SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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)

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

      As of May 3, 2005, 29,696,467 shares of common stock of the Registrant were outstanding.

ADVANCIS PHARMACEUTICAL CORPORATION

INDEX

Form 10-Q

PART I — FINANCIAL INFORMATION

ADVANCIS PHARMACEUTICAL CORPORATION

BALANCE SHEETS

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

ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENTS OF OPERATIONS

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

ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

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

ADVANCIS PHARMACEUTICAL CORPORATION

STATEMENTS OF CASH FLOWS

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

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS

      The accompanying unaudited financial statements of Advancis Pharmaceutical Corporation (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s 2004 Annual Report on Form 10-K. The interim financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature.

      Operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005.

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

      Product Sales. Revenue from product sales is recognized when substantially all the risks and rewards of ownership have passed to the customer. Revenues are reduced at the time of sale to reflect expected returns, discounts, rebates, and chargebacks. These estimates are based on terms, historical experience, trend analysis, and market conditions.

      Contract revenues include license fees and milestone payments associated with collaborations with third parties. Revenue from non-refundable, upfront license fees where the Company has continuing involvement is recognized ratably over the development or agreement period. Revenue associated with performance milestones is recognized based upon the achievement of the milestones, as defined in the respective agreements.

      Revenue for reimbursement of development costs is recognized 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.

      Royalties from licensees are based on third-party sales of licensed products and will be recorded in accordance with contract terms when third-party results are reliably measurable and collectibility is reasonably assured.

      Deferred Revenue represents cash received in excess of revenue recognized.

      The Company classifies all of its marketable securities as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported as a component of stockholders’ equity (deficit) in comprehensive income (loss). Marketable securities available for current operations are classified

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS — (Continued)

in the balance sheet as current assets; marketable securities held for long-term purposes are classified as noncurrent assets. Interest income, net of amortization of premium on marketable securities, and realized gains and losses on securities are included in “Interest income” in the statements of operations.

      Accounts receivable represent amounts due from wholesalers for sales of pharmaceutical products. Allowances for estimated product returns, discounts, and chargebacks are recorded as reductions to gross accounts receivable. Amounts due for estimated rebates payable to third parties are included in accrued liabilities.

      Inventories consist of finished products purchased from third parties and are stated at the lower of cost or market. Cost is determined on the first-in, first-out (FIFO) method.

      Employee stock awards under the Company’s compensation plans are accounted for by the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB 25) and related interpretations.

      In accordance with SFAS 148, the following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123. Because options vest over several years and additional option grants are expected to be made in future years, the pro forma results are not representative of the pro forma results for future years.

      Basic earnings per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed based on the weighted average shares outstanding adjusted for all dilutive potential common shares. The dilutive impact, if any, of common stock equivalents outstanding during the period, including outstanding stock options, is measured by the treasury stock method. Potential common shares are not included in the computation of diluted earnings per share if they are antidilutive. The Company incurred net losses for the three months ended March 31, 2005 and 2004, and, accordingly, did not assume exercise of any of the Company’s outstanding stock options, because to do so would be antidilutive.

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS — (Continued)

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

      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 April 2005, the SEC announced that the effective date to implement SFAS 123R has been delayed for certain public companies. Accordingly, 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 January 1, 2006. Adoption of the expense provisions of SFAS 123R is 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.

      The Company records revenue from sales of pharmaceutical products (Keflex) and from the recognition of revenue earned under collaboration agreements.

      Product Sales. The Company’s largest customers are large wholesalers of pharmaceutical products. Three of these large wholesalers accounted for approximately 50.1%, 26.0%, and 14.8% of the Company’s net revenues from product sales in the three-month period ending March 31, 2005.

      Collaboration with Par Pharmaceutical for Amoxicillin PULSYS. In May 2004, the Company entered into an agreement with Par Pharmaceutical to collaborate in the further development and commercialization of a PULSYS-based amoxicillin product. The Company will conduct the development program, including the manufacture of clinical supplies and the conduct of clinical trials, and be responsible for obtaining regulatory approval for the product. The Company will own the product trademark and manufacture or arrange for supplies of the product for commercial sales. Par will be the sole distributor of the product. 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, the Company received an upfront fee of $5 million and a commitment from Par to fund all further development expenses. Development expenses incurred by the Company will be partially funded by quarterly payments aggregating $28 million over the period July 2004 through October 2005, of which up to $14 million is contingently refundable. Revenue related to the receipt of the quarterly payments is recognized based on actual costs incurred as the work is performed, limited to the minimum amounts expected to be received under the agreement and excluding amounts contingent on future events or that are contingently refundable,

