CONFORMED COPY


                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                            ------------------------

                                    FORM 10-Q

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

                  For the quarterly period ended March 31, 2004
                             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
 Incorporation or Organization)               Identification No.)

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


                                 (215) 579-7388
                      ------------------------------------
                         (Registrant's Telephone Number,
                              Including Area Code)

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

                        Yes:   X                  No:
                             ------

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

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

     Indicate  the  number of  shares  outstanding  of each of the  Registrant's
classes of Common Stock as of May 1, 2004:

            Class                                   Number of Shares
 ---------------------------                        -----------------
 Common Stock $.01 par value                            14,332,867


<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.

                                TABLE OF CONTENTS
                                -----------------


                                                                           Page

PART I.  FINANCIAL INFORMATION...........................................    1

   Item 1.    Financial Statements (unaudited)...........................    1

              Condensed Consolidated Balance Sheets as of March 31, 2004
                    and December 31, 2003 (unaudited)....................    2

              Condensed Consolidated Statements of Operations for the Three
                    Months Ended March 31, 2004 and 2003 (unaudited).....    3

              Condensed Consolidated Statements of Cash Flows for the Three
                    Months Ended March 31, 2004 and 2003 (unaudited).....    4

              Notes to Condensed Consolidated Financial Statements
                    (unaudited)..........................................    5

   Item 2.    Management's Discussion and Analysis of Financial Condition
              and Results of Operations..................................   11

              Results of Operations......................................   14

              Liquidity and Capital Resources............................   18

              Additional Risks That May Affect Results...................   22

   Item 3.    Quantitative and Qualitative Disclosures About Market Risk.   28

   Item 4.    Controls and Procedures....................................   29

PART II.    OTHER INFORMATION............................................   30

    Item 1.    Legal Proceedings.........................................   30

    Item 2.    Changes in Securities and Use of Proceeds.................   31

    Item 5.    Other Information.........................................   31

    Item 6.    Exhibits and Reports on Form 8-K..........................   33

SIGNATURES...............................................................   34


                                      -i-
<PAGE>



                          PART I. FINANCIAL INFORMATION

                    Item 1. Financial Statements (unaudited).

                                      -1-

<PAGE>

<TABLE>
<CAPTION>
                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES
                      Condensed Consolidated Balance Sheets
                      March 31, 2004 and December 31, 2003
                    (amounts in thousands, except share data)
                                   (unaudited)
                                                                                 March 31,           December 31,
                                  Assets                                            2004                 2003
                                                                              -------------          ------------
Current assets:

<S>                                                                           <C>                   <C>
   Cash and cash equivalents...........................................       $    31,168           $    32,670
   Accounts receivable, net of allowances of $1,348 and $1,308 at
     March 31, 2004 and December 31, 2003, respectively................             6,419                 4,959
   Inventories.........................................................             1,711                 1,672
   Prepaid expenses and other current assets...........................             2,506                 1,732
                                                                                    -----                 -----
         Total current assets..........................................            41,804                41,033

Equipment and leasehold improvements, net..............................               542                   496
Acquired product rights, net...........................................             1,603                 1,749
Other assets...........................................................                27                    27
                                                                                    -----                 -----
         Total assets..................................................       $    43,976           $    43,305
                                                                              ===========           ===========
                   Liabilities and Stockholders' Equity
Current liabilities:

   Accounts payable....................................................       $     3,939           $     3,273
   Accrued expenses....................................................             4,997                 4,950
   Preferred dividends payable.........................................                --                   800
                                                                                  -------               -------
         Total current liabilities.....................................             8,936                 9,023
                                                                                  -------               -------
Deferred revenue.......................................................               318                   326
                                                                                  -------               -------
Commitments and Contingencies

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 at March 31, 2004 and
     December 31, 2003 (liquidation value of $20,800); 150,000
     shares of Series A participating preferred stock, $0.01 par
     value, designated and no shares issued
     and outstanding at March 31, 2004 and December 31, 2003..........                 2                    2
   Common stock, $0.01 par value; 25,000,000 shares authorized,
     14,131,377 and 13,842,200 shares issued and outstanding at
     March 31, 2004 and December 31, 2003, respectively................              141                   138
   Additional paid in capital..........................................          104,467               103,670
   Accumulated deficit.................................................          (69,888)              (69,854)
                                                                                 -------               -------
         Total stockholders' equity....................................           34,722                33,956
                                                                                 -------               -------
         Total liabilities and stockholders' equity....................       $   43,976            $   43,305
                                                                              ==========            ==========
</TABLE>

      See accompanying notes to unaudited condensed financial statements.

                                      -2-

<PAGE>

<TABLE>
<CAPTION>

                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES
                 Condensed Consolidated Statements of Operations
               For the Three Months Ended March 31, 2004 and 2003
             (amounts in thousands, except share and per share data)
                                   (unaudited)

                                                                                Three Months Ended March 31,
                                                                                ---------------------------
                                                                                 2004                 2003
                                                                                 ----                 ----

Revenues:
<S>                                                                        <C>                  <C>
   Net product sales..............................................         $       13,328       $      11,370
   Contract revenues..............................................                     60                 550
   License revenues...............................................                     18                 237
                                                                                ---------           ---------
        Total revenues............................................                 13,406              12,157
                                                                                ---------           ---------
Operating expenses:
   Cost of product sales..........................................                  2,001               1,914
   Research and development.......................................                  1,389               1,023
   Selling, general and administrative - other....................                  8,119               8,017
   Selling, general and administrative - legal settlement (note 7)                  2,000                  --
                                                                                ---------           ---------
         Total operating expenses.................................                 13,509              10,954
                                                                                ---------           ---------
         Operating (loss) income..................................                   (103)              1,203
                                                                                ---------           ---------
Other income (expense):
   Interest income................................................                     72                  31
   Other expense..................................................                     (3)                 (6)
                                                                                ---------           ---------
         Net (loss) income........................................                    (34)              1,228
Preferred stock dividend..........................................                    400                 400
                                                                                ---------           ---------
Net (loss) income allocable to common stockholders................         $         (434)        $       828
                                                                                ==========          =========

Net (loss) income per basic share allocable to common stockholders         $        (0.03)        $      0.07
                                                                                ==========          =========
Weighted average shares used in computing net income per basic
   share allocable to common stockholders.........................             13,970,730          11,394,226
                                                                              ============        ===========
Net (loss) income per diluted share allocable to common
   stockholders...................................................         $       (0.03)         $      0.07
                                                                                ==========          =========
Weighted average shares used in computing net income per diluted
   share allocable to common stockholders.........................             13,970,730          12,181,045
                                                                              ============        ===========
</TABLE>

See accompanying noted to unaudited condensed consolidated financial statements.

