COLLAGENEX PHARMACEUTICALS INC - 10-K Annual 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 twelve (12) months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days.

CollaGenex Pharmaceuticals, Inc. and subsidiaries is a specialty pharmaceutical company currently focused on developing and marketing innovative proprietary medical therapies to the dental and dermatology markets. We currently market four pharmaceutical products to the dental market through our professional dental sales force, and we market one prescription product to the dermatology market through our professional dermatology sales force.

Our first product, Periostat®, is an orally administered, prescription pharmaceutical product that was approved by the United States Food and Drug Administration (the “FDA”) in September 1998 and is the first and only dental pharmaceutical to treat adult periodontitis. Periostat works by inhibiting the enzymes that destroy periodontal support tissues and by enhancing bone protein synthesis. Periostat is indicated as an adjunct to scaling and root planing, or SRP, the most prevalent therapy for adult periodontitis, to reduce pocket depth and to promote attachment level gain in patients with adult periodontitis. Adult periodontitis, a chronic disease characterized by the progressive loss of attachment between the tooth root and the surrounding periodontal structures, can cause tooth loss if untreated.

Pursuant to an exclusive License and Marketing Agreement with Atrix Laboratories, Inc. (“Atrix,” the predecessor to QLT USA, Inc., who purchased the assets of Atrix in November 2004), we began, in October 2001, to actively market Atrix’s proprietary dental products, Atridox® and Atrisorb FreeFlow®, and, in February 2002, Atrisorb-D®, to the United States dental market. In May 2002, we executed a sublicense agreement with Altana Inc. to market and distribute Pandel®, a prescription mid-potency topical corticosteroid product developed by Altana Inc. to dermatologists in the United States and Puerto Rico.

We also sell a separately branded form of Periostat to United Research Laboratories/ Mutual Pharmaceutical Company, Inc. (“Mutual”) pursuant to a License and Supply Agreement we executed with Mutual in April 2004. This Agreement formed part of a settlement of outstanding litigation with Mutual relating to our patents for Periostat. In the settlement Mutual agreed and confessed to judgment that our Periostat patents are valid and infringed by Mutual’s Abbreviated New Drug Application (“ANDA”) for a generic form of Periostat. The License and Supply Agreement provides for us to sell a separately branded version of Periostat to Mutual at prices below our average sales price for Periostat.

Prior to the sale of our U.K. and European dental assets in November 2004 to Alliance Pharma plc (“Alliance”), a U.K. specialty pharmaceuticals company, Periostat was also sold through wholesalers and directly to dentists in the United Kingdom through our wholly-owned subsidiary, CollaGenex International, Ltd., and by distributors and licensees in certain other overseas markets.

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

In addition to our marketed products, we have a pipeline of products in clinical and pre-clinical development. These products are based on our two proprietary platform technologies, IMPACs^tm and Restoraderm^tm. The IMPACs (Inhibitors of Multiple Proteases and Cytokines) platform includes a series of novel, proprietary tetracycline-based compounds discovered during the development of Periostat. Research

has shown that certain unique properties of these tetracylines may be applicable to other diseases involving inflammation and/or destruction of the body’s connective tissues, including acne, rosacea (a dermatological condition sometimes referred to as acne rosacea), ocular rosacea, acute lung injury and cancer metastasis, among others. We are further evaluating various compounds to assess whether they are safe and effective in these applications.

Periostat is our first FDA-approved IMPACs product. Periostat-MR^tm is a once-a-day, modified-release formulation of Periostat currently in a Phase III clinical trial for the treatment of adult periodontitis. Oracea^tm, which has the same active ingredient and modified-release formulation as Periostat-MR, is in two Phase III clinical trials for the treatment of rosacea. Col-3, a second generation IMPACs compound, has completed Phase II trials for the treatment of HIV-related Kaposi’s sarcoma and is currently in Phase II clinical trials for the treatment of rosacea.

Our Restoraderm technology is a proprietary, foam-based, topical drug delivery technology that originated from a Swedish collaborator. We have acquired all right, title and interest to the Restoraderm technology and are committed to initiate the development of five products based on this technology before the end of 2005. We are currently developing Restoraderm products for the treatment of acne and psoriasis.

During 2004, we continued to implement our plans to expand into the dermatology market. We completed and announced the preliminary results of a double-blinded, placebo-controlled 134-patient Phase III clinical trial to evaluate the safety and efficacy of Periostat to treat rosacea. We also completed enrollment of two double-blinded, placebo-controlled Phase III clinical studies to evaluate the use of Oracea to treat rosacea. As noted above, we purchased the Restoraderm topical drug delivery technology and in addition, we continue to actively seek product licensing opportunities to enhance our near-term offerings to the dermatology market.

