SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File Number: 000-50414

ADVANCIS PHARMACEUTICAL CORPORATION

(Exact name of Registrant as specified in its Charter)

(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 22, 2005, 22,839,930 shares of the registrant’s common stock were outstanding. As of June 30, 2004, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $67,474,886.

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.

ADVANCIS PHARMACEUTICAL CORPORATION

INDEX

FORM 10-K

FORWARD-LOOKING STATEMENTS

      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.

PART I

Overview

      We are a pharmaceutical company focused on developing and commercializing anti-infective 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 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^tm (PULSYS).

      We have focused initially on developing pulsatile formulations of approved and marketed anti-infective drugs that no longer have patent protection or that have patents expiring in the next three years. Our lead PULSYS product candidates, based on the antibiotic amoxicillin, are currently under evaluation in two separate Phase III clinical trials and we have an additional four pulsatile product candidates in preclinical development. Preclinical product candidates will be prioritized and advanced into clinical trials based on their commercial opportunity and our level of financial and personnel resources. We continue to explore pulsatile formulations for a range of other antibiotics.

      We plan to advance key PULSYS products and clinical candidates to the market in the near-term through product collaborations with partners providing financial support and/or sales and marketing expertise. We will also seek opportunities to supplement our commercial portfolio through co-promotions, in-licensing or the acquisition of antibiotic compounds we believe could be enhanced with our PULSYS technology. We have focused corporate resources on initiatives that we believe present the most attractive product opportunities, with the goal of bringing new products to the market in the near-term. We have undertaken a review of our product portfolio, and have prioritized those product candidates that we believe show the most promise with our PULSYS technology and provide the greatest potential commercial opportunity. We intend to commercialize our pulsatile products in a cost-effective manner through existing partners, third party collaborations, and an internal sales and marketing force.

      We are currently developing commercialization plans for our Amoxicillin PULSYS products, along with our collaboration partner, Par Pharmaceutical Companies, Inc. Together, we expect to target high-volume prescribers with a community-based sales force detailing family practitioners and internists. We are considering several sales and marketing alternatives for Amoxicillin PULSYS, including working with contract sales organizations, developing our own internal sales organization, or co-promoting products with additional partners. Assuming successful outcomes of our ongoing Phase III trials, we believe Amoxicillin PULSYS could be launched by as early as 2006.

      At the end of the second quarter of 2004, we acquired the U.S. rights to Keflex® (cephalexin) from Eli Lilly. We currently have a small sales and marketing staff promoting Keflex to national accounts. We expect to continue to build our commercial infrastructure and capabilities for selling, marketing and distributing the Keflex brand of cephalexin and are exploring initiatives to further build upon the high name recognition and reputation of Keflex. These efforts with Keflex have enabled us to take important steps toward developing our in-house commercial capabilities which are expected to be expanded with the anticipated launch of our Amoxicillin PULSYS products.

      We anticipate beginning Phase I clinical trials for the development of a once-daily PULSYS version of Keflex in 2005. We believe the added convenience of improving Keflex from its typical two to four times per day dosing regimen to a once-daily product can create an attractive commercial opportunity. In addition, we believe that the addition of a Keflex PULSYS product may allow us to further utilize any sales, marketing and distribution capabilities that we expect to have in place through the sales of existing Keflex and Amoxicillin PULSYS products.

      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, Keflex and the Keflex logo 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. References to scientific articles in this annual report on Form 10-K are made for your convenience and such articles are not incorporated by reference.

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 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 altogether. According to testimony before the U.S. Congress by John G. Bartlett, M.D., chair of the Infectious Disease Society of America Task Force on Antimicrobial Availability in October, 2004, “Major pharmaceutical companies are losing interest in the antibiotics market because these drugs simply are not as profitable as drugs that treat chronic conditions and lifestyle issues.” We believe that the unmet need 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 drug candidates may 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 and antifungals. Early preclinical research is being conducted to explore potential applications in these areas.

      Anticipated reduced development risk, cost and timeframe. 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 preclinical and clinical data and accelerate our drug development process.

      Pipeline of product candidates in clinical and preclinical trials. We currently have two Amoxicillin PULSYS product candidates in Phase III clinical trials and four pulsatile drug or drug combination candidates in preclinical development. We continue to explore pulsatile formulations for a range of other antibiotics and antibiotic combinations and will seek to in-license or acquire antibiotic products that we believe can be improved with our novel pulsatile dosing approach.

      PULSYS commercialization strategy. We intend to build a fully-integrated pharmaceutical company with discovery, development, manufacturing, distribution, and brand sales and marketing capabilities. We believe that this commercialization strategy will allow us to fully maximize the value of our brand assets; first, those associated with our acquisition of Keflex product rights, and second, those associated with our PULSYS product assets, enabling us to retain significant control over our development and marketing activities. In support of the introduction of our first anticipated pulsatile product, Amoxicillin PULSYS, we intend to develop our own sales and marketing capabilities targeting high-volume prescribers, such as family practitioners and internists. Over time, we intend to expand our sales and marketing capabilities and to enter into agreements with other pharmaceutical companies, such as the agreement we have in place with Par Pharmaceutical, to provide us with a broad range of commercialization opportunities.

      Multi-level patent strategy. We have implemented a multi-level patent strategy in order to protect our pulsatile drugs. The first level is composed 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 composed 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 16 issued U.S. patents and 24 U.S. patent applications. Our issued patents cover certain compositions and methods for using pulsatile dosing. We also own 33 foreign-filed patent applications, which foreign-filed patent applications correspond to our U.S. patents and applications. We also own 10 International (PCT) patent applications, each of which International (PCT) patent applications we anticipate converting into several individually foreign-filed patent applications to further correspond to our U.S. patents and applications.

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-infectives market. According to sales data compiled by IMS Health, an independent pharmaceutical industry research firm, worldwide anti-infective sales were approximately $52.8 billion in 2003, including $24.1 billion in North America. Antibiotics accounted for approximately $30.6 billion of such 2003 worldwide sales, including more than $11.9 billion in North America (IMS World Review 2003).

      Increased resistance to existing therapies. Certain medical, veterinary and agricultural 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 one-third of all Streptococcus pneumoniae, a type of bacteria that can cause pneumonia, meningitis and ear

infections are resistant to penicillin. The increased prevalence of resistant bacteria has resulted in prolonged hospitalizations, increased healthcare costs and higher mortality rates.

      Growing need for improved new treatments. 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, we believe 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 and the expense associated with large and lengthy clinical trials.

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

      The significant unmet needs in the anti-infective market prompted our founders to search for a more efficient method to attack bacteria. In a series of seminal laboratory experiments, we observed that antibiotics such as amoxicillin are more effective in killing bacteria when delivered in three to five discrete pulses of drug within the initial six to eight hours of a dosing interval. To take advantage of these experimental findings, we have developed a proprietary technology called PULSYS that enables front-loaded, sequential, pulsatile delivery of orally administered antibiotics. We believe that our novel finding, as implemented through our PULSYS technology, will potentially enable therapeutic advantages including:

      Our approach to improving antibiotic effectiveness represents a departure from traditional methods, which have focused on increasing drug dosages and searching for new classes of drugs. Our pulsatile dosing approach attempts to increase antibiotic effectiveness by better exploiting vulnerabilities in the growth cycle and natural defense mechanisms of bacteria.

      The graph below conceptually illustrates drug concentration profiles 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.

      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 reduce the emergence of antibiotic-resistant bacteria strains, but that it is able to do so at significantly lower drug concentrations and with potentially shorter courses of therapy than those required under currently available treatments. For example, our preclinical studies have shown the following:

      We believe that additional unpublished and ongoing in vitro and animal preclinical studies provide further support for the utility of once-daily PULSYS antibiotic dosing.

