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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-K/A
 Amendment No. 1
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the Fiscal Year Ended December 31, 2005
 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: 0-27406
 CONNETICS CORPORATION
 (Exact name of registrant as specified in its charter)
 Delaware(State or other jurisdiction of
incorporation or organization)
    
    94-3173928(I.R.S. Employer
Identification No.)3160 Porter Drive,
Palo Alto, California(Address of principal executive offices)
    
    94304(Zip Code)
 Registrants telephone number, including area code:
(650) 843-2800
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value per share
Preferred Share Purchase Rights
 o þ
 o þ
 o þ
 o
  o þ o
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##### Table of Contents



DOCUMENTS INCORPORATED BY REFERENCE
 Part III incorporates information by reference from the registrants definitive proxy
statement for the 2006 Annual Meeting of Stockholders.




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##### 



Table of Contents
 PageExplanatory Note
    
    1Forward-Looking Statements
    
    3PART IItem 1.
    
    Business
    
    4The Company
    
    4Our Strategy
    
    6Our Products
    
    7Product Candidates and Clinical Trials
    
    9Royalty-Bearing Products and Licensed Technology
    
    11Sales and Marketing
    
    12Competition
    
    13Customers
    
    14Research and Development and Product Pipeline
    
    14Patents and Proprietary Rights
    
    15Trademarks
    
    16Manufacturing
    
    16Warehousing and Distribution
    
    16Government Regulation
    
    17Marketing to Healthcare Professionals
    
    21Environmental Regulation
    
    21Employees
    
    22Available Information
    
    22Executive Officers of the Company
    
    22Item 1A.
    
    Risk Factors
    
    23Item 1B.
    
    Unresolved Staff Comments
    
    38PART IIItem 6.
    
    Selected Financial Data
    
    39Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    43Item 8.
    
    Financial Statements and Supplementary Data
    
    67Item 9A.
    
    Controls and Procedures
    
    67PART IVItem 15.
    
    Exhibits and Financial Statement Schedules
    
    73Signatures
    
    74Index to Consolidated Financial Statements
    
    F-1Index to ExhibitsEXHIBIT 10.13EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  i




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EXPLANATORY NOTE
  Revenue Reserves
   1




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Identification of Material Weaknesses
  Reliance on Prior Consolidated Financial Statements
          2




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Please refer to Note 2 to the Notes to Consolidated Financial Statements for additional
information on the restatement.
 
 Forward-Looking Statements
 Our disclosure and analysis in this Report, in other reports that we file with the Securities
and Exchange Commission, in our press releases and in our officers public statements contain
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and
Section 21E of the Securities Exchange Act of 1934. Forward-looking statements give our current
expectations or forecasts of future events. Forward-looking statements may turn out to be wrong.
They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties.
Many factors mentioned in this Report, such as governmental regulation and competition in our
industry, will be important in determining future results. No forward-looking statement can be
guaranteed, and actual results may vary materially from those anticipated in any forward-looking
statement.
 You can identify forward-looking statements by the fact that they do not relate strictly to
historical or current events. They use words such as anticipate, estimate, expect, will,
may, intend, plan, believe and similar expressions in connection with discussion of future
operating or financial performance. Although we believe our plans, intentions and expectations
reflected in these forward-looking statements are reasonable, we may not achieve these plans,
intentions or expectations.
 Forward-looking statements in this Report include, but are not limited to, those relating to
the commercialization of our currently marketed and anticipated products, the progress of our
product development programs, developments with respect to clinical trials and the regulatory
approval process, the results of our sales and marketing efforts, the outcome of contingencies such
as legal proceedings, and financial results. Actual results, performance or achievements could
differ materially from those contemplated, expressed or implied by the forward-looking statements
contained in this Report. In particular, this Report sets forth important factors that could cause
actual results to differ materially from our forward-looking statements. These and other factors,
including general economic factors and business strategies, and other factors we do not currently
know, may be significant, now or in the future, and the factors set forth in this Report may affect
us to a greater extent than indicated. All forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the cautionary statements
set forth in this Report and in other documents that we file from time to time with the Securities
and Exchange Commission. Except as required by law, we do not undertake any obligation to update
any forward-looking statement, whether as a result of new information, future events or otherwise.
In particular, except as they may relate to matters directly related to the revenue reserves issues
impacted by the restatement, we have not updated any forward looking statements made in our
original Annual Report on Form 10-K filed on March 13, 2006.
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PART I
 
 Item 1. Business
 
 THE COMPANY
 References in this Report to Connetics, the Company, we, our and us refer to Connetics
Corporation, a Delaware corporation, and its consolidated subsidiaries. Unless the
context specifically requires otherwise, these terms include Connetics Australia Pty Ltd. and
Connetics Holdings Pty Ltd.
 Connetics was incorporated in Delaware in February 1993. Our principal executive offices are
located at 3160 Porter Drive, Palo Alto, California 94304 and our telephone number is (650)
843-2800. Connetics(R), Luxíq(R), OLUX(R), Evoclin(R), Extina(R), Soriatane(R), VersaFoam(R) and
the seven interlocking Cs design are registered trademarks, and Liquipatch(TM),
VersaFoam-EF(TM), Desilux(TM) and Primolux(TM) are trademarks, of Connetics. Velac(R) is a
registered trademark of Astellas Pharma Europe B.V. (formerly Yamanouchi Europe B.V.); Rogaine(R)
is a registered trademark of Pfizer, Inc. (formerly Pharmacia Corporation); Lamisil(R) is a
registered trademark of Novartis Consumer Health SA. All other trademarks or service marks
appearing in this Report are the property of their respective companies. We disclaim any
proprietary interest in the marks and names of others.
      4




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
    
    Liquipatch(TM).In 2001, we entered into a global licensing agreement with Novartis
Consumer Health SA for the use of our Liquipatch drug-delivery system in topical antifungal
applications. Novartis anticipates initial European launch of a product using the
Liquipatch technology in 2006.
    
    Rogaine(R) Foam.In 2002, we entered into a license agreement with Pfizer, Inc.
(formerly Pharmacia Corporation) pursuant to which we granted Pfizer exclusive global
rights, excluding Japan, to our proprietary foam drug delivery technology for use with
Pfizers Rogaine hair loss
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
    
    OLUX Foam.In September 2004, we entered into a license agreement granting Pierre Fabre
Dermatologie exclusive commercial rights to OLUX for Europe, excluding Italy, where the
product is licensed to Mipharm S.p.A. The license agreement with Pierre Fabre also grants
marketing rights for certain countries in South America and Africa. Pierre Fabre will
market the product under different trade names. Under the terms of the license agreement
with Pierre Fabre, we received an upfront license payment, and will receive milestone
payments and royalties on product sales. Pierre Fabre will be responsible for costs
associated with product manufacturing, sales, marketing, and distribution in its licensed
territories. Pierre Fabre anticipates an initial launch of OLUX in select European markets
in 2006.
 
 OUR STRATEGY
   
    
    Maximizing Commercial Opportunities for Our Marketed Products.We have a focused sales
force dedicated to establishing our products as the standard of care for their respective
indications. Our commercial strategy is to call on those medical professionals in
dermatology who are most likely to prescribe products for the treatment of skin diseases or
conditions. The reach of our dermatology sales force allows us to effectively reach
approximately 98% of our dermatology target audience in 2005. With the acquisition of the
PediaMed Pharmaceuticals, Inc. sales force, we have added 87 individuals who, beginning in
February 2006, will be targeting those pediatricians who prescribe dermatology products for
the treatment of skin diseases or conditions.
    
    Advancing the Development of Novel Dermatology Drugs.We plan to continue to leverage
our investment in Connetics Australia and the CSB to enhance our ability to develop novel
products and drug delivery technologies for the dermatology market.
    
    Broadening Our Product Portfolio Through Development, License or Acquisition.We
believe we can leverage our dermatology-dedicated product development and commercial
activities by acquiring or licensing additional products for the dermatology market. We
regularly evaluate the licensing or acquisition of additional product candidates. We may
also acquire additional technologies or businesses that we believe will enhance our
research and development or commercial capabilities.
    
    Selective Collaborations that Leverage Our Technology.As we expand certain aspects of
our development pipeline and delivery technologies, we may partner with pharmaceutical or
biotech
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companies to gain access to additional marketing expertise, such as over-the-counter or
non-U.S. markets, or physician groups on whom we do not currently call. Our approach to
partnership will be on a selective basis, seeking to maintain the highest possible value of
our products and product candidates.
 
 OUR PRODUCTS
 OLUX and Luxíq Foams
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Soriatane
     Evoclin Foam
   8




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PRODUCT CANDIDATES AND CLINICAL TRIALS
  Desilux Foam
   Primolux Foam
  Extina Foam
  9




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Velac Gel
   Other Pipeline Formulations
  10




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Royalty-Bearing
Products and Licensed Technology  Liquipatch.
 
 ROYALTY-BEARING PRODUCTS AND LICENSED TECHNOLOGY
 Foam Technology.
  OLUX and Luxíq Foams
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Liquipatch.
 Actimmune(R).
 
 SALES AND MARKETING
  www.olux.com www.luxiq.com www.soriatane.com www.evoclin.com
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COMPETITION
   13




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CUSTOMERS
  
 RESEARCH AND DEVELOPMENT AND PRODUCT PIPELINE
   14




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PATENTS AND PROPRIETARY RIGHTS
    15




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TRADEMARKS
  
 MANUFACTURING
  
 WAREHOUSING AND DISTRIBUTION
 Customers
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GOVERNMENT REGULATION
 Generally  Product Development. Risk Factors  We may spend a significant amount
of money to obtain FDA and other regulatory approvals, which may never be granted  We cannot
sell our current products and product candidates if we do not obtain and maintain governmental
approvals
   FDA Approval.
 