                                      -3-

<PAGE>


<TABLE>
<CAPTION>

                                            COLLAGENEX PHARMACEUTICALS, INC.
                                                    AND SUBSIDIARIES
                                    Condensed Consolidated Statements of Cash Flows
                                   For the Three Months Ended March 31, 2004 and 2003
                                                 (dollars in thousands)
                                                      (unaudited)
                                                                                    Three Months Ended March 31,
                                                                                    ----------------------------
                                                                                      2004                2003
                                                                                    --------             -------
Cash flows from operating activities:
<S>                                                                            <C>                  <C>
   Net (loss) income.....................................................      $        (34)        $     1,228
   Adjustments to reconcile net (loss) income to net cash (used in)
     provided by operating activities:
         Non-cash compensation expense...................................                --                 251
         Depreciation and amortization expense...........................               249                 222
         Accounts receivable provisions..................................                40                 175
       Changes in operating assets and liabilities:
         Accounts receivable.............................................            (1,500)                615
         Inventories.....................................................               (39)                (96)
         Prepaid expenses and other assets...............................              (774)               (529)
         Accounts payable................................................               666                (231)
         Accrued expenses................................................                47                (635)
         Deferred revenue................................................                (8)               (210)
                                                                                    -------             -------
             Net cash (used in) provided by operating activities.........            (1,353)                790
                                                                                    -------             -------

Cash flows from investing activities:
   Capital expenditures..................................................              (149)               (136)
                                                                                    -------             -------
             Net cash used in investing activities.......................              (149)               (136)
                                                                                    -------             -------
Cash flows from financing activities:
   Net proceeds from issuance of common stock............................               800                 163
   Payment of preferred dividends........................................              (800)               (800)
   Repayment of long-term debt...........................................                --                  --
                                                                                    -------             -------
             Net cash provided by (used in) financing activities.........                --                (637)
                                                                                    -------             -------

             Net (decrease) increase in cash and cash equivalents........            (1,502)                 17
Cash and cash equivalents at beginning of period.........................            32,670              10,112
                                                                                    -------             -------
Cash and cash equivalents at end of period...............................      $     31,168         $    10,129
                                                                               ============         ===========
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements.

                                      -4-

<PAGE>


                        COLLAGENEX PHARMACEUTICALS, INC.
                                AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                             March 31, 2004 and 2003
                  (dollars in thousands, except per share data)
                                   (Unaudited)

Note 1 -- Basis of Presentation

     The unaudited condensed  consolidated  financial statements included herein
have been prepared by the Company,  pursuant to the rules and regulations of the
Securities and Exchange Commission and in accordance with accounting  principles
generally  accepted in the United  States of America.  Certain  information  and
footnote  disclosures  normally  included in the annual  consolidated  financial
statements prepared in accordance with accounting  principles generally accepted
in the United States of America have been condensed or omitted  pursuant to such
rules  and  regulations.   These  unaudited  condensed   consolidated  financial
statements  should  be read in  conjunction  with  the  Company's  2003  audited
consolidated financial statements and footnotes included in its Annual Report on
Form 10-K for the year ended December 31, 2003.

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

     Certain  amounts in the 2003  consolidated  financial  statements have been
reclassified to the 2004 presentation.

     In the opinion of the  Company's  management,  the  accompanying  unaudited
condensed  consolidated  financial  statements  have  been  prepared  on a basis
substantially  consistent with the audited consolidated financial statements for
the year ended December 31, 2003 and contain adjustments,  all of which are of a
normal recurring nature,  necessary to present fairly the Company's consolidated
financial  position at March 31, 2004,  the results of operations  for the three
months  ended March 31, 2004 and 2003,  and the cash flows for the three  months
ended March 31, 2004 and 2003. Interim results are not necessarily indicative of
results anticipated for the full fiscal year.

     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  compensation
plans at fair  value.  Accordingly,  the  Company  has  elected to  account  for
stock-based  compensation under Accounting  Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related  interpretations and
compensation  cost for stock  options  issued to  employees  is  measured as the
excess,  if any, of the market price of the Company's stock at the date both the
number of shares  and price  per  share are known  (measurement  date)  over the
exercise  price.  Such amounts are amortized on a  straight-line  basis over the
respective vesting periods of the option grants.  Transactions with nonemployees
(if any) in which goods or


                                      -5-
<PAGE>

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.

     As set  forth  below,  the  pro  forma  disclosures  of net  (loss)  income
allocable  to  common  stockholders  and  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:

                                                       Three Months Ended
                                                            March 31,
                                                  -----------------------------
                                                   2004                  2003
                                                   -----                 -----
 Net (loss) income allocable to
     common stockholders:

     As reported............................     $  (434)              $  828

     Add: Stock-based employee
        compensation expenses
        included in net (loss) income
        allocable to common stockholders....         --                   251

     Less: Stock-based employee
        compensation under fair value
        based method........................      (1,025)              (1,194)
                                                  -------              -------
     Pro forma..............................    $ (1,459)             $  (115)
                                                ========              =======

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

     As reported...........................     $  (0.03)             $  0.07
                                                ========              =======
     Pro forma.............................     $  (0.10)             $ (0.01)
                                                ========              =======

Note 2 -- Inventories

     Inventories  at March  31,  2004  and  December  31,  2003  consist  of the
following:

                                                    2004                 2003
                                                    ----                 ----

Raw materials.........................           $    137             $    396
Work-in-process.......................              1,104                   52
Finished goods........................                470                1,224
                                                   -------              -------
                                                 $  1,711             $  1,672
                                                  ========              =======

                                      -6-
<PAGE>

Note 3 - Letter of Commitment for Line of Credit

     On May 3, 2004,  the Company  executed a letter of  commitment to renew its
revolving  credit facility with Silicon Valley Bank,  which expired on March 15,
2004.  Pursuant to the terms of the  commitment  letter,  the  Company  shall be
permitted  to borrow up to the  lesser  of  $5,000 or 80% of  eligible  accounts
receivable,  as defined.  The amount  eligible to the Company will be reduced by
any outstanding  letters of credit which may be issued under the credit facility
in amounts  totaling up to $2,000.  As the Company pays down  amounts  under any
letter  of  credit,  the  amount  available  to it  under  the  credit  facility
increases. The Company is not obligated to draw amounts and any borrowings shall
bear interest,  payable monthly,  at the current prime rate. Without the consent
of 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 maintain a minimum tangible net worth equal to $28,000,
subject to certain upward adjustments,  as a result of profitable  operations or
additional debt or equity financings.  In addition,  the Company must maintain a
quick  ratio  of at  least  2.0 to  1.0.  The  Company  expects  to  secure  its
obligations  under the  credit  facility  through  the  granting  of a  security
interest  in favor of the bank with  respect to all of the  Company's  corporate
assets.