      We currently have two pulsatile amoxicillin product candidates that have progressed into Phase III clinical trials, and an additional four product candidates in preclinical development. 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 the necessary dosing levels for efficacy have been well-demonstrated in animal models of disease. 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. To date, we have administered our pulsatile drug candidates to an aggregate of 316 healthy subjects in Phase I trials.

      In the second quarter of 2004, we selected amoxicillin formulations for evaluation in our Phase III program designed to support product approvals for Amoxicillin PULSYS for the treatment of adolescents, adults and pediatrics with pharyngitis and/or tonsillitis due to Group A streptococcal infections. On October 15, 2004, the first patient was dosed in our Phase III study in adolescents and adults and our first patient was enrolled in our Phase III trial in pediatrics on January 5, 2005. We expect to announce the results from the trial in adolescents and adults in June 2005 and from the pediatric trial in the third quarter of 2005. If the trials are successful, we expect to file 505 (b) (2) New Drug Applications with the FDA for the adult and pediatric products in the fourth quarter of 2005.

      Currently, our drug product candidates 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.

      Based on meetings with the FDA regarding the study program for our amoxicillin products, we are proceeding with studies designed to meet the agency’s requirements and anticipate that those studies will be appropriate to support an NDA approval, assuming successful clinical results.

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 our proprietary design strategy, which we created to evaluate and develop new pulsatile drug candidates. This approach 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 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 once-daily dosing, lower doses, and in many cases, shorter treatment periods. We believe that these advantages will be further reflected with at least some of our pulsatile drugs in fewer dose-related side effects, reduced incidence of resistance and improved efficacy.

      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.

      Focus on first-line, broad-spectrum antibiotics for community infections. We are pursuing a product development strategy focused primarily on first-line, broad spectrum antibiotics for community infections. Our pulsatile antibiotic products are expected to target upper respiratory tract infections and skin and skin structure infections in particular. The target indications for our current product candidates cover approximately 65 percent of antibiotics-related diagnoses and are intended to compete against six of the top ten most-prescribed antibiotics in 2004. We believe products utilizing our front-loaded, pulsed dosing approach will support once-daily dosing where two-to-four times daily dosing is the norm, with a concomitant reduction in dose and treatment duration (in some cases) compared to current traditional therapies.

      Develop sales and marketing functions across multiple products. We intend to build over time a fully-integrated pharmaceutical company with discovery, development, manufacturing, distribution, sales, and marketing capabilities. We believe that this commercialization strategy will allow us to fully maximize the value of our PULSYS product assets and retain significant control over our development and marketing activities. In support of the introduction of our first product, Amoxicillin PULSYS, we intend to develop our own sales and marketing capabilities. We believe that a significant proportion of prescriptions for first-line, broad-spectrum antibiotics is written by a relatively small number of high-volume prescribers who can be reached by a community-based sales force. Over time, we intend to expand our sales and marketing capabilities to provide even greater market coverage. We also plan to enter into agreements with other pharmaceutical companies, such as the agreement we have in place with Par Pharmaceutical, to exploit our partners’ sales and marketing capabilities in order to optimally market our products.

      License or acquire antibiotic products. We continue to explore pulsatile formulations for a wide range of other antibiotics and antibiotic combinations and we intend to in-license or acquire antibiotic products that we believe can be improved with our novel pulsatile dosing approach.

Our Marketed Products

      On June 30, 2004, we acquired the U.S. rights to Keflex brand of cephalexin from Eli Lilly and Company. The purchase price was $11.2 million, including transaction costs, which was paid in cash from our working capital. The asset purchase includes the exclusive rights to manufacture, sell and market Keflex in the United States (including Puerto Rico). We also acquired Keflex trademarks, technology and new drug applications (NDAs) supporting the approval of Keflex capsules and oral suspension. In addition, on June 30, 2004, we entered into a manufacturing supply agreement with Eli Lilly, under which Lilly has agreed to sell certain Keflex product inventory to us and to continue to manufacture and supply Keflex products for us during a transition period, unless we terminate the agreement at an earlier date. On December 9, 2004, we announced that we entered into a commercial supply agreement with Ceph International Corporation, a wholly owned subsidiary of MOVA Pharmaceutical Corporation, to secure a long-term supply for Keflex products beyond the transitional period. We are currently in discussions with Ceph regarding an expansion of the manufacturing relationship.

      Keflex is a first-generation cephalosporin approved for treatment of several types of bacterial infections. Keflex is most commonly used in the treatment of uncomplicated skin and skin structure infections and, to a lesser extent, upper respiratory tract infections. Keflex is among the most prescribed antibiotics in the U.S., however, generic competition is intense, and a high percentage of all Keflex prescriptions are substituted by generic versions of cephalexin, the active ingredient in Keflex. We market Keflex in the U.S. to healthcare practitioners, pharmacists, and pharmaceutical wholesalers.

      In addition to assuming sales and marketing responsibilities for Keflex, we have initiated a research program with the goal of developing a once-a-day cephalexin product utilizing our proprietary PULSYS dosing technology. In the event we are able to develop and commercialize a PULSYS-based Keflex product, another cephalexin product relying on the acquired NDAs, or other pharmaceutical products using the acquired trademarks, Eli Lilly will be entitled to royalties on these new products. Royalties are payable on a new product by new product basis for five years following the first commercial sale for each new product, up to a maximum aggregate royalty per calendar year. All royalty obligations with respect to any defined new product cease after the fifteenth anniversary of the first commercial sale of the first defined new product.

Our Product Pipeline

      The following table summarizes the antibiotic compounds we have in clinical trials and 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 preclinical product candidates is still in the early

stage of 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.

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

      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 2004, amoxicillin had U.S. retail sales of approximately $600 million, on a prescription base of approximately 54 million (IMS National

Prescription Audit 2004). Amoxicillin is generally recommended for dosing two or three times daily, for a period of ten to 14 days.

      Our in vitro studies demonstrated that pulsatile dosing of amoxicillin had significantly better bacterial killing efficiency than standard regimens of amoxicillin (analogous to immediate release products taken twice-daily or three-times daily) against a resistant strain of Streptococcus pneumoniae — see “Preclinical Research Supporting our Approach” above.

      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 and using our own sales and marketing capabilities. In May 2004, we entered into an agreement to develop and commercialize our pulsatile amoxicillin product with Par Pharmaceutical — see “Our Collaboration with Par Pharmaceutical for Amoxicillin PULSYS.”

      Our Amoxicillin PULSYS product candidates are in Phase III clinical trials for the treatment of pharyngitis/tonsillitis. If the clinical trials are successful and we receive FDA approval, Amoxicillin PULSYS may be the first and only once-daily amoxicillin treatment of pharyngitis/ tonsillitis approved in the United States. We are developing two formulations, an adult formulation presented in a tablet, and a pediatric sprinkle.

      Today in the United States, the most frequently prescribed pharyngitis prescription is for 500mg of amoxicillin three times daily for ten days, or 15 grams total over the course of therapy. In addition, amoxicillin is the most commonly mentioned antibiotic associated with the pharyngitis/tonsillitis diagnosis. Our Amoxicillin PULSYS product under evaluation in the Phase III clinical trial in adolescents and adults is dosed 775mg once-daily for seven days, or 5.4 grams total per course of therapy. Therefore, if our clinical trials results are positive and we receive FDA approval and successfully launch the product, we would be able to dose approximately one-third the amount of amoxicillin, while also providing the convenience of once-daily dosing and a shorter course of therapy. Pediatric patients receiving Amoxicillin PULSYS in the pediatric pivotal trial may receive either a 475mg dose or 775mg sprinkle dose, depending on the age of the patient, once-daily for a period of seven days.

      We intend to evaluate the potential of Amoxicillin PULSYS in additional upper respiratory tract infections such as bronchitis, otitis media, or sinusitis in the future. We believe the market opportunity for a once-daily Amoxicillin PULSYS product is substantial, with more than 54 million prescriptions written for amoxicillin formulations in 2004, making it the most widely prescribed antibiotic drug in the United States.

