Middlebrook Pharmaceuticals (MBRK) 10-Q 2006 Q2 Quarterly report

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)
þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2006
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from           to

Commission File Number:000-50414

Advancis Pharmaceutical Corporation

(Exact name of Registrant as specified in its Charter)

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

(301) 944-6600

(Registrant’s telephone number, including area code)

None

(Former name, former address and former

fiscal year — if changed since last report)

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange ActRule 12b-2). (Check one).

Large Accelerated Filer o     Accelerated Filer o     Non-accelerated Filer þ

Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o     No þ

As of August 3, 2006, 30,330,611 shares of common stock of the Registrant were outstanding.

ADVANCIS PHARMACEUTICAL CORPORATION

INDEX

FORM 10-Q

		Page
PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):
	Condensed Balance Sheets at June 30, 2006 and December 31, 2005		2
	Condensed Statements of Operations for the three and six months ended June 30, 2006 and 2005		3
	Condensed Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2006		4
	Condensed Statements of Cash Flows for the six months ended June 30, 2006 and 2005		5
	Notes to Condensed Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		33
Item 4.	Controls and Procedures		34
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		35
Item 1A.	Risk Factors		35
Item 2.	Unregistered Sales of Securities and Use of Proceeds		35
Item 3.	Defaults Upon Senior Securities		35
Item 4.	Submission of Matters to a Vote of Security Holders		35
Item 5.	Other Information		36
Item 6.	Exhibits		36
Signatures			37
Exhibit Index			38

1

PART I — FINANCIAL INFORMATION

Item 1.   Financial Statements (Unaudited)

ADVANCIS PHARMACEUTICAL CORPORATION

CONDENSED BALANCE SHEETS

	June 30, 2006			December 31, 2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	15,320,713		$	18,116,968
Marketable securities		5,573,401			11,314,090
Restricted cash		—			418,244
Accounts receivable, net		73,980			756,764
Notes receivable from officer		121,500			121,500
Inventories, net		491,779			219,451
Prepaid expenses and other current assets		922,098			797,253
Total current assets		22,503,471			31,744,270
Property and equipment, net		13,070,815			14,450,627
Restricted cash		870,840			1,182,680
Deposits and other assets		1,341,336			884,312
Intangible assets, net		8,956,165			9,535,003
Total assets	$	46,742,627		$	57,796,892
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,404,995		$	1,686,487
Accrued expenses and advances		6,958,162			7,071,731
Lines of credit and short-term debt		8,047,093			895,204
Total current liabilities		16,410,250			9,653,422
Lines of credit — noncurrent portion		—			597,208
Note payable		75,000			75,000
Accrued severance — noncurrent portion		278,646			1,235,394
Deferred contract revenue		11,625,000			11,625,000
Deferred rent and credit on lease concession		1,272,180			1,268,857
Total liabilities		29,661,076			24,454,881
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value; 25,000,000 shares authorized; no shares issued or outstanding at June 30, 2006 and December 31, 2005		—			—
Common stock, $0.01 par value; 225,000,000 shares authorized, and 30,300,559 and 29,765,139 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively		303,006			297,652
Capital in excess of par value		146,199,765			144,766,213
Deferred stock-based compensation		—			(623,051	)
Accumulated deficit		(129,418,205	)		(111,095,308	)
Accumulated other comprehensive loss		(3,015	)		(3,495	)
Total stockholders’ equity		17,081,551			33,342,011
Total liabilities and stockholders’ equity	$	46,742,627		$	57,796,892

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

2

ADVANCIS PHARMACEUTICAL CORPORATION

CONDENSED STATEMENTS OF OPERATIONS

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
	(Unaudited)
Revenues:
Product sales	$	336,357		$	1,030,479		$	1,196,588		$	2,030,354
Contract revenue		���			285,087			—			701,754
Reimbursement of development costs		—			1,885,273			—			5,095,387
Total revenues		336,357			3,200,839			1,196,588			7,827,495
Costs and expenses:
Cost of product sales		25,021			102,746			77,606			178,777
Research and development		6,762,016			10,228,995			13,963,216			23,468,640
Selling, general and administrative		4,459,196			2,424,855			6,931,783			5,254,417
Total expenses		11,246,233			12,756,596			20,972,605			28,901,834
Loss from operations		(10,909,876	)		(9,555,757	)		(19,776,017	)		(21,074,339	)
Interest income		232,826			274,336			526,588			436,414
Interest expense		(25,312	)		(31,411	)		(50,283	)		(63,510	)
Other income (loss)		(23,185	)		—			976,815			—
Net loss	$	(10,725,547	)	$	(9,312,832	)	$	(18,322,897	)	$	(20,701,435	)
Basic and diluted net loss per share	$	(0.35	)	$	(0.34	)	$	(0.61	)	$	(0.82	)
Shares used in calculation of basic and diluted net loss per share		30,281,280			27,519,395			30,162,840			25,146,631

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

3

ADVANCIS PHARMACEUTICAL CORPORATION

CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

														Accumulated
					Capital in			Deferred						Other			Total
	Common		Par		Excess of			Stock-Based			Accumulated			Comprehensive			Stockholders’
	Shares		Value		Par Value			Compensation			Deficit			Income (Loss)			Equity
	(Unaudited)
Balance at December 31, 2005		29,765,139	$	297,652	$	144,766,213		$	(623,051	)	$	(111,095,308	)	$	(3,495	)	$	33,342,011
Exercise of stock options		496,489		4,965		271,737			—			—			—			276,702
Vesting of restricted stock		38,931		389		23,748			—			—			—			24,137
Issuance and remeasurement of stock options for services		—		—		170,107			—			—			—			170,107
Stock-based employee compensation expense		—		—		1,591,011			—			—			—			1,591,011
Elimination of deferred stock-based compensation due to adoption of SFAS 123R		—		—		(623,051	)		623,051			—			—			—
Comprehensive income (loss):
Net loss		—		—		—			—			(18,322,897	)		—			(18,322,897	)
Unrealized gain on marketable securities		—		—		—			—			—			480			480
Total comprehensive loss		—		—		—			—			—			—			(18,322,417	)
Balance at June 30, 2006		30,300,559	$	303,006	$	146,199,765		$	—		$	(129,418,205	)	$	(3,015	)	$	17,081,551

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

4

ADVANCIS PHARMACEUTICAL CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

	Six Months Ended June 30,
	2006			2005
	(Unaudited)
Cash flows from operating activities:
Net loss	$	(18,322,897	)	$	(20,701,435	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,961,118			2,034,447
Stock-based compensation		1,761,118			840,324
Deferred rent and credit on lease concession		3,323			37,890
Amortization of premium on marketable securities		218,548			278,849
Loss on disposal of fixed assets		23,185			—
Recognition of advance payment for potential sale of Keflex		(1,000,000	)		—
Changes in:
Accounts receivable		682,784			(117,150	)
Inventories		(272,328	)		(219,388	)
Prepaid expenses and other current assets		(124,845	)		344,456
Deposits other than on property and equipment		—			(100,000	)
Accounts payable		(281,492	)		(1,225,169	)
Accrued expenses		(46,180	)		1,780,825
Deferred contract revenue		—			3,702,859
Net cash used in operating activities		(15,397,666	)		(13,343,492	)
Cash flows from investing activities:
Purchase of marketable securities		(9,632,379	)		—
Sale and maturities of marketable securities		15,155,000			8,705,000
Purchases of property and equipment		(50,653	)		(1,373,976	)
Deposits on property and equipment		(250,000	)		(24,822	)
Proceeds from sale of fixed assets		25,000			—
Restricted cash		730,084			(10,026	)
Net cash provided by investing activities		5,977,052			7,296,176
Cash flows from financing activities:
Proceeds from issuance of debt, net of issue costs		7,792,976			—
Payments on lines of credit		(1,445,319	)		(511,122	)
Proceeds from private placement of common stock, net of issue costs		—			25,770,184
Proceeds from exercise of common stock options		276,702			20,705
Net cash provided by financing activities		6,624,359			25,279,767
Net increase (decrease) in cash and cash equivalents		(2,796,255	)		19,232,451
Cash and cash equivalents, beginning of period		18,116,968			10,395,757
Cash and cash equivalents, end of period	$	15,320,713		$	29,628,208
Supplemental disclosure of cash flow information:
Cash paid for interest	$	50,283		$	63,510
Supplemental disclosure of noncash transactions:
Reclassification of liability related to early exercises of restricted stock to equity upon vesting of the restricted stock	$	24,137		$	24,137

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

5

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS

1.   Basis of Presentation

The accompanying unaudited condensed 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 toForm 10-Q and Article 10 ofRegulation 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 condensed financial statements should be read in conjunction with the Company’s 2005 Annual Report onForm 10-K. The interim condensed 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 and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006.

The Company expects to incur losses from operations for the foreseeable future. It expects to continue to incur substantial research and development expenses in 2006, including expenses related to preclinical testing and clinical trials. It also expects selling and marketing expenses to increase, due to the commercial launch of the new Keflex 750 milligram capsules. Future capital requirements will depend on a number of factors, including the continued progress of research and development of product candidates, the timing and outcome of regulatory approvals, payments received or made under any future collaborative agreements, the costs involved in preparing, filing, prosecuting, maintaining, defending and enforcing patent claims and other products, the availability of financing and the Company’s or its partners’ success in developing markets for the product candidates. The company believes that its cash, cash equivalents and marketable securities of $20.9 million on hand as of June 30, 2006, together with cash receipts anticipated in 2006 and 2007 from sales of Keflex products, provide it with enough capital resources to finance ongoing operations, including the ongoing Phase III clinical trial, through 2007 and into 2008. The Company will continue to balance the pace of development with its funding position, and it anticipates the resources described above will be sufficient to fund planned operating expenses, debt repayments and capital equipment requirements for the next 12 to 18 months, barring unforeseen developments.

