##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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Form 10-K

|           |  |                                                                                              
|---------- |  | ---------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                              
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2003                                              
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to                                              

Commission File Number: 000-50414



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ADVANCIS PHARMACEUTICAL CORPORATION

(Exact name of Registrant as specified in its
Charter)


|                                                                   |  |                                            
|------------------------------------------------------------------ |  | -------------------------------------------
|Delaware                                                           |  | 52-2208264                                 
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. employer identification
    number)
|                                                                  
|20425 Seneca Meadows Parkway                                       |  |                                            
|Germantown, Maryland                                               |  | 20876                                      
|(Address of principal
    executive offices)                       |  | (Zip Code)                                 

(301) 944-6600

(Registrants telephone number, including
area code)


None

(Former name, former address and former fiscal
year  if changed since last report)


Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act: Common Stock, par value $0.01
per share


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 þ          No o

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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes o          No þ

As of February 17, 2004, 22,792,517 shares
of the registrants common stock were outstanding. As of
February 17, 2004, the aggregate market value of the common
stock held by non-affiliates of the registrant was approximately
$83,370,197. The registrants common stock was not publicly
traded on June 30, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of
Advancis Pharmaceutical Corporations Notice of Annual
Stockholders Meeting and Proxy Statement, to be filed
within 120 days after the end of the registrants
fiscal year, are incorporated by reference into Part III of this
Annual Report.



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TABLE OF CONTENTS



|                                                                  |                                                                                                         |  |  |  |  |  |  | 
|----------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|ADVANCIS PHARMACEUTICAL CORPORATION                              
|PART I                                                           
|                                                                  | Item 1. Business                                                                                       
|                                                                  | Overview                                                                                               
|                                                                  | Advancis Highlights                                                                                    
|                                                                  | Market Opportunity                                                                                     
|                                                                  | Our Solution                                                                                           
|                                                                  | Our Strategy                                                                                           
|                                                                  | Our Product Pipeline                                                                                   
|                                                                  | Generic Product Candidate                                                                              
|                                                                  | Our Collaboration with GlaxoSmithKline                                                                 
|                                                                  | Our Collaboration with Par Pharmaceutical                                                              
|                                                                  | Manufacturing                                                                                          
|                                                                  | Marketing and Sales                                                                                    
|                                                                  | Competition                                                                                            
|                                                                  | Patent and Intellectual Property Protection                                                            
|                                                                  | Government Regulation                                                                                  
|                                                                  | Employees                                                                                              
|                                                                  | FACTORS THAT MAY AFFECT OUR BUSINESS                                                                   
|                                                                  | Risks Related to our Business                                                                          
|                                                                  | Risks Related to our Industry                                                                          
|                                                                  | Other Risks                                                                                            
|                                                                  | Item 2. Properties                                                                                     
|                                                                  | Item 3. Legal Proceedings                                                                              
|                                                                  | Item 4. Submission of Matters to a Vote of Security Holders                                            
|PART II                                                          
|                                                                  | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|                                                                  | Item 6. Selected Consolidated Financial Data                                                           
|                                                                  | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|                                                                  | Background                                                                                             
|                                                                  | Results of Operations                                                                                  
|                                                                  | Liquidity and Capital Resources                                                                        
|Payments Due by Period                                           
|                                                                  | Recent Accounting Pronouncements                                                                       
|                                                                  | Critical Accounting Policies and Estimates                                                             
|                                                                  | Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995                       
|                                                                  | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|                                                                  | Item 8. Financial Statements and Supplementary Data                                                    
|                                                                  | Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure              
|                                                                  | Item 9A. Controls and Procedures                                                                       
|PART III                                                         
|                                                                  | Item 10. Directors and Executive Officers of the Registrant                                            
|                                                                  | Item 11. Executive Compensation                                                                        
|                                                                  | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|                                                                  | Item 13. Certain Relationships and Related Transactions                                                
|                                                                  | Item 14. Principal Accounting Fees and Services                                                        
|PART IV                                                          
|                                                                  | (b) Reports on Form 8-K                                                                                
|SIGNATURES                                                       
|INDEX TO FINANCIAL STATEMENTS                                    
|REPORT OF INDEPENDENT AUDITORS                                   
|ADVANCIS PHARMACEUTICAL CORPORATION BALANCE SHEETS               
|STATEMENTS OF OPERATIONS                                         
|ADVANCIS PHARMACEUTICAL CORPORATION NOTES TO FINANCIAL STATEMENTS
|                                                                  | Use of Estimates                                                                                       
|                                                                  | Cash and Cash Equivalents                                                                              
|                                                                  | Restricted Cash                                                                                        
|                                                                  | Fair Value of Financial Instruments                                                                    
|                                                                  | Marketable Securities                                                                                  
|                                                                  | Comprehensive Income                                                                                   
|                                                                  | Property and Equipment                                                                                 
|                                                                  | Intangible Assets                                                                                      
|                                                                  | Revenue Recognition                                                                                    
|                                                                  | Research and Development                                                                               
|                                                                  | Impairment of Long-Lived Assets                                                                        
|                                                                  | Deferred Credit on Lease Concession                                                                    
|                                                                  | Accounting for Stock-Based Compensation                                                                
|                                                                  | Income Taxes                                                                                           
|                                                                  | Earnings Per Share                                                                                     
|                                                                  | Recent Accounting Pronouncements                                                                       
|                                                                  | Convertible Notes Payable                                                                              
|                                                                  | Lines of Credit                                                                                        
|                                                                  | Montgomery County Note Payable                                                                         
|                                                                  | Voting                                                                                                 
|                                                                  | Dividends                                                                                              
|                                                                  | Liquidation Preference                                                                                 
|                                                                  | Redemption                                                                                             
|                                                                  | Conversion                                                                                             
|                                                                  | Reverse Stock Split                                                                                    
|                                                                  | Initial Public Offering                                                                                
|                                                                  | Beneficial Conversion Feature -- Interest Expense on Convertible Notes                                 
|                                                                  | Restricted Stock                                                                                       
|                                                                  | Leases                                                                                                 
|                                                                  | Legal Proceedings                                                                                      
|                                                                  | Loans to Executive Officer                                                                             
|                                                                  | Consulting Arrangements                                                                                
|Ex23.1                                                           
|Ex-31.1                                                          
|EX-31.2                                                          
|Ex-32.1                                                          
|EX-32.2                                                          



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ADVANCIS PHARMACEUTICAL CORPORATION

INDEX

FORM 10-K

|         |  |                                                                                                    |  |      |    | 
|-------- |  | -------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|         |  |                                                                                                    |  | Page
|         |  |                                                                                                    |  |     
|PART I  
|Item 1.  |  | Business                                                                                           |  |      | 2  | 
|Item 2.  |  | Properties                                                                                         |  |      | 30 | 
|Item 3.  |  | Legal Proceedings                                                                                  |  |      | 30 | 
|Item 4.  |  | Submission of Matters to a Vote of
    Security Holders                                            |  |      | 30 | 
|PART II 
|Item 5.  |  | Market for Registrants Common Equity and
    Related Stockholder Matters                          |  |      | 31 | 
|Item 6.  |  | Selected Consolidated Financial Data                                                               |  |      | 32 | 
|Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |  |      | 33 | 
|Item 7A. |  | Quantitative and Qualitative Disclosures About
    Market Risk                                     |  |      | 44 | 
|Item 8.  |  | Financial Statements and Supplementary Data                                                        |  |      | 45 | 
|Item 9.  |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure           |  |      | 45 | 
|Item 9A. |  | Controls and Procedures                                                                            |  |      | 45 | 
|PART III
|Item 10. |  | Directors and Executive Officers of
    the Registrant                                             |  |      | 46 | 
|Item 11. |  | Executive Compensation                                                                             |  |      | 46 | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |  |      | 46 | 
|Item 13. |  | Certain Relationships and
    Related Transactions                                                 |  |      | 46 | 
|Item 14. |  | Principal Accounting Fees and Services                                                             |  |      | 46 | 
|PART IV 
|Item 15. |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                |  |      | 46 | 

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PART I






|        |         
|------- | --------
|Item 1. | Business

This annual report on Form 10-K contains
forward-looking statements, within the meaning of the Securities
Exchange Act of 1934 and the Securities Act of 1933, that
involve risks and uncertainties. In some cases, forward-looking
statements are identified by words such as believe,
anticipate, expect, intend,
plan, will, may and similar
expressions. You should not place undue reliance on these
forward-looking statements, which speak only as of the date of
this report. All of these forward-looking statements are based
on information available to us at this time, and we assume no
obligation to update any of these statements. Actual results
could differ from those projected in these forward-looking
statements as a result of many factors, including those
identified in the section titled Factors That May Affect
Our Business, Managements Discussion and
Analysis of Financial Condition and Results of Operations
and elsewhere. We urge you to review and consider the various
disclosures made by us in this report, and those detailed from
time to time in our filings with the Securities and Exchange
Commission, that attempt to advise you of the risks and factors
that may affect our future results.




Overview

We are a pharmaceutical company focused on
developing and commercializing pulsatile drug products that
fulfill substantial unmet medical needs in the treatment of
infectious disease. We are developing a broad portfolio of drugs
based on our novel biological finding that bacteria exposed to
antibiotics in front-loaded, sequential bursts, or pulses, are
killed more efficiently and effectively than those exposed to
standard antibiotic treatment regimens. Based on this finding,
we have developed a proprietary, once-a-day pulsatile delivery
technology called PULSYS.

We have focused initially on developing pulsatile
formulations of approved and marketed drugs that no longer have
patent protection or that have patents expiring in the next
three years. We currently have four pulsatile drugs in Phase I/
II clinical trials, four pulsatile drugs or drug combinations in
late stage preclinical development and are exploring pulsatile
formulations for a range of other antibiotics.

We intend to commercialize our pulsatile products
through third party collaborations and with an internal
marketing and sales force. In July 2003, we entered into a
collaboration agreement with GlaxoSmithKline pursuant to which
we licensed patents and PULSYS technology for use with its
Augmentin (amoxicillin/clavulanate combination) products, which
collectively had 2002 U.S. sales of over $1.5 billion, and
with limited other amoxicillin products. GlaxoSmithKline will be
responsible for the clinical development, manufacture and sale
of the products. We received an initial payment of
$5 million from GlaxoSmithKline upon signing of our
collaboration agreement, a $3 million payment upon
achievement of the first milestone, and can receive additional
milestone payments of up to $49 million if it achieves
specified product development goals. In addition, upon
commercialization of any of the products, we would receive
certain royalty payments and may receive incentive payments of
up to $50 million if specified annual sales goals are
achieved.

We are also developing a non-pulsatile, generic
formulation of the antibiotic Biaxin XL (extended release
clarithromycin), for which the patent covering the active
pharmaceutical ingredient expires in 2005. We have licensed to
Par Pharmaceutical the distribution and marketing rights to this
product. We intend to use any cash flow generated by this
product to accelerate development of our pulsatile drug
candidates.

We were incorporated in Delaware in
December 1999 and commenced operations in
January 2000. Our principal executive offices are located
at 20425 Seneca Meadows Parkway, Germantown, Maryland 20876. Our
telephone number is (301) 944-6600. Our website is
www.advancispharm.com. Information contained on our website is
not part of, and is not incorporated into, this annual report on
Form 10-K. Our filings with the SEC are available without
charge on our website as soon as reasonably practicable after
filing.

Advancis, Advancis Pharmaceutical Corp., the
Advancis logo, PULSYS and MAPS are trademarks and trade names of
Advancis Pharmaceutical Corporation. All other trademarks, trade
names or service marks appearing in this annual report on
Form 10-K are the property of their respective owners.

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Advancis Highlights

Focus on significant unmet needs in the
growing antibiotic market.The large
market for antibiotics is expected to continue to grow in light
of the aging of the United States population, the increased use
of therapies that compromise the immune system such as cancer
chemotherapy and the growing prevalence of immune related
diseases such as AIDS. In addition, the increased incidence of
antibiotic resistant bacteria has limited the effectiveness of
many currently available antibiotics. Despite the substantial
and growing antibiotic market, there has been little progress in
addressing the limitations of currently available antibiotics,
such as increased incidence of resistant bacteria and
inconvenient multiple daily dosage requirements and lengthy
treatments, which reduce patient compliance. Many large
pharmaceutical companies have reduced discovery and development
efforts in this sector and others have stopped developing
antibiotic products. We believe that the unmet needs and
apparent lack of emphasis by many large pharmaceutical companies
create substantial opportunities in this market.

Broadly applicable approach with multiple
advantages.We believe our pulsatile
drugs have multiple therapeutic advantages over currently
available antibiotics, including improved efficacy, reduced
incidence of resistance, fewer side effects, once daily dosing,
shorter treatment periods and increased bioavailability (or
ability to be absorbed by the body). Although our studies of
pulsatile drugs have been limited to antibiotics, we believe
that pulsatile dosing may offer therapeutic advantages in the
areas of antivirals, antifungals and oncology.

Anticipated reduced development risk, cost and
time frame.We intend to reduce
development risk and expense and decrease time to market for our
drug candidates by focusing on developing improved versions of
approved and marketed drugs, either delivered alone or in
combination with other drugs. Since these existing drugs have
already been proven to be safe and effective, we anticipate
being able to rely, in part, on prior regulatory approvals and
existing safety and efficacy data in seeking FDA approval of our
pulsatile drugs. We expect that our ability to rely on these
prior approvals and existing data will significantly reduce the
costs associated with generating our own pre-clinical and
clinical data and accelerate our drug development process.

Pipeline of product candidates in clinical and
pre-clinical trials.We currently have
four pulsatile drugs in Phase I/ II clinical trials, four
pulsatile drugs or drug combinations in late stage preclinical
development and are exploring pulsatile formulations for a range
of other antibiotics and antibiotic combinations. We are also
developing a non-pulsatile, generic formulation of Biaxin XL
(extended release clarithromycin), for which the patent covering
the active pharmaceutical ingredient expires in 2005. We have
licensed to Par Pharmaceutical the distribution and marketing
rights to this product. We intend to use any cash flow generated
by this product to accelerate development of our pulsatile drug
candidates.

Multiple PULSYS commercialization
strategies.We anticipate
collaborating with other large pharmaceutical companies, in
addition to GlaxoSmithKline, to apply our technology to develop
pulsatile versions of widely distributed antibiotics, such as
those prescribed by general practitioners, as well as
combinations of such products. These collaborations will allow
us to enter large markets more quickly with the greater
financial and marketing resources of our partners. We also
intend to develop proprietary antibiotic combination products
and will seek to in-license or acquire antibiotic products that
we believe can be improved with our novel pulsatile dosing
approach. Our internal product development and drug acquisition
activities are focused on drugs that we can sell to concentrated
groups of pharmaceutical prescribers, such as hospital-based
physicians and specialists, as well as primary care physicians.
These strategies provide us with a broad range of opportunities
to achieve commercial success.

Multi-level patent
strategy.We have implemented a
multi-level patent strategy in order to protect our pulsatile
drugs. The first level is comprised of umbrella
patents and patent applications to protect the pulsatile
delivery of general classes of drugs, such as antibiotics and
antivirals. The second level is comprised of
sub-umbrella patents and patent applications,
protecting the pulsatile delivery of subclasses of drugs, such
as beta-lactam antibiotics with enzyme inhibitors. The third
level includes filing patent applications for specific pulsatile
drugs. We intend to continue to use and enhance this strategy in
order to protect our intellectual property. We currently own 14
issued U.S. patents, two allowed U.S. patents, and 42 U.S.
patent applications. We also own 26 international patent
applications corresponding to these U.S. patents and
applications.

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Market Opportunity

Infectious diseases are caused by pathogens such
as bacteria, viruses and fungi that enter the body through the
skin or mucous membranes of the lungs, nasal passages and
gastrointestinal tract, and overwhelm the bodys immune
system. These pathogens establish themselves in various tissues
and organs throughout the body and cause a number of serious
and, in some cases, lethal infections.

We believe that the antibiotic market presents a
highly attractive opportunity for the following reasons:

Substantial market.Antibiotics, along with antiviral medications and antifungal
medications, constitute the primary categories of the
anti-infective market. According to sales data compiled by IMS
Health, an independent pharmaceutical industry research firm,
worldwide anti-infective sales were approximately
$44.7 billion in 2002, including $20.3 billion in
North America. Antibiotics accounted for approximately
$27.2 billion of such 2002 worldwide sales, including more
than $10 billion in North America.

Increased resistance to existing
therapies.Certain medical practices
and sociological factors have led to increased bacterial
resistance to many currently available antibiotics. Bacterial
resistance has been fostered through the erroneous prescription
of anti-infective drugs for non-bacterial infections and
unconfirmed infections and the administration of broad spectrum
antibiotics before the specific disease-causing pathogen has
been identified. In addition, the lack of patient compliance
with prescribed course of therapies has contributed to bacterial
resistance to currently marketed compounds. For example, it is
estimated that penicillin is ineffective against one-third of
all Streptococcus pneumoniae, a type of bacteria that can
cause pneumonia, meningitis and ear infections. The increased
prevalence of resistant bacteria has resulted in prolonged
hospitalizations, increased healthcare costs and higher
mortality rates.

Growing need for improved new
drugs.Social and demographic factors
are contributing to the growth in the antibiotic market and the
need for new, more effective therapies. The aging population of
the United States is more likely to have suppressed immune
systems and will require drugs that are effective against
increasingly resistant strains of bacteria. Patients diagnosed
with diseases that target the immune system, such as AIDS,
increasingly require therapies that are more effective to combat
infection. In addition, the pharmaceutical industry continues to
develop therapeutics, such as cancer chemotherapy, that weaken
the immune system as a side effect of the primary therapy. As a
result, there is a strong demand for new treatments that are
more potent, more effective against resistant strains and that
cause fewer side effects.

Difficulties in developing new classes of
anti-infective compounds.We believe
that the growing problem of resistance and other limitations of
currently available antibiotics are not being adequately
addressed. Moreover, many of the large pharmaceutical companies
have reduced research and development efforts in this sector and
others have stopped producing anti-infective products, possibly
because of the difficulties involved in developing new
antibiotic compounds.

Reduced development risk and
costs.In vitro and early in vivotesting of anti-infective drugs has been shown to be more
predictive of human clinical results than testing in other
therapeutic categories. Accordingly, there is reduced
development risk and cost associated with the production of
anti-infective products.

Limitations of standard treatment
regimens.In addition to the increased
incidence of antibiotic resistant bacteria, we believe that
standard antibiotic treatment regimens have several other
limitations, including multiple daily dosage requirements,
lengthy treatment periods, limited effectiveness and severe side
effects, all of which decrease patient compliance and
ultimately, therapeutic efficacy.




Our Solution



| |                    
| | -------------------
| | Our Novel Discovery

The significant unmet needs in the anti-infective
market prompted our founders to search for a more efficient
method to attack bacteria. We found that, as a result of the
relatively short natural life cycle of bacteria, antibiotics are
more effective in killing bacteria when released in three to
five pulses that each occur within the first six to eight hours
following initial dosing. To exploit this finding, we have
developed a proprietary, once-a-

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day delivery technology called PULSYS that
enables rapid, pulsatile delivery of antibiotics and improved
bioavailability, or ability to be absorbed by the body. We
believe that our novel finding, as implemented through our
PULSYS technology, will result in the following therapeutic
advantages:




| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | Improved bactericidal activity, or bacteria
    killing efficiency.                                             
|
| |  | Once daily dosing and shorter length of treatment
    resulting in increased patient convenience and compliance.
|
| |  | Lower overall drug dose with reduced side effect
    profile.                                                   
|
| |  | Decreased emergence of antibiotic resistant
    bacteria.                                                       



| |                                           
| | ------------------------------------------
| | Biological Foundation for our
    Approach

Our approach to improving antibiotic
effectiveness represents a departure from traditional methods,
which were focused on increasing drug dosages and searching for
new classes of drugs. Our pulsatile dosing approach attempts to
increase antibiotic effectiveness by better addressing the
growth cycle and natural defense mechanisms of bacteria. Studies
have shown that antibiotics are generally more effective against
bacteria that are actively growing. Following the administration
of a dose of immediate release antibiotics, surviving bacteria
generally react by entering into a dormant state during which
the bacteria are more difficult to kill. Our preclinical studies
show that our pulsatile approach is more effective because the
gradually increasing staggered releases of drugs do not appear
to trigger the natural defense mechanisms in bacteria that cause
the bacteria to enter into a dormant state. As a result, the
active bacteria may be acted upon and killed more easily by the
antibiotic agent. By keeping the bacteria in an active,
non-defensive state, we may be able to increase antibiotic
effectiveness without increasing overall dosages.

The graph below conceptually illustrates drug
concentration in a patients bloodstream over a 24-hour
period comparing drugs administered through our PULSYS system
with standard twice daily dosing. The standard dosing regimen
reflects the administration of an immediate release tablet at
the start of a day, followed by an additional immediate release
tablet 12 hours later. The PULSYS profile reflects the
administration of a single dose designed to release the drug in
four front-loaded pulses, with no additional doses administered
for the balance of the day.

(DOSING GRAPH)



| |                    
| | -------------------
| | Preclinical Results

We have evaluated the effectiveness of
antibiotics administered in front-loaded, sequential pulses in
both laboratory and animal studies. Our preliminary findings
indicate that the pulsatile dosing of certain antibiotics not
only eliminates more bacteria and may lower the development of
antibiotic-resistant bacteria strains, but that it is

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able to do so at significantly lower drug
concentrations and with shorter courses of therapy than those
required under currently available treatments. For example, our
preclinical studies with amoxicillin have shown that:




| |   |                                                                                                                                                                                                                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Standard regimens of amoxicillin (immediate
    release products taken two or three times daily) inhibited
    growth of a resistant strain of Strep. pneumoniae, but
    did not have a bactericidal effect, whereas pulsatile dosing of
    amoxicillin had a significant bactericidal effect against such
    resistant strain of Strep. Pneumoniae.
|
| |  | Strep. pneumoniaebecame more resistant after three or
    four days of two or three times a day dosing of amoxicillin, but
    did not become resistant after once daily dosing with our PULSYS
    system over the same time period.                                                                                                                  
|
| |  | Amoxicillin delivered through our PULSYS system
    eliminated a sensitive strain of Strep. pneumoniaeat
    antibiotic levels that would not otherwise be expected to
    inhibit bacterial growth.                                                                                                                                                   



| |                 
| | ----------------
| | Clinical Results

We currently have five drug candidates, including
four pulsatile drug candidates, in Phase I/ II clinical trials.
During Phase I studies, a drug is initially introduced into
healthy human subjects and tested for safety, dosage, tolerance,
absorption, metabolism, distribution and excretion. During Phase
II studies, a drug is introduced to patients that have the
medical condition that the drug is intended to treat. Phase II
studies are intended to identify possible adverse effects and
safety risks, to determine the efficacy of the product for
specific targeted diseases and to determine dosage tolerance and
optimal dosage. Phase II studies may often be combined with
Phase I studies (referred to as Phase I/ II studies) in certain
instances when safety issues may be less prevalent. Currently,
our drug products primarily represent improved versions of
approved and marketed drugs, either delivered alone or in
combination with other drugs. Since these existing drugs have
already been proven to be safe and effective, we anticipate
being able to rely, in part, on prior regulatory approvals and
existing safety and efficacy data in seeking FDA approval of our
pulsatile drugs.

Our drug candidates in Phase I/ II clinical
trials have been administered to an aggregate of 479 subjects.
Of these subjects, 166 subjects have been treated with our
pulsatile drug products and 313 subjects have been treated with
different formulations of our generic clarithromycin product.
Our initial results from our Phase I/ II clinical trials on our
pulsatile drug candidates support our ability to deliver each of
these product candidates in a pulsatile manner. We are
conducting additional Phase I/ II clinical trials to optimize
the dosing profile. Studies for our pulsatile products differ in
scope and purpose from those for our generic product; the latter
are primarily to demonstrate bioequivalence. We have conducted
preliminary bioequivalence tests with our generic clarithromycin
product and are planning pivotal in vivobioequivalence
tests to support an ANDA filing for this product.

PULSYS  Our Enabling
Technology

In order to develop drugs based on our novel
biological finding, we created a proprietary, once-a-day drug
delivery technology called PULSYS. PULSYS is designed to
sequentially release specific portions of the drug dose,
yielding a pulsatile pattern of antibiotic release. PULSYS is a
solid oral dosage form that may contain multiple pellets with
varying release profiles that are combined in a proportion to
produce optimum medication levels during the first few hours
after dosing. We anticipate that our pulsatile drugs will each
provide for once-a-day dosing.

PULSYS utilizes commonly used inactive
ingredients and common manufacturing processes. We are also
exploring the administration of pulsatile drugs in forms other
than solid oral dosage forms.

PULSYS drugs are designed using MAPS, our
proprietary enabling design regimen, which we created to
evaluate and develop new pulsatile drug candidates. MAPS
combines computer simulations with microbiology and other
laboratory experiments to analyze the physical, chemical,
biological and microbiological properties of each specific
antibiotic in order to optimize selection and design of
pulsatile drug candidates. This analysis includes an evaluation
of the solubility, permeability, stability and metabolism
profiles of antibiotics as a function of position in the
gastro-intestinal tract. We attempt to optimize overall
antibiotic bioavailability by adjusting the

6



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timing and composition of pulses. By examining
the bioavailability of antibiotics prior to the selection of
PULSYS candidates, we believe that we will increase the
likelihood of successful product development.





Our Strategy

We intend to use our novel finding and related
proprietary technology to develop and commercialize more
efficient, effective and convenient pharmaceutical products,
with an initial focus on antibiotics. To achieve this objective,
we have adopted the following product development and
commercialization strategies:

Commercialize products with multiple
advantages.We intend to develop
pulsatile drugs that have multiple therapeutic advantages over
currently available antibiotics, including improved efficacy,
reduced incidence of resistance, fewer side effects, once daily
dosing, shorter treatment periods and increased bioavailability.

Focus initially on existing
antibiotics.We intend to reduce
development risk and expense and decrease time to market for our
drug candidates by focusing on improved versions of approved and
marketed drugs, either delivered alone or in combination with
other drugs. The additional benefits of developing improved
formulations of existing and approved antibiotics include
reasonable and predictable production costs and higher
probability of market acceptance due to the use of well-known
antibiotics. In addition, since these existing products have
already been proven to be safe and effective, we anticipate
being able to rely on existing approvals and existing safety and
efficacy data, which would allow us to reduce the amount of new
data that we will need to generate in order to support FDA
approval of our products.

Pursue third party collaborations for widely
distributed antibiotics.We anticipate
collaborating with other large pharmaceutical companies, in
addition to GlaxoSmithKline, to apply our technology to develop
pulsatile versions of widely distributed antibiotics, such as
those prescribed by general practitioners, as well as
combinations of such products. These collaborations will allow
us to enter large markets more quickly with the greater
financial and marketing resources of our partners. In addition,
we intend to incorporate our technology into products that are
under development and to apply our technology to produce
improved formulations of broad spectrum antibiotics that have
not been successfully commercialized because of problems such as
inconvenient dosing regimens or efficacy concerns.

Develop proprietary antibiotic combination
products.We intend to focus our
initial internal development efforts on pulsatile formulations
of antibiotic combination products that we can sell to
concentrated groups of customers, such as hospital-based
physicians or specialists. This concentration will allow us to
commercialize our pulsatile drugs with a relatively small
internal sales force. Our initial proprietary pulsatile drug
candidate is a fluoroquinolone/metronidazole combination.

License or acquire antibiotic
products.We intend to license or
acquire antibiotic products that we believe can be improved with
our PULSYS technology. We are focused on drugs and drug
candidates that would be sold in niche markets and that have
been proven to be safe and effective in their traditional
formulations.




Our Product Pipeline

The following table summarizes the antibiotic
compounds we have in clinical trials and late stage preclinical
development. We expect that these compounds will serve as the
basis for drug products or, with additional clinical
development, drug combination products. Each of our product
candidates is still in the early stage of

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development. Due to our on-going research and
development efforts, additional or alternative compounds may be
selected to replace or supplement the compounds described below.


|                                                               |  |                                                                      |  |                                      |  |                                                                           |  |                                          
|-------------------------------------------------------------- |  | -------------------------------------------------------------------- |  | ------------------------------------ |  | ------------------------------------------------------------------------- |  | -----------------------------------------
|Advancis                                                       |  |                                                                      |  |                                      |  | PULSYS                                                                    |  |                                          
|Product                                                        |  | Key Indication(s)                                                    |  | Current Therapy                      |  | Targeted Added Value                                                      |  | Product Opportunity                      
|                                                               |  |                                                                      |  |                                      |  |                                                                           |  |                                          
|PHASE I/ II PULSYS PRODUCT
    CANDIDATES                     
|Amoxicillin                                                    |  | Upper respiratory tract infections (URTI)                            |  | 10-14 days, two or three times daily |  | Once daily, lower dose, shorter duration (5-7
    days)                   |  | Alone and in combination with other drugs
|Clarithromycin                                                 |  | URTI, acute exacerbation of chronic bronchitis
    (AECB), sinusitis |  | 7-14 days, one to two times daily    |  | Once daily, lower dose, shorter duration (5-7
    days)                   |  | Alone or in combination with other drugs 
|Metronidazole                                                  |  | Trichomoniasis, amebiasis                                            |  | 1-10 days, one to three times daily  |  | Single dose therapy                                                       |  | Alone and in combination with other drugs
|Amoxicillin/ clavulanate combination                           |  | AECB, sinusitis                                                      |  | 10-14 days, two or three times daily |  | Once daily, lower dose, shorter duration (5-7
    days)                   |  | As a combination                         
|NON-PULSATILE GENERIC PRODUCT CANDIDATE (ANDA
    to be filed)
|Clarithromycin extended release(1)                             |  | URTI, AECB, sinusitis                                                |  | 7-14 days, once daily                |  | N/A                                                                       |  | Alone                                    
|PRECLINICAL PRODUCT CANDIDATES (2)                            
|Amoxicillin/ clarithromycin combination                        |  | URTI, urinary tract infections (UTI), AECB,
    sinusitis            |  | 10-14 days, twice daily              |  | Once daily, lower dose, broader spectrum, shorter
    duration (5-7 days) |  | As a combination                         
|Cefuroxime                                                     |  | UTI, skin and skin structure infections                              |  | 7-10 days, twice daily               |  | Once daily, lower dose, shorter duration (3-5
    days)                   |  | Alone and in combination with other drugs
|Ciprofloxacin                                                  |  | UTI, intra- abdominal infections                                     |  | 3-14 days, once or twice daily       |  | Once daily, lower dose, shorter duration (1-3
    days)                   |  | Alone and in combination with other drugs
|Fluoroquinolone/ metronidazole combination                     |  | Intra-abdominal infections post- surgery                             |  | 7-14 days, twice daily               |  | Once daily, shorter duration (3-5 days)                                   |  | As a combination                         



---



|    |                                                                                             
|--- | --------------------------------------------------------------------------------------------
|(1) | Non-pulsatile equivalent to Biaxin XL tablets
    (clarithromycin extended-release tablets).
|   
|(2) | We are conducting in vitrostudies of each
    of our preclinical products.                  

For an explanation of the terms Preclinical,
Phase I, Phase II, Phase I/II, Phase III and
ANDA, please refer to the information under the heading
Government Regulation below.

Our research and development group is actively
engaged in identifying additional candidates for our product
development pipeline, such as cefpodoxime, doxycycline and a
cephalosporin/clarithromycin combination. In identifying our
product opportunities, our research and development group works
directly with our formulation group to examine the practical
aspects of drug development, including manufacturability and
applicable regulatory issues.

We intend to explore the use of our pulsatile
dosing approach beyond antibiotics to other therapeutic
categories, such as antiviral and antifungal therapies and
treatments for cancer. Although we have not tested the
effectiveness of pulsatile dosing for these applications, we
believe that our approach may yield benefits similar to those we
have found for the treatment of bacterial infections.