Note 4 - Commitments and Contingencies

     On August 24, 2001, the Company signed an exclusive  License Agreement (the
"Atrix  License  Agreement")  with Atrix  Laboratories,  Inc. to market  Atrix's
proprietary dental products, Atridox(R), Atrisorb(R) FreeFlow and Atrisorb(R)-D,
to the United States dental  market.  Pursuant to the terms of the Atrix License
Agreement,  the Company is 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 another Atrix product that the Company  markets.
The Company  met the  required  spending  requirements  in 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 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  approximately
$3,150,  of which no more than $1,000 shall be payable prior to January 1, 2005.
The Company  paid $38 under this  Agreement  during the three months ended March
31, 2004 and has paid an aggregate of $968 through  March 31, 2004.  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
such a patent fails to issue, seven years.

     As of March 31, 2004,  the Company has an obligation to purchase  $1,082 of
inventory from the Company's third-party manufacturer of Periostat over the next
twelve months.

                                      -7-
<PAGE>


     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.

Note 5 -- Stock Compensation Charge

     During  March  2003,  the  Company  executed  an  agreement  with  Brian M.
Gallagher,  Ph.D., the Company's former  chairman,  chief executive  officer and
president,  pursuant to which Dr.  Gallagher was  compensated  for,  among other
things,  his services during a transition period and to recognize his historical
contributions  to the  Company.  As a  result  of this  agreement,  the  Company
recognized a non-cash  compensation charge relating to certain  modifications of
Dr.  Gallagher's stock option agreements of approximately  $251 during the three
months  ended  March 31,  2003.  The  Company  also  entered  into a  consulting
agreement  with Dr.  Gallagher  pursuant  to which  he is  providing  consulting
services to the Company for a period of 24 months, commencing in December 2003.

Note 6 -- Termination of Co-Promotion/License Agreements

     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 the first quarter
of 2003, the Company accelerated the recognition of $222 of unamortized deferred
revenue related to the $400 up-front payment received in 1996.

     Pursuant to a Co-Promotion Agreement the Company executed with Merck & Co.,
Inc. in September  1999, the Company  received the exclusive right to co-promote
Vioxx(R), a prescription strength non-steroidal  anti-inflammatory drug that was
approved by the United  States Food and Drug  Administration  (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 restatement 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. The Company will continue to earn nominal  residual  contract
revenues through 2005 from the expired agreement with Merck.

     In March 2003, the Company  executed  co-promotion  agreements  with Sirius
Laboratories,  Inc.  pursuant  to which the  Company  jointly  marketed  Sirius'
Laboratories'  AVAR(TM)  product  line and  Pandel(R) to  dermatologists  in the
United States. These agreements

                                      -8-

<PAGE>

were mutually  terminated on December 31, 2003.  The Company did not receive any
revenue  during the quarter  ended March 31, 2004 and does not expect to receive
contract revenues from Sirius Laboratories' AVAR hereafter.

     On October 1, 2002, the Company entered into a Product Detailing  Agreement
with Novartis Consumer Health,  Inc.  pursuant to which the Company  co-promoted
Denavir(R) to our target  dentists in the United  States and received  detailing
fees  and  performance  incentives  from  Novartis  Consumer  Health,  Inc.  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.  The Company did not receive any revenue during the quarter ended March
31, 2004 and does not expect to receive  contract  revenues  from  Novartis with
respect to Denavir hereafter.

Note 7 -- Mutual Settlement

     In July 2003, the Company sued United  Research  Laboratories,  Inc./Mutual
Pharmaceutical  Company, Inc. ("Mutual") in the United States District Court for
the Eastern  District of New York,  alleging that Mutual infringed the Company's
patents for Periostat(R) for the treatment of adult periodontitis. The Company's
complaint  also alleged that Mutual  infringed  the  Company's  patent rights by
submitting an Abbreviated New Drug  Application  ("ANDA") with the FDA,  seeking
FDA approval to market a generic tablet version of Periostat.

     In a separate  action in the United States  District Court for the District
of Columbia, the Company sought and, on July 22, 2003, was granted a preliminary
injunction  preventing  the FDA from  approving  generic  versions of Periostat,
including Mutual's version. Mutual intervened in that case.

     In July 2003,  Mutual commenced an action against the Company in the United
States District Court for the Eastern District of  Pennsylvania.  Mutual alleged
that the Company had engaged in an effort to monopolize  the market for low-dose
doxycycline products.

     On April 8, 2004,  the  Company  announced  that it had settled all pending
litigation  between the Company and Mutual.

     In connection  with the  settlement,  the Company and Mutual entered into a
License and Supply Agreement pursuant to which Mutual received a license to sell
a branded version of Periostat.  Under this  agreement,  the Company will be the
sole  supplier of this  product to Mutual,  subject to certain  conditions.  The
product  will  be  sold  to  Mutual  at  prices  below  the  Company's   average
manufacturer's  price through May 2007 or the earlier termination of such supply
arrangements under certain circumstances. In addition, the Company agreed not to
grant any license to sell  Periostat  in generic  form to any third party during
the supply term.

     In the  settlement,  Mutual  agreed  and  confessed  to  judgment  that the
Company's  Periostat  patents are valid and would be infringed by the commercial
manufacture,  use, sale, importation or offer for sale of the generic version of
Periostat for which Mutual  submitted its ANDA.  Mutual  consented to a judgment
enjoining Mutual and any party acting in concert with Mutual from infringing the
Company's patents by 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

                                      -9-
<PAGE>

jurisdiction, or until Mutual is granted a license under the patents, which will
occur under the License and Supply  Agreement if a third-party,  generic version
of Periostat is launched and remains on the market for a certain  period of time
or the Company materially breaches its obligations under the agreement. Finally,
Mutual agreed to withdraw from the FDA case in the District of Columbia.

     The Company agreed to pay to Mutual the amount of $2,000,  which represents
a portion of the  anticipated  fees and expenses that the Company will save as a
result of the  settlement  of the pending  actions with Mutual.  This charge has
been  recorded  in the  first  quarter  of 2004.  Under  the  Company's  license
agreement  with the  Research  Foundation  of the State  University  of New York
("SUNY") covering Periostat, the Company is entitled to deduct costs incurred to
defend its patents,  including this payment,  from current and future  royalties
due SUNY on net sales of Periostat and Mutual's branded version of Periostat.