    
    Preclinical Testing.Generally, a company must conduct preclinical studies before it
can obtain FDA approval for a new therapeutic agent. The basic purpose of preclinical
investigation is to gather enough evidence on a potential new agent through laboratory and
animal testing to demonstrate there is a reasonable enough expectation of efficacy to
justify exposing humans to the risk of adverse events associated with any new drug, and to
demonstrate there are no safety signals that would suggest it would not be prudent to begin
preliminary trials in humans. The sponsor of these studies submits the results to the FDA
as a part of an investigational new drug application, or IND, that the FDA must review
before human clinical trials of an investigational drug can start. FDA approval of new
drug candidates requires an adequate demonstration of safety and efficacy in man. For each
investigational product entering clinical trials, we are required to file an IND and
perform our clinical studies to IND standards set by the FDA.
    
    Clinical Trials.Clinical trials are normally done in three distinct phases and
generally take two to five years, but may take longer, to complete:
 
    
    Phase I trials generally involve administration of a product to a small number
of patients to determine safety, tolerance and the metabolic and pharmacologic
actions of the agent in humans and the side effects associated with increasing
doses.
    
    Phase II trials generally involve administration of a product to a larger group
of patients with a particular disease to obtain evidence of the agents
effectiveness against the targeted disease, to further explore risk and side effect
issues, and to confirm preliminary
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data regarding optimal dosage ranges.
    
    Phase III trials involve more patients, and often more locations and clinical
investigators than the earlier trials. At least one such trial is required for FDA
approval to market a branded, or non-generic, drug.
  
    
    Regulatory Submissions.The Food, Drug and Cosmetic Act outlines the process by which a
company can request approval to commercialize a new product. After we complete the
clinical trials of a new drug product, we must file an NDA with the FDA. We used the
so-called 505(b)(2) application process for OLUX, Luxíq, and Evoclin, which permitted us in
each case to satisfy the requirements for a full NDA by relying on published studies or the
FDAs findings of safety and effectiveness based on studies in a previously-approved NDA
sponsored by another applicant, together with the studies generated on our products. If
studies previously submitted by another applicant and relied upon as part of 505(b)(2)
application are found by the FDA not to be up to contemporary standards, it may be
necessary to repeat them. The FDA may also require 505(b)(2) applicants to provide
additional safety data that was not required at the time of the original application.
Generally, however, the number of clinical trials required to support a 505(b)(2)
application, and the amount of information in the application itself, may be substantially
less than that required to support a traditional NDA application. The 505(b)(2) process
will not be available for all of our other product candidates, and as a result the drug
development process may be longer for our future product candidates than it has been for
our products to date. The FDA may also require an applicant to conduct post-approval
studies or implement risk management programs that do not delay market entry but do
increase product-related research and development costs.
  Manufacturing.
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Post-Approval Regulation.
 Pharmacy Boards.
 Fraud and Abuse Regulations.
    Medicaid and State Rebate Programs.
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Risk Factors  Our sales depend on payment and reimbursement from third party
payors, and if they reduce or refuse payment or reimbursement, the use and sales of our products
will suffer, we may not increase our market share, and our revenues and profitability will suffer  The growth of managed care organizations and other third-party reimbursement policies may
have an adverse effect on our pricing policies and our margins
 
 MARKETING TO HEALTHCARE PROFESSIONALS
  
 ENVIRONMENTAL REGULATION
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EMPLOYEES
  
 AVAILABLE INFORMATION
 http://www.connetics.com ir@connetics.com
 
 EXECUTIVE OFFICERS OF THE COMPANY
  Name
    
    Age
    
    PositionThomas G. Wiggans
    
    
    54
    
    
    Chairman of the Board and Chief Executive OfficerC. Gregory Vontz
    
    
    45
    
    
    President and Chief Operating OfficerJohn L. Higgins
    
    
    35
    
    
    Chief Financial Officer; Executive Vice President,
Finance and Corporate DevelopmentKatrina J. Church
    
    
    44
    
    
    Executive Vice President, Legal Affairs; General Counsel
and SecretaryLincoln Krochmal, M.D.
    
    
    59
    
    
    Executive Vice President, Research and Product DevelopmentMatthew W. Foehr
    
    
    33
    
    
    Senior Vice President, Technical Operations
 Thomas Wiggans
 Gregory Vontz
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John Higgins
 Katrina Church
 Lincoln Krochmal, M.D.
 Matthew Foehr
 
 Item 1A. Risk Factors
  23




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Risks Related to Our Business
 We derive nearly all of our revenue from product sales, and any decrease in our product sales would
harm our business.
  
    
    manufacturing or supply interruptions,
    
    the development of new competitive pharmaceuticals to treat the conditions addressed by
our products,
    
    marketing or pricing actions by our competitors,
    
    changes in the prescribing or procedural practices of dermatologists or pediatricians,
    
    changes in the reimbursement or substitution policies of third-party payors or retail
pharmacies,
    
    the outcome of disputes relating to patents, and
    
    changes in state and federal law that adversely affect our ability to market our
products to dermatologists, pediatricians, and other healthcare professionals.
 We are subject to an SEC investigation and face an increased risk of litigation in connection with
errors identified in our financial statements and related restatement.
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Our decision to reduce wholesale inventory will decrease our product revenue, and may increase our
exposure to holding excess and/or obsolete inventory.
   We
face additional risks and costs if our actions taken to remediate
material weaknesses in our
internal control over financial reporting are insufficient or if we fail to maintain all of the
controls necessary for continued compliance. As a result, current and potential stockholders could
lose confidence in our financial reporting, which would harm our business and the trading price of
our stock.
     Our operating results may fluctuate. This fluctuation could cause our financial results to be
below expectations and the market prices of our securities to decline.
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If we do not sustain profitability, stockholders may lose their investment.
  Our commercial success depends in part on our ability and the ability of our licensors to obtain
and maintain patent protection on technologies, to preserve trade secrets, and to operate without
infringing the proprietary rights of others.
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Evoclin Foam represents a new product entry for us into the acne market and we may be unable to
achieve desired market acceptance and sales of Evoclin Foam.
  Our total revenue depends on receiving royalties and contract payments from third parties, and we
cannot control the amount or timing of those revenues.
  
    
    royalties generated from licensing arrangements may be insignificant or may fluctuate
from period to period, and
    
    a loss of royalties could have a disproportionately large impact on our operating income
in periods where the operating income is a small profit.
 We rely on our employees and consultants to keep our trade secrets confidential.
  The growth of our business depends in part on our ability to identify, acquire on favorable terms,
and assimilate technologies, products or businesses.
  27




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
    
    difficulties in and costs associated with assimilating the operations, technologies,
personnel and products of the acquired companies,
    
    assumption of known or unknown liabilities or other unanticipated events or
circumstances, and
    
    risks of entering markets in which we have limited or no experience. For example, while
the acquisition of the PediaMed sales organization will greatly expand our presence in the
pediatric market, we cannot be certain pediatricians will respond favorably to our direct
promotional efforts.
  Our future product revenues could be reduced by imports from countries where our products are
available at lower prices.
   Our use of hazardous materials exposes us to the risk of environmental liabilities, and we may
incur substantial additional costs to comply with environmental laws.
  Risks Related to Our Convertible Senior Notes
 We have made significant payments to Holders of the 2003 Notes in consideration for the consent of
the Holders of the 2003 Notes to certain amendments and waivers of such Notes and will be obligated
to make related tax payments.
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Our reported earnings per share may be more volatile because of the conversion provisions of our
2003 Notes or the exercise of outstanding stock options.
  Our current and future indebtedness and debt service obligations may adversely affect our cash
flow.
 per annum
  29




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Risks Related to Our Products
 Because we rely on third-party manufacturers and suppliers, any manufacturing difficulties they
encounter could delay future revenues from our product sales.
    If our contract manufacturers fail to comply with FDA GMP regulations, we may be unable to meet
demand for our products and may lose potential revenue.
  If our supply of finished products is interrupted, our ability to maintain our inventory levels
could suffer and future revenues may be delayed.
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Orders for our products may decrease depending on the inventory levels held by our major customers.
Significant changes in orders from our major customers could cause our operating results to vary
significantly from quarter to quarter.
 Risk Factors Related to Our Business  Our decision to reduce wholesale inventory could
decrease our product revenue
 We cannot sell our current products and product candidates if we do not obtain and maintain
governmental approvals.
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
    
    change our methods of marketing and selling products,
    
    take FDA-mandated corrective action, which could include placing advertisements or
sending letters to physicians rescinding previous advertisements or promotion,
    
    incur substantial expenses, including fines, penalties, legal fees and costs to comply
with the FDAs requirements,
    