2.   Summary of Significant Accounting Policies

Use of Estimates

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

Revenue Recognition

Product sales revenueis 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 revenuesinclude 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 costsis 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.

Deferred contract revenuerepresents cash received in excess of revenue recognized.

6

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

Research and Development

The Company expenses research and development costs as incurred. Research and development costs primarily consist of salaries and related expenses for personnel, fees paid to consultants and outside service providers, including clinical research organizations for the conduct of clinical trials, costs of materials used in clinical trials and research and development, development costs for contract manufacturing prior to FDA approval of products, depreciation of capital resources used to develop products, and costs of facilities.

Cash and Cash Equivalents

Cash equivalents are highly liquid investments with a maturity of three months or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, commercial paper and high-quality corporate bonds. At June 30, 2006 and December 31, 2005, the Company maintained all of its cash and cash equivalents in three financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand, and the Company believes there is minimal risk of losses on such cash balances.

Marketable Securities

The Company classifies all of its marketable securities asavailable-for-sale.Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported as a component of stockholders’ equity in accumulated other comprehensive loss. Marketable securities available for current operations are classified in the balance sheet as current assets; marketable securities held for long-term purposes are classified as noncurrent assets. Interest income, 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

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

Inventories

Inventories consist of finished products purchased from third-party contract manufacturers and are stated at the lower of cost or market. Cost is determined on thefirst-in, first-out (FIFO) method. Reserves for obsolete or slow-moving inventory are recorded as reductions to inventory cost.

Earnings Per Share

Basic earnings per share is computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed based on the weighted average shares outstanding adjusted for all dilutive potential common shares. The dilutive impact, if any, of potential common shares 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 and six months ended June 30, 2006 and 2005, and, accordingly, did not assume exercise of any of the Company’s outstanding stock options, because to do so would be antidilutive.

7

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED 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:

	June 30,
(Number of Underlying Common Shares)	2006		2005
Stock options		4,274,309		5,010,594
Nonvested stock		30,052		75,950
Warrants		2,396,357		2,396,357
Total		6,700,718		7,482,901

Recent Accounting Pronouncements

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R,“Share-Based Payment,”(SFAS 123R), 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. The Company selected the modified prospective method of adoption. Under this method, compensation expense recognized by the Company for the three and six month periods ended June 30, 2006 included: (a) compensation expense for all share-based payments granted prior to, but not vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. Results for prior periods were not restated. See Notes 11 and 12 for more details on stock-based compensation.

In February 2005, the EITF added to its agenda IssueNo. 05-4,“The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF IssueNo. 00-19, ‘Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.’”The issue addresses liquidated damages provisions associated with registration rights agreements and the diversity in practice that exists in accounting for such provisions. In June 2005 and September 2005, the EITF discussed the Issue but did not reach a consensus. Further deliberations by the EITF have been postponed until the FASB addresses whether a registration rights agreement is a derivative. The Company is monitoring the progress of the FASB and EITF on this Issue.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”),“Accounting for Uncertainty in Income Taxes,”an interpretation of FASB Statement No. 109 (“SFAS 109”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109,“Accounting for Income Taxes.”It prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact, if any, of FIN 48 on its financial statements.

3.   Revenue

The Company records revenue from sales of pharmaceutical products (Keflex brand) and, in 2005, 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 39.9%, 32.1%, and 20.6% of the Company’s net revenues from product sales in the six-month period ended June 30, 2006.

Contract Revenue.  Revenue recognized for upfront payments and milestones under collaboration agreements in 2005 of $701,754 represented amortization of a $5,000,000 upfront payment received from Par

8

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

Pharmaceutical under a collaboration agreement entered into in May 2004. The collaboration agreement was terminated in August 2005. No revenue from collaboration agreements was recognized in 2006.

4.   Marketable Securities

Marketable securities, including accrued interest, at June 30, 2006 were as follows:

	June 30, 2006
			Gross		Gross
	Amortized		Unrealized		Unrealized
Available-for-Sale	Cost		Gains		Losses			Fair Value
Marketable securities:
Corporate debt securities:
-In unrealized gain position	$	—	$	—	$	—		$	—
-In unrealized loss position under 12 months		5,576,416				(3,015	)		5,573,401
-In unrealized loss position over 12 months		—		—		—			—
Total	$	5,576,416	$	—	$	(3,015	)	$	5,573,401

Each of the Company’s marketable securities at June 30, 2006 matures within six months.

5.   Accounts Receivable

Accounts receivable, net, consists of the following:

	June 30,			December 31,
	2006			2005
Accounts receivable for product sales, gross	$	174,843		$	1,109,684
Allowances for discounts and chargebacks		(100,863	)		(352,920	)
Accounts receivable for product sales, net	$	73,980		$	756,764

The Company’s largest customers are large wholesalers of pharmaceutical products. Three of these large wholesalers accounted for approximately 49.4%, 32.9%, and 10.9% of the Company’s accounts receivable for product sales as of June 30, 2006.

6.   Inventories

Inventories, net, consist of the following:

	June 30,			December 31,
	2006			2005
Finished goods	$	646,421		$	373,818
Reserve for obsolete and slow-moving inventory		(154,642	)		(154,367	)
Inventories, net	$	491,779		$	219,451

The Company periodically reviews its product inventories on hand. Inventory levels are evaluated by management relative to product demand, remaining shelf life, future marketing plans and other factors, and reserves for obsolete and slow-moving inventories are recorded for amounts which may not be realizable.

9

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

7.   Property and Equipment

Property and equipment consists of the following:

	Estimated Useful Life	June 30,			December 31,
	(Years)	2006			2005
Construction in progress	n/a	$	554,673		$	535,463
Computer equipment	3		1,014,810			1,010,757
Furniture and fixtures	3-10		1,405,918			1,405,918
Equipment	3-10		9,139,653			9,197,693
Leasehold improvements	Shorter of economic lives or lease term		8,738,230			8,719,668
Subtotal			20,853,284			20,869,499
Less — accumulated depreciation			(7,782,469	)		(6,418,872	)
Property and equipment, net		$	13,070,815		$	14,450,627

8.   Intangible Assets

Intangible assets at June 30, 2006 and December 31, 2005 consist of the following:

	June 30, 2006
	Gross Carrying		Accumulated			Net Carrying
	Amount		Amortization			Amount
Keflex brand rights	$	10,954,272	$	(2,190,864	)	$	8,763,408
Keflex non-compete agreement		251,245		(100,488	)		150,757
Patents acquired		120,000		(78,000	)		42,000
Intangible assets	$	11,325,517	$	(2,369,352	)	$	8,956,165

	December 31, 2005
	Gross Carrying		Accumulated			Net Carrying
	Amount		Amortization			Amount
Keflex brand rights	$	10,954,272	$	(1,643,148	)	$	9,311,124
Keflex non-compete agreement		251,245		(75,366	)		175,879
Patents acquired		120,000		(72,000	)		48,000
Intangible assets	$	11,325,517	$	(1,790,514	)	$	9,535,003

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 and $578,838 for the three and six-month periods ended June 30, 2006 and 2005, respectively. For the year ending December 31, 2006 and for the next five years, annual amortization expense for acquired intangible assets is expected to be approximately $1.2 million per year for 2006, 2007 and 2008, and approximately $1.1 million for 2009 and 2010.

10

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

9.   Accrued Expenses and Advances

Accrued expenses consist of the following:

	June 30,		December 31,
	2006		2005
Bonus	$	589,596	$	849,078
Professional fees		476,321		352,445
Sales and marketing expense		889,286		—
Severance — current portion		1,631,459		1,870,479
Insurance and benefits		194,060		179,109
Liability for exercised unvested stock options		18,632		42,770
Research and development expenses		1,947,763		1,546,469
Product returns		784,950		791,282
Other expenses		426,095		440,099
Advance payment for potential sale of Keflex assets		—		1,000,000
Total accrued expenses	$	6,958,162	$	7,071,731

Accrued Sales and Marketing

In connection with the commercialization of the Company’s new Keflex 750 mg product, the Company commenced sales and marketing activities. The accrued liability for sales and marketing represents the Company’s estimate for unbilled services provided by third parties for advertising, marketing, and contract sales activities as of June 30, 2006.

Accrued Severance

	Balance at								Balance at
Accrued Severance — 2006 Activity	December 31, 2005		Reversal			Cash Paid			June 30, 2006
2005 Workforce Reduction	$	3,105,873	$	(358,530	)	$	(837,238	)	$	1,910,105
Current portion	$	1,870,479							$	1,631,459
Noncurrent portion		1,235,394								278,646
	$	3,105,873							$	1,910,105

During the first six months of 2006, an executive was rehired for whom a severance charge had previously been recorded upon his termination in 2005. Upon his rehiring, the remaining accrued severance applicable to that individual of $358,530 that was no longer payable was reversed, and the benefit was recorded as a reduction in Selling, General and Administrative Expense.

Advance Payment for Potential Sale of Keflex Assets

In August 2005, Advancis entered into an agreement in principle with a private company for the potential sale of its Keflex assets, including the rights to the U.S. brand and inventories. As part of the agreement, the potential buyer made a $1,000,000 payment to Advancis, which provided it with exclusive negotiating rights through December 31, 2005. The payment was recorded as an advance, since, under certain conditions, the payment could become refundable or, if the sale were to have been completed, the $1,000,000 payment would have been applied to the purchase price. The two parties did not enter into a definitive agreement for the asset sale, and in January 2006, Advancis decided to retain the Keflex assets. The agreement in principle expired on February 28, 2006. Accordingly, the advance payment of $1,000,000 was recognized as income in 2006.

