by financing activities...............           18,926             1,088            9,737
                                                                                 ---------         ---------        ---------
                 Net increase in cash and cash equivalents...............           22,558             3,941            2,462
Cash and cash equivalents at beginning of year...........................           10,112             6,171            3,709
                                                                                 ---------         ---------        ---------
Cash and cash equivalents at end of year.................................           32,670         $  10,112        $   6,171
                                                                                 =========         =========        =========
Supplemental schedule of noncash investing and  financing activities:
     Common stock dividends issued or issuable on preferred stock........        $      --         $   1,451        $   1,680
                                                                                 =========         =========        =========
     Accrued liability for Altana license................................        $      --         $     900        $      --
                                                                                 =========         =========        =========
     Cash dividends declared on preferred stock..........................        $     800         $     800        $      --
                                                                                 =========         =========        =========
     Issuance of warrants to purchase common stock in connection
          with equity line...............................................        $      --         $     248        $      --
                                                                                 =========         =========        =========
Supplemental disclosure of cash flow information:
     Cash paid during the year for interest..............................        $      --         $       5        $      17
                                                                                 =========         =========        =========
     Cash paid during the year for income taxes..........................        $     197         $      --        $      --
                                                                                 =========         =========        =========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-6
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

(1)  Business

     CollaGenex    Pharmaceuticals,    Inc.   and   subsidiaries    ("CollaGenex
     Pharmaceutical"  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,  Atridox,  Atrisorb FreeFlow and Atrisorb-D
     (the "Atrix Products") under an exclusive licensing and marketing agreement
     with Atrix  Laboratories,  Inc.  ("Atrix") and Pandel under a  sublicensing
     agreement with Altana,  Inc.  ("Altana").  During 2001,  2002 and 2003, the
     Company  also  co-promoted  VIOXX(R)  with  Merck  and  Co.  ("Merck")  and
     Denavir(R)  with Novartis  Consumer  Health,  Inc.  ("Novartis")  to dental
     professionals on a contract basis.  Beginning in April of 2003, the Company
     was engaged in a  co-promotion  agreement  with Sirius  Laboratories,  Inc.
     ("Sirius") in which the parties jointly  marketed  Sirius' AVAR(TM) product
     line to dermatologists in the United States,  while Sirius  co-promoted the
     Pandel  product  line.  Co-promotion  agreements  with Merck,  Novartis and
     Sirius  expired or were mutually  terminated  as of December 31, 2003.  The
     Company has other  internally  developed  proprietary  compounds for cancer
     metastasis 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 equivalents are invested in money market funds.

     Inventories

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

     Acquired Product Rights

     Product  rights are  stated at cost and are  amortized  over the  estimated
     useful  life of the  products  using the  straight-line  method  and have a
     weighted average useful life of 6 years.  Amortization of product rights is
     charged to cost of product sales.

                                      F-7
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     Equipment and Leasehold Improvements

     Equipment  and  leasehold  improvements,  consisting of computer and office
     equipment,  exhibit  equipment and leasehold  improvements  are 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.

     Financial Instruments

     The carrying  amounts of cash and cash  equivalents,  accounts  receivable,
     accounts  payable,   accrued  expenses  and  preferred   dividends  payable
     approximate   fair  value  because  of  the  short  term  nature  of  these
     instruments.

     Net Product Sales

     In  September  1998 the Company  received  approval  from the Food and Drug
     Administration  ("FDA") to market  Periostat.  In 2001, the Company entered
     into an exclusive  licensing  and  marketing  agreement  with Atrix for the
     Atrix Products.  In 2002, the Company  entered into a sublicense  agreement
     with Altana to market and distribute  Pandel.  The Company recognizes sales
     revenue for Periostat,  Pandel and the Atrix Products upon shipment.  Sales
     are reported net of  allowances  for  discounts,  rebates,  wholesaler  and
     distributor  chargebacks  and product returns which are provided for at the
     time of the sale.

     Contract Revenues

     Contract  revenues for Vioxx and Denavir are fee-based  arrangements  where
     revenue is earned as prescriptions  are filled and recognized  according to
     the provisions of each collaborative agreement.  Contract revenues for AVAR
     are  calculated  as a percentage  of the sales gross margin  recognized  by
     Sirius,  in accordance with the provisions of the agreement with Sirius and
     are recognized when product is shipped by Sirius. The Company does not take
     title to the products being promoted under these arrangements.

                                      F-8
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     License Revenue

     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,  development  or  regulatory  process.
     Payments,  if any,  received in advance of performance under a contract are
     deferred and recognized when earned. Upfront license fees where the Company
     has continuing  involvement  are deferred and recognized over the estimated
     performance  period of each  individual  licensing  agreement in accordance
     with the SEC's Staff  Accounting  Bulletin No. 104 (SAB 104). In 2003,  SAB
     104 replaced Staff Accounting  Bulletin No. 101 (SAB 101) which the Company
     adopted in 2000.  The  provisions  related to  up-front  license  fees were
     unchanged  in SAB  104  versus  SAB  101.  During  2003,  2002,  and  2001,
     respectively,  the Company  recorded  $52, $59 and $60 in license  revenues
     which  were  deferred  upon the  implementation  of SAB 101 and which  were
     previously  recognized as license  revenues  under the  historical  revenue
     recognition policy prior to the adoption of SAB 101.

     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  2003,  2002 and 2001 were  $139,  $3,091  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

                                      F-9
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     make  estimates  and  assumptions  that affect the amounts  reported in the
     consolidated  financial  statements and accompanying  notes. Actual results
     could differ from those estimates.

     Stock-Based Compensation

     Statement  of  Financial  Accounting  Standards  (SFAS) No. 123 (SFAS 123),
     "Accounting for Stock-Based  Compensation," encourages but does not require
     companies to record compensation cost for stock-based employee and director
     compensation plans at fair value. Accordingly,  compensation cost for stock
     options  issued to employees  and  directors 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.