    disrupt the distribution of products and stop sales until we are in compliance with the
FDAs position.
 We may spend a significant amount of money to obtain FDA and other regulatory approvals, which may
never be granted. Failure to obtain such regulatory approvals could adversely affect our prospects
for future revenue growth.
  We depend on a limited number of customers, and if we lose any of them, our business could be
harmed.
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Our revenues depend on payment and reimbursement from third party payors, and if they reduce or
refuse payment or reimbursement, the use and sales of our products will suffer, we may not increase
our market share, and our revenues and profitability will suffer.
    Our continued growth depends on our ability to develop new products, and if we are unable to
develop new products, our expenses may exceed our net revenues without any return on the
investment.
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If we do not successfully integrate new products into our business, we may not be able to sustain
revenue growth and we may not be able to compete effectively.
  We rely on third parties to conduct clinical trials for our product candidates, and those third
parties may not perform satisfactorily. If those third parties do not perform satisfactorily, it
may significantly delay commercialization of our products, increase expenditures and negatively
affect our prospects for future revenue growth.
  We rely on the services of a single company to distribute our products to our customers. A delay
or interruption in the distribution of our products could negatively impact our business.
  Risks Related to Our Industry
 We face intense competition, which may limit our commercial opportunities and limit our ability to
generate revenues.
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The growth of managed care organizations and other third-party reimbursement policies and state
regulatory agencies may have an adverse effect on our pricing policies and our margins.
   Our industry is subject to extensive governmental regulation.
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
    
    fines or other civil or criminal sanctions,
    
    delays in product development, distribution, marketing and sale,
    
    denials or suspensions of regulatory approvals of our products, and
    
    recalls of our products.
 If product liability lawsuits are brought against us, we may incur substantial costs.
  Risks Related to Our Stock
 Our common stock may be delisted from the NASDAQ Global Market which may reduce the price of our
common stock and the levels of liquidity available to our stockholders and cause confusion among
investors.
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Our stock price is volatile and the value of your investment could decline in value.
  
    
    the restatement of our financial statements for the five years ended December 31, 2005
as further discussed in this Annual Report on Form 10-K/A, and the related delayed filing
of our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2006,
    
    our pending SEC investigation,
    
    quarterly variations in results,
    
    any decision by NASDAQ Global Market to delist our common stock,
    
    the results of our solicitation of waivers from our Noteholders,
    
    the timing of new product introductions,
    
    clinical trial results and regulatory developments,
    
    competition, including both branded and generic,
    
    business and product market cycles,
    
    fluctuations in customer requirements,
    
    the availability and utilization of manufacturing capacity,
    
    the timing and amounts of royalties paid to us by third parties, and
    
    issues with the safety or effectiveness of our products.
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Period
    
    High
    
    Low2005
    
    $
    28.99
    
    
    $
    12.002004
    
    $
    29.92
    
    
    $
    17.69
 
 Item 1B. Unresolved Staff Comments
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PART II
 
 Item 6. Selected Financial Data
    39




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Connetics Corporation
Selected Consolidated Financial Data (in thousands, except per share amounts)
 Years Ended December 31,2002
    
    
    20012005
    
    
    2004
    
    
    2003
    
    
    (Restated)
    
    
    (Restated)(Restated)
    
    
    (Restated)
    
    
    (Restated)
    
    
    (7)
    
    
    (7)Consolidated Statements of
Operations Data:Net revenues:Product
    
    $
    175,417
    
    
    $
    140,922
    
    
    $
    66,439
    
    
    $
    46,295
    
    
    $
    30,310Royalty and contract(1)
    
    
    952
    
    
    
    2,296
    
    
    
    8,725
    
    
    
    5,190
    
    
    
    3,141Total net revenues
    
    
    176,369
    
    
    
    143,218
    
    
    
    75,164
    
    
    
    51,485
    
    
    
    33,451Operating costs and
expenses:Cost of product
revenues (excluding
amortization of
acquired product
rights)
    
    
    16,292
    
    
    
    12,623
    
    
    
    5,053
    
    
    
    4,190
    
    
    
    3,123Amortization of
intangible assets(2)
    
    
    13,598
    
    
    
    11,471
    
    
    
    819
    
    
    
    805
    
    
    
    1,048Research and
development
    
    
    31,915
    
    
    
    21,539
    
    
    
    30,109
    
    
    
    25,821
    
    
    
    19,156Selling, general and
administrative
    
    
    97,566
    
    
    
    73,206
    
    
    
    41,781
    
    
    
    36,819
    
    
    
    35,014In-process research
and development and
milestone payments(3)
    
    
    1,000
    
    
    
    3,500
    
    
    
    
    
    
    
    4,350
    
    
    
    1,080Loss on program
termination(4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    312
    
    
    
    1,142Total operating costs
and expenses
    
    
    160,371
    
    
    
    122,339
    
    
    
    77,762
    
    
    
    72,297
    
    
    
    60,563Income (loss) from
operations
    
    
    15,998
    
    
    
    20,879
    
    
    
    (2,598
    )
    
    
    (20,812
    )
    
    
    (27,112
    )Gain on sale of investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,086
    
    
    
    122Gain on sale of Ridaura
product line(5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,002Interest and other income
(expense), net
    
    
    201
    
    
    
    (1,475
    )
    
    
    (426
    )
    
    
    1,039
    
    
    
    1,978Income (loss) before
income taxes
    
    
    16,199
    
    
    
    19,404
    
    
    
    (3,024
    )
    
    
    (17,687
    )
    
    
    (17,010
    )Income tax provision
(benefit)
    
    
    (9,922
    )
    
    
    1,469
    
    
    
    1,133
    
    
    
    181
    
    
    
    345Net income (loss)
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )
    
    $
    (17,868
    )
    
    $
    (17,355
    )Net income (loss) per
share:Basic
    
    $
    0.75
    
    
    $
    0.51
    
    
    $
    (0.13
    )
    
    $
    (0.58
    )
    
    $
    (0.58
    )Diluted
    
    $
    0.70
    
    
    $
    0.48
    
    
    $
    (0.13
    )
    
    $
    (0.58
    )
    
    $
    (0.58
    )Shares used to compute
basic and diluted net
income (loss) per share:Basic
    
    
    35,039
    
    
    
    35,036
    
    
    
    31,559
    
    
    
    30,757
    
    
    
    29,861Diluted(6)
    
    
    41,335
    
    
    
    37,443
    
    
    
    31,559
    
    
    
    30,757
    
    
    
    29,861
 40




---



##### Table of Contents



(1)
    
    In the second quarter of 2003, we received a one-time royalty payment from S.C. Johnson in
the amount of $2.9 million in connection with our aerosol spray technology.(2)
    
    In March 2004, we acquired exclusive U.S. rights to Soriatane, resulting in an intangible
asset that is being amortized over 10 years. Amortization charges for the Soriatane rights
were $12.8 million in 2005 and $10.6 million in 2004.(3)
    
    In May 2002, we entered into an agreement with Astellas Pharma Europe B.V. (formerly
Yamanouchi Europe, B.V.) to license Velac(R) Gel. In connection with this agreement we paid
Astellas an initial $2.0 million licensing fee in the second quarter of 2002 and recorded
another $2.0 million in the fourth quarter of 2002 when we initiated the Phase III trial for
Velac Gel. In the third quarter of 2004, we recorded an additional milestone payment of $3.5
million upon filing an NDA with the FDA. In December 2005, we paid $1.0 million to Astellas
in exchange for worldwide rights to Velac Gel.(4)
    
    In 2001, we recorded a net charge of $1.1 million representing costs accrued in connection
with a reduction in workforce and the wind down of development contracts related to our
discontinued Relaxin program.(5)
    
    In April 2001, we sold our rights to our product Ridaura for $9.0 million in cash plus a
royalty on annual sales in excess of $4.0 million through March 2006. We recognized a gain of
$8.0 million in connection with this transaction.(6)
    
    We compute diluted net income (loss) per share using the weighted average of all potential
shares of common stock outstanding during the period. We also include stock options and
convertible debt if they are dilutive in the calculation of diluted net income (loss) per
share. As part of the dilutive calculation we excluded interest expense related to the $90
million convertible debt, net of tax effect from net income, to arrive at adjusted net income
for purposes of computing diluted net income for the year ended December 31, 2005. See Note 3
Net Income (Loss) Per Share in the Notes to Consolidated Financial Statements contained in
this Report for the calculations for the years ended December 31, 2005, 2004 and 2003. The
years ended December 31, 2002 and 2001 do not have dilutive securities or interest expense
related to convertible debt.(7)
    
    The restatement for 2002 decreased net revenues by $1.3 million to $46.3 million, increased
net loss by $1.3 million to $17.9 million, and increased basic and diluted net loss per share
by $0.04 to $0.58. The restatement for 2001 decreased net revenues by $0.6 million to $30.3
million, increased net loss by $0.6 million to $17.4 million, and increased basic and diluted
net loss per share by $0.02 to $0.58. 41




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##### Table of Contents



2003
    
    2002
    
    20012005
    
    2004
    
    (Restated)
    
    (Restated)
    
    (Restated)(Restated)
    
    (Restated)
    
    (1)
    
    (1)
    
    (1)Consolidated Balance
Sheet Data:Cash, cash equivalents,
marketable securities and
restricted cash
    
    $
    275,155
    
    
    $
    76,346
    
    
    $
    114,966
    
    
    $
    33,788
    
    
    $
    48,476Working capital (2)
    
    
    245,564
    
    
    
    68,153
    
    
    
    110,299
    
    
    
    23,294
    
    
    
    43,413Total assets (2)
    
    
    457,489
    
    
    
    263,297
    
    
    
    150,744
    
    
    
    61,383
    
    
    
    72,983Convertible senior notes
    
    
    290,000
    
    
    
    90,000
    
    
    
    90,000
    
    
    
    
    
    
    
    Total stockholders equity
    
    
    99,917
    
    
    