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

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, accordingly, file reports, proxy statements and other information with the Securities and Exchange Commission. Such reports, proxy statements and other information can be read and copied at the public reference facilities maintained by the Securities and Exchange Commission at the Public Reference Room, 450 Fifth Street, NW, Washington, D.C. 20549. Information regarding the operation the Public Reference Room may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a web site (http://www.sec.gov) that contains material regarding issuers that file electronically with the Securities and Exchange Commission.

Our Internet address is www.collagenex.com. We are not including the information contained on our web site as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge on our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

Adult periodontitis is a chronic disease characterized by the progressive loss of attachment between the periodontal ligament and the surrounding alveolar bone, as well as breakdown of the alveolar bone itself, ultimately resulting in tooth loss. According to industry data, an estimated one-third of all adults in the United States, or approximately 67 million people, suffer from some form of periodontal disease. Approximately 13 million people seek professional treatment annually for periodontal disease, resulting in over 15 million periodontal procedures and annual expenditures of approximately $6.0 billion, primarily for procedures and surgeries performed by a periodontist or a dental professional.

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

Periostat, a 20 mg dose of doxycycline hyclate, is a unique sub-anti-microbial dosage strength that suppresses the chronic and progressive tissue degradation characteristic of periodontitis, without exerting any anti-microbial effect. Doxycycline is an active ingredient of several FDA approved drugs and has been in use, at higher dosages, for approximately 35 years. At such higher doses, it is indicated for the treatment of microbial infections and, along with other tetracyclines, has a well established safety record. Periostat is intended to be taken orally by the patient between dental visits. Periostat’s primary mechanisms of action are believed to be through the down-regulation of the activity of collagenases, which belong to a broad class of enzymes known as matrix metalloproteinases. Collagenase is excessively produced as a result of the inflammation caused by bacterial infection in the gums. In addition to, and independent of regulating collagenases activity, doxycycline has also been shown to enhance bone protein synthesis, thereby helping to restore the damage caused by periodontitis.

In September 1998, the FDA granted United States marketing approval for Periostat as an adjunct to SRP to promote attachment level gain and reduce pocket depth in patients with adult periodontitis. Periostat was made available for prescription use in November 1998 and was fully launched commercially in January 1999. Since January 1999, nearly 4.0 million prescriptions for Periostat and Mutual’s branded version of Periostat have been filled and over 40,000 dentists have written a prescription for either Periostat or Mutual’s branded version of Periostat. Periostat tablets are manufactured for us by Pharmaceutical Manufacturing Research Services, Inc., a contract manufacturing company.

In April 2004, as part of a settlement of all outstanding litigation with Mutual relating to our patents for Periostat, we entered into a License and Supply Agreement with Mutual. The License and Supply Agreement provides for us to sell a separately branded version of Periostat to Mutual at prices below our average wholesale acquisition cost for Periostat. The Agreement runs through May 15, 2007, unless terminated earlier.

Prior to September 2004, we sold Periostat to wholesalers and directly to dentists in the United Kingdom, and our European partners marketed and distributed Periostat in Israel, Portugal, Austria and Switzerland. In November 2004, we sold all of our U.K. and European dental assets to Alliance, a U.K. specialty pharmaceuticals company, for gross proceeds of $3.3 million. These assets consisted primarily of certain trademark rights, marketing authorizations, customer lists and other intangible assets. Pursuant to a Supply Agreement we executed on November 3, 2004 with Alliance, we supply Periostat in bulk tablet form to Alliance at a negotiated fair value transfer price for sales in the U.K., Europe and Israel.

Pursuant to the terms of an exclusive License and Marketing Agreement that we executed with Atrix Laboratories, Inc. in August 2001 (now known as QLT USA, Inc.), we obtained the right to market, sell and distribute Atrix’s proprietary dental products, Atridox, Atrisorb FreeFlow and Atrisorb-D to the United States dental community. We believe that these products generally complement Periostat in the treatment of adult periodontitis.

Atridox is a locally-applied, anti-microbial therapy for the treatment of chronic adult periodontitis. Atridox uses Atrix’s patented drug delivery technology, Atrigel®, for the targeted delivery of doxycycline, which, in sufficient concentrations, has been shown to reduce the levels of bacteria in the periodontal pocket. Atridox is a gel that is placed into affected periodontal pockets by a dental professional and resorbs over a two week period. In pivotal double-blinded, placebo-controlled clinical trials conducted by Atrix, the administration of Atridox was shown to increase attachment level between the gums and the teeth and decrease periodontal pocket depth in patients with adult periodontitis.

cut away from the underlying bone structure to allow the periodontist to repair the periodontal support structure. When the flap is subsequently repositioned, a membrane barrier product such as Atrisorb FreeFlow is placed between the flap and the bone to prevent the downgrowth of epithelial tissues, which interferes with the re-attachment of the gums to the teeth.