     During the three months ended March 31, 2004, the Company  incurred  $2,493
in legal defense,  litigation and settlement costs for the aforementioned  suits
with Mutual,  $587 of which was deducted from  royalties  payable to SUNY during
the period.  Such  cumulative  legal costs  exceeded the amount of the royalties
payable to SUNY as of March 31,  2004.  As of March 31,  2004,  the  Company has
$3,677 in  previously  recognized  legal  expenses  available  to offset  future
royalties earned by SUNY, if any.

Note 8 -- Sales Force Restructuring

     On April 22, 2004, the Company announced the restructuring of the Company's
pharmaceutical  sales  organization  into dedicated dental and dermatology sales
forces.  The  restructuring is intended to increase the Company's sales focus on
high-prescribing  dentists and dermatologists  while reducing the Company's cost
base.  Prior to the  reorganization,  virtually all of the Company's  115-person
pharmaceutical  sales force called on both dentists and dermatologists to market
the  Company's  portfolio  of  dental  and  dermatology   products.   After  the
restructuring,  the  Company  has a 56-person  dental  sales force  calling on a
highly  targeted  group of 10,000  high  prescribing  dentists  and a  33-person
dermatology sales force calling on the 5,600  dermatologists who are the highest
prescribers of acne,  rosacea and dermatitis  products.  The Company  expects to
incur a charge for such restructuring costs during the second quarter of 2004.

                                      -10-

<PAGE>


Item 2. 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 (the "FDA")
in  September  1998 and is the  first  and only  pharmaceutical  to treat  adult
periodontitis  by  inhibiting  the  enzymes  that  destroy  periodontal  support
tissues.

     We are marketing Periostat and other pharmaceutical  products to the dental
and dermatology  communities through our own dedicated  professional sales force
of approximately 90 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, in February 2002,  Atrisorb-D(R),  to the United
States  dental  market  (the  "Atrix  Products").  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  through  drug  wholesalers  and large  retail  chains 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 Products are distributed  through  specialty  distributors  who sell these
products directly to dental practitioners in the United States and Puerto Rico.

     We incurred a net loss of approximately  $34,000 for the three months ended
March 31,  2004.  With the  exception  of the years ended  December 31, 2002 and
December  31, 2003,  during which years we achieved net income of  approximately
$902,000 and $6.4 million,  respectively,  we have incurred  losses in each year
since  inception and have an  accumulated  deficit of $69.9 million at March 31,
2004.

     Statements  contained or incorporated by reference in this Quarterly Report
on Form  10-Q  that  are not  based  on  historical  fact  are  "forward-looking
statements" within the meaning of Section 21E of the Securities  Exchange Act of
1934,  as amended.  Forward-looking  statements  may be identified by the use of
forward-looking   terminology  such  as  "may,"  "will,"  "expect,"  "estimate,"
"anticipate,"  "continue,"  or similar  terms,  variations  of such terms or the
negative of those terms. This Form 10-Q contains forward-looking statements that
involve  risks  and  uncertainties.  Our  business  of  selling,  marketing  and
developing  pharmaceutical products is subject to a number of significant risks,
including  risks  relating  to the  implementation  of  CollaGenex's  sales  and
marketing  plans  for  Periostat  and  other  products  that  we  market,  risks
associated  with our  arrangement  with Mutual,  risks  inherent in research and
development  activities,  risks  associated with enforcement of our intellectual
property rights, risks that the FDA will approve products 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.

                                      -11-

<PAGE>

CollaGenex's  success  depends to a large degree upon the market  acceptance  of
Periostat by periodontists,  dental practitioners,  other health care providers,
patients and  insurance  companies  and the success of our  dermatology  product
candidates.  There can be no  assurance  that  CollaGenex's  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  CollaGenex.  In  addition,  there can be no  assurance  that
CollaGenex 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  CollaGenex's   filings  with  the  Securities  and  Exchange
Commission,  CollaGenex's  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.

     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(TM),  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
Quarterly  Report  are the  property  of  their  respective  owners  and are not
property of CollaGenex Pharmaceuticals, Inc. or any of our subsidiaries.

     Critical Accounting Policies and Estimates

     Management's  discussion and analysis of its financial position and results
of operations are based upon our consolidated  financial statements,  which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make 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.

     Revenue Recognition

     We recognize product sales revenue upon shipment, net of estimated returns,
provided

                                      -12-
<PAGE>

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 or 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) 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
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. The Tax Reform Act of 1986 contains

                                      -13-
<PAGE>

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.


Results of Operations

     During the three months ended March 31, 2004, we achieved net product sales
of $13.3 million from the sale of Periostat,  the Atrix Products and Pandel.  In
addition,  during the three months ended March 31, 2004, we generated $60,000 in
contract  revenues  mainly  from  residual  contract  revenues  from our expired
agreement  with Merck & Co.,  Inc.  for  Vioxx(R)  and $18,000 in  international
licensing revenues for Periostat.

     Three Months Ended March 31, 2004  Compared to Three Months Ended March 31,
2003

Revenues

--------------------------------------------------------------------------------
Revenues
(dollars in thousands)          2004          Change              2003
--------------------------------------------------------------------------------
Net Product Sales.........  $   13,328         17.2%          $  11,370
--------------------------------------------------------------------------------
Contract Revenues.........          60        (89.1)%               550
--------------------------------------------------------------------------------
License Revenues..........          18        (92.4)%               237
                            -------------     -------         ---------
--------------------------------------------------------------------------------
     Total................  $   13,406          10.3%         $  12,157
--------------------------------------------------------------------------------

     Total  revenues  during the three  months  ended  March 31, 2004 were $13.4
million,  representing  a 10.3%  increase  over total  revenues of $12.2 million
during the three  months  ended  March 31,  2003.  Such 2004  revenues  included
approximately  $13.3 million in net product  sales of Periostat,  Pandel and the
Atrix Products,  $60,000 in contract revenues,  which were derived from residual
contract  revenues from our expired  agreement with Merck for Vioxx, and $18,000
of international  licensing revenues for Periostat.  Net product sales increased
$2.0 million, or 17.2%, to $13.3 million during the three months ended March 31,
2004  compared to $11.4  million  during the three  months  ended March 31, 2003
primarily  due to higher sales of Periostat  and Pandel.  Periostat  net product
sales increased as a result of price increases and unit volume growth.