    124,892
    
    
    
    43,806
    
    
    
    42,852
    
    
    
    60,741
 
 (1)
    
    As of December 31, 2003, the restatement reduced working capital by $1.9 million to
$110.3 million, and reduced total stockholders equity by $1.9 million to $43.8 million.
As of December 31, 2002, the restatement reduced working capital by $1.9 million to $23.3
million, increased total assets by $1.8 million to $61.4 million, and reduced total
stockholders equity by $1.9 million to $42.9 million. As of December 31, 2001, the
restatement reduced working capital by $0.6 million to $43.4 million, increased total
assets by $0.7 million to $73.0 million, and reduced total stockholders equity by $0.6
million to $60.7 million.(2)
    
    On the consolidated balance sheets, accruals for product returns and chargeback
accruals that were previously netted against accounts receivable have been reclassified to
product-related accruals. 42




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Revenue Reserves
    43




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##### Table of Contents



Immaterial Adjustments
  Impact of Restatement
 (in thousands)
 Rebates andYear ended December 31,
    
    Chargebacks
    
    
    Returns
    
    
    Total2001
    
    $
    250
    
    
    $
    363
    
    
    $
    6132002
    
    
    431
    
    
    
    847
    
    
    
    1,2782003
    
    
    (431
    )
    
    
    598
    
    
    
    1672004
    
    
    221
    
    
    
    916
    
    
    
    1,1372005
    
    
    6,964
    
    
    
    931
    
    
    
    7,895Total
    
    $
    7,435
    
    
    $
    3,655
    
    
    $
    11,090
 44




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##### Table of Contents



Year Ended December 31, 2005RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    183,312
    
    
    $
    (7,895
    )
    
    $
    
    
    
    $
    175,417Royalty and contract
    
    
    952
    
    
    
    
    
    
    
    
    
    
    
    952Total net revenues
    
    
    184,264
    
    
    
    (7,895
    )
    
    
    
    
    
    
    176,369Operating costs and expenses
    
    
    160,367
    
    
    
    
    
    
    
    4
    
    
    
    160,371Income from operations
    
    
    23,897
    
    
    
    (7,895
    )
    
    
    (4
    )
    
    
    15,998Interest and other income, net
    
    
    201
    
    
    
    
    
    
    
    
    
    
    
    201Income before income taxes
    
    
    24,098
    
    
    
    (7,895
    )
    
    
    (4
    )
    
    
    16,199Income tax benefit (b)
    
    
    (9,860
    )
    
    
    
    
    
    
    (62
    )
    
    
    (9,922
    )Net income
    
    $
    33,958
    
    
    $
    (7,895
    )
    
    $
    58
    
    
    $
    26,121Net income per share:Basic
    
    $
    0.97
    
    
    
    
    
    
    
    
    
    
    $
    0.75Diluted
    
    $
    0.89
    
    
    
    
    
    
    
    
    
    
    $
    0.70Shares used to compute basic and diluted net income per share:Basic
    
    
    35,039
    
    
    
    
    
    
    
    
    
    
    
    35,039Diluted
    
    
    41,335
    
    
    
    
    
    
    
    
    
    
    
    41,335
 
 (a)
    
    Net product revenues  The adjustment of $7.9 million represents an increase in our
revenue reserves of $7.0 million to capture additional liability for rebates and
chargebacks and $931,000 to capture additional liability for product returns.(b)
    
    Income tax provision (benefit)  The adjustment of $62,000 represents the tax effect of
the adjustments. Year Ended December 31, 2004RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    142,059
    
    
    $
    (1,137
    )
    
    $
    
    
    
    $
    140,922Royalty and contract
    
    
    2,296
    
    
    
    
    
    
    
    
    
    
    
    2,296Total net revenues
    
    
    144,355
    
    
    
    (1,137
    )
    
    
    
    
    
    
    143,218Operating costs and expenses
    
    
    122,372
    
    
    
    
    
    
    
    (33
    )
    
    
    122,339Income from operations
    
    
    21,983
    
    
    
    (1,137
    )
    
    
    33
    
    
    
    20,879Interest and other expense, net
    
    
    (1,475
    )
    
    
    
    
    
    
    
    
    
    
    (1,475
    )Income before income taxes
    
    
    20,508
    
    
    
    (1,137
    )
    
    
    33
    
    
    
    19,404Income tax provision (b)
    
    
    1,493
    
    
    
    
    
    
    
    (24
    )
    
    
    1,469Net income
    
    $
    19,015
    
    
    $
    (1,137
    )
    
    $
    57
    
    
    $
    17,935Net income per share:Basic
    
    $
    0.54
    
    
    
    
    
    
    
    
    
    
    $
    0.51Diluted
    
    $
    0.51
    
    
    
    
    
    
    
    
    
    
    $
    0.48Shares used to compute basic and diluted net income per share:Basic
    
    
    35,036
    
    
    
    
    
    
    
    
    
    
    
    35,036Diluted
    
    
    37,443
    
    
    
    
    
    
    
    
    
    
    
    37,443
 
 (a)
    
    Net product revenues  The adjustment of $1.1 million represents an increase in our
revenue reserves of $221,000 to capture additional liability for rebates and chargebacks
and $916,000 to capture additional liability for product returns.(b)
    
    Income tax provision (benefit)  The adjustment of $24,000 represents the tax effect of
the adjustments. 45




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##### Table of Contents



Year Ended December 31, 2003As
    
    
    RevenuePreviously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    66,606
    
    
    $
    (167
    )
    
    $
    
    
    
    $
    66,439Royalty and contract
    
    
    8,725
    
    
    
    
    
    
    
    
    
    
    
    8,725Total net revenues
    
    
    75,331
    
    
    
    (167
    )
    
    
    
    
    
    
    75,164Operating costs and expenses
    
    
    77,838
    
    
    
    
    
    
    
    (76
    )
    
    
    77,762Loss from operations
    
    
    (2,507
    )
    
    
    (167
    )
    
    
    76
    
    
    
    (2,598
    )Interest and other expense, net
    
    
    (426
    )
    
    
    
    
    
    
    
    
    
    
    (426
    )Loss before income taxes
    
    
    (2,933
    )
    
    
    (167
    )
    
    
    76
    
    
    
    (3,024
    )Income tax provision (b)
    
    
    1,167
    
    
    
    
    
    
    
    (34
    )
    
    
    1,133Net loss
    
    $
    (4,100
    )
    
    $
    (167
    )
    
    $
    110
    
    
    $
    (4,157
    )Net loss per share:Basic
    
    $
    (0.13
    )
    
    
    
    
    
    
    
    
    
    $
    (0.13
    )Diluted
    
    $
    (0.13
    )
    
    
    
    
    
    
    
    
    
    $
    (0.13
    )Shares used to compute basic
and diluted net loss per share:Basic
    
    
    31,559
    
    
    
    
    
    
    
    
    
    
    
    31,559Diluted
    
    
    31,559
    
    
    
    
    
    
    
    
    
    
    
    31,559
 
 (a)
    
    Net product revenues  The adjustment of $167,000 represents a decrease of $431,000 in
our revenue reserves for rebates and chargebacks, partially offset by an increase in our
revenue reserves of $598,000 to capture additional liability for product returns.(b)
    
    Income tax provision  The adjustment of $34,000 represents the tax effect of the
adjustments. (in millions)
 As PreviouslySignificant Revenue Adjustment,
    
    Reported
    
    
    Adjustment
    
    
    As RestatedSoriatane Medicaid reduction
    
    $
    3.4
    
    
    $
    (2.4
    )
    
    $
    1.0Soriatane return reduction
    
    
    3.6
    
    
    
    
    
    
    
    3.6Total Soriatane reserve reduction
    
    
    7.0
    
    
    
    (2.4
    )
    
    
    4.6Evoclin Medicaid reduction
    
    
    1.0
    
    
    
    (0.1
    )
    
    
    0.9
 EXECUTIVE SUMMARY
 Key Aspects of Our Business
   
    
    OLUX (clobetasol propionate) Foam, 0.05%, a super high-potency topical steroid
prescribed for the treatment of steroid responsive dermatological diseases of the scalp and
mild to moderate plaque-type psoriasis of non-scalp regions excluding the face and
intertriginous areas;
 46




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##### Table of Contents




    
    Luxíq (betamethasone valerate) Foam, 0.12%, a mid-potency topical steroid prescribed for
scalp dermatoses such as psoriasis, eczema and seborrheic dermatitis;
    
    Soriatane (acitretin), an oral medicine for the treatment of severe psoriasis; and
    
    Evoclin (clindamycin phosphate) Foam, 1%, a topical treatment for acne vulgaris.
     Certain Events in 2005 and Recent Developments
 Financing Matters.
   47




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##### Table of Contents



Clinical Trials.
    Marketing.
 48




---



##### Table of Contents



Litigation.
 Licensing.
 Acquisition of PediaMed Sales Organization.
 RESULTS OF OPERATIONS
 Net Revenues
  Years Ended December 31,2005
    
    
    2004
    
    
    2003(Restated)
    
    
    (Restated)
    
    
    (Restated)(Dollars in thousands)
    
    $
    
    
    % Change
    
    
    $
    
    
    % Change
    
    
    $Gross product revenues
    
    $
    226,567
    
    
    
    32
    %
    
    $
    171,862
    
    
    
    122
    %
    
    $
    77,516Managed care and Medicaid rebates
    
    
    (24,447
    )
    
    
    64
    %
    
    
    (14,891
    )
    