     The Company has elected to account for stock-based  compensation  under APB
     Opinion No. 25,  "Accounting  for Stock  Issued to  Employees"  and related
     interpretations.  As set  forth  below,  the pro forma  disclosures  of net
     income (loss) allocable to common  stockholders and income (loss) per share
     allocable to common stockholders are as if the Company had adopted the fair
     value  based  method of  accounting  in  accordance  with SFAS No.  123, as
     amended by SFAS No.  148,  which  assumes  the fair value  based  method of
     accounting had been adopted using the assumptions described in note 8:


<TABLE>
<CAPTION>

                                                        2003            2002            2001
                                                     --------------------------------------------
Net  income (loss) allocable to
     common stockholders:
<S>                                                   <C>            <C>            <C>
     As reported..............................        $  4,827       $   (727)      $  (9,824)
     Add: Stock-based employee
     compensation expenses included in
     net income (loss) allocable to common
     stockholders reported....................             251             --              29
     Less: Stock-based employee
     compensation under fair value
     based method.............................          (5,015)        (3,735)         (3,898)
                                                      --------      ---------       ---------
     Pro forma................................        $     63      $  (4,462)      $ (13,693)
                                                      ========      =========       =========

Basic net income (loss) per share
     allocable to common
     stockholders:


                                      F-10
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     As reported..............................        $   0.40      $   (0.06)      $   (0.94)
                                                      ========      =========       =========
     Pro forma................................        $   0.01      $   (0.40)      $   (1.31)
                                                      ========      =========       =========
</TABLE>



<TABLE>
<CAPTION>



                                                        2003            2002            2001
                                                     --------------------------------------------
Diluted net income (loss) per share
allocable to common stockholders
<S>                                                   <C>           <C>             <C>
     As reported..............................        $   0.38      $   (0.06)      $   (0.94)
                                                      ========      =========       =========
     Pro forma................................        $   0.01      $   (0.40)      $   (1.31)
                                                      ========      =========       =========
</TABLE>

     Concentration of Credit and Other Risks

     The Company  invests its excess cash in money  market funds with major U.S.
     financial institutions.  The Company has established guidelines relative to
     diversification and maturities that maintain safety and liquidity.

     The  Company  currently  contracts  with a single  source for the  domestic
     manufacturing  of Periostat  tablets 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 2003,  three  customers
     accounted for 43%, 31% and 20% of net product sales,  respectively.  During
     2002, three customers  accounted for 32%, 24% and 19% of net product sales,
     respectively.  During 2001, four customers  accounted for 28%, 15%, 13% and
     10%, of net product sales, respectively.

     During the years  ended  December  31,  2003,  2002 and 2001,  Periostat(R)
     accounted  for  approximately  82%, 82% and 87% of our total net  revenues,
     respectively.

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


                                      F-11
<PAGE>


     Impairment of Long-Lived Assets

     Pursuant to SFAS No. 144,  "Accounting  for the  Impairment  or Disposal of
     Long-Lived Assets," we evaluate long-lived assets and intangible assets for
     impairment  when factors  indicate that the carrying amount of an asset may
     not be  recoverable.  When  factors  indicate  that such  assets  should be
     evaluated  for  possible  impairment,  we review the  realizability  of our
     long-lived  assets by analyzing  the projected  undiscounted  cash flows in
     measuring  whether  the  asset  is  recoverable.  Impairment,  if  any,  is
     recognized as the difference  between the asset carrying value and its fair
     value. No such adjustments were recorded in 2003, 2002 or 2001.

     Net Income (Loss) Per Share

     Basic  income per share  (EPS) is  calculated  by  dividing  income  (loss)
     allocable to common  stockholders by the weighted  average shares of common
     stock  outstanding.  Net income  (loss)  allocable  to common  stockholders
     includes  dividends  on the  preferred  stock.  Diluted  EPS  reflects  the
     potential  dilution  that could occur if  outstanding  options and warrants
     were exercised.  As of December 31, 2002 and December 31, 2001, the Company
     had outstanding stock options and stock warrants which were not included in
     the  calculation  of  diluted  net  loss  per  share  allocable  to  common
     stockholders  because to do so would be  anti-dilutive.  Diluted  EPS would
     also include the effect of dilution to income of convertible securities. As
     of December 31, 2003,  2002 and 2001,  the Company had certain  convertible
     preferred  stock which had not been included in the  calculation of diluted
     net income (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  were equal in 2002 and 2001.  For the year ended December 31,
     2003,  the  denominator  used to  calculate  diluted  income  per share was
     741,726  higher than the  denominator  used to  calculate  basic income per
     share.  This  difference in share amounts  related to in the money employee
     stock options and warrants.

     Recently Issued Accounting Standards

     SFAS  No.  150,   Accounting  for  Certain   Financial   Instruments   with
     Characteristics  of both  Liabilities  and Equity,  was issued in May 2003.
     This Statement establishes standards for the classification and measurement
     of certain financial  instruments with  characteristics of both liabilities
     and equity. The Statement also includes required  disclosures for financial
     instruments within its scope. For the Company,  the Statement was effective
     for  instruments  entered into or modified  after May 31, 2003. For certain
     mandatorily  redeemable  financial  instruments,   the  Statement  will  be
     effective for the Company on a later date.  The Company  currently does not
     have any financial instruments that are within the scope of this Statement.


                                      F-12

<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     Reclassification

     Certain  amounts in the 2002  consolidated  financial  statements have been
     reclassified to the 2003 presentation.