     Contract revenues for the three months ended March 31, 2004 decreased 89.1%
to $60,000 from $550,000 during the three months ended March 31, 2003, primarily
due to the expiration and/or mutual  termination of our co-promotion  agreements
with Merck,  Novartis and Sirius  Laboratories  during  2003.  Such 2004 revenue
related to residual  contract revenue from our expired  agreement with Merck for
Vioxx.

     We recorded $18,000 and $237,000 in licensing revenues for the three months
ended March 31, 2004 and March 31, 2003, 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.


                                      -14-
<PAGE>


Cost of Product Sales

--------------------------------------------------------------------------------
Cost of Product Sales                        2004        Change        2003
(dollars in thousands)
--------------------------------------------------------------------------------
Cost of Product Sales..................  $  2,001          4.5%     $  1,914
--------------------------------------------------------------------------------
Percent of Net Product Sales...........      15.0%         N/A          16.8%
--------------------------------------------------------------------------------

     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 $2.0  million,  or 15.0% of net  product  sales
during the three months ended March 31, 2004, compared to $1.9 million, or 16.8%
of net  product  sales  during  the three  months  ended  March 31,  2003.  As a
percentage of net product sales, cost of net product sales decreased compared to
the three months ended March 31, 2003,  due to  Periostat  price  increases  and
product mix.

Research and Development

--------------------------------------------------------------------------------
Research and Development                   2004         Change          2003
(dollars in thousands)
--------------------------------------------------------------------------------
Research and development............... $  1,389         35.8%        $  1,023
--------------------------------------------------------------------------------
Percentage of Total Revenues...........     10.4%         N/A              8.4%
--------------------------------------------------------------------------------

     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  $366,000,  or 35.8%, to $1.4
million  during the three months  ended March 31, 2004 from $1.0 million  during
the three months ended March 31, 2003.

     Development projects conducted during the three months ended March 31, 2004
included  our  continuing  clinical  and  manufacturing  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  $71,000  and  $55,000,  respectively.  If all  of the  potential
products  are  successful,   additional  formulation  development  expenses  and
milestones fees could be as much as $11.1 million.

     Clinical  projects totaling $704,000 were conducted during the three months
ended March 31, 2004 and primarily included a Phase III trial in 134 patients to
evaluate the 20 mg current commercial formulation of Periostat for the treatment
of rosacea and a separate  Phase III study to evaluate  Periostat MR, a modified
release  formulation  of Periostat,  for the  treatment of adult  periodontitis.
Additional  clinical  development costs could include as much as $7.5 million in
costs associated with the clinical development of Periostat MR for the treatment
of both adult

                                      -15-

<PAGE>

periodontitis and rosacea.  At this time, it is premature to estimate the future
costs  associated  with the clinical  development  of our  licensed  Restoraderm
technology.

     Other research and  development  expenses  incurred during the three months
ended March 31, 2004  included  $25,000 in regulatory  consulting  and legal and
filing  fees under the Mutual  Recognition  Procedure  in Europe,  $128,000  for
various  regulatory  costs,  including  annual FDA filing fees,  patent fees and
regulatory   expenses  in  the  United  States,  and  $51,000  in  manufacturing
development  costs for Metastat(R) and the ImpacsTM  compounds.  Direct salaries
and other  personnel  expenses  incurred during the three months ended March 31,
2004 were  $256,000.  Additionally,  during such  period we incurred  $98,000 in
consulting, travel and other office expenses.

     Development projects conducted during the three months ended March 31, 2003
included  our  continuation  of  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
$320,000 and $49,000, respectively.

     Clinical  projects totaling $248,000 were conducted during the three months
ended March 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, including a Phase III trial in patients
to evaluate Periostat for the treatment of rosacea.

     Other research and  development  expenses  incurred during the three months
ended March 31, 2003  included  $11,000 in regulatory  consulting  and legal and
filing fees under the Mutual  Recognition  Procedure  in Europe and $162,000 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  three  months  ended  March  31,  2003  were   $140,000.
Additionally,  during such period we incurred $93,000 in consulting,  travel and
other office expenses.

Selling, General and Administrative

--------------------------------------------------------------------------------
Selling, General and Administrative               2004       Change       2003
(dollars in thousands)
--------------------------------------------------------------------------------
Selling, General and Administrative -
  other....................................... $  8,119       1.3%      $ 8,017
--------------------------------------------------------------------------------
Selling, General and Administrative -
   legal settlement...........................    2,000       N/A           --
                                                 -------                -------
--------------------------------------------------------------------------------
Subtotal...................................... $ 10,119      26.2%      $ 8,017
--------------------------------------------------------------------------------
Percentage of Total Revenues..................     75.5%      N/A         65.9%
--------------------------------------------------------------------------------

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


                                      -16-
<PAGE>


     Selling, general and administrative - other expenses increased 1.3% to $8.1
million  during the three months  ended March 31, 2004 from $8.0 million  during
the three months ended March 31, 2003.

     Significant  components  of  selling,  general and  administrative  - other
expenses  incurred  during the three months ended March 31, 2004  included  $4.5
million in direct selling and sales training expenses, $2.0 million in marketing
expenses (including  advertising and promotion  expenditures for Periostat,  the
Atrix  Products  and  Pandel)  and $1.6  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 three months ended March 31, 2003  included  $4.0
million in direct selling and sales training expenses, $2.1 million in marketing
expenses (including  advertising and promotion  expenditures for Periostat,  the
Atrix Products and  co-promotion  expenses  relating to Vioxx and Pandel),  $1.7
million  in  general  and  administrative   expenses,   which  include  business
development,  finance  and  corporate  activities  and  $251,000  related to the
modifications of certain stock options.

     Selling,  general and  administrative - legal settlement  consisted of $2.0
million  during the three  months ended March 31, 2004 which  resulted  from the
accrual  for a one-time  payment to United  Research  Laboratories,  Inc./Mutual
Pharmaceutical Company, Inc. ("Mutual") in connection with the settlement of all
outstanding litigation between us and Mutual.


Other Income/Expense

--------------------------------------------------------------------------------
Other Income/Expense                        2004          Change          2003
--------------------------------------------------------------------------------
Interest income.....................    $  72,000         132.2%       $ 31,000
--------------------------------------------------------------------------------
Other expense.......................    $   3,000         (50.0)%      $  6,000
--------------------------------------------------------------------------------

     Interest  income  increased to $72,000 for the three months ended March 31,
2004  compared  to $31,000  for the three  months  ended  March 31,  2003.  This
increase was due to higher average  investment  balances in 2004.  Other expense
was $3,000 for the three months ended March 31, 2004  compared to $6,000 for the
three months ended March 31, 2003.