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS — (Continued)

with the balance of cash received in excess of revenue recognized recorded as deferred revenue. The excess of the development costs incurred by the Company over the quarterly payments made by Par will be funded subsequent to commercialization, by the distribution to the Company of Par’s share of operating profits until the excess amount has been reimbursed. The Company does not record any amounts as revenue on a current basis which are dependent on achievement of future operating profits. The $5.0 million upfront payment is being amortized on a straight-line basis through May 2007, with $416,667 recognized as contract revenue for the three-month period ended March 31, 2005, and $3,611,110 recorded as deferred revenue as of March 31, 2005. Revenue recognized by the Company for reimbursement of development expenses was $3,210,114 for the three-month period ended March 31, 2005, with $6,925,577 recorded as deferred revenue as of March 31, 2005.

      Marketable securities, including accrued interest, at March 31, 2005 were as follows:

      Maturities of the Company’s marketable securities at March 31, 2005 are as follows:

      Accounts receivable, net, consists of the following:

      The Company’s largest customers are large wholesalers of pharmaceutical products. Three of these large wholesalers accounted for approximately 43.2%, 35.4%, and 15.0% of the Company’s accounts receivable for product sales as of March 31, 2005.

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS — (Continued)

      Property and equipment consists of the following:

      During the three-month period ended March 31, 2005 the Company expended approximately $782,000 to purchase primarily laboratory and manufacturing equipment.

      Intangible assets at March 31, 2005 and December 31, 2004 consist of the following:

      Identifiable intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. The Keflex brand rights are amortized over 10 years, the non-compete agreement with Eli Lilly and Company is amortized over 5 years, and certain acquired patents are amortized over 10 years.

      Amortization expense for acquired intangible assets with definite lives was $289,419 for the three-month period ended March 31, 2005 and $3,000 for the three-month period ended March 31, 2004, For the year ending December 31, 2005 and for the next five years, annual amortization expense for acquired intangible assets will be approximately $1.2 million per year.

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO FINANCIAL STATEMENTS — (Continued)

      Accrued expenses consist of the following:

      On January 24, January 28, and March 29, 2005 the Company granted stock options to purchase up to 957,850, 150,000, and 26,650 shares of common stock, respectively, to certain employees and scientific advisory board members. The exercise price of the options is the fair market price of the Company’s stock on the grant date.

      In December 2003, Aventis and Aventis Pharmaceuticals Inc. brought an action against the Company in the U.S. District Court for the District of Delaware. The Complaint contains six counts, based upon both federal and state law, alleging, in essence, that the Company has infringed on the plaintiffs’ trademark. The plaintiffs seek injunctive relief, as well as unspecified monetary damages. 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 the Company’s financial position, results of operations, or cash flows.

      In April 2005, the Company closed a private placement of common stock and warrants to purchase common stock, resulting in the receipt of $27.25 million in gross proceeds. The newly issued shares were priced at $3.98, the closing price of the Company’s common stock on April 25, 2005. Investors in the private placement also received five-year warrants to purchase approximately 2.4 million shares of common stock at an exercise price of $4.78 per share.

      Following the completion of the offering, the Company was advised by The Nasdaq Stock Market that the offering was completed at a price determined by Nasdaq to be less than market value. Nasdaq determined that the market value of the transaction was $4.03375 per share. As a result, Nasdaq determined that the offering required stockholder approval because it represented 20 percent or more of the Company’s total outstanding shares and included an affiliate of two directors of the Company.

      In response to this notice of deficiency by Nasdaq, the Company intends to seek stockholder approval for the offering. A special meeting of stockholders will be held as soon as practicable. The Company believes that stockholder approval is assured because the holders of a majority of the Company’s common stock have agreed to vote in favor of the transaction. Based on conversations with representatives of Nasdaq, the Company believes that the proposed stockholder approval will resolve the deficiency.

      The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and the related notes included elsewhere in this Form 10-Q and the financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2004 Annual Report on Form  10-K. This discussion contains forward-looking statements the accuracy of which involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, those discussed herein and in our 2004 Annual Report. See “Forward-looking Statements.”

      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 and Company.

      Our future operating results will depend largely on the magnitude of payments from our current and potential future collaborative partners and the progress of other product candidates currently in our research and development pipeline. The results of our operations will vary significantly from year to year and quarter to quarter and depend on, among other factors, the timing of our entry into new collaborations, the timing of the receipt of payments from collaborators and the cost and outcome of clinical trials.