(3)  Composition of Certain Financial Statement Captions

     Inventories

     Inventories at December 31, 2003 and 2002 consist of the following:

                                               2003                 2002
                                         --------------       --------------
    Raw materials...................     $          396       $          233
    Work-in-process.................                 52                   56
    Finished goods..................              1,224                1,126
                                         --------------       --------------
                                         $        1,672       $        1,415
                                         ==============       ==============

     Equipment and Leasehold Improvements

     Equipment and leasehold  improvements at December 31, 2003 and 2002 consist
     of the following:

<TABLE>
<CAPTION>
                                                       2003                 2002                 Useful Life
                                                  -------------        --------------      -------------------------
<S>                                               <C>                  <C>                         <C>
 Computer and office equipment............        $        1,133       $        1,203              3-5 years
 Exhibit equipment........................                   451                  327                5 years
                                                                                            Shorter of 10 years or
 Leasehold improvements...................                    45                   45              lease term
                                                  --------------       --------------
                                                           1,629                1,575
 Less: accumulated depreciation
      and amortization....................               (1,133)              (1,016)
                                                  --------------       ---------------
                                                  $          496       $          559
                                                  ==============       ==============
</TABLE>

     Acquired Product Rights

     Acquired  product  rights at  December  31,  2003 and 2002  consist  of the
     following:

                                                     2003            2002
                                               --------------   -------------
       Acquired product rights..............    $   2,700        $   2,700
       Less: accumulated
            amortization....................         (951)            (365)
                                                ---------        ---------
                                                $   1,749        $   2,335
                                                =========        =========

                                      F-13

<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     Amortization  expense  which is included in cost of product sales was $586,
$366 and $17 in 2003,  2002 and 2001,  respectively.  Expected  amortization  of
acquired product rights is as follows:

                         2004.................     $      586
                         2005.................            586
                         2006.................            100
                         2007.................            100
                         2008.................            100
                         Thereafter...........            277
                                                   -----------
                                                   $    1,749
                                                   ===========

       Accrued Expenses

       Accrued expenses at December 31, 2003 and 2002 consist of the following:

                                                2003             2002
                                          ---------------   ---------------
 Product licensing fees...............   $          --      $         900
 Contracted development and
       manufacturing costs............             835                456
 Sales and marketing costs.............            202                255
 Payroll and related costs.............          1,925              1,479
 Professional and consulting fees......            922                339
 Royalties.............................            645                553
 Deferred revenue......................             52                 59
 Income taxes..........................             85                 --
 Miscellaneous taxes...................            139                103
 Other.................................            145                161
                                           -----------        -----------
                                         $       4,950      $       4,305
                                           ===========        ===========

(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 leased corporate office
     in  Newtown,  Pennsylvania.  The  term of the  note was  three  years  with
     interest at 9.54% per annum, with monthly minimum payments of principal and
     interest. The Company repaid the note in 2002.

(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

                                      F-14
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     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  $20,000  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  $18,500.  OCM
     Principal Opportunities Fund, L.P. (OCM) led the investor group, which also
     included certain current stockholders of the Company.

     During the first three years following  issuance,  the preferred stock paid
     dividends  in common stock at a rate of 8.4% per annum.  Beginning  May 12,
     2002,  the  preferred  stock pays  dividends  in cash at a rate of 8.0% per
     annum.  The  preferred  stock was  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  $1,600,  $1,629  and  $1,680  were
     declared in 2003, 2002 and 2001, respectively.

     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 $10,000 in the aggregate  outstanding at any time for working
     capital  requirements  in the ordinary  course of  business;  or (iii) make


                                      F-15

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     research and development expenditures in excess of $7,000 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.

     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 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.  No  warrants  have  been
     exercised and all 400,000 warrants remain outstanding at December 31, 2003.
     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 years, at an exercise price of $5.70 per
     share.  During 2002, 7,140 warrants were exercised into 4,654 shares of the
     Company's  common stock.  During 2003, the remaining  142,860 warrants were
     exercised into 92,195 shares of the Company's common stock. The majority of
     these warrant exercises were in cashless transactions. Accordingly, none of
     the 150,000  warrants remain  outstanding at December 31, 2003. As a result
     of this financing,  the conversion price of the preferred stock was 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).

     On February 14, 2002, the Company  entered into an equity line  arrangement
     under the  terms of a Common  Stock  Purchase  Agreement  with  Kingsbridge
     Capital Limited.  Pursuant to this agreement,  the Company was able, at its
     sole  discretion  and from time to time through  February 13, 2003, to sell
     shares of its common stock to Kingsbridge at a discount to market price, as
     determined  prior to each such sale.  The equity line provided for the sale
     of up to  $8,500 in  registered  shares of the  Company's  common  stock to
     Kingsbridge.  The equity line terminated  pursuant to its terms on February
     13, 2003 and, prior to such termination, the Company issued an aggregate of
     151,522 shares of common stock for gross proceeds of $1,266.

     In connection with the consummation of such equity line and pursuant to the
     terms of a warrant  agreement  executed by the Company,  the Company issued
     Kingsbridge  a warrant to purchase  40,000 shares of its common stock at an
     exercise price of $9.38 per share.  The  conversion  price of the Company's
     preferred  stock was reduced to $9.89 as a result of the issuance of shares
     under the equity line and the  issuance of such  warrant.  Such  warrant is
     exercisable  as of August 14, 2002, and will expire on August 13, 2007. The
     fair value of the  warrants  issued in  connection  with the Equity Line of
     approximately  $248 has no net impact as the increase to additional paid in
     capital representing the value of the warrants

                                      F-16

<PAGE>

     issued is offset by the decrease in additional paid in capital representing
     a cost of the  offering.  No warrants  have been  exercised  and all 40,000
     warrants are outstanding at December 31, 2003.

