NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2004 and 2003

(dollars in thousands, except per share data)

(Unaudited)

Note 1 — Basis of Presentation

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

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

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

In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements have been prepared on a basis substantially consistent with the audited consolidated financial statements for the year ended December 31, 2003 and contain adjustments, all of which are of a normal recurring nature, necessary to present fairly the Company’s consolidated financial position at June 30, 2004, the results of operations for the three and six months ended June 30, 2004 and 2003, and the cash flows for the six months ended June 30, 2004 and 2003. Interim results are not necessarily indicative of results anticipated for the full fiscal year.

Statement of Financial Accounting Standards (SFAS) No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” encourages but does not require companies to record compensation cost for stock-based employee and director compensation plans at fair value. Accordingly, the Company has elected to account for stock-based compensation under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and compensation cost for stock options issued to employees and directors is measured as the excess, if any, of the market price of the Company’s stock at the date both the number of shares and price per share are known (measurement date) over the exercise price. Such amounts are amortized on a straight-line basis over the respective vesting periods of the option grants. Transactions with nonemployees (if any) in which goods or services are the consideration received for the issuance of equity instruments are accounted for on a fair value basis in accordance with SFAS 123 and related interpretations.

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As set forth below, the pro forma disclosures of net income (loss) allocable to common stockholders and income (loss) per share allocable to common stockholders are as if the Company had adopted the fair value based method of accounting in accordance with SFAS No. 123, as amended by SFAS No. 148, which assumes the fair value based method of accounting had been adopted:

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Note 3 — Line of Credit

On June 7, 2004, the Company entered into a Loan Modification Agreement with Silicon Valley Bank to renew its revolving credit facility, as modified by such agreement, which had expired on March 15, 2004. The credit facility expires on May 31, 2006. Pursuant to the terms of the credit facility, the Company may borrow up to the lesser of $5,000 or 80% of eligible accounts receivable, as defined under the credit facility. The amount available to the Company is reduced by any outstanding letters of credit which may be issued under the credit facility in amounts totaling up to $2,000. As the Company pays down amounts under any letter of credit, the amount available to it under the credit facility increases. As of June 30, 2004, the Company had an outstanding letter of credit approximating $544 that served as collateral for certain inventory purchase commitments of the Company. The Company is not obligated to draw amounts and any borrowings shall bear interest, payable monthly, at the current prime rate. Without the consent of Silicon Valley Bank, the Company, among other things, shall not: (i) merge or consolidate with another entity; (ii) acquire assets outside the ordinary course of business; or (iii) pay or declare any cash dividends on the Company’s common stock. The Company must maintain a minimum tangible net worth, as defined, of at least $28,000, subject to certain upward adjustments, as a result of profitable operations or additional debt or equity financings. In addition, the Company must maintain a quick ratio of at least 2 to 1. In addition, the Company has secured its obligations under the credit facility through the granting of a security interest in favor of the bank with respect to all of the Company’s assets. As of June 30, 2004, the Company had no borrowings outstanding against the credit facility.

Note 4 — Commitments and Contingencies

On August 24, 2001, the Company signed an exclusive License Agreement (the “Atrix License Agreement”) with Atrix Laboratories, Inc. to market Atrix’s proprietary dental products, Atridox ^® , Atrisorb ^® FreeFlow and Atrisorb ^® -D, to the United States dental market. Pursuant to the terms of the Atrix License Agreement, the Company is required to make certain annual minimum expenditures for the lesser of $4,000 or 30% of the Company’s contribution margin, as defined in the agreement, relating to a specific Atrix product that the Company markets and the lesser of $2,000 or 30% of the Company’s contribution margin, as defined in the agreement, relating to another Atrix product that the Company markets. The Company spent $863 during the year ended December 31, 2003 which, in the aggregate, exceeded the spending requirements for each of the provisions in the Agreement. During the six month periods ending June 30, 2004 and June 30, 2003, the Company spent in the aggregate $480 and $468, respectively, related to each provision in the Agreement.