Under the terms of our License and Marketing Agreement with Atrix, we are required to make certain annual minimum expenditures for advertising and promotional activities over the term of the agreement beginning January 1, 2003, including: (i) the lesser of $4.0 million or 30% of our contribution margin, as defined in the agreement, relating to a specific Atrix product that we market, and (ii) the lesser of $2.0 million or 30% of our contribution margin, as defined in the agreement, relating to a separate Atrix product that we market. These annual requirements were met by us in 2004. In 2003, we and Atrix agreed to share funding for training and maintaining a corps of dental hygienists who would serve as part-time, professional sales associates in the dental market, with a specific focus on the Atrix products. This 2003 arrangement terminated on December 31, 2004.

The License and Marketing Agreement terminates incrementally with respect to each Atrix product, upon each successive expiration date of the patent protection afforded to such product. We may terminate the License and Marketing Agreement at any time, with or without cause, upon twelve (12) months prior written notice to Atrix. Furthermore, either party may terminate the agreement upon the occurrence of certain conditions, as more fully set forth in the License and Marketing Agreement.

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

Pursuant to a Co-Promotion Agreement we executed with Merck & Co., Inc. in September 1999, we received the exclusive right to co-promote Vioxx®, a prescription strength non-steroidal anti-inflammatory drug, to the dental community. The agreement provided for certain payments by Merck to us upon sales of Vioxx. In September 2002, we executed an amendment, extension and restatement of the Co-Promotion Agreement which provided that the agreement would expire on December 31, 2003. We will continue to earn nominal residual contract revenues through December 2005 from this agreement. The Co-Promotion Agreement provides for indemnification of us by Merck against any claims arising from manufacturing or design defects in the Vioxx product or for which we, as the promoter of the product, may be strictly liable as if we were a seller of an inherently dangerous product. During the year ended December 31, 2004, we recorded $237,000 in residual contract revenues under this agreement.

In October 2002, we entered into a Product Detailing Agreement with Novartis Consumer Health, Inc. pursuant to which we co-promoted Denavir® to target dentists in the United States and received detailing fees and performance incentives from Novartis Consumer Health, Inc. The agreement with Novartis to co-promote Denavir expired on September 30, 2003, and we and Novartis decided not to renew the arrangement with respect to Denavir. We did not receive any revenue during the year ended December 31, 2004 and do not expect to receive any future contract revenues from Novartis with respect to Denavir.

In an effort to increase our sales focus on high-prescribing dentists and dermatologists while reducing our cost base, in 2004 we restructured our pharmaceutical sales organization into dedicated dental and dermatology sales forces. Prior to the reorganization, each representative was responsible for covering a territory that included approximately 100 dentists and periodontists believed to be potential high volume prescribers of Periostat and was also expected to call on approximately 50 dermatology offices with a high potential for prescribing Pandel. After the restructuring, we have a 56-person dental sales force calling on a highly targeted group of 10,000 high prescribing dentists and a 33-person dermatology sales force calling on the 5,600 dermatologists who comprise our target market.

We believe that our sales effort is distinguished from typical dental and dermatology promotion by our focus on education. We produce educational marketing materials, detail aids and product samples that are used extensively by our representatives in their presentations to dentists and in promoting Pandel to dermatologists. Reprints of peer reviewed research and journal articles that relate to our technologies are also provided, as well as video presentations. We believe that peer-to-peer communications are vital to increasing the acceptance of Periostat by dentists and increasing our own understanding of the dermatology market. Therefore, we arrange speaking engagements and teleconferences where clinical experts and practitioners share their experiences with other professionals.

Sales training is an important component of our sales and marketing efforts. New representatives receive four weeks of field training and two weeks of intensive office training in periodontal disease, host response, dermatology, territory management and selling skills. Training continues at district-level meetings throughout the year. In a complex regulatory environment, we also train sales personnel on compliance with the relevant rules and guidelines of the FDA and other government agencies.

In December 2000, the United Kingdom Medicines Control Agency approved a tablet formulation of Periostat, and in June 2001, we applied for the registration of Periostat tablets with the European Union Member States and Norway. In 2002 and 2003, we received approval for the marketing of Periostat in Austria, Finland, Switzerland, Ireland, Israel, Italy, Luxembourg, the Netherlands, Portugal and Canada. On November 3, 2004, CollaGenex International Limited (“CIL”), our wholly-owned U.K. subsidiary, sold its U.K. and European dental assets to Alliance, a U.K. specialty pharmaceuticals company, for net proceeds of $3.0 million pursuant to a Sale of Assets Agreement. This agreement provided for the sale by CIL to Alliance of trademark rights, U.K. and European governmental marketing authorizations, and distribution agreements and other intangible assets relating to the sale or potential sale of Periostat in the U.K., Europe, Israel, South Africa, New Zealand and Australia. The agreement also granted Alliance an option to acquire a license to register and market Periostat-MR in the same territories. We have retained all rights to Periostat-MR for all other clinical indications. We also entered into a Supply Agreement with Alliance pursuant to which we will supply Periostat in bulk tablet form to Alliance at a negotiated fair value transfer price.