     On May 29, 2002, the Company's  Board of Directors  approved an Amended and
     Restated Shareholder  Protection Rights Agreement (the "Rights Agreement").
     The Rights Agreement amended and restated,  in its entirety,  the Company's
     then existing  Shareholder  Protection  Rights Agreement (the "Prior Rights
     Agreement")  dated  September  15,  1997,  as  amended,  by and between the
     Company  and  American  Stock  Transfer & Trust  Company,  as rights  agent
     thereunder. American Stock Transfer & Trust Company remains as rights agent
     under  the  Rights   Agreement.   Each  right  previously   authorized  and
     distributed  under the Prior Rights  Agreement  was deemed to  constitute a
     Right  under the Rights  Agreement  effective  May 29,  2002.  The Board of
     Directors  further  authorized  the issuance of one Right for each share of
     the Company's  common stock issued between the date of the Rights Agreement
     and the earlier of the Distribution Date or the Expiration Date, as defined
     in the Rights Agreement.

     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, 2003,
     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 February 2003,  the Company filed a  registration  statement on Form S-3
     with the Securities and Exchange  Commission related to the public offering
     of up to an aggregate of 2,000,000 shares of common stock. In October 2003,
     the Company sold 2,000,000 shares of its common stock previously registered
     on its Registration  Statement on Form S-3 for an aggregate  purchase price
     of $20,000,  which  generated net proceeds to the Company of  approximately
     $18,703, after the payment of placement agent fees and related expenses.

                                      F-17
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


(6)  Licensing and Marketing Agreements

     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 in 2001 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, which was met for 2002, and on an annual basis commencing with fiscal
     year  2003,  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.  These annual requirements were met
     by the Company in 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  twenty-four  months of the agreement,  which
     were met. 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  of  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  preferred
     stock was reduced to $9.91 per share.

     On May 24, 2002,  the Company  executed a Sublicense  Agreement with Altana
     Inc. ("Altana"), the United States subsidiary of Altana Pharma AG, pursuant
     to which the Company was granted the exclusive right to create improvements
     to, market, advertise, promote, distribute, offer for sale and sell, in the
     United  States and Puerto Rico,  Pandel(R)  Cream,  a  mid-potency  topical
     corticosteroid  that  is  indicated  for  the  relief  of  mild-to-moderate
     inflammatory   disorders  of  the  skin,  such  as  atopic  dermatitis  and
     psoriasis. Altana currently licenses such rights from Taisho Pharmaceutical
     Co., Ltd., a company  organized and existing  under the laws of Japan.  The
     Company will purchase from Altana all Pandel products to be sold.  Pursuant
     to the  terms of such  agreement,  the  Company  agreed  to pay  Altana  an
     aggregate  sublicense  fee of $1,700,  of which $800 was paid in  September
     2002 and $900 of which was paid in May 2003.  The  sublicense  fee has been
     capitalized  and is  being  amortized  to cost of  product  sales  over the
     estimated term of agreement.  In addition, the Company is required to pay a
     royalty fee equal to a percentage

                                      F-18
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     of the net sales of the product, if any. The agreement may be terminated by
     the  Company:  (i) at any time,  without  cause,  upon twelve  months prior
     written  notice;  (ii) if Altana  shall  commit  any  uncured,  willful  or
     material  breach of the  provisions  of the  agreement;  or (iii) if Altana
     shall cease to manufacture or supply the product to the Company. Altana may
     terminate the agreement: (i) at any time, without cause, upon twelve months
     written  notice;  (ii) if the Company shall commit any uncured,  willful or
     material  breach of the provisions of the  agreement;  (iii) if the Company
     shall cease to offer the product for distribution to its customers; or (iv)
     if the Company fails to make certain payments or fulfill certain  invoicing
     obligations.

     On March 14, 2003, the Company  terminated its license agreement with Roche
     S.P.A.  As a result of the  termination of the agreement,  during 2003, the
     Company  accelerated  the  recognition of the remaining $222 of unamortized
     deferred  revenue related to the $400 up-front payment received in 1996. In
     June  2003,  the  Company  recognized  $425  related to the  collection  of
     outstanding milestone payments from Roche.

     Pursuant to a  Co-Promotion  Agreement  the Company  executed with Merck in
     September  1999,  the Company  received the  exclusive  right to co-promote
     Vioxx, a prescription strength  non-steroidal  anti-inflammatory  drug that
     was  approved  by the FDA on May 20,  1999 to  relieve  osteoarthritis  and
     manage acute pain in adults,  including dental pain. The agreement provided
     for certain  payments  by Merck to the  Company  upon sales of Vioxx to the
     dental community. On September 23, 2002, the Company executed an amendment,
     extension and  reinstatement of the Co-Promotion  Agreement with Merck with
     respect  to  Vioxx.  In  accordance  with  that  amendment,  extension  and
     restatement,  the Company's agreement with Merck  automatically  expired on
     December 31, 2003.

     In March 2003, the Company  executed  co-promotion  agreements  with Sirius
     pursuant to which we jointly  marketed  both the Sirius'  AVAR product line
     and Pandel to  dermatologists  in the United States.  These agreements were
     mutually terminated in December 2003.

     On October 1, 2002, the Company entered into a Product Detailing  Agreement
     with Novartis pursuant to which the Company  co-promoted  Denavir to target
     dentists in the United States and received  detailing fees and  performance
     incentives from Novartis. The agreement with Novartis to co-promote Denavir
     expired on September 30, 2003, and the Company and Novartis  decided not to
     renew the arrangement with respect to Denavir.