8



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| |                             
| | ----------------------------
| | Pulsatile Product Candidates

We intend to develop the pulsatile drugs listed
below, incorporating one or more of the following improvements:



| |   |                                                                          
| | - | -------------------------------------------------------------------------
| |  | Once-a-day formulation.                                                  
|
| |  | Lower dose.                                                              
|
| |  | Shorter duration of therapy.                                             
|
| |  | Reduced side effect profile.                                             
|
| |  | Combination product with superior efficacy over
    either product alone.
|
| |  | Improved pediatric dosage form.                                          
|
| |  | Geriatric dosage form.                                                   



| |            
| | -----------
| | Amoxicillin

Amoxicillin (marketed by GSK as Amoxil and
marketed by other companies as a generic product) is a
semi-synthetic antibiotic that is effective for the treatment of
a variety of conditions, including ear, nose and throat
infections, urinary tract infections, skin infections and lower
respiratory infections. In 2002, amoxicillin had U.S. sales of
approximately $490 million. Amoxicillin is generally
recommended for dosing two or three times daily, for a period of
ten to 14 days.

Our in vitrostudies demonstrated that
standard regimens of amoxicillin (immediate release products
taken twice daily or three-times daily) inhibited growth of a
resistant strain of Strep. pneumoniae, but did not have a
bactericidal effect, whereas pulsatile dosing of amoxicillin had
a significant bactericidal effect against such resistant strain
of Strep. pneumoniae. Our studies also showed that:



| |   |                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Strep. pneumoniaebecame more resistant after three or
    four days of two or three times a day dosing of amoxicillin, but
    did not become resistant after once daily dosing with our PULSYS
    system over the same time period.
|
| |  | Amoxicillin delivered through our PULSYS system
    eliminated a sensitive strain of Strep. pneumoniaeat
    antibiotic levels that would not have otherwise be expected to
    inhibit bacterial growth.                            

Our initial results from Phase I/ II clinical
trials support our ability to deliver amoxicillin in a pulsatile
manner. We are currently conducting additional Phase I/ II
clinical trials to optimize the dosing profile.

We intend to develop pulsatile amoxicillin
products alone and in combination with other drugs. We
anticipate marketing our amoxicillin products and amoxicillin
combination products through third party collaborations. For
example, in March 2004, we entered into a letter of intent
to develop and commercialize our pulsatile amoxicillin product
with Par Pharmaceutical  see Our Collaboration with
Par Pharmaceutical.



| |               
| | --------------
| | Clarithromycin

Clarithromycin (marketed by Abbott Laboratories
as Biaxin and Biaxin XL, a once daily treatment) is a
semi-synthetic antibiotic, which is available as tablets and
granules for oral suspension. Clarithromycin is effective for
the treatment of various mild to moderate infections, including
pharyngitis/tonsillitis, sinusitis, chronic bronchitis and
pneumonia. In 2002, clarithromycin had U.S. sales of
approximately $650 million, including sales for both Biaxin
and Biaxin XL. Clarithromycin is generally prescribed for twice
daily dosing, for a period of seven to 14 days.

In our in vivo(mice) studies, mice
infected with Strep. pneumoniaehad a 90% survival rate
when treated with clarithromycin dosed once daily in a pulsatile
manner as compared to a 50% survival rate when treated with
twice daily dosing of immediate release clarithromycin.
Moreover, mice in the pulsatile treatment group achieved maximum
survivability after five days of treatment compared to maximum
survivability after eight days of treatment in the immediate
release group. In the same study, mice infected with H.
influenzaehad a 90% survival

9



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rate when treated with clarithromycin dosed in a
pulsatile manner as compared to a 10% survival rate when treated
with immediate release clarithromycin.


Our initial results from Phase I/ II clinical
trials support our ability to deliver clarithromycin in a
pulsatile manner. We are currently conducting additional Phase
I/ II clinical trials to optimize the dosing profile.

We intend to develop pulsatile clarithromycin
products alone or in combination with other drugs. We anticipate
marketing our clarithromycin products and clarithromycin
combination products through third party collaborations.



| |              
| | -------------
| | Metronidazole

Metronidazole (marketed by Pfizer as Flagyl and
as a generic product by other companies) is a synthetic
antibiotic with antiprotozoal and antibacterial activity.
Metronidazole products are effective for the treatment of a
variety of conditions, including trichomoniasis and amebiasis.
In 2002, metronidazole had U.S. sales of approximately
$75 million. Metronidazole is typically dosed twice daily,
for a period of one to ten days.

Our in vitrostudies indicate that
metronidazole dosed in a pulsatile manner is as effective
against sensitive and highly resistant bacteria as three-times
daily dosing of immediate release metronidazole. We found that
metronidazole quickly killed bacteria in vitrowhen
administered in a pulsatile fashion. Bacterial colony counts
were reduced to undetectable levels after ten hours and were
maintained at this level for the duration of the 96-hour
experiment against specific sensitive strains of bacteria. These
data suggest that a more convenient, once-daily alternative to
the standard one to three times daily regimen could be achieved
with PULSYS.

Our initial results from Phase I/ II clinical
trials support our ability to deliver metronidazole in a
pulsatile manner. We intend to conduct additional Phase I/ II
clinical trials to optimize the dosing profile.

We intend to develop pulsatile metronidazole
products alone and in combination with other drugs. We
anticipate marketing our metronidazole products and
metronidazole combination products through an internal sales
force.



| |                                    
| | -----------------------------------
| | Amoxicillin/clavulanate combination

Amoxicillin/clavulanate (marketed by GSK as
Augmentin, and sold by other companies as a generic product) is
an antibacterial combination consisting of the semi-synthetic
antibiotic, amoxicillin, and the beta-lactamase inhibitor,
clavulanate. The combination of amoxicillin and clavulanate is
effective for the treatment of a variety of conditions,
including ear, nose and throat infections, genitourinary tract
infections, skin infections and lower respiratory infections. In
2002, amoxicillin/clavulanate products had U.S. sales of
approximately $1.9 billion. Amoxicillin/clavulanate is
generally recommended for administration two or three times
daily, for a period of ten to 14 days. We have entered into
a license agreement with GSK for the development of a pulsatile
formulation of the amoxicillin/clavulanate combination. We are
cooperating with GSK, as it designs additional preclinical
experiments and additional Phase I/ II clinical trials and
develops its commercialization strategy.



| |                                           
| | ------------------------------------------
| | Amoxicillin/clarithromycin
    combination

Amoxicillin and clarithromycin are each effective
for the treatment of various infections such as the elimination
of H. pyloriin gastric ulcer therapy. We intend to
develop a value-added amoxicillin/clarithromycin combination
product which we believe may deliver performance superior to
either drug alone.

Our in vitrostudies have shown that the
combination of amoxicillin/clarithromycin when delivered in
vitroin a pulsatile fashion was at least as effective in
killing bacteria, and in some instances, more effective than the
individual antibiotics in eliminating bacteria, even at doses
that were significantly lower than the doses used when
administered individually. These results indicate that the
combination may be more effective than either of the individual
antibiotics administered alone.

Our initial results from Phase I/ II clinical
trials of each of amoxicillin and clarithromycin, as described
above, support our ability to deliver each of these antibiotics
in a pulsatile manner. As described above, we are

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currently conducting Phase I/ II clinical trials
to optimize the dosing profiles of each of amoxicillin and
clarithromycin.


We anticipate marketing this combination product
through third party collaborations.



| |           
| | ----------
| | Cefuroxime

Cefuroxime axetil (marketed by GSK as Ceftin and
by other companies as a generic product) is a semi-synthetic
antibiotic, available as tablets and granules for oral
suspension. Cefuroxime is effective for the treatment of various
mild to moderate infections, including urinary tract infections
and skin/skin structure infections. In 2002, cefuroxime had U.S.
sales of approximately $365 million. Cefuroxime is
generally prescribed for twice daily dosing, for a period of
seven to ten days.

In our in vitrostudies, cefuroxime
administered once daily in a pulsatile manner demonstrated
initial bactericidal activity against Staph. aureusand
Strep. pneumoniaecomparable to twice-daily, immediate
release treatment. In contrast to the twice-daily treatment
regimen, pulsatile cefuroxime continued to reduce bacterial
colonies for two days following the initial day of treatment.

We intend to develop a value-added formulation of
cefuroxime or another similar drug in the cephalosporins class
alone and in combination with other drugs, which we would market
through third party collaborations.



| |              
| | -------------
| | Ciprofloxacin

Ciprofloxacin (marketed by Bayer as Cipro) is a
synthetic broad-spectrum antibiotic, which is available as
tablets and granules for oral suspension. Ciprofloxacin is
effective for the treatment of various mild to moderate
infections, including urinary tract infections, sinusitis and
lower respiratory tract infections. In 2002, ciprofloxacin had
U.S. sales of approximately $1 billion. Ciprofloxacin is
typically dosed twice daily, for a period of three to
14 days.

Our in vitrostudies indicate that
ciprofloxacin dosed once daily in a pulsatile manner is as
effective as twice daily dosing of immediate release
ciprofloxacin without altering the overall daily dose. We found
that ciprofloxacin quickly killed bacteria in vitrowhen
administered in a pulsatile fashion. These data suggest that a
more convenient, once-daily alternative to twice-daily,
immediate release ciprofloxacin could be achieved with PULSYS.

We intend to develop a pulsatile formulation of
ciprofloxacin primarily for use in combination with other
antibiotic drugs, such as metronidazole, which we are also
developing with the PULSYS system. We anticipate marketing our
ciprofloxacin combination products through an internal sales
force. In the event we produce a pulsatile product candidate
consisting solely of ciprofloxacin, we anticipate marketing such
product through a third party collaboration.



| |                                              
| | ---------------------------------------------
| | Fluoroquinolone/metronidazole
    combination

We intend to develop a pulsatile
fluoroquinolone/metronidazole product. We believe that the
combination of fluoroquinolone and metronidazole will prove to
be effective for the treatment of infections caused by a mixture
of anaerobic and aerobic bacteria, such as diabetic foot
infections or post-surgery intra-abdominal infections.

Based on the results of our pulsatile
fluoroquinolone and metronidazole experiments, we believe that a
combination product containing fluoroquinolone and metronidazole
may perform in a fashion superior to either drug alone,
particularly when one or both drugs is delivered in a pulsatile
manner.

We anticipate marketing this combination product
through an internal sales force targeting gastro-intestinal
surgeons.

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Generic Product Candidate



| |                                
| | -------------------------------
| | Clarithromycin Extended Release

As part of our analysis in evaluating a pulsatile
clarithromycin product, we identified an opportunity to
formulate a generic equivalent of Biaxin XL, which we believe we
can commercialize without infringing upon the patents held by
Abbott Laboratories. We filed a patent application covering the
production method of our generic version of this product in
October 2000 and are currently in the final stages of
clinical trials. In 2002, Abbotts sales of immediate
release clarithromycin were approximately $315 million and
its sales of extended release clarithromycin were approximately
$335 million. Although our generic equivalent product does
not incorporate our pulsatile drug delivery technology, we
believe that it presents an opportunity to generate cash flow to
accelerate development of our pulsatile drug candidates. We have
licensed to Par Pharmaceutical the distribution and marketing
rights to this product.

In the fourth quarter of 2003, we received
results from certain bio-equivalency studies of our generic
clarithromycin product and in February 2004 received results
from a more extensive bio-equivalency study using the same
formulation of the product. The initial study of 40 subjects
indicated that the product satisfies all bio-equivalency
standards established by the FDA when the product is taken with
food, which is consistent with the instructions on the product
label. However, in an initial study of 34 subjects and the
expanded 132-subject study completed in February, the product
narrowly missed one of the bio-equivalency standards when taken
in the non-recommended, fasted state. While the peak
drug concentration for our product fell below the confidence
interval needed to statistically meet the bio-equivalence
standard under this scenario, our product demonstrated a more
sustained release profile than the branded (Abbott) counterpart.
We intend to pursue a new bio-equivalency study with an adjusted
formulation of the product, designed to modify the release
profile of the product to more closely correspond to Biaxin XL
and meet the standard for bio-equivalence. We expect that the
new formulation and subsequent bio-equivalency studies will
involve an expanded relationship with Par, whereby Par will
assume many of the commercial manufacturing responsibilities for
the generic product and the filing of the ANDA.

We believe this modified strategy will allow for
a more efficient ANDA approval process and take advantage of
Pars focus and experience in the generic marketplace. If
the new bio-equivalency study proceeds as anticipated, we expect
to make an ANDA filing by the third quarter of 2004, and to
ultimately launch the product in the second half of 2005. As
Abbotts relevant patent for Biaxin XL expires in the
second half of 2005, we anticipate that we will be able to
launch our generic product shortly following the patent
expiration. However, we can provide no assurance that any
generic product will be launched in such time frame, or at all.
We are also continuing discussions with various manufacturers,
including Par, to supply this product for commercial launch.




Our Collaboration with
GlaxoSmithKline

In July 2003, we entered into a license
agreement with GlaxoSmithKline pursuant to which we licensed
patents and PULSYS technology to GSK for use with its Augmentin
(amoxicillin/clavulanate combination) products and with limited
other amoxicillin products. Under the agreement, GSK will be
responsible, at its cost and expense, to use commercially
reasonable efforts for the clinical development, manufacture and
sale of the licensed products. We received an initial
non-refundable, non-creditable payment of $5 million from
GSK upon signing of the agreement, a $3 million payment
upon achievement of the first milestone, and would be entitled
to receive additional milestone payments from GSK not to exceed
an aggregate of $49 million if it achieves certain product
development goals, including commencement of clinical trials and
the filing and approval of an NDA with the FDA. In addition, we
will receive royalty payments on the commercial sale of products
developed under the agreement. We may also receive sales
milestone payments of up to $50 million if specified annual
sales goals are achieved. The agreement provides for the payment
of royalties in each country for at least ten years from the
date of the first commercial sale of any licensed product in
such country, but the agreement may be terminated at any time by
GSK upon relatively short notice or terminated by either party
upon a material breach of the agreement by, or the bankruptcy
of, the other party. Our receipt of milestone payments, royalty
payments and sales milestone payments under the agreement will
depend on the ability of GSK to develop and commercialize the
products covered by the agreement and is subject to certain
conditions and limitations. We cannot assure you

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that we will receive any additional milestone or
royalty payments or that our collaboration with GSK will result
in the approval and marketing of any drug.





Our Collaboration with Par
Pharmaceutical

In September 2003, we entered into an
agreement pursuant to which we licensed to Par Pharmaceutical
the distribution and marketing rights to our generic
clarithromycin product. Under the agreement, we will be
responsible for the clinical development, regulatory approval
and arranging for the initial manufacture of the product and Par
Pharmaceutical will be responsible for the marketing and sale of
the product. We are entitled to receive milestone payments from
Par Pharmaceutical not to exceed an aggregate of $6 million
upon achievement of certain goals, including acceptance of an
ANDA by the FDA and commercial launch of the product. In
addition, we will receive royalty payments equal to over 50% of
the net profits from the sale of the product, which royalty rate
may be reduced to an amount as low as 25% at our election, upon
the assumption by Par Pharmaceutical of certain of our
obligations and risks relating to the development of the
product. The agreement has an indefinite term, but may be
terminated at any time by Par Pharmaceutical upon relatively
short notice. Our receipt of milestone and royalty payments
under the agreement are subject to certain conditions and
limitations and will depend on our success in developing the
product and the ability of Par Pharmaceutical to commercialize
and sell the product. We cannot assure you that we will receive
any milestone or royalty payments or that our collaboration with
Par Pharmaceutical will result in the marketing of any drug. Par
Pharmaceutical has the right to refrain from marketing
activities upon the occurrence of certain events, such as the
assertion of patent infringement claims. In addition, subject to
a limited exception, we will be obligated to pay for one-half of
any costs, expenses or damages resulting from any claims for
patent infringement.

In March 2004, we signed a letter of intent
with Par Pharmaceutical as our strategic partner to develop and
commercialize our pulsatile amoxicillin product. Under the terms
of the letter of intent, we would receive a fee of $5 million
and a commitment from Par Pharmaceutical to fund all further
development expenses in exchange for granting Par Pharmaceutical
the exclusive right to sell Amoxicillin PULSYS and the
co-exclusive right to market the product. The two parties intend
to jointly fund and run the marketing and sales program and to
share operating profits from product sales on an equal basis. We
would be responsible for the manufacturing program, would retain
all patents and trademarks, and would be responsible for patent
and trademark enforcement. The parties expect to negotiate and
finalize a definitive agreement, but cannot assure you that a
definitive agreement will be entered into in accordance with
these terms, or at all.




Manufacturing

We currently rely on third-party contract
manufacturers to produce sufficient quantities of our product
candidates for use in the preclinical studies and clinical
trials that we are conducting. However, we are in the process of
developing the capability to manufacture the necessary supplies
for use in our pre-clinical studies and clinical trials. We
anticipate that our pilot facility will satisfy our drug
production needs through at least Phase II and, in some cases,
through Phase III clinical trials. We believe that our initial
focus on the production of improved formulations of approved and
marketed drugs will reduce the risk and time involved in the
establishment of manufacturing capabilities because production
of these drugs involves well-known, common manufacturing
processes. Until we complete the qualification of our
manufacturing facility, we must depend on third-party contract
manufacturers for production of our clinical supplies.

We intend to rely on third-party contract
manufacturers to produce sufficient quantities of our drugs for
certain of our Phase III clinical trial supplies. In addition,
since we intend to rely on third parties for large scale
commercialization, we have and will continue to engage those
contract manufacturers who have the capability to manufacture
drug products in bulk quantities for commercialization.

In connection with our manufacturing activities,
we generate hazardous waste. We are subject to federal and state
regulation regarding the disposal of hazardous and potentially
hazardous waste. We may incur costs to comply with such
regulations now or in the future.

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Marketing and Sales

We have no sales, marketing or distribution
capabilities. In order to commercialize any of our product
candidates, we must either make arrangements with third parties
to perform these services for us or acquire or develop internal
sales, marketing and distribution capabilities. We intend to
rely on partnerships with larger companies for the sale of
widely distributed antibiotics and for international sales. We
intend to develop an internal sales force to enable us to market
and sell our proprietary combination products in concentrated
markets. We also intend to use such an internal sales force to
market and sell acquired or licensed products improved with
PULSYS.




Competition

The pharmaceutical industry is highly competitive
and characterized by a number of established, large
pharmaceutical companies, as well as smaller emerging companies.
Our main competitors are:



| |   |                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Large pharmaceutical companies, such as GSK,
    Pfizer, Johnson & Johnson, Aventis, Abbott Laboratories,
    AstraZeneca, Bayer, Bristol-Myers Squibb and Merck, that may
    develop new drug compounds that render our drugs obsolete or
    noncompetitive.
|
| |  | Smaller pharmaceutical and biotechnology
    companies and specialty pharmaceutical companies engaged in
    research and development of novel antibiotics, such as Cubist,
    Vicuron, InterMune and King.                                                   
|
| |  | Drug delivery companies, such as Johnson &
    Johnsons Alza division, Biovail and SkyePharma, that may
    develop a dosing regimen that is more effective than pulsatile
    dosing.                                                                        

In addition, with respect to our generic version
of Biaxin XL, we will compete with Abbott Laboratories, the
manufacturer of the branded drug, and other manufacturers of
generic products.

Many of our competitors possess greater
financial, managerial and technical resources and have
established reputations for successfully developing and
marketing drugs, all of which put us at a competitive
disadvantage. We may also face competition for the in-licensing
of products from other companies that may be able to offer
better terms to the licensors. Furthermore, new developments,
including the development of methods of preventing the incidence
of disease, such as vaccines, occur rapidly in the
pharmaceutical industry. These developments may render our
product candidates or technologies obsolete or noncompetitive.




Patent and Intellectual Property
Protection

Our success depends in part on our ability to
obtain patents, to protect trade secrets, to operate without
infringing upon the proprietary rights of others and to prevent
others from infringing on our proprietary rights. We seek to
protect our proprietary position by, among other methods, filing
U.S. and foreign patent applications related to our proprietary
technology, inventions and improvements that are important to
the development of our business. Further, all of our employees
have executed agreements assigning to us all rights to any
inventions and processes they develop while they are employed by
us.

In addition, we intend to use license agreements
to access external products and technologies, as well as to
convey our own intellectual property to others. We will be able
to protect our proprietary rights from unauthorized use by third
parties only to the extent that our proprietary rights are
covered by valid and enforceable patents or are effectively
maintained as trade secrets. Protection of our intellectual
property rights is subject to a number of risks.

We currently own 16 issued and allowed U.S.
patents and 42 U.S. patent applications. Our issued patents
cover certain compositions and methods using pulsatile dosing.
We also own 26 pending international patent applications
corresponding to these U.S. patents and applications.




Government Regulation

We are subject to extensive pre- and post-market
regulation by the FDA, including regulations that govern the
testing, manufacturing, safety, efficacy, labeling, storage,
record keeping, advertising, and promotion of drugs

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under the Federal Food, Drug and Cosmetic Act and
the Public Health Services Act, and by comparable agencies in
foreign countries. FDA approval is required before any dosage
form of any new drug, a generic equivalent of a previously
approved drug, or a new combination of previously approved
drugs, can be marketed in the United States. All applications
for FDA approval must contain information relating to
pharmaceutical formulation, stability, manufacturing,
processing, packaging, labeling and quality control.




| |                             
| | ----------------------------
| | New Drug Application Process

The process required by the FDA before a new drug
may be marketed in the United States generally involves:



| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Completion of preclinical laboratory and animal
    testing.                                                                                               
|
| |  | Submission of an investigational new drug
    application (IND) which must become effective before the
    commencement of clinical trials.                
|
| |  | Performance of adequate and well-controlled human
    clinical trials to establish the safety and efficacy of the
    proposed drug products intended use.
|
| |  | Submission to and approval by the FDA of a New
    Drug Application (NDA).                                                                                 

PRECLINICAL:Preclinical studies generally include laboratory evaluation of
product chemistry, formulation and stability, as well as animal
studies, to assess the safety and efficacy of the product.
Preclinical trials also provide a basis for design of human
clinical studies.

Human clinical trials are typically conducted in
three sequential phases which may overlap:

PHASE I:During
Phase I studies, the drug is initially introduced into healthy
human subjects and tested for safety, dosage tolerance,
absorption, metabolism, distribution and excretion.

PHASE II:During
Phase II studies, the drug is introduced to patients that have
the medical condition that the drug is intended to treat. Phase
II studies are intended to identify possible adverse effects and
safety risks, to determine the efficacy of the product for
specific targeted diseases and to determine dosage tolerance and
optimal dosage. Phase II studies may often be combined with
Phase I studies (referred to as Phase I/ II studies) in certain
instances when safety issues may be less prevalent.

PHASE III:When
Phase II evaluations demonstrate that a dosage range of the
product is effective and has an acceptable safety profile, Phase
III trials are undertaken to further evaluate dosage, clinical
efficacy and to further test for safety in an expanded patient
population, often at geographically dispersed clinical study
sites.

The drug sponsor, the FDA or the institutional
review board at each institution at which a clinical trial is
being performed may suspend a clinical trial at any time for
various reasons, including a concern that the subjects are being
exposed to an unacceptable health risk.

The results of product development, preclinical
animal studies and human studies are submitted to the FDA as
part of the NDA. The NDA also must contain extensive
manufacturing information. The FDA may approve or disapprove the
NDA if applicable FDA regulatory criteria are not satisfied or
it may require additional clinical data to continue to evaluate
the NDA.

In our NDA submissions, we intend to rely, in
part, on prior FDA approvals of the antibiotic ingredients used
in our products and on data generated by other parties which
help to demonstrate the safety and effectiveness of those
ingredients. In the case of products that we may develop in
conjunction with sponsors of previously approved products, we
expect that we will have a specific right of reference to the
data contained in the prior applications. In any case in which
we do not have a specific right of reference from the sponsor of
the previously approved product, we anticipate our NDA
submissions would be covered by Section 505(b)(2) of the
Federal Food, Drug and Cosmetic Act. All data necessary to
satisfy the FDA of the safety and effectiveness of our own
versions of these products will have to be generated by or for
us and submitted to the FDA in support of our applications.
These data are expected to include data establishing the safety
and efficacy of the pulsatile dosage

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and any other differences between the dosage form
and the conditions for use of our products and the dosage form
and conditions for use of the previously approved products. In
the case of antibiotic ingredients not previously approved to be
manufactured and sold in the combinations that we propose, it
will also be necessary for us to satisfy the FDAs
combination drug policy with data establishing that each active
component contributes to the effectiveness of the combination
and that the dosage of each component is such that the
combination is safe and effective for a significant patient
population requiring such concurrent therapy. In its review of
our NDA submissions, the FDA will have broad discretion to
require us to generate data on these matters, and it is
impossible to predict the number or nature of the studies that
may be required before the agency will grant an approval. No
assurance can be given that NDAs submitted for our products will
receive FDA approval on a timely basis, or at all.


In addition to the need to submit new clinical
data and other information sufficient to support the approval of
our NDA submissions, under certain circumstances there are
additional procedures that may need to be followed, and
limitations that may apply, to the submission or approval of a
NDA covered by Section 505(b)(2) of the Federal Food, Drug
and Cosmetic Act. However, these procedures and limitations will
not apply to the products in our development pipeline which
contain active ingredients that are classified by FDA as
antibiotics and that were the subject of approval applications
submitted to FDA prior to November 21, 1997. The only
active ingredients which are being considered in our current
development projects which do not fall within this exempt
antibiotic category are metronidazole, and fluoroquinolones such
as ciprofloxacin. Of these, at the present time, we do not
believe that the applicable limitations will have any effect on
our metronidazole development projects. With respect to products
containing fluoroquinolones such as ciprofloxacin, in the
absence of a licensing agreement, any application for approval
that we submit to FDA may need to include statutorily-required
certifications regarding our non-infringement of certain patents
covering previously approved products, we may be required to
notify the original NDA holder and patent holder of those
filings, and we may be subject to approval delays of up to
30-months, or longer, in the event that the patent holder brings
suit against us for patent infringement within 45 days of
such notifications.

Because all of the products that we have in
development, other than our products that would contain only
metronidazole or fluoroquinolone ingredients such as
ciprofloxacin, contain antibiotic ingredients that were
submitted to the FDA for approval prior to November 21,
1997, we will not, under current law, be able to submit to the
FDA patent information covering those products. Therefore, once
approved, the FDAs Orange Book, which lists patent
information on drug products, will not include patent
information on those products. As a consequence, potential
competitors who submit 505(b)(2) or ANDA applications for
generic versions of those products will not have to provide
certifications regarding any of our patents that they may
infringe or to provide us notice if they intend to market their
products prior to expiration of those patents. Additionally, if
we bring a patent infringement action against any such
applicants, an automatic 30-month stay of approval of those
potentially infringing products will not be granted. However, we
would be entitled to pursue traditional patent-law procedures
and remedies, such as preliminary and permanent injunctions. In
the case of potential generic versions of any of our products
that are not classified as exempt antibiotics, such as those
containing only metronidazole or fluoroquinolone ingredients
such as ciprofloxacin, we would be entitled to list our
applicable patents in the Orange Book, potential competitors who
submit 505(b)(2) or ANDA applications for generic version of
those products would be subject to the certification and notice
requirements, and we could obtain automatic 30-month stays of
approval of the generic products while we pursue patent
infringement actions against the applicants.

Under the Prescription Drug User Fee Act
(PDUFA) generally, the submission of an NDA is subject to
substantial application user fees, currently exceeding $500,000,
and the manufacturer and/or sponsor under an approved NDA are
also subject to annual product and establishment user fees,
currently exceeding $30,000 per product and $200,000 per
establishment. These fees are typically increased annually.
Because our products in development contain only active
ingredients that have been previously approved in other
applications for the same usage indications we intend to seek
approval for, we do not believe that we should be subject to any
of these user fees. However, FDA has adopted a broad
interpretation of the scope of the user fee requirements and,
even if we disagree with the legal basis for that
interpretation, we may be required to pay these fees with
respect to some or all of our products unless and until
FDAs interpretation is successfully challenged.
Nevertheless, we believe that

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the first NDA submission for our pulsatile drug
products will be eligible for a waiver of the application fee
because of our status as a small business under the user fee
statutes. In addition, the PDUFA statute has been subject to
significant amendments in connection with its regular
reauthorization. We are not in a position to predict whether and
how the user fee requirements will be interpreted and applied to
us and our products in the future.




| |                                             
| | --------------------------------------------
| | Abbreviated New Drug Application
    Process

The Drug Price Competition and Patent Term
Restoration Act of 1984, or the Hatch-Waxman Act, established
abbreviated FDA approval procedures for those proprietary drugs
that are no longer protected by patents and which are shown to
be equivalent to previously approved proprietary drugs. Approval
to manufacture these drugs is obtained by filing an abbreviated
new drug application (ANDA). An ANDA is a submission that
contains data and information pertaining to the active
pharmaceutical ingredient, drug product formulation,
specifications and stability of the generic drug, as well as
analytical methods, manufacturing process validation data and
quality control procedures. As a substitute for clinical safety
and efficacy data on the product, the applicant is generally
required to provide data from studies in humans establishing
that the ANDA drug formulation is bioequivalent to the
previously approved proprietary drug. A product is not eligible
for ANDA approval if it is not determined by the FDA to be
equivalent to the referenced brand-name drug or if it is
intended for a different use. However, such a product might be
approved under an NDA with supportive data from clinical trials.

One advantage of the ANDA approval process is
that an ANDA applicant generally can rely upon equivalence data
in lieu of conducting preclinical testing and clinical trials to
demonstrate that a product is safe and effective for its
intended use. We intend to follow this process with respect to
our generic clarithromycin product. We do not believe that our
generic clarithromycin product will infringe any outstanding
patent after expiration of the clarithromycin API patent.
Therefore because that product uses an active antibiotic
ingredient first submitted to the FDA for approval prior to
November 20, 1997, we will not have to submit certifications
with respect to outstanding patents covering Biaxin XL and will
not be subject to a potential 30-month stay of the approval of
our product in the event that the holder(s) of those patents
choose to bring a patent infringement claim against us. However,
traditional patent law procedures and remedies may be pursued by
the patent holders, including preliminary and permanent
injunctions against marketing of our product and damages for
marketing an infringing product. Therefore, because of the
inapplicability of the patent listing and certification
procedures, resolution of potential patent infringement claims
with respect to our product may be impossible until after we
have obtained approval of our ANDA. This may cause delays in our
ability or willingness to market the product upon ANDA approval
and/or may subject us to a risk of substantial monetary damages
in the event that we market the product prior to the resolution
of any infringement claims that may be made.

No assurance can be given that any ANDA submitted
for any of our products will receive FDA approval on a timely
basis, if at all, or that the FDA will not require us to submit
NDAs for products that we believe are eligible for ANDA
submission.

Satisfaction of FDA pre-market approval
requirements typically takes several years and the actual time
required may vary substantially based upon the type, complexity
and novelty of the product or the medical condition it is
intended to treat. Government regulation may delay or prevent
marketing of potential products for a considerable period of
time and impose costly procedures upon a manufacturers
activities. Success in early stage clinical trials does not
assure success in later stage clinical trials. Data obtained
from clinical activities is not always conclusive and may be
susceptible to varying interpretations that could delay, limit
or prevent regulatory approval.

Once approved, a product approval may be
withdrawn if compliance with pre-and post-market regulatory
standards is not maintained or if problems are identified at a
later date. In addition, the FDA may require post-marketing
studies to monitor the safety and/or effectiveness of approved
products and may limit further marketing of the product based on
the results of these post-marketing studies. The FDA has broad
post-market regulatory and enforcement powers, including the
ability to levy fines and civil penalties, suspend or delay
issuance of approvals, seize or recall products, and withdraw
approvals.

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The FDA also strictly regulates the promotional
claims that may be made about prescription drug products. In
particular, the FDA requires substantiation of any claims of
superiority of one product over another including, in many
cases, requirements that such claims be proven by adequate and
well- controlled head-to-head clinical trials. To the extent
that market acceptance of our products may depend on their
superiority over existing therapies, any restriction on our
ability to advertise or otherwise promote claims of superiority,
or requirements to conduct additional expensive clinical trials
to provide proof of such claims, could negatively affect the
sales of our products and/or our costs.