Preferred Stock Dividend

     Preferred  stock  dividends  included  in net  income  allocable  to common
stockholders  were $400,000 during each of the three months ended March 31, 2004
and March 31, 2003. 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.


                                      -17-
<PAGE>

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 March 31,  2004,  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.

     On May 3, 2004,  we executed a letter of  commitment to renew our revolving
credit  facility  with  Silicon  Valley Bank,  which  expired on March 15, 2004.
Pursuant to the terms of the commitment  letter, we shall be permitted to borrow
up to the lesser of $5.0  million or 80% of  eligible  accounts  receivable,  as
defined. The amount eligible to us will be reduced by any outstanding letters of
credit which may be issued under the credit  facility in amounts  totaling up to
$2.0  million.  As we pay down  amounts  under any letter of credit,  the amount
available to us under the credit  facility  increases.  We are not  obligated to
draw amounts and any borrowings  shall bear interest,  payable  monthly,  at the
current prime rate.  Without the consent of Silicon Valley Bank, we, among other
things, shall not: (i) merge or consolidate with another entity;


                                      -18-
<PAGE>

(ii) acquire  assets  outside the ordinary  course of business;  or (iii) pay or
declare  any cash  dividends  on our common  stock.  We must  maintain a minimum
tangible  net  worth  equal  to  $28.0   million,   subject  to  certain  upward
adjustments,  as a result of profitable  operations or additional debt or equity
financings.  In addition, we must maintain a quick ratio of at least 2.0 to 1.0.
We expect to secure  our  obligations  under the  credit  facility  through  the
granting of a security  interest in favor of the bank with respect to all of our
corporate  assets.  We cannot be certain that we will sign definitive  documents
with respect to the credit  facility  with Silicon  Valley Bank or, if executed,
that  such  documents  will  contain  each  of  the  above-described  terms  and
conditions.

     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 payments in the
aggregate amount of up to approximately $3.2 million, of which no more than $1.0
million  shall be payable  prior to January 1, 2005.  We paid $38,000 under this
agreement  during  the  three  months  ended  March  31,  2004 and have  paid an
aggregate of $968,000  through March 31, 2004. 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.

                                      -19-
<PAGE>

     At March 31, 2004, we had cash and cash equivalents of approximately  $31.2
million,  a decrease of $1.5 million from the $32.7 million  balance at December
31, 2003.  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 March 31, 2004 was
$32.9 million,  an increase of $900,000 from $32.0 million at December 31, 2003.
This increase was primarily  attributable to the cash proceeds from the exercise
of stock options and warrants.  During the three months ended March 31, 2004, we
invested $149,000 in capital expenditures and paid $800,000 in cash dividends to
the holders of our Series D preferred stock.

     We currently  believe that  projected  sales of our United States  marketed
products in combination  with contract and license  revenues and working capital
at March 31, 2004,  will allow us to fund our operations,  capital  expenditures
and preferred stock dividend  requirements  for at least the next twelve months.
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,  our  arrangement  with Mutual,  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.

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

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

     o    The success of our dermatology franchise;

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

     o    The renewal of our credit facility with Silicon Valley Bank;

     o    The receptivity of the capital markets to future financings;

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

     o    The effect of our arrangement with Mutual; and

     o    The outcome and consequences of 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
and contractual  commitments with our marketing partners for certain selling and
promotional expenses associated with the products

                                      -20-
<PAGE>


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 March 31, 2004:


<TABLE>
<CAPTION>

                                                             Payments Due by Period

                                                   Nine Months
                                                      ending
     Contractual                                    December 31,        2005 and           2007 and      2009 and
     Obligations                   Total               2004               2006               2008           after
---------------------------------------------------------------------------------------------------------------------
<S>                          <C>                  <C>                <C>                 <C>              <C>
Operating Leases(1)......    $    2,411,000       $     413,000      $   1,108,000       $    694,000     $196,000
---------------------------------------------------------------------------------------------------------------------
Unconditional Purchase
   Obligations...........    $    1,082,000(2)    $   1,082,000                 --                 --           --
---------------------------------------------------------------------------------------------------------------------
Co-Promotional
   Commitments...........             (3)                (3)                (3)                 (3)            (3)
---------------------------------------------------------------------------------------------------------------------
Cash Dividends on
   Series D Preferred
   Stock.................    $    7,200,000(4)    $     800,000(4)   $   3,200,000(4)    $  3,200,000(4)       (4)
---------------------------------------------------------------------------------------------------------------------
Consulting Payments......    $      601,000(5)    $     297,000(5)   $     304,000(5)              --           --
---------------------------------------------------------------------------------------------------------------------
Total Contractual            $   11,294,000       $   2,592,000      $   4,612,000       $  3,894,000     $196,000
   Obligations...........
---------------------------------------------------------------------------------------------------------------------
</TABLE>

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

(2)  Such  amounts  represent  a  minimum  purchase  order  commitment  with our
     third-party  manufacturer  of  Periostat.  This  commitment  relates to the
     twelve month period commencing on March 31, 2004.

(3)  We are 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
     another Atrix product that we market. See further information regarding the
     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."

                                      -21-
<PAGE>

(5)  Such  amount  represents  consulting  payments  to  be  made  to  Brian  M.
     Gallagher,  our former chief executive  officer and president in connection
     with 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 $1.0 million shall
be payable prior to January 1, 2005.  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.

Additional Risks That May Affect Results

     Important  factors could cause our actual results to differ materially from
those  indicated  or  implied  by   forward-looking   statements   contained  or
incorporated  by reference in this Quarterly  Report on Form 10-Q.  Factors that
could cause or contribute to such  differences  include those factors  discussed
below.  If any of the following risks actually  occur,  our business,  financial
condition or results of operations would likely suffer.

     We Rely on Periostat for Most of Our Revenue.

     During the three  months  ended March 31, 2004 and for the years ended 2003
and 2002,  Periostat  accounted for approximately  89%, 82% and 82% 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.

     Although we recently  settled our litigation with West-ward  Pharmaceutical
Corporation  and Mutual,  other  companies may have submitted  applications  for
approval of generic  versions

                                      -22-
<PAGE>

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.  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
Abbreviated New Drug Applications ("ANDAs") submitted for any generic version of
Periostat.  Until the Court has made a final  ruling on our  complaint,  the FDA
cannot  approve any ANDAs 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.

     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 result,  our  business,  financial  condition,  cash flows and results of
operations would be materially adversely affected.