11

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

10.   Borrowings

Total lines of credit and short-term debt consist of the following:

	June 30,			December 31,
	2006			2005
Merrill Lynch Capital term loan	$	8,000,000		$	—
Line of credit — equipment lender		47,093			115,389
Bank line of credit		—			1,377,023
Total lines of credit and loans		8,047,093			1,492,412
Less: Current portion		(8,047,093	)		(895,204	)
Lines of credit, noncurrent	$	—		$	597,208

On June 30, 2006, the Company entered into a $12 million senior secured credit facility with Merrill Lynch Capital, consisting of an $8 million term loan (“Term Loan”) and a $4 million revolving loan facility (“Revolving Loan”).

The Term Loan matures on June 30, 2009 and is payable in 36 equal monthly payments of principal. Interest on the outstanding balance of the Term Loan is payable monthly at an annual rate equal to the one-month LIBOR rate plus 5.0 percent. The Company borrowed the entire Term Loan commitment of $8 million at closing on June 30, 2006, and received net proceeds of $7,792,976. From the net loan proceeds, $987,008 was used to fully repay existing bank loans. The Company incurred $207,024 in debt issue costs, which are included as a component of Deposits and Other Assets and will be amortized using the effective interest method as additional interest expense over the expected 36 month loan term. If the Term Loan is prepaid, the Company is required to pay a prepayment fee of 2.0 percent, 1.25 percent, or 0.75 percent, if the prepayment is made within the first, second, or third years after closing (June 30, 2006), respectively.

The Revolving Loan commitment provides for up to $4 million in borrowing capacity with a commitment expiry date of March 30, 2010, with an interest rate equal to the one-month LIBOR plus 3.75 percent per annum. Credit available under the Revolving Loan is subject to certain borrowing base conditions based on eligible accounts receivable of the Company. The Revolving Loan commitment may also be used for the issuance of letters of credit, up to an aggregate amount of $1,000,000. There were no borrowings or letters of credit outstanding under this facility at June 30, 2006. An unused line fee of 0.045 percent per month is payable on the average unused daily balance of the Revolving Loan commitment. If the Revolving Loan commitment is terminated prior to the expiration date of March 30, 2010, the Company is required to pay a deferred commitment fee of 2.0 percent, 1.25 percent, 0.75 percent, or 0.25 percent of the Revolving Loan commitment amount if the termination is made within the first, second, third or fourth years after closing (June 30, 2006), respectively.

Pursuant to the credit and security agreement, the Company granted a security interest in substantially all of its assets existing at the date of closing as well as those acquired during the term of the agreement, to Merrill Lynch Capital, excluding intellectual property, which is subject to a negative pledge. The agreement does not require the issuance of stock warrants or other equity types of securities.

The agreement restricts the Company’s ability to incur additional debt, pay dividends, repurchase stock, or engage in specified other transactions outside the normal course of business, as long as borrowings are outstanding under the agreement. The credit and security agreement also requires the Company to be in compliance with certain financial covenants, including achievement of a minimum quarterly amount of revenue or, during the first three-month period of the agreement, a minimum value of products invoiced, and maintenance of a minimum liquidity level. Beginning with the quarter ending December 31, 2006 and continuing thereafter, the financial covenant for minimum quarterly revenue is $5,000,000, an amount which significantly exceeds quarterly revenue recorded by the Company in prior periods and which requires the successful commercialization and market acceptance of the Company’s Keflex 750mg product. In addition, the agreement contains a material adverse change clause under which the lender could accelerate the Company’s obligations under the credit and security agreement upon either

12

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

(1) the occurrence of an event that could reasonably be expected to result in a material adverse change, or (2) if the lender determines, in its good faith opinion, that there is a reasonable likelihood that the Company will fail to comply with one or more of the financial covenants during the succeeding financial reporting period. Due to the subjective acceleration clause, the entire outstanding balance of the term loan is classified as a current liability, pursuant to FASB TechnicalBulletin 79-3,“Subjective Acceleration Clauses in Long-Term Debt Agreements.”

If the Company borrows in the future under the Revolving Loan commitment, the balance would be classified as a current liability, because the loan agreement contains both a subjective acceleration clause and a requirement to maintain a lock-box arrangement whereby remittances from the Company’s customers immediately reduce the outstanding obligation. In accordance with EITF 95-22,“Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that include Both a Subjective Acceleration Clause and a Lock-box Arrangement,” indebtedness under a revolving credit facility containing such provisions should be considered a short-term liability.

11.   Stock Option Plan

The Company currently grants stock options under the Stock Incentive Plan (the “Plan”). The number of shares available for issuance under the Plan is 7,848,182.

Options granted under the Plan may be incentive stock options or non-statutory stock options. Stock purchase rights may also be granted under the Plan. Incentive stock options may only be granted to employees. The compensation committee of the Board of Directors determines the period over which options become exercisable. Options granted to employees, consultants and advisors normally vest over a4-year period. Options granted to directors, upon their initial appointment or election, vest monthly over periods of 36 or 48 months. Annual director grants vest monthly over 12 months. The exercise price of incentive stock options and non-statutory stock options shall be no less than 100% of the fair market value per share of the Company’s common stock on the grant date. The term of all options is 10 years. As of June 30, 2006, there were 1,922,638 shares of common stock available for future option grants.

The following table summarizes the activity of the Company’s stock option plan for the six months ended June 30, 2006:

	Number of			Weighted-Average		Weighted Average		Aggregate Intrinsic
	Options			Exercise Price		Remaining Term		Value
Outstanding, December 31, 2005		4,095,417		$	4.79
Granted		1,102,120			1.91
Exercised		(496,489	)		0.56
Cancelled		(426,739	)		7.27
Outstanding, June 30, 2006		4,274,309		$	4.27		8.4 years	$	3,411,687
Exercisable, June 30, 2006		1,955,859		$	5.40		7.8 years	$	1,246,421

The total intrinsic value of options exercised during the six months ended June 30, 2006 was $577,590. Cash received by the Company upon the issuance of shares from option exercises was $276,702. The Company’s policy is to issue new shares of common stock to satisfy stock option exercises.

13

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

A summary of the Company’s nonvested options as of and for the six months ended June 30, 2006 is presented below:

				Weighted Average
	Number of Nonvested			Grant Date
	Stock Options			Fair Value
Outstanding, December 31, 2005		2,009,729		$	4.21
Granted		1,102,120			1.34
Vested		(568,274	)		4.08
Forfeited		(26,608	)		2.72
Outstanding, June 30, 2006		2,516,967		$	3.00

12.   Stock-Based Compensation

The Company has recorded stock-based compensation expense for the grant of stock options to employees and to nonemployee consultants as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
Stock-Based Compensation Expense:	2006			2005			2006		2005
Employees:
SFAS 123R fair-value method	$	908,323		$	—		$	1,591,011	$	—
APB 25 intrinsic value method		—			470,758			—		977,088
Subtotal — Employees		908,323			470,758			1,591,011		977,088
Nonemployee consultants:
Amortization of variable stock-based compensation		(7,299	)		(148,743	)		170,107		(136,764	)
Total	$	901,024		$	322,015		$	1,761,118	$	840,324

	Three Months Ended				Six Months Ended
	June 30,				June 30,
Included in Income Statement Captions as Follows:	2006		2005		2006		2005
Research and development expense	$	352,785	$	33,910	$	706,314	$	236,517
Selling, general and administrative expense		548,239		288,105		1,054,804		603,807
Total	$	901,024	$	322,015	$	1,761,118	$	840,324

Employees.  Prior to January 1, 2006, the Company’s share-based awards were 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. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R,“Share-Based Payment”(SFAS 123R). This Statement replaces SFAS No. 123 and supersedes APB 25. SFAS 123R requires that employee share-based compensation be measured using a fair value method and that the resulting compensation cost be recognized in the financial statements. The Company adopted SFAS 123R using the modified prospective transition method, which requires the recognition of compensation expense under the Statement on a prospective basis only. Accordingly, prior period financial statements have not been restated. Under this transition method, stock-based compensation cost for the first and second quarters of 2006 includes (a) compensation cost for all share-based awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based awards granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the fair value provisions of SFAS 123R.

14

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

Under APB 25, the Company had recorded deferred stock-based compensation for certain stock options granted in prior years with an exercise price below the estimated fair market value at the date of grant. The deferred stock-based compensation was amortized as a charge to expense over the related vesting periods of the options. In accordance with SFAS 123R, effective January 1, 2006, the Company reversed the remaining balance of deferred stock-based compensation, netting the balance of $623,051 against Capital in Excess of Par Value.

SFAS 123R also requires the Company to estimate forfeitures in calculating the expense related to share-based compensation rather than recognizing forfeitures as a reduction in expense as they occur. Prior to the adoption of SFAS 123R, the Company accounted for forfeitures as they occurred as permitted under previous accounting standards. The cumulative effect adjustment of adopting the change in estimating forfeitures was not considered material to the financial statements upon implementation as of January 1, 2006 or for the six months ended June 30, 2006.

The Company records compensation expense over the requisite service period, which is equal to the vesting period. For awards granted prior to January 1, 2006, compensation expense is recognized on a graded-vesting basis over the vesting term. For awards granted on or after January 1, 2006, compensation is recognized on a straight-line basis over the vesting term. All share-based compensation costs are charged to expense and not capitalized.

As of June 30, 2006, the total unrecognized compensation cost related to nonvested stock awards was $3,656,312, and the related weighted-average period over which it is expected to be recognized is approximately 2.0 years.

As a result of the adoption of SFAS 123R, the Company’s net loss for the three and six months ended June 30, 2006 was approximately $739,000 and $1,250,000, respectively, higher than it would have been under the Company’s previous intrinsic value method of accounting for share-based compensation. Basic and diluted net loss per common share for the three and six months ended June 30, 2006 were negatively impacted by the change in accounting method by approximately $0.02 and $0.04 per share, respectively. The adoption of SFAS 123R had no effect on the Company’s operating cash flows or financing cash flows, as the Company has not realized the benefits of tax deductions in excess of recognized compensation costs due to its net operating loss position.