      Amoxicillin/clavulanate (marketed by GlaxoSmithKline 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 2004, amoxicillin/ clavulanate products had U.S. retail sales of approximately $1.7 billion on a prescription base of approximately 21 million (IMS National Prescription Audit 2004). Amoxicillin/ clavulanate is generally recommended for administration two or three times daily, for a period of ten to 14 days. In 2004, antibiotic products containing the combination of amoxicillin and clavulanate were the 4th most prescribed antibiotic in the United States.

      We are developing a PULSYS combination of the antibiotics amoxicillin and clavulanate for the treatment of upper respiratory tract infections such as acute otitis media and sinusitis. Clavulanate expands the spectrum of activity of amoxicillin by irreversibly binding to beta-lactamase producing enzymes released by certain types of bacteria. Without the presence of clavulanate, these enzymes would render amoxicillin useless in the treatment of infections caused by beta-lactamase producing strains of bacteria.

      We believe that in the future, effective treatments for diseases such as otitis media and sinusitis must provide coverage against beta-lactamase producing strains of Haemophilus influenzae, one of the more prominent causative strains of bacteria isolated in acute otitis media and sinusitis. (Piglansky L, et al. (2003). The Pediatric Infectious Disease Journal, 22:405-12. Dagan, R. (2001). Vaccine, 19:9-16)

      We believe that the Amoxicillin/ Clavulanate PULSYS product candidate we are developing would be the first and only once-daily formulation of this combination antibiotic drug available in the United States. We intend to develop both tablet and sprinkle presentations of this product to serve adult and pediatric patients. In December 2004, we modified our Amoxicillin PULSYS agreement with Par Pharmaceutical to include an amoxicillin/ clavulanate product for acute otitis media — see “Our Collaboration with Par Pharmaceutical for Amoxicillin PULSYS.”

      We are developing a once-daily PULSYS version of Keflex, our first generation oral cephalosporin antibiotic. Our intent is to develop a once-daily Keflex PULSYS for uncomplicated skin and skin structure infections. Currently, Keflex is the antibiotic most frequently prescribed by physicians in the treatment of uncomplicated skin and skin structure infections. Most commonly, Keflex is prescribed 500mg three times per day for a period of ten days. We believe a once-daily version of Keflex PULSYS may represent a substantial market opportunity. In 2004, cephalexin, the active ingredient in Keflex, was the third most prescribed antibiotic in the United States, with approximately $545 million in retail sales and more than 24 million prescriptions (IMS National Prescription Audit 2004).

      We intend to utilize the sales and marketing capabilities that we develop for our Amoxicillin PULSYS product candidates in order to commercialize Keflex PULSYS. We may determine that in order to maximize the commercial potential of Keflex PULSYS, it may be advantageous to enter into agreements with other pharmaceutical companies to expand the sales and marketing effort supporting the product.

      We are developing a combination antibiotic product candidate that combines an expanded-spectrum macrolide antibiotic, such as clarithromycin, with a beta-lactam antibiotic, such as amoxicillin. We believe that the combination of a macrolide and a beta-lactam antibiotic will considerably expand the spectrum of activity against bacteria suspected to cause serious, lower respiratory tract infections. Bacteria such as penicillin-resistant Streptococcus pneumoniae, atypical pathogens, and beta-lactamase producing Haemophilus influenzae are particularly difficult to treat with currently available antibiotics. The amoxicillin/macrolide antibiotic combination we are exploring will be evaluated with the goal of delivering a lower total daily dose of each antibiotic ingredient in a once-daily formulation targeting community-acquired pneumonia.

      Our in vitro studies have shown that the combination of amoxicillin/ clarithromycin when delivered in vitro in a pulsatile fashion eradicated resistant Streptococcus pneumoniae to undetected levels, while the antibiotic combination at the same doses was ineffective when given twice- and three-times daily — see “Preclinical Research Supporting our Approach” above.

      Our initial results from preclinical studies and 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.

      This combination agent, if successfully developed and commercialized, would compete against extended-spectrum macrolides such as clarithromycin or azithromycin, ketolides, and fluoroquinolones. More than 50 million prescriptions are written each year for these types of antibiotics.

      We anticipate marketing this combination product using our own sales and marketing capabilities or through third party collaborations. We may determine that it is advantageous to collaborate with another pharmaceutical company for the development and commercialization of this or other combination products in order to accelerate drug development, commercialization, and market penetration.

      To maximize the use of our resources on projects that will provide the best return to our shareholders, our current focus is on the antibiotic product candidates that include amoxicillin, amoxicillin in combination with other antibiotics, and Keflex. We have also identified additional product candidates which we believe could be developed for delivery in a pulsatile manner. The timing of further development work on these candidates

depends on our resources as well as our evaluation of the commercial potential of the products. These candidates include: clarithromycin, ciprofloxacin and other fluoroquinolones, metronidazole, and fluoroquinolone/ metronidazole and cephalosporin/ macrolide combinations.

      We intend to explore the use of our pulsatile dosing approach beyond antibiotics to other therapeutic categories, such as antivirals and antifungals. 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. The timing of development work in these categories depends on our resources, as well as our evaluation of the commercial potential of these products.

Collaboration Agreements

      In May 2004, we entered into an agreement with Par Pharmaceutical to collaborate in the further development and commercialization of a PULSYS-based amoxicillin product. We are solely responsible for the development program, including the manufacture of clinical supplies and the conduct of clinical trials, and are responsible for obtaining regulatory approval for the products. We will own the product trademark and will manufacture or arrange for supply of the product for commercial sales. Par will be the sole distributor of the product and the companies will share sales and marketing responsibilities. Both parties will share commercialization expenses, including pre-marketing costs and promotion costs, on an equal basis. Operating profits from sales of the product will also be shared on an equal basis.

      Under the agreement, we received an upfront fee of $5 million and a commitment from Par to fund all further development expenses. Development expenses incurred by Advancis will be funded by quarterly payments aggregating $28 million over the period from July 2004 through October 2005. The excess of the development costs incurred by us and the quarterly payments made by Par will be funded subsequent to commercialization, by the distribution to us of Par’s share of operating profits until the excess amount has been reimbursed.

      The agreement may be terminated by Par, either for cause, in the event of material increases in development costs or delays in program timing, or for other reasons. In the event that Par terminates the agreement for cause, no further quarterly development payments will be due to us; further, if we commercialize the product subsequent to Par’s termination and if Par has funded at least $20 million in development payments at the time of termination, Par will have a right to receive a percentage of its development payments from future net operating profits on product sales, if any. In the event of termination for other reasons, Par will be required to pay to us the lesser of (1) the excess of our cumulative development costs over the cumulative quarterly payments made by Par or (2) the difference between the cumulative quarterly payments actually made by Par through the termination date and the total of the quarterly payments specified in the agreement. We cannot assure you that we will receive any additional payments or that our collaboration with Par will result in the approval and marketing of any drug.

      In December 2004, we modified our collaboration with Par to include a PULSYS version of the antibiotic combination amoxicillin/ clavulanate for acute otitis media in children. Under the updated agreement, the combination amoxicillin/ clavulanate product for otitis media replaced the previously envisioned amoxicillin-only product for that indication. Based on discussions with infectious disease opinion-leaders, we believe that amoxicillin/ clavulanate is emerging as a first-line therapy resulting from shifts in the causative pathogens associated with otitis media. As such, we believe this combination represents an attractive market opportunity for an enhanced pulsatile version of the drug.

      Financial terms of the agreement did not change; however, we believe the combination PULSYS product will target a greater prescription base than that of a single-entity drug product for the otitis media indication. We believe approximately 30 percent of current amoxicillin/ clavulanate prescriptions are for acute otitis media and its usage may increase over current levels as the combination emerges as a first-line therapy. We reacquired the rights to develop amoxicillin/ clavulanate products from the discontinuation of the Company’s prior agreement with GlaxoSmithKline — see “Termination of the Collaboration with GlaxoSmithKline” below.