From time to time, including presently,
legislation is drafted and introduced that could significantly
change the statutory provisions governing the approval,
manufacturing and marketing of drug products. In addition, FDA
regulations and guidance are often revised or reinterpreted by
the agency in ways that may significantly affect our business
and our products. It is impossible to predict whether
legislative changes will be enacted, or FDA regulations,
guidance or interpretations changed, or what the impact of such
changes, if any, may be.

We and our products are also subject to numerous
federal, state and local laws relating to such matters as safe
working conditions, manufacturing practices, environmental
protection, and disposal of hazardous or potentially hazardous
substances. We may incur substantial costs to comply with such
laws and regulations now or in the future.



| |                            
| | ---------------------------
| | Foreign Regulatory Approval

Outside the United States, our ability to market
our products will also be contingent upon receiving marketing
authorizations from the appropriate regulatory authorities. The
foreign regulatory approval process includes all the risks
associated with FDA approval described above. The requirements
governing conduct of clinical trials and marketing authorization
vary widely from country to country.

Under European Union regulatory systems,
marketing authorizations may be submitted either under a
centralized or decentralized procedure. The centralized
procedure provides for the grant of a single marketing
authorization that is valid for all European Union member
states. The decentralized procedure provides for mutual
recognition of national approval decisions. Under this
procedure, the holder of a national marketing authorization may
submit an application to the remaining member states. Within
90 days of receiving the application and assessment report,
each member state must decide whether to recognize approval. We
plan to choose the European regulatory filing procedure that we
believe will allow us to obtain regulatory approvals quickly.
However, the chosen regulatory strategy may not secure
regulatory approvals or approvals of the chosen product
indications. In addition, these approvals, if obtained, may take
longer than anticipated.

We cannot assure you that any of our product
candidates will prove to be safe or effective, will receive
regulatory approvals, or will be successfully commercialized.




Employees

As of February 17, 2004, we had 81
employees, 18 of whom are senior management, 31 are in
supervisory positions and 32 are non-management. Of the 81
employees, 50 perform scientific and research activities and 23
hold advanced degrees.




FACTORS THAT MAY AFFECT OUR BUSINESS

There are a number of important factors that
could cause our actual results to differ materially from those
that are indicated by forward-looking statements. Those factors
include, without limitation, those listed below and elsewhere
herein.




Risks Related to our Business



| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | We expect to incur losses for the
    foreseeable future and may never become
    profitable.

From the date we began operations in
January 2000 through December 31, 2003, we have
incurred operating losses of approximately $42.7 million,
including operating losses of approximately $19.4 million
for the fiscal

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year ended December 31, 2003,
$14.2 million for the fiscal year ended December 31,
2002 and $7.3 million for the fiscal year ended
December 31, 2001. Our losses to date have resulted
principally from research and development costs related to the
development of our product candidates, the purchase of equipment
and establishment of our facilities and general and
administrative costs related to our operations.


We expect to incur substantial losses for the
foreseeable future as a result of increases in our research and
development costs, including costs associated with conducting
preclinical testing and clinical trials, and regulatory
compliance activities.

Our chances for achieving profitability will
depend on numerous factors, including success in:



| |   |                                                             
| | - | ------------------------------------------------------------
| |  | developing and testing product candidates;                  
|
| |  | achieving milestones under our collaboration
    agreements;
|
| |  | receiving regulatory approvals;                             
|
| |  | developing proprietary antibiotic products;                 
|
| |  | commercializing our products; and                           
|
| |  | establishing our competitive position.                      

Many of these factors will depend on
circumstances beyond our control. We cannot assure you that we
will ever become profitable.



| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Substantially all of our product candidates
    are based on a finding that could ultimately prove to be
    incorrect, or could have limited applicability.

Substantially all of our product candidates are
based on our finding that bacteria exposed to antibiotics in
front-loaded, rapid sequential bursts are eliminated more
efficiently and effectively than those exposed to presently
available treatment regimens. We have not identified with
certainty the actual scientific mechanism that produces the
finding that pulsatile delivery of antibiotics is more effective
than standard treatment regimens, and we have only limited
results from clinical trials involving this finding in humans.
While preliminary studies in animals have supported our finding
that pulsatile delivery of antibiotics is more effective than
standard treatment regimens, no clinical trials testing efficacy
in humans have commenced. Ultimately, our finding may be
incorrect, in which case our pulsatile drugs would not differ
substantially from competing drugs and may be inferior to them.
If these products are substantially identical or inferior to
products already available, the market for our pulsatile drugs
will be reduced or eliminated.

Even if pulsatile dosing is more effective than
ordinary dosing, we may be unable to apply this finding
successfully to a substantial number of products in the
anti-infective market. Our preliminary studies indicate that
pulsatile dosing may not provide superior performance for all
types of antibiotics. Additionally, we have not conducted any
studies with anti-viral or anti-fungal medications. If we cannot
apply our technology to a wide variety of antibiotics or other
anti-infectives, our potential market will be substantially
reduced.



| |                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our delivery technology may not be
    effective, which would prevent us from commercializing products
    that are more effective than those of our
    competitors.

Even if we are correct that pulsatile dosing is
more effective than ordinary dosing of antibiotics, our delivery
technology must be effective in humans for the administration of
pulses at an appropriate level. If our PULSYS delivery
technology is not effective in delivering rapid bursts of
antibiotics, or is unable to do so at an appropriate level, and
we are not able to create an alternative delivery method for
pulsatile dosing that proves to be effective, we will be unable
to capitalize on any advantage of our discovery. Should this
occur, our pulsatile product candidates may not be more
effective that those of our competitors, which may decrease or
eliminate market acceptance of our products.

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| |                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If a competitor produces and commercializes
    an antibiotic that is superior to our pulsatile antibiotics, the
    market for our potential products would be reduced or
    eliminated.

We have devoted a substantial amount of our
research efforts and capital to the development of pulsatile
antibiotics. We are aware that Aventis S.A. is developing Ketek,
a drug that belongs to a new class of antibiotics known as
ketolides. This antibiotic may compete against our pulsatile
antibiotics in the treatment of upper respiratory tract
infections. A number of pharmaceutical companies are also
developing new classes of compounds, such as oxazolidinones,
that may also compete against our pulsatile antibiotics. In
addition, other companies are developing technologies to enhance
the efficacy of antibiotics by adding new chemical entities that
inhibit bacterial metabolic function. If a competitor produces
and commercializes an antibiotic or method of delivery of
antibiotics that provides superior safety, effectiveness or
other significant advantages over our pulsatile antibiotics, the
value of our pulsatile drugs would be substantially reduced. As
a result, we would need to conduct substantial new research and
development activities to establish new product targets, which
would be costly and time consuming. In the event we are unable
to establish new product targets, we will be unable to generate
sources of revenue.



| |                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have not commissioned an extensive third
    party patent infringement, invalidity and enforceability
    investigation on pulsatile dosing and we are aware of one issued
    patent covering pulsatile delivery.

Our patents, prior art and infringement
investigations were primarily conducted by our senior management
and other employees. Although our patent counsel has consulted
with management in connection with managements
intellectual property investigations, our patent counsel has not
undertaken an extensive independent analysis to determine
whether our pulsatile technology infringes upon any issued
patents or whether our issued patents or patent applications
covering pulsatile dosing could be invalidated or rendered
unenforceable for any reason. We are aware of one issued patent
owned by a third party that covers certain aspects of delivering
drugs by use of two delayed release pulses. The patent covers a
drug delivery system employing two delayed release pulses using
two polymers. The claims made by this patent could be argued to
cover certain aspects of our technology. However, we believe
that we will be able to manufacture and market formulations of
our pulsatile products without infringing any valid claims under
this patent. Any reformulation of our products, if required,
could be costly and time-consuming and may not be possible. We
cannot assure you that a claim will not be asserted by such
patent holder or any other holder of an issued patent that any
of our products infringe their patent or that our patents are
invalid or unenforceable. We may be exposed to future litigation
by third parties based on claims that our products or activities
infringe the intellectual property rights of others. We cannot
assure you that, in the event of litigation, any claims would be
resolved in our favor. Any litigation or claims against us,
whether or not valid, may result in substantial costs, could
place a significant strain on our financial resources, divert
the attention of management and harm our reputation. In
addition, intellectual property litigation or claims could
result in substantial damages and force us to do one or more of
the following:



| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | cease selling, incorporating or using any of our
    products that incorporate the challenged intellectual property;                                                         
|
| |  | obtain a license from the holder of the infringed
    intellectual property right, which license may be costly or may
    not be available on reasonable terms, if at all; or
|
| |  | redesign our products, which would be costly and
    time-consuming and may not be possible.                                                                                 



| |                                                                                 
| | --------------------------------------------------------------------------------
| | Our generic clarithromycin product may face
    intellectual property challenge.

Currently, clarithromycin is covered by a series
of patents that are owned or controlled by a company having
substantially greater financial and other resources than us. We
do not intend to market any clarithromycin products until the
patent covering the active pharmaceutical ingredient
(API) for clarithromycin expires in 2005, at which time we
intend to commercialize a generic, extended release
clarithromycin product. We have licensed to Par Pharmaceutical
the right to distribute and market this generic clarithromycin
product. Under our agreement with Par Pharmaceutical, it has the
right to refrain from any marketing activities upon the
occurrence of certain events, such as the assertion of patent
infringement claims. In addition, subject to a limited
exception, we will be obligated to pay for one-half of any
costs, expenses or damages resulting from any claims for patent

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infringement. We are aware of a U.S. patent
covering an extended release clarithromycin product and we are
also aware of issued patents relating to the production of
clarithromycin products. We believe that we will be able to
manufacture and market a formulation of a clarithromycin product
without infringing these patents. In the event a claim is
brought against us, our distributors, licensees or collaborators
for patent infringement, we cannot assure you that any legal
proceedings would be resolved in our favor. If such a dispute
were resolved against us, in addition to potential damages,
which could be substantial, the commercial manufacture or sale
of our generic clarithromycin product candidate could be
enjoined unless a license were obtained. There can be no
assurances that if a license is required, such license would be
made available on terms acceptable to us, or at all. Any claim
of patent infringement may involve substantial expenditures and
divert the time and effort of management.




| |                                                                                
| | -------------------------------------------------------------------------------
| | We have not sought patent protection for
    certain aspects of our technology.

We have not filed for patent protection with
respect to specific formulations, materials (including inactive
ingredients) or manufacturing process approaches that are
incorporated in our individual pulsatile antibiotic products,
and we may not seek such patent coverage in the future. In
producing our pulsatile antibiotics, we expect to use general
formulation techniques used in the industry that would be
modified by us and which would, therefore, include know-how and
trade secrets that we have developed. We cannot be certain that
a patent would issue to cover such intellectual property and
currently, we would prefer to keep such techniques and know-how
as our trade secrets. In the event a competitor is able to
develop technology substantially similar to ours and patent that
approach, we may be blocked from using certain of our
formulations or manufacturing process approaches, which could
limit our ability to develop and commercialize products.



| |                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to develop and
    successfully commercialize our product candidates, we may never
    achieve profitability.

We have not commercialized any products or
recognized any revenue from product sales. All of our pulsatile
drugs are in early stages of development and currently only four
pulsatile product candidates are being tested in Phase I/ II
clinical trials. We expect that we must conduct significant
additional research and development activities before we will be
able to receive final regulatory approval to commercialize any
pulsatile products. We must successfully complete Phase I/ II
clinical trials, commence and successfully complete Phase III
clinical trials and obtain regulatory approval for our pulsatile
drugs before we are able to generate revenue from their sales.
Even if we succeed in developing and commercializing one or more
of our pusatile drugs, we may never generate sufficient or
sustainable revenue to enable us to be profitable.



| |                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not successfully attract and
    retain collaborative partners, or our partners do not satisfy
    their obligations, we will be unable to develop our partnered
    product candidates.

During the early stages of our development, we
intend to enter into collaborative arrangements with third
parties to develop certain product candidates. These
collaborations may be necessary in order for us to:



| |   |                                                   
| | - | --------------------------------------------------
| |  | fund our research and development activities;     
|
| |  | fund manufacturing by third parties;              
|
| |  | seek and obtain regulatory approvals; and         
|
| |  | successfully commercialize our product candidates.

Currently, we have collaborative agreements with
GSK and Par Pharmaceutical. In connection with the GSK
agreement, we have granted to GSK certain rights regarding the
use of patents and our PULSYS technology with
amoxicillin/clavulanate combination products and certain other
amoxicillin products, including development and marketing
rights. In connection with the Par Pharmaceutical agreement, we
have licensed to Par Pharmaceutical the distribution and
marketing rights to our generic clarithromycin product. We do
not have day-to-day control over the activities of GSK or Par
Pharmaceutical with respect to any such product candidates. We
cannot assure you that GSK or Par Pharmaceutical will fulfill
their respective obligations under these agreements. If GSK
fails to fulfill its obligations under our agreement, we may be
unable to assume the development of the products covered by that
agreement or enter into alternative arrangements with a third
party. If Par Pharmaceutical fails to

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fulfill its obligations under our agreement, we
may encounter delays in the commercialization of our generic
clarithromycin product. Accordingly, our ability to receive any
revenue from the product candidates covered by these agreements
is dependent on the efforts of GSK and Par Pharmaceutical. We
could also become involved in disputes with GSK or Par
Pharmaceutical, which could lead to delays in or termination of
our development and commercialization programs and
time-consuming and expensive litigation or arbitration. The GSK
agreement provides for the payment of royalties in each country
for at least ten years from the date of the first commercial
sale of any licensed product in such country, but the agreement
may be terminated at any time by GSK upon relatively short
notice or terminated by either party upon a material breach of
the agreement by, or the bankruptcy of, the other party. The Par
Pharmaceutical agreement has an indefinite term, but may be
terminated at any time by Par Pharmaceutical upon relatively
short notice. If either GSK or Par Pharmaceutical terminates or
breaches its agreement, or otherwise fails to complete its
obligations in a timely manner, our chances of successfully
developing or commercializing these product candidates would be
materially and adversely affected.


In addition, the growth of our business and
development of additional product candidates may require that we
seek additional collaborative partners. For example, in
March 2004, we entered into a letter of intent to develop
and commercialize our pulsatile amoxicillin product with Par
Pharmaceutical. We cannot assure you that we will be able to
enter into this or other collaborative agreements with partners
on terms favorable to us, or at all, and any future agreement
may expose us to similar risks that we face under our existing
agreements with GSK and Par Pharmaceutical. Our inability to
enter into additional collaborative arrangements with other
partners, or our failure to maintain such arrangements, would
limit the number of product candidates which we could develop
and ultimately, decrease our sources of any future revenues.



| |                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------
| | If we cannot enter into new licensing
    arrangements, our ability to develop a diverse product portfolio
    could be limited.

A component of our business strategy is
in-licensing drug compounds developed by other pharmaceutical
and biotechnology companies or academic research laboratories
that may be marketed and developed or improved upon using our
novel technologies. Competition for promising compounds can be
intense and currently we have not entered into any arrangement
to license any drugs from other companies. If we are not able to
identify licensing opportunities or enter into licensing
arrangements on acceptable terms, we will be unable to develop a
diverse portfolio of products.



| |                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------
| | Our executive officers and other key
    personnel are critical to our business and our future success
    depends on our ability to retain them.

We are highly dependent on the principal members
of our scientific and management teams, including Edward M.
Rudnic, our president and chief executive officer, Steven A.
Shallcross, our senior vice president and chief financial
officer, Kevin S. Sly, our senior vice president, business
development and strategic marketing and Colin E. Rowlings, our
senior vice president, pharmaceutical research and development.
In order to pursue our product development, marketing and
commercialization plans, we will need to hire additional
personnel with experience in clinical testing, government
regulation, manufacturing, marketing and business development.
We may not be able to attract and retain personnel on acceptable
terms given the intense competition for such personnel among
biotechnology, pharmaceutical and healthcare companies,
universities and non-profit research institutions. We are not
aware of any present intention of any of our key personnel to
leave our company or to retire. However, although we have
employment agreements with our executive officers, these
employees may terminate their services upon 90 days
advance notice. The loss of any of our key personnel, or the
inability to attract and retain qualified personnel, may
significantly delay or prevent the achievement of our research,
development or business objectives and could materially
adversely affect our business, financial condition and results
of operations. Although we maintain key man life insurance on
Dr. Rudnic, such insurance may not be sufficient to cover
the costs of the loss of his services and the expense of
recruiting and hiring a new president and chief executive
officer.

22



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| |                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to complete clinical trials and
    ultimately, commercialize products will be delayed if we are
    unable to obtain sufficient APIs or finished products from
    certain suppliers.

We obtain active pharmaceutical ingredients
(APIs) from certain specialized manufacturers for use in
clinical studies that we intend to conduct without assistance
from collaborative partners. Although the antibiotics and
finished products we use in our clinical studies may be obtained
from several suppliers, our applications for regulatory approval
may authorize only one supplier as our source. In the event an
authorized supplier in an application for regulatory approval
loses its regulatory status as an acceptable source or otherwise
becomes unable or unwilling to supply the API to us at a
commercially reasonable price, we would need to locate another
source. A change to a supplier not previously approved in our
application for regulatory approval or an alteration in the
procedures or product provided to us by an approved supplier may
require formal approval by the U.S. Food and Drug Administration
(FDA) before we could use the API in the production of
commercial supplies for our products or use the finished product
for commercialization. These factors could result in delays in
conducting or completing our clinical trials and delay our
ability to commercialize products.



| |                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------
| | Clinical trials for our product candidates
    may be delayed due to our dependence on third parties for the
    conduct of such trials.

We have limited experience in conducting and
managing clinical trials. We rely, and will continue to rely, on
third parties, including our collaborative partners, clinical
research organizations and outside consultants, to assist us in
managing and monitoring clinical trials. Our reliance on these
third parties may result in delays in completion of, or the
failure to complete, these trials if they fail to perform their
obligations under our agreements.



| |                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If clinical trials for our products are
    unsuccessful or delayed, we will be unable to meet our
    anticipated development and commercialization
    timelines.

We must demonstrate through pre-clinical testing
and clinical trials that our product candidates are safe and
effective for use in humans before we can obtain regulatory
approvals for their commercial sale. In addition, if we make
claims of superiority over existing products, we will need to
prove such claims in additional clinical trials. For drug
products such as our amoxicillin/clarithromycin combination
product which contains active ingredients in fixed combinations
that have not been previously approved by the FDA, clinical
studies may also need to be conducted in order to establish the
contribution of each active component to the effectiveness of
the combination in an appropriately identified patient
population.

Conducting clinical trials is a lengthy,
time-consuming and expensive process. Currently we only have
four pulsatile drug products in Phase I/ II clinical trials and
we have not completed such trials and additional studies in
animals to extrapolate proper dosage for Phase III clinical
efficacy trials in humans. In the event we incorrectly identify
a dosage as appropriate for human clinical trials, any results
we receive from such trials may not properly reflect the actual
efficacy or safety of our products. Furthermore, we do not
expect to have results from Phase III clinical efficacy trials
in humans until at least 2005.

The commencement and rate of completion of
clinical trials for our products may be delayed by many factors,
including:



| |   |                                                         
| | - | --------------------------------------------------------
| |  | lack of efficacy during the clinical trials;            
|
| |  | unforeseen safety issues;                               
|
| |  | slower than expected rate of patient recruitment;
    or
|
| |  | government or regulatory delays.                        

The results from pre-clinical testing and early
clinical trials are often not predictive of results obtained in
later clinical trials. Although a new product may show promising
results in pre-clinical and initial clinical trials, it may
subsequently prove unfeasible or impossible to generate
sufficient safety and efficacy data to obtain necessary
regulatory approvals. Data obtained from preclinical and
clinical studies are susceptible to varying interpretations,
which may delay, limit or prevent regulatory approval. In
addition, we may encounter regulatory

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delays or rejections as a result of many factors,
including results that do not support our claims, perceived
defects in the design of clinical trials and changes in
regulatory policy during the period of product development. Our
business, financial condition and results of operations may be
materially adversely affected by any delays in, or termination
of, our clinical trials or a determination by the FDA that the
results of our trials are inadequate to justify regulatory
approval.




| |                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may be unable to demonstrate the
    bio-equivalence of our generic clarithromycin product, which may
    delay or prevent our filing of an ANDA and the eventual
    commercialization of the product.

In the fourth quarter of 2003, we received
results from certain bio-equivalency studies of our generic
clarithromycin product and in February 2004 received results
from a more extensive bio-equivalency study using the same
formulation of the product. The initial study of 40 subjects
indicated that the product satisfies all bio-equivalency
standards established by the FDA when the product is taken with
food, which is consistent with the instructions on the product
label. However, in an initial study of 34 subjects and the
expanded 132-subject study completed in February, the product
narrowly missed one of the bio-equivalency standards when taken
in the non-recommended, fasted state. While the peak
drug concentration for our product fell below the confidence
interval needed to statistically meet the bio-equivalence
standard under this scenario, our product demonstrated a more
sustained release profile than the branded (Abbott) counterpart.
We intend to pursue a new bio-equivalency study with an adjusted
formulation of the product, designed to modify the release
profile of the product to more closely correspond to Biaxin XL
and meet the standard for bio-equivalence. If the new
bio-equivalency study proceeds as anticipated, we expect to make
an ANDA filing by the third quarter of 2004, and to ultimately
launch the product in the second half of 2005. As Abbotts
relevant patent for Biaxin XL expires in the second half of
2005, we anticipate that we will be able to launch our generic
product shortly following the patent expiration. However, we can
provide no assurance that any generic product will be launched
in such time frame, or at all.



| |                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need additional capital in the
    future. If additional capital is not available, we may be forced
    to delay or curtail the development of our product
    candidates.

We anticipate that our existing capital
resources, including the net proceeds of this offering, and
interest earned on such proceeds, will enable us to maintain our
current operations for at least the next 24 months. Our
requirements for additional capital may be substantial and will
depend on many other factors, including:



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | successful commercialization of our generic
    formulation of Biaxin XL;      
|
| |  | payments received under present or future
    collaborative partner agreements;
|
| |  | continued progress of research and development of
    our pulsatile drugs;     
|
| |  | our ability to license drugs from others for use
    with PULSYS;              
|
| |  | costs associated with protecting our intellectual
    property rights;         
|
| |  | development of marketing and sales capabilities;
    and                       
|
| |  | market acceptance of our products.                                             

We have no significant committed sources of
additional capital. To the extent our capital resources are
insufficient to meet future capital requirements, we will have
to raise additional funds to continue the development of our
product candidates. We cannot assure you that funds will be
available on favorable terms, if at all. To the extent we raise
additional capital through the sale of securities, the issuance
of those securities could result in dilution to our
stockholders. In addition, if we obtain debt financing, a
substantial portion of our operating cash flow may be dedicated
to the payment of principal and interest on such indebtedness,
thus limiting funds available for our business activities. If
adequate funds are not available, we may be required to curtail
significantly our development and commercialization activities.

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| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | We could be forced to pay substantial
    damage awards if product liability claims that may be brought
    against us are successful.

The use of any of our product candidates in
clinical trials, and the sale of any approved products, may
expose us to liability claims and financial losses resulting
from the use or sale of our products. We have obtained limited
product liability insurance coverage for our clinical trials,
which we believe is adequate to cover our present activities.
However, such insurance may not be adequate to cover any claims
made against us. In addition, we may not be able to maintain
insurance coverage at a reasonable cost or in sufficient amounts
or scope to protect us against losses.



| |                                                                                                    
| | ---------------------------------------------------------------------------------------------------
| | If our products are not accepted by the
    market, our revenues and profitability will
    suffer.

Even if we obtain regulatory approval to market
our products, our products may not gain market acceptance among
physicians, patients, healthcare payors and the medical
community. The degree of market acceptance of any pharmaceutical
product that we develop will depend on a number of factors,
including:



| |   |                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------
| |  | demonstration of clinical efficacy and safety;                                                                                                
|
| |  | cost-effectiveness; potential advantages over
    alternative therapies;                                                                      
|
| |  | reimbursement policies of government and
    third-party payors; and                                                                          
|
| |  | effectiveness of our marketing and distribution
    capabilities and the effectiveness of such capabilities of our
    collaborative partners.

Our product candidates, if successfully
developed, will compete with a number of products manufactured
and marketed by major pharmaceutical companies, biotechnology
companies and manufacturers of generic drugs. Our products may
also compete with new products currently under development by
others. Physicians, patients, third-party payors and the medical
community may not accept and use any product candidates that we
or our collaborative partners develop. To the extent current
antibiotics already successfully treat certain infections,
physicians may not be inclined to prescribe our pulsatile drugs
for the same indications. If our products do not achieve
significant market acceptance, we will not be able to generate
significant revenues or become profitable.



| |                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our ability to conduct clinical trials will
    be impaired if we fail to qualify our clinical supply
    manufacturing facility and we are unable to maintain
    relationships with current clinical supply manufacturers or
    enter into relationships with new manufacturers.

We currently rely on several contractors to
manufacture product samples for our clinical studies that we
intend to conduct without assistance from collaborative
partners. In the fourth quarter of 2003, we completed
construction of a manufacturing facility for production of
clinical supplies sufficient for use through our Phase II and,
in some cases, Phase III clinical trials. We expect this
facility to be qualified and operational in 2004. We have no
experience qualifying manufacturing facilities and we may not be
able to qualify such facility at the currently anticipated
schedule. If we are unsuccessful in qualifying our own
manufacturing facility and fail to maintain our relationships
with our current clinical supply manufacturers or enter into
relationships with new manufacturers, we will be unable to
conduct our clinical trials effectively.

We intend to rely on third-parties to manufacture
products that we intend to sell through our own
commercialization and sales efforts. We believe that there are a
variety of manufacturers that we may retain to produce these
products. However, once we retain a manufacturing source, if we
are unable to maintain our relationship with such manufacturer,
qualifying a new manufacturing source will be time consuming and
expensive, and may cause delays in the development of our
products.



| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to establish marketing, sales
    and distribution capabilities, or fail to enter into
    arrangements with third parties, we will not be able to
    commercialize our products.

We do not have any sales, marketing or
distribution capabilities. In order to commercialize any product
candidates that receive final regulatory approval, we must
either acquire or develop an internal marketing and sales force
with technical expertise and with supporting distribution
capabilities or make arrangements with third

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parties to perform these services for us. In
order to market any of our product candidates directly, we must
either acquire or develop a sales and distribution
infrastructure. The acquisition or development of a sales and
distribution infrastructure would require substantial resources,
which may divert the attention of our management and key
personnel, and defer our product development efforts. To the
extent that we enter into marketing and sales arrangements with
other companies, our revenues will depend on the efforts of
others. These efforts may not be successful. If we fail to
develop sales, marketing and distribution channels, or enter
into arrangements with third parties, we will experience delays
in product sales and incur increased costs.





Risks Related to our Industry



| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Any inability to protect our intellectual
    property could harm our competitive position.

Our success will depend in part on our ability to
obtain patents and maintain adequate protection of other
intellectual property for our technologies and products in the
U.S. and other countries. If we do not adequately protect our
intellectual property, competitors may be able to use our
technologies and erode or negate our competitive advantage.
Further, the laws of some foreign countries do not protect our
proprietary rights to the same extent as the laws of the U.S.,
and we may encounter significant problems in protecting our
proprietary rights in these foreign countries.

The patent positions of pharmaceutical and
biotechnology companies, including our patent positions, involve
complex legal and factual questions and, therefore, validity and
enforceability cannot be predicted with certainty. Patents may
be challenged, deemed unenforceable, invalidated or
circumvented. We will be able to protect our proprietary rights
from unauthorized use by third parties only to the extent that
we cover our proprietary technologies with valid and enforceable
patents or we effectively maintain such proprietary technologies
as trade secrets. We will apply for patents covering both our
technologies and product candidates as we deem appropriate. We
may fail to apply for patents on important technologies or
products in a timely fashion, or at all, and in any event, the
applications we do file may be challenged and may not result in
issued patents. Any future patents we obtain may not be
sufficiently broad to prevent others from practicing our
technologies or from developing competing products. Furthermore,
others may independently develop similar or alternative
technologies or design around our patented technologies. In
addition, if challenged, our patents may be declared invalid.
Even if valid, our patents may fail to provide us with any
competitive advantages.

We rely upon trade secrets protection for our
confidential and proprietary information. We have taken measures
to protect our proprietary information; however, these measures
may not provide adequate protection. We seek to protect our
proprietary information by entering into confidentiality
agreements with employees, collaborators and consultants.
Nevertheless, employees, collaborators or consultants may still
disclose our proprietary information, and we may not be able to
meaningfully protect our trade secrets. In addition, others may
independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to our trade
secrets.

If
we do not compete successfully in the development and
commercialization of products and keep pace with rapid
technological change, we will be unable to capture and sustain a
meaningful market position.

The biotechnology and pharmaceutical industries
are highly competitive and subject to significant and rapid
technological change. While we are not aware of any company
using rapid bursts of antibiotics as a treatment method, there
are numerous companies actively engaged in the research and
development of anti-infectives.

Our main competitors are:



| |   |                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | large pharmaceutical companies, such as GSK,
    Pfizer, Johnson & Johnson, Aventis, Abbott Laboratories,
    AstraZeneca, Bayer, Bristol-Myers Squibb and Merck, that may
    develop new drug compounds that render our drugs obsolete or
    noncompetitive;
|
| |  | smaller pharmaceutical and biotechnology
    companies and specialty pharmaceutical companies engaged in
    research and development of novel antibiotics, such as Cubist,
    Vicuron, InterMune and King; and                                               

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| |   |                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | drug delivery companies, such as Johnson &
    Johnsons Alza division, Biovail and SkyePharma, that may
    develop a dosing regimen that is more effective than pulsatile
    dosing.

Many of these competitors, either alone or
together with their collaborative partners, have substantially
greater financial resources and larger research and development
staffs than we do. In addition, many of these competitors,
either alone or together with their collaborative partners, have
significantly greater experience than we do in:



| |   |                                                                                    
| | - | -----------------------------------------------------------------------------------
| |  | developing products;                                                               
|
| |  | undertaking preclinical testing and human
    clinical trials;                     
|
| |  | obtaining approvals of products from the FDA and
    other regulatory agencies; and
|
| |  | manufacturing and marketing products.                                              

Developments by others may render our product
candidates or technologies obsolete or noncompetitive. We face
and will continue to face intense competition from other
companies for collaborative arrangements with pharmaceutical and
biotechnology companies, for establishing relationships with
academic and research institutions, and for licenses of products
or technology. These competitors, either alone or with their
collaborative partners, may succeed in developing technologies
or products that are more effective than ours.



| |                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we experience delays in obtaining
    regulatory approvals, or are unable to obtain or maintain
    regulatory approvals, we may be unable to commercialize any
    products.

Our product candidates are subject to extensive
and rigorous domestic government regulation. The FDA regulates,
among other things, the development, testing, manufacture,
safety, efficacy, record-keeping, labeling, storage, approval,
advertising, promotion, sale and distribution of pharmaceutical
products. If our products are marketed abroad, they will also be
subject to extensive regulation by foreign governments. None of
our product candidates has been approved for sale in the U.S. or
any foreign market. The regulatory review and approval process
takes many years, requires the expenditure of substantial
resources, involves post-marketing surveillance and may involve
ongoing requirements for post-marketing studies. The actual time
required for satisfaction of FDA pre-market approval
requirements may vary substantially based upon the type,
complexity and novelty of the product or the medical condition
it is intended to treat. Government regulation may delay or
prevent marketing of potential products for a considerable
period of time and impose costly procedures upon a
manufacturers activities. Delays in obtaining regulatory
approvals may:



| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | adversely affect the commercialization of any
    drugs that we or our collaborative partners develop;
|
| |  | impose costly procedures on us or our
    collaborative partners;                                     
|
| |  | diminish any competitive advantages that we or
    our collaborative partners may attain; and         
|
| |  | adversely affect our receipt of revenues or
    royalties.                                            

Success in early stage clinical trials does not
assure success in later stage clinical trials. Data obtained
from clinical activities is not always conclusive and may be
susceptible to varying interpretations that could delay, limit
or prevent regulatory approval.