The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provision of SFAS 123 to options granted under the Company’s stock-based compensation plan for the three and six-month periods ended June 30, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option-pricing model and amortized to expense using a graded vesting schedule with forfeitures recognized as a reduction in expense as they occur.

	Three Months Ended			Six Months Ended
	June 30, 2005			June 30, 2005
Net loss, as reported	$	(9,312,832	)	$	(20,701,435	)
Add — Stock-based employee compensation expense determined under the intrinsic value method		470,758			977,088
Less — Stock-based employee compensation expense determined under the fair value based method		(1,845,824	)		(3,887,529	)
Pro forma net loss applicable to common stockholders	$	(10,687,898	)	$	(23,611,876	)
Net loss per share:
Basic and diluted, as reported	$	(0.34	)	$	(0.82	)
Basic and diluted, pro forma	$	(0.39	)	$	(0.94	)

15

ADVANCIS PHARMACEUTICAL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS — (Continued)

The weighted average fair value of options granted to employees during the six months ended June 30, 2006 and 2005 was $1.34 and $2.78 per share, respectively. The fair value of each option grant was estimated on the date of grant using the Black-Scholes options pricing model with the following assumptions for grants in 2006 and 2005:

	June 30,
	2006			2005
Expected term (in years)		6.25			5
Risk-free interest rate		4.56	%		3.69	%
Volatility		75.0	%		80.0	%
Dividend yield		0	%		0	%

The Company has elected to determine the expected term of share-based awards granted subsequent to January 1, 2006 using the transition approach provided by Staff Accounting Bulletin No. 107, under which an expected term of 6.25 years may be used for four-year grants. Due to the limited Company-specific historical and implied volatility data, the Company has based its estimate of expected volatility of stock awards upon the historical volatility rates of other comparable public companies. The risk-free rate is based on U.S. Treasury yields in effect at the time of grant corresponding with the expected term of the options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.

Non-employee Consultants.  The Company has recorded stock-based compensation expense for options granted to non-employee consultants and Scientific Advisory Board (SAB) members in accordance with Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation,”based on the fair value of the equity instruments issued. 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 IssueNo. 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”The Company recognizes an expense for such options throughout the vesting period as the services are provided by the non-employee consultants and SAB members, based on the fair value of the options at each reporting period. The options are valued using the Black-Scholes option pricing model. As of June 30, 2006, the balance of unamortized stock-based compensation for options granted to non-employees was approximately $50,000. This amount will be adjusted based on changes in the fair value of the options at the end of each reporting period. As of June 30, 2006, 117,929 options are outstanding and exercisable for non-employee consultants.

13.   Employee Stock Purchase Plan

During 2003, the Company adopted an employee stock purchase plan which provides for the issuance of up to 100,000 shares of common stock. This plan, which is intended to qualify under Section 423 of the Internal Revenue Code, provides the Company’s employees with an opportunity to purchase shares of its common stock through payroll deductions. Options to purchase the common stock may be granted to each eligible employee periodically. The purchase price of each share of common stock will not be less than the lesser of 85% of the fair market value of the common stock at the beginning or end of the option period. Participation is limited so that the right to purchase stock under the purchase plan does not accrue at a rate which exceeds $25,000 of the fair market value of our common stock in any calendar year. To date, no shares have been issued under this plan.

14.   Commitments and Contingencies

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, the trial was held in May 2005, and the Company is currently waiting for the judgment of the Court. 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 but could possibly have a material adverse effect on its results of operations for a particular period.

16

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed financial statements and the related notes included elsewhere in thisForm 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 2005 Annual Report onForm 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 2005 Annual Report. See“Forward-looking Statements.”

Our Business

Advancis Pharmaceutical Corporation was incorporated in Delaware in December 1999 and commenced operations on January 1, 2000. We are a pharmaceutical company focused on developing and commercializing anti-infective drug products that fulfill unmet medical needs in the treatment of infectious disease. We are developing a 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 21 issued U.S. patents and one issued foreign patent covering our proprietaryonce-a-day pulsatile delivery technology called PULSYS. We have initially focused on developing PULSYS product candidates utilizing approved and marketed drugs that no longer have patent protection or that have patents expiring in the next several years. Our lead pulsatile product candidate, based on the antibiotic amoxicillin, is currently under evaluation in a Phase III clinical trial and our Keflex PULSYS product candidate, based on the antibiotic cephalexin, is currently under evaluation in a Phase I clinical trial. We also have a number of additional pulsatile product candidates in preclinical development. We acquired the U.S. rights to Keflex (cephalexin) from Eli Lilly in 2004. We currently sell our line of Keflex products to wholesalers in both capsule and powder formulations. In May 2006, we received U.S. Food and Drug Administration (FDA) approval for two additional Keflex strengths — 333mg capsules and 750mg capsules. We will initially focus our commercialization initiatives solely on the Keflex 750mg capsules. In support of the launch of the Keflex 750mg capsules, and in anticipation of our first potential pulsatile product, Amoxicillin PULSYS, we have entered into an agreement with a contract sales organization for the deployment of 75 contract sales representatives across the United States. We have also entered into agreements with third-party contract manufacturers for the commercial supply of our products.

General

Our future operating results will depend largely on our ability to successfully develop and commercialize our lead product, Amoxicillin PULSYS, successfully commercializing our new Keflex products, 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 a number of factors, including risks related to our business, risks related to our industry, and other risks which are detailed in our 2005 Annual Report onForm 10-K.

Management Overview of the Second Quarter of 2006

The following is a summary of key events that occurred during and subsequent to the second quarter of 2006.

Amoxicillin PULSYS product development

•  In September 2005, after extensive study of the data from our unsuccessful Amoxicillin PULSYS Phase III clinical trials, we decided to conduct a new Phase III clinical trial for adults and adolescents, extending the length of treatment from seven days to 10 days, using our existing formulation of Amoxicillin PULSYS. Our Phase III trial began in November 2005 and is designed to support product approval for Amoxicillin PULSYS for the treatment of adolescents and adults with acute pharyngitisand/or tonsillitis due to Group A streptococcal infections. Study enrollment concluded on May 31, 2006, with a total of 620 patients, and the trial data is currently under review and analysis by our contract research organization. We expect to receive and to publicly report top-line results, including the trial’s primary and secondary endpoints, in August 2006.

17

Keflex Capsules (Cephalexin, USP) — Marketed Products and Product Development

•  In the second quarter of 2006, net sales of our branded capsule and powder for oral suspension Keflex products were approximately $0.3 million. For the first six months of 2006, net sales of Keflex products were approximately $1.2 million. These sales consist solely of 250mg and 500mg capsules.

•  On May 12, 2006, the FDA approved our supplemental New Drug Application (NDA) for two new strengths of our Keflex antibiotic. We received approval to market 333mg and 750mg Keflex capsules. In June 2006, we announced that we entered into an agreement with Innovex, the commercialization division of Quintiles Transnational Corp., to provide us contract sales and marketing services in support of the new Keflex 750mg strength. Terms of the agreement include the training, hiring, and deployment of 75 contract sales representatives targeting high Keflex-prescribing physicians across the United States. On July 25, 2006, we announced that Keflex 750mg capsules had been manufactured, packaged, and were shipping to pharmacies nationwide. Our sales representatives began directly promoting Keflex 750mg capsules to targeted physicians as well as providing patient starter samples in late July 2006.

•  We continued development of a PULSYS version of Keflex, having completed a third Phase I study in the second quarter of 2006, evaluating the pharmacokinetic profile of various combinations of pulsatile cephalexin formulations.

$12 Million Credit Facility Completed

•  On June 30, 2006, we closed a $12 million secured credit facility with Merrill Lynch Capital, consisting of an $8 million term loan and a $4 million revolving loan facility. The term loan was drawn in its entirety at closing, and matures in three years. The revolving loan facility matures 45 months from the closing date, and credit available under this facility will be determined based on a percentage of our accounts receivable. We expect to use the proceeds from the credit facility for working capital and plan to repay borrowings with cash flow from operations.

Focus for Remainder of 2006

Our primary focus for the remainder of 2006 will be on the completion of our Amoxicillin PULSYS Phase III clinical trial for adults and adolescents and on the commercialization of our Keflex 750mg capsules. If our Amoxicillin PULSYS trial is successful, we anticipate completing an NDA supporting product approval and to file the NDA with the FDA by year-end 2006 or early 2007. We will continue promoting the new Keflex 750mg capsules through our 75 contract sales representatives and eight Advancis district sales managers to targeted U.S. physicians throughout the remainder of 2006 and into 2007. We will also continue pre-clinical development of a once-daily version of cephalexin PULSYS.

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.

18

Revenue Recognition

We recognize revenue for the sale of pharmaceutical products and for payments received, if any, under collaboration agreements for licensing, milestones, and reimbursement of development costs as follows:

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. 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 (two years, in the case of our oral suspension products). Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. We estimate the level of sales which will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net revenues. Our estimates take into consideration historical returns of our products and our future expectations. We periodically review the reserves established for returns and adjust them based on actual experience. The amount of actual product 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. 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.

19

Inventories

Inventory is stated at the lower of cost or market with cost determined under thefirst-in, first-out method. Inventory consists of Keflex finished capsules and finished oral suspension powder. We purchase our Keflex products from third-party manufacturers only at the completion of the manufacturing process, and accordingly have no raw material orwork-in-process inventories. At least on a quarterly basis, we review our inventory levels and write down inventory that has become obsolete or has a cost basis in excess of its expected net realizable value or is in excess of expected requirements.