(7)  Line of Credit

     On March 19, 2001, the Company 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. The Company
     may  borrow  up to  the  lesser  of


                                      F-19
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     $4,000 or 80% of eligible accounts receivable, as defined, under the credit
     facility.   The  amount  available  to  the  Company  is  also  reduced  by
     outstanding letters of credit which may be issued under the credit facility
     in amounts totaling up to $1,500.  As of December 31, 2003, the Company had
     an  outstanding  letter  of  credit   approximating  $124  that  served  as
     collateral for certain inventory purchase  committments of the Company (see
     note 11). As the Company pays down amounts under the letter of credit,  the
     amount available to it under the Facility will increase. The Company is 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.  Without the consent of the Silicon
     Valley  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 of $5,000,  subject to certain  upward  adjustments as defined in
     the amendment,  as a result of profitable  operations or additional debt or
     equity  financings  and a minimum of $2,000 in cash at Silicon Valley Bank,
     net of borrowings under the credit facility,  which expires March 15, 2004.
     The Company is  currently  negotiating  to renew the credit  facility for a
     two-year term upon  termination.  In addition,  the Company has secured its
     obligations  under the credit  facility  through the granting of a security
     interest in favor of the bank with respect to all of its assets,  including
     intellectual property. As of December 31, 2003 and 2002, the Company had no
     borrowings outstanding against the credit facility.

(8)  Stock Option Plans

     The Company has three  stock-based  compensation  plans (the Plans) and has
     adopted  the   disclosure-only   provisions  of  SFAS  123  and  SFAS  148,
     "Accounting  For Stock Based  Compensation-Transition  and  Dislcosures and
     Amendment 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  at the  date of  grant  in the  consolidated
     financial statements for stock options issued to employees and directors as
     exercise prices equal the market value on the grant date.

     The 1992 Stock Option Plan,  as amended,  (the 1992 Plan)  provided for the
     granting of incentive and nonqualified 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 ten
     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 1996.

     The 1996 Stock Option Plan,  as amended,  (the 1996 Plan)  provides for the
     granting of incentive and nonqualified options to employees and consultants
     to purchase  up to  3,000,000  shares of the  Company's  common  stock at a
     price, for the incentive options, not

                                      F-20
<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     less than the fair market  value on the  measurement  date.  Incentive  and
     nonqualified  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 ten 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.

     The Nonemployee  Director Stock Option Plan (the Nonemployee Director Plan)
     provides for the issuance of stock options to new nonemployee  directors to
     purchase up to 300,000 shares of common stock 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 2003 and 2002,  certain  existing  members of the Board of Directors
     were  granted  74,500 and 62,136  options,  respectively,  at a fair market
     value of $10.80 and $6.60 per share, respectively. These grants were issued
     under  the 1996  Stock  Option  Plan.  Such  options  vest  25% per  annum,
     commencing one year from the grant date.

     During 2001 and 2000, 360,000 and 237,750 options were granted to employees
     at fair market value with  weighted  average  exercise  prices of $5.19 and
     $5.00 per share, respectively. These grants were not issued under the terms
     of any of the above Plans. Such options are exercisable for a period of ten
     years  from the date of grant  and  generally  vest over a two to five year
     period.

     At December 31, 2003,  there were 575,672 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
     statements of operations over the respective vesting periods of such grants
     $0, $0 and $29 in 2003, 2002 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 option pricing model.

     As a result of a transition  agreement with Brian M. Gallagher,  Ph.D., the
     Company's  former  chairman,  chief  executive  officer and president,  the
     Company  recognized  a  non-cash  compensation  charge of $251 for the year
     ended  December  31,  2003  relating  to  certain   modifications   to  Dr.
     Gallagher's stock option agreements (see note 11).

                                      F-21
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     On December 8, 2003, the Company granted stock options to Colin W. Stewart,
     its newly appointed  president and chief executive  officer,  effective the
     date of commencement of his employment.  These options were granted without
     stockholder approval under the following terms: 300,000 non-qualified stock
     options,  exercise  price equal to the fair market value on the grant date,
     ten-year  term and vesting at the rate of 20% for each year of service with
     the  Company.  In  certain  circumstances,  if  the  closing  price  of the
     Company's  common  stock  exceeds a  pre-determined  per share  price for a
     certain  number of  consecutive  days,  a portion of such options will vest
     immediately.

     The following table summarizes stock option activity for 2001 through 2003:

                                                           Weighted average
                                            Options     exercise price per share
                                         ------------  -------------------------
     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
          Granted..........................      616,086             7.91
          Exercised........................     (31,050)             4.70
          Cancelled........................     (82,475)             9.90
                                              ----------       ----------
     Balance, December 31, 2002............    2,955,170       $     8.91
          Granted..........................      899,350            10.23
          Exercised........................    (374,374)             4.52
          Cancelled........................     (47,142)            10.38
                                              ----------       ----------
     Balance, December 31, 2003............    3,433,004       $     9.72
                                              ==========        ==========

                                      F-22
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     As of December  31,  2003,  the  following  options  were  outstanding  and
     exercisable by price range as follows:

<TABLE>
<CAPTION>

                                                   Outstanding                                Exercisable
                             -----------------------------------------------   -----------------------------
                                                Weighted                                          Weighted
                                                average         Weighted                          average
                                               remaining        average                           exercise
      Range of exercise        Number of      contractual    exercise price      Number of        price per
           prices               options      life (in years)   per share         options          share
     ------------------        --------      --------------  --------------     ----------      ------------
<S>                              <C>              <C>           <C>                 <C>            <C>
     $0.33-$2.00                 69,000           1.6           $1.02               69,000         $1.02
     $4.62-$6.75                643,871           6.1            5.55              436,143          5.56
     $7.01-$8.88                603,640           7.9            8.04              241,726          8.04
     $9.00-$11.88             1,534,413           6.8           10.07              620,313          9.88
     $12.00-$22.63              582,080           5.7           16.17              487,579         15.92
                              ---------         ------        --------           ---------       --------
                              3,433,004           6.6           $9.72            1,854,761         $9.88
                              =========         ======        ========           =========       ========
</TABLE>