Any required approvals, once obtained, may be
withdrawn. Further, if we fail to comply with applicable FDA and
other regulatory requirements at any stage during the regulatory
process, we may encounter difficulties including:



| |   |                                                                   
| | - | ------------------------------------------------------------------
| |  | delays in clinical trials or commercialization;                   
|
| |  | product recalls or seizures;                                      
|
| |  | suspension of production and/or distribution;                     
|
| |  | withdrawals of previously approved marketing
    applications; and
|
| |  | fines, civil penalties and criminal prosecutions.                 

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We expect to rely on certain of our collaborative
partners to file investigational new drug applications and
generally direct the regulatory approval process for many of our
products. These collaborative partners may not be able to
conduct clinical testing or obtain necessary approvals from the
FDA or other regulatory authorities for any product candidates.
If we fail to obtain required governmental approvals, we or our
collaborative partners will experience delays in, or be
precluded from, marketing products developed through our
research.

We and our contract manufacturers also are
required to comply with applicable FDA good manufacturing
practice regulations. Good manufacturing practice regulations
include requirements relating to quality control and quality
assurance as well as the corresponding maintenance of records
and documentation. Manufacturing facilities are subject to
inspection by the FDA. These facilities must be approved before
we can use them in commercial manufacturing of our products. We
or our contract manufacturers may not be able to comply with the
applicable good manufacturing practice requirements and other
FDA regulatory requirements. If we or our contract manufacturers
fail to comply, we could be subject to fines or other sanctions,
or be precluded from marketing our products.



| |                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------
| | The manufacture and storage of
    pharmaceutical and chemical products is subject to environmental
    regulation and risk.

Because of the chemical ingredients of
pharmaceutical products and the nature of their manufacturing
process, the pharmaceutical industry is subject to extensive
environmental regulation and the risk of incurring liability for
damages or the costs of remedying environmental problems. We use
a number of chemicals and drug substances that can be toxic to
humans. These chemicals include acids, solvents and other
reagents used in the normal course of our chemical and
pharmaceutical analysis, and other materials, such as polymers,
inactive ingredients and drug substances, used in the research,
development and manufacture of drug products. If we fail to
comply with environmental regulations to use, discharge or
dispose of hazardous materials appropriately or otherwise to
comply with the conditions attached to our operating licenses,
the licenses could be revoked and we could be subject to
criminal sanctions and/or substantial liability or could be
required to suspend or modify our operations.

Environmental laws and regulations can require us
to undertake or pay for investigation, clean-up and monitoring
of environmental contamination identified at properties that we
currently own or operate or that we formerly owned or operated.
Further, they can require us to undertake or pay for such
actions at offsite locations where we may have sent hazardous
substances for disposal. These obligations are often imposed
without regard to fault. In the event we are found to have
violated environmental laws or regulations, our reputation will
be harmed and we may incur substantial monetary liabilities. We
currently have insurance coverage that we believe is adequate to
cover our present activities. However, this insurance may not be
available or adequate to cover any losses arising from
contamination or injury resulting from our use of hazardous
substances.



| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | Market acceptance of our products will be
    limited if users of our products are unable to obtain adequate
    reimbursement from third-party payors.

The commercial success of our product candidates
will depend in part on the availability of reimbursement from
third-party payors, including government health administrators,
managed care providers and private health insurers. Even if we
succeed in bringing any of our proposed products to market, we
cannot assure you that third-party payors will consider our
products cost-effective or provide reimbursement in whole or in
part for their use.

Significant uncertainty exists as to the
reimbursement status of newly approved health care products.
Third-party payors may conclude that our products are less safe,
effective or cost-effective than existing products. Therefore,
third-party payors may not approve our products for
reimbursement.

If third-party payors do not approve our products
for reimbursement or fail to reimburse them adequately, sales
will suffer as some physicians or their patients will opt for a
competing product that is approved for reimbursement or is
adequately reimbursed. Even if third-party payors make
reimbursement available, reimbursement levels may not be
sufficient for us to realize an appropriate return on our
investment in product development.

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Moreover, the trend toward managed healthcare in
the United States, the growth of organizations such as health
maintenance organizations, and legislative proposals to reform
healthcare and government insurance programs could significantly
influence the purchase of healthcare services and products,
resulting in lower prices and reduced demand for our products.
In addition, legislation and regulations affecting the pricing
of pharmaceuticals may change in ways adverse to us. While we
cannot predict the likelihood of any of these legislative or
regulatory proposals, if any government or regulatory agencies
adopt these proposals, they could materially adversely affect
our business, financial condition and results of operations.




Other Risks



| |                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | HealthCare Ventures V, L.P. and HealthCare
    Ventures VI, L.P. have substantial control over our business and
    the interests of the HealthCare Ventures partnerships may not be
    consistent with the interests of our other
    stockholders.

HealthCare Ventures V, L.P. and HealthCare
Ventures VI, L.P. currently beneficially own an aggregate of
40.2% of our outstanding common stock. James H. Cavanaugh and
Harold R. Werner, members of our board of directors, are general
partners of HealthCare Partners V, L.P. and HealthCare Partners
VI, L.P., which are the general partners of HealthCare Ventures
V, L.P. and HealthCare Ventures VI, L.P., respectively.
Accordingly, the HealthCare Ventures partnerships are able to
exert significant influence over all matters requiring
stockholder approval, including the election and removal of
directors and any merger, consolidation or sale of all or
substantially all of our assets, as well as over the day-to-day
management of our business. The HealthCare Ventures partnerships
may direct our affairs in a manner that is not consistent with
the interests of our other stockholders. In addition, this
concentration of ownership could have the effect of delaying,
deferring or preventing a change in control, or impeding a
merger or consolidation, takeover or other business combination
or a sale of all or substantially all of our assets.



| |                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------
| | Future sales of our common stock, or the
    perception that these sales may occur, could depress our stock
    price.

Sales of substantial amounts of our common stock
in the public market, or the perception in the public markets
that these sales may occur, could cause the market price of our
common stock to decline. This could also impair our ability to
raise additional capital through the sale of our equity
securities. Options to purchase a total of 2,235,488 shares were
outstanding as of December 31, 2003. We have filed a
registration statement on Form S-8 to register these and
all other shares of common stock issuable under our stock
incentive plan. Stockholders prior to our initial public
offering and holders of options to purchase our common stock own
75.9% of the outstanding shares of our common stock on a
fully-diluted basis. Following the expiration of a 180-day
lock-up period to which the shares held by these
stockholders will be subject, the holders of those shares will,
subject to vesting requirements, generally be entitled to
dispose of those shares. Moreover, underwriters of our initial
public offering may, in their sole discretion and at any time
without notice, release holders from the sale restrictions on
their shares. In addition to the adverse effect a price decline
could have on holders of our common stock, such a decline could
impede our ability to raise capital or to make acquisitions
through the issuance of additional shares of our common stock or
other equity securities.

The holders of approximately 15,062,474 shares of
our common stock have rights to cause us to file registration
statements on their behalf and to include their shares in
registration statements that we may file on our behalf or on
behalf of other stockholders. By exercising their registration
rights and selling a large number of shares, these holders could
cause the price of our common stock to decline. Furthermore, if
we file a registration statement to offer additional shares of
our common stock and have to include shares held by those
holders, it could impair our ability to raise needed capital by
depressing the price at which we could sell our common stock.



| |                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our certificate of incorporation and
    provisions of Delaware law could discourage a takeover you may
    consider favorable or could cause current management to become
    entrenched and difficult to replace.

Provisions in our certificate of incorporation
and Delaware law may have the effect of delaying or preventing a
merger or acquisition of us, or making a merger or acquisition
less desirable to a potential acquirer, even when

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the stockholders may consider the acquisition or
merger favorable. Under the terms of our certificate of
incorporation, we are authorized to issue 25 million shares
of blank check preferred stock, and to determine the
price, privileges, and other terms of these shares. The issuance
of any preferred stock with superior rights to our common stock
could reduce the value of our common stock. In particular,
specific rights we may grant to future holders of preferred
stock could be used to restrict an ability to merge with or sell
our assets to a third party, preserving control by present
owners and management and preventing you from realizing a
premium on your shares.


In addition, we are subject to provisions of the
Delaware corporation law that, in general, prohibit any business
combination with a beneficial owner of 15% or more of our common
stock for five years unless the holders acquisition of our
stock was approved in advance by our board of directors. These
provisions could affect our stock price adversely.



| |                                                                                    
| | -----------------------------------------------------------------------------------
| | The price of our common stock has been and
    will likely continue to be volatile.

Prior to October 2003, there was no public
market for our common stock. We cannot predict the extent to
which investor interest will lead to the development of an
active and liquid trading market in our common stock. The
initial public offering price of our common stock was $10.00 per
share. Since our initial public offering, the closing price of
our common stock has been as high as $10.05 and as low as $7.02
per share. Some companies that have had volatile market prices
for their securities have been subject to securities class
action suits filed against them. If a suit were to be filed
against us, regardless of the outcome, it could result in
substantial costs and a diversion of our managements
attention and resources. This could have a material adverse
effect on our business, results of operations and financial
condition.






|        |           
|------- | ----------
|Item 2. | Properties

Our principal executive offices are located in an
approximately 62,000 square foot facility in Germantown,
Maryland. We moved into this facility in May 2003 and
completed the transfer of our laboratory function to this
facility in December 2003. The lease for this facility
expires in June 2013. We also have an approximately 8,432
square foot lab and office facility in Gaithersburg, Maryland,
the lease for which expires in November 2005. We believe
that our facilities are suitable and adequate to meet our
current needs.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

We are not a party to any material pending legal
proceedings, other than ordinary routine litigation incidental
to our business.

In December 2003, Aventis and Aventis
Pharmaceuticals Inc. brought an action against the Company in
the U.S. District Court for the District of Delaware. The
Complaint contains six counts, based upon both federal and state
law, alleging, in essence, that the Company has infringed on the
plaintiffs trademark. The plaintiffs seek injunctive
relief, as well as unspecified monetary damages. The case is in
the very early stage of pleadings. It is the opinion of
management that the ultimate outcome of this matter will not
have a material adverse effect upon the Companys financial
position, results of operations, or cash flows.






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

No matters were submitted to a vote of our
security holders during the fourth quarter of the fiscal year
ended December 31, 2003 other than those matters previously
described in our Quarterly Report on Form 10-Q with respect
to the nine months ended September 30, 2003.

30



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##### Table of Contents






PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Our common stock has been traded on The Nasdaq
National Market under the symbol AVNC since October 17,
2003. Since that time the closing price of our common stock as
quoted by Nasdaq has been as high as $10.05 per share and as low
as $7.02 per share.

As of February 17, 2004, there were 96
holders of record of our common stock. This figure does not
represent the actual number of beneficial owners of our common
stock because shares are generally held in street
name by securities dealers and others for the benefit of
individual owners who may vote the shares. We have never
declared or paid any cash dividends on our common stock. We
currently intend to retain our future earnings, if any, to
finance the further development and expansion of our business
and do not intend to pay cash dividends for the foreseeable
future. Any future determination to pay dividends will be at the
discretion of our board of directors and will depend on our
financial condition, results of operations, capital
requirements, restrictions contained in current or future
financing instruments and such other factors as our board of
directors deems relevant.

In October 2003, we completed a 1 for
1.83008 reverse stock split of our common stock. The conversion
ratios of our outstanding preferred stock were adjusted to
reflect this reverse stock split. Our preferred stock
automatically converted into shares of common stock upon the
closing of our initial public offering.

In the three months ended December 31, 2003,
we issued the following securities that were not registered
under the Securities Act:



| |   |                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------
| |  | 15,062,474 shares of common stock upon the
    conversion of our outstanding shares of convertible preferred
    stock.               
|
| |  | 41,727 shares of common stock as a result of
    stock option exercises at prices ranging from $0.27 per share to
    $0.62 per share.
|
| |  | 27,032 shares of common stock as a result of
    warrant exercises at prices ranging from $2.29 per share to
    $4.12 per share.     

All of the above-described issuances were exempt
from registration (1) pursuant to Section 4(2) of the
Securities Act, or Regulation D or Rule 144A
promulgated thereunder, as transactions not involving a public
offering, (2) Rule 701 promulgated under the Securities Act
or (3) as transactions not involving a sale of securities.
With respect to each transaction listed above, no general
solicitation was made by either us or any person acting on our
behalf, the securities sold are subject to transfer restrictions
and the certificates for the shares contained an appropriate
legend stating such securities have not been registered under
the Securities Act and may not be offered or sold absent
registration or pursuant to an exemption therefrom. No
underwriters were involved in connection with the sales of
securities referred to above.

31



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##### Table of Contents








|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

The selected financial data should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and our
financial statements and the related notes appearing elsewhere
in this annual report on Form 10-K. The statement of
operations data for the fiscal years ended December 31,
2003, 2002 and 2001 and the balance sheet data as of
December 31, 2003 and 2002 are derived from our audited
financial statements appearing elsewhere in this annual report
on Form 10-K. The statement of operations data and balance
sheet data for fiscal 2000 is derived from audited financial
statements not included in this annual report on Form 10-K.
The historical results are not necessarily indicative of the
results to be expected in any future period. The Company
commenced operations on January 1, 2000; accordingly, the
table below presents data for the four years from inception.

|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |           | 
|------------------------------------------------------------------------------------- | -------------------------- | -------------------------------- | ----------- | ---------- |  | ---- | ----------- | ---------- |  | - | ---------- | --------- |  | - | ---------- | --------- | 
|                                                                                      |                            |                                 
|                                                                                      |                            | For the years ended December 31,
|                                                                                      |                            |                                 
|                                                                                      |                            | 2003                             |             | 2002       |  | 2001 |             | 2000      
|                                                                                      |                            |                                  |             |            |  |      |             |           
|Statements of Operations Data                                                         |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Contract revenue                                                                      |                            | $                                | 3,625,000   |            |  | $    |            |            |  | $ |           |           |  | $ |           |          
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Cost and expenses:                                                                    |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|                                                                                      | Research and development   |                                  |             | 16,594,629 |  |      |             | 10,855,130 |  |   |            | 5,295,308 |  |   |            | 1,133,014 | 
|                                                                                      | General and administrative |                                  |             | 6,427,453  |  |      |             | 3,323,879  |  |   |            | 1,958,602 |  |   |            | 751,962   | 
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Total expenses                                                                        |                            |                                  | 23,022,082  |            |  |      | 14,179,009  |            |  |   | 7,253,910  |           |  |   | 1,884,976  |          
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Loss from operations                                                                  |                            |                                  | (19,397,082 | )          |  |      | (14,179,009 | )          |  |   | (7,253,910 | )         |  |   | (1,884,976 | )        
|Interest income (expense), net                                                        |                            |                                  | 88,565      |            |  |      | 102,629     |            |  |   | 69,334     |           |  |   | 66,713     |          
|Beneficial conversion feature  deemed
    interest                                   |                            |                                  | (1,666,667  | )          |  |      |            |            |  |   |           |           |  |   |           |          
|Other expense                                                                         |                            |                                  |            |            |  |      | (47,615     | )          |  |   |           |           |  |   |           |          
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Net loss                                                                              |                            |                                  | (20,975,184 | )          |  |      | (14,123,995 | )          |  |   | (7,184,576 | )         |  |   | (1,818,263 | )        
|Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock |                            |                                  | (209,173    | )          |  |      | (73,925     | )          |  |   | (37,594    | )         |  |   | (11,887    | )        
|Beneficial conversion feature  deemed
    dividend to preferred stockholders         |                            |                                  | (20,907,620 | )          |  |      |            |            |  |   |           |           |  |   |           |          
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Net loss applicable to common stockholders                                            |                            | $                                | (42,091,977 | )          |  | $    | (14,197,920 | )          |  | $ | (7,222,170 | )         |  | $ | (1,830,150 | )        
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Basic and diluted net loss per share                                                  |                            | $                                | (7.58       | )          |  | $    | (16.37      | )          |  | $ | (12.59     | )         |  | $ | (4.38      | )        
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Shares used in computing net loss per share,
    basic and diluted                    |                            |                                  | 5,554,773   |            |  |      | 867,239     |            |  |   | 573,699    |           |  |   | 417,857    |          
|                                                                                      |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Balance Sheet Data at Year-End:                                                       |                            |                                  |             |            |  |      |             |            |  |   |            |           |  |   |            |          
|Cash, cash equivalents and marketable securities                                      |                            | $                                | 65,087,122  |            |  | $    | 4,059,911   |            |  | $ | 16,472,049 |           |  | $ | 2,061,304  |          
|Total assets                                                                          |                            |                                  | 84,174,843  |            |  |      | 9,058,523   |            |  |   | 18,575,075 |           |  |   | 3,019,888  |          
|Long-term debt, including current portion                                             |                            |                                  | 2,440,588   |            |  |      | 1,730,934   |            |  |   | 1,089,882  |           |  |   |           |          
|Mandatorily redeemable convertible preferred stock                                    |                            |                                  |            |            |  |      | 28,439,295  |            |  |   | 25,391,170 |           |  |   | 4,433,481  |          
|Accumulated deficit                                                                   |                            |                                  | (44,102,018 | )          |  |      | (23,126,834 | )          |  |   | (9,002,839 | )         |  |   | (1,818,263 | )        
|Total stockholders equity (deficit)                                                  |                            |                                  | 70,149,920  |            |  |      | (22,701,459 | )          |  |   | (8,701,660 | )         |  |   | (1,710,150 | )        

32



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##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion of our financial
condition and results of operations should be read in
conjunction with the financial statements and the notes to those
statements included elsewhere in this annual report on Form
10-K. This discussion may contain forward-looking statements
that involve risks and uncertainties. As a result of many
factors, such as those set forth under
Business  Factors that May Affect our
Business and elsewhere in this annual report on
Form 10-K, our actual results may differ materially from
those anticipated in these forward-looking statements.




Background

Since we began our operations in
January 2000, we have devoted substantially all of our
resources to the discovery and development of pharmaceutical
products for the treatment of bacterial infections. We have not
generated any revenues from product sales. We currently have
four pulsatile drugs in Phase I/ II clinical trials, four
pulsatile drugs or drug combinations in late stage preclinical
development and are exploring pulsatile formulations for a range
of other antibiotics and antibiotic combinations. We are also
developing a non-pulsatile, generic formulation of
Biaxin XL.

Revenues.We have
generated minimal operating revenues since our inception. Any
revenues that we may receive in the near future are expected to
consist primarily of license fees, milestone payments and
research reimbursement payments to be received from
collaborative partners. If our development efforts result in
clinical success, regulatory approval and successful
commercialization of our products, we could generate revenues
from sales of our products and from receipt of royalties on
sales of licensed products. We received a payment of
$5 million from GlaxoSmithKline upon signing of our license
agreement in July 2003, which has been deferred and is
being recognized as revenue throughout the estimated development
period of the contract. In December 2003, the Company was
notified by GSK that the first milestone event had been
achieved, and the Company recorded revenue for the
$3.0 million contractual value of the milestone. Remaining
milestone payments under this agreement will be recognized as
revenue in accordance with our revenue recognition policies set
forth in Note 2 to the financial statements included elsewhere
in this annual report. In September 2003, we entered into
an agreement pursuant to which we licensed to Par Pharmaceutical
the distribution and marketing rights to our generic
clarithromycin product. We are entitled to receive milestone
payments from Par Pharmaceutical not to exceed an aggregate of
$6 million upon achievement of certain goals. To date, no
milestone payments from Par Pharmaceutical have been received.

Research and Development
Expenses.We expect our research and
development expenses to increase as we continue to develop our
product candidates. These expenses consist primarily of salaries
and related expenses for personnel, fees paid to professional
service providers in conjunction with independently monitoring
our clinical trials and acquiring and evaluating data in
conjunction with our clinical trials, costs of contract
manufacturing services, costs of materials used in clinical
trials and research and development, depreciation of capital
resources used to develop our products, costs of facilities and
the legal costs of pursuing patent protection of our
intellectual property. We expense research and development costs
as incurred. We believe that significant investment in product
development is a competitive necessity and plan to continue
these investments in order to be in a position to realize the
potential of our product candidates and proprietary
technologies. We expect to incur licensing costs in the future
that could be substantial, as we increase our efforts to license
existing product candidates.

33



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##### Table of Contents



The following table summarizes our product
development initiatives for the fiscal years ended
December 31, 2003, 2002 and 2001. Included in this table is
the research and development expense recognized in connection
with each product candidate currently in clinical development
and all preclinical product candidates as a group.

|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |             | 
|---------------------------------------- | ---------------------------- | ----------------------- | ---------- | ----------------- |  | ----------- | ---------- | ------------- |  | ----- | --------- | --------- |  | - | ---------- | ---------- |  |  |  | ----------- | 
|                                         |                              |                         |            |                   |  |             |            | Total Expense |  |      
|                                         |                              |                         |            |                   |  |             |            | Incurred from |  |      
|                                         |                              |                         |            | Inception         |  |            
|                                         |                              | Year Ended December 31, |            | (January 1, 2000) |  | Clinical   
|                                         |                              |                         |            | to December 31,   |  | Development
|                                         |                              | 2003                    |            | 2002              |  | 2001        |            | 2003          |  | Phase
|                                         |                              |                         |            |                   |  |             |            |               |  |      
|Direct Project Costs(1)                  |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|                                         | Amoxicillin                  |                         | $          | 4,890,000         |  |             | $          | 1,171,000     |  |       | $         | 1,588,000 |  |   | $          | 7,875,000  |  |  |  | Phase I/II  | 
|                                         | Clarithromycin               |                         |            | 1,169,000         |  |             |            | 1,986,000     |  |       |           | 1,501,000 |  |   |            | 5,115,000  |  |  |  | Phase I/II  | 
|                                         | Metronidazole                |                         |            | 465,000           |  |             |            | 482,000       |  |       |           | 793,000   |  |   |            | 1,925,000  |  |  |  | Phase I/II  | 
|                                         | Amoxicillin/ Clavulanate(2)  |                         |            | 28,000            |  |             |            | 61,000        |  |       |           |          |  |   |            | 89,000     |  |  |  | Phase I/II  | 
|                                         | Generic Clarithromycin       |                         |            | 5,975,000         |  |             |            | 3,709,000     |  |       |           | 336,000   |  |   |            | 10,020,000 |  |  |  | Phase I/II  | 
|                                         | Other Product Candidates     |                         |            | 938,000           |  |             |            | 1,646,000     |  |       |           | 135,000   |  |   |            | 2,719,000  |  |  |  | Preclinical | 
|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|                                         | Total Direct Project Costs   |                         |            | 13,465,000        |  |             |            | 9,055,000     |  |       |           | 4,353,000 |  |   |            | 27,743,000 |  |  |  |             | 
|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|Indirect Project Costs(1)                |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|                                         | Facility                     |                         |            | 1,113,000         |  |             |            | 658,000       |  |       |           | 584,000   |  |   |            | 2,408,000  |  |  |  |             | 
|                                         | Depreciation                 |                         |            | 664,000           |  |             |            | 459,000       |  |       |           | 185,000   |  |   |            | 1,340,000  |  |  |  |             | 
|                                         | Patent                       |                         |            | 503,000           |  |             |            | 206,000       |  |       |           | 88,000    |  |   |            | 856,000    |  |  |  |             | 
|                                         | Other Indirect Overhead      |                         |            | 850,000           |  |             |            | 477,000       |  |       |           | 85,000    |  |   |            | 1,531,000  |  |  |  |             | 
|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|                                         | Total Indirect Project Costs |                         |            | 3,130,000         |  |             |            | 1,800,000     |  |       |           | 942,000   |  |   |            | 6,135,000  |  |  |  |             | 
|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            
|Total Research &
    Development Expense |                              | $                       | 16,595,000 |                   |  | $           | 10,855,000 |               |  | $     | 5,295,000 |           |  | $ | 33,878,000 |            |  |  |  |            
|                                         |                              |                         |            |                   |  |             |            |               |  |       |           |           |  |   |            |            |  |  |  |            



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Many of our research and development costs are
    not attributable to any individual project because we use
    resources across several development projects. We record direct
    costs, including personnel costs and related benefits and
    stock-based compensation, on a project-by-project basis. We
    record indirect costs that support a number of our research and
    development activities in the aggregate.
|   
|(2) | We have entered into an agreement under which
    GlaxoSmithKline will be responsible for funding future clinical
    development of this product.                                                                                                                                                                                                                                                                             

Conducting clinical trials is a lengthy,
time-consuming and expensive process. Currently we only have
four pulsatile drug products in Phase I/ II clinical trials, and
we have not completed such trials and additional studies in
animals to extrapolate proper dosage for Phase III clinical
efficacy trials in humans. The commencement and rate of
completion of clinical trials for our products may be delayed by
many factors, including:



| |   |                                                         
| | - | --------------------------------------------------------
| |  | lack of efficacy during the clinical trials;            
|
| |  | unforeseen safety issues;                               
|
| |  | slower than expected rate of patient recruitment;
    or
|
| |  | government or regulatory delays.                        

In addition, we may encounter regulatory delays
or rejections as a result of many factors, including results
that do not support our claims, perceived defects in the design
of clinical trials and changes in regulatory policy during the
period of product development. Our business, financial condition
and results of operations may be materially adversely affected
by any delays in, or termination of, our clinical trials or a
determination by the FDA that the results of our trials are
inadequate to justify regulatory approval. As part of our
commercialization strategy, we may seek to establish
collaborative relationships for some of our products in order to
help us develop and market some of these product candidates.
There can be no assurance that we will be successful in doing
so. As a result of

34



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##### Table of Contents



these risks and uncertainties, we are unable to
estimate the specific timing and future costs of our clinical
development programs or the timing of material cash inflows, if
any, from our product candidates.


General and Administrative
Expenses.General and administrative
expenses consist primarily of salaries and other related costs
for personnel serving executive, finance, accounting,
information technology and human resource functions. Other costs
include facility costs not otherwise included in research and
development expense and professional fees for legal and
accounting services. We expect that our general and
administrative expenses will increase as we add personnel and
incur a full fiscal year of expenses related to becoming subject
to the reporting obligations applicable to public companies. Our
general and administrative expenses have increased as a result
of our expansion into a new facility beginning in the second
half of 2003.

Stock-Based
Compensation.We have recorded
deferred stock-based compensation expense in connection with the
grant of stock options to employees. Deferred stock-based
compensation for options granted to employees is the difference
between the fair value for financial reporting purposes of our
common stock on the date such options were granted and their
exercise price. We recorded deferred stock-based compensation
and capital in excess of par value of approximately
$8.2 million in the year ended December 31, 2003
related to stock options granted to employees. These amounts
were recorded as a component of stockholders equity
(deficit) and are being amortized as charges to operations
over the vesting periods of the options. We recorded
amortization of deferred stock-based compensation of
approximately $2.2 million for the year ended
December 31, 2003.

We recorded stock-based compensation of
$1.3 million during the year ended December 31, 2003
for options granted to non-employee consultants and scientific
advisory board (SAB) members in accordance with
Statement of Financial Accounting Standards No. 123 based
on the fair value of the equity instruments issued. Except for
one grant to a non-employee consultant for past services, the
options required future service. Stock-based compensation for
options granted to non-employee consultants and SAB members
which require future service is periodically remeasured as the
underlying options vest in accordance with Emerging Issues Task
Force Issue No. 96-18. We will recognize an expense for
such options throughout the vesting period as the services are
provided by the non-employee consultants and SAB members. As of
December 31, 2003, the balance of unamortized stock-based
compensation for options requiring future service granted to
non-employees was approximately $500,000. This amount will be
adjusted based on changes in the fair value of the options at
the end of each reporting period. For the options granted to a
non-employee consultant for past services, we recorded a
one-time stock-based compensation charge of $710,000 in the
fourth quarter of 2003.

Beneficial Conversion
Feature.In March 2003, we issued
convertible notes to certain existing investors for an aggregate
of $5.0 million. The notes and accrued interest were
converted into 2,263,272 shares of Series E mandatorily
redeemable convertible preferred stock in July 2003, at a
price which was lower than the estimated fair value of our
common stock at the date of the issuance of the notes. As a
result, we recorded a beneficial conversion charge in the form
of deemed interest of approximately $1.7 million. In
July 2003, we completed the sale of 9,292,284 shares of
series E mandatorily redeemable convertible preferred stock. We
determined that the issuance resulted in a beneficial conversion
feature calculated in accordance with EITF 00-27. As a result,
we recorded a beneficial conversion charge in the form of deemed
dividends of approximately of $20.9 million. All of our
outstanding series E convertible preferred stock was converted
into common stock upon the closing of an initial public offering.

Interest Income (Expense) and Other
Expense.Interest income consists of
interest earned on our cash, cash equivalents and marketable
securities. Interest expense consists of interest incurred on
equipment debt and convertible notes, net of interest
capitalized.

Net Losses.We have
a limited history of operations. We anticipate that our results
of operations will fluctuate for the foreseeable future due to
several factors, including payments made or received pursuant to
licensing or collaboration agreements, progress of our research
and development efforts, and the timing and outcome of
regulatory approvals. Our limited operating history makes
predictions of future operations difficult or impossible. Since
our inception, we have incurred significant losses. As of
December 31, 2003, we had an accumulated deficit of
approximately $44.1 million. We anticipate incurring
additional losses, which may increase, for the foreseeable
future.

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##### Table of Contents






Results of Operations



| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Fiscal Year Ended December 31, 2003
    Compared to Fiscal Year Ended December 31,
    2002

Revenues.We
recorded revenues of $3.6 million during the fiscal year
ended December 31, 2003 and did not record any revenues
during the fiscal year ended December 31, 2002. Revenues in
2003 consist of recognition of a portion of a license fee as
well as achievement of a contract milestone. Revenue of $625,000
was recognized for amortization of a $5.0 million upfront
payment received from GlaxoSmithKline (GSK) in
July 2003, which is expected to be amortized into revenue
on a straight-line basis through June 2007. In December
2003, the Company was notified by GSK that the first milestone
event had been achieved, and the Company recorded revenue for
the $3.0 million contractual value of the milestone.

Research and Development
Expenses.Research and development
expenses increased $5.7 million, or 53%, to
$16.6 million for the fiscal year ended December 31,
2003 from $10.9 million for the fiscal year ended
December 31, 2002. Research and development expenses
consist of direct costs which include salaries and related costs
of research and development personnel, and the costs of
consultants, materials and supplies associated with research and
development projects, as well as clinical studies. Indirect
research and development costs include facilities, depreciation,
patents and other indirect overhead costs.

The following table shows the aggregate changes
in research and development expenses reflecting all of our
project expenses.

|                                  |                                                             |                         |            |            |  |   |            |           | 
|--------------------------------- | ----------------------------------------------------------- | ----------------------- | ---------- | ---------- |  | - | ---------- | --------- | 
|                                  |                                                             |                        
|                                  |                                                             | Year Ended December 31,
|                                  |                                                             |                        
|Research and Development Expenses |                                                             | 2003                    |            | 2002      
|                                  |                                                             |                         |            |           
|Direct project costs              |                                                             |                         |            |            |  |   |            |          
|                                  | Personnel, benefits and related costs                       |                         | $          | 5,866,000  |  |   | $          | 3,576,000 | 
|                                  | Stock-based compensation                                    |                         |            | 1,903,000  |  |   |            | 142,000   | 
|                                  | Consultants, supplies, materials and other
    direct costs |                         |            | 3,737,000  |  |   |            | 3,921,000 | 
|                                  | Clinical studies                                            |                         |            | 1,959,000  |  |   |            | 1,416,000 | 
|                                  |                                                             |                         |            |            |  |   |            |          
|                                  | Total direct costs                                          |                         |            | 13,465,000 |  |   |            | 9,055,000 | 
|Indirect project costs            |                                                             |                         | 3,130,000  |            |  |   | 1,800,000  |          
|                                  |                                                             |                         |            |            |  |   |            |          
|Total                             |                                                             | $                       | 16,595,000 |            |  | $ | 10,855,000 |          
|                                  |                                                             |                         |            |            |  |   |            |          

Direct costs increased $4.4 million
primarily as a result of increases of $6.0 million relating
to the development of our pulsatile amoxicillin and generic
clarithromycin product candidates, partially offset by decreases
of an aggregate of $800,000 relating to the development of our
pulsatile clarithromycin and metronidazole product candidates
and decreases of an aggregate of $800,000 relating to the
evaluation of new preclinical product candidates. These changes
reflect increases of $2.3 million related to personnel,
benefits and related costs, an increase of $1.8 million
attributable to stock-based compensation, partially offset by a
decrease of $200,000 in expenses for consultants, supplies and
materials (due to an increase of development work performed in
house), and higher related clinical studies expense of $500,000
due to an increase in the number of subjects dosed. We conducted
a total of nine Phase I/ II clinical studies in 2003 (seven for
our generic clarithromycin, and two for our pulsatile
amoxicillin products) compared to a total of nine Phase I/ II
clinical studies in 2002 (four for our generic clarithromycin,
three for our pulsatile clarithromycin, and one each for our
pulsatile amoxicillin and metronidazole product candidates).