    
    120
    %
    
    
    (6,775
    )Cash discounts and other
    
    
    (10,239
    )
    
    
    *
    
    
    
    (3,785
    )
    
    
    104
    %
    
    
    (1,856
    )Product returns
    
    
    (9,867
    )
    
    
    55
    %
    
    
    (6,360
    )
    
    
    *
    
    
    
    (1,746
    )Chargebacks
    
    
    (6,597
    )
    
    
    12
    %
    
    
    (5,904
    )
    
    
    *
    
    
    
    (700
    )Net product revenues
    
    
    175,417
    
    
    
    24
    %
    
    
    140,922
    
    
    
    112
    %
    
    
    66,439
 
 *
    
    Percentage not meaningful. 49




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##### Table of Contents



Years Ended December 31,2005
    
    
    2004
    
    
    2003(Restated)
    
    
    (Restated)
    
    
    (Restated)(Dollars in thousands)
    
    $
    
    
    % Change
    
    
    $
    
    
    %Change
    
    
    $Net product revenues:Soriatane
    
    $
    69,864
    
    
    
    31
    %
    
    $
    53,462
    
    
    
    100
    %
    
    $
    OLUX Foam
    
    
    58,009
    
    
    
    (4
    %)
    
    
    60,733
    
    
    
    28
    %
    
    
    47,540Evoclin Foam
    
    
    24,783
    
    
    
    *
    
    
    
    2,838
    
    
    
    100
    %
    
    
    Luxíq Foam
    
    
    22,619
    
    
    
    (5
    %)
    
    
    23,756
    
    
    
    27
    %
    
    
    18,688Other
    
    
    142
    
    
    
    7
    %
    
    
    133
    
    
    
    (37
    %)
    
    
    211Total net product revenues
    
    
    175,417
    
    
    
    24
    %
    
    
    140,922
    
    
    
    112
    %
    
    
    66,439Royalty and contract revenues:Royalty
    
    
    571
    
    
    
    (69
    %)
    
    
    1,839
    
    
    
    (76
    %)
    
    
    7,788Contract
    
    
    381
    
    
    
    (17
    %)
    
    
    457
    
    
    
    (51
    %)
    
    
    937Total royalty and contract revenues
    
    
    952
    
    
    
    (59
    %)
    
    
    2,296
    
    
    
    (74
    %)
    
    
    8,725Total net revenues
    
    $
    176,369
    
    
    
    23
    %
    
    $
    143,218
    
    
    
    91
    %
    
    $
    75,164
 
 *
    
    Percentage not meaningful.      50




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##### Table of Contents



Product
    
    Months on HandSoriatane
    
    
    4.2OLUX Foam
    
    
    4.6Evoclin Foam
    
    
    4.3Luxíq Foam
    
    
    5.4Weighted average for all products
    
    
    4.6
   51




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##### Table of Contents



Royalty and Contract Revenues
    Cost of Product Revenues
  Years Ended December 31,2005
    
    2004
    
    2003As a % of Net
    
    
    
    
    
    As a % of Net
    
    
    
    
    
    As a % of NetProduct
    
    
    
    
    
    Product
    
    
    
    
    
    Product(Dollars in thousands)
    
    $
    
    Revenues
    
    $
    
    Revenues
    
    $
    
    RevenuesCost of product
revenues (excluding
amortization of
acquired product
rights)
    
    $
    16,292
    
    
    
    9
    %
    
    $
    12,623
    
    
    
    9
    %
    
    $
    5,053
    
    
    
    8
    %
    52




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##### Table of Contents



Amortization of Intangible Assets
  Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $Amortization of intangible assets
    
    $
    13,598
    
    
    
    19
    %
    
    $
    11,471
    
    
    
    *
    
    
    $
    819
 
 *
    
    Percentage not meaningful.   Research and Development
  Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $Research and development expenses
    
    $
    31,915
    
    
    
    48
    %
    
    $
    21,539
    
    
    
    (29
    )%
    
    $
    30,109
   53




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##### Table of Contents



Years Ended December 31,(In
millions)                                                Category
    
    2005
    
    2004
    
    2003Preclinical and clinical research in the development of new dermatology products
    
    $
    14.7
    
    
    $
    6.4
    
    
    $
    13.0Optimization of manufacturing and process development for existing dermatology products
    
    
    5.0
    
    
    
    2.7
    
    
    
    2.8Quality assurance and quality control in the maintenance and enhancement of existing
dermatology products
    
    
    4.0
    
    
    
    4.9
    
    
    
    5.2Manufacturing, process development and optimization of dermatology products under development
    
    
    3.7
    
    
    
    3.6
    
    
    
    2.1Regulatory review of new and existing dermatology products
    
    
    4.1
    
    
    
    2.7
    
    
    
    1.6Basic research and formulation of new dermatology products
    
    
    1.6
    
    
    
    1.6
    
    
    
    1.3Quality assurance and quality control in the development of new dermatology products
    
    
    1.5
    
    
    
    1.8
    
    
    
    2.0
  Accumulated Program-Estimated
    
    RelatedCompletion of
    
    Research andPhase of
    
    Phase III
    
    DevelopmentDescription
    
    Development
    
    Clinical Trials
    
    Expenses through 2005Desilux(TM) (desonide), VersaFoam-EF, 0.05%
    
    NDA filed
    
    Completed
    
    $7.8 millionPrimolux (clobetasol propionate) VersaFoam-EF, 0.05%
    
    Data Analysis
    
    Completed
    
    $6.0 millionExtina(R) (ketoconazole) VersaFoam, 2%
    
    Phase III
    
    August 2006
    
    $2.4 millionPreclinical research and development for multiple
dermatological indications
    
    Preclinical
    
    N/A
    
    $3.2 million
 Risk Factors  We cannot sell our current products and product candidates
if we do not obtain and maintain governmental approvals,  We may spend a significant amount of
money to obtain FDA and other regulatory approvals, which may never be granted,  Failure to
obtain such regulatory approvals could adversely affect our prospects for future revenue growth.
We rely on third parties to conduct clinical trials for our product candidates, and those third
parties may not perform satisfactorily,  If those third parties do not perform satisfactorily,
it may significantly delay commercialization of our products, increase expenditures and negatively
affect our prospects for future revenue growth  Our continued growth depends on our ability
to develop new products, and if we are unable to develop new products, our expenses may exceed our
revenues without any return on the investment.
 54




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Selling, General and Administrative Expenses
  Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $Selling, general and administrative expenses
    
    $
    97,566
    
    
    
    33
    %
    
    $
    73,206
    
    
    
    75
    %
    
    $
    41,781
  
    
    increased direct and indirect promotional capabilities ($7.8 million),
    
    increased marketing and sales activities such as advertising, tradeshows and
conventions ($5.7 million),
    
    increased expenses related to market research and product sampling ($4.6 million),
    
    increased labor and benefit expenses, primarily due to increased headcount in the
marketing, general and administrative departments ($2.3 million), and
    
    increased outside legal, audit and tax expenses ($1.0 million).
  
    
    increased direct and indirect promotional capabilities ($11.0 million),
    
    increased marketing and sales activities such as advertising, tradeshows and
conventions ($4.1 million),
 
    
    increased labor and benefit expenses, primarily due to increased headcount in the
marketing, general and administrative departments ($2.4 million),
    
    increased outside legal, audit and tax expenses ($1.9 million),
    
    increased expenses related to product sampling ($1.8 million), and
    
    increased business insurance costs ($1.1 million).
  55




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In-Process Research and Development and Milestone Payments
  Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $In-process research
and development and
milestone payments
    
    $
    1,000
    
    
    
    (71
    )%
    
    $
    3,500
    
    
    
    *
    
    
    
    
 
 *
    
    Percentage not meaningful.   Interest and other income (expense), net
 Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $Interest and other income (expense), netInterest income
    
    $
    6,981
    
    
    
    485
    %
    
    $
    1,194
    
    
    
    23
    %
    
    $
    972Interest expense
    
    
    (6,504
    )
    
    
    134
    %
    
    
    (2,778
    )
    
    
    70
    %
    
    
    (1,632
    )Other income (expense), net
    
    
    (276
    )
    
    
    (353
    )%
    
    
    109
    
    
    
    (53
    )%
    
    
    234
 Interest Income.
 Interest Expense.
 56




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##### Table of Contents



Provision for (Benefit from) Income Taxes
 Years Ended December 31,2005
    
    2004
    
    2003(Dollars in thousands)
    
    $
    
    % Change
    
    $
    
    % Change
    
    $Income tax provision (benefit)
    
    $
    (9,922
    )
    
    
    *
    
    
    $
    1,469
    
    
    
    30
    %
    
    $
    1,133
 
 *
    
    Percentage not meaningful.     Note 12 of Notes to Consolidated Financial
Statements
 LIQUIDITY AND CAPITAL RESOURCES
 December 31,2005
    
    2004(Dollars in thousands)
    
    $
    
    % Change
    
    $Cash, cash equivalents and marketable securities
    
    $
    271,096
    
    
    
    275
    %
    
    $
    72,383
 Sources and Uses of Cash.
  57




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Fluctuation in Current Assets
    
    Explanation$17.3 million decrease  gross accounts receivable
    
    Decrease is primarily
a result of a lower
level of the fourth
quarters shipments
occurring in December
2005 as compared to
December 2004.
Specifically, December
2005 shipments
represented only 16%
of gross revenues for
the fourth quarter of
2005, whereas December
2004 shipments
accounted for 48% of
gross revenues for the
fourth quarter of
2004.$16.2 million increase  prepaid expenses and other current assets
    