      For accounting purposes, we are recognizing revenue for the upfront fee on a straight line basis over the estimated development period. We are recognizing revenue for reimbursement of development costs as the actual costs to perform the work are incurred. Revenue recognized is limited to minimum amounts expected to be received under the specific agreements and excludes amounts contingent on future events, such as successful commercialization, and amounts that are contingently refundable.

      In July 2003, we entered into a license agreement with GlaxoSmithKline (GSK) 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 was 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 payment of $5 million from GSK upon signing of the agreement, a $3 million payment upon achievement of the first milestone, and would have been entitled to receive additional milestone payments from GSK not to exceed an aggregate of $49 million if it achieved certain product development goals. In addition, we were eligible to receive royalty payments on the commercial sale of products developed under the agreement. We could have also received sales milestone payments of up to $50 million if specified annual sales goals were achieved.

      The agreement could be terminated at any time by GSK upon relatively short notice. Our receipt of milestone payments, royalty payments and sales milestone payments under the agreement depended on the ability of GSK to develop and commercialize the products covered by the agreement and was subject to certain conditions and limitations.

      As previously disclosed, on October 15, 2004, we were notified that GSK would terminate the collaboration, effective December 15, 2004. We believe that pulsatile amoxicillin/ clavulanate is technically and commercially viable, and are exploring other avenues and partners for the development and commercialization of the product candidate — see “Our Collaboration with Par Pharmaceutical for Amoxicillin PULSYS” above. Additionally, we believe continued progress on our pulsatile version of amoxicillin will help support future productive PULSYS collaborations. As a result of the termination, we accelerated the recognition of the remaining deferred revenue of approximately $3.2 million related to the collaboration during the fourth quarter of 2004. The termination will have no other effects on our financial position.

      In September 2003, we entered into an agreement pursuant to which we licensed to Par Pharmaceutical the distribution and marketing rights to our generic formulation of Abbott’s Biaxin XL (clarithromycin extended release tablets). 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 could receive royalty payments equal to more than 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. 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. We cannot assure you that we will receive any milestone or royalty payments or that our collaboration with Par will result in the approval and marketing of any drug.

      As previously disclosed, during the third quarter of 2004, we conducted bioequivalence studies on two revised formulations of the generic product, and both formulations failed to achieve bioequivalence. We determined that due to the non-core nature of the product, the expense involved in the development of additional

formulations, the continued redirection of our resources required to pursue the product, and the reduced market potential given the emergence of competing products, we would discontinue further development work on the product. Advancis and Par are currently in discussions regarding the status of the agreement. All development work on this product has been expensed as incurred.

Sales and Marketing

      In order to commercialize our product candidates, we must acquire or develop internal sales, marketing and distribution capabilities or contract with third parties to perform these services for us. In support of the introduction of our first PULSYS product candidate, Amoxicillin PULSYS, we intend to develop our own sales and marketing capabilities. We believe that a significant percentage of prescriptions for first-line, broad-spectrum antibiotics is written by high-volume prescribers who can be reached by a community-based sales force. Over time, we intend to expand our sales and marketing capabilities to provide even greater market coverage. We also plan to enter into agreements with other pharmaceutical companies, such as the agreement we have in place with Par Pharmaceutical, to capitalize on our partners’ sales and marketing capabilities in order to optimally market our products.

      We are currently developing commercialization plans for our Amoxicillin PULSYS products, along with our partner, Par Pharmaceutical. Together, we expect to target high-volume prescribers with a community-based sales force. We intend to build our internal sales force to enable us to sell and market our proprietary PULSYS products in concentrated markets. We also are considering the use of third party sales organizations to supplement our internal capabilities, especially during the early stages of our sales force development.

      We currently have a small sales and marketing staff promoting the Keflex brand of cephalexin to national accounts. Keflex is primarily sold directly to pharmaceutical wholesalers. In the pharmaceutical industry there are a limited number of major wholesalers responsible for the majority of sales. Product sales of Keflex to Cardinal Health Inc., McKesson Corporation, and AmerisourceBergen Corporation represented approximately 95 percent of our net revenue from Keflex in 2004.

      We expect to continue to build our commercial infrastructure and capabilities for selling, marketing, and distributing Keflex, and are exploring initiatives to further benefit from the high name recognition and reputation of Keflex. These efforts with Keflex have enabled us to begin to develop our in-house commercial capabilities in anticipation of the launch of our Amoxicillin PULSYS products.

      We currently manage the distribution of Keflex, including warehousing and shipping through Integrated Commercialization Solutions, a division of AmerisourceBergen Corporation. If we successfully develop and receive regulatory approval for additional product candidates, we intend to continue to distribute all approved products through third-party vendors.

      If we successfully develop and receive regulatory approval to market additional product candidates, we believe we will have to substantially expand our sales and marketing capabilities and/or enter into partnerships with other pharmaceutical companies to successfully commercialize our product candidates. We will need to successfully recruit sales and marketing personnel and build a sales and marketing infrastructure to successfully commercialize Amoxicillin PULSYS and any additional products or product candidates that we develop, acquire or license. Our future profitability will depend in part on our ability to develop additional sales and marketing capabilities to commercialize our future products to our target audiences.

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:

      There are many approved antibiotics available to treat bacterial conditions in the United States. Our product Keflex, and products that are in development, will compete with other available products based primarily on:

      Our Keflex brand of cephalexin faces significant competition from generic distributors of cephalexin capsules and suspension. Currently, a significant portion of the prescriptions written for Keflex are substituted at the pharmacy with generic versions of Keflex, supplied through leading generic drug manufacturers including Teva, Stada, IVAX, Ranbaxy, and others.

      In some instances our novel products that utilize our PULSYS technology may compete against non-pulsatile drug products that share the same active ingredient, but are less convenient or require more cumbersome administration schedules. A number of these non-pulsatile drug products are available in generic form. Companies such as Teva, Ranbaxy, IVAX, Sandoz and Stada, and others are major manufacturers and distributors of generic versions of antibiotics with whom we may compete in the future.

      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.

      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. Our competitors may be able to apply their resources and capabilities to develop and commercialize products that have distinct, enhanced, or perceived advantages versus our products. The competitors may be in a position to devote greater resources in the sales, marketing, and distribution of these products and therefore considerably impact our ability to successfully commercialize our own products.

Manufacturing

      We currently rely on third-party contract manufacturers to produce sufficient quantities of our product candidates for use in our preclinical studies and 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 development of manufacturing capabilities because production of these drugs involves well-established and well-accepted manufacturing techniques and processes. We intend to continue to rely upon third-party contract manufacturers for production of our clinical and commercial supplies. The use of third-parties for these activities allows us to minimize our initial capital investment and reduce the risk that would be associated with the establishment of our own commercial manufacturing and distribution operations. With the possible transition to non-beta lactam products, we anticipate that our pilot facility could satisfy our drug production needs for clinical supplies through at least Phase II and, in some cases, through Phase III clinical trials.

      In December 2004, we entered into a commercial supply agreement with Ceph International Corporation, a wholly owned subsidiary of MOVA Pharmaceutical Corporation, to secure a long-term supply for our Keflex brand of products. This agreement provides for commercial supply of our Keflex product beyond the transitional period agreed to by Eli Lilly as part of our June 2004 acquisition. In addition, we are in the process of securing long-term commercial supply of our Amoxicillin PULSYS products.

      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.

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 U.S. patents and 24 U.S. patent applications. Our issued patents cover certain compositions and methods using pulsatile dosing. We also own 33 foreign-filed patent applications, which foreign-filed patent applications correspond to our U.S. patents and applications. We also own 10 International (PCT) patent applications, each of which International (PCT) patent applications we anticipate converting into several individually foreign-filed patent applications to further correspond to our 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 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.

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

      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 and questions of absorption, metabolism, distribution and excretion are well-established.