Indirect project costs increased by
$1.3 million to $3.1 million primarily related to an
increase in facility related costs, depreciation and overhead
due to the expansion of our corporate and research and
development facilities.

During 2004, and thereafter, we expect that
research and development expenses will increase substantially as
we increase the number of products for which we conduct clinical
trials.

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##### Table of Contents



General and Administrative
Expenses.General and administrative
expenses increased $3.1 million, or 93%, to
$6.4 million for the fiscal year ended December 31,
2003 from $3.3 million for the fiscal year ended
December 31, 2002.

|                                     |       |                         |           |           |  |   |           |           | 
|------------------------------------ | ----- | ----------------------- | --------- | --------- |  | - | --------- | --------- | 
|                                     |       |                        
|                                     |       | Year Ended December 31,
|                                     |       |                        
|                                     |       | 2003                    |           | 2002     
|                                     |       |                         |           |          
|Salaries, benefits and related costs |       | $                       | 1,847,000 |           |  | $ | 1,730,000 |          
|Stock-based compensation             |       |                         | 1,538,000 |           |  |   | 43,000    |          
|Legal and consulting expenses        |       |                         | 1,773,000 |           |  |   | 883,000   |          
|Other expenses                       |       |                         | 1,269,000 |           |  |   | 668,000   |          
|                                     |       |                         |           |           |  |   |           |          
|                                     | Total |                         | $         | 6,427,000 |  |   | $         | 3,324,000 | 
|                                     |       |                         |           |           |  |   |           |          

General and administrative expenses consist of
salaries and related costs for executive and other
administrative personnel, as well as professional fees and
facility costs. Approximately $1.5 million of the total
$3.1 million increase in general and administrative
expenses is attributable to increased stock-based compensation
charges. Salaries, benefits and related costs for personnel
increased $117,000 in 2003 due to higher compensation and
benefits expenses related to new hires, partially offset by
lower recruiting fees and relocation costs. Legal and consulting
costs increased $890,000 due to increased legal support
activities in 2003 primarily related the Companys
transition to a publicly-listed corporation, as well as
consulting fees incurred in support of business development
activities. Other expenses increased $601,000, primarily due to
increased audit fees, higher costs related to the new corporate,
research and development facility, and increased insurance
expenses.

Net Interest Income (Expense) and Other
Expense.Net interest expense was
$1,578,000 for the fiscal year ended December 31, 2003
compared to net interest income of $54,000 for the fiscal year
ended December 31, 2002.

|                                                            |  |                         |            |      |  |   |          |  
|----------------------------------------------------------- |  | ----------------------- | ---------- | ---- |  | - | -------- | -
|                                                            |  |                        
|                                                            |  | Year Ended December 31,
|                                                            |  |                        
|                                                            |  | 2003                    |            | 2002
|                                                            |  |                         |            |     
|Interest income                                             |  | $                       | 254,000    |      |  | $ | 338,000  |  
|Interest expense, net of interest capitalized               |  |                         | (165,000   | )    |  |   | (236,000 | )
|Beneficial conversion feature  deemed
    interest expense |  |                         | (1,667,000 | )    |  |   |         |  
|Other expense                                               |  |                         |           |      |  |   | (48,000  | )
|                                                            |  |                         |            |      |  |   |          |  
|Total, net                                                  |  | $                       | (1,578,000 | )    |  | $ | 54,000   |  
|                                                            |  |                         |            |      |  |   |          |  

The increase in net interest expense in 2003 of
$1.6 million is primarily due to the beneficial conversion
feature of deemed interest expense of $1.7 million. The
beneficial conversion feature is a one-time charge that related
to the issuance of the Companys convertible notes in
March 2003 at a favorable conversion ratio for the
noteholders.

The decrease in interest income of $84,000 is
primarily attributable to lower average interest rates for the
fiscal year ended December 31, 2003 compared to the prior
year, partially offset by the effect of an increase in average
invested balances due to the issuance of Series E preferred
stock and the initial public offering of common stock in the
second half of 2003.

Interest expense (net of capitalized interest)
decreased $71,000 compared to the prior year. The net decrease
is due to higher interest expense in 2003 of $32,000 from an
increase in borrowings to fund additions of equipment, partially
offset by $103,000 for the capitalization of interest in 2003
attributable to the new corporate, research and development
construction.

Other expense of $48,000 in 2002 represents bank
commitment fees related to a cancelled debt financing. There
were no similar items in 2003.

37



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##### Table of Contents





| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | Fiscal Year Ended December 31, 2002
    Compared to Fiscal Year Ended December 31,
    2001

Revenues.We did not
record any revenues during the fiscal years ended
December 31, 2002 or 2001.

Research and Development
Expenses.Research and development
expenses increased $5.6 million, or 106%, to
$10.9 million for the fiscal year ended December 31,
2002 from $5.3 million for the fiscal year ended
December 31, 2001. Research and development expenses
consist of direct costs which include salaries and related costs
of research and development personnel, and the costs of
consultants, materials and supplies associated with research and
development projects as well as clinical studies. Indirect
research and development costs include facilities, depreciation,
patents and other indirect overhead costs.

The following table shows the aggregate changes
in research and development expenses reflecting all of our
project expenses.

|                                  |                                                             |                         |            |           |  |   |           |           | 
|--------------------------------- | ----------------------------------------------------------- | ----------------------- | ---------- | --------- |  | - | --------- | --------- | 
|                                  |                                                             |                        
|                                  |                                                             | Year Ended December 31,
|                                  |                                                             |                        
|Research and Development Expenses |                                                             | 2002                    |            | 2001     
|                                  |                                                             |                         |            |          
|Direct project costs              |                                                             |                         |            |           |  |   |           |          
|                                  | Personnel, benefits and related costs                       |                         | $          | 3,718,000 |  |   | $         | 1,683,000 | 
|                                  | Consultants, supplies, materials and other
    direct costs |                         |            | 3,921,000 |  |   |           | 2,167,000 | 
|                                  | Clinical studies                                            |                         |            | 1,416,000 |  |   |           | 503,000   | 
|                                  |                                                             |                         |            |           |  |   |           |          
|                                  | Total direct costs                                          |                         |            | 9,055,000 |  |   |           | 4,353,000 | 
|Indirect project costs            |                                                             |                         | 1,800,000  |           |  |   | 942,000   |          
|                                  |                                                             |                         |            |           |  |   |           |          
|Total                             |                                                             | $                       | 10,855,000 |           |  | $ | 5,295,000 |          
|                                  |                                                             |                         |            |           |  |   |           |          

Direct costs increased $4.7 million
primarily as a result of increases of $3.9 million relating
to the development of our pulsatile clarithromycin and generic
clarithromycin product candidates, increases of
$1.5 million relating to the evaluation of new preclinical
product candidates, partially offset by decreases of an
aggregate of $728,000 relating to the development of our
pulsatile amoxicillin and metronidazole product candidates.
These changes reflect increases of $2.0 million related to
personnel, benefits and related costs (which includes $142,000
attributable to stock-based compensation), $1.8 million in
expenses for consultants, supplies and materials due to an
increase in the number of clinical studies, and higher related
clinical studies expenses of $913,000. We conducted a total of
nine Phase I/ II clinical studies in 2002 (four for our generic
clarithromycin, three for our pulsatile clarithromycin, and one
each for our pulsatile amoxicillin and metronidazole product
candidates) compared to a total of four Phase I/ II clinical
studies in 2001 (one each for our pulsatile amoxicillin,
clarithromycin and metronidazole product candidates and one for
our generic clarithromycin product candidate).

Indirect project costs also increased by $858,000
to $1.8 million primarily related to an increase of
$740,000 in facility related costs, depreciation and overhead
due to the expansion of our previous corporate and research and
development facilities in 2002.

General and Administrative
Expenses.General and administrative
expenses increased $1.3 million, or 65%, to
$3.3 million for the fiscal year ended December 31,
2002 from $2.0 million for the fiscal year ended
December 31, 2001. General and administrative expenses
consist of salaries and related costs for executive and other
administrative personnel. The increase was primarily due to
higher compensation and benefits expenses related to new hires.
General and administrative expenses in 2002 included $43,000 of
stock-based compensation expense.

Net Interest Income (Expense) and Other
Expense.Net interest income and other
expense was $54,000 for the fiscal year ended December 31,
2002 compared to net interest income of $70,000 for the fiscal
year ended December 31, 2001.

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|                 |  |                         |          |      |  |   |          |  
|---------------- |  | ----------------------- | -------- | ---- |  | - | -------- | -
|                 |  |                        
|                 |  | Year Ended December 31,
|                 |  |                        
|                 |  | 2002                    |          | 2001
|                 |  |                         |          |     
|Interest income  |  | $                       | 338,000  |      |  | $ | 184,000  |  
|Interest expense |  |                         | (236,000 | )    |  |   | (114,000 | )
|Other expense    |  |                         | (48,000  | )    |  |   |         |  
|                 |  |                         |          |      |  |   |          |  
|Total, net       |  | $                       | 54,000   |      |  | $ | 70,000   |  
|                 |  |                         |          |      |  |   |          |  

The increase in interest income was attributable
to higher average cash balances for the fiscal year ended
December 31, 2002, partially offset by an increase in
interest expense attributable to an increase in our equipment
term loan obligations and other expense of $48,000 consisting of
bank commitment fees related to a cancelled debt financing.




Liquidity and Capital Resources

We have funded our operations principally with
the proceeds of $54.5 million from a series of five preferred
stock offerings and one issue of convertible notes over the
period 2000 through 2003 and the net proceeds of
$54.3 million from our initial public offering in
October 2003.



| |                                   
| | ----------------------------------
| | Cash and Marketable
    Securities

At December 31, 2003, cash, cash equivalents
and marketable securities were $65.1 million compared to
$4.1 million at December 31, 2002.

|                          |       |                    |            |            |  |   |           |           | 
|------------------------- | ----- | ------------------ | ---------- | ---------- |  | - | --------- | --------- | 
|                          |       |                   
|                          |       | As of December 31,
|                          |       |                   
|                          |       | 2003               |            | 2002      
|                          |       |                    |            |           
|Cash and cash equivalents |       | $                  | 37,450,000 |            |  | $ | 4,060,000 |          
|Marketable securities     |       |                    | 27,637,000 |            |  |   |          |          
|                          |       |                    |            |            |  |   |           |          
|                          | Total |                    | $          | 65,087,000 |  |   | $         | 4,060,000 | 
|                          |       |                    |            |            |  |   |           |          

Our cash and cash equivalents are highly liquid
investments with a maturity of 90 days or less at date of
purchase and consist of time deposits, investments in money
market funds with commercial banks and financial institutions,
and commercial paper of high-quality corporate issuers. Our
marketable securities are also highly-liquid investments and are
classified as available-for-sale, as they can be utilized for
current operations. The Companys investment policy
requires the selection of high-quality issuers, with bond
ratings of AAA to A1+/ P1. The Companys objective is to
maintain its investment portfolio at an average duration of
approximately one year.

Also, we maintain cash balances with financial
institutions in excess of insured limits. We do not anticipate
any losses with respect to such cash balances.



| |          
| | ---------
| | Cash Flow

The following table summarizes our sources and
uses of cash and cash equivalents for fiscal years ending
December 31, 2003, 2002, and 2001.

|                                                         |  |                         |             |      |  |      |             |   |  |   |            |  
|-------------------------------------------------------- |  | ----------------------- | ----------- | ---- |  | ---- | ----------- | - |  | - | ---------- | -
|                                                         |  |                        
|                                                         |  | Year Ended December 31,
|                                                         |  |                        
|                                                         |  | 2003                    |             | 2002 |  | 2001
|                                                         |  |                         |             |      |  |     
|Net cash used in operating activities                    |  | $                       | (11,084,000 | )    |  | $    | (12,796,000 | ) |  | $ | (6,404,000 | )
|Net cash provided by (used in)
    investing activities  |  |                         | (36,413,000 | )    |  |      | 3,041,000   |   |  |   | (7,589,000 | )
|Net cash provided by financing activities                |  |                         | 80,887,000  |      |  |      | 3,628,000   |   |  |   | 22,119,000 |  
|                                                         |  |                         |             |      |  |      |             |   |  |   |            |  
|Net increase (decrease) in cash and
    cash equivalents |  | $                       | 33,390,000  |      |  | $    | (6,127,000  | ) |  | $ | 8,126,000  |  
|                                                         |  |                         |             |      |  |      |             |   |  |   |            |  

Net cash used in operating activities in 2003 was
$11.1 million, primarily due to the net loss of
$21.0 million. The differences between revenue in the net
loss and cash receipts and between expenses in the net loss and
cash expenditures are explained as follows:

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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenue / Cash
    Receipts:Revenue included in the net
    loss was $3.6 million, although cash receipts in 2003 were
    $5.0 million. The difference of $1.4 million results
    from two factors. First, the Company received an upfront cash
    payment of $5.0 million from GSK, but only amortized
    $625,000 of this amount into 2003 revenue. Second, the
    additional $3.0 million of 2003 revenue was earned and
    recorded in 2003, but the cash was not received until 2004. The
    $1.4 million difference between revenue and cash receipts
    is included in the working capital account changes of
    $3.0 million in accounts receivable and $4.4 million
    in deferred contract revenue.
|
| | Expenses / Cash
    Expenditures:Expenses included in the
    net loss were $24.6 million, compared to cash expenditures
    for operating activities of $16.1 million. The difference
    of $8.5 million is attributable to non-cash expense charges
    of $6.1 million and working capital account changes related
    to expenses of $2.4 million. The non-cash expense charges
    of $6.1 million primarily consist of depreciation,
    stock-based compensation, a non-recurring beneficial conversion
    feature deemed interest expense, and amortization of premium on
    marketable securities.                                                                                                         

Net cash used in operating activities in fiscal
2002 was $12.8 million, primarily due to the net loss of
$14.1 million. Excluding noncash charges of $688,000 for
depreciation and stock-based compensation expense, the net loss
was $13.4 million. An increase in working capital of
approximately $640,000 reduced the amount of net cash used in
operating activities to $12.8 million. In 2002, the Company
continued to focus on research and development, and it did not
generate any revenue. Operating losses were funded by the
proceeds of preferred stock issuances in 2002 and in 2001.

Net cash used in operating activities in fiscal
2001 was $6.4 million, primarily due to the net loss of
$7.2 million reduced by a net increase in working capital.
In 2001, the Companys second year, activities were focused
on research and development, and the Company had no revenue.
Losses were funded by the proceeds of preferred stock issuances.

Net cash used in investing activities during
fiscal 2003 was $36.4 million. The Company invested
$27.9 million of its IPO proceeds in marketable securities,
representing securities with maturities exceeding ninety days.
The Company also spent $9.0 million (excluding
$1.6 million of accrued construction costs) on the
acquisition of property and equipment, primarily for the
build-out of its new corporate, research and development
facility in Germantown, Maryland. An additional $338,000 of cash
was required by the Companys equipment financing terms to
be placed in financial institutions on a restricted basis as
additional loan collateral. Partially offsetting these cash
outflows was the receipt of $830,000 in cash as part of the
tenant improvement allowance for our corporate, research and
development facility; this amount will be amortized as a
reduction in rent expense over the term of the lease.

Net cash provided by investing activities during
fiscal 2002 was $3.0 million. The inflow of cash was primarily
due to $6.2 million from sales and maturities of marketable
securities which had been acquired in the prior year. Capital
expenditures in 2002 were $1.4 million. In preparation for
the Companys move to its new corporate, research and
development facility, the Company entered into a lease during
2002 and provided the landlord a letter of credit in
satisfaction of the requirement for a $941,000 security deposit;
the bank providing the letter of credit required cash collateral
of this amount, which is reported as restricted cash. Total cash
restricted during 2002 was $1.4 million, representing the
requirements for the building lease security deposit as well as
collateral for equipment financings. The building lease security
deposit requirement will be reduced and eliminated over a
five-year period.

Net cash used in investing activities during
fiscal 2001 was $7.6 million, primarily due to the
$6.2 million purchase of marketable securities with the
proceeds from the Companys Series C and Series D
preferred stock financing rounds. The Company also made capital
expenditures of $1.5 million.

Net cash from financing activities for fiscal
2003 was $80.9 million. The major financing activities
included $5.0 million from the issue of convertible notes
in March 2003, $20.8 million from the closing of the
Series E preferred stock financing round in July 2003,
and $54.3 million from the closing of Companys
initial public offering of its common stock in
October 2003. The Company also obtained $1.3 million
from draws under its lines of credit for equipment financing.

40



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##### Table of Contents



Net cash from financing activities during fiscal
2002 was $3.6 million, primarily from the receipt of
$3.0 million from the second closing of the Series D
preferred stock financing round in February 2002.

Net cash from financing activities during fiscal
2001 was $22.1 million, primarily from $6.0 million of
proceeds from the Companys Series C preferred stock
financing round in April 2001 and $14.9 million
received from the first closing of the Series D preferred
stock financing round in October 2001.



| |           
| | ----------
| | Borrowings

We are a party to four credit facilities for an
aggregate amount of $6.6 million used to finance the purchase of
equipment and to one loan agreement for $75,000 with a local
government development fund. Of the total amount, $2.4 million
was outstanding as of December 31, 2003 and
$4.2 million was available for future draws, as summarized
in the following table:

|                         |  |                                                        |                |             |           |                  |           |  |           |   |           | 
|------------------------ |  | ------------------------------------------------------ | -------------- | ----------- | --------- | ---------------- | --------- |  | --------- | - | --------- | 
|                         |  |                                                       
|                         |  | As of December 31, 2003                               
|                         |  |                                                       
|                         |  |                                                        |                | Amount      |           | Remaining Amount
|Debt Obligations         |  | Interest Rates                                         |                | Outstanding |           | Available       
|                         |  |                                                        |                |             |           |                 
|Fixed rate borrowings    |  |                                                        | 5.00% - 11.62% |             |           | $                | 895,000   |  |           | $ |          | 
|Variable rate borrowings |  | LIBOR or Fixed Cost ofFunds plus 250  280basis points |                |             | 1,546,000 |                  |           |  | 4,154,000 |  
|                         |  |                                                        |                |             |           |                  |           |  |           |   |           | 
|Totals                   |  |                                                        |                |             |           | $                | 2,441,000 |  |           | $ | 4,154,000 | 
|                         |  |                                                        |                |             |           |                  |           |  |           |   |           | 

The Company expects to draw the remaining amount
available of $4.2 million under its $5.5 million bank
credit line to finance the purchase of additional equipment for
its new corporate, research and development facility. The
Company does not currently hedge variable rate borrowings.



| |                        
| | -----------------------
| | Contractual Obligations

The following table summarizes our contractual
obligations at December 31, 2003 and the effects such
obligations are expected to have on our liquidity and cash flows
in future periods.






Payments Due by Period


|                                   |  |                |        |      |  |      |       |      |  |      |       |      |  |       |       |  |  |   |       |  |  |   |       |  |  |   |       | 
|---------------------------------- |  | -------------- | ------ | ---- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ----- | ----- |  |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                                   |  |                |        |      |  |      |       |      |  |      |       |      |  | After
|Contractual Obligations            |  | Total          |        | 2004 |  | 2005 |       | 2006 |  | 2007 |       | 2008 |  | 2008 
|                                   |  |                |        |      |  |      |       |      |  |      |       |      |  |      
|                                   |  |               
|                                   |  | (in thousands)
|Short and long-term debt           |  | $              | 2,441  |      |  | $    | 954   |      |  | $    | 617   |      |  | $     | 577   |  |  | $ | 293   |  |  | $ |      |  |  | $ |      | 
|Operating lease obligations        |  |                | 10,585 |      |  |      | 1,095 |      |  |      | 1,180 |      |  |       | 1,027 |  |  |   | 1,052 |  |  |   | 1,082 |  |  |   | 5,149 | 
|                                   |  |                |        |      |  |      |       |      |  |      |       |      |  |       |       |  |  |   |       |  |  |   |       |  |  |   |       | 
|Total contractual cash obligations |  | $              | 13,026 |      |  | $    | 2,049 |      |  | $    | 1,797 |      |  | $     | 1,604 |  |  | $ | 1,345 |  |  | $ | 1,082 |  |  | $ | 5,149 | 
|                                   |  |                |        |      |  |      |       |      |  |      |       |      |  |       |       |  |  |   |       |  |  |   |       |  |  |   |       | 

During fiscal 2003, the Company spent
approximately $9.0 million (excluding accrued construction
costs) for capital expenditures, primarily for leasehold
improvements and equipment for its new corporate, research and
development facility. In addition, approximately
$1.6 million is included in accrued liabilities at
December 31, 2003 for work completed and equipment
delivered as of that date. We expect to acquire an additional
$4.2 million of equipment in fiscal 2004 to complete the
initial fit-out of our corporate, research and development
facility. Our $5.5 million line of credit established in
July 2003 will be the primary source of funds for this
equipment.

In addition to the contractual obligations in the
above table, the Company may incur funding liabilities for
obligations which it enters into on a discretionary basis. These
discretionary obligations could include additional facilities,
investments in new technologies or products, acquisitions,
funding of clinical trials, or similar events.



| |                        
| | -----------------------
| | Prospective Information

We expect to incur losses from operations for the
foreseeable future. We expect to incur increasing research and
development expenses, including expenses related to additions to
personnel and clinical trials. We expect that our general and
administrative expenses will increase in the future as we expand
our business development, legal

41



---



##### Table of Contents



and accounting staff, add infrastructure and
incur a full fiscal year of the additional costs related to
being a public company, including directors and
officers insurance, investor relations programs and
increased professional fees. Our future capital requirements
will depend on a number of factors, including the continued
progress of our research and development of product candidates,
the timing and outcome of regulatory approvals, payments
received or made under collaborative agreements, the costs
involved in preparing, filing, prosecuting, maintaining,
defending and enforcing patent claims and other intellectual
property rights, the acquisition of licenses to new products or
compounds, the status of competitive products, the availability
of financing and our or our partners success in developing
markets for our product candidates. We believe our existing
cash, cash equivalents and marketable securities will be
sufficient to fund our operating expenses, debt repayments and
capital equipment requirements for at least the next two years.


Except for the equipment lines of credit
described above, we have no credit facility or other committed
sources of capital. To the extent our capital resources are
insufficient to meet future capital requirements, we will need
to raise additional capital or incur indebtedness to fund our
operations. There can be no assurance that additional debt or
equity financing will be available on acceptable terms, if at
all. If adequate funds are not available, we may be required to
delay, reduce the scope of or eliminate our research and
development programs, reduce our commercialization efforts or
obtain funds through arrangements with collaborative partners or
others that may require us to relinquish rights to certain
product candidates that we might otherwise seek to develop or
commercialize independently. Any future funding may dilute the
ownership of our equity investors.




Recent Accounting Pronouncements

In December 2002, the EITF reached consensus
on EITF Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables,that the
provisions of EITF Issue No. 00-21 should be used to
determine when a revenue arrangement for multiple deliverables
should be divided into separate units of accounting and, if
separation is appropriate, how the arrangement consideration
should be allocated to the identified accounting units. The
provisions of EITF Issue No. 00-21 are effective for
revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. Management evaluates multiple elements
in accordance with this EITF Issue for new arrangements into
which the Company enters.

In January 2003, the FASB issued FIN 46,
Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin No. 51,
Consolidated Financial Statements. FIN 46
establishes accounting guidance for consolidation of variable
interest entities that function to support the activities of the
primary beneficiary. In October 2003, the FASB issued FASB
Staff Position FIN 46-6, Effective Date of FASB
Interpretation No. 46, Consolidation of Variable Interest
Entitiesdeferring the effective date for applying the
provisions of FIN 46 for public entities interest in
variable interest entities or potential variable interest
entities created before February 1, 2003 until financial
statements of interim or annual periods that end after
December 15, 2003. In December 2003, the FASB issued
FIN 46 (revised December 2003), Consolidation of
Variable Interest Entities. This revised
interpretation is effective for all entities no later than the
end of the first reporting period that ends after March 15,
2004. We have no investment in or contractual relationship or
other business relationship with a variable interest entity and
therefore the adoption of this interpretation will not have any
impact on our financial position or results of operations.
However, if we enter into an such arrangement with a variable
interest entity in the future or an entity with which we have a
relationship is reconsidered based on guidance in FIN 46 to be a
variable interest entity, our financial position or results of
operations might be impacted.

In November 2003, during discussions on EITF
Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments, the EITF reached a consensus which
requires certain quantitative and qualitative disclosures for
debt and marketable equity securities classified as
available-for-sale or held-to-maturity under SFAS 115 and SFAS
124 that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. The
consensus on quantitative and qualitative disclosures is
effective for fiscal years ending after December 15, 2003
and comparative information for earlier periods presented is not
required. We currently do not have any impaired investments and
thus the adoption of this consensus did not have a material
impact on our financial statements.

42



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##### Table of Contents






Critical Accounting Policies and
Estimates

Our discussion and analysis of our financial
condition and results of operations are based on our financial
statements, which have been prepared in accordance with
accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of
assets, liabilities and expenses. On an ongoing basis, we
evaluate our estimates and judgments, including those related to
revenue recognition, accrued expenses, fair value of stock
options related to stock-based compensation and income taxes. We
based our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or
conditions.

We believe the following critical accounting
policies affect our more significant judgments and estimates
used in the preparation of our financial statements.

Revenue Recognition.We use the milestone payment method of revenue recognition when
all milestones in respect of payments to be received under
contractual arrangements are determined to be substantive,
at-risk and the culmination of an earnings process. Substantive
milestones are payments that are conditioned upon events
requiring substantive effort, when the amounts of the milestones
are reasonable relative to the time, effort and risk involved in
achieving them and when the milestones are reasonable relative
to each other and the amount of any up-front payment. If these
criteria are not met, the timing of the recognition of revenue
from the milestone payment may vary.

Accrued Expenses.As
part of the process of preparing financial statements, we are
required to estimate accrued expenses for services performed and
liabilities incurred. This process involves identifying services
that have been performed on our behalf and estimating the level
of service performed and the associated cost incurred for such
service as of each balance sheet date in our financial
statements. Examples of estimated accrued expenses for services
include professional service fees, such as lawyers and
accountants, contract service fees, such as amounts paid to
clinical monitors, data management organizations and
investigators in conjunction with clinical trials, and fees paid
to contract manufacturers in conjunction with the production of
clinical materials. In connection with such service fees, our
estimates are most affected by our understanding of the status
and timing of services provided relative to the actual levels of
services incurred by such service providers. The majority of our
service providers invoice us monthly in arrears for services
performed. In the event that we do not identify certain costs
that have begun to be incurred or we under- or over-estimate the
level of services performed or the costs of such services, our
reported expenses for such period would be too low or too high.
The date on which certain services commence, the level of
services performed on or before a given date and the cost of
such services are often judgmental. We make these judgments
based upon the facts and circumstances known to us in accordance
with generally accepted accounting principles. The Company also
makes estimates for other liabilities incurred, including health
insurance costs for its employees. The Company is self-insured
for claims made under its health insurance program and records
an estimate at the end of a period for claims not yet reported.
The Companys risk exposure is limited, as claims over a
maximum amount are covered by an aggregate stop loss insurance
policy.

Stock-Based
Compensation.We have elected to
follow APB 25, Accounting for Stock Issued to
Employees,and related interpretations, in accounting
for our stock-based compensation plans, rather than the
alternative fair value accounting method provided for under SFAS
123, Accounting for Stock-Based Compensation.In the notes to our financial statements we provide pro
forma disclosures in accordance with SFAS 148 and related
pronouncements. We account for transactions in which services
are received in exchange for equity instruments based on the
fair value of such services received from non-employees or of
the equity instruments issued, whichever is more reliably
measured, in accordance with SFAS 123 and EITF Issue
No. 96-18. The two factors which are most likely to affect
charges or credits to operations related to stock-based
compensation are the fair value of the common stock underlying
stock options for which stock-based compensation is recorded and
the volatility of such fair value.

If our estimates of the fair value of these
equity instruments are too high or too low, our expenses will be
overstated or understated. Because shares of our common stock
were not publicly traded during part of the period

43



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##### Table of Contents



covered by this report, we have valued our stock
and stock option grants by considering comparative values of
stock of public companies discounted for the risk and limited
liquidity of our common stock, the pricing of private sales of
our convertible preferred stock, events that have occurred since
the date of the grants, economic trends, perspective provided by
investment banks and the comparative rights and preferences of
the securities we granted compared to the rights and preferences
of our other outstanding equity securities.


Income Taxes.As
part of the process of preparing our financial statements we are
required to estimate our income taxes in each of the
jurisdictions in which we operate. We account for income taxes
by the liability method. Under this method, deferred income
taxes are recognized for tax consequences in future years of
differences between the tax bases of assets and liabilities and
their financial reporting amounts at each year-end, based on
enacted laws and statutory tax rates applicable to the periods
in which the differences are expected to affect taxable income.
Valuation allowances are provided if, based upon the weight of
available evidence, it is more likely than not that some or all
of the deferred tax assets will not be realized.

We have not recorded any tax provision or benefit
for the years ended December 31, 2003, 2002 and 2001. We
have provided a valuation allowance for the full amount of our
net deferred tax assets since realization of any future benefit
from deductible temporary differences and net operating loss
cannot be sufficiently assured at December 31, 2003 and
2002. At December 31, 2003 and 2002, we had federal and
state net operating loss carryforwards of approximately
$26.6 million and $16.1 million, respectively,
available to reduce future taxable income, which will begin to
expire in 2020. Under the provisions of the Internal Revenue
Code, certain substantial changes in our ownership may result in
a limitation on the amount of net operating loss carry forwards
which can be used in future years. We believe that ownership
changes to date will not limit future utilization of net
operating loss carryforwards.




Safe Harbor Statement under the Private
Securities Litigation Reform Act of 1995

Certain statements contained in
Business and Managements Discussion and
Analysis of Financial Condition and Results of Operations,
are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as
amended. The forward-looking statements are based on our current
intent, belief and expectations. These statements are not
guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. Actual
results may differ materially from these forward-looking
statements because of our unproven business model, our
dependence on new technologies, the uncertainty and timing of
clinical trials, our ability to develop and commercialize
products, our dependence on collaborators for services and
revenue, our substantial indebtedness and lease obligations, our
changing requirements and costs associated with planned
facilities, intense competition, the uncertainty of patent and
intellectual property protection, our dependence on key
management and key suppliers, the uncertainty of regulation of
products, the impact of future alliances or transactions and
other risks described in this filing and our other filings with
the Securities and Exchange Commission. Existing and prospective
investors are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of todays
date. We undertake no obligation to update or revise the
information contained in this announcement whether as a result
of new information, future events or circumstances or otherwise.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Our exposure to market risk is currently confined
to our cash and cash equivalents, marketable securities, and
restricted cash that generally have maturities of less than one
year. We currently do not hedge interest rate exposure. We have
not used derivative financial instruments for speculation or
trading purposes. Because of the short-term maturities of our
cash, cash equivalents and marketable securities, we do not
believe that an increase in market rates would have any
significant impact on the realized value of our investments, but
may increase the interest expense associated with our debt.

Our most liquid assets are cash, cash equivalents
and marketable securities. Because of their liquidity, these
assets are not directly affected by inflation. We also believe
that we have intangible assets in the value of our intellectual
property. In accordance with generally accepted accounting
principles, we have not capitalized the

44



---



##### Table of Contents



value of this intellectual property on our
balance sheet. Due to the nature of this intellectual property,
we believe that these intangible assets are not affected by
inflation. Because we intend to retain and continue to use our
equipment, furniture and fixtures and leasehold improvements, we
believe that the incremental inflation related to replacement
costs of such items will not materially affect our operations.
However, the rate of inflation affects our expenses, such as
those for employee compensation and contract services, which
could increase our level of expenses and the rate at which we
use our resources.







|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The information required by this item is set
forth on pages F-1 to F-24.