Intangible Assets

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.

Accrued Expenses

As part of the process of preparing financial statements, we are required to estimate accrued expenses for services performed and liabilities incurred. This process involves identifying services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for such service as of each balance sheet date in our financial statements. Examples of estimated accrued expenses for services include professional service fees, such as lawyers and accountants, contract service fees, such as amounts paid to clinical monitors, data management organizations and investigators in conjunction with clinical trials, fees paid to our contract sales organization, 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.

Stock-Based Compensation

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R,“Share-Based Payment”(SFAS 123R). The Company adopted SFAS 123R using the modified prospective transition method, which requires the recognition of compensation expense under the Statement on a prospective basis only. Accordingly, prior period financial statements have not been restated. Under this transition method, stock-based compensation cost for the first and second quarters of 2006 include (a) compensation cost for all share-based awards

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granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based awards granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the fair value provisions of SFAS 123R.

SFAS 123R also requires us to estimate forfeitures in calculating the expense related to share-based compensation rather than recognizing forfeitures as a reduction in expense as they occur. To the extent actual forfeitures differ from our estimates, such amounts will be recorded as a cumulative adjustment in the period that the estimates are revised. We plan to refine our estimated forfeiture rate as we obtain more historical data.

We determine the value of stock option grants using the Black-Scholes option-pricing model. Our determination of fair value of share-based payment awards on the date of grant is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and projected employee stock option exercise behaviors. This model requires that we estimate our future expected stock price volatility as well as the period of time that we expect the share-based awards to be outstanding.

The Company has elected to determine the expected term of share-based awards granted subsequent to January 1, 2006 using the transition approach provided by Staff Accounting Bulletin No. 107, under which an expected term of 6.25 years may be used for four-year grants. We plan to refine our estimate of expected term in the future as we obtain more historical data. A shorter expected term would result in lower compensation expense. Due to the limited Company-specific historical and implied volatility data, the Company has based its estimate of expected volatility of stock awards upon the historical volatility rates of other comparable public companies. Using a higher volatility input to the Black-Scholes model would result in a higher compensation expense. The risk-free rate is based on U.S. Treasury yields in effect at the time of grant corresponding with the expected term of the options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.

Income Taxes

As part of the process of preparing our financial statements we are required to estimate our income taxes in each of the jurisdictions in which we operate. We account for income taxes by the liability method. Under this method, deferred income taxes are recognized for tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end, based on enacted laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. We have not recorded any tax provision or benefit for the three andsix-month periods ended June 30, 2006 or 2005. 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, 2005 and June 30, 2006.

Recent Accounting Pronouncements

Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R,“Share-Based Payment,”(SFAS 123R), 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. We selected the modified prospective method of adoption. Under this method, compensation expense recognized by us for the three and six months ended June 30, 2006 included: (a) compensation expense for all share-based payments granted prior to, but not vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. Results for prior periods were not restated. See Notes 10 and 11 to the financial statements for more details on stock-based compensation.

In February 2005, the EITF added to its agenda IssueNo. 05-4,“The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject to EITF IssueNo. 00-19, ‘Accounting for Derivative Financial

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Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.’ ”The issue addresses liquidated damages provisions associated with registration rights agreements and the diversity in practice that exists in accounting for such provisions. In June 2005 and September 2005, the EITF discussed the Issue but did not reach a consensus. Further deliberations by the EITF have been postponed until the FASB addresses whether a registration rights agreement is a derivative. We are monitoring the progress of the FASB and EITF on this Issue.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”),“Accounting for Uncertainty in Income Taxes,”an interpretation of FASB Statement No. 109 (“SFAS 109”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109,“Accounting for Income Taxes.”It prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact, if any, of FIN 48 on our financial statements.

Research and Development Expenses

We expect our research and development expenses to be significant 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, and costs of facilities. 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

Summary of Product Development Initiatives.  The following table summarizes our product development initiatives for the three and six-month periods ended June 30, 2006 and 2005. Included in this table is the research and development expense recognized in connection with each product candidate currently in clinical development and all preclinical product candidates as a group.

	Three Months Ended				Six Months Ended				Clinical
	June 30,				June 30,				Development
	2006		2005		2006		2005		Phase
Direct Project Costs(1)
Amoxicillin PULSYS(2)	$	3,510,000	$	6,475,000	$	7,643,000	$	16,503,000		Phase III
Keflex Product Development		1,225,000		822,000		2,321,000		1,551,000		Phase I
Other Product Candidates		287,000		511,000		351,000		776,000		Preclinical
Total Direct Project Costs		5,022,000		7,808,000		10,315,000		18,830,000
Indirect Project Costs(1)
Facility		733,000		923,000		1,522,000		1,827,000
Depreciation		618,000		672,000		1,250,000		1,316,000
Other Indirect Overhead		389,000		825,000		876,000		1,495,000
Total Indirect Expense		1,740,000		2,420,000		3,648,000		4,638,000
Total Research & Development Expense	$	6,762,000	$	10,228,000	$	13,963,000	$	23,468,000

(1)

Many of our research and development costs are not attributable to any individual project because we share resources across several development projects. We record direct costs, including personnel costs and related benefits and stock-based compensation, on aproject-by-project basis. We record indirect costs that support a number of our research and development activities in the aggregate.

(2)

We currently have an adult and adolescent amoxicillin formulation in a Phase III clinical trial, which commenced enrollment in November 2005. We previously conducted Phase III clinical trials for the adolescent/adult formulation which commenced October 15, 2004 and for the pediatric formulation which commenced on January 5, 2005. These two previous Phase III trials failed to achieve their desired microbiological

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and clinical endpoints. See“Amoxicillin PULSYS”below. We previously had an agreement under which Par Pharmaceutical was be responsible for funding the anticipated future development costs of this product. See“Termination of Our Collaboration with Par Pharmaceutical for Amoxicillin PULSYS”below.

Amoxicillin PULSYS

We previously conducted two Amoxicillin PULSYS Phase III clinical trials in 2004/2005 for the treatment of adolescents/adults and children with acute pharyngitis and/or tonsillitis due to Group A streptococcal infections (strep throat) that failed to achieve their desired microbiological and clinical endpoints. Both trials failed to achieve eradication rates that were statistically non-inferior to the four-times-a-day comparator therapy and also failed to reach the 85 percent eradication rate necessary for FDA approval as a first-line therapy for strep throat. Following extensive analysis of data from our prior Amoxicillin PULSYS clinical trials, we decided to conduct a redesigned Phase III trial in adults and adolescents and to extend the length of treatment for our product candidate from seven days to 10 days. On November 9, 2005, Advancis began enrolling patients into our new Phase III trial for our Amoxicillin PULSYS product candidate in adults and adolescents with strep throat. The study completed enrollment with 620 patients on May 31, 2006 and we expect to publicly report top-line results in August 2006. If the trial is successful, we expect to file a 505 (b) (2) New Drug Application with the FDA for the adult product in late 2006 or early 2007. If approved, Amoxicillin PULSYS may be the first and only once-daily amoxicillin treatment of pharyngitis/tonsillitis approved in the United States. Even if our Amoxicillin PULSYS product candidate is approved by the FDA, the earliest we could launch Amoxicillin PULSYS would be by the end of 2007. These forward-looking statements are based on information available to us at this time. Actual results could differ because our trial results could be delayed or unsuccessful or due to delays in FDA approval, which may never occur.

Termination of Our Collaboration with Par Pharmaceutical for Amoxicillin PULSYS

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. Under the terms of the agreement, we conducted the development program, including the manufacture of clinical supplies and the conduct of clinical trials, and were responsible for obtaining regulatory approval for the product. We were to own the product trademark and to manufacture or arrange for supply of the product for commercial sales. Under the agreement, we received an upfront fee of $5.0 million and a commitment from Par to fund all further development expenses. Development expenses incurred by us were to be partially funded by quarterly payments aggregating $28 million over the period of July 2004 through October 2005, of which up to $14 million is contingently refundable. We recognized revenue related to the receipt of the quarterly payments from Par based on actual costs incurred as the work was performed, limited to the minimum amounts expected to be received under the agreement and excluding amounts contingent on future events or that were contingently refundable, with the balance of cash received in excess of revenue recognized recorded as deferred revenue.

On August 3, 2005, we were notified by Par of its decision to terminate the Amoxicillin PULSYS collaboration agreement. Under certain circumstances, the termination clauses of the agreement may entitle Par to receive a share of net profits up to one-half of their $23.25 million funding of the development of certain Amoxicillin PULSYS products, should a product covered by the agreement be successfully commercialized. Accordingly, we retained deferred revenue of $11.625 million related to the agreement, and accelerated the recognition into current revenue of the remaining balance of deferred revenue related to reimbursement of our development costs and to the upfront fee.

Keflex Brand

On June 30, 2004, we acquired the U.S. rights to the Keflex brand of cephalexin from Eli Lilly and Company for $11.2 million. 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, we entered into a manufacturing supply agreement under which Lilly agreed to continue to manufacture and supply Keflex products for us through December 2005. In December 2004, we entered into an agreement for the future supply of Keflex with Ceph International Corporation, a subsidiary of Patheon, Inc., in Puerto Rico.

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Keflex is a first-generation cephalosporin approved for treatment of several types of bacterial infections. Keflex is most commonly used in the treatment of uncomplicated skin and skin structure infections and, to a lesser extent, upper respiratory tract infections. Keflex is among the most prescribed antibiotics in the U.S.; however, generic competition is intense, and a high percentage of all Keflex prescriptions are filled by lower cost, generic versions of cephalexin, the active ingredient in Keflex. We have the exclusive U.S. rights to manufacture, sell and market Keflex pursuant to a purchase agreement with Eli Lilly and Company. We market Keflex in the U.S. to healthcare practitioners, pharmacists, pharmaceutical wholesalers and retail pharmacy chains.