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On February 11, 2002, the Company executed a Co-operation, Development and Licensing Agreement pursuant to which the Company was granted an exclusive, sublicenseable, transferable license with respect to the Restoraderm ^™ topical drug delivery system which the Company intends to develop for dermatological applications. Pursuant to the terms of such agreement, upon the occurrence of certain events, the Company will be required to pay certain future consulting, royalty and milestone payments in the aggregate amount of up to approximately $3,150. The Company paid $76 under this Agreement during the six months ended June 30, 2004 and has paid an aggregate of $1,006 through June 30, 2004. The term of such agreement is for the life of any patent that may be issued to the Company for the first product the Company develops utilizing such technology, or, if such a patent fails to issue, seven years.

As of June 30, 2004, the Company has an obligation to purchase $544 of inventory from the Company’s third-party manufacturer of Periostat over the next twelve months.

On June 10, 2002, the Company executed a Development and Licensing Agreement with Shire Laboratories, Inc. pursuant to which the Company was granted an exclusive worldwide license (including the right to sublicense) to develop, make, have made, use, supply, export, import, register and sell products for the treatment of various inflammatory disorders using Shire’s technology. In addition, under the agreement, certain product development functions shall be performed for the Company. Also under the agreement, the Company is committed to payments of up to $5,200 in the aggregate for the indications for which it currently seeks approval. The payments may be made in cash or at the Company’s option, a combination of cash and the Company’s common stock, upon the achievement of certain clinical and regulatory milestones. Pursuant to the terms of such agreement, the Company shall also pay a percentage of certain net sales of products, if any, utilizing any part of the technology. The Company may terminate the agreement upon sixty days notice.

Note 5 — Stock Compensation Charge

During March 2003, the Company executed an agreement with Brian M. Gallagher, Ph.D., the Company’s former chairman, chief executive officer and president, pursuant to which Dr. Gallagher was compensated for, among other things, his services during a transition period and to recognize his historical contributions to the Company. As a result of this agreement, the Company recognized a non-cash compensation charge relating to certain modifications of Dr. Gallagher’s stock option agreements of approximately $251 during the six months ended June 30, 2003. The Company also entered into a consulting agreement with Dr. Gallagher pursuant to which he is providing consulting services to the Company for a period of 24 months, commencing in December 2003.

Note 6 — Termination of Co-Promotion/License Agreements

On March 14, 2003, the Company terminated its license agreement with Roche S.P.A. As a result of the termination of the agreement, during the first quarter of 2003, the Company accelerated the recognition of $222 of unamortized deferred revenue related to the $400 up-front payment received in 1996.

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Pursuant to a Co-Promotion Agreement the Company executed with Merck & Co., Inc. in September 1999, the Company received the exclusive right to co-promote Vioxx ^® , a prescription strength non-steroidal anti-inflammatory drug that was approved by the United States Food and Drug Administration (the “FDA”) on May 20, 1999. The agreement provided for certain payments by Merck to the Company upon sales of Vioxx to the dental community. On September 23, 2002, the Company executed an amendment, extension and restatement of the Co-Promotion Agreement with Merck with respect to Vioxx. In accordance with that amendment, extension and restatement, the Company’s agreement with Merck automatically expired on December 31, 2003. The Company will continue to earn nominal residual contract revenues through 2005 from the expired agreement with Merck. During the three and six months ended June 30, 2004, the Company recorded $60 and $120, respectively, in residual contract revenues.

In March 2003, the Company executed co-promotion agreements with Sirius Laboratories, Inc. pursuant to which the Company jointly marketed Sirius Laboratories’ AVAR ^™ product line and Pandel ^® to dermatologists in the United States. These agreements were mutually terminated on December 31, 2003. The Company has not received any revenue during the six months ended June 30, 2004 and does not expect to receive contract revenues from Sirius Laboratories’ AVAR thereafter.

On October 1, 2002, the Company entered into a Product Detailing Agreement with Novartis Consumer Health, Inc. pursuant to which the Company co-promoted Denavir ^® 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 the Company and Novartis decided not to renew the arrangement with respect to Denavir. The Company has not received any revenue during the six months ended June 30, 2004 and does not expect to receive contract revenues from Novartis with respect to Denavir thereafter.