      The following is a summary of key events that occurred in the first quarter of 2005.

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

      At the end of the second quarter of 2004, we acquired the Keflex brand of cephalexin from Eli Lilly and Company. 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, with Phase I/ II clinical trials expected in late 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.

      Summary of Product Development Initiatives. The following table summarizes our product development initiatives for the three-month periods ended March 31, 2005 and 2004.

      Amoxicillin PULSYS Phase III. We completed enrollment in our adolescent and adult Phase III trial on March 29, 2005, with 510 patients enrolled. Our adolescent and adult pivotal trial for a tablet form of

amoxicillin was designed as a 500-patient, double-blind, double-dummy, non-inferiority Phase III trial and was conducted at 64 investigator sites across the country. The study began enrollment on October 15, 2004.

      We announced that we had completed enrollment in our pediatric Amoxicillin PULSYS Phase III trial on April 25, 2005, with a total of 579 children enrolled. Our Phase III trial for Amoxicillin PULSYS in a “sprinkle” formulation for pediatric patients began enrollment on January 5, 2005. This trial was designed as a 500-patient investigator-blind, non-inferiority Phase III trial for a pulsatile form of amoxicillin and was conducted at 77 investigator sites across the country and included many of the key opinion leaders in the pediatric field.

      Our Phase III clinical program is designed to support product approvals for Amoxicillin PULSYS for the treatment of acute pharyngitis and/or tonsillitis due to Group A streptococcal infections. We expect to report top-line results from the adult trial in mid-June 2005, and to report top-line results from the pediatric trial in July 2005. If the trials are successful, we expect to file separate 505(b)(2) New Drug Applications with the FDA for each product by year-end 2005.

      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. We recorded amortization of deferred stock-based compensation related to employees of approximately $506,000 for the three-month period ended March 31, 2005.

      Non-employee Consultants. We recorded stock-based compensation expense of $12,000 during the three month period ended March 31, 2005, for options granted to non-employee consultants and scientific advisory board (SAB) members in accordance with Statement of Financial Accounting Standards No. 123 based on the fair value of the equity instruments issued. 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. 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 March 31, 2005, the balance of unamortized stock-based compensation for options granted to non-employees was approximately $90,000. This amount will be adjusted based on changes in the fair value of the options at the end of each reporting period.

      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 will conduct the development program, including the manufacture of clinical supplies and the conduct of clinical trials, and be responsible for obtaining regulatory approval for the product. We will own the product trademark and manufacture or arrange for supplies of the product for commercial sales. Par will be the sole distributor of the product. 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 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.

      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 mininum 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 December 2004, our amoxicillin collaboration with Par was revised to include the development of an amoxicillin/clavulanate PULSYS product for the treatment of otitis media.

      On June 30, 2004, we acquired the U.S. rights to the 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, market and sell Keflex in the United States and Puerto Rico. We also acquired Keflex trademarks, technology and new drug applications (NDAs) supporting the approval of Keflex. In addition, on June 30, 2004, we entered into a manufacturing supply agreement with Eli Lilly, under which Lilly has agreed to continue to manufacture and supply Keflex products for us for a transition period, unless we terminate the agreement at an earlier date. In December 2004, we entered into an agreement for the future supply of Keflex with Ceph International Corporation in Puerto Rico.

      In addition to assuming sales and marketing responsibilities for Keflex, we expect to begin clinical development of an enhanced cephalexin utilizing Advancis’ proprietary once-a-day pulsatile dosing technology called PULSYS. 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 15^th anniversary of the first commercial sale of the first defined new product.

Results of Operations

      Revenues. We recorded revenues of $4,627,000 and $313,000 during the three month periods ended March 31, 2005 and 2004, respectively, 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.

      Revenues recognized in 2004 for amortization of upfront licensing fees represent the amortization of a $5.0 million upfront payment received from GlaxoSmithKline (GSK) in 2003, of which the remainder was recognized in the fourth quarter of 2004 due to the termination of the collaboration agreement, and for 2005 represented 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 in 2005 of $3,210,000 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 during the quarter. Cost of product sales was $76,000 in 2005, compared to zero in 2004.

      Research and Development Expenses. Research and development expenses increased by $5.4 million, or 68%, to $13.2 million for the three months ended March 31, 2005 compared to $7.9 million for the three months ended March 31, 2004. Research and development expense consists 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 discloses the components of research and development expenses reflecting all of our project expenses.