Keflex Products	Key Indication(s)	Status	Marketing Rights
Keflex Capsules — 250 mg and 500 mg	Skin and skin structure infections; upper respiratory tract infections	FDA-approved	U.S. and Puerto Rico rights
Keflex Powder for Oral Suspension — 125 mg and 250 mg	Skin and skin structure infections; upper respiratory tract infections	FDA-approved	U.S. and Puerto Rico rights
Keflex Line Extension products — 333 mg capsules and 750 mg capsules(1)	Skin and skin structure infections; upper respiratory tract infections	FDA-approved	U.S. and Puerto Rico rights

(1) On May 12, 2006, we received approval of our supplemental NDA (sNDA) to the Food & Drug Administration requesting approval of Keflex 333mg capsules and 750mg capsules.

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

In May 2006, we announced that the U.S. Food and Drug Administration (FDA) approved our supplemental NDA for two new Keflex strengths — 333mg capsules and 750mg capsules. Following FDA approval, we commenced commercialization initiatives focused solely on the Keflex 750mg capsules through a targeted and dedicated national contract sales force of 75 sales representatives and eight Advancis district sales managers.

Advancis, along with our contract sales organization, Innovex, the commercialization division of Quintiles Transnational Corp., completed extensive sales representative training in July 2006. We shipped Keflex 750mg capsules to pharmacies nationwide, and sales representatives began promoting the product on July 17, 2006.

Results of Operations

Three months ended June 30, 2006 compared to three months ended June 30, 2005

Revenues.  We recorded revenues of $336,000 and $3,201,000 during the three month periods ended June 30, 2006 and 2005, respectively, as follows:

	Three Months Ended June 30,
	2006		2005
Keflex product sales — net	$	336,000	$	1,031,000
Amortization of upfront license fee — Par amoxicillin		—		285,000
Reimbursement of development costs — Par amoxicillin		—		1,885,000
Total	$	336,000	$	3,201,000

Net product sales consist primarily of shipments of the Keflex 250 and 500 milligram strengths to wholesalers. In the past, we have not actively promoted the Keflex 250mg and 500mg products. As a result, our quarterly sales

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results have been based primarily on the ordering patterns of our wholesaler customers, which can be variable. Net revenues for the second quarter of 2006 of $0.3 million, consisting entirely of net product sales of Keflex 250 and 500 capsules, are lower than the net Keflex product sales of $1.0 million in the second quarter of 2005. The decrease in Keflex sales compared to prior periods was mainly due to a net reduction in orders received from our wholesaler customers for our Keflex 250 and 500 products. In addition, there is increasing substitution of generic cephalexin for prescriptions of existing 250mg and 500mg Keflex brand capsules. Net product sales in the prior year also included approximately $215,000 revenue from Keflex powder for oral suspension, including initial wholesaler stocking, but net sales of this product in 2006 were insignificant.

Revenues recognized in 2005 for amortization of upfront licensing fees represent the amortization of a $5.0 million upfront payment received from Par Pharmaceutical in May 2004 in connection with our collaboration for Amoxicillin PULSYS, which was being amortized into revenue on a straight-line basis over the estimated development period. This collaboration was terminated in August 2005.

Reimbursement of development costs revenue in 2005 of $1,885,000 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 as well as royalties, if applicable. Cost of product sales declined from $103,000 in 2005 to $25,000 in 2006, as a result in the decline in sales from 2005.

Research and Development Expenses.  Research and development expenses were lower by $3.5 million, or 34%, to $6.8 million for the three months ended June 30, 2006 compared to $10.2 million for the three months ended June 30, 2005. 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, and other indirect overhead costs.

The following table discloses the components of research and development expenses reflecting all of our project expenses.

	Three Months Ended
	June 30,
Research and Development Expenses	2006		2005
Direct project costs:
Personnel, benefits and related costs	$	1,540,000	$	2,172,000
Stock-based compensation		353,000		34,000
Contract R&D, consultants, materials and other costs		1,055,000		2,873,000
Clinical trials		2,074,000		2,729,000
Total direct costs		5,022,000		7,808,000
Indirect project costs		1,740,000		2,420,000
Total	$	6,762,000	$	10,228,000

Direct costs decreased $2.8 million compared to 2005, primarily because our 2005 results reflect the costs of conducting two Phase III amoxicillin studies concurrently, compared to only one Phase III study in progress in the second quarter of 2006. A $3.2 million reduction in amoxicillin and other direct project costs was partially offset by an increase of $0.4 million in expenses related to the development of new Keflex products in 2006.

The decline in personnel, benefits and related costs in 2006 was the result of a reduction in staff that occurred in the third quarter of 2005.

Indirect project costs decreased by $0.7 million, due to the beneficial effect of lower headcount on indirect categories such as travel costs, office and general lab supplies, and equipment related expense.

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Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased 84% to $4.5 million for the three months ended June 30, 2006 from $2.4 million for the three months ended June 30, 2005.

	Three Months Ended
	June 30,
Selling, General and Administrative Expenses	2006		2005
Salaries, benefits and related costs	$	616,000	$	587,000
Stock-based compensation		548,000		288,000
Legal and consulting expenses		169,000		252,000
Marketing launch costs		970,000		—
Contract sales expenses		648,000		—
Other expenses		1,508,000		1,298,000
Total	$	4,459,000	$	2,425,000

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. Increases totaled $2.0 million for the quarter compared to 2005, as we prepared for product launch of our Keflex line extension. Salaries, benefits and related costs increased in 2006 compared to 2005 due primarily to eight district sales manager positions staffed during the quarter. Stock-based compensation expense reflects the impact of adoption of SFAS 123R, which commenced January 1, 2006. Marketing launch costs of $1.0 million reflect advertising and other marketing costs such as package design, travel costs, and launch consulting, while contract sales expenses of $0.6 million include costs related to the contract sales organization engaged to assist in the launch and ongoing selling of our Keflex products.

Net Interest Income (Expense).  Net interest income in the three months ended June 30, 2006 was $208,000 compared to net interest income of $243,000 in the three months ended June 30, 2005. Although interest rates were higher, net interest income was lower in 2006 due to significantly reduced cash and investment balances versus 2005. Proceeds from the $8 million term loan were received at the end of the quarter, and thus were not available for investment during the period.

	Three Months Ended June 30,
	2006			2005
Interest income	$	233,000		$	274,000
Interest expense		(25,000	)		(31,000	)
Total, net	$	208,000		$	243,000

Six months ended June 30, 2006 compared to six months ended June 30, 2005

Revenues.  We recorded revenues of $1,197,000 and $7,827,000 during the six-month periods ended June 30, 2006 and 2005, respectively, as follows:

	Six Months Ended
	June 30,
	2006		2005
Keflex product sales — net	$	1,197,000	$	2,030,000
Amortization of upfront licensing fees — Par amoxicillin		—		702,000
Reimbursement of development costs — Par amoxicillin		—		5,095,000
Total	$	1,197,000	$	7,827,000

Net product sales consist primarily of shipments of the Keflex 250 and 500 milligram strengths to wholesalers. In the past, we have not actively promoted the Keflex 250mg and 500mg products. As a result, our quarterly sales results have been based primarily on the ordering patterns of our wholesaler customers, which can be variable. Net revenues for the six months ended June 30, 2006 of $1.2 million, consisting entirely of net product sales of Keflex

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250 and 500 capsules, are lower than the net Keflex product sales of $2.0 million in the six months ended June 30, 2005. The decrease in Keflex sales compared to prior periods was mainly due to a net reduction in orders received from our wholesaler customers for our Keflex 250 and 500 products. In addition, there is increasing substitution of generic cephalexin for prescriptions of existing 250mg and 500mg Keflex brand capsules. In addition, net product sales in the prior year included approximately $215,000 revenue from Keflex powder for oral suspension, including initial wholesaler stocking, but net sales of this product in 2006 were insignificant.

Reimbursement of development costs revenue in 2005 of $5,095,000 related to the Par Amoxicillin collaboration agreement was recognized based on the related costs incurred. The contract was terminated in August 2005, and the remaining balance of non-refundable payments was recognized in revenue; therefore, there are no similar collaboration revenues in 2006.

Cost of Product Sales.  Cost of product sales represents the purchase cost of the Keflex products sold during the period, together with royalties due on the sale of certain products. Cost of product sales was $78,000 for the six months ended June 30, 2006 versus $179,000 for the comparable period of 2005. The decline is due to lower sales in the quarter, and to a lesser extent a change in product mix due to lack of significant oral suspension sales in 2006.

Research and Development Expenses.  Research and development expenses declined by $9.5 million, or 41%, to $14.0 million for the six months ended June 30, 2006 compared to $23.5 million for the six months ended June 30, 2005.

The following table discloses the components of research and development expenses reflecting all of our project expenses.

	Six Months Ended
	June 30,
Research and Development Expenses	2006		2005
Direct project costs:
Personnel, benefits and related costs	$	2,954,000	$	4,556,000
Stock-based compensation		706,000		237,000
Contract R&D, consultants, materials and other costs		1,574,000		4,920,000
Clinical trials		5,080,000		9,117,000
Total direct costs		10,314,000		18,830,000
Indirect project costs		3,649,000		4,638,000
Total	$	13,963,000	$	23,468,000

Direct costs declined $8.5 million due primarily to the decrease in amoxicillin project costs from 2005 of $8.9 million, as in 2005 we had two phase III trials underway versus one phase III trial in 2006. Keflex development efforts were increased in 2006, resulting in an increased expense of $0.8 million versus 2005, while other projects overall decreased by $0.4 million for the period.