     The  weighted  average  fair values of stock  options  granted to employees
     during  2003,  2002 and  2001  were  $6.39,  $6.07  and  $4.57  per  share,
     respectively,  on the date of grant. Such fair values were determined using
     the  Black-Scholes  option  pricing  model and are  based on the  following
     assumptions:

                                                 2003       2002          2001
                                             -----------------------------------
 Expected life in years -
     Employees and directors...............       7          7            7
 Risk-free interest rate...................     3.52%       4.30%        4.88%
 Volatility................................      81%         83%          85%
 Expected dividend yield...................      --%         --%          --%

     On September 18, 2002, the Company  executed  agreements  with each of five
     officers  of the  Company  that  provided,  among  other  things,  for  the
     accelerated  vesting of  unvested  options  upon a change of control of the
     Company.  As of December 31, 2003, there were 300,000 options whose vesting
     would  have  accelerated  as a result  of these  agreements  if a change of
     control had  occurred,  and in this  circumstance  the  Company  would have
     recorded compensation expense of $116, as measured by the difference in the
     exercise price of the options with potentially  accelerated vesting and the
     fair value of the Company's  common stock on the date the  agreements  were
     executed. A non-cash charge will be recorded in the future upon a change in
     control for only those options which would have otherwise  expired unvested
     except  for the  resulting  acceleration  of  vesting  as a result of these
     agreements.

                                      F-23
<PAGE>
                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

(9)  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.

     For 2003,  income  tax  expense  consists  of current  Federal  alternative
     minimum tax of $80 and state income tax of $5. The tax effects of temporary
     differences  that give rise to  significant  portions of the  deferred  tax
     assets  and  deferred  tax  liability  at  December  31,  2003 and 2002 are
     presented below:

                                                   2003           2002
                                                ----------     ----------
     Deferred tax assets:
       Depreciation                            $      14       $     16
       Amortization                                  230             --
       Net operating loss carryforwards           23,198         23,952
       Tax credit carryforwards                      973            874
       Accrued expenses                            1,190          1,053
       Deferred revenue                              134            242
                                                ---------     ---------
            Total gross deferred assets           25,739         26,137
       Less valuation allowance                  (25,739)       (26,137)
                                                ---------     ----------
                           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,  2003 and 2002.  As of
     December 31, 2003 and 2002, $1,463 and $45, respectively,  of the Company's
     gross deferred tax assets are attributable to stock option compensation. To
     the extent  such asset is realized  in the  future,  the  benefit  would be
     credited directly to stockholders' equity.

     The net change in the valuation  allowance for the years ended December 31,
     2003  and  2002  was  a  decrease   of   approximately   $1,816  and  $544,
     respectively,  related  primarily to utilization of net operating losses in
     2003 and 2002.

                                      F-24
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     At December 31, 2003, the Company had approximately  $57,000 of Federal and
     $32,000  of state net  operating  loss  carryforwards  available  to offset
     future   taxable   income.   The  Federal  and  state  net  operating  loss
     carryforwards  will begin expiring in 2010 and 2006,  respectively,  if not
     utilized.  The  Company  also  has  research  and  development  tax  credit
     carryforwards  of  approximately  $893  available to reduce  Federal income
     taxes  which  begin  expiring  in  2007.  In  addition,   the  Company  had
     approximately  $3,400 of foreign net operating loss  carryforwards  with an
     indefinite expiration date.

     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  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, 2003,  approximately  $35,000 is
     immediately  available to offset future taxable income.  In addition to the
     section 382  limitation,  the state net operating  loss  carryforwards  are
     subject to a $2,000 annual limitation.

     Reconciliations  of the  income  tax  expense  (benefit)  from the  Federal
statutory rates for 2003, 2002 and 2001 are as follows:

<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                             ----------------------------------------------------------------
                                                    2003                   2002                    2001
                                             -----------------    -------------------    --------------------

<S>                                           <C>        <C>       <C>          <C>       <C>          <C>
        Statutory Federal income tax          $  2,214   34.0%     $   307      34.0%     $   (2,769)  (34.0%)
        Adjustments resulting from:
          State taxes, net of Federal                3     --           16       1.8            (588)    7.2
          benefit
          Permanent items and others              (316)  (4.8)         221      24.5           1,506    18.5
          Increase (decrease) in valuation
             allowance                          (1,816) (27.9)        (544)    (60.3)          1,851    22.7
                                              ---------  -----     --------    ------      ---------    -----
        Total income tax expense (benefit)    $     85    1.3%     $    --        --%      $      --      --%
                                              =========  =====     ========    ======       ========    ======
</TABLE>

(10) Technology License

     At the time of its formation in 1992, the Company entered into an agreement
     with the Research  Foundation of the State  University of New York at Stony
     Brook ("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  twenty
     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.  Legal costs
     incurred by the Company in defending the patent

                                      F-25

<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     underlying the technology license, if any, are deducted from royalties paid
     to SUNY (See Note 12). A minimum annual royalty of $50 per year is required
     for the duration of the technology  license.  The Company  incurred royalty
     expense for this technology of $1,832,  $1,563 and $1,348 in 2003, 2002 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.

(11) Commitments and Contingencies

     The Company maintains various operating leases,  primarily for office space
     and equipment.  As of December 31, 2003, future minimum rent payments under
     noncancellable operating leases are as follows:

              2004...................           $   530
              2005...................               554
              2006...................               554
              2007...................               360
              2008...................               334
              Thereafter.............               196
                                                -------
                     Total...........           $ 2,528
                                                ========

     Rent expense for the years ended  December 31, 2003,  2002 and 2001 totaled
     $327, $356 and $337, respectively.

     During  2003,  the  Company  entered  into  a  three-year  operating  lease
     agreement for certain sales automation equipment.  Under this agreement the
     Company is required to make monthly payments based on the monthly number of
     users.