Note 7 — Mutual Settlement

In July 2003, the Company sued United Research Laboratories, Inc./Mutual Pharmaceutical Company, Inc. (“Mutual”) in the United States District Court for the Eastern District of New York, alleging that Mutual’s announced launch of a generic version of Periostat ^® would infringe the Company’s patents directed to the use of Periostat for the treatment of adult periodontitis. The Company’s complaint also alleged that Mutual infringed the Company’s patent rights by its offering to sell its generic drug and by submitting an Abbreviated New Drug Application (“ANDA”) with the FDA, seeking FDA approval to market a generic tablet version of Periostat. The Company’s compliant also alleged that Mutual’s offer to sell its generic version of Periostat prior to receiving FDA approval constituted unfair competition under Section 43(a) of the Lanham (Trademark) Act.

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

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

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

In connection with the settlement, the Company and Mutual entered into a License and Supply Agreement pursuant to which Mutual received a license to sell a branded version of Periostat. Under this agreement, the Company will be the sole supplier of this product to Mutual, subject to certain conditions. The product will be sold to Mutual at prices below the Company’s average manufacturer’s price for Periostat through May 15, 2007 or the earlier termination of such supply arrangements under certain circumstances. In addition, the Company agreed not to grant any license to sell Periostat in generic form to any third party during the supply term.

In the settlement, Mutual agreed and confessed to judgment that the Company’s Periostat patents are valid and would be infringed by the commercial manufacture, use, sale, importation or offer for sale of the generic version of Periostat for which Mutual submitted its ANDA. Mutual consented to a judgment enjoining Mutual and any party acting in concert with Mutual from infringing the Company’s patents by making and selling a generic version of Periostat until the Company’s patents expire or are declared invalid or unenforceable by a court of competent jurisdiction from which decision no appeal has been taken or all appeals have been exhausted. Under the terms of the License and Supply Agreement, Mutual would be granted a license under the patents if a third-party, generic version of Periostat is launched and remains on the market for a certain period of time, or if the Company materially breaches its obligations under the agreement. Finally, Mutual agreed to withdraw from the FDA case in the District of Columbia.

The Company paid to Mutual $2,000, which represented a portion of the anticipated fees and expenses that the Company will save as a result of the settlement of the pending actions with Mutual. This charge was recorded in the first quarter of 2004. Under the Company’s license agreement with the Research Foundation of the State University of New York (“SUNY”) covering Periostat, the Company is entitled to deduct costs incurred to defend its patents, including this payment, from current and future royalties due to SUNY on net sales of Periostat and Mutual’s branded version of Periostat. In April 2004, the Company recorded net product sales of $4,689 associated with the initial stocking shipment to Mutual pursuant to the License and Supply Agreement. The revenues associated with this transaction included a one-time discount from the price Mutual is contractually obligated to pay for their branded version of Periostat on all subsequent orders. At June 30, 2004, the revenues associated with the initial stocking sale are reflected in the Company’s accounts receivable balance. The outstanding receivable from Mutual is due and payable in various installments commencing on August 20, 2004 through October 20, 2004.

During the three months ended March 31, 2004 and June 30, 2004, the Company incurred $2,493 (which includes the $2,000 Mutual settlement) and $365, respectively in legal defense,

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litigation and settlement costs, $952 of which in the aggregate was deducted from royalties payable to SUNY during such periods. Such cumulative legal costs exceeded the amount of the royalties payable to SUNY as of June 30, 2004. As of June 30, 2004, the Company has $3,514 in previously recognized legal expenses available to offset future royalties earned by SUNY, if any.

Note 8 — Sales Force Restructuring

On April 22, 2004, the Company announced the restructuring of the Company’s pharmaceutical sales organization into dedicated dental and dermatology sales forces. The restructuring is intended to increase the Company’s sales focus on high-prescribing dentists and dermatologists while reducing the Company’s cost base. Prior to the reorganization, virtually all of the Company’s 115-person pharmaceutical sales force called on both dentists and dermatologists to market the Company’s portfolio of dental and dermatology products. After the restructuring, the Company has a 56-person dental sales force calling on a highly targeted group of 10,000 high prescribing dentists and a 33-person dermatology sales force calling on the 5,600 dermatologists who are the highest prescribers of acne, rosacea and dermatitis products. The Company incurred a $480 charge for such restructuring costs during the quarter ended June 30, 2004. As of June 30, 2004, approximately $320 of these restructuring costs had been paid by the Company.

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