Contract research and development, consulting, materials and other direct costs decreased $3.3 million, and clinical trials expense declined by $4.0 million, as we are conducting one phase III amoxicillin study in 2006 compared to two in 2005. Personnel and related costs reflected lower staffing in 2006 due to a reduction in force implemented in the second half of 2005, and increased stock-based compensation reflects the impact of adoption of SFAS 123R effective January 1, 2006.

Indirect project costs also decreased by $1.0 million, reflecting lower facility costs related to consolidation of our offices, lower travel and other personnel-related costs due to the lower headcount in 2006 compared to 2005, and lower consulting and other costs supporting research and development activities.

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Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased $1.7 million, or 32%, to $6.9 million for the six months ended June 30, 2006 from $5.3 million for the six months ended June 30, 2005.

	Six Months Ended
	June 30,
Selling, General and Administrative Expenses	2006			2005
Salaries, benefits and related costs	$	1,045,000		$	1,365,000
Severance costs		(359,000	)		—
Stock-based compensation		1,055,000			604,000
Legal and consulting expenses		657,000			723,000
Marketing launch costs		1,086,000			—
Contract sales expenses		648,000			—
Other expenses		2,800,000			2,563,000
Total	$	6,932,000		$	5,255,000

Lower salaries, benefits and related costs of $0.3 million are due to lower headcount compared to 2005 as a result of the reduction in force implemented in the third quarter of 2005. Severance charges of $0.4 million recognized in the third quarter of 2005 were reversed in 2006 upon the rehiring of an executive prior to the expiration of his severance benefits. Stock-based compensation expense reflects the impact of adoption of SFAS 123R effective with the first quarter of 2006.

We initiated Keflex 750mg product launch activities, such as advertising and the recruiting of sales representatives by our contract sales organization, during the first half of 2006, resulting in marketing and selling expense of $1.7 million in advance of actual product launch, which commenced in July 2006.

Net Interest Income (Expense).  Net interest income in the six months ended June 30, 2006 was $477,000 compared to net interest income of $372,000 in the six months ended June 30, 2005. Interest income was higher in 2006 primarily due to increased short-term interest rates.

	Six Months Ended
	June 30,
	2006			2005
Interest income	$	527,000		$	436,000
Interest expense		(50,000	)		(64,000	)
Total, net	$	477,000		$	372,000

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, the net proceeds of $54.3 million from our initial public offering in October 2003, and a private placement of common stock for net proceeds of $25.8 million in April 2005. In addition, we have received funding of $8.0 million and $28.25 million from GlaxoSmithKline and Par Pharmaceutical, respectively, as a result of collaboration agreements for the development of new products. Since July 2004, we have also received cash from sales of our Keflex products. We received a $1.0 million advance payment in 2005 from a potential buyer of our Keflex brand, which we recognized in income in 2006 as the sale was not completed. In the second quarter of 2006, we received net proceeds of $6.9 million from a term loan, net of the payoff of existing debt.

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Cash and Marketable Securities

At June 30, 2006 cash, cash equivalents and marketable securities were $20.9 million compared to $29.4 million at December 31, 2005.

	June 30,		December 31,
	2006		2005
Cash and cash equivalents	$	15,321,000	$	18,117,000
Marketable securities		5,573,000		11,314,000
Total	$	20,894,000	$	29,431,000

Our cash and cash equivalents are highly liquid investments with a maturity of 90 days or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, and commercial paper of high-quality corporate issuers. Our marketable securities are also highly-liquid investments and are classified asavailable-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 June 30, 2006 no security was held with a maturity greater than 6 months 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.

Cash Flow

The following table summarizes our sources and uses of cash and cash equivalents for the six-month periods ending June 30, 2006 and 2005.

	Six Months Ended
	June 30,
	2006			2005
Net cash used in operating activities	$	(15,397,000	)	$	(13,344,000	)
Net cash provided by investing activities		5,977,000			7,296,000
Net cash provided by financing activities		6,624,000			25,280,000
Net decrease in cash and cash equivalents	$	(2,796,000	)	$	19,232,000

	Six Months Ended
	June 30,
Operating Activities	2006			2005
Cash receipts:
Cash received from product sales	$	1,885,000		$	1,958,000
Cash received from collaboration partners		—			9,500,000
Interest income received and other		951,000			716,000
Total cash receipts		2,836,000			12,174,000
Cash disbursements:
Cash paid for employee compensation and benefits		4,954,000			6,407,000
Cash paid to vendors, suppliers, and other		13,279,000			19,111,000
Total cash disbursements		18,233,000			25,518,000
Net cash used in operating activities	$	(15,397,000	)	$	(13,344,000	)

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Although Keflex sales declined 41 percent in the first half of 2006 as compared to 2005, cash received from product sales in 2006 declined only 4 percent due to strong sales in the fourth quarter of 2005, of which related accounts receivable was collected in the first quarter of 2006. Cash received from collaboration partners in 2005 was a result of the Par collaboration, which was terminated in August 2005. The decrease in cash paid for employee-related expenses reflects lower headcount in 2006 due to the reduction in force implemented in the third quarter of 2005, and cash paid to vendors and others reflect reduced clinical trial costs in 2006, as we are conducting one Phase III trial compared to two Phase III trials in the comparison period of 2005.

	Six Months Ended
	June 30,
Investing Activities	2006		2005
Cash receipts:
Sale of marketable securities, net of purchases	$	15,155,000	$	8,705,000
Restricted cash		730,000		—
Proceeds from sale of fixed assets		25,000		—
Total cash receipts		15,910,000		8,705,000
Cash disbursements:
Purchase of marketable securities		9,632,000		—
Restricted cash		—		10,000
Property and equipment purchases and deposits		301,000		1,399,000
Total cash disbursements		9,933,000		1,409,000
Net cash provided by investing activities	$	5,977,000	$	7,296,000

Investing activities in 2006 consisted primarily of purchases or maturities of marketable securities, from which some net proceeds were transferred to cash to fund operations. Restricted cash was released as collateral upon payoff of existing debt ($0.5 million) and as provided for in a facilities lease agreement ($0.2 million). Purchases of equipment slowed versus 2005, as we have reduced need for additional equipment pending trial results later in 2006.

	Six Months Ended
	June 30,
Financing Activities	2006		2005
Cash receipts:
Proceeds from issuance of debt, net	$	7,793,000	$	—
Proceeds from private placement of common stock, net		—		25,770,000
Proceeds from exercise of stock options		276,000		21,000
Total cash receipts		8,069,000		25,791,000
Cash disbursements:
Payments on lines of credit		1,445,000		511,000
Net cash provided by investing activities	$	6,624,000	$	25,280,000

Major financing activities include a private placement of common stock in 2005, and a term loan in 2006. The increase in proceeds from option exercises was due to terminated employees exercising prior to expiration of their options. Repayment of lines of credit increased as all outstanding equipment loans with M&T Bank were paid off from the proceeds of the new term loan.

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Borrowings

We are a party to credit facilities with an aggregate outstanding amount of $8.1 million, including an equipment financing loan with $47,000 remaining, a $12 million senior secured credit facility with Merrill Lynch Capital of which $8.0 million has been drawn, and a loan agreement with a local government development fund, as described in the following table.

	As of June 30, 2006
				Remaining
		Amount		Amount
Debt Obligations	Interest Rates	Outstanding		Available
GE Capital term loan	Fixed rate — 8.45%	$	47,000	$	—
Montgomery County development loan	Fixed rate — 5.00%		75,000		—
Merrill Lynch Capital term loan	Variable rate — LIBOR plus 5%		8,000,000		—
Merrill Lynch Capital revolving loan	Variable rate — LIBOR plus 3.75%		—		4,000,000
Totals		$	8,122,000	$	4,000,000

The $12 million senior secured credit facility with Merrill Lynch Capital consists of an $8 million term loan and a $4 million revolving loan facility. We used the proceeds from the credit facility to repay existing indebtedness to M&T Bank of approximately $1 million, and anticipate using the remaining proceeds for general corporate purposes.

The $8 million Term Loan was drawn in its entirety at closing on June 30, 2006, and carries a maturity of three years, with equal monthly payments of principal. This loan is classified as a current liability due to the existence of a subjective acceleration clause which could, under certain circumstances, require the entire amount outstanding to be repaid within one year. Interest on the outstanding balance of the Term Loan is payable monthly at an annual rate equal to the one month LIBOR rate plus 5 percent. We issued no stock warrants or other dilutive securities in conjunction with the creation of the credit facility, and expect to repay the loan with cash flow from operations.

The Revolving Loan provides for an additional $4 million in potential borrowing capacity, subject to a borrowing base calculation based on eligible accounts receivable. It has a maturity of 45 months from closing, with an interest rate equal to the one month LIBOR plus 3.75 percent.

Pursuant to the credit and security agreement, we granted a security interest in substantially all of our assets existing at the date of closing as well as those acquired during the term of the agreement, to Merrill Lynch Capital, excluding intellectual property, which is subject to a negative pledge. The agreement does not require the issuance of stock warrants or other equity types of securities.

The agreement restricts our ability to incur additional debt, pay dividends, repurchase stock, or engage in specified other transactions outside the normal course of business, as long as borrowings are outstanding under the agreement. The credit and security agreement also requires us to be in compliance with certain financial covenants, including achievement of a minimum quarterly amount of revenue or, during the first three-month period of the agreement, a minimum value of products invoiced, and maintenance of a minimum liquidity level. Beginning with the quarter ending December 31, 2006 and continuing thereafter, the financial covenant for minimum quarterly revenue is $5,000,000, an amount which significantly exceeds quarterly revenue recorded by the Company in prior periods and which requires the successful commercialization and market acceptance of the Company’s Keflex 750mg product. In addition, the agreement contains a material adverse change clause under which the lender could accelerate the our obligations under the credit and security agreement upon either (1) the occurrence of an event that could reasonably be expected to result in a material adverse change, or (2) if the lender determines, in its good faith opinion, that there is a reasonable likelihood that we will fail to comply with one or more of the financial covenants during the succeeding financial reporting period. Due to the subjective acceleration clause, the entire outstanding balance of the term loan is classified as a current liability, pursuant to FASB TechnicalBulletin 79-3,“Subjective Acceleration Clauses in Long-Term Debt Agreements.”