      Direct costs increased $4.7 million as a result of an increase of $6.9 million relating to the development of our pulsatile amoxicillin product candidates, less decreases in generic clarithromycin of $1.5 million and other product candidates of $0.7 million.

      Contract research and development, consulting, materials and other direct costs increased $0.4 million in preparation for our amoxicillin clinical trials, and clinical trials expense increased $4.7 million as we reached a level of intensive effort in the amoxicillin Phase III trials.

      Indirect project costs also increased by $0.7 million, primarily due to an increase in facility-related costs of $0.4 million and equipment depreciation of $0.3 million, resulting from the opening of our new corporate, research and development facility and acquisition of product manufacturing equipment used to produce amoxicillin for clinical trials.

      Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $0.4 million, or 12%, to $2.8 million for the three months ended March 31, 2005 from $3.2 million for the three months ended March 31, 2004.

      Selling, general and administrative expenses consist of salaries and related costs for executive and other administrative personnel, selling and product distribution costs, professional fees and facility costs. Stock-based compensation costs decreased $0.4 million as the employee-based option expense recognized under APB Opinion 25 is recorded using an accelerated method of amortization. Legal and consulting costs decreased $0.3 million due primarily to a higher level of legal activity in 2004 in support of collaboration agreement negotiations. Other expenses increased $0.2 million, primarily due to amortization of the Keflex intangible assets of $0.3 million.

      Net Interest Income (Expense). Net interest income in the three months ended March 31, 2005 was $130,000 compared to net interest income of $190,000 in the three months ended March 31, 2004. Interest income was higher in 2004 as increased balances in cash, cash equivalents and marketable securities in 2004 generated substantially higher interest income than in 2005.

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 $18.75 million from GlaxoSmithKline and Par Pharmaceutical, respectively, as a result of collaboration agreements for the development of new products, as well as cash of $3.3 million from net product sales of existing Keflex brand antibiotics. Also, we completed a private placement of common stock for gross proceeds of $27.25 million in April 2005.

      At March 31, 2005 cash, cash equivalents and marketable securities were $22.3 million compared to $30.1 million at December 31, 2004.

      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. Our investment policy requires the selection of high-quality issuers, with bond ratings of AAA to A1+/ P1. Our objective is to limit the investment portfolio to a maximum average duration of approximately one year, with no individual investment exceeding a two-year duration. At March 31, 2005 no security was held with a maturity greater than 1 year from that date.

      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 the three-month periods ending March 31, 2005 and 2004.

      Net cash used in operating activities in the three-month period ending March 31, 2005 was $6.6 million, primarily due to the net loss of $11.4 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 $4.8 million for the following reasons:

      Net cash used in operating activities in the three-month period ending March 31, 2004 was $5.5 million, primarily due to the net loss of $10.6 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 $5.1 million for the following reasons:

      Net cash provided by investing activities during the three-month period ending March 31, 2005 was $2.2 million. The most significant investing activities included the maturity of $3.0 million of marketable securities and the purchase of property and equipment for $0.8 million.

      Net cash used in investing activities during the three-month period ending March 31, 2004 was $16.9 million. $3.0 million was used for the purchase of equipment for the Company’s research and development operations, and $13.9 million was invested in marketable securities.

      Net cash used in financing activities for the three-month period ending March 31, 2005 was $0.3 million. The major financing activity was repayment of $0.3 million on the Company’s existing borrowings.

      Net cash provided by financing activities for the three-month period ending March 31, 2004 was $0.6 million. The major financing activities included proceeds from lines of credit of $0.8 million and repayments on lines of credit of $0.2 million.

      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, $2.3 million was outstanding as of March 31, 2005, as summarized in the following table:

      We do not currently hedge fixed or variable rate borrowings.

      In April 2005, the Company closed a private placement of common stock and warrants to purchase common stock, resulting in the receipt of $27.25 million in gross proceeds. The newly issued shares were priced at $3.98, the closing price of the Company’s common stock on April 25, 2005. Investors in the private placement also received five-year warrants to purchase approximately 2.4 million shares of common stock at an exercise price of $4.78 per share.

      Following the completion of the offering, the Company was advised by The Nasdaq Stock Market that the offering was completed at a price determined by Nasdaq to be less than market value. Nasdaq determined that the market value of the transaction was $4.03375 per share. As a result, Nasdaq determined that the offering required stockholder approval because it represented 20 percent or more of the Company’s total outstanding shares and included an affiliate of two directors of the Company.