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

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Our management, including our principal executive
and principal financial officers, has evaluated the
effectiveness of our disclosure controls and procedures as of
December 31, 2003. Our disclosure controls and procedures
are designed to provide reasonable assurance that the
information required to be disclosed in this annual report on
Form 10-K has been appropriately recorded, processed,
summarized and reported. Based on that evaluation, our principal
executive and principal financial officers have concluded that
our disclosure controls and procedures are effective at the
reasonable assurance level.

Our management, including our principal executive
and principal financial officers, has evaluated any changes in
our internal control over financial reporting that occurred
during the year ended December 31, 2003, and has concluded
that there was no change that occurred during the year ended
December 31, 2003 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.

45



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##### Table of Contents






PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

We incorporate herein by reference the
information concerning directors and executive officers in our
Notice of Annual Stockholders Meeting and Proxy Statement
to be filed within 120 days after the end of our fiscal
year (the 2004 Proxy Statement).






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

We incorporate herein by reference the
information concerning executive compensation to be contained in
the 2004 Proxy Statement.






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

We incorporate herein by reference the
information concerning security ownership of certain beneficial
owners and management to be contained in the 2004 Proxy
Statement.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

We incorporate herein by reference the
information concerning certain relationships and related
transactions to be contained in the 2004 Proxy Statement.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

We incorporate herein by reference the
information concerning certain relationships and related
transactions to be contained in the 2004 Proxy Statement.




PART IV



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



|    |                                                                     
|--- | --------------------------------------------------------------------
|(a) | The following documents are filed as part of this
    Annual Report:



|    |                              
|--- | -----------------------------
|(1) | Index to Financial Statements

|                                                                                                                     |  |        |     | 
|-------------------------------------------------------------------------------------------------------------------- |  | ------ | --- | 
|                                                                                                                     |  | Page  
|                                                                                                                     |  | Number
|                                                                                                                     |  |       
|Report of PricewaterhouseCoopers LLP,
    Independent Auditors                                                       |  |        | F-2 | 
|Balance Sheets at December 31, 2003
    and 2002                                                                     |  |        | F-3 | 
|Statements of Operations for the years ended
    December 31, 2003, 2002 and 2001                                    |  |        | F-4 | 
|Statements of Changes in Stockholders
    Equity (Deficit) for the years ended December 31,
    2003, 2002 and 2001 |  |        | F-5 | 
|Statements of Cash Flows for the years ended
    December 31, 2003, 2002 and 2001                                    |  |        | F-6 | 
|Notes to Financial Statements                                                                                        |  |        | F-7 | 



|    |                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------
|(2) | Financial Statement Schedules Financial statement
    schedules are omitted because they are not required.
|   
|(3) | Exhibits                                                                                                  

46



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##### Table of Contents



|            |    |       |  |                                                                                                                                                                                                                                                                                
|----------- | -- | ----- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    |      
|            |    |      
|            | 3  | .1*   |  | Certificate of Incorporation                                                                                                                                                                                                                                                   
|            | 3  | .2*   |  | Bylaws                                                                                                                                                                                                                                                                         
|            | 4  | .1*   |  | Specimen Stock Certificate                                                                                                                                                                                                                                                     
|            | 10 | .1*   |  | Executive Employment Agreement between the
    Registrant and Edward M. Rudnic dated January 7, 2000                                                                                                                                                                           
|            | 10 | .2*   |  | Executive Employment Agreement between the
    Registrant and Steven A. Shallcross dated February 22, 2002                                                                                                                                                                     
|            | 10 | .3*   |  | Executive Employment Agreement between the
    Registrant and Colin E. Rowlings dated February 22, 2002                                                                                                                                                                        
|            | 10 | .4*   |  | Executive Employment Agreement between the
    Registrant and Kevin S. Sly dated February 25, 2002                                                                                                                                                                             
|            | 10 | .5*   |  | Executive Employment Agreement between the
    Registrant and Robert Guttendorf dated January 3, 2003                                                                                                                                                                          
|            | 10 | .6*   |  | Executive Employment Agreement between the
    Registrant and Sandra E. Wassink dated August 13, 2003                                                                                                                                                                          
|            | 10 | .7*   |  | Executive Employment Agreement between the
    Registrant and Beth A. Burnside dated August 13, 2003                                                                                                                                                                           
|            | 10 | .8*   |  | Executive Employment Agreement between the
    Registrant and Darren Buchwald dated September 1, 2003                                                                                                                                                                          
|            | 10 | .9*   |  | Form of Indemnification Agreement                                                                                                                                                                                                                                              
|            | 10 | .10*  |  | Stock Incentive Plan                                                                                                                                                                                                                                                           
|            | 10 | .11*  |  | Form of Incentive Stock Option Agreement                                                                                                                                                                                                                                       
|            | 10 | .12*  |  | Form of Non-qualified Stock Option Agreement                                                                                                                                                                                                                                   
|            | 10 | .13*  |  | Form of Stock Restriction Agreement                                                                                                                                                                                                                                            
|            | 10 | .14** |  | Employee Stock Purchase Plan                                                                                                                                                                                                                                                   
|            | 10 | .15*  |  | Form of Employment Agreement on Ideas, Inventions
    and Confidential Information                                                                                                                                                                                             
|            | 10 | .16*  |  | Construction Services Agreement between the
    Registrant and Barclay White Skanska, Inc. dated July 12,
    2002                                                                                                                                                             
|            | 10 | .17*  |  | Amendment No. 1 dated April 7, 2003 to Agreement
    between Owner and Construction Manager dated July 12, 2002
    between the Registrant and Skanska USA Building, Inc. successor
    by merger to Barclay White Skanska, Inc.                                               
|            | 10 | .18*  |  | Standard Form of Agreement between Owner and
    Architect with Standard Form of Architects Services
    between the Registrant and Gaudreau, Inc. dated July 8, 2002                                                                                                         
|            | 10 | .19*  |  | Lease Agreement between the Registrant and Seneca
    Meadows Corporate Center II LLC dated August 1, 2002                                                                                                                                                                     
|            | 10 | .20*  |  | Stock Purchase Pledge Agreement between the
    Registrant and Edward M. Rudnic dated October 15, 2001                                                                                                                                                                         
|            | 10 | .21*  |  | Form of Stock Purchase Promissory Note by Edward
    M. Rudnic dated October 15, 2001                                                                                                                                                                                          
|            | 10 | .22*  |  | Amendment dated June 12, 2002 to Stock Purchase
    Pledge Agreement dated October 15, 2001 between the Registrant
    and Edward M. Rudnic                                                                                                                                    
|            | 10 | .23*  |  | Amendment dated July 30, 2003 to the Stock
    Purchase Pledge Agreement and Stock Restriction Agreement dated
    October 15, 2001, as amended, between the Registrant and Edward
    M. Rudnic                                                                               
|            | 10 | .24*  |  | Note Issuance Agreement between the Registrant
    and HealthCare Ventures VI, L.P., Rho Management Trust, I,
    Steven Ostrofsky, Private Equity Holdings L.L.C., Targeted
    Entrepreneurial Services, LLC and the DC 1998 NFA Trust FBO Lee
    Casty dated March 28, 2003
|            | 10 | .25*  |  | Form of Convertible Promissory Note dated March
    28, 2003                                                                                                                                                                                                                   
|            | 10 | .26*  |  | Amendment to Secured Convertible Promissory Note
    dated June 23, 2003                                                                                                                                                                                                       
|            | 10 | .27*  |  | Fourth Amended and Restated Stockholders
    Agreement                                                                                                                                                                                                                        

47



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##### Table of Contents



|            |    |       |  |                                                                                                                                                          
|----------- | -- | ----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    |      
|            |    |      
|            | 10 | .28*  |  | Omnibus Addendum and Amendment to Series E
    Convertible Preferred Stock Purchase Agreement and Fourth
    Amended and Restated Stockholders Agreement
|            | 10 | .29*  |  | Consulting Agreement dated August 18, 2000
    between the Registrant and Jenefir Isbister as amended                                                    
|            | 10 | .30*  |  | Credit Agreement between the Registrant and
    Manufacturers and Traders Trust Company dated July 31, 2003                                              
|            | 10 | .31*  |  | Specific Security Agreement between the
    Registrant and Manufacturers and Traders Trust Company dated
    July 31, 2003                               
|            | 10 | .32*+ |  | Development and License Agreement between the
    Registrant and GlaxoSmithKline dated July 18, 2003                                                     
|            | 10 | .33*+ |  | Supply, Distribution and Marketing Agreement
    between the Registrant and Par Pharmaceutical, Inc. dated
    September 4, 2003                         
|            | 23 | .1    |  | Consent of PricewaterhouseCoopers LLP,
    Independent Accountants.                                                                                      
|            | 31 | .1    |  | Rule 13a-14(a) Certification of Principal
    Executive Officer.                                                                                         
|            | 31 | .2    |  | Rule 13a-14(a) Certification of Principal
    Financial Officer.                                                                                         
|            | 32 | .1    |  | Section 1350 Certification of Chief Executive
    Officer.                                                                                               
|            | 32 | .2    |  | Section 1350 Certification of Chief Financial
    Officer.                                                                                               



---



| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| | * | Incorporated by reference to our Registration
    Statement on Form S-1 (File No. 333-107599).



|   |                                                                                               
|-- | ----------------------------------------------------------------------------------------------
|** | Incorporated by reference to our Registration
    Statement on Form S-8 (File No. 333-109728).



| |   |                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | + | Confidential treatment requested for certain
    portions of this Exhibit pursuant to Rule 406 under the
    Securities Act, which portions are omitted and filed separately
    with the Securities and Exchange Commission.




(b) Reports on Form 8-K



| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We filed a Current Report on Form 8-K, on
    November 24, 2003, furnishing our financial results for the
    three and nine months ended September 30, 2003.
|
| | We filed a Current Report on Form 8-K, on
    February 12, 2004, furnishing our financial results for the
    year ended December 31, 2003.                  

48



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##### Table of Contents






SIGNATURES

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



| |                                    
| | -----------------------------------
| | ADVANCIS PHARMACEUTICAL CORPORATION



| |     |                     
| | --- | --------------------
| | By: | /s/ EDWARD M. RUDNIC

| |                                          
| | -----------------------------------------
| |                                          
| | Edward M. Rudnic, Ph.D.                  
| | President and Chief Executive
    Officer

Dated: March 8, 2004

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and the dates indicated:

|                                                |  |                                                                                                               |  |               |  | 
|----------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                                |  |                                                                                                               |  |              
|Signature                                       |  | Title                                                                                                         |  | Date         
|                                                |  |                                                                                                               |  |              
|                                               
|/s/ EDWARD M. RUDNICEdward M. Rudnic, Ph.D.     |  | President, Chief Executive Officer and Director
    (Principal Executive Officer)                             |  | March 8, 2004
|                                               
|/s/ STEVEN A. SHALLCROSSSteven A. Shallcross    |  | Senior Vice President, Chief Financial Officer
    and Treasurer (Principal Financial and Accounting Officer) |  | March 8, 2004
|                                               
|/s/ JAMES D. ISBISTERJames D. Isbister          |  | Chairman of the Board and Director                                                                            |  | March 8, 2004
|                                               
|/s/ JAMES H. CAVANAUGHJames H. Cavanaugh, Ph.D. |  | Director                                                                                                      |  | March 8, 2004
|                                               
|/s/ ELIZABETH CZEREPAKElizabeth Czerepak        |  | Director                                                                                                      |  | March 8, 2004
|                                               
|/s/ R. GORDON DOUGLASR. Gordon Douglas, M.D.    |  | Director                                                                                                      |  | March 8, 2004
|                                               
|/s/ RICHARD W. DUGANRichard W. Dugan            |  | Director                                                                                                      |  | March 8, 2004
|                                               
|/s/ WAYNE T. HOCKMEYERWayne T. Hockmeyer, Ph.D. |  | Director                                                                                                      |  | March 8, 2004
|                                               
|/s/ HAROLD R. WERNERHarold R. Werner            |  | Director                                                                                                      |  | March 8, 2004

49



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##### Table of Contents






INDEX TO FINANCIAL STATEMENTS

|                                                                                                                     |  |        |     | 
|-------------------------------------------------------------------------------------------------------------------- |  | ------ | --- | 
|                                                                                                                     |  | Page  
|                                                                                                                     |  | Number
|                                                                                                                     |  |       
|Report of PricewaterhouseCoopers LLP,
    Independent Auditors                                                       |  |        | F-2 | 
|Balance Sheets at December 31, 2003
    and 2002                                                                     |  |        | F-3 | 
|Statements of Operations for the Years ended
    December 31, 2003, 2002 and 2001                                    |  |        | F-4 | 
|Statements of Changes in Stockholders
    Equity (Deficit) for the Years ended December 31, 2003,
    2002 and 2001 |  |        | F-5 | 
|Statements of Cash Flows for the Years ended
    December 31, 2003, 2002 and 2001                                    |  |        | F-6 | 
|Notes to Financial Statements                                                                                        |  |        | F-7 | 

F-1



---



##### Table of Contents






REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and

Stockholders of Advancis Pharmaceutical
Corporation


In our opinion, the accompanying balance sheets
and the related statements of operations, of changes in
stockholders equity (deficit) and of cash flows
present fairly, in all material respects, the financial position
of Advancis Pharmaceutical Corporation (the Company)
at December 31, 2003 and December 31, 2002, and the results
of its operations and its cash flows for each of the three years
in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of
the Companys management; our responsibility is to express
an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

/s/ PricewaterhouseCoopers LLP

McLean, Virginia

February 19, 2004


F-2



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##### Table of Contents






ADVANCIS PHARMACEUTICAL CORPORATION

BALANCE SHEETS

|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |             |             |           |            | 
|---------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------- | ------------------------------------------------------------ | ---------- | ---------- | --------- | ----------- | ----------- | --------- | ---------- | 
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                         
|                                                                                                           |                                                                                                                                                                                                               | December 31,                                                                                                                                                                                                            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                         
|                                                                                                           |                                                                                                                                                                                                               | 2003                                                                                                                                                                                                                     |                           | 2002                                                        
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                             
|ASSETS                                                                                                     |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|Current assets:                                                                                            |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           | Cash and cash equivalents                                                                                                                                                                                     |                                                                                                                                                                                                                          | $                         | 37,450,490                                                   |            |            | $         | 4,059,911   |            
|                                                                                                           | Marketable securities                                                                                                                                                                                         |                                                                                                                                                                                                                          |                           | 27,636,632                                                   |            |            |           |            |            
|                                                                                                           | Accounts receivable                                                                                                                                                                                           |                                                                                                                                                                                                                          |                           | 3,000,000                                                    |            |            |           |            |            
|                                                                                                           | Prepaid expenses and other current assets                                                                                                                                                                     |                                                                                                                                                                                                                          |                           | 1,127,464                                                    |            |            |           | 172,512     |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | Total current assets      |                                                              |            | 69,214,586 |           |             |             | 4,232,423 |           
|Property and equipment, net                                                                                |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 12,512,792                |                                                              |            |            | 2,693,208 |            
|Restricted cash                                                                                            |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 1,776,569                 |                                                              |            |            | 1,438,538 |            
|Deposits                                                                                                   |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 477,396                   |                                                              |            |            | 488,854   |            
|Notes receivable                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 121,500                   |                                                              |            |            | 121,500   |            
|Intangible assets, net                                                                                     |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 72,000                    |                                                              |            |            | 84,000    |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | Total assets              |                                                              | $          | 84,174,843 |           |             | $           | 9,058,523 |           
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|LIABILITIES, MANDATORILY REDEEMABLE
    CONVERTIBLE PREFERRED
    STOCK AND STOCKHOLDERS EQUITY (DEFICIT) |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|Current liabilities:                                                                                       |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           | Accounts payable                                                                                                                                                                                              |                                                                                                                                                                                                                          | $                         | 2,683,713                                                    |            |            | $         | 758,773     |            
|                                                                                                           | Accrued expenses                                                                                                                                                                                              |                                                                                                                                                                                                                          |                           | 3,757,863                                                    |            |            |           | 830,980     |            
|                                                                                                           | Lines of credit  current portion                                                                                                                                                                             |                                                                                                                                                                                                                          |                           | 953,984                                                      |            |            |           | 595,704     |            
|                                                                                                           | Deferred contract revenue                                                                                                                                                                                     |                                                                                                                                                                                                                          |                           | 1,250,000                                                    |            |            |           |            |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | Total current liabilities |                                                              |            | 8,645,560  |           |             |             | 2,185,457 |           
|Lines of credit  non current portion                                                                      |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 1,411,604                 |                                                              |            |            | 1,060,230 |            
|Note payable                                                                                               |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 75,000                    |                                                              |            |            | 75,000    |            
|Deferred contract revenue                                                                                  |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 3,125,000                 |                                                              |            |            |          |            
|Deferred credit on lease concession                                                                        |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | 767,759                   |                                                              |            |            |          |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          | Total liabilities         |                                                              |            | 14,024,923 |           |             |             | 3,320,687 |           
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|Commitments and contingencies                                                                              |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           | Mandatorily redeemable convertible preferred
    stock:                                                                                                                                                       |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |             |            
|                                                                                                           |                                                                                                                                                                                                               | Series A, $0.01 par value; no shares
    authorized, issued or outstanding at December 31, 2003;
    2,000,000 shares authorized, issued and outstanding (liquidation
    preference of $2,607,964) at December 31, 2002 |                           |                                                              |           |            |           |             | 1,989,471   |          
|                                                                                                           |                                                                                                                                                                                                               | Series B, $0.01 par value; no shares
    authorized issued or outstanding at December 31, 2003;
    2,000,000 shares authorized, issued and outstanding (liquidation
    preference of $3,064,781) at December 31, 2002  |                           |                                                              |           |            |           |             | 2,488,355   |          
|                                                                                                           |                                                                                                                                                                                                               | Series C, $0.01 par value; no shares
    authorized issued or outstanding at December 31, 2003;
    4,010,000 shares authorized, issued and outstanding (liquidation
    preference of $7,071,498) at December 31, 2002  |                           |                                                              |           |            |           |             | 5,998,100   |          
|                                                                                                           |                                                                                                                                                                                                               | Series D, $0.01 par value; no shares
    authorized issued or outstanding at December 31, 2003;
    7,999,999 shares authorized, issued and outstanding (liquidation
    preference of $20,071,641) at December 31, 2002 |                           |                                                              |           |            |           |             | 17,963,369  |          
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           | Total mandatorily redeemable convertible
    preferred stock |            |            |          |             |             |           | 28,439,295 | 
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|Stockholders equity (deficit):                                                                            |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           | Preferred stock, $0.01 par value; 25,000,000
    shares authorized; no shares issued and outstanding at
    December 31, 2003; no shares authorized, issued or
    outstanding at December 31, 2002           |                                                                                                                                                                                                                          |                           |                                                             |            |            |           |            |            
|                                                                                                           | Common stock, $0.01 par value; 225,000,000 shares
    and 23,333,333 shares authorized, and 22,639,344 shares and
    1,376,306 shares issued and outstanding at December 31,
    2003 and 2002, respectively |                                                                                                                                                                                                                          |                           | 226,394                                                      |            |            |           | 13,763      |            
|                                                                                                           | Capital in excess of par value                                                                                                                                                                                |                                                                                                                                                                                                                          |                           | 120,141,450                                                  |            |            |           | 514,598     |            
|                                                                                                           | Deferred stock-based compensation                                                                                                                                                                             |                                                                                                                                                                                                                          |                           | (6,126,286                                                   | )          |            |           | (102,986    | )          
|                                                                                                           | Accumulated deficit                                                                                                                                                                                           |                                                                                                                                                                                                                          |                           | (44,102,018                                                  | )          |            |           | (23,126,834 | )          
|                                                                                                           | Accumulated other comprehensive income                                                                                                                                                                        |                                                                                                                                                                                                                          |                           | 10,380                                                       |            |            |           |            |            
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               | Total stockholders equity (deficit)                                                                                                                                                                                     |                           |                                                              | 70,149,920 |            |           |             | (22,701,459 | )        
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            
|                                                                                                           |                                                                                                                                                                                                               | Total liabilities, mandatorily redeemable
    convertible preferred stock and stockholders
    equity (deficit)                                                                                                         |                           | $                                                            | 84,174,843 |            |           | $           | 9,058,523   |          
|                                                                                                           |                                                                                                                                                                                                               |                                                                                                                                                                                                                          |                           |                                                              |            |            |           |            

The accompanying notes are an integral part of
these financial statements.

F-3



---



##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION






STATEMENTS OF OPERATIONS


|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |           |           | 
|------------------------------------------------------------------------------------- | -------------------------- | ----------------------- | ----------- | ---------- | ---------- | ---- | ----------- | ---------- | ---------- | - | ---------- | --------- | --------- | 
|                                                                                      |                            |                        
|                                                                                      |                            | Year Ended December 31,
|                                                                                      |                            |                        
|                                                                                      |                            | 2003                    |             | 2002       |            | 2001
|                                                                                      |                            |                         |             |            |            |     
|Contract revenue                                                                      |                            | $                       | 3,625,000   |            |            | $    |            |            |            | $ |           |          
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Cost and expenses:                                                                    |                            |                         |             |            |            |      |             |            |            |   |            |          
|                                                                                      | Research and development   |                         |             | 16,594,629 |            |      |             | 10,855,130 |            |   |            | 5,295,308 |          
|                                                                                      | General and administrative |                         |             | 6,427,453  |            |      |             | 3,323,879  |            |   |            | 1,958,602 |          
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|                                                                                      |                            | Total expenses          |             |            | 23,022,082 |      |             |            | 14,179,009 |   |            |           | 7,253,910 | 
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Loss from operations                                                                  |                            |                         | (19,397,082 | )          |            |      | (14,179,009 | )          |            |   | (7,253,910 | )        
|Interest income                                                                       |                            |                         | 253,504     |            |            |      | 338,135     |            |            |   | 183,641    |          
|Interest expense                                                                      |                            |                         | (164,939    | )          |            |      | (235,506    | )          |            |   | (114,307   | )        
|Beneficial conversion feature  deemed
    interest expense                           |                            |                         | (1,666,667  | )          |            |      |            |            |            |   |           |          
|Other expense                                                                         |                            |                         |            |            |            |      | (47,615     | )          |            |   |           |          
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Net loss                                                                              |                            |                         | (20,975,184 | )          |            |      | (14,123,995 | )          |            |   | (7,184,576 | )        
|Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock |                            |                         | (209,173    | )          |            |      | (73,925     | )          |            |   | (37,594    | )        
|Beneficial conversion feature  deemed
    dividend to preferred stockholders         |                            |                         | (20,907,620 | )          |            |      |            |            |            |   |           |          
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Net loss applicable to common stockholders                                            |                            | $                       | (42,091,977 | )          |            | $    | (14,197,920 | )          |            | $ | (7,222,170 | )        
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Basic and diluted net loss per share applicable
    to common stockholders            |                            | $                       | (7.58       | )          |            | $    | (16.37      | )          |            | $ | (12.59     | )        
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          
|Shares used in calculation of basic and diluted
    net loss per share                |                            |                         | 5,554,773   |            |            |      | 867,239     |            |            |   | 573,699    |          
|                                                                                      |                            |                         |             |            |            |      |             |            |            |   |            |          

The accompanying notes are an integral part of
these financial statements.

F-4



---



##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENT OF CHANGES IN STOCKHOLDERS
EQUITY (DEFICIT)

|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |             |             |  
|---------------------------- | ------------------------------------------------------------------------------------------- | --------------------------------------------- | ---------- | ---------- | - | ---------- | ------- | ------------ | - | ----------- | ----------- | ------------- | - | ------------- | ---------- | ---------- | - | - | ----------- | ----------- | ----------- | - | ------ | - | ------ | - | ----------- | ----------- | ----------- | -
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             | Accumulated   |   | Total        
|                             |                                                                                             |                                               |            |            |   | Capital in |         | Deferred     |   |             |             | Other         |   | Stockholders
|                             |                                                                                             | Common                                        |            | Par        |   | Excess of  |         | Stock-Based  |   | Accumulated |             | Comprehensive |   | Equity       
|                             |                                                                                             | Shares                                        |            | Value      |   | Par Value  |         | Compensation |   | Deficit     |             | Income        |   | (Deficit)    
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |              
|Balance at December 31, 2000 |                                                                                             |                                               | 743,137    |            |   | $          | 7,431   |              |   | $           | 100,682     |               |   | $             |           |            |   | $ | (1,818,263  | )           |             | $ |       |   |        | $ | (1,710,150  | )          
|                             | Issuance of restricted stock                                                                |                                               |            | 599,564    |   |            |         | 5,996        |   |             |             | 224,664       |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 230,660     |            
|                             | Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock       |                                               |            |           |   |            |         |             |   |             |             | (37,594       | ) |               |            |           |   |   |             |            |             |   |        |  |        |   |             | (37,594     | )          
|                             | Net loss                                                                                    |                                               |            |           |   |            |         |             |   |             |             |              |   |               |            |           |   |   |             | (7,184,576  | )           |   |        |  |        |   |             | (7,184,576  | )          
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |            
|Balance at December 31, 2001 |                                                                                             |                                               | 1,342,701  |            |   |            | 13,427  |              |   |             | 287,752     |               |   |               |           |            |   |   | (9,002,839  | )           |             |   |       |   |        |   | (8,701,660  | )          
|                             | Issuance of restricted stock                                                                |                                               |            | 33,605     |   |            |         | 336          |   |             |             | 12,497        |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 12,833      |            
|                             | Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock       |                                               |            |           |   |            |         |             |   |             |             | (73,925       | ) |               |            |           |   |   |             |            |             |   |        |  |        |   |             | (73,925     | )          
|                             | Issuance of stock options for services                                                      |                                               |            |           |   |            |         |             |   |             |             | 155,334       |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 155,334     |            
|                             | Deferred stock-based compensation                                                           |                                               |            |           |   |            |         |             |   |             |             | 132,940       |   |               |            | (132,940   | ) |   |             |            |             |   |        |  |        |   |             |            |            
|                             | Amortization of deferred
    stock-based compensation                                       |                                               |            |           |   |            |         |             |   |             |             |              |   |               |            | 29,954     |   |   |             |            |             |   |        |  |        |   |             | 29,954      |            
|                             | Net loss                                                                                    |                                               |            |           |   |            |         |             |   |             |             |              |   |               |            |           |   |   |             | (14,123,995 | )           |   |        |  |        |   |             | (14,123,995 | )          
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |            
|Balance at December 31, 2002 |                                                                                             |                                               | 1,376,306  |            |   | $          | 13,763  |              |   | $           | 514,598     |               |   | $             | (102,986   | )          |   | $ | (23,126,834 | )           |             | $ |       |   |        | $ | (22,701,459 | )          
|                             | Issuance of restricted stock                                                                |                                               |            | 173,532    |   |            |         | 1,735        |   |             |             | 89,359        |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 91,094      |            
|                             | Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock       |                                               |            |           |   |            |         |             |   |             |             | (209,173      | ) |               |            |           |   |   |             |            |             |   |        |  |        |   |             | (209,173    | )          
|                             | Cashless exercise of warrants                                                               |                                               |            | 27,032     |   |            |         | 271          |   |             |             | (301          | ) |               |            |           |   |   |             |            |             |   |        |  |        |   |             | (30         | )          
|                             | Issuance of stock options for services                                                      |                                               |            |           |   |            |         |             |   |             |             | 1,260,117     |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 1,260,117   |            
|                             | Deferred stock-based compensation                                                           |                                               |            |           |   |            |         |             |   |             |             | 8,204,446     |   |               |            | (8,204,446 | ) |   |             |            |             |   |        |  |        |   |             |            |            
|                             | Amortization of deferred
    stock-based compensation                                       |                                               |            |           |   |            |         |             |   |             |             |              |   |               |            | 2,181,146  |   |   |             |            |             |   |        |  |        |   |             | 2,181,146   |            
|                             | Beneficial conversion feature  deemed
    interest on convertible notes                    |                                               |            |           |   |            |         |             |   |             |             | 1,666,667     |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 1,666,667   |            
|                             | Beneficial conversion feature  deemed
    dividend on issuance of Series E preferred stock |                                               |            |           |   |            |         |             |   |             |             | 20,907,620    |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 20,907,620  |            
|                             | Accretion of beneficial conversion feature 
    deemed dividend                            |                                               |            |           |   |            |         |             |   |             |             | (20,907,620   | ) |               |            |           |   |   |             |            |             |   |        |  |        |   |             | (20,907,620 | )          
|                             | Issuance of common stock in public offering, net
    of issuance costs                      |                                               |            | 6,000,000  |   |            |         | 60,000       |   |             |             | 54,251,900    |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 54,311,900  |            
|                             | Conversion of preferred stock to common stock                                               |                                               |            | 15,062,474 |   |            |         | 150,625      |   |             |             | 54,363,837    |   |               |            |           |   |   |             |            |             |   |        |  |        |   |             | 54,514,462  |            
|                             | Comprehensive income (loss):                                                                |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |             |            
|                             |                                                                                             | Net loss                                      |            |            |  |            |         |              |  |             |             |               |  |               |            |            |  |   |             |             | (20,975,184 | ) |        |   |       |   |             |             | (20,975,184 | )
|                             |                                                                                             | Unrealized gain on marketable securities, net |            |            |  |            |         |              |  |             |             |               |  |               |            |            |  |   |             |             |            |   |        |   | 10,380 |   |             |             | 10,380      |  
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |            
|                             |                                                                                             | Total comprehensive loss                      |            |            |  |            |         |              |  |             |             |               |  |               |            |            |  |   |             |             |            |   |        |   |       |   |             |             | (20,964,804 | )
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |            
|Balance at December 31, 2003 |                                                                                             |                                               | 22,639,344 |            |   | $          | 226,394 |              |   | $           | 120,141,450 |               |   | $             | (6,126,286 | )          |   | $ | (44,102,018 | )           |             | $ | 10,380 |   |        | $ | 70,149,920  |            
|                             |                                                                                             |                                               |            |            |   |            |         |              |   |             |             |               |   |               |            |            |   |   |             |             |             |   |        |   |        |   |             |            

The accompanying notes are an integral part of
these financial statements.