    Includes a recorded
tax asset of
approximately $9.9
million; increases are
primarily a result of
growth in our business
and related expenses.$2.4 million increase  inventory
    
    Increase is related to
an increase in our
business activity.
 Increases in Liabilities
    
    Explanation$13.8 million increase  product-related accruals
    
    Product-related accruals
increased as a function
of our increased product
revenues. Other
increases are a result
of the increase in our
business activity.$4.0 million increase  accounts payable
    
    Increase is related to
an increase in our
business activity and
timing of payments made.$2.8 million increase  other accrued liabilities
    
    Increase is related to
an increase in our
business activity and
timing of payments made.
    58




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Contractual Obligations and Commercial Commitments
  Payments Due by PeriodLess
    
    
    
    
    
    
    
    
    
    
    MoreThan
    
    
    
    
    
    
    
    
    
    
    Than(In millions)Contractual Obligations
    
    Total
    
    
    1 Year
    
    
    1 - 3 Years
    
    
    3 - 5 Years
    
    
    5 YearsLong-Term Debt Obligations(1)
    
    $
    311.9
    
    
    $
    6.0
    
    
    $
    100.9
    
    
    $
    5.0
    
    
    $
    200.0Operating Lease Obligations(2)
    
    
    18.8
    
    
    
    3.8
    
    
    
    5.0
    
    
    
    3.2
    
    
    
    6.8Purchase Obligations(3)(4)
    
    
    27.4
    
    
    
    21.3
    
    
    
    3.0
    
    
    
    1.7
    
    
    
    1.4Total Contractual Cash Obligations
    
    $
    358.1
    
    
    $
    31.1
    
    
    $
    108.9
    
    
    $
    9.9
    
    
    $
    208.2
 
 (1)
    
    Long-Term Debt Obligations refer to the convertible senior notes that we issued in 2003
and 2005. The 2005 Notes bear interest at a rate of 2.00% per annum for the initial five
year period, which is payable in arrears on March 30 and September 30 of each year until
March 30, 2010. We made the first interest payment on September 30, 2005. For the
remaining five-year period commencing on March 30, 2010, we will pay contingent interest
for six-month periods if the average trading price of a note is above a specified level for
a specified period prior to the six-month period. No contingent interest is included in
the table above. In addition, beginning on March 30, 2010, the original principal amount
will be increased at a rate that provides holders with an aggregate annual yield to
maturity of 2.00%. The amounts reflected above include annual interest payments of
approximately $4 million per year through 2009 and $1 million for interest in 2010 assuming
that the notes are redeemed or converted before maturity. No contingent interest or
accretion is included in the table above as the debt is callable by the Company in 2010.The 2003 Notes bear interest at a rate of 2.25% per annum, which is payable
semi-annually in arrears on May 30 and November 30 of each year, beginning November 30,
2003. The 2003 Notes are convertible at any time at the option of note holders into
shares of our common stock at a conversion rate of 46.705 shares for each $1,000
principal amount of notes, subject to adjustment in certain circumstances, which is
equivalent to a conversion price of approximately $21.41 per share. The amounts
reflected above include annual interest payments of approximately $2 million per year,
assuming that the notes are not redeemed or converted before maturity.(2)
    
    In June 2004, we signed a series of non-cancelable facility lease agreements to lease
approximately 96,000 square feet of space in Palo Alto, California that we occupied in
February 2005. We sublease an additional 19,447 square feet of office space which we have
not occupied in Palo Alto; payment under this sublease commenced on January 1, 2006. Under
our agreement with DPT, we are also obligated to pay approximately $56,000 per year in rent
for the pro rataportion of DPTs facility allocated to the aerosol line. Under the DPT
agreement, we will pay rent for the term of the agreement or as long as we own the
associated assets, whichever is longer. We also lease various automobiles and office
equipment under similar leases, expiring through 2008.(3)
    
    In March 2002 we entered into a manufacturing and supply agreement with DPT that
requires minimum purchase commitments, beginning six months after the opening of the
commercial production line and continuing for 10 years. Also in 2002 we entered into a
license agreement that requires minimum royalty payments beginning in 2005 and continuing
for fifteen years, unless the agreement is terminated earlier by either party. In 2003, we
entered into a five year service agreement for prescription information that requires
minimum fees. We paid $14.9 million, $4.3 million and $2.2 million related to these
agreements for the years ended December 31, 2005, 2004 and 2003, respectively.(4)
    
    In connection with our manufacturing and supply agreements with our three suppliers,
KIK, DPT and Roche, we may incur penalties related to cancellation of purchase orders,
including paying an amount equal to the entire cancelled purchase order. We did not incur
any penalties related to the cancellation of purchase orders for KIK, DPT or Roche for the
years 59




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##### Table of Contents



ended December 31, 2005, 2004 and 2003, respectively. We had approximately $19.0
million in outstanding open purchase orders to our suppliers at December 31, 2005 and the
entire amount is included in the table in the Less Than 1 Year column.   OFF-BALANCE SHEET ARRANGEMENTS
  SUBSEQUENT EVENTS
 PediaMed
Sales Organization Acquisition
  Notices of Default and Consent Solicitation
  60




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RECENT ACCOUNTING PRONOUNCEMENTS
    61




---



##### Table of Contents



CRITICAL ACCOUNTING POLICIES AND ESTIMATES
   Revenue Recognition
   62




---



##### Table of Contents



Gross-to-Net Sales Adjustments
  Returns
     Managed Care Rebates
  63




---



##### Table of Contents



Medicaid Rebates
   Chargebacks
   64




---



##### Table of Contents



Cash Discounts
  Other Adjustments
  Use of Information from External Sources
   65




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##### Table of Contents



Use of Estimates in Reserves
 See Results of Operations, Revenues for
additional detail on changes in our revenue reserves and the related impact on net revenues.
 Goodwill, Purchased Intangibles and Other Long-Lived Assets  Impairment Assessments
    66




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Provision for (Benefit from) Income Taxes
   
 Item 8. Financial Statements and Supplementary Data
 Item 15(a) Index to Consolidated Financial
Statements.
 
 Item 9A. Controls and Procedures
 Disclosure Controls and Procedures
  67




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Management s Report on Internal Control Over Financial Reporting (Restated)
    68




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##### Table of Contents



Changes in Internal Control over Financial Reporting
  Remediation of Material Weaknesses
  
    
    we modified the methodology used to estimate accruals for rebates and chargebacks to
fully capture the future liability related to product inventory in the distribution
channel and other factors, including anticipated price increases for our products and
estimated future usage of our products by patients enrolled in Medicaid programs and
contracted managed care organizations;
    
    with respect to the accrual for product returns, we revised our methodology (a) to
estimate the return rate on our most recent three years data, resulting in an
estimated rate that is more responsive to current return trends, (b) to apply the rate
to production lots, (c) to consider the relevant risk of return, and (d) to take into
account current price and anticipated price increases;
    
    we designated an individual with significant industry
experience as our Senior Revenue Manager with specific responsibility
for managing our revenue-reserves estimation process, and increased
the involvement of our Vice President, Finance and Administration in the estimation
process; and
    
    we engaged external consultants to assist us in revising our methodologies to ensure
we considered all relevant factors and that the computational aspects of the models were
appropriate.
  
    
    significantly increase the level of involvement and intradepartmental communication
in a way that will foster improved shared information between our
finance department and
other departments, including, but not limited to, commercial operations, specifically
personnel involved in our sales operations, managed care and manufacturing activities;
 69




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##### Table of Contents




    
    train all relevant finance and commercial operations personnel regarding the new
revenue-reserves methodologies and the controls and procedures surrounding channel
inventory and product returns;
    
    develop formal policies regarding the preparation and maintenance of contemporaneous
documentation supporting orders, demand forecasts, inventory, and information necessary
for the calculation of revenue reserves;
    
    perform periodic regular reconciliations of our inventory data with third party
wholesalers inventory reports; and
    
    hire additional finance and commercial personnel with specific, relevant industry
experience to manage the more sophisticated methodologies adopted in connection with
the restatement of our financial statements.
  70




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REPORT OF ERNST & YOUNG LLP,
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
       71




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72




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PART IV
 
 Item 15. Exhibits and Financial Statement Schedules
 (a) Financial Statements.
 PageReport of Independent Registered Public Accounting Firm
    
    F-2Consolidated Balance Sheets as of December 31, 2005 and 2004 (restated)
    
    F-3Consolidated Statements of Operations for each of the three years in the period ended December 31, 2005 (restated)
    
    F-4Consolidated Statements of Stockholders Equity for each of the three years in the period ended December 31, 2005 (restated)
    
    F-5Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2005 (restated)
    
    F-7Notes to Consolidated Financial Statements (restated)
    
    F-8
 Financial Statement Schedules.
 Schedule II  Valuation and Qualifying Accounts
 AdditionsBalance at
    
    Charged toAllowance for Doubtful
    
    Start of
    
    Expense/Revenue
    
    
    
    
    
    Balance atAccounts and Cash Discounts
    
    Period
    
    Net of Reversals
    
    Utilizations
    
    End of PeriodYear ended December 31,2005 (restated)
    
    $
    708,000
    
    
    $
    4,962,000
    
    
    $
    (5,140,000
    )
    
    $
    530,0002004 (restated)
    
    $
    210,000
    
    
    $
    3,463,000
    
    
    $
    (2,965,000
    )
    