We do not currently hedge any borrowings.

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Contractual Obligations and Other Commercial Commitments

We have entered into contractual agreements in connection with developing our products and technology and to perform clinical trials. We have a remaining contractual amount due for our on-going Amoxicillin PULSYS Phase III clinical trial. Although the contract could be cancelled should we decide to do so, in which case we would be liable to the vendor for the work performed to the date of cancellation, it is our intent to complete the clinical trial for the remaining cost of approximately $2.3 million.

We have entered into a manufacturing agreement with Ceph International Corporation, a subsidiary of Patheon, Inc., for the manufacturing of our Keflex products. The agreement contains a provision for minimum purchase requirements, based on our rolling-annual production forecast. We estimate that our potential liability for the minimum purchase requirement as of June 30, 2006, is approximately $4 million.

We have entered into an agreement with Innovex, a division of Quintiles, for contract sales services. Innovex is providing 75 sales representatives dedicated to promotion of the Keflex 750 product. We have a commitment to pay fees to Innovex to cover the costs of the sales force, as well as related expenses. We estimate this commercial commitment as an expense of approximately $14 million over the next 18 months. The agreement is cancelable at our option, which we would consider exercising if the Keflex 750 launch is not successful. The cost of termination would be approximately $1 million.

We have entered into a $12 million credit facility with Merrill Lynch Capital, under which an $8 million term loan is outstanding as of June 30, 2006. The principal is repayable in 36 equal monthly installments of $222,222 with interest payable at LIBOR plus 5 percent per annum.

Prospective Information

We expect to incur losses from operations for the foreseeable future. We expect to continue to incur substantial research and development expenses in 2006, including expenses related to preclinical testing and clinical trials. We expect that our selling and marketing expenses will increase after the first quarter of 2006, as we continue the commercial launch of our Keflex 750mg. If the launch is successful, we will collect cash on these incremental sales which would offset some or all of our increased selling and marketing expenses in 2006. We believe the Keflex line extension products, primarily the 750mg capsules, have the potential to generate significant cash in excess of selling costs in 2007. We also expect a limited window of opportunity for these products, approximating 18 to 24 months, should generic pharmaceutical companies decide to compete with our line extension products.

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 any future 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.

After receiving the results in June and July 2005 of our unsuccessful pediatric and adult Phase III trials, we conducted an intensive analysis of the data with the intent to reach a conclusion regarding the future of our Amoxicillin PULSYS development program. In September 2005, we decided to continue our Amoxicillin PULSYS development program and to conduct a new Phase III clinical trial. In July and September 2005, we reduced our workforce by approximately 38% as part of an initiative to reduce operating expenses. The cost reduction enhances our ability to rely on our existing resources to fund our operations over the next year. The launch of the Keflex 750mg capsules is underway and, we believe, has the potential to generate significant cash flow in excess of its incremental production, sales and marketing costs. In addition, the closing of the $12 million Merrill Lynch Capital credit facility provides us with financial flexibility. We believe that our cash, cash equivalents and marketable securities of $20.9 million on hand as of June 30, 2006, together with cash receipts in 2006 and 2007 from sales of our Keflex products, provide us with enough capital resources to finance our ongoing operations, including our ongoing Phase III clinical trial, through 2007 and into 2008. We will continue to balance our pace of development with our funding position, and we anticipate the resources described above will be sufficient to fund our planned operating expenses, debt repayments and capital equipment requirements for the next 12 to 18 months, barring unforeseen developments. This forecast is a forward-looking statement that involves risks and uncertainties, and actual results could vary. Key assumptions in the forecast include the successful commercialization and market

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acceptance of Keflex 750mg capsules, beginning in 2006 and continuing into 2007, as well as the repayment of the term loan principal to Merrill Lynch Capital in accordance with the scheduled repayment terms. If these assumptions differ from actual results, our liquidity will be materially impacted and our forecasted cash requirements will be significantly higher than described above, and we may not have sufficient cash to fund our planned operating expenses and debt repayments. Should we not meet our forecast or should we be required to repay the Merrill Lynch Capital term loan on an accelerated basis, we will experience significant liquidity issues.

We have no unused credit facility, other than the potential borrowing capacity under the Merrill Lynch revolving loan commitment of $4 million, or other committed sources of capital. There can be no assurance that we will have borrowing capacity available under the Merrill Lynch Capital revolving loan in the future, as the borrowing base calculations are dependent on future levels of our eligible accounts receivable and availability of the revolving loan is dependent on the occurrence of no events of default. To the extent our capital resources are insufficient to meet future capital requirements, we will need to raise additional capital, incur indebtedness, or consider the sale of company assets in order 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.

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:

•  general economic and business conditions;

•  changes in governmental laws and regulations relating to the development and commercialization of pharmaceutical products;

•  the financial condition of our collaborative partners; and

•  competition in our industry.

All written and oral forward-looking statements made in connection with this Quarterly Report onForm 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 2005 Annual Report onForm 10-K. We disclaim any obligation to update information contained in any forward-looking statement.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

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

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We have interest rate risk related to the senior secured credit facility with Merrill Lynch Capital, as the interest rate on the borrowings outstanding is variable. A 1% increase in the interest rate would have the effect of increasing interest expense by approximately $80,000 annually, based on the outstanding principal balance at June 30, 2006.

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.

Item 4.   Controls and Procedures

Our management, including our principal executive and principal financial officers, has evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2006. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this Quarterly Report onForm 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 June 30, 2006, and has concluded that there was no change that occurred during the quarterly period ended June 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1.   Legal Proceedings

We are not a party to any material pending legal proceedings, other than ordinary routine litigation incidental to our business. In December 2003, Aventis and Aventis Pharmaceuticals Inc., now part of sanofi-aventis, 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, the trial was held in May 2005, and we are currently waiting for the judgment of the Court. It is the opinion of management that the ultimate outcome of this matter will not have a material adverse effect upon the Company’s financial position, results of operations, or cash flows.

Item 1A.   Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1,“Item 1A. Risk Factors”in our Annual Report onForm 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report onForm 10-K are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial conditionsand/or operating results.

On June 30, 2006, the Company entered into a $12 million senior secured credit facility with Merrill Lynch Capital, consisting of an $8 million term loan and a $4 million revolving loan facility. The Company borrowed the entire $8 million available under the term loan commitment at closing, and the term loan principal is repayable over a three-year basis. The credit and security agreement requires the Company to be in compliance with certain financial covenants, including achievement of a minimum quarterly amount of revenue or, during the first three-month period of the agreement, a minimum value of products invoiced, and maintenance of a minimum liquidity level. In addition, the agreement contains a material adverse change clause under which the lender could accelerate the Company’s obligations under the credit and security agreement upon either (1) the occurrence of an event that could reasonably be expected to result in a material adverse change, or (2) if the lender determines, in its good faith opinion, that there is a reasonable likelihood that the Company will fail to comply with one or more of the financial covenants during the succeeding financial reporting period. Should the Company fail to meet the financial covenants in the agreement or should the lender decide to subjectively accelerate the loan, the Company could be required to repay the term loan principal immediately. This could have a material, unfavorable effect on the Company’s financial condition.

Item 2.   Unregistered Sales of Securities and Use of Proceeds

None

Item 3.   Defaults Upon Senior Securities

None

Item 4.   Submission of Matters to Vote of Security Holders

At our Annual Meeting of Stockholders, held on May 24, 2006, the following members were re-elected to the Board of Directors:

	Affirmative		Votes
	Votes		Withheld
Terms expiring in 2009
James H. Cavanaugh		23,738,399		174,878
Wayne T. Hockmeyer		23,737,299		175,978
Edward M. Rudnic		23,750,659		162,618

In addition, the following directors had terms of office that continued after the Annual Meeting of Stockholders: R. Gordon Douglas, M.D., Richard W. Dugan and Harold R. Werner.

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The following proposals were approved at our Annual Meeting of Stockholders:

	Affirmative						Broker
	Votes		Negative Votes		Abstentions		Non-Votes
Ratification of the selection of PricewaterhouseCoopers LLP as the Company’s independent auditors for the fiscal year ending December 31, 2006		23,895,826		13,166		4,285		—

Item 5.   Other Information

None

Item 6.   Exhibits

10	.1	Credit and Security Agreement, dated June 30, 2006, between the registrant and Merrill Lynch Capital.
31	.1	Rule 13a-14(a) Certification of Principal Executive Officer.
31	.2	Rule 13a-14(a) Certification of Principal Financial Officer.
32	.1	Section 1350 Certification of Chief Executive Officer.
32	.2	Section 1350 Certification of Chief Financial Officer.

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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.

Advancis Pharmaceutical Corporation

By:  /s/  Edward M. Rudnic

Edward M. Rudnic, Ph.D.

President and Chief Executive Officer

By:  /s/  Robert C. Low

Robert C. Low

Vice President, Finance and Acting

Chief Financial Officer

Dated: August 9, 2006

37

EXHIBIT INDEX

Exhibit
Page
Number
	10	.1	Credit and Security Agreement, dated June 30, 2006, between the registrant and Merrill Lynch Capital.
	31	.1	Rule 13a-14(a) Certification of Principal Executive Officer.
	31	.2	Rule 13a-14(a) Certification of Principal Financial Officer.
	32	.1	Section 1350 Certification of Chief Executive Officer.
	32	.2	Section 1350 Certification of Chief Financial Officer.

38