F-5



---



##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENTS OF CASH FLOWS

|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |            |         |            |            |  
|-------------------------------------------------------- | ------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------------------- | ---------- | ----------- | ----------- | ----------- | ------- | --------- | ----------- | ---------- | ------- | ---------- | ---------- | -
|                                                         |                                                                                 |                                                                                                                                      
|                                                         |                                                                                 | Year Ended December 31,                                                                                                              
|                                                         |                                                                                 |                                                                                                                                      
|                                                         |                                                                                 | 2003                                                                                                                                  |                                               | 2002                                  |            | 2001       
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |            
|Cash flows from operating activities:                    |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         | Net loss                                                                        |                                                                                                                                       | $                                             | (20,975,184                           | )          |             | $           | (14,123,995 | )       |           | $           | (7,184,576 | )      
|                                                         | Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |            |        
|                                                         |                                                                                 | Depreciation and amortization                                                                                                         |                                               |                                       | 736,036    |             |             |             | 502,981 |           |             |            | 245,007 |           
|                                                         |                                                                                 | Stock-based compensation                                                                                                              |                                               |                                       | 3,441,263  |             |             |             | 185,288 |           |             |            |        |           
|                                                         |                                                                                 | Amortization of deferred credit on
    lease concession                                                                               |                                               |                                       | (62,251    | )           |             |             |        |           |             |            |        |           
|                                                         |                                                                                 | Amortization of premium on
    marketable securities                                                                                  |                                               |                                       | 231,600    |             |             |             |        |           |             |            |        |           
|                                                         |                                                                                 | Interest accrued on convertible notes                                                                                                 |                                               |                                       | 92,362     |             |             |             |        |           |             |            |        |           
|                                                         |                                                                                 | Beneficial conversion feature  deemed
    interest expense                                                                           |                                               |                                       | 1,666,667  |             |             |             |        |           |             |            |        |           
|                                                         |                                                                                 | Changes in:                                                                                                                           |                                               |                                       |            |             |             |             |         |           |             |            |         |           
|                                                         |                                                                                 |                                                                                                                                       | Accounts receivable                           |                                       |            | (3,000,000  | )           |             |         |          |             |            |         |           |           
|                                                         |                                                                                 |                                                                                                                                       | Prepaid expenses and other current assets     |                                       |            | (954,952    | )           |             |         | (83,013   | )           |            |         | 40,932     |           
|                                                         |                                                                                 |                                                                                                                                       | Deposits other than on property and equipment |                                       |            | 95,068      |             |             |         | (71,308   | )           |            |         | (4,958     | )         
|                                                         |                                                                                 |                                                                                                                                       | Accounts payable                              |                                       |            | 1,924,940   |             |             |         | 483,714   |             |            |         | 126,669    |           
|                                                         |                                                                                 |                                                                                                                                       | Accrued expenses                              |                                       |            | 1,345,211   |             |             |         | 310,356   |             |            |         | 372,457    |           
|                                                         |                                                                                 |                                                                                                                                       | Deferred contract revenue                     |                                       |            | 4,375,000   |             |             |         |          |             |            |         |           |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 |                                                                                                                                       |                                               | Net cash used in operating activities |            |             | (11,084,240 | )           |         |           | (12,795,977 | )          |         |            | (6,404,469 | )
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Cash flows from investing activities:                    |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         | Purchase of marketable securities                                               |                                                                                                                                       |                                               | (27,857,852                           | )          |             |             |            |         |           |             | (6,202,075 | )      
|                                                         | Sale and maturities of marketable securities                                    |                                                                                                                                       |                                               |                                      |            |             |             | 6,202,075   |         |           |             |           |        
|                                                         | Purchases of property and equipment                                             |                                                                                                                                       |                                               | (8,963,111                            | )          |             |             | (1,439,677  | )       |           |             | (1,479,401 | )      
|                                                         | Deposits on property and equipment                                              |                                                                                                                                       |                                               | (83,610                               | )          |             |             | (283,246    | )       |           |             | 92,693     |        
|                                                         | Restricted cash                                                                 |                                                                                                                                       |                                               | (338,031                              | )          |             |             | (1,438,538  | )       |           |             |           |        
|                                                         | Landlord lease concession                                                       |                                                                                                                                       |                                               | 830,010                               |            |             |             |            |         |           |             |           |        
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 |                                                                                                                                       | Net cash from (used in) investing activities  |                                       |            | (36,412,594 | )           |             |         | 3,040,614 |             |            |         | (7,588,783 | )         
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Cash flows from financing activities:                    |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         | Proceeds from lines of credit                                                   |                                                                                                                                       |                                               | 1,346,061                             |            |             |             | 1,019,866   |         |           |             | 1,317,224  |        
|                                                         | Proceeds from note payable                                                      |                                                                                                                                       |                                               |                                      |            |             |             | 75,000      |         |           |             |           |        
|                                                         | Payments on lines of credit                                                     |                                                                                                                                       |                                               | (636,407                              | )          |             |             | (453,814    | )       |           |             | (227,342   | )      
|                                                         | Proceeds from convertible notes payable                                         |                                                                                                                                       |                                               | 5,000,000                             |            |             |             |            |         |           |             |           |        
|                                                         | Proceeds from exercise of common
    stock options                              |                                                                                                                                       |                                               | 91,094                                |            |             |             | 12,833      |         |           |             | 109,160    |        
|                                                         | Proceeds from issuance of preferred stock, net of
    issuance costs            |                                                                                                                                       |                                               | 20,774,765                            |            |             |             | 2,974,200   |         |           |             | 20,920,095 |        
|                                                         | Proceeds from initial public offering, net of
    issuance costs                |                                                                                                                                       |                                               | 54,311,900                            |            |             |             |            |         |           |             |           |        
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 |                                                                                                                                       | Net cash from financing activities            |                                       |            | 80,887,413  |             |             |         | 3,628,085 |             |            |         | 22,119,137 |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Net increase (decrease) in cash and
    cash equivalents |                                                                                 |                                                                                                                                       | 33,390,579                                    |                                       |            |             | (6,127,278  | )           |         |           | 8,125,885   |           
|Cash and cash equivalents, beginning
    of period       |                                                                                 |                                                                                                                                       | 4,059,911                                     |                                       |            |             | 10,187,189  |             |         |           | 2,061,304   |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Cash and cash equivalents, end of period                 |                                                                                 | $                                                                                                                                     | 37,450,490                                    |                                       |            | $           | 4,059,911   |             |         | $         | 10,187,189  |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Supplemental disclosure of cash flow information:        |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Cash paid for interest, net of
    interest capitalized                                                                               |                                               | $                                     | 38,511     |             |             | $           | 211,393 |           |             | $          | 114,287 |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|Supplemental disclosure of non-cash transactions:        |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Conversion of convertible notes, including
    accrued interest, into Series E mandatorily redeemable
    convertible preferred stock |                                               | $                                     | 5,092,362  |             |             | $           |        |           |             | $          |        |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Accretion of beneficial conversion feature for
    Series E convertible preferred stock                                               |                                               | $                                     | 20,907,620 |             |             | $           |        |           |             | $          |        |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Conversion of preferred stock to common                                                                                               |                                               | $                                     | 54,514,462 |             |             | $           |        |           |             | $          |        |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Exercise of stock option for note receivable                                                                                          |                                               | $                                     |           |             |             | $           |        |           |             | $          | 121,500 |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock                                                 |                                               | $                                     | 209,173    |             |             | $           | 73,925  |           |             | $          | 37,594  |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           
|                                                         |                                                                                 | Purchase of property in accrued liabilities                                                                                           |                                               | $                                     | 1,580,509  |             |             | $           |        |           |             | $          |        |           
|                                                         |                                                                                 |                                                                                                                                       |                                               |                                       |            |             |             |             |         |           |             |           

The accompanying notes are an integral part of
these financial statements.

F-6



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##### Table of Contents






ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS



|   |                       
|-- | ----------------------
|1. | Nature of the Business

Advancis Pharmaceutical Corporation (the
Company), formerly Advanced Pharma, Inc., was
incorporated in Delaware in December 1999 and commenced
operations on January 1, 2000. The Company has focused on
the development of anti-infective pharmaceutical formulations
that will provide the convenience of once-a-day dosing with
improved therapeutic advantages for ailments such as sinusitis,
respiratory tract infections, urinary tract infections, skin and
skin structure infections and post-surgical infections. The
Company intends to develop and commercialize improved
formulations of currently marketed anti-infective products using
various means of administration and proprietary drug delivery
technology, including the Companys PULSYS
technology. The Company plans to accomplish this through
corporate partnerships for the development, sale and marketing
of some of these products, while retaining rights to develop,
sell and market others.

During the fourth quarter of 2003, the Company
commenced operations at its new corporate, research and
development facility in Germantown, Maryland, raised capital
from completion of its initial public offering, and recognized
revenue from achievement of its first contract milestone.
Accordingly, management has determined that the Company is no
longer in the development stage. As a result, all references to
cumulative statement of operations, stockholders equity
(deficit), and statements of cash flows have been eliminated in
the accompanying financial statements.



|   |                                               
|-- | ----------------------------------------------
|2. | Summary of Significant Accounting
    Policies






Use of Estimates


The preparation of financial statements in
conformity with generally accepted accounting principles in the
United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.




Cash and Cash Equivalents

Cash equivalents are highly liquid investments
with a maturity of three months or less at date of purchase and
consist of time deposits, investments in money market funds with
commercial banks and financial institutions, commercial paper
and high-quality corporate bonds. At December 31, 2003 and
2002, the Company maintained all of its cash and cash
equivalents in three financial institutions. Deposits held with
banks may exceed the amount of insurance provided on such
deposits. Generally, these deposits may be redeemed upon demand,
and the Company believes there is minimal risk of losses on such
cash balances.




Restricted Cash

The Company has established cash deposit accounts
in the amounts of $335,769 and $500,000 that are pledged as
collateral for lines of credit (see Note 6). Also, in
conjunction with the lease of its corporate, research and
development facility, the Company provided the landlord with a
letter of credit, which was collateralized with a restricted
cash deposit in the amount of $940,800 (see Note 16). These
deposits are recorded as non-current restricted cash at
December 31, 2003 and 2002.




Fair Value of Financial
Instruments

The carrying amounts of the Companys
financial instruments, which include cash and cash equivalents,
marketable securities, notes payable and line of credit
borrowings, approximate their fair values due to their short
maturities.

F-7



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)






Marketable Securities

The Company classifies all of its marketable
securities as available-for-sale. Available-for-sale securities
are carried at fair value, with the unrealized gains and losses
reported as a component of stockholders equity
(deficit) in comprehensive income (loss). Marketable
securities available for current operations are classified in
the balance sheet as current assets; marketable securities held
for long-term purposes are classified as noncurrent assets.
Interest income and realized gains and losses on securities are
included in Interest income in the statements of
operations.




Comprehensive Income

SFAS No. 130, Reporting
Comprehensive Income,requires a full set of
general-purpose financial statements to include the reporting of
comprehensive income. Comprehensive income is
composed of two components, net income and other comprehensive
income. For the year ended December 31, 2003, other
comprehensive income of $10,380 consists of unrealized gains and
losses on available-for-sale marketable securities. For the
years ended December 31, 2002 and 2001, there were no items
of other comprehensive income.




Property and Equipment

Property and equipment are stated at cost and
depreciated over their estimated useful lives using the
straight-line method. Upon retirement or sale, the cost of
assets disposed of and the related accumulated depreciation are
removed from the accounts and any resulting gain or loss is
credited or charged to operations. Repairs and maintenance costs
are expensed as incurred. In accordance with SFAS No. 34,
Capitalization of Interest Cost, the Company
capitalized interest cost of $103,446 in the year ended
December 31, 2003 related to the build-out of its
corporate, research and development facility. No interest was
capitalized in the year ended December 31, 2002.




Intangible Assets

Intangible assets consist of the cost of
capitalized patent applications. Patents are carried at cost
amounting to $120,000, less accumulated amortization which is
calculated on a straight-line basis over the estimated useful
lives of the patents, not to exceed 20 years. The Company
periodically reviews the carrying value of patents to determine
whether the carrying amount of the patent is recoverable. For
the years ended December 31, 2003, 2002 and 2001, there
were no adjustments to the carrying values of patents. The
Company is amortizing the cost of the patent applications over a
period of ten years. Ownership of all of its patents is retained
by the Company in all of its transactions. Amortization expense
for each of the years ended December 31, 2003, 2002 and
2001 was $12,000. Accumulated amortization as of
December 31, 2003 and 2002 is $48,000 and $36,000,
respectively. The estimated amortization expense for each of the
five succeeding fiscal years is $12,000.




Revenue Recognition

Contract revenues include license fees and
milestone payments associated with collaborations with third
parties. Revenue from non-refundable, upfront license fees where
the Company has continuing involvement is recognized ratably
over the development or agreement period. Revenue associated
with performance milestones is recognized based upon the
achievement of the milestones, as defined in the respective
agreements. Royalties from licensees are based on third-party
sales of licensed products and will be recorded in accordance
with contract terms when third-party results are reliably
measurable and collectibility is reasonably assured.

F-8



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)






Research and Development

The Company expenses research and development
costs as incurred. Research and development costs primarily
consist of salaries and related expenses for personnel and
capital resources. Other research and development expenses
include fees paid to consultants and outside service providers
and the costs of materials used in clinical trials and research
and development.




Impairment of Long-Lived
Assets

SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets,establishes accounting standards for the impairment of
long-lived assets. The Company reviews its long-lived assets,
including property and equipment, for impairment whenever events
or circumstances indicate that the carrying amount of an asset
may not be recoverable. If this review indicates that the asset
will not be recoverable based on the expected undiscounted net
cash flows of the related asset, an impairment loss is
recognized. There were no impairment losses recognized in 2003,
2002 and 2001.




Deferred Credit on Lease
Concession

During 2003, the Company received $830,010 in
cash from the landlord in connection with the build-out of its
corporate, research and development facility. This amount is
being amortized as a reduction to rent expense over the term of
the lease. In 2003, the Company amortized $62,251 of the
deferred credit on lease concession.




Accounting for Stock-Based
Compensation

Employee stock awards under the Companys
compensation plans are accounted for by the intrinsic value
method in accordance with Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to
Employees,(APB 25) and related interpretations.
During 2003 and 2002, stock options were granted with an
exercise price which was below the estimated fair market value
of the common stock at the date of grant. Deferred stock-based
compensation of $8,204,446 and $132,940 was recorded during 2003
and 2002, respectively, in accordance with APB 25, and will be
amortized over the related vesting period of the options. The
Company recorded stock-based compensation expense related to
employee stock options of $2,181,146 and $29,954 during 2003 and
2002, respectively. No compensation cost was recognized for
employee stock-based compensation in 2001, as all options
granted during those years had an exercise price equal to the
market value of the underlying common stock on the date of grant.

In accordance with SFAS 148, the following table
illustrates the effect on net loss and net loss per share as if
the Company had applied the fair value recognition provisions of
SFAS 123. Because options vest over several

F-9



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

years and additional option grants are expected
to be made in future years, the pro forma results are not
representative of the pro forma results for future years.

|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | ---- |  | ---- | ----------- | - |  | - | ---------- | -
|                                                                                                  |  |             
|                                                                                                  |  | December 31,
|                                                                                                  |  |             
|                                                                                                  |  | 2003         |             | 2002 |  | 2001
|                                                                                                  |  |              |             |      |  |     
|Net loss, as reported                                                                             |  | $            | (20,975,184 | )    |  | $    | (14,123,995 | ) |  | $ | (7,184,576 | )
|Add  Stock-based employee compensation
    expense determined under the intrinsic value method   |  |              | 2,181,146   |      |  |      | 29,954      |   |  |   |           |  
|Less  Stock-based employee compensation
    expense determined under the fair value based method |  |              | (2,677,989  | )    |  |      | (161,755    | ) |  |   | (88,579    | )
|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  
|Pro forma net loss                                                                                |  |              | (21,472,027 | )    |  |      | (14,255,796 | ) |  |   | (7,273,155 | )
|Accretion of issuance costs of mandatorily
    redeemable convertible preferred stock             |  |              | (209,173    | )    |  |      | (73,925     | ) |  |   | (37,594    | )
|Beneficial conversion feature-deemed dividend to
    preferred stockholders                       |  |              | (20,907,620 | )    |  |      |            |   |  |   |           |  
|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  
|Pro forma net loss applicable to common
    stockholders                                          |  | $            | (42,588,820 | )    |  | $    | (14,329,721 | ) |  | $ | (7,310,749 | )
|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  
|Net loss per share:                                                                               |  |              |             |      |  |      |             |   |  |   |            |  
|Basic and diluted, as reported                                                                    |  | $            | (7.58       | )    |  | $    | (16.37      | ) |  | $ | (12.59     | )
|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  
|Basic and diluted, pro forma                                                                      |  | $            | (7.67       | )    |  | $    | (16.52      | ) |  | $ | (12.74     | )
|                                                                                                  |  |              |             |      |  |      |             |   |  |   |            |  

The weighted average fair value of options
granted during 2003, 2002 and 2001 was $5.59, $0.59 and $0.44
per share, respectively. The fair value of each option grant was
estimated on the date of grant using the Black-Scholes options
pricing model with the following assumptions for grants in 2003,
2002 and 2001:

|                         |  |              |  |               |  |      
|------------------------ |  | ------------ |  | ------------- |  | -----
|                         |  |             
|                         |  | December 31,
|                         |  |             
|                         |  | 2003         |  | 2002          |  | 2001 
|                         |  |              |  |               |  |      
|Expected life (in years) |  | 5            |  | 5             |  | 4    
|Risk-free interest rate  |  | 3.28%        |  | 3.19% to 4.7% |  | 5.94%
|Volatility               |  | 80%          |  | 80%           |  | 80%  
|Dividend yield           |  | 0%           |  | 0%            |  | 0%   




Income Taxes

The Company accounts for income taxes by the
liability method. Under this method, deferred income taxes are
recognized for tax consequences in future years of differences
between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end, based on enacted
laws and statutory tax rates applicable to the periods in which
the differences are expected to affect taxable income. Valuation
allowances are provided if, based upon the weight of available
evidence, it is more likely than not that some or all of the
deferred tax assets will not be realized.




Earnings Per Share

Basic earnings per share is computed based on the
weighted average number of common shares outstanding during the
period. Diluted earnings per share is computed based on the
weighted average shares outstanding adjusted for all dilutive
potential common shares. The dilutive impact, if any, of common
stock equivalents outstanding during the period, including
outstanding stock options and warrants, is measured by the
treasury stock method. The dilutive impact, if any, of the
Companys redeemable convertible preferred stock is measured

F-10



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

using the if-converted method. Potential common
shares are not included in the computation of diluted earnings
per share if they are antidilutive. The Company incurred net
losses for 2003, 2002 and 2001 and, accordingly, did not assume
exercise or conversion of any of the Companys outstanding
stock options, warrants or redeemable convertible preferred
stock because to do so would be antidilutive.

The following are the securities that could
potentially dilute basic earnings per share in the future that
were not included in the computation of diluted earnings per
share because to do so would have been antidilutive for the
periods presented:

|                                     |  |              |           |      |  |      |            |  |  |  |           | 
|------------------------------------ |  | ------------ | --------- | ---- |  | ---- | ---------- |  |  |  | --------- | 
|                                     |  |             
|                                     |  | December 31,
|                                     |  |             
|(Number of Underlying Common Shares) |  | 2003         |           | 2002 |  | 2001
|                                     |  |              |           |      |  |     
|Preferred stock                      |  |              |          |      |  |      | 8,748,251  |  |  |  | 8,019,685 | 
|Stock options                        |  |              | 2,235,488 |      |  |      | 844,198    |  |  |  | 573,281   | 
|Nonvested restricted stock           |  |              | 424,290   |      |  |      | 496,153    |  |  |  | 564,183   | 
|Warrants                             |  |              |          |      |  |      | 36,524     |  |  |  | 33,961    | 
|                                     |  |              |           |      |  |      |            |  |  |  |           | 
|Total                                |  |              | 2,659,778 |      |  |      | 10,125,126 |  |  |  | 9,191,110 | 
|                                     |  |              |           |      |  |      |            |  |  |  |           | 




Recent Accounting
Pronouncements

In December 2002, the Emerging Issues Task
Force (EITF) reached consensus on EITF Issue
No. 00-21, Accounting for Revenue Arrangements
with Multiple Deliverables,that the provisions of
EITF Issue No. 00-21 should be used to determine when a
revenue arrangement for multiple deliverables should be divided
into separate units of accounting and, if separation is
appropriate, how the arrangement consideration should be
allocated to the identified accounting units. The provisions of
EITF Issue No. 00-21 are effective for revenue arrangements
entered into in fiscal periods beginning after June 15,
2003.

In January 2003, the FASB issued FIN 46,
Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin
No. 51,Consolidated Financial
Statements. FIN 46 establishes accounting guidance for
consolidation of variable interest entities that function to
support the activities of the primary beneficiary. In
October 2003, the FASB issued FASB Staff Position FIN
46-6,Effective Date of FASB Interpretation
No. 46, Consolidation of Variable Interest
Entities deferring the effective date for applying the
provisions of FIN 46 for public entities interest in
variable interest entities or potential variable interest
entities created before February 1, 2003 until financial
statements of interim or annual periods that end after
December 15, 2003. In December 2003, the FASB issued
FIN 46 (revised December 2003),Consolidation of
Variable Interest Entities. This revised
interpretation is effective for all entities no later than the
end of the first reporting period that ends after March 15,
2004. We have no investment in or contractual relationship or
other business relationship with a variable interest entity and
therefore the adoption of this interpretation will not have any
impact on our financial position or results of operations.
However, if we enter into such an arrangement with a variable
interest entity in the future or an entity with which we have a
relationship is reconsidered based on guidance in FIN 46 to be a
variable interest entity, our financial position or results of
operations might be impacted.

In November 2003, during discussion on EITF
Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments, the EITF reached a consensus which
requires certain quantitative and qualitative disclosures for
debt and marketable equity securities classified as
available-for-sale or held-to-maturity under SFAS 115 and SFAS
124 that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. The
consensus on quantitative and qualitative disclosures is
effective for fiscal years ending after December 15, 2003
and comparative information for earlier periods presented is not
required. We currently do not have any impaired investments and
thus the adoption of this consensus did not have a material
impact on our financial statements.

F-11



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)



|   |        
|-- | -------
|3. | Revenue

On July 18, 2003, the Company entered into a
development and license agreement with GlaxoSmithKline
(GSK) pursuant to which the Company has exclusively
licensed patents and PULSYS technology to GSK for use on some of
its products. Under the agreement, GSK will be responsible for
the clinical development, manufacture, commercialization and
sale of the licensed products. In consideration for the
licensing of its technology, the Company received an initial
upfront payment of $5.0 million and can receive milestone
payments not to exceed $52.0 million over the development
period if GSK achieves specified product development goals. In
addition, upon commercialization of any of the products, the
Company could receive royalty payments and may receive
additional incentive payments of up to $50.0 million if
specified annual sales goals are achieved.

The Company recognized contract revenue of
$3.6 million in the year ended December 31, 2003 for
amortization of the initial up front payment from GSK as well as
achievement of the first milestone from GSK. Revenue of $625,000
represents amortization of the $5.0 million upfront payment
from GSK, which is expected to be amortized into revenue on a
straight-line basis through June 2007. In
December 2003, the Company was notified by GSK that the
first milestone event was achieved, and the Company recognized
revenue of $3.0 million for this event.

In September 2003, the Company entered into
an agreement pursuant to which it licensed to Par Pharmaceutical
the distribution and marketing rights to the Companys
generic clarithromycin product. The Company is entitled to
receive milestone payments from Par Pharmaceutical not to exceed
an aggregate of $6.0 million upon achievement of certain goals.
To date, no milestone payments from Par Pharmaceutical have been
received.



|   |                      
|-- | ---------------------
|4. | Marketable Securities

Marketable securities, including accrued
interest, at December 31, 2003 were as follows:

|                       |                              |                   |            |            |  |            |        |            |  |   |         |         |   |   |            |            | 
|---------------------- | ---------------------------- | ----------------- | ---------- | ---------- |  | ---------- | ------ | ---------- |  | - | ------- | ------- | - | - | ---------- | ---------- | 
|                       |                              |                  
|                       |                              | December 31, 2003
|                       |                              |                  
|                       |                              |                   |            | Gross      |  | Gross      |        |           
|                       |                              | Amortized         |            | Unrealized |  | Unrealized |        |           
|Available-for-sale     |                              | Cost              |            | Gains      |  | Losses     |        | Fair Value
|                       |                              |                   |            |            |  |            |        |           
|Marketable securities: |                              |                   |            |            |  |            |        |            |  |   |         |         |   |   |            |           
|                       | Corporate debt securities    |                   | $          | 24,613,413 |  |            | $      | 6,113      |  |   | $       | (12,897 | ) |   | $          | 24,606,629 | 
|                       | Government agency securities |                   |            | 3,012,839  |  |            |        | 17,164     |  |   |         |        |   |   |            | 3,030,003  | 
|                       |                              |                   |            |            |  |            |        |            |  |   |         |         |   |   |            |           
|                       |                              | $                 | 27,626,252 |            |  | $          | 23,277 |            |  | $ | (12,897 | )       |   | $ | 27,636,632 |           
|                       |                              |                   |            |            |  |            |        |            |  |   |         |         |   |   |            |           

The Company had no marketable securities at
December 31, 2002.

Maturities of the Companys marketable
securities at December 31, 2003 are as follows:

|                                     |                    |                   |            |            |  |   |            |            | 
|------------------------------------ | ------------------ | ----------------- | ---------- | ---------- |  | - | ---------- | ---------- | 
|                                     |                    |                  
|                                     |                    | December 31, 2003
|                                     |                    |                  
|                                     |                    | Amortized         |            |           
|Available-for-sale                   |                    | Cost              |            | Fair Value
|                                     |                    |                   |            |           
|Maturities of marketable securities: |                    |                   |            |            |  |   |            |           
|                                     | Less than one year |                   | $          | 21,907,609 |  |   | $          | 21,896,688 | 
|                                     | One to two years   |                   |            | 5,718,643  |  |   |            | 5,739,944  | 
|                                     |                    |                   |            |            |  |   |            |           
|                                     |                    | $                 | 27,626,252 |            |  | $ | 27,636,632 |           
|                                     |                    |                   |            |            |  |   |            |           

F-12



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|5. | Property and Equipment

Property and equipment consist of the following:

|                                |  |             |      |              |  |      |            |   |  |   |           |  
|------------------------------- |  | ----------- | ---- | ------------ |  | ---- | ---------- | - |  | - | --------- | -
|                                |  |             |      |             
|                                |  | Estimated   |      | December 31,
|                                |  | Useful Life |      |             
|                                |  | (Years)     |      | 2003         |  | 2002
|                                |  |             |      |              |  |     
|Construction in progress        |  |             |      |              |  | $    | 2,526,977  |   |  | $ | 474,608   |  
|Computer equipment              |  |             | 3    |              |  |      | 645,310    |   |  |   | 373,855   |  
|Furniture and fixtures          |  |             | 5    |              |  |      | 1,073,915  |   |  |   | 537,953   |  
|Equipment                       |  |             | 3-10 |              |  |      | 2,886,199  |   |  |   | 1,977,037 |  
|Leasehold improvements          |  |             | 10   |              |  |      | 6,850,448  |   |  |   | 75,776    |  
|                                |  |             |      |              |  |      |            |   |  |   |           |  
|                                |  |             |      |              |  |      | 13,982,849 |   |  |   | 3,439,229 |  
|Less  accumulated depreciation |  |             |      |              |  |      | (1,470,057 | ) |  |   | (746,021  | )
|                                |  |             |      |              |  |      |            |   |  |   |           |  
|                                |  |             |      |              |  | $    | 12,512,792 |   |  | $ | 2,693,208 |  
|                                |  |             |      |              |  |      |            |   |  |   |           |  

Depreciation expense for the years ended
December 31, 2003, 2002 and 2001 was $724,036, $490,981,
and $233,007, respectively.

During the year ended December 31, 2003, the
Company expended approximately $10.5 million, including
accrued construction costs, for the construction of its
corporate, research and development facility and purchase of
equipment.



|   |           
|-- | ----------
|6. | Borrowings

The Companys obligations on borrowings are
as follows:

|                               |  |              |           |      |  |   |           | 
|------------------------------ |  | ------------ | --------- | ---- |  | - | --------- | 
|                               |  |             
|                               |  | December 31,
|                               |  |             
|                               |  | 2003         |           | 2002
|                               |  |              |           |     
|Lines of credit                |  | $            | 2,365,588 |      |  | $ | 1,655,934 | 
|Montgomery County note payable |  |              | 75,000    |      |  |   | 75,000    | 
|                               |  |              |           |      |  |   |           | 
|                               |  | $            | 2,440,588 |      |  | $ | 1,730,934 | 
|                               |  |              |           |      |  |   |           | 

Principal payments under borrowings are as
follows:

|                         |  |   |           |  
|------------------------ |  | - | --------- | -
|Year Ending December 31, |  |  
|                         |  |  
|2004                     |  | $ | 953,984   |  
|2005                     |  |   | 617,160   |  
|2006                     |  |   | 576,747   |  
|2007                     |  |   | 292,697   |  
|                         |  |   |           |  
|                         |  |   | 2,440,588 |  
|Less: Current portion    |  |   | (953,984  | )
|                         |  |   |           |  
|                         |  | $ | 1,486,604 |  
|                         |  |   |           |  




Convertible Notes Payable

On March 28, 2003, the Company issued
$5.0 million convertible notes to certain of its existing
preferred stockholders. These notes were convertible into shares
of the first Qualified Financing, as defined in the Note
agreement, and bear interest of 7% per annum compounding monthly
until maturity and 12% per annum

F-13



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

compounding monthly after maturity. On
July 2, 2003, the note holders opted to convert the
Convertible Notes and accrued interest into 2,263,272 shares of
Series E Convertible Preferred Stock.




Lines of Credit

In January 2001, the Company entered into a
$1.5 million line of credit facility to finance the
purchase of specified equipment based on lender-approved
equipment schedules. The implicit interest rate is 11.62%. In
connection with this line of credit, the Company agreed to issue
to the lenders assignee warrants to purchase up to 26,228
shares of the Companys common stock, subject to the
aggregate amount of draw downs under the credit facility (see
Note 11). The Company has granted a security interest in
the assets purchased under the credit line. During 2003 and
2002, the Company had no draw downs under the line of credit.
During 2003 and 2002, the Company repaid $325,843 and $350,784,
respectively. The balance outstanding at December 31, 2003
and 2002 was $413,255 and $739,098, respectively.

In February 2002, the Company entered into a
$2.0 million line of credit facility to finance the
purchase of specified equipment based on approved equipment
schedules. The implicit interest rates were between 8.35% and
9.35%. In connection with the line of credit, the Company agreed
to issue to the lender warrants to purchase up to 9,714 shares
of the Companys common stock, subject to the aggregate
amount of draw downs under the credit facility (see
Note 11). During 2003, the Company had no draw downs under
the line of credit and repaid $99,262. During 2002, the Company
drew down $527,586 under the line of credit and repaid $21,902.
The balance outstanding at December 31, 2003 and 2002 was
$406,422 and $505,684, respectively.

In March 2002, the Company entered into a
$500,000 line of credit facility with a bank to finance the
purchase of equipment. The interest rate will be floating 30-Day
LIBOR + 250 basis points or fixed cost of funds
+ 250 basis points. Each drawing requires monthly
repayment of principal plus interest based upon a 48-month
repayment schedule. The line of credit has a first lien on all
assets purchased with the proceeds of this line. As of
December 31, 2003, the Company has a $335,769 restricted
account (see Note 2) with the bank to be used as collateral
for this line of credit. During 2003, the Company had no draw
downs under the line of credit and repaid $123,076. During 2002,
the Company drew down $492,280 and repaid $81,128. The balance
outstanding at December 31, 2003 and 2002 was $288,076 and
$411,152, respectively.

In July 2003, the Company entered into a
$5.5 million line of credit facility with a bank to finance
the purchase of equipment associated with the fit-out of the
Companys corporate, research and development facility. The
facility has an interest rate of floating 30-Day LIBOR plus
280 basis points or fixed cost of funds plus 280 basis
points. Each drawing requires monthly repayment of principal
plus interest based upon a 36-month repayment schedule for
computer equipment or a 48-month repayment schedule for all
other equipment. The line of credit has a first lien on all
assets purchased with the proceeds of the line. As collateral
for the line of credit, the Company maintains a restricted
account with the bank in the amount of $500,000 (see
Note 2). During 2003, the Company drew down $1,346,061 and
repaid $88,226. The balance outstanding under this facility at
December 31, 2003 was approximately $1,257,835.




Montgomery County Note
Payable

In December 2001, the Company entered into
an Economic Development Fund Agreement with Montgomery County,
Maryland. The primary purpose of the Economic Development Fund
is to assist private employers who are located, planning to
locate or substantially expand operations in Montgomery County.
In September 2002, the Company received a $75,000 loan from the
County. The loan will be amortized over 5 years from the
loan disbursement date, with a moratorium on both the principal
and the interest payment, until the third anniversary of the
loan. The interest rate is fixed at 5% per annum. The principal
and accrued interest must be repaid by the fifth anniversary of
the loan disbursement date in quarterly installments with the
first quarterly payment due on the 15th day of the month
following the moratorium expiration date.