      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 form 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 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 $600,000, 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 the first NDA submission for our pulsatile drug products may 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.

      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 22, 2005, we had 88 employees, 27 of whom are senior management, 22 are in supervisory positions and 39 are non-management. Of the 88 employees, 56 perform scientific and research activities and 26 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

      From the date we began operations in January 2000 through December 31, 2004, we have incurred operating losses of approximately $77.4 million, including operating losses of approximately $34.7 million for the fiscal year ended December 31, 2004, $19.4 million for the fiscal year ended December 31, 2003, and $14.2 million for the fiscal year ended December 31, 2002. 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:

      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 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. 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 traditional 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.

      Even if we are correct that pulsatile dosing is more effective than traditional dosing of antibiotics, our delivery technology must be effective in humans such that the pulsatile administration of drugs are at levels that prove effective in curing infections. If our PULSYS delivery technology is not effective in delivering rapid bursts of antibiotics, or is unable to do so at an appropriate concentration 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 than those of our competitors, which may decrease or eliminate market acceptance of our products.

      We have devoted a substantial amount of our research efforts and capital to the development of pulsatile antibiotics. Competitors are developing or have developed new drugs that may compete with our pulsatile antibiotics. For example, sanofi-aventis recently launched 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.

      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:

      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.

      We have not commercialized any pulsatile products or recognized any revenue from PULSYS product sales. With the exception of our Amoxicillin PULSYS product, all of our pulsatile drugs are in early stages of development with a total of only four pulsatile product candidates having been tested in Phase I/ II clinical trials to date. Our Amoxicillin PULSYS products are currently in Phase III clinical trials, however, we must successfully complete these Phase III clinical trials and obtain regulatory approval for our pulsatile products before we are able to commercialize pulsatile products and generate revenue from their sales. We expect that we must conduct significant additional research and development activities on our other pulsatile products successfully completing preclinical, Phase I, Phase I/ II or Phase II, and Phase III clinical trials before we will be able to receive final regulatory approval to commercialize these pulsatile products. Even if we succeed in developing and commercializing one or more of our pulsatile drugs, we may never generate sufficient or sustainable revenue to enable us to be profitable.

      For certain product candidates, we intend to enter into collaborative arrangements with third parties. These collaborations may be necessary in order for us to:

      Currently, we have a collaborative agreement with Par Pharmaceutical for our Amoxicillin PULSYS products. If Par Pharmaceutical fails to fulfill its obligations under our agreement, we may encounter delays in the commercialization of our product. Accordingly, our ability to receive any revenue from the product candidates covered by these agreements is dependent on the efforts of Par Pharmaceutical. We could also become involved in disputes with Par Pharmaceutical, which could lead to delays in or termination of our development and commercialization programs and time-consuming and expensive litigation or arbitration. If Par Pharmaceutical either terminates or breaches our agreement, or otherwise fails to complete its obligations in a timely manner, our chances of successfully developing or commercializing our amoxicillin 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. We cannot assure you that we will be able to enter into 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 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.

      A component of our business strategy is in-licensing or acquiring 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 or acquire any drugs from other companies. If we are not able to identify licensing or acquisition opportunities or enter into arrangements on acceptable terms, we will be unable to develop a diverse portfolio of products. Any product candidate that we acquire will require additional research and development efforts prior to commercial sale, including extensive preclinical and/or clinical testing and approval by the FDA and corresponding foreign regulatory authorities. All product candidates are prone to the risks of failure inherent in pharmaceutical product development, including the possibility that the product candidate will not be safe, non-toxic and effective or approved by regulatory authorities. In addition, we cannot assure you that any approved products that we develop or acquire will be: manufactured or produced economically; successfully commercialized; widely accepted in the marketplace or that we will be able to recover our significant expenditures in connection with the development or acquisition of such products. In addition, proposing, negotiating and implementing an economically viable acquisition is a lengthy and complex process. Other companies, including those with substantially greater financial, sales and marketing resources, may compete with us for the acquisition of product candidates and approved products. We may not be able to acquire the rights to additional product candidates and approved products on terms that we find acceptable, or at all. In addition, if we acquire product candidates from third parties, we will be dependent on third parties to supply such products to us for sale. We could be materially adversely affected by the failure or inability of such suppliers to meet performance, reliability and quality standards.

      We are highly dependent on the principal members of our scientific and management teams, including Edward M. Rudnic, our chairman, president and chief executive officer, Steven A. Shallcross, our senior vice president and chief financial officer, Kevin S. Sly, our senior vice president and chief business officer, and Barry Hafkin, our senior vice president of research and development and chief scientific officer. 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.

      We obtain active pharmaceutical ingredients (APIs) and finished products 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 or finished products 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.

      We have limited experience in conducting and managing clinical trials. We rely, and will continue to rely, on third parties, including 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.

      We must demonstrate through preclinical 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, we will also need to demonstrate through clinical trials any claims we may wish to make that our product candidates are comparable or superior to existing products. For drug products such as our amoxicillin/macrolide and cephalosporin/macrolide combination product candidates, which are expected to contain 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 have two Amoxicillin PULSYS products in Phase III clinical trials. We expect to have results from the adolescent and adult trial in June 2005 and results from the pediatric trial in the third quarter of 2005. For our other products we have not completed preclinical studies and initial clinical trials (Phase I, Phase I/ II or Phase II) 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 optimal efficacy or safety of our products and may not support approval in the absence of additional clinical trials using a different dosage.

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

      The results from preclinical 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 preclinical 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 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 anticipate that our existing capital resources, expected products sales, and payments under our existing collaborative agreement will enable us to maintain our current operations for at least the next 12 months. We anticipate that we will need additional capital to fund our operations beyond 2005 and expect to seek additional funds during 2005. Our requirements for additional capital may be substantial and will depend on many other factors, including:

      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.

      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.

      Even if we obtain regulatory approval to market our PULSYS 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:

      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.

      We currently obtain our Keflex product from Eli Lilly under an agreement that will expire in December 2005. Before this agreement expires, we intend to transition the manufacturing of our Keflex product to Ceph International Corporation, a wholly-owned subsidiary of MOVA Pharmaceutical Corporation. Although we believe that the API and finished products for Keflex may be obtained from several suppliers, our applications for regulatory approval currently authorize only Eli Lilly as our source. We must revise our application to permit Ceph International to manufacture our Keflex products or rely on Ceph International’s existing regulatory approvals. In the event that Lilly or Ceph is unable to supply the products to us at a commercially reasonable price or breaches its agreement with us, or if Lilly or Ceph loses its regulatory status as an acceptable source, we would need to locate another source. A change to a supplier not previously approved or an alteration in the procedures or product provided to us by an approved supplier may require formal approval by the FDA before the product could be sold. These factors could limit our ability to sell Keflex and would materially adversely affect our revenues.

      We rely largely upon specialty pharmaceutical distributors and wholesalers to deliver Keflex to end users, including physicians, hospitals, and pharmacies. There can be no assurance that these distributors and wholesalers will adequately fulfill the market demand for Keflex, nor can there be any guarantee that these service providers will remain solvent. Given the high concentration of sales to certain pharmaceutical distributors and wholesalers,

we could experience a significant loss if one of our top customers were to declare bankruptcy or otherwise become unable to pay its obligations to us.

      The cost of pharmaceutical products continues to be a subject of investigation and action by governmental agencies, legislative bodies and private organizations in the U.S. and other countries. In the U.S., most states have enacted legislation requiring or permitting a dispensing pharmacist to substitute a generic equivalent to the prescribed drug. Federal legislation requires pharmaceutical manufacturers to pay to state Medicaid agencies prescribed rebates on drugs to enable them to be eligible for reimbursement under Medicaid programs. Federal and state governments continue to pursue efforts to reduce spending in Medicaid programs, including restrictions on amounts agencies will reimburse for certain products. In addition, some states are seeking rebates in excess of the amounts required by federal law, and there are federal legislative proposals to expand current Medicaid rebates. We also must give discounts or rebates on purchases or reimbursements of Keflex by certain other federal and state agencies and programs. Our ability to earn sufficient returns on Keflex depends, in part, on the availability of reimbursements from third party payers, such as health insurers, governmental health administration authorities and other organizations and the amount of rebates payable under Medicaid programs.