    $
    708,0002003 (restated)
    
    $
    212,000
    
    
    $
    1,550,000
    
    
    $
    (1,552,000
    )
    
    $
    210,000
  (b) Exhibits. See Index to Exhibits.
 (c) Financial
Statements Schedules. See Item 15(a)(2), above.
 73




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SIGNATURES
  Connetics Corporationa Delaware corporationBy:
    
    /s/ John L. HigginsJohn L. HigginsChief Financial OfficerExecutive Vice President, Financeand Corporate Development
  74




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##### Table of Contents



CONNETICS CORPORATION
Form 10-K/A
 
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
  PageReport of Independent Registered Public Accounting Firm
    
    F-2Consolidated Balance Sheets as of December 31, 2005 and 2004 (restated)
    
    F-3Consolidated Statements of Operations for each the three years in the
period ended December 31, 2005 (restated)
    
    F-4Consolidated Statements of Stockholders Equity for each of the three
years in the period ended December 31, 2005 (restated)
    
    F-5Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 2005 (restated)
    
    F-7Notes to Consolidated Financial Statements (restated)
    
    F-8
 F-1




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REPORT OF ERNST & YOUNG LLP,
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
       
 F-2




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##### Table of Contents



CONNETICS CORPORATION
 
 CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
 December 31,2005
    
    
    2004(Restated)
    
    
    (Restated)AssetsCurrent assets:Cash and cash equivalents
    
    $
    29,988
    
    
    $
    18,261Marketable securities
    
    
    241,108
    
    
    
    54,122Restricted cash  current
    
    
    1,000
    
    
    
    1,000Accounts receivable, net of cash discounts and allowances of $530 in 2005 and $708 in 2004
    
    
    11,100
    
    
    
    28,191Inventory
    
    
    7,485
    
    
    
    5,020Prepaid expenses
    
    
    8,451
    
    
    
    7,581Other current assets
    
    
    13,487
    
    
    
    1,963Total current assets
    
    
    312,619
    
    
    
    116,138Property and equipment, net
    
    
    14,438
    
    
    
    11,830Restricted cash  long term
    
    
    3,059
    
    
    
    2,963Debt issuance costs, deposits and other assets
    
    
    12,313
    
    
    
    3,707Goodwill and other intangible assets, net
    
    
    115,060
    
    
    
    128,659Total assets
    
    $
    457,489
    
    
    $
    263,297Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    16,609
    
    
    $
    13,521Accrued liabilities related to acquisition of product rights
    
    
    1,867
    
    
    
    2,710Accrued payroll and related expenses
    
    
    6,193
    
    
    
    5,746Product-related accruals
    
    
    35,371
    
    
    
    21,621Accrued clinical trial costs
    
    
    1,117
    
    
    
    751Other accrued liabilities
    
    
    5,898
    
    
    
    3,636Total current liabilities
    
    
    67,055
    
    
    
    47,985Convertible senior notes
    
    
    290,000
    
    
    
    90,000Other non-current liabilities
    
    
    517
    
    
    
    420Commitments and contingenciesStockholders equity:Preferred stock, $0.001 par value:5,000,000 shares authorized; none issued or outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value; 100,000,000 shares authorized; 36,751,458 and 35,874,633
shares issued and 33,537,255 and 35,792,730 outstanding at December 31, 2005 and 2004,
respectively
    
    
    37
    
    
    
    36Treasury stock, at cost; 3,214,203 and 81,903 at December 31, 2005 and 2004, respectively
    
    
    (60,447
    )
    
    
    (1,060
    )Additional paid-in capital
    
    
    247,880
    
    
    
    238,726Deferred stock compensation
    
    
    
    
    
    
    (13
    )Accumulated deficit
    
    
    (88,080
    )
    
    
    (114,201
    )Accumulated other comprehensive income
    
    
    527
    
    
    
    1,404Total stockholders equity
    
    
    99,917
    
    
    
    124,892Total liabilities and stockholders equity
    
    $
    457,489
    
    
    $
    263,297
 See accompanying Notes to Consolidated Financial Statements.
 F-3




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##### Table of Contents



CONNETICS CORPORATION
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 Years Ended December 31,2005
    
    
    2004
    
    
    2003(Restated)
    
    
    (Restated)
    
    
    (Restated)Net revenues:Product
    
    $
    175,417
    
    
    $
    140,922
    
    
    $
    66,439Royalty and contract
    
    
    952
    
    
    
    2,296
    
    
    
    8,725Total net revenues
    
    
    176,369
    
    
    
    143,218
    
    
    
    75,164Operating costs and expenses:Cost of product revenues (excluding amortization of acquired product rights)
    
    
    16,292
    
    
    
    12,623
    
    
    
    5,053Amortization of intangible assets
    
    
    13,598
    
    
    
    11,471
    
    
    
    819Research and development
    
    
    31,915
    
    
    
    21,539
    
    
    
    30,109Selling, general and administrative
    
    
    97,566
    
    
    
    73,206
    
    
    
    41,781In-process research and development and milestone payments
    
    
    1,000
    
    
    
    3,500
    
    
    
    Total operating costs and expenses
    
    
    160,371
    
    
    
    122,339
    
    
    
    77,762Income (loss) from operations
    
    
    15,998
    
    
    
    20,879
    
    
    
    (2,598
    )Interest and other income (expense):Interest income
    
    
    6,981
    
    
    
    1,194
    
    
    
    972Interest expense
    
    
    (6,504
    )
    
    
    (2,778
    )
    
    
    (1,632
    )Other income (expense), net
    
    
    (276
    )
    
    
    109
    
    
    
    234Income (loss) before income taxes
    
    
    16,199
    
    
    
    19,404
    
    
    
    (3,024
    )Income tax provision (benefit)
    
    
    (9,922
    )
    
    
    1,469
    
    
    
    1,133Net income (loss)
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )Net income (loss) per share:Basic
    
    $
    0.75
    
    
    $
    0.51
    
    
    $
    (0.13
    )Diluted
    
    $
    0.70
    
    
    $
    0.48
    
    
    $
    (0.13
    )Shares used to compute basic and diluted net income (loss) per share:Basic
    
    
    35,039
    
    
    
    35,036
    
    
    
    31,559Diluted
    
    
    41,335
    
    
    
    37,443
    
    
    
    31,559
 See accompanying Notes to Consolidated Financial Statements.
 F-4




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CONNETICS CORPORATION
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In thousands)
 Number of
    
    
    
    
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    TotalCommon
    
    
    Common
    
    
    Treasury
    
    
    Paid-In
    
    
    Deferred
    
    
    Accumulated
    
    
    Other
    
    
    StockholdersShares
    
    
    Stock
    
    
    Stock, at
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    Comprehensive
    
    
    EquityOutstanding
    
    
    Amount
    
    
    Cost
    
    

(Restated)
    
    
    Compensation
    
    
    (Restated)
    
    
    Income
    
    
    (Restated)Balance
at January 1, 2003, as
originally reported
    
    
    31,180
    
    
    $
    31
    
    
    $
    (458
    )
    
    $
    170,227
    
    
    $
    (48
    )
    
    $
    (126,088
    )
    
    $
    1,079
    
    
    $
    44,743Restatement (see
Note 2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,891
    )
    
    
    
    
    
    
    (1,891
    )Balance at January
1, 2003, as
restated
    
    
    31,180
    
    
    
    31
    
    
    
    (458
    )
    
    
    170,227
    
    
    
    (48
    )
    
    
    (127,979
    )
    
    
    1,079
    
    
    
    42,852Common stock issued
under stock option
and purchase plans
    
    
    674
    
    
    
    1
    
    
    
    (186
    )
    
    
    4,344
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,159Exercise of warrants
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    153
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153Stock compensation
expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    17Comprehensive loss:Net loss
(Restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,157
    )
    
    
    
    
    
    
    (4,157
    )Unrealized loss on
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (167
    )
    
    
    (167
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    949
    
    
    
    949Total comprehensive
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,375
    )Balance at December
31, 2003
    
    
    31,885
    
    
    
    32
    
    
    
    (644
    )
    
    
    174,724
    
    
    
    (31
    )
    
    
    (132,136
    )
    
    
    1,861
    
    
    
    43,806Common stock issued
under stock option
and purchase plans
    
    
    858
    
    
    
    1
    
    
    
    (416
    )
    
    
    6,763
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,348Tax benefit on
stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213Issuance of common
stock through
private placement
    
    
    3,000
    
    
    
    3
    
    
    
    
    
    
    
    56,901
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,904Exercise of warrants
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    125
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    125Stock compensation
expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    18Comprehensive
income:Net income
(Restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,935
    
    
    
    
    
    
    
    17,935Unrealized loss on
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (583
    )
    
    
    (583
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    126
    
    
    
    126
 F-5




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##### Table of Contents



Number of
    
    
    
    
    
    
    
    
    
    

    Additional
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    
    TotalCommon
    
    
    Common
    
    
    Treasury
    
    
    Paid-in
    
    
    Deferred
    
    
    Accumulated
    
    
    Other
    
    
    StockholdersShares
    
    
    Stock
    
    
    Stock, at
    
    
    Capital
    
    
    Stock
    
    
    Deficit
    
    
    Comprehensive
    
    
    EquityOutstanding
    
    
    Amount
    
    
    Cost
    
    
    (Restated)
    
    
    Compensation
    
    
    (Restated)
    