      In response to this notice of deficiency by Nasdaq, the Company intends to seek stockholder approval for the offering. A special meeting of stockholders will be held as soon as practicable. The Company believes that stockholder approval is assured because the holders of a majority of the Company’s common stock have agreed to vote in favor of the transaction. Based on conversations with representatives of Nasdaq, the Company believes that the proposed stockholder approval will resolve the deficiency.

      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.

      In April 2005, we entered into agreements under which Clonmel Healthcare, Limited will provide us with a commercial supply of Amoxicillin PULSYS products which are currently being evaluated in Phase III clinical trials. Under the agreements, we will fund expansion of Clonmel’s facility and certain equipment additions to support the commercial manufacturing program. The facility expansion is currently being designed, and the total estimated cost is not yet determined. The build-out agreement may be terminated by us with 30 days’ notice, in which case we would be liable to Clonmel for their actual incurred costs to date, which were immaterial as of March 31, 2005.

      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 infrastructure to our organization. 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 current or anticipated 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 anticipate that our existing cash, cash equivalents and marketable securities, together with anticipated funds under our existing amoxicillin collaboration with Par and from our Keflex product sales, will be sufficient to fund our planned operating expenses, debt repayments and capital equipment requirements well into 2006. Assuming positive Phase III trial results and FDA approval of the Company’s Amoxicillin PULSYS products, we may consider raising additional capital on favorable terms later in 2005 or 2006 to support the expected late-2006 commercial launch of Amoxicillin PULSYS products and the further development of additional PULSYS product candidates. Alternatively, if such additional funds are not obtained, we intend to reduce our rates of expenditure and capital investment, which may delay the development or commercialization of products in our development pipeline.

      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, effect changes to our facilities or personnel, or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain product candidates that we might otherwise seek to develop or commercialize independently. Any future funding may dilute the ownership of our equity investors.

Recent Accounting Pronouncements

      In December 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 APB Opinion 25’s intrinsic value method of accounting for share-based payments. In April 2005, the SEC announced that the effective date to implement SFAS 123R has been delayed for certain public companies. Accordingly, 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 January 1, 2006. 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.

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. We record chargebacks and rebates 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. Although we have a limited history of selling Keflex products, we are also able to utilize in our analysis historical data for chargebacks and rebates obtained from the seller as part of our due diligence prior to acquiring the brand. 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 believe that we have sufficient data to estimate future returns at the time of sale. Although we have a limited history of selling Keflex products, we are also able to utilize in our analysis historical data for product returns obtained from the seller as part of our due diligence prior to acquiring the brand, and our return policy is generally the same as the seller’s. 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 returns 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 annual 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 three-month periods ended March 31, 2005 or 2004. 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 March 31, 2005.

Forward-looking Statements

      This report contains forward-looking statements. These statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. In some cases, forward-looking statements may be identified by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other comparable terminology. You should not place undue reliance on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect actual results, levels of activity, performance or achievements. Factors that may cause actual results to differ materially from current expectations include, but are not limited to:

      All written and oral forward-looking statements made in connection with this Quarterly Report on Form 10-Q which are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the “Risk Factors” and other cautionary statements included in our 2004 Annual Report on Form 10-K. We disclaim any obligation to update information contained in any forward-looking statement.

      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.

      Our management, including our principal executive and principal financial officers, has evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2005. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this Quarterly Report on Form 10-Q has been appropriately recorded, processed, summarized and reported. Based

on that evaluation, our principal executive and principal financial officers have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

      Our management, including our principal executive and principal financial officers, has evaluated any changes in our internal control over financial reporting that occurred during the quarterly period ended March 31, 2005, and has concluded that there was no change that occurred during the quarterly period ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

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

      In December 2003, Aventis and Aventis Pharmaceuticals Inc. brought an action against the Company in the U.S. District Court for the District of Delaware. The Complaint contains six counts, based upon both federal and state law, alleging, in essence, that the Company has infringed on the plaintiffs’ trademark. The plaintiffs seek injunctive relief, as well as unspecified monetary damages. 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 the Company’s financial position, results of operations, or cash flows.

      From October 15, 2003, the effective date of our Registration Statement on Form S-1 (File No. 333-107599) to March 31, 2005, we have used the entire $54.3 million of the net offering proceeds from our initial public offering, as follows:

      None

      None

      None

SIGNATURES

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

Dated: May 11, 2005

EXHIBIT INDEX