      We currently rely on several contractors to manufacture product samples for our clinical studies. 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 the future. We have no experience qualifying manufacturing facilities and we may not be able to qualify the facility. 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.

      We have limited sales, marketing, and distribution capabilities. In order to commercialize any product candidates that receive final regulatory approval, we must considerably expand our commercial capabilities or make arrangements with third parties to perform these services for us. In order to market any of our product candidates directly, we must considerably expand our commercial infrastructure, including distribution, marketing, and sales personnel. The expansion or contracting 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 sales and marketing arrangements with other companies, our revenues will depend on the efforts of others. These efforts may not be successful. If we fail to expand sales, marketing and distribution capabilities, or fail to enter into arrangements with third parties, we will experience delays in product sales and incur increased costs.

Risks Related to our Industry

      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.

      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:

      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:

      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.

      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 PULSYS 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:

      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:

      We may rely on future 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.

      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.

      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.

      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. 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.

      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. Selling of a large number of shares by any of our existing shareholders or management shareholders 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.

      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 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.

      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 price of our common stock has been as high as $10.30 and as low as $2.50 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.

      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.

      In August 2004, we entered into a lease for approximately 53,000 square feet of additional research and development space, in a building adjacent to the Company’s existing headquarters in Germantown, Maryland. The lease for this facility expires in May 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. Also, in September 2004 we rented an office of approximately 6,681 square feet for engineering space in Bridgewater, New Jersey under a short-term lease that expires in September 2006.

      We believe that our facilities are suitable and adequate to meet our current needs.

      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 us 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 we have infringed on the plaintiffs’ trademark. The plaintiffs seek injunctive relief, as well as unspecified monetary damages. Discovery has been completed, and the case is set for trial to commence in May 2005. It is the opinion of management that the ultimate outcome of this matter will not have a material adverse effect upon our financial position, results of operations, or cash flows.

      No matters were submitted to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2004.

PART II

      Our common stock has been traded on The Nasdaq National Market under the symbol AVNC since October 17, 2003. The following table sets forth the quarterly high and low sales prices per share of our common stock as reported by Nasdaq for each quarter during the last two fiscal years, commencing on October 17, 2003:

      As of February 22, 2005, there were 133 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.

      From October 15, 2003, the effective date of our Registration Statement on Form S-1 (File No. 333-107599), to December 31, 2004, we have used approximately $42.6 million of the net offering proceeds from our initial public offering, as follows:

      We currently intend to use the remaining proceeds of the offering for research and development activities, including clinical trials for our product candidates, purchases of capital equipment, licensing activities and other general corporate purposes. The amount and timing of our actual expenditures will depend on numerous factors, including the progress of our research and development activities and clinical trials, the number and breadth of our product development programs, our ability to establish and maintain corporate collaborations and other arrangements, and the amount of cash, if any, generated by our operations. We will retain broad discretion in the allocation and use of the proceeds of the offering. Pending application of the remaining proceeds, as described above, we have invested the proceeds in short-term, investment-grade, interest-bearing securities.

      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 the “Forward-Looking Statements” and “Factors that May Affect our Business” sections in Part 1, Item 1 and elsewhere in this annual report on Form 10-K, our actual results may differ materially from those anticipated in these forward-looking statements.

Our Business

      Advancis Pharmaceutical Corporation was incorporated in Delaware in December 1999 and commenced operations on January 1, 2000. We are a pharmaceutical company focused on developing and commercializing pulsatile drug products that fulfill unmet medical needs in the treatment of infectious disease. We are developing a broad portfolio of drugs based on the novel biological finding that bacteria exposed to antibiotics in front-loaded, sequential bursts, or pulses, are killed more efficiently than those exposed to standard antibiotic treatment regimens. We currently have 16 issued U.S. patents covering our proprietary once-a-day pulsatile delivery technology called PULSYS. We have initially focused 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. Our lead pulsatile product candidates, based on the antibiotic amoxicillin, are currently under evaluation in two separate Phase III clinical trials. We also have an additional four pulsatile drugs or drug product combination candidates in preclinical development. At the end of the second quarter of 2004, we acquired the U.S. rights to Keflex (cephalexin) from Eli Lilly. We currently employ a small sales and marketing staff that is promoting Keflex products to national accounts. In support of the introduction of our first anticipated pulsatile product, Amoxicillin PULSYS, we intend to develop our own sales and marketing capabilities. We will target high-volume prescribers, such as family practitioners and internists, and over time expand our internal sales and marketing capabilities through third party collaborations.

Management Review of 2004 and Focus for 2005

      The year ended December 31, 2004 was Advancis’ first full year as a public company, following our initial public offering on October 16, 2003. The following is a summary of key events that occurred during the year.

      Our current focus is on the successful development and commercialization of our pulsatile product candidates, initially Amoxicillin PULSYS.

      During 2004, we evaluated a number of products for possible acquisition that would be consistent with our philosophy of focusing on currently-marketed drug products that we may be able to improve potential using our pulsatile-dosing approach. At the end of the second quarter of 2004, we acquired the Keflex brand of cephalexin. Cephalexin had retail sales of $545 million in 2004, on a prescription base of 25 million.

      Our primary focus for 2005 and 2006 is to fully develop and commercialize our Amoxicillin PULSYS product candidates, which are currently in Phase III trials for pharyngitis/tonsillitis. We intend to develop an additional amoxicillin/clavulanate PULSYS product candidate to address pediatric otitis media. We also intend to

focus our development efforts on a PULSYS version of Keflex, beginning with Phase I/ II clinical trials expected in 2005. In addition, we expect to continue the evaluation of our preclinical product candidates.

      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.

      The following table summarizes research and development expense for our product development initiatives for the fiscal years ended December 31, 2004, 2003 and 2002. See “Our Product Pipeline” above for our current priority product candidates.

      Selling, 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 sales and marketing costs, product distribution expenses, facility costs not otherwise included in research and development expense, professional fees for legal and accounting services, and amortization of intangible assets.

      Employees. We have recorded deferred stock-based compensation expense in connection with the grant of certain 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. In accordance with APB Opinion 25, “Accounting for Stock Issued 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 related to employees of approximately $3.3 million, $2.2 million and $30,000 for the years ended December 31, 2004, 2003, and 2002, respectively. In addition, in 2004 we recorded a charge of $490,000 for stock-based compensation in connection with the retirement of the chairman of the board of directors.

      Non-employee Consultants. We recorded stock-based compensation expense of $26,000 and $1.3 million during the years ended December 31, 2004 and 2003, for options granted to non-employee consultants and scientific advisory board (SAB) members in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” based on the fair value of the equity instruments issued. Except for one grant in 2003 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 is periodically remeasured as the underlying options vest in accordance with Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” We 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, 2004, the balance of unamortized stock-based compensation for options granted to non-employees was approximately $120,000. 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 2003.

      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, “Application of Issue No. 98-5 to Certain Convertible Instruments.” 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 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.

      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, 2004, we had an accumulated deficit of approximately $78.1 million. We anticipate incurring additional annual losses, perhaps at higher levels, for the foreseeable future.

Results of Operations

      Revenues. We recorded revenues of $11.4 million during the fiscal year ended December 31, 2004 compared to $3.6 million during the fiscal year ended December 31, 2003, as follows:

      Product sales of Keflex commenced in July 2004, subsequent to the purchase of the brand rights in the U.S. market from Eli Lilly. There were no product sales in 2003.