     In addition,  in connection with our settlement with Mutual, we will be the
sole supplier to Mutual of a branded  version of  Periostat,  subject to certain
conditions, at prices below our average manufacturer's price through May 2007 or
the   earlier   termination   of  such  supply   arrangements   due  to  certain
circumstances.  During  the  second  quarter  of 2004,  we will ship an  initial
stocking order of product to Mutual, including a one-time promotional allowance,
which we expect will affect our quarterly sales patterns and profitability for a
portion of 2004.  Although we expect to generate  gross  margins in the range of
86% to 88% of our total net sales of Periostat,  our overall Periostat  revenues
could decline significantly, which could materially harm our business.

     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 March
31, 2004, 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.
Although we achieved net income of $6.4 million for the year ended  December 31,
2003,  we  incurred a net loss of $34,000 for the three  months  ended March 31,
2004 and we expect  to incur  significant  future  expenses,  particularly  with
respect to the sales and  marketing of  Periostat,  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.

     Our core  technology is licensed from The Research  Foundation of the State
University of


                                      -23-
<PAGE>


New York, or 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.

     Although we have settled all pending  litigation with Mutual,  we cannot be
certain that other third  parties will not receive FDA approval and  introduce a
competitive  generic  version of Periostat.  Any  infringement or related action
involving 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.

     If We  Materially  Default on or Breach Our  Agreement  With Mutual or if a
Generic Version of Periostat is Shipped by a Generic Third-Party  Competitor and
Remains   Available  For  Sale  for  a  Certain  Period  of  Time,   Mutual  May
Independently  Manufacture  and Sell a Branded  Version  of  Periostat,  and Our
Business will be Materially Harmed.

     In connection  with our settlement  with Mutual,  we entered into a License
and Supply Agreement with Mutual, pursuant to which Mutual received a license to
sell a branded version of Periostat.  Under this agreement,  we will be the sole
supplier of this  product to Mutual,  subject to certain  conditions,  at prices
below our average manufacturer's price through May 2007 or the


                                      -24-
<PAGE>

earlier  termination of such supply  arrangements  under certain  circumstances.
Upon a material default by us or a breach of our obligations under our agreement
with Mutual or if a generic  version of  Periostat  is shipped by a  third-party
generic  competitor and remains available for sale for a certain period of time,
Mutual would be entitled to  independently  manufacture and sell its own branded
version of Periostat.  If Mutual  manufactures and sells its own branded version
of Periostat,  Mutual will be entitled to freely sell its branded product to the
market,  including to our  customers,  and we will not receive any revenues from
these  sales.  If  Mutual  manufactures  and sells its own  branded  version  of
Periostat,  our revenues  could decline  significantly  and our business will be
materially harmed.

     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,
including  the  branded  version  of  Periostat  that we supply to  Mutual.  Any
inability  of PMRS to produce  and supply  product  on agreed  upon terms  could
result in delays in the supply of Periostat and could result in a default in our
agreement with Mutual which would permit Mutual to independently manufacture and
sell its own branded version 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


                                      -25-
<PAGE>

before they can be marketed in the United  States.  Also,  we cannot  market our
approved  products  for new  indications  until the 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,
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 and Large Retail Chains  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.  For the three  months ended March 31,  2004,  sales to Cardinal  Health,
Inc.,  McKesson  Corporation  and  Amerisource-Bergen  Corporation,  represented
approximately  39%, 41% and 16% 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  Periostat  trade  inventory  levels,  this  plan  may not be
effective.   If  Periostat  trade  inventory  levels  become  too  high,  or  if
prescription   growth  of  Periostat  is  lower  than  expected  by  the  trade,
wholesalers  and large retail  chains  could reduce their orders for  Periostat,
which  could  result in reduced  sales of  Periostat  and  adversely  affect our
operating results.


                                      -26-
<PAGE>


     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. On April 22, 2004, we announced the restructuring of our  pharmaceutical
sales organization into dedicated dental and dermatology sales forces. After the
restructuring,  we have a  56-person  dental  sales  force  calling  on a highly
targeted group of 10,000 high prescribing  dentists and a 33-person  dermatology
sales force calling on the 5,600  dermatologists who are the highest prescribers
of acne,  rosacea and  dermatitis  products.  Our future success will depend on,
among  other  things,  our ability to: (i)  achieve  market  acceptance  for any
current 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 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  22.1% 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  22.1% of the outstanding shares of our
common stock or equity securities


                                      -27-
<PAGE>

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.

     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, 2001  through  March 31,  2004,  as reported  on the Nasdaq  National
Market:


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

  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
  March 31, 2004.....................      $14.16         $10.10

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     We had cash and cash equivalents at March 31, 2004 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 March 31, 2004.



                                      -28-
<PAGE>



Item 4. 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 Securities
Exchange Act of 1934,  as amended,  or Exchange  Act) as of March 31,  2004.  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 March
31, 2004,  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 Securities and
Exchange Commission'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 March 31, 2004 that has  materially  affected,  or is  reasonably
likely to materially affect, our internal control over financial reporting.


                                      -29-
<PAGE>


                           PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

United  Research   Laboratories,   Inc./Mutual   Pharmaceutical   Company,  Inc.
Litigation

     In July 2003,  we sued Mutual in the United States  District  Court for the
Eastern  District of New York,  alleging  that Mutual  infringed our patents for
Periostat for the treatment of adult  periodontitis.  Our complaint also alleged
that Mutual  infringed  our patent  rights by  submitting  an ANDA with the FDA,
seeking FDA approval to market a generic tablet version of Periostat.

     In a separate  action in the United States  District Court for the District
of  Columbia,  we sought and, on July 22, 2003,  we were  granted a  preliminary
injunction  preventing  the FDA from  approving  generic  versions of Periostat,
including Mutual's version. Mutual intervened in that case.

     In July 2003,  Mutual  commenced an action  against us in the United States
District Court for the Eastern District of Pennsylvania.  Mutual alleged that we
had  engaged in an effort to  monopolize  the market  for  low-dose  doxycycline
products.

     On April 8, 2004, we announced  that we had settled all pending  litigation
between us and Mutual.

     In connection with the settlement, we and Mutual entered into a License and
Supply  Agreement  pursuant to which Mutual received a license to sell a branded
version of Periostat. Under this agreement, we will be the sole supplier of this
product to Mutual,  subject to certain  conditions,  at prices below our average
manufacturer's  price through May 2007 or the earlier termination of such supply
arrangements under certain  circumstances.  In addition,  we agreed not to grant
any license to sell  Periostat  in generic  form to any third  party  during the
supply term.