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

In 1995, we entered into a supply agreement with Hovione International Limited pursuant to which the active ingredient in Periostat, doxycycline hyclate, is supplied to us by Hovione from its offshore facilities. Hovione supplies a substantial portion of the doxycycline used in the United States from two independent facilities, providing for a back-up supply in the event that one facility is unable to manufacture. The initial term of the supply agreement expired on January 25, 2000 and, pursuant to an addendum to that agreement, the term was extended to May 14, 2006 and thereafter automatically renews for successive two-year periods unless, 90 days prior to the expiration of any such periods, either party gives the other party written notice of termination. In addition, in the event of a default that remains uncured for 90 days, the non-defaulting party can terminate the supply agreement effective immediately at the end of such ninety-day period. We rely on Hovione as our sole supplier of doxycycline, and have no back-up supplier at this time.

In September 2000, we entered into a Service and Supply Agreement with a contract manufacturer, Pharmaceutical Manufacturing Research Services, Inc. (“PMRS”), for the tablet formulation of Periostat. PMRS manufactures the Periostat brand and Mutual’s branded version of Periostat. Our current arrangement with PMRS has been extended until the earlier of March 30, 2007 or until a generic 20 mg doxycycline hyclate tablet is available on the market. Currently, PMRS is the sole third-party contract manufacturer to supply a tablet formulation of Periostat to us. We intend to contract with additional manufacturers for the commercial manufacture of Periostat tablets. PMRS is required to comply with current good manufacturing practices, or cGMP, requirements.

In November 1998, we executed a Distribution Services Agreement with Cardinal Health Specialty Pharmaceutical Services, or SPS, pursuant to which SPS acts as our exclusive logistics provider for Periostat in the United States and Puerto Rico. Under this agreement, SPS warehouses and ships Periostat and Pandel from its central distribution facility in Laverne, Tennessee to wholesalers that distribute our products to pharmacies throughout the United States for prescription sale to patients. SPS also provides various customer and financial support services to us, including billing and collections, contract pricing maintenance, cash application, chargeback processing and related reporting services. The Distribution Services Agreement had an initial term of three years with automatic renewal for successive one-year periods unless notice of termination was provided by either party 90 days prior to expiration. We negotiated a three-year extension of such agreement having similar terms to the original agreement with an effective date of March 1, 2002.

In February 2002, we executed a Wholesale Service Agreement effective November 2001 with National Specialty Services, Inc., now known as Cardinal Health Specialty Pharmaceutical Distribution, or SPD, pursuant to which SPD acts as our non-exclusive authorized distributor of Atridox, Atrisorb FreeFlow and Atrisorb-D. Under this agreement, SPD will also provide certain additional services, including marketing, sales detail report production and contract administration. The Wholesale Service Agreement has an initial term of three years and shall renew automatically for successive one-year periods unless notice of termination is provided by either party 90 days prior to expiration.

Historically in the pharmaceutical industry, wholesalers have been speculative in their purchasing practices in anticipation of product price increases. To manage this process, we executed Inventory Management Agreements with our major wholesaler customers in 2003, which will expire in 2005. Under these agreements, the wholesalers provide us with weekly retail demand information and current stocking levels for our products; additionally they agree to manage the variability of their purchases within specified limits. In return we give the wholesalers the right to purchase a specific amount of inventory from us at the sales price in effect immediately prior to announced price increases. In recent months, our wholesaler customers, as well as others in the industry, have begun to modify their business models from arrangements where they derive profits from the management of various discounts and rebates, to arrangements where they charge a fee for their services. We have not yet reached agreement with our wholesaler customers concerning the terms of our future relationship.

Our research and development activities are conducted primarily by third parties including contract research organizations and academic and government institutions. The main focus of these activities is the identification and development of novel tetracycline-based compounds for application in a variety of inflammatory and tissue-destructive disorders.

Under normal physiological conditions, the natural breakdown of collagen is in part regulated by the interaction between the degradative properties of matrix metalloproteinases and a group of naturally occurring biomolecules called tissue inhibitors of metalloproteinases, which modulate the level of matrix metalloproteinase activity. In many pathological conditions, however, the balance between collagen production and degradation is disrupted resulting in excessive loss of tissue collagen, a process called collagenolysis. One such example is the progressive destruction of the periodontal ligament and alveolar bone in adult periodontitis. Similar degradative activity is associated with other disorders and conditions such as cancer metastasis, wounds, osteoarthritis, osteoporosis, rheumatoid arthritis and diabetic nephropathy.