     Pursuant  to the terms of the Atrix  License  Agreement  (see note 6),  the
     Company will be required to make certain  annual minimum  expenditures  for
     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.
     The Company met the required spending requirements in 2002 and 2003 related
     to  this  Agreement.

     On February 11, 2002, the Company executed a Co-operation,  Development and
     Licensing Agreement pursuant to which the Company was granted an exclusive,
     sublicenseable,  transferable  license with respect to the  Restoraderm(TM)
     topical drug delivery system which

                                      F-26

<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     the Company intends to develop for dermatological applications. Pursuant to
     the terms of such  agreement,  upon the occurrence of certain  events,  the
     Company  will be  required to pay certain  future  consulting,  royalty and
     milestone  payments in the  aggregate  amount of up to $3,188,  and no more
     than $2,150 and $1,038 of which  shall be payable  prior to January 1, 2004
     and  January  1,  2005,  respectively.  The  Company  paid  $600 and  $330,
     respectively,  under  this  Agreement  in 2003 and  2002.  The term of such
     agreement  is for the life of any patent  that may be issued to the Company
     for the first product the Company develops  utilizing such technology,  or,
     if the Company does not acquire any patentable products, seven years.

     On June  10,  2002,  the  Company  executed  a  Development  and  Licensing
     Agreement with Shire  Laboratories,  Inc. pursuant to which the Company was
     granted an exclusive  worldwide license (including the right to sublicense)
     to develop, make, have made, use, supply, export, import, register and sell
     products for the treatment of various inflammatory  disorders. In addition,
     under  the  agreement,  certain  product  development  functions  shall  be
     performed  for the  Company.  Also under the  agreement,  the  Company  has
     committed to payments, in cash or at the Company's option, a combination of
     cash and the  Company's  common  stock,  upon the  achievement  of  certain
     clinical and regulatory milestones in the event the Company pursues certain
     applications  of the  technology  which  could  total up to  $7,900  in the
     aggregate.  Pursuant to the terms of such agreement, the Company shall also
     pay a percentage  of certain net sales of products,  if any,  utilizing any
     part of the technology.  The Company may terminate the agreement upon sixty
     days notice.

     As of December 31, 2003, the Company has  obligations to purchase $1,139 of
     inventory from various suppliers over the next twelve months.

     In December 2003, Brian M. Gallagher, Ph.D., the Company's former chairman,
     chief  executive  officer and  president,  left the Company to pursue other
     interests.  Dr.  Gallagher  will  continue  to  serve  as a  member  of the
     Company's  Board of  Directors.  In March  2003,  the  Company  executed an
     agreement  with Dr.  Gallagher,  pursuant to which Dr.  Gallagher will also
     remain a consultant to the Company through  December 2005.  Expected future
     payments  to  Dr.  Gallagher,   are  $324  and  $304  for  2004  and  2005,
     respectively.  The Company paid $20 in consulting fees to Dr. Gallagher for
     the year ended  December 31, 2003. In 2003,  the Company also  recognized a
     stock  compensation  charge  of  approximately  $251  relating  to  certain
     modifications of Dr. Gallagher's stock option agreements.

(12) Litigation

     In November  2002,  the Company  commenced  an action in the United  States
     District  Court for the  Eastern  District  of New York  seeking to prevent
     West-ward  Pharmaceutical  Corporation  ("West-ward")  from  selling 20 mg.
     Capsules of doxycycline hyclate to treat


                                      F-27
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)


     periodontal  disease,  which the Company  believes would  infringe  patents
     covering  the  Company's  Periostat(R)  product.  As discussed  below,  the
     Company has settled all pending litigation with West-ward.

     In July 2003,  the Company  commenced  an action  against  United  Research
     Laboratories/Mutual  Pharmaceutical Company ("Mutual") in the United States
     District  Court for the  Eastern  District  of New York  seeking to prevent
     Mutual from  introducing  20 mg.  tablets of  doxycycline  hyclate into the
     market in the United  States.  The Company's suit alleges  infringement  on
     patents to which it is the exclusive licensee.

     In July 2003,  Mutual commenced an action against the Company in the United
     States  District  Court for the Eastern  District of  Pennsylvania.  Mutual
     alleges that the Company has engaged in an overall scheme to monopolize the
     market for low-dose  doxycycline  products.  In addition,  the suit alleges
     that the Company has engaged in exclusionary,  unfair, and  anticompetitive
     practices.  Mutual  seeks an award of treble  damages,  injunctive  relief,
     compensatory,  punitive and  exemplary  damages and  reasonable  attorneys'
     fees. In January 2004, the Court stayed all proceedings in the case.

     In June 2003,  we commenced an action and filed a motion for a  preliminary
     injunction in the United States District Court for the District of Columbia
     challenging  FDA's decision to treat Periostat as an antibiotic  drug, thus
     denying Periostat certain protections  afforded  non-antibiotic drugs under
     the Food,  Drug, and Cosmetic Act against FDA approval of generic copies of
     Periostat.  West-ward  and Mutual  intervened  in this action.  On July 22,
     2003, the Court granted a preliminary  injunction  temporarily  restraining
     the FDA  from  approving  any  ANDA  submitted  for a  generic  version  of
     Periostat (doxycycline hyclate) 20 mg.

     Until the United  States  District  Court for the  District of Columbia has
     made a final ruling on the regulatory  status of Periostat,  the FDA cannot
     approve  the ANDAs for  West-ward's  20 mg.  doxycycline  hyclate  capsule,
     Mutual's 20 mg. doxycycline hyclate tablet, or any other ANDA for a generic
     version of Periostat. Cross motions for summary judgment are pending.