      Revenues recognized in 2004 and 2003 from the amortization of upfront licensing fees include the amortization of a $5.0 million upfront payment received from GlaxoSmithKline (GSK) in July 2003, of which the unamortized portion of $3.2 million was recognized in 2004 due to the termination of the collaboration agreement, and the amortization of a $5.0 million upfront payment received from Par Pharmaceutical in May 2004, which is expected to be amortized into revenue on a straight-line basis through May 2007.

      Reimbursement of development costs revenue of $3.6 million related to the Par amoxicillin agreement was recognized based on the related costs incurred.

      Cost of Product Sales. Cost of product sales represents the purchase cost of the Keflex products sold in 2004. Cost of product sales was $170,000 in 2004. There were no product sales in 2003.

      Research and Development Expenses. Research and development expenses increased $17.0 million, or 103%, to $33.6 million for the fiscal year ended December 31, 2004 from $16.6 million for the fiscal year ended December 31, 2003. 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.

      Direct costs increased $12.3 million primarily as a result of increases of $11.1 million relating to the development of our pulsatile amoxicillin product candidate, plus increases of an aggregate of $2.4 million relating to the evaluation of new preclinical product candidates, partially offset by decreases of an aggregate of $1.4 million relating to the development of our pulsatile clarithromycin and generic clarithromycin product candidates.

      Increased project staffing levels in 2004 versus 2003 resulted in an increase of $3.7 million related to personnel, benefits and related costs. Contract research and development, consulting, materials and other direct costs increased $4.9 million in preparation for our clinical trials, and clinical trials expense increased $4.5 million from 2003 as we initiated two Phase III studies in 2004 (adult and pediatric amoxicillin PULSYS) as well as conducted 13 Phase I/ II studies compared to nine Phase I/ II studies in 2003.

      Indirect project costs also increased by $4.7 million, primarily due to an increase in facility-related costs of $1.8 million, depreciation of $1.3 million, and overhead of $1.6 million due to increased patent and legal costs, insurance, and Scientific Advisory Board expenses.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $5.8 million, or 90%, to $12.2 million for the fiscal year ended December 31, 2004 from $6.4 million for the fiscal year ended December 31, 2003.

      Selling, general and administrative expenses consist of salaries and related costs for executive and other administrative personnel, as well as professional fees and facility costs. Salaries, benefits and related costs for personnel increased $0.8 million in 2004 due to higher compensation and benefits expenses related to new hires. Approximately $0.9 million of the total $5.8 million increase in general and administrative expenses is attributable to increased stock-based compensation charges, primarily due to the effect of certain 2003 grants being amortized for a full year in 2004. Legal and consulting costs increased $0.9 million in 2004 due to increased support activities attributable to the Company’s first full year of being a publicly-traded corporation, assistance in business development activities, litigation support and Sarbanes-Oxley compliance. Other expenses increased $3.1 million, principally due to higher costs for building and equipment operating expenses and depreciation of $0.5 million, amortization of $0.6 million of Keflex intangibles, increased audit fees and investor communications costs of $0.3 million related to the Company’s first full-year status as a public company, and

increased business development marketing costs of $0.7 million related to identification and development of new market opportunities, including Keflex brand enhancement.

      Net Interest Income (Expense) and Other Expense. Net interest income was $669,000 for the fiscal year ended December 31, 2004 compared to net interest expense of $1.6 million for the fiscal year ended December 31, 2003.

      The increase in net interest income in 2004 of $2.2 million is primarily due to the beneficial conversion feature of deemed interest expense of $1.7 million incurred in 2003 (no similar item in 2004), plus increased interest income in 2004 of $540,000 resulting from the Company’s investment in marketable securities subsequent to its initial public offering of common stock in the second half of 2003. The deemed interest expense related to the beneficial conversion feature was 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.

      Interest expense (net of capitalized interest) decreased $40,000 compared to the prior year. The Company has paid down in 2004 older fixed rate borrowings that were at higher interest rates than its newer, variable rate borrowings.

      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 was 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.

      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.

      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.

      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.

      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.

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. Additionally, we have received funding of $8.0 million and $14.0 million from GlaxoSmithKline and Par Pharmaceutical, respectively, as a result of collaboration agreements for the development of new products.

      At December 31, 2004, unrestricted cash, cash equivalents and marketable securities were $30.1 million compared to $65.1 million at December 31, 2003.

      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.

      The following table summarizes our sources and uses of cash and cash equivalents for fiscal years ending December 31, 2004, 2003, and 2002.

          Operating Activities

      Net cash used in operating activities in the year ended December 31, 2004 was $15.5 million, primarily due to the net loss of $34.0 million as adjusted for noncash charges and the timing of revenue recognition. Cash used in operating activities is less than the net loss for accounting purposes by $18.5 million for the following reasons:

      Net cash used in operating activities in the year ended December 31, 2003 was $11.1 million, primarily due to the net loss of $21.0 million as adjusted for noncash charges and the timing of revenue recognition. Cash used in operating activities is less than the net loss for accounting purposes by $9.9 million for the following reasons:

      Net cash used in operating activities in the year ended December 31, 2002 was $12.8 million, primarily due to the net loss of $14.1 million as adjusted for noncash charges and the timing of revenue recognition. Cash used in operating activities is less than the net loss for accounting purposes by $1.3 million. The Company had no revenue or cash receipts in 2002. Cash expenditures were approximately $1.3 million less than expenses for accounting purposes, primarily due to noncash expenses for depreciation, amortization, and stock-based compensation.

          Investing Activities

      Net cash used in investing activities during the year ended December 31, 2004 was $11.7 million. The most significant investing activities included the acquisition of Keflex intangibles for $11.2 million, and purchases of and deposits on property and equipment of $7.0 million. Net purchases and sales of marketable securities provided $6.6 million during the period.

      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 90 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 fit-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 provided by financing activities for the year ended December 31, 2004 was $0.2 million. The major financing activities included loan draws of $1.4 million for equipment financing in connection with the fit-out of the Company’s new corporate, research and development facility and repayments of $1.2 million on the Company’s existing borrowings.

      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.

      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.

      We are a party to four credit facilities for an aggregate amount of $5.9 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, $2.6 million was outstanding as of December 31, 2004, as summarized in the following table:

      In 2004 we made our final draws of $1.4 million prior to expiration of the bank credit line. We continue to explore options to obtain equipment financing on terms that would be favorable to the Company. The Company does not currently hedge variable rate borrowings.

      Our amoxicillin development and commercialization agreement with Par may be terminated by Par, either for cause, in the event of increases in development costs or delays in program timing, or for other reasons. In the event that Par terminates the agreement for cause, no further quarterly development payments will be due to us; further, if we commercialize the product subsequent to Par’s termination and if Par has funded at least $20 million in development payments at the time of termination, Par will have a right to be paid a percentage of its development payments from future net operating profits on product sales, if any. In the event of termination for other reasons, Par will be required to pay to us the lesser of (1) the excess of our cumulative development costs over the cumulative quarterly payments made by Par or (2) the difference between the cumulative quarterly payments actually made by Par through the termination date and the total of the quarterly payments specified in the agreement. We cannot assure you that we will receive any additional payments or that our collaboration with Par will result in the approval and marketing of any drug.

      The following table summarizes our contractual obligations at December 31, 2004 and the effects such obligations are expected to have on our liquidity and cash flows in future periods.

Payments Due by Period

      During fiscal 2004, the Company spent approximately $7.0 million for capital expenditures, primarily for leasehold improvements and equipment for its new corporate, research and development facility as well as for equipment purchased for use at third-party manufacturing facilities.

      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.

      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 selling, general and administrative expenses will increase in the future as we expand our business development, legal and accounting staff, and add sales and marketing infrastructure. 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 until at least the first quarter of 2006 and expect to seek additional funds in 2005.

      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 January 2004, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” as revised. FIN 46R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company has adopted FIN 46R and has determined that it does not currently hold interests in any entities that are subject to the consolidation provisions of this interpretation.