Elements of our core technology are licensed on an exclusive basis from SUNY and results from the research of Drs. Lorne M. Golub and Thomas F. McNamara and their colleagues at SUNY. These researchers demonstrated that tetracyclines can significantly reduce the pathologically excessive collagen degradation associated with periodontitis. They also were able to demonstrate that this result was unrelated to the antibiotic properties of tetracyclines. Furthermore, they demonstrated that the administration of doses of antibiotic tetracyclines well below the dosage levels necessary to destroy microbes (sub-antimicrobial doses) was effective in preventing the loss of connective tissue in models of periodontitis. Studies published in scientific journals support the hypothesis that the mechanism of action for this activity is the result, in part, of the direct binding of tetracyclines to certain metal binding sites associated with the matrix metalloproteinase structure.

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

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

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

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

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

Overall clinical disease severity based on the Clinician’s Global Severity Assessment Scale declined significantly in the group of patients treated with Periostat compared to placebo, with a greater number of patients on Periostat showing a complete clearing of the disease at 16 weeks compared to those patients on placebo. The erythema in patients in the Periostat group showed a trend toward greater improvement compared to patients in the placebo group.

Based on the these clinical results, we initiated two Phase III clinical trials enrolling more than 550 patients to confirm the safety and efficacy of Oracea, our once-a-day formulation of doxycycline for the treatment of rosacea. Both studies are identical in design and conducted concurrently. In December 2004, we announced that we had completed enrollment for these two trials, which include a 16 week treatment period, and we expect the trials to be completed in the second quarter of 2005.

The development of a modified release formulation for Periostat-MR and Oracea is being conducted through an agreement with Shire Laboratories. During 2003, we announced that a suitable formulation had been developed, and Phase III clinical trials using the new formulation were initiated during 2004 for both Periostat-MR and Oracea. A patent covering the new formulation was filed with the United States Patent and Trademark Office (the “USPTO”) in 2003. We have incurred approximately $2.4 million in expenses developing a modified release formulation through December 31, 2004.

In February 2002, we announced that we had licensed a topical drug delivery technology named Restoraderm. In August 2004, we purchased all right, title and interest in this technology, pursuant to the terms of an Asset Purchase and Product Development Agreement (the “Purchase Agreement”). The Purchase Agreement superseded our Co-operation, Development and License Agreement executed in February 2002. Under the terms of the Purchase Agreement, the purchase price of the assets shall be up to $1.0 million, subject to the achievement of certain milestones. We are also required to pay certain product development milestone payments in the aggregate amount of up to approximately $2.0 million as well as royalty and sublicense fees upon product commercialization. As of December 31, 2004, approximately $283,000 of these fees had been paid by us. We paid an additional $150,000 in January 2005. We anticipate spending approximately $4.8 million in development expenses through commercialization of our first two prescription products to treat acne and psoriasis based on the Restoraderm technology.

Restoraderm is designed to enhance the dermal delivery of a variety of active ingredients and we intend to use it as the platform on which to develop a portfolio of topical dermatological pharmaceuticals. The Restoraderm technology incorporates certain lipid compositions to enhance the natural skin barrier and facilitate the delivery of therapeutic active ingredients into the skin. The Restoraderm technology is currently still under development, and we anticipate that the first products to be developed using the technology will be available towards the end of 2005.

Our IMPACs technology comprises a family of compounds which have shown the ability to inhibit inflammation as well as the activity of various enzymes in the inflammatory cascade that lead to tissue destruction. Periostat is our first FDA-approved IMPACs compound, and Periostat-MR and Oracea are currently in Phase III clinical trials to demonstrate their safety and efficacy in treating adult periodontitis and rosacea, respectively. A next generation compound, Col-3, has been in human clinical trials under the sponsorship of the National Cancer Institute, or NCI, for the treatment of various cancers, including HIV-related Kaposi’s sarcoma, and we intend during 2005 to evaluate Col-3 as a treatment for acne.

invasion is a complex process that involves the destruction of the basement membrane, or structural support tissue, of the lymphatic or circulatory system, and the migration of tumor cells to secondary sites, followed by proliferation of these cells. Data from pre-clinical studies sponsored by us at two major universities suggest that several of our IMPACS drug candidates have potent activity in models of cancer invasion.

In 2001, at its cost, the NCI initiated an open-label, two-dose study to determine clinical efficacy of Metastat®, our lead compound for the treatment of metastatic cancer, in patients with HIV-related Kaposi’s sarcoma. This multi-center, Phase 2 study enrolled 75 patients with HIV-related Kaposi’s sarcoma by March 2003. Patients received one of two different doses of Metastat, in some cases for more than two years. The NCI conducted an interim analysis that was published in April 2004. The data suggests that some patients obtained significant relief (both partial responses and complete responses) of their tumor burden, which was maintained on average for more than 12 months. The study is still ongoing and awaiting final analysis.