     As a result  of the  ruling in the  United  States  District  Court for the
     District of Columbia,  the Company  withdrew its then pending  motion for a
     temporary  restraining  order  and  preliminary  injunction  in its  patent
     infringement  suit  against  Mutual,  which was filed in the United  States
     District Court for the Eastern District of New York, although its complaint
     remains  outstanding.  In  November,  2003 the  proceedings  in the  patent
     infringement  case were stayed pending a determination by the United States
     Patent and Trademark Office of its  re-examination of the  patents-in-suit,
     subject to the parties' right to conduct limited  discovery  related to the
     potential re-instatement of the Company's motion for a temporary


                                      F-28

<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)

     restraining  order and preliminary  injunction.  The Company cannot predict
     the outcome of these matters.

     On November 7, 2003, the Company settled all pending litigation between the
     Company and West-ward. In the settlement, West-ward agreed and confessed to
     judgment  that the Company's  Periostat  patents are valid and infringed by
     the filing of  West-ward's  ANDA.  West-ward  also agreed and  confessed to
     judgment  that the  Company's  Periostat  patents would be infringed by the
     manufacture and sale of a generic version of Periostat. West-ward consented
     to a judgment  enjoining  West-ward  and any party  acting in concert  with
     West-ward from making and selling a generic  version of Periostat until the
     Company's  patents  expire or are declared  invalid or  unenforceable  by a
     court of competent jurisdiction. Finally, West-ward agreed to withdraw from
     the  FDA  case  in the  District  of  Columbia.  In  connection  with  this
     settlement, the Company agreed to pay a portion of West-ward's actual legal
     expenses in the amount of $700.

     The  Company  anticipates  that its  future  legal  costs in these  matters
     relating to patent  infringement  and defense  will be  reimbursed  by SUNY
     pursuant to a  Technology  License  Agreement  with SUNY to the extent that
     these  legal  expenses do not exceed  royalties  earned by SUNY during that
     period.  During the years  ended  December  31 2003 and 2002,  the  Company
     incurred $3,757 and $129, respectively,  in legal, defense,  litigation and
     settlement  costs for the  aforementioned  law  suits  with  West-ward  and
     Mutual,  $1,750 and $129 of which was deducted  from  royalties  payable to
     SUNY during these periods.  In the event such cumulative legal costs exceed
     the amount of the royalties  payable to SUNY,  the Company will not be able
     to recover such legal costs from SUNY. As of December 31, 2003, the Company
     has $1,749 in previously recorded legal expenses available to offset future
     royalties which may become payable to SUNY, if any.

(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, as defined, not to exceed the limits established by
     the Internal  Revenue Code. All  contributions  made by  participants  vest
     immediately in the participant's account. During each of the years ended
     December 31, 2003 and 2002, the Company made a  discretionary  contribution
     of $100 to the Plan. The Company did not make any contributions in 2001.

(14) Related Party Transactions

     During  2003,  the  Company  engaged  an outside  firm to  perform  certain
     consulting services for approximately $55. One of the primary  stakeholders
     in the  outside  firm  is a  current  member  of  the  Company's  Board  of
     Directors.


                                      F-29
<PAGE>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                        December 31, 2003, 2002 and 2001

                  (Dollars in thousands, except per share data)



(15) Quarterly Financial Data (Unaudited)

     The tables below  summarize the  Company's  unaudited  quarterly  operating
     results for 2003 and 2002.
<TABLE>
<CAPTION>
                                                                          Three months ended
                                                 -----------------------------------------------------------------
                                                     March 31,       June 30,      September 30,     December 31,
                                                       2003            2003            2003             2003
                                                  --------------   -----------    ------------      ------------
<S>                                                  <C>           <C>             <C>               <C>
       Total revenues........................        $ 12,157      $   12,686      $  13,916         $  14,099
       Gross margin on product sales.........           9,456          10,012         10.890            11,319
       Net income...........................            1,228           1,597          1,230             2,371
       Net income allocable to common
         stockholders.......................              828           1,197            830             1,971
       Basic net income per share allocable
         to common stockholders.............             0.07            0.10           0.07              0.14
       Diluted net income per share
         allocable to common stockholders...         $   0.07      $     0.10      $    0.06        $     0.14

                                                 -----------------------------------------------------------------
                                                                          Three months ended
                                                 -----------------------------------------------------------------
                                                     March 31,       June 30,      September 30,     December 31,
                                                       2002            2002            2002             2002
                                                  --------------   -----------    ------------      ------------
    Total revenues............................     $   10,760       $  10,967      $  11,229        $   11,662
    Gross margin on product sales.............          8,301           8,779          9,054             9,263
    Net income (loss).........................           (557)           (385)           756             1,088
    Net income (loss) allocable to common
      stockholders............................           (977)           (794)           356               688
    Basic and diluted net income (loss) per
      share allocable to common stockholders..
                                                   $    (0.09)      $   (0.07)     $    0.03        $     0.06
</TABLE>


                                      F-30
<PAGE>

                COLLAGENEX PHARMACEUTICALS, INC. AND SUBSIDIARIES
                          FINANCIAL STATEMENT SCHEDULE

                        Valuation and Qualifying Accounts

                  Years Ended December 31, 2003, 2002 and 2001
                                 (in thousands)

<TABLE>
<CAPTION>

----------------------------------------------------------------------------------------------------------------------
<S>     <C>                 <C>                          <C>                   <C>                <C>
        Col A               Col B                        Col C                 Col D              Col E
----------------------------------------------------------------------------------------------------------------------
    Description       Balance at the          Additions                      Deductions      Balance at the End
                    Beginning of Period                                                          of Period
----------------------------------------------------------------------------------------------------------------------
Accounts Receivable                       Charged to Statement    Other
     Allowance:                               of Operations
----------------------------------------------------------------------------------------------------------------------
        2003              $ 1,412               $ 3,009           $ --       $ 3,113             $ 1,308

        2002              $   950               $ 3,462           $ --       $ 3,000             $ 1,412

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


                                      F-31