     In the  settlement,  Mutual  agreed  and  confessed  to  judgment  that our
Periostat   patents  are  valid  and  would  be  infringed  by  the   commercial
manufacture,  use, sale, importation or offer for sale of the generic version of
Periostat for which Mutual  submitted its ANDA.  Mutual  consented to a judgment
enjoining Mutual and any party acting in concert with Mutual from infringing our
patents by making and selling a generic  version of Periostat  until our patents
expire  or are  declared  invalid  or  unenforceable  by a  court  of  competent
jurisdiction, or until Mutual is granted a license under the patents, which will
occur under the License and Supply  Agreement if a third-party,  generic version
of Periostat is launched and remains on the market for a certain  period of time
or we materially  breach our obligations  under the agreement.  Finally,  Mutual
agreed to withdraw from the FDA case in the District of Columbia.

     We agreed to pay to Mutual the amount of  $2,000,000,  which  represents  a
portion of the  anticipated  fees and expenses  that we will save as a result of
the settlement of the pending actions with Mutual. This charge has been recorded
in the first  quarter of 2004.  Under our license  agreement  with SUNY covering
Periostat,  we are  entitled to deduct  costs  incurred  to defend its  patents,
including this payment,  from current and future royalties due SUNY on net sales
of Periostat and Mutual's branded version of Periostat.


                                      -30-
<PAGE>

Item 2. Changes in Securities and Use of Proceeds.

Changes in Securities

     The  following  information  relates  to all of the  securities  sold by us
within the past quarter which were not registered  under the securities  laws at
the time of grant, issuance and/or sale:

     Option Grants

     During the first quarter of 2004, we granted stock options  pursuant to our
1996 Stock Plan which were not  registered  under the Securities Act of 1933, as
amended,  or 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:

                                            Weighted Average
        Number of Shares                Exercise Price Per Share
        -----------------            ---------------------------------

             428,707                             $10.29


     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 the Company.  We registered these securities on a Registration
Statement  on Form S-8 filed with the  Securities  and  Exchange  Commission  on
February 6, 2004.

Item 5. Other Information.

Appointment  of Klaus P.  Theobald,  M.D.  as Senior  Vice  President  and Chief
Medical Officer

     On January 21, 2004, we announced  the  appointment  of Klaus P.  Theobald,
M.D., to the position of Senior Vice President and Chief Medical Officer.

Positive Outcome of Phase III Clinical Study

     On February 17,  2004,  we  announced  the positive  outcome of a Phase III
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 was the largest  clinical  trial ever  conducted to
evaluate a systemic  therapy for rosacea.  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.



                                      -31-
<PAGE>


Patient  Screening and  Enrollment of  Multi-center  Phase III Clinical Study of
Periostat MR for Adult Periodontitis

     On April 5, 2004, we announced that we had initiated  patient screening and
enrollment  of a  multi-center,  double-blinded,  placebo-controlled  Phase  III
clinical  study to evaluate the  efficacy of  Periostat MR for the  treatment of
adult periodontitis.  Periostat MR is a new, once-daily formulation of Periostat
for the treatment of adult periodontitis.

Settlement of Litigation with Mutual

     On April 8, 2004, we announced  that we had settled all pending  litigation
between us and Mutual.

     In connection  with our settlement  with Mutual,  we entered into a License
and Supply Agreement with Mutual, pursuant to which Mutual received a license to
sell a branded version of Periostat.  Under this agreement,  we will be the sole
supplier of this  product to Mutual,  subject to certain  conditions,  at prices
below  our  average  manufacturer's  price  through  May  2007  or  the  earlier
termination of such supply arrangements due to certain circumstances.

     We agreed to pay to Mutual the amount of  $2,000,000,  which  represents  a
portion of the  anticipated  fees and expenses  that we will save as a result of
the settlement of the pending actions with Mutual. This charge has been recorded
in the first  quarter of 2004.  Under our license  agreement  with SUNY covering
Periostat,  we are  entitled to deduct  costs  incurred  to defend its  patents,
including this payment,  from current and future royalties due SUNY on net sales
of Periostat and Mutual's branded version of Periostat.

Formation of Dedicated Dental and Dermatology Sales Forces

     On April 22, 2004, we announced  the  restructuring  of our  pharmaceutical
sales  organization  into dedicated  dental and  dermatology  sales forces.  The
restructuring  is  intended  to  increase  our sales  focus on  high-prescribing
dentists  and  dermatologists  while  reducing  our  cost  base.  Prior  to  the
reorganization,  virtually  all of our  115-person  pharmaceutical  sales  force
called on both dentists and dermatologists to market our portfolio of dental and
dermatology products. After the restructuring,  we have a 56-person dental sales
force calling on a highly targeted group of 10,000 high prescribing dentists and
a 33-person  dermatology sales force calling on the 5,600 dermatologists who are
the highest prescribers of acne, rosacea and dermatitis products.

Letter of Commitment for Renewal of Credit Facility

     On May 3, 2004,  we executed a letter of  commitment to renew our revolving
credit  facility  with  Silicon  Valley Bank,  which  expired on March 15, 2004.
Pursuant to the terms of the commitment  letter,  we will be permitted to borrow
up to the lesser of $5.0  million or 80% of  eligible  accounts  receivable,  as
defined.  We are not  obligated  to draw amounts and any  borrowings  shall bear
interest,  payable  monthly,  at the current prime rate. We expect to secure our
obligations  under the  credit  facility  through  the  granting  of a  security
interest in favor of the bank with respect to all of our corporate assets.


                                      -32-
<PAGE>

Item 6. Exhibits and Reports on Form 8-K.

  (a)  Exhibits

       31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
            2002.

       31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
            2002.

       32   Certification Pursuant to 18 U.S.C. Section 1350.

  (b)  Reports on Form 8-K.

       On February 24, 2004, we filed a Current Report on Form 8-K 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).


                                      -33-
<PAGE>


                                   SIGNATURES


     Pursuant to the  requirements  of the Securities  Exchange Act of 1934, the
Registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.

                                   CollaGenex Pharmaceuticals, Inc.



Date:    May 10, 2004              By:    /s/ Colin W. Stewart
                                       ----------------------------------------
                                         Colin W. Stewart
                                         President and Chief Executive Officer
                                        (Principal Executive Officer)


Date:    May 10, 2004              By:    /s/ Nancy C. Broadbent
                                        ---------------------------------------
                                         Nancy C. Broadbent
                                         Chief Financial Officer (Principal
                                         Financial and Accounting Officer)


                                      -34-