We have not developed forecasts for the sale of products arising from the commercialization of Metastat in Kaposi’s sarcoma, nor do we anticipate spending significant resources on the development of Metastat until it is clear from the currently conducted studies that the drug has a tolerable safety profile and a high likelihood of clinical and commercial success.

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

Our success will depend in part on patent and trade secret protection for our technologies, products and processes, and on our ability to operate without infringement of proprietary rights of other parties both in the United States and in foreign countries. Because of the substantial length of time and expense associated with bringing new products through development to the marketplace, the pharmaceutical industry places considerable importance on obtaining and maintaining patent and trade secret protection for new technologies, products and processes.

We depend on our license from SUNY for all of our IMPACs technology. The SUNY License grants us an exclusive worldwide license to make and sell products employing tetracyclines that are designed or utilized to alter a biological process. In consideration of the license granted to us, we: (i) issued to SUNY 78,948 shares of our common stock in 1992; and (ii) have agreed to pay SUNY royalties on the net sales of products employing tetracyclines, with minimum annual royalty payments of $50,000 per year. The term of the license is: (i) until the expiration of the last to expire of the licensed patents in each country; or (ii) until November 18, 2018, at which time we have a fully paid, non-exclusive license. Our rights under the SUNY License are subject to certain statutory rights of the United States government resulting from federal support of research activities at SUNY.

Thirty one United States patents and United States patent applications held by SUNY are licensed to us under the SUNY License. SUNY also has obtained patents in certain European countries, Canada and Japan, and has pending patent applications in certain other foreign countries which correspond to its United States patents relating to methods of use of tetracyclines. Eighty-seven patents have been issued in foreign countries. All of SUNY’s United States and foreign patents expire between 2004 and 2019.

On June 10, 2002, we executed a Development and Licensing Agreement with Shire Laboratories, Inc. pursuant to which we were granted an exclusive worldwide license (including the right to sublicense) to use Shire technology and patents to develop prescription products for the treatment of various inflammatory disorders. Under the agreement, certain product development functions will be performed for us by Shire. We have committed to pay Shire milestone payments in cash or, at our option, in a combination of cash and our common stock, upon the achievement of certain clinical and regulatory milestones. These payments could total up to $5.2 million in the aggregate. Under the agreement we must also pay Shire a percentage of net sales of any products utilizing any part of the licensed technology. We may terminate the agreement upon sixty days notice.

Previously, we successfully settled various patent related litigation with West-ward Pharmaceutical Corporation (“West-ward”) in 2003. West-ward, a generic pharmaceutical company, had filed an ANDA for a generic version of Periostat. We sued West-ward and other defendants in the United States District Court for the Eastern District of New York, alleging that West-ward infringed our patents for Periostat for the treatment of adult periodontitis by submitting an ANDA with the FDA, seeking FDA approval to market a generic capsule version of Periostat. In the settlement, West-ward agreed and confessed to judgment that our Periostat patents are valid and were infringed by the filing of West-ward’s ANDA. We agreed to pay a portion of West-ward’s actual legal expenses in the amount of $700,000.

In a similar case, we settled all pending litigation with Mutual on April 8, 2004. Mutual, another generic pharmaceutical company, had filed an ANDA for a generic version of Periostat. We sued Mutual in the United States District Court for the Eastern District of New York, claiming that Mutual infringed the claims of our Periostat patents. In the settlement, Mutual agreed and confessed to judgment that our Periostat patents are valid and were infringed by the filing of Mutual’s ANDA. We agreed to pay Mutual a portion of our anticipated savings in legal expenses in the amount of $2.0 million. In connection with the settlement, we entered into a License and Supply Agreement pursuant to which Mutual received a license to sell a branded version of Periostat. We are the sole supplier of this product to Mutual, subject to certain conditions. The product will be sold to Mutual at prices below our average manufacturer’s price for Periostat through May 15, 2007 or the earlier termination of such supply arrangements. Early termination may occur under certain circumstances, including the successful entry of a third party generic competitor to Periostat. If at any time a generic version of Periostat becomes available on the market at a price lower than the selling price of Mutual’s branded version of Periostat, the value of the branded product then in Mutual’s or its customers’ inventory will decrease. Under our License and Supply Agreement with Mutual, if the generic product remains on the market for a specific period of time, we will have to provide retroactive credit to Mutual to offset such devaluations in Mutual’s or its customers’ inventory.