      In December 2004, the FASB issued SFAS 123R, “Share-Based Payment,” a revision of SFAS 123, “Accounting for Stock-based Compensation.” SFAS 123R requires public companies to recognize expense associated with share-based compensation arrangements, including employee stock options, using a fair value-based option pricing model, and eliminates the alternative to use Opinion 25’s intrinsic value method of accounting for share-based payments. In accordance with the new pronouncement, the Company plans to begin recognizing the expense associated with its share-based payments, as determined using a fair value-based method, in its statement of operations beginning on July 1, 2005. Adoption of the expense provisions of SFAS 123R are expected to have a material impact on the Company’s results of operations. The standard allows three alternative transition methods for public companies: modified prospective application without restatement of prior interim periods in the year of adoption; modified prospective application with restatement of prior interim periods in the year of adoption; and retroactive application with restatement of prior financial statements to include the same amounts that were previously included in pro forma disclosures. The Company has not determined which transition method it will adopt.

      In December 2004, the FASB issued SFAS 153, “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29, “Accounting for Nonmonetary Transactions.” SFAS 153 is based on the principle that exchange of nonmonetary assets should be measured based on the fair market value of the assets exchanged. SFAS 153 eliminates the exception of nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153 is effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005. We are currently evaluating the provisions of SFAS 153 and do not believe that its adoption will have a material impact on our financial condition, results of operations and liquidity.

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 accrued expenses, fair valuation of stock 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.

      We recognize revenue for the sale of pharmaceutical products and for payments received under collaboration agreements for licensing, milestones, and reimbursement of development costs.

      Product Sales. Revenue from product sales, net of estimated provisions, is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectibility is reasonably probable. Our customers consist primarily of large pharmaceutical wholesalers who sell directly into the retail channel. Provisions for sales discounts, and estimates for chargebacks, rebates, and product returns are established as a reduction of product sales revenue at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves. These revenue reductions are generally reflected either as a direct reduction to accounts receivable through an allowance, or as an addition to accrued expenses if the payment is due to a party other than the wholesaler.

      Chargebacks and rebates are based on the difference between the prices at which we sell our products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payers, including governmental agencies. We record an estimate at the time of sale to the wholesaler of the amount to be charged back to us or rebated to the end user. We have recorded reserves for chargebacks and rebates based upon various factors, including current contract prices, historical trends, and our future expectations. The amount of actual chargebacks and rebates claimed could be either higher or lower than the amounts we accrued. Changes in our estimates would be recorded in the income statement in the period of the change.

      Product returns. In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used prior to its expiration date, which for our Keflex product is typically three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. We estimate the level of sales which will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net revenues. Our estimates take into consideration historical returns of our products and our future expectations. We periodically review the reserves established for returns and adjust them based on actual experience. The amount of actual product return could be either higher or lower than the amounts we accrued. Changes in our estimates would be recorded in the income statement in the period of the change. If we over or under estimate the quantity of product which will ultimately be returned, there may be a material impact to our financial statements.

      Contract Revenue. 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. Up-front payments are recorded as deferred revenue. We estimate the length of the remaining development period and amortize an up-front payment over that development period.

      Reimbursement of Development Costs. We record revenue for reimbursement of development costs as the actual costs to perform the work are incurred. We are required to use judgment in recognizing reimbursement revenue in cases where the agreement provides for funding to us that is not dependent on actual costs we incur within a specific fiscal period. For our collaboration with Par Pharmaceutical for Amoxicillin PULSYS, for example, we are entitled to quarterly payments in pre-established amounts that fund our development work. Our policy is to limit revenue recognized to the minimum amounts expected under a specific collaboration agreement and to exclude amounts contingent on future events, such as successful commercialization and future profit-sharing, and amounts that are contingently refundable. Revenue recognized is limited to cumulative amounts under each contract such that, at any time, if a termination of the agreement were to occur, revenue previously recognized would not need to be reversed. Cash received in excess of revenue recognized is recorded as deferred revenue, with the deferred revenue recognized as revenue at the time future events occur that remove the contingencies.

      Acquired Intangible Assets. We acquired the U.S. rights to the Keflex brand of cephalexin in 2004. We may acquire additional pharmaceutical products in the future that include license agreements, product rights and other identifiable intangible assets. When intangible assets are acquired, we review and identify the individual intangible assets acquired and record them based on relative fair values. Each identifiable intangible asset is then reviewed to determine if it has a definite life or indefinite life, and definite-lived intangible assets are amortized over their estimated useful lives.

      Impairment. We assess the impairment of identifiable intangibles on an quarterly basis or when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include significant underperformance compared to historical or projected future operating results, significant changes in our use of the acquired assets or the strategy for our overall business, or significant negative industry or economic trends. If we determine that the carrying value of intangible assets may not be recoverable based upon the existence of one or more of these factors, we first perform an assessment of the asset’s recoverability based on expected undiscounted future net cash flow, and if the amount is less than the asset’s value, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

      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. We also make estimates for other liabilities incurred, including health insurance costs for our employees. We are self-insured for claims made under our health insurance program and record an estimate at the

end of a period for claims not yet reported. Our risk exposure is limited, as claims over a maximum amount are covered by an aggregate stop loss insurance policy.

      We have elected to follow APB Opinion No. 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 No. 123, “Accounting for Stock-Based Compensation.” In the notes to our financial statements we provide pro forma disclosures in accordance with SFAS No. 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 No. 123 and EITF Issue No. 96-18. The 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. Since the Company’s initial public offering in October 2003, we have used the quoted market price of our common stock as the fair value, and we have established an estimate for volatility by considering the volatility of the stock of other comparable public companies.

      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, 2004, 2003 and 2002. 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 carry forwards cannot be sufficiently assured at December 31, 2004 and 2003. At December 31, 2004 and 2003, we had federal and state net operating loss carryforwards of approximately $51.9 million and $26.6 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. At December 31, 2004, the Company had research and experimentation tax credit carryforwards of approximately $2.7 million, of which $2.6 million are federal tax credit carryforwards which begin to expire in 2020 and $0.1 million are state tax credit carryforwards which begin to expire in 2018.

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.

      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 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.

      The information required by this item is set forth on pages F-1 to F-27.

      None.

Evaluation of Disclosure 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, 2004. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported on a timely basis. 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.

Changes in Internal Control over Financial Reporting during the Quarter

      Our management, including our principal executive and principal financial officers, has evaluated any changes in our internal control over financial reporting that occurred during our most recent fiscal quarter, which ended December 31, 2004, and has concluded that there was no change that occurred during the quarter ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s Annual Report on Internal Control over Financial Reporting

      The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s system of internal controls over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

      Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      Management, including the chief executive officer and chief financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Based on our assessment, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2004.

      The Company’s independent auditors have audited management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 as stated in their report which appears on pages F-2 and F-3.

      None.

PART III

      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 “2005 Proxy Statement”).

      We incorporate herein by reference the information concerning executive compensation to be contained in the 2005 Proxy Statement.

      We incorporate herein by reference the information concerning security ownership of certain beneficial owners and management to be contained in the 2005 Proxy Statement.

      We incorporate herein by reference the information concerning certain relationships and related transactions to be contained in the 2005 Proxy Statement.

      We incorporate herein by reference the information concerning certain relationships and related transactions to be contained in the 2005 Proxy Statement.

PART IV

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

(1) Index to Financial Statements

      Financial statement schedules are omitted because they are not required or are adequately explained in the financial statements.

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.

Dated: March 10, 2005

      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:

INDEX TO FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Shareholders of Advancis Pharmaceutical Corporation:

We have completed an integrated audit of Advancis Pharmaceutical Corporation’s 2004 financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Financial statements

In our opinion, the accompanying balance sheets and the related statements of operations, of changes in stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of Advancis Pharmaceutical Corporation at December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements 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.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable

assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

McLean, Virginia

March 9, 2005

ADVANCIS PHARMACEUTICAL CORPORATION

BALANCE SHEETS

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

ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENTS OF OPERATIONS