F-14



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

According to the agreement, the County will
permanently forgive part or all of the $75,000 loan principal
balance together with the accrued interest if the following
conditions are met:



| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | $25,000 will be forgiven if the Company has made
    a capital investment in Montgomery County exceeding
    $7.5 million by the third anniversary date of loan
    disbursement date.
|
| |  | $25,000 will be forgiven if the Company generates
    at least 80% of the specified projected headcount of new full
    time employees by the end of 2004.                            
|
| |  | $25,000 will be forgiven if the Company maintains
    a specified number of full time employees through 2006.                                                                         

The Company must repay the entire $75,000 if it
relocates to a site outside Montgomery County, or moves all or
substantial parts of its business outside the county, within
5 years of the date of the promissory note.



|   |                 
|-- | ----------------
|7. | Accrued Expenses

Accrued expenses consist of the following:

|                                                   |  |              |           |      |  |   |         | 
|-------------------------------------------------- |  | ------------ | --------- | ---- |  | - | ------- | 
|                                                   |  |             
|                                                   |  | December 31,
|                                                   |  |             
|                                                   |  | 2003         |           | 2002
|                                                   |  |              |           |     
|Bonus accrual                                      |  | $            | 994,989   |      |  | $ | 420,000 | 
|Accrued professional fees                          |  |              | 519,567   |      |  |   | 237,192 | 
|Relocation accrual                                 |  |              | 149,397   |      |  |   | 88,815  | 
|Insurance and benefits                             |  |              | 334,788   |      |  |   | 67,329  | 
|Liability for exercised unvested
    stock options |  |              | 92,191    |      |  |   | 9,304   | 
|Accrued research and development expenses          |  |              | 29,753    |      |  |   |        | 
|Other accrued expenses                             |  |              | 56,669    |      |  |   | 8,340   | 
|Construction costs                                 |  |              | 1,580,509 |      |  |   |        | 
|                                                   |  |              |           |      |  |   |         | 
|Total accrued expenses                             |  | $            | 3,757,863 |      |  | $ | 830,980 | 
|                                                   |  |              |           |      |  |   |         | 



|   |                                                       
|-- | ------------------------------------------------------
|8. | Mandatorily Redeemable Convertible Preferred
    Stock

From January 2000 (commencement of
operations) through the Companys initial public offering
in October 2003, the company financed its operations
primarily from the issuance of mandatorily redeemable
convertible preferred stock. At the completion of the
Companys initial public offering, all mandatorily
redeemable convertible preferred stock was automatically
converted into 15,062,074 shares of common stock.

In 2000, the Company issued 2,000,000 shares of
Series A Redeemable Convertible Preferred Stock and
2,000,000 shares of Series B Redeemable Convertible
Preferred Stock. In 2001, the Company issued 4,010,000 shares of
Series C Redeemable Convertible Preferred Stock and
6,666,666 shares of Series D Redeemable Convertible
Preferred Stock. In 2002, the Company issued an additional
1,333,333 shares of Series D Redeemable Convertible
Preferred Stock.

On July 2, 2003, the Company sold 2,484,886
shares of Series E Convertible Preferred Stock to certain
of its existing preferred stockholders at a price of $2.25 per
share. Also on July 2, 2003, the Company issued 2,263,272
shares of Series E Convertible Preferred Stock upon
conversion of the Convertible Notes (see Note 6). On
July 25, 2003, the Company sold an additional 6,807,398
shares of Series E Convertible Preferred Stock to new
investors at $2.25 per share.

F-15



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

Each series of the mandatorily redeemable
convertible preferred stock had the following terms:




Voting

The holders of the preferred stock were entitled
to vote, together with the holders of common stock, on all
matters submitted to stockholders for a vote. Each preferred
stockholder was entitled to the number of votes equal to the
number of shares of common stock into which each preferred share
was convertible at the time of such vote. In addition, the
holders of a majority in voting power of the preferred stock are
entitled to elect two of the Companys directors.




Dividends

The holders were entitled to receive, when and as
declared by the Board of Directors and out of funds legally
available, noncumulative dividends, payable in preference and
priority to any payment of any dividend on common stock. No
dividends were declared or paid by the Company.




Liquidation Preference

In the event of any liquidation, dissolution or
winding-up of the affairs of the Company, the holders of each of
the then outstanding series of preferred stock were entitled to
receive for each share an amount equal to the sum of their
original cost per share, plus 10% per annum thereon, compounded
annually, plus all declared but unpaid dividends, payable in
preference and priority to any payments made to the holders of
the then outstanding common stock.




Redemption

Until the preferred stock was converted, the
holder or holders of at least a majority of each of the
outstanding series of preferred stock had the right, after
December 31, 2003, to require the Company to redeem the
preferred stock by paying in cash a sum equal to 100% of the
original purchase price of the preferred stock plus any declared
but unpaid dividends. Following such a request, and subject to
availability of funds, the Company was obligated to redeem 25%
of the preferred stock then owned by the requesting holders
annually.

At December 31, 2002, the combined
redemption amount for Series A, Series B,
Series C and Series D Preferred Stock was $28,514,998.
The total carrying value of the Series A, Series B,
Series C and Series D Preferred Stock differs from the
redemption amount due to stock issuance costs which have been
netted from the proceeds at issuance date, and are being
accreted through the redemption date.




Conversion

Each share of mandatorily redeemable convertible
preferred stock, at the option of the holder, was convertible
into a number of fully paid shares of common stock as determined
by dividing the respective preferred stock issue price by the
conversion price in effect at the time. Conversion was automatic
immediately upon the closing of the Companys public
offering.



|   |                                   
|-- | ----------------------------------
|9. | Preferred Stock 
    Undesignated

On October 22, 2003, the Companys
certificate of incorporation was amended to authorize the issue
of up to 25,000,000 shares of undesignated preferred stock. The
Companys Board of Directors, without any further action by
the Companys stockholders, is authorized to issue shares
of undesignated preferred stock in one of more classes or
series. The Board may fix the rights, preferences and privileges
of the preferred stock. The preferred stock could have voting or
conversion rights that could adversely affect the voting power
or other rights of common stockholders. As of December 31,
2003, no shares of preferred stock have been issued.

F-16



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|10. | Common Stock

Effective with the Companys initial public
offering on October 22, 2003, the Companys
certificate of incorporation was amended to increase the number
of authorized shares of common stock to 225,000,000.

Each share of common stock is entitled to one
vote. The holders of common stock are also entitled to receive
dividends whenever funds are legally available and when declared
by the Board of Directors, subject to the prior rights of
holders of all classes of stock outstanding.




Reverse Stock Split

On September 5, 2003, the Companys
Board of Directors authorized certain officers to complete a 1
for 1.83008 reverse stock split of common stock. On
October 7, 2003, the Companys stockholders approved
the reverse stock split of common stock, and the Company filed
an amendment to its certificate of incorporation to complete the
reverse stock split. All common share and per share amounts have
been retroactively restated to reflect the reverse stock split.




Initial Public Offering

On October 16, 2003, the Company priced its
initial public offering of 6,000,000 shares of common stock at
an offering price of $10.00 per share. The Companys stock
started trading on October 17, 2003 on The Nasdaq National
Market under the symbol AVNC. The initial public
offering was closed on October 22, 2003. The net proceeds
were approximately $54.3 million after deducting the
underwriting fee and other offering expenses. Upon the closing
of the initial public offering, all shares of the Companys
outstanding preferred stock were automatically converted into
common stock.



|    |         
|--- | --------
|11. | Warrants

In connection with the commencement of a lease
for the Companys premises in December 2000, the
Company granted to the lessor a freely exercisable warrant to
purchase 10,928 shares of the Companys common stock (the
Lessor Warrant Shares) at an exercise price of $2.29
per share. The expiration date of the warrant was
December 1, 2010, which was the tenth anniversary of the
effective date. The Lessor Warrant Shares were valued using the
Black Scholes option pricing model at $0.27 per Lessor Warrant
Share and the aggregate value was de minimus. The lessor
exercised the warrant on December 31, 2003 on a cashless
basis, and 7,773 shares were issued.

In January 2001, the Company entered into a
$1.5 million line of credit facility to finance the
purchase of specified equipment based on approved equipment
schedules (see Note 6). In connection with the line of credit,
the Company agreed to issue the lenders assignee warrants
to purchase such number of shares of the Companys common
stock as determined by calculating the following: 4% of the
amount of funds drawn by the Company divided by a per share
exercise price of $2.29. As of December 31, 2002, based on
actual draw downs, the Company had issued stock warrants for
23,033 shares of common stock (the Lender Warrant
Shares). The warrants are immediately exercisable, and the
expiration dates were from January 22, 2008 to
July 24, 2008. The Lender Warrant Shares were valued using
the Black Scholes option pricing model at $0.15 per Lender
Warrant Share and the aggregate value was de minimus. At the
closing of the Companys initial public offering, the
warrants were automatically exercised on a cashless basis and
17,753 shares were issued.

In February 2002, the Company entered into a
$2.0 million line of credit facility to finance the
purchase of specified equipment based on lender approved
equipment schedules (see Note 6). In connection with the line of
credit, the Company agreed to issue the lender warrants to
purchase such number of shares of the Companys common
stock as determined by calculating the following: 2% of the
funds drawn by the Company divided by a per share exercise price
of $4.12. As of December 31, 2002, based on actual draw
downs, the Company had issued stock warrants to purchase 2,563
shares of common stock (the Lender Warrant Shares).
The warrants

F-17



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

were immediately exercisable, and expired between
July 14, 2009 and December 10, 2009. The warrants were
valued using the Black Scholes option pricing model at $1.19 per
Lender Warrant Share and the aggregate value was de minimus. At
the closing of the Companys initial public offering, the
warrants were automatically exercised on a cashless basis and
1,506 shares were issued.



|    |                               
|--- | ------------------------------
|12. | Beneficial Conversion Features






Beneficial Conversion Feature 
Interest Expense on Convertible Notes


On March 28, 2003, the Company issued
$5.0 million of convertible notes to certain of its
existing preferred stockholders. In July 2003, the note
holders exercised their right to convert the convertible notes
and accrued interest into 2,263,272 shares of the Companys
Series E mandatorily redeemable convertible preferred
stock. The Series E preferred stock was convertible into
common stock at a price per share which was below the estimated
fair value of the Companys common stock at the date of
issuance of the notes. Accordingly, the Company recorded a
non-cash beneficial conversion charge of
$1.7 million as additional interest expense for the year
ended December 31, 2003.



| |                                                                                                    
| | ---------------------------------------------------------------------------------------------------
| | Beneficial Conversion Feature 
    Series E Mandatorily Redeemable Convertible Preferred
    Stock

In July 2003, the Company completed the sale
of 9,292,284 shares of Series E mandatorily redeemable
convertible preferred stock for proceeds of $20.9 million.
After evaluating the fair value of the Companys common
stock in contemplation of its initial public offering, the
Company determined that the issuance of the Series E
preferred stock resulted in a beneficial conversion feature
calculated in accordance with EITF Issue No. 00-27,
Application of Issue No. 98-5 to Certain
Convertible Instrumentsof $20.9 million which
was accreted in July 2003 and is reflected in the net loss
applicable to common stockholders for the year ended
December 31, 2003.



|    |                  
|--- | -----------------
|13. | Stock Option Plan

The Company currently grants stock options under
the Stock Incentive Plan (the Plan). In
March 2001, October 2001, April 2002,
September 2003 and October 2003, the number of shares
available for issuance under the Plan was increased to
1,142,081, 1,633,863, 2,185,696, 4,098,182 and 5,098,182,
respectively.

Options granted under the Plan may be incentive
stock options or non-statutory stock options. Stock purchase
rights may also be granted under the Plan. Incentive stock
options may only be granted to employees. The compensation
committee of the Board of Directors determines the period over
which options become exercisable. Options granted to employees,
consultants and advisors normally vest over a 4-year period.
Options granted to one non-employee consultant vested over two
years; that consultant, however, terminated her relationship
with the Company during 2002 and the option was terminated.
Options granted to directors, upon their initial appointment or
election, vest monthly over 36 months. Annual director
grants vest monthly over 12 months. The exercise price of
incentive stock options and non-statutory stock options shall be
no less than 100% of the fair market value per share of the
Companys common stock on the grant date. The term of all
options is 10 years except, with respect to one incentive stock
option held by a Company executive, the term of which is
5 years. As of December 31, 2003 and 2002, there were
1,905,867 and 691,117 shares of common stock available for
future option grants, respectively.

F-18



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

The following table summarizes the activity of
the Companys stock option plan for the years ended
December 31, 2003, 2002 and 2001:

|                               |  |           |           |                  |  |   |      | 
|------------------------------ |  | --------- | --------- | ---------------- |  | - | ---- | 
|                               |  | Number of |           | Weighted-Average
|                               |  | Options   |           | Exercise Price  
|                               |  |           |           |                 
|Outstanding, December 31, 2000 |  |           | 131,142   |                  |  | $ | 0.28 | 
|Granted                        |  |           | 1,047,714 |                  |  |   | 0.44 | 
|Exercised                      |  |           | 599,564   |                  |  |   | 0.38 | 
|Cancelled                      |  |           | 6,011     |                  |  |   | 0.28 | 
|                               |  |           |           |                  |  |   |      | 
|Outstanding, December 31, 2001 |  |           | 573,281   |                  |  |   | 0.44 | 
|Granted                        |  |           | 365,066   |                  |  |   | 0.62 | 
|Exercised                      |  |           | 50,817    |                  |  |   | 0.44 | 
|Cancelled                      |  |           | 43,332    |                  |  |   | 0.38 | 
|                               |  |           |           |                  |  |   |      | 
|Outstanding, December 31, 2002 |  |           | 844,198   |                  |  |   | 0.53 | 
|Granted                        |  |           | 1,741,057 |                  |  |   | 4.30 | 
|Exercised                      |  |           | 306,446   |                  |  |   | 0.91 | 
|Cancelled                      |  |           | 43,321    |                  |  |   | 1.32 | 
|                               |  |           |           |                  |  |   |      | 
|Outstanding, December 31, 2003 |  |           | 2,235,488 |                  |  | $ | 3.45 | 
|                               |  |           |           |                  |  |   |      | 

The following table summarizes information about
stock options outstanding, and exercisable at December 31,
2003, 2002 and 2001:

|                   |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|------------------ |  | ------------------- | --------- | ------------------- |  | -------------- | --- | ----------- |  | -------------- | ----- |  |  |  | ------- |  |  | - | ----- | 
|                   |  |                     |           |                    
|                   |  | Options Outstanding |           | Options Exercisable
|                   |  |                     |           |                    
|                   |  |                     |           | Weighted-           |  |                |     |            
|                   |  |                     |           | Average             |  | Weighted-      |     |             |  | Weighted-     
|Range of           |  | Number              |           | Remaining           |  | Average        |     | Number      |  | Average       
|Exercise Prices    |  | Outstanding         |           | Contractual Life    |  | Exercise Price |     | Exercisable |  | Exercise Price
|                   |  |                     |           |                     |  |                |     |             |  |               
|December 31, 2003: |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|$0.28 to $0.62     |  |                     | 1,224,835 |                     |  |                | 8.2 |             |  | $              | 0.57  |  |  |  | 172,713 |  |  | $ | 0.49  | 
|$1.41              |  |                     | 361,414   |                     |  |                | 9.7 |             |  | $              | 1.41  |  |  |  | 2,732   |  |  | $ | 1.41  | 
|$10.00             |  |                     | 649,239   |                     |  |                | 9.8 |             |  | $              | 10.00 |  |  |  | 40,702  |  |  | $ | 10.00 | 
|                   |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|                   |  |                     | 2,235,488 |                     |  |                | 8.9 |             |  | $              | 3.45  |  |  |  | 216,147 |  |  | $ | 2.29  | 
|                   |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|December 31, 2002: |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|$0.28 to $0.62     |  |                     | 844,198   |                     |  |                | 8.3 |             |  | $              | 0.53  |  |  |  | 117,672 |  |  | $ | 0.48  | 
|                   |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|December 31, 2001: |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 
|$0.28 to $0.62     |  |                     | 573,281   |                     |  |                | 8.6 |             |  | $              | 0.44  |  |  |  | 5,533   |  |  | $ | 0.30  | 
|                   |  |                     |           |                     |  |                |     |             |  |                |       |  |  |  |         |  |  |   |       | 

The Company granted 178,201, 20,218 and 27,321
stock options to non-employee consultants and scientific
advisory board (SAB) members during 2003, 2002 and
2001, respectively. Included in the 2003 grants is a grant for
85,313 options to a non-employee consultant for past services,
for which the Company expensed the entire value of $710,657 at
the time of grant. The Company will recognize an expense for all
other options granted to non-employee consultants throughout the
vesting period of the options, and as long as those non-employee
consultants and SAB members continue to perform services for the
Company, based on the fair value of the options at each
reporting period. The options are valued using the Black Scholes
option pricing model. Total stock-based compensation expense for
non-employee consultants recognized during 2003 and 2002 was
$1,260,117 and $155,334, respectively. The stock-based
compensation expense for the year 2001 was de

F-19



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

minimis. As of December 31, 2003, the
balance of unamortized stock-based compensation for options
granted to non-employees was approximately $500,000.




Restricted Stock

Certain of the Companys directors,
consultants and employees (and/or immediate family members or
related entities to which certain of those individuals have
transferred their options or shares of common stock) have
entered into the Companys standard form of stock
restriction agreement as a condition to their exercise of
options to acquire common stock pursuant to the Plan. These
agreements provide, among other things, for a right of first
refusal to the Company in connection with the option
holders sale of the common stock, as well as the right for
the Company to purchase the stockholders common stock in
the event that the stockholders relationship with the
Company is terminated under certain circumstances. Shares issued
under non-statutory stock options exercised prior to vesting are
subject to forfeiture in accordance with the vesting schedule of
the granted stock options. During 2003, 2002 and 2001, certain
of the Companys employees, board members and consultants
exercised unvested stock options, awarded under the
Companys Stock Incentive Plan, to acquire a total of
139,332, 50,817, and 599,564 shares, respectively, of restricted
common stock. At December 31, 2003 and 2002, 424,290 and
496,153 shares, respectively, of restricted common stock remain
unvested pursuant to awards.

Consistent with the provisions of EITF
No. 00-23, for all exercises of stock options into unvested
restricted stock after March 2002, the Company recorded a
liability for the amount of the proceeds received, which is
reclassified to equity upon the vesting of the restricted stock.
As of December 31, 2003 and 2002, $92,191 and $9,304
related to 150,124 and 17,212 shares of restricted stock,
respectively, was recorded as a liability.

Of the stock options exercised in 2001 into
unvested restricted stock, Dr. Rudnic and two affiliated
trusts exercised a total of 295,069 non-statutory stock options
in October 2001. The exercise price was paid through the
issuance of full-recourse promissory notes in the aggregate
principal amount of $121,500. Interest accrues on the notes at
5.50% and the term of the notes is five years. As of
December 31, 2003 and 2002, unpaid interest accrued on the
notes is $1,113 and $1,114, respectively. The shares issued upon
exercise of the options were pledged as security for the
repayment of the promissory notes (the Pledge). In
addition, pursuant to the terms of a stock restriction
agreement, all of these shares were subject to repurchase by the
Company upon any termination of Dr. Rudnics
employment (the Termination Repurchase Right). In
February 2002, the stock restriction agreement was amended
to provide the Company with an additional right, upon the
Companys request, to repurchase 54,642 of the shares from
Dr. Rudnic if the Company failed to meet certain
performance milestones during 2002 (the Milestone
Repurchase Right). In January 2003, the
Companys Board of Directors decided not to exercise the
Companys Milestone Repurchase Right. The Milestone
Repurchase Right was never exercised by the Company and lapsed
in February 2003. The 54,642 shares remain subject to the
Pledge and the Termination Repurchase Right.



|    |             
|--- | ------------
|14. | Income Taxes

The Company has not recorded any tax provision or
benefit for the years ended December 31, 2003, 2002 and
2001. The Company has provided a valuation allowance for the
full amount of its net deferred tax assets since realization of
any future benefit from deductible temporary differences and net
operating loss carryforwards cannot be sufficiently assured at
December 31, 2003 and 2002.

F-20



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

Deferred tax assets consist of the following:

|                                        |                         |              |             |      |  |   |            |   | 
|--------------------------------------- | ----------------------- | ------------ | ----------- | ---- |  | - | ---------- | - | 
|                                        |                         |             
|                                        |                         | December 31,
|                                        |                         |             
|                                        |                         | 2003         |             | 2002
|                                        |                         |              |             |     
|Net operating loss carryforwards        |                         | $            | 10,274,352  |      |  | $ | 6,212,259  |  
|Start-up costs                          |                         |              | 2,909,568   |      |  |   | 2,478,827  |  
|Deferred revenue                        |                         |              | 1,689,625   |      |  |   |           |  
|Depreciation and amortization           |                         |              | (76,547     | )    |  |   | (128,018   | )
|Accrued expenses                        |                         |              | 188,103     |      |  |   | 288,122    |  
|Charitable contributions                |                         |              | 9,930       |      |  |   | 8,438      |  
|Stock-based compensation                |                         |              | 1,151,932   |      |  |   |           |  
|Research and experimentation tax credit |                         |              | 1,301,258   |      |  |   | 856,589    |  
|                                        |                         |              |             |      |  |   |            |  
|Deferred tax assets                     |                         |              | 17,448,221  |      |  |   | 9,716,217  |  
|Valuation allowance                     |                         |              | (17,448,221 | )    |  |   | (9,716,217 | )
|                                        |                         |              |             |      |  |   |            |  
|                                        | Net deferred tax assets |              | $           |     |  |   | $          |  | 
|                                        |                         |              |             |      |  |   |            |  

The effective tax rate differs from the U.S.
federal statutory tax rate of 34% due to the following:

|                                                            |  |                         |       |      |  |      |       |    |  |  |       |   
|----------------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                                            |  |                        
|                                                            |  | Year Ended December 31,
|                                                            |  |                        
|                                                            |  | 2003                    |       | 2002 |  | 2001
|                                                            |  |                         |       |      |  |     
|U.S. federal statutory income tax rate                      |  |                         | (34.0 | )%   |  |      | (34.0 | )% |  |  | (34.0 | )%
|State income taxes, net of federal tax benefit              |  |                         | (4.1  | )%   |  |      | (4.6  | )% |  |  | (4.6  | )%
|Beneficial conversion feature  deemed
    interest expense |  |                         | 2.7   | %    |  |      | (0.0  | )% |  |  | (0.0  | )%
|Permanent items                                             |  |                         | 0.7   | %    |  |      | 0.2   | %  |  |  | (0.7  | )%
|Research and experimentation tax credit                     |  |                         | (2.1  | )%   |  |      | (4.6  | )% |  |  | (2.4  | )%
|Change in valuation allowance                               |  |                         | 36.8  | %    |  |      | 43.0  | %  |  |  | 41.7  | % 
|                                                            |  |                         |       |      |  |      |       |    |  |  |       |   
|Effective tax rate                                          |  |                         | (0.0  | )%   |  |      | (0.0  | )% |  |  | (0.0  | )%
|                                                            |  |                         |       |      |  |      |       |    |  |  |       |   

At December 31, 2003 and 2002, the Company
had federal and state net operating loss carryforwards of
approximately $26.6 million and $16.1 million,
respectively, available to reduce future taxable income, which
will begin to expire in 2020. At December 31, 2003 and
2002, the Company had research and experimentation tax credit
carryforwards of approximately $1.3 million and
$0.9 million, which will begin to expire in 2020.

Under the provisions of the Internal Revenue
Code, certain substantial changes in the Companys
ownership may result in a limitation on the amount of net
operating loss carryforwards which can be used in future years.
The Company believes that ownership changes to date will not
limit the future utilization of net operating loss carryforwards.



|    |                                                         
|--- | --------------------------------------------------------
|15. | 401(k) Savings Plan and Employee Stock
    Purchase Plan

During 2000, the Company established a defined
contribution savings plan under Section 401(k) of the
Internal Revenue Code. This plan covers substantially all
employees who meet minimum age and service requirements and
allows participants to defer a portion of their annual
compensation on a pre-tax basis. The Companys Board of
Directors has discretion to match contributions made by the
Companys employees. To date there were no matching
contributions made by the Company.

During 2003, the Company adopted an employee
stock purchase plan which provides for the issuance of up to
100,000 shares of common stock. This plan, which is intended to
qualify under Section 423 of the Internal

F-21



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)

Revenue Code, provides our employees with an
opportunity to purchase shares of our common stock through
payroll deductions. Options to purchase our common stock will be
granted to each eligible employee periodically. The purchase
price of each share of common stock will not be less than the
lesser of 85% of the fair market value of the common stock at
the beginning or end of the option period. Participation is
limited so that the right to purchase stock under the purchase
plan does not accrue at a rate which exceeds $25,000 of the fair
market value of our common stock in any calendar year. To date,
no shares have been issued under this plan.



|    |                              
|--- | -----------------------------
|16. | Commitments and Contingencies






Leases


In August 2002, the Company entered into a
10-year lease for its corporate, research and development
facility in Germantown, Maryland, which is renewable for two
periods of five consecutive years each at the end of the
original term. The Company took possession of the lease space
during 2003. In conjunction with the execution of the lease
agreement, the Company provided the landlord with a letter of
credit, which the Company collateralized with a $940,800
restricted cash deposit (see Note 2). The Company also leases
additional laboratory space in Gaithersburg, Maryland under a
noncancelable operating lease, which expires in
November 2005. The Company also leases office equipment
expiring at various dates through 2008. Rent expense under all
leases was $671,537, $347,901 and $252,138 for the years ended
December 31, 2003, 2002 and 2001, respectively.

Future minimum lease payments under noncancelable
operating leases at December 31, 2003 are as follows:

|                         |  |           |            | 
|------------------------ |  | --------- | ---------- | 
|                         |  | Operating
|Year Ending December 31, |  | Leases   
|                         |  |          
|2004                     |  | $         | 1,095,006  | 
|2005                     |  |           | 1,180,096  | 
|2006                     |  |           | 1,027,267  | 
|2007                     |  |           | 1,051,431  | 
|2008                     |  |           | 1,081,721  | 
|Thereafter               |  |           | 5,149,160  | 
|                         |  |           |            | 
|                         |  | $         | 10,584,681 | 
|                         |  |           |            | 

The lease on the Companys corporate,
research and development facility includes scheduled base rent
increases over the term of the lease. The total amount of the
base rent payments will be charged to expense on the
straight-line method over the term of the lease.




Legal Proceedings

The Company is a party to legal proceedings and
claims that arise during the ordinary course of business. In
December 2003, Aventis and Aventis Pharmaceuticals Inc.
brought an action against the Company in the U.S. District Court
for the District of Delaware. The Complaint contains six counts,
based upon both federal and state law, alleging, in essence,
that the Company has infringed on the plaintiffs
trademark. The plaintiffs seek injunctive relief, as well as
unspecified monetary damages. The case is in the very early
stage of pleadings. It is the opinion of management that the
ultimate outcome of this matter will not have a material adverse
effect upon the Companys financial position, results of
operations, or cash flows.

F-22



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)



|    |                           
|--- | --------------------------
|17. | Related Party Transactions






Loans to Executive Officer


In October 2001, we provided loans to
Dr. Edward Rudnic, our president, chief executive officer
and a director, and two trusts affiliated with Dr. Rudnic,
that are evidenced by full recourse notes in the aggregate
principal amount of $121,500. The notes bear interest at a fixed
annual interest rate of 5.5%, with the interest payable
annually, and mature in October 2006. The proceeds from
these notes were used to exercise options to purchase 295,069
shares of our common stock. The loans are secured by 295,069
shares of our common stock issued to Dr. Rudnic and the two
trusts, plus any additional shares purchased by these holders.
Following exercise, Dr. Rudnic transferred by gift a total
of 38,250 shares of our common stock to five family members and
two other individuals. The shares of common stock remain pledged
to secure the loans to Dr. Rudnic. As of December 31,
2003, the total amount outstanding under the loans was $122,613,
including accrued interest.




Consulting Arrangements

In December 2002, we entered into a
consulting arrangement with Mr. James Isbister, the
chairman of our board of directors, which provides for a payment
to Mr. Isbister of $60,000 per year in exchange for
consulting services. These consulting services include tactical
advice and planning with regard to corporate operations,
financing approaches, and product development and
commercialization strategies.

In December 2002, we entered into a
consulting agreement with Jenefir D. Isbister, Ph.D., the spouse
of Mr. James Isbister and a professor and research
microbiologist at George Mason University. Under the terms of
the consulting agreement, we pay Dr. Isbister $1,500 per
day for consultation and research support services in connection
with our identification and development of pulsatile antibiotic
delivery strategies. The current consulting agreement will
expire in December 2004. In 2003 and 2002, we paid an
aggregate of $56,000 and $65,100, respectively to
Dr. Isbister under this agreement. We also granted options
to Dr. Isbister that were exercised for 43,714 shares of
our common stock at a weighted average exercise price of $0.53
per share.



|    |                                     
|--- | ------------------------------------
|18. | Quarterly Financial Data (Unaudited)

The following table presents unaudited quarterly
financial data of the Company. The Companys quarterly
results of operations for these periods are not necessarily
indicative of future results of operations.

|                             |                   |          |   |           |  |          |   |               |   |               |   |            |   |  |   |             |   |  |   |        |  
|---------------------------- | ----------------- | -------- | - | --------- |  | -------- | - | ------------- | - | ------------- | - | ---------- | - |  | - | ----------- | - |  | - | ------ | -
|                             |                   |          |   |           |  |          |   |               |   | Basic and    
|                             |                   |          |   |           |  |          |   |               |   | Diluted      
|                             |                   |          |   |           |  |          |   |               |   | Net Loss     
|                             |                   |          |   |           |  |          |   | Net Loss      |   | Per Share    
|                             |                   |          |   |           |  |          |   | Applicable to |   | Applicable to
|                             |                   | Contract |   | Operating |  |          |   | Common        |   | Common       
|                             |                   | Revenue  |   | Loss      |  | Net Loss |   | Stockholders  |   | Stockholders 
|                             |                   |          |   |           |  |          |   |               |   |              
|Year ended December 31, 2003 |                   |          |   |           |  |          |   |               |   |               |   |            |   |  |   |             |   |  |   |       
|                             | First quarter     |          | $ |          |  |          | $ | (3,237,382    | ) |               | $ | (3,253,184 | ) |  | $ | (3,271,762  | ) |  | $ | (3.33  | )
|                             | Second quarter    |          |   |          |  |          |   | (4,153,926    | ) |               |   | (4,236,279 | ) |  |   | (4,255,062  | ) |  |   | (4.04  | )
|                             | Third quarter (a) |          |   | 312,500   |  |          |   | (6,534,493    | ) |               |   | (8,152,710 | ) |  |   | (29,135,970 | ) |  |   | (20.19 | )
|                             | Fourth quarter    |          |   | 3,312,500 |  |          |   | (5,471,281    | ) |               |   | (5,333,011 | ) |  |   | (5,429,183  | ) |  |   | (0.29  | )
|                            
|Year ended December 31, 2002 |                   |          |   |           |  |          |   |               |   |               |   |            |   |  |   |             |   |  |   |       
|                             | First quarter     |          |   |          |  |          |   | (2,524,181    | ) |               |   | (2,475,117 | ) |  |   | (2,492,278  | ) |  |   | (3.44  | )
|                             | Second quarter    |          |   |          |  |          |   | (3,660,022    | ) |               |   | (3,624,924 | ) |  |   | (3,643,708  | ) |  |   | (4.23  | )
|                             | Third quarter     |          |   |          |  |          |   | (4,072,671    | ) |               |   | (4,064,740 | ) |  |   | (4,083,730  | ) |  |   | (4.39  | )
|                             | Fourth quarter    |          |   |          |  |          |   | (3,922,135    | ) |               |   | (3,959,214 | ) |  |   | (3,978,204  | ) |  |   | (4.24  | )

F-23



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##### Table of Contents



ADVANCIS PHARMACEUTICAL CORPORATION


NOTES TO FINANCIAL
STATEMENTS  (Continued)



|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Note (a): | The third quarter of fiscal 2003 was the
    Companys first quarter of revenue recognition. Also in the
    third quarter of fiscal 2003, a beneficial conversion feature
    for deemed interest expense of $1,666,667 was included in
    Operating Loss and an additional $20,907,620 for a beneficial
    conversion feature for a deemed dividend to preferred
    stockholders was included in the calculation of the Net Loss
    Applicable to Common Stockholders.

F-24