We vigorously enforce our patent rights against any and all third-party infringers. This strategy remains unchanged, although the decision in January 2005 of the United States District Court for the District of Columbia affects the legal framework and the process we must follow. That decision upheld the FDA’s classification of Periostat as an antibiotic drug which is not entitled to the protection otherwise available to non-antibiotic drugs under the Hatch Waxman amendments to the Food, Drug, and Cosmetic Act. According to the reasoning in that decision, our future sub-antimicrobial doxycycline compounds, such as Oracea, would also be considered antibiotic drugs. As a consequence, unless we prevail in the appeal of that decision, we will not receive automatic notice of drug approval applications made by competitors for generic versions of Periostat or of our future doxycycline compounds such as Oracea, and we will not be entitled to an automatic

As another part of our strategy to maintain enforceability and strengthen our Periostat patents, in 2003, we filed requests for reexamination of the Periostat patents in the office of the USPTO. The reexaminations were filed in view of additional prior art raised by West-ward and Mutual while defending against our patent infringement charges. In connection with the reexamination process, the patent examiner initially rejected the claims of the Periostat patents. However, following further interviews with the USPTO, we have been notified that the USPTO intends to issue a Reexamination Certificate confirming the patentability of certain amended claims of the RE 34,656 patent that we believe cover the use of Periostat. Although the reexamination procedure has upheld the validity of the RE 34,656 patent, we can give no assurances that the validity of our patents will be upheld in the litigation against IVAX and CorePharma or that the court will agree that generic 20 mg tablets of doxycycline hyclate sold by IVAX and CorePharma would infringe the RE 34,656 patent.

Our success also depends on our know-how, trade secrets, and the skills, knowledge and experience of our scientific and technical personnel. We try to protect these assets by requiring all employees to enter into confidentiality agreements that prohibit the disclosure of confidential information to anyone outside CollaGenex. We also seek such agreements from our consultants, advisors and research collaborators. There can be no assurance that adequate protection will be provided for our trade secrets, know-how or other proprietary information in the event of any unauthorized use or disclosure.

Government authorities regulate research, development, testing, manufacture, labeling, promotion, advertising, distribution, and marketing of the products we develop and market. In the United States, the FDA regulates Atridox, Pandel, Periostat and our products in development as drugs under the Federal Food, Drug, and Cosmetic Act and implementing regulations. The FDA regulates Atrisorb FreeFlow and Atrisorb-D as medical devices under the Food, Drug, and Cosmetic Act and implementing regulations. Failure to comply with FDA requirements may subject us to administrative or judicial sanctions, such as the FDA’s refusal to approve pending applications or warning letters, product recalls, product seizures, total or partial suspension of production or distribution, withdrawal of approvals, import detentions, injunctions, and/or criminal prosecution.

Pre-clinical tests include laboratory evaluations of product chemistry, toxicity, and formulation, as well as animal studies. The results of the pre-clinical tests, together with manufacturing information, analytical data, and a plan for studying the product in humans, are submitted to the FDA as part of an investigational new drug exemption, which must become effective before human clinical trials may begin. An investigational new

drug exemption automatically becomes effective 30 days after receipt by the FDA, unless before that time the FDA raises concerns or questions about issues such as the conduct of the trials outlined in the investigational new drug exemption. In that case, the investigational new drug exemption is placed on clinical hold and the sponsor and the FDA must resolve any outstanding FDA concerns or questions before clinical trials can proceed. Submission of an investigational new drug exemption does not always result in the FDA allowing clinical trials to commence.

Clinical trials involve administration of the investigational drug to human subjects under the supervision of qualified investigators and are conducted under protocols detailing the objectives of the study, the parameters to be used in monitoring safety, and the effectiveness criteria to be evaluated. Each protocol must be submitted to the FDA as part of the investigational new drug exemption process, and must be reviewed and approved by an independent Institutional Review Board before it can begin.

Clinical trials typically are conducted in three sequential phases, but the phases may overlap or be combined. Phase I usually involves the initial introduction of the investigational drug into people to evaluate its safety, dosage tolerance, phamacodynamics, and, if possible, to gain an early indication of its effectiveness. Phase II usually involves trials in a limited patient population to evaluate dosage tolerance and appropriate dosage, identify possible adverse effects and safety risks and evaluate preliminarily the efficacy of the drug for specific indications. Phase III trials usually further evaluate clinical efficacy and test further for safety by using the drug in its final form in an expanded patient population.

Assuming successful completion of the required clinical testing, the results of the preclinical studies and of the clinical studies, together with other detailed information, including information on the manufacture and composition of the drug, are submitted to the FDA in the form of a new drug application requesting approval to market the product for one or more indications. Before approving an application, the FDA usually will inspect the facility or the facilities at which the drug is manufactured, and will not approve the product unless compliance with cGMP is satisfactory. If the FDA determines the application and the manufacturing facilities are acceptable, the FDA will issue an approval letter. If the FDA determines the application or manufacturing facilities are not acceptable, the FDA will outline the deficiencies in the submission and often will request additional testing or information. Notwithstanding the submission of any requested additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval.

The FDA approved our NDA for Periostat in 1998. Atrisorb and Pandel have also received FDA approval. However, we cannot be sure that any additional approvals will be granted on a timely basis, if at all. After approval, certain changes to the approved product, such as adding new indications, manufacturing changes, or additional labeling claims are subject to further FDA review and approval. For example, before we can market Periostat for additional indications now being evaluated, we will be required to obtain an additional FDA approval.

In some circumstances, approved drugs are provided protection from generic versions of the approved drug for specified time periods. For example, the law provides for patent protection or market exclusivity in certain circumstances. The FDA has not provided such protection to Periostat, and the recent decision of the United States District Court for the District of Columbia upheld the FDA’s actions.

Like drugs, medical devices also require FDA authorization before they can be marketed in the United States. Atrisorb FreeFlow and Atrisorb-D have received clearance for marketing. Modifications to those products, however, could require additional approval or clearance. Approved and cleared drugs and medical devices remain subject to comprehensive regulation by the FDA while they are being marketed. For example, marketers and manufacturers of approved and cleared drugs and medical devices are required to report certain adverse reactions and production problems, if any, to the FDA, and to comply with requirements concerning advertising and promotional labeling for their products. The FDA does not permit marketing or promotion of an approved or cleared drug product or medical device for an unapproved or uncleared use. Also, quality

control and manufacturing procedures must continue to conform to the FDA’s requirements for cGMP (for drugs) or Quality Systems Regulation (for medical devices) after approval. Accordingly, we, our manufacturers, and our suppliers must continue to expend time, money, and effort in the area of production and quality control to maintain compliance with these and other aspects of regulatory compliance. The FDA periodically inspects manufacturers to assess compliance with manufacturing and other requirements. We buy bulk active ingredient for Periostat, Mutual’s branded version of Periostat and our products in development from third party suppliers and finish the products in third party manufacturing facilities. The other products we market, Atridox, Atrisorb FreeFlow, Atrisorb-D and Pandel are provided by suppliers.

In addition to the applicable FDA requirements, we are subject to foreign regulatory authorities governing clinical trials and drug sales. Whether or not FDA approval has been obtained, approval of a pharmaceutical product by the comparable regulatory authorities of foreign countries must be obtained prior to the commencement of marketing of the product in those countries. The approval process varies from country to country and the time required may be longer or shorter than that required for FDA approval.

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


(Mark One)
þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended December 31, 2004

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to


Delaware		52-1758016
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
41 University Drive, Newtown, Pennsylvania (Address of Principal Executive Offices)		18940 (Zip Code)


Class		Number of Shares

Common Stock, $0.01 par value		14,410,677


Item			Page

PART I
	1.	Business		1
	2.	Properties		26
	3.	Legal Proceedings		26
	4.	Submission of Matters to a Vote of Security Holders		27
PART II
	5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		27
	6.	Selected Consolidated Financial Data		28
	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
	7A.	Quantitative and Qualitative Disclosures about Market Risk		43
	8.	Financial Statements and Supplementary Data		43
	9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		43
	9A.	Controls and Procedures		43
	9B.	Other Information		45
PART III
	10.	Directors and Executive Officers of the Registrant		46
	11.	Executive Compensation		46
	12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		46
	13.	Certain Relationships and Related Transactions		46
	14.	Principal Accountant Fees and Services		46
PART IV
	15.	Exhibits and Financial Statement Schedules		46
SIGNATURES				47
EXHIBIT INDEX				48
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE				F-1
NONSTATUTORY STOCK OPTION AGREEMENT
SALE OF ASSETS AGREEMENT
NON-EMPLOYEE DIRECTOR COMPENSATION SUMMARY
EXECUTIVE OFFICER COMPENSATION SUMMARY
LIST OF SUBSIDIARIES OF THE REGISTRANT
CONSENT OF KPMG LLP
CERTIFICATION PURSUANT TO SECTION 302
CERTIFICATION PURSUANT TO SECTION 302
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350


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

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

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

	•	submission to the FDA of an NDA for approval;

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

	•	FDA review and approval of the NDA.

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Title of Each Class		Name of Each Exchange on Which Registered

None


Products	Territory Where Marketed		Marketing Partner

Periostat		United States and Puerto Rico		Not applicable
Periostat		Canada		Pharmascience, Inc.
Atridox		United States and Puerto Rico		Atrix Laboratories, Inc./QLT USA, Inc.
Atrisorb FreeFlow		United States and Puerto Rico		Atrix Laboratories, Inc./QLT USA, Inc.
Atrisorb-D		United States and Puerto Rico		Atrix Laboratories, Inc./QLT USA, Inc.
Pandel		United States and Puerto Rico		Altana, Inc.


Item 1.	*Business.*


	*Our Current Marketed Products*


	Periostat


	Pandel