    
    Income
    
    
    (Restated)Total comprehensive
income

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,478Balance at December
31, 2004
    
    
    35,793
    
    
    
    36
    
    
    
    (1,060
    )
    
    
    238,726
    
    
    
    (13
    )
    
    
    (114,201
    )
    
    
    1,404
    
    
    
    124,892Common stock issued
under stock option
and purchase plans
    
    
    876
    
    
    
    1
    
    
    
    
    
    
    
    8,640
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,641Repurchase of
common stock
    
    
    (3,132
    )
    
    
    
    
    
    
    (59,387
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (59,387
    )Tax benefit on
stock options (Restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    514
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    514Stock compensation
expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    13Comprehensive
income:Net income
(restated)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,121
    
    
    
    
    
    
    
    26,121Unrealized loss on
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (725
    )
    
    
    (725
    )Foreign currency
translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (152
    )
    
    
    (152
    )Total comprehensive
income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,244Balance at December
31, 2005
    
    
    33,537
    
    
    $
    37
    
    
    $
    (60,447
    )
    
    $
    247,880
    
    
    $
    
    
    
    $
    (88,080
    )
    
    $
    527
    
    
    $
    99,917
 See accompanying Notes to Consolidated Financial Statements.
 F-6




---



##### Table of Contents



CONNETICS CORPORATION
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 Years Ended December 31,2005
    
    
    2004
    
    
    2003(Restated)
    
    
    (Restated)
    
    
    (Restated)Cash flows from operating activities:Net income (loss)
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:Depreciation
    
    
    1,773
    
    
    
    1,433
    
    
    
    1,422Amortization of intangible assets
    
    
    13,598
    
    
    
    11,471
    
    
    
    819Amortization
of convertible senior notes issuance costs
    
    
    1,271
    
    
    
    708
    
    
    
    430Accruals and allowances for discounts, returns and chargebacks
    
    
    (177
    )
    
    
    499
    
    
    
    (3
    )Stock compensation expense
    
    
    13
    
    
    
    18
    
    
    
    17Changes in assets and liabilities:Accounts receivable
    
    
    17,279
    
    
    
    (21,274
    )
    
    
    (1,277
    )Inventory
    
    
    (2,390
    )
    
    
    (3,631
    )
    
    
    (493
    )Prepaids and other assets
    
    
    (16,157
    )
    
    
    (4,698
    )
    
    
    (3,304
    )Accounts payable
    
    
    4,020
    
    
    
    9,806
    
    
    
    (4,275
    )Product-related accruals
    
    
    13,750
    
    
    
    14,332
    
    
    
    3,205Accrued and other current liabilities
    
    
    2,379
    
    
    
    2,629
    
    
    
    (156
    )Deferred revenue
    
    
    345
    
    
    
    89
    
    
    
    (739
    )Other non-current liabilities
    
    
    95
    
    
    
    404
    
    
    
    Net cash provided by (used in) operating activities
    
    
    61,920
    
    
    
    29,721
    
    
    
    (8,511
    )Cash flows from investing activities:Purchases of marketable securities
    
    
    (358,030
    )
    
    
    (62,472
    )
    
    
    (135,352
    )Sales and maturities of marketable securities
    
    
    170,319
    
    
    
    104,483
    
    
    
    62,909Purchases of property and equipment
    
    
    (4,515
    )
    
    
    (7,638
    )
    
    
    (959
    )Transfer from (to) restricted cash
    
    
    (96
    )
    
    
    (3,659
    )
    
    
    420Acquisition of patent and product rights
    
    
    
    
    
    
    (123,529
    )
    
    
    (200
    )Net cash used in investing activities
    
    
    (192,322
    )
    
    
    (92,815
    )
    
    
    (73,182
    )Cash flows from financing activities:Proceeds from issuance of convertible senior notes, net of issuance costs
    
    
    193,085
    
    
    
    
    
    
    
    86,316Proceeds from issuance of common stock in private placement, net of issuance costs
    
    
    
    
    
    
    56,901
    
    
    
    Proceeds from issuance of common stock from the exercise of stock options and
employee stock purchase plan, net of repurchases of unvested shares
    
    
    8,641
    
    
    
    6,476
    
    
    
    4,312Purchases of treasury stock
    
    
    (59,387
    )
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    142,339
    
    
    
    63,377
    
    
    
    90,628Effect of foreign currency exchange rates on cash and cash equivalents
    
    
    (210
    )
    
    
    32
    
    
    
    387Net change in cash and cash equivalents
    
    
    11,727
    
    
    
    315
    
    
    
    9,322Cash and cash equivalents at beginning of year
    
    
    18,261
    
    
    
    17,946
    
    
    
    8,624Cash and cash equivalents at end of year
    
    $
    29,988
    
    
    $
    18,261
    
    
    $
    17,946Supplementary information:Interest paid
    
    $
    4,025
    
    
    $
    2,030
    
    
    $
    1,028Income taxes paid
    
    $
    710
    
    
    $
    1,061
    
    
    $
    1,541
 See accompanying Notes to Consolidated Financial Statements.
 F-7




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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
 Note 1. Organization and Development of the Company
 (see Note 5)
 Note 2. Restatement
  Revenue Reserves
   F-8




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##### Table of Contents



Immaterial Adjustments
  (in thousands):
 December 31, 2005RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedAccounts receivable, net of cash
discounts and allowances of $530
(a)
    
    $
    11,100
    
    
    $
    
    
    
    $
    
    
    
    $
    11,100Other current assets
    
    
    301,452
    
    
    
    
    
    
    
    67
    
    
    
    301,519Long-term assets
    
    
    144,870
    
    
    
    
    
    
    
    
    
    
    
    144,870Total assets
    
    
    457,422
    
    
    
    
    
    
    
    67
    
    
    
    457,489Product-related
accruals (a), (b), (c)
    
    
    24,281
    
    
    
    11,090
    
    
    
    
    
    
    
    35,371Other
current liabilities (c)
    
    
    31,851
    
    
    
    
    
    
    
    (167
    )
    
    
    31,684Long-term liabilities
    
    
    290,517
    
    
    
    
    
    
    
    
    
    
    
    290,517Total liabilities
    
    
    346,649
    
    
    
    11,090
    
    
    
    (167
    )
    
    
    357,572Accumulated deficit
    
    
    (77,215
    )
    
    
    (11,090
    )
    
    
    225
    
    
    
    (88,080
    )Other stockholders equity
    
    
    187,988
    
    
    
    
    
    
    
    9
    
    
    
    187,997Total stockholders equity
    
    
    110,773
    
    
    
    (11,090
    )
    
    
    234
    
    
    
    99,917Total liabilities and
stockholders equity
    
    $
    457,422
    
    
    $
    
    
    
    $
    67
    
    
    $
    457,489
 
 (a)
    
    Accruals for product returns and chargebacks were previously netted against
accounts receivable and have been reclassified to product-related accruals. F-9




---



##### Table of Contents



(b)
    
    Product-related accruals  The adjustment of $11.1 million represents $7.4 million
related to an increase in our rebates and chargebacks reserve and $3.7 million related to
an increase in our returns reserve.(c)
    
    Accruals for payments due to wholesalers under distribution
service agreements that were previously included as other accrued
liabilities have been reclassified to product-related accruals. (in thousands, except per share amounts)
 Year Ended December 31, 2005RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    183,312
    
    
    $
    (7,895
    )
    
    $
    
    
    
    $
    175,417Royalty and contract
    
    
    952
    
    
    
    
    
    
    
    
    
    
    
    952Total net revenues
    
    
    184,264
    
    
    
    (7,895
    )
    
    
    
    
    
    
    176,369Operating costs and expenses
    
    
    160,367
    
    
    
    
    
    
    
    4
    
    
    
    160,371Income (loss) from operations
    
    
    23,897
    
    
    
    (7,895
    )
    
    
    (4
    )
    
    
    15,998Interest and other income (expense), net
    
    
    201
    
    
    
    
    
    
    
    
    
    
    
    201Income (loss) before income taxes
    
    
    24,098
    
    
    
    (7,895
    )
    
    
    (4
    )
    
    
    16,199Income tax provision (benefit) (b)
    
    
    (9,860
    )
    
    
    
    
    
    
    (62
    )
    
    
    (9,922
    )Net income (loss)
    
    $
    33,958
    
    
    $
    (7,895
    )
    
    $
    58
    
    
    $
    26,121Net income (loss) per share:Basic
    
    $
    0.97
    
    
    
    
    
    
    
    
    
    
    $
    0.75Diluted
    
    $
    0.89
    
    
    
    
    
    
    
    
    
    
    $
    0.70Shares used to compute basic and diluted
net income (loss) per share:Basic
    
    
    35,039
    
    
    
    
    
    
    
    
    
    
    
    35,039Diluted
    
    
    41,335
    
    
    
    
    
    
    
    
    
    
    
    41,335
 
 (a)
    
    Net product revenues  The adjustment of $7.9 million represents an increase in our
revenue reserves of $7.0 million related to an increase in our rebates and chargebacks
reserve and $931,000 related to an increase in our returns reserve.(b)
    
    Income tax provision (benefit)  The adjustment of $62,000 represents the tax effect of
the other adjustments. F-10




---



##### Table of Contents



Three Months Ended March 31, 2005
    
    
    Three Months Ended June 30, 2005(unaudited)
    
    
    (unaudited)As
    
    
    Revenue
    
    
    
    
    
    
    As
    
    
    RevenuePreviously
    
    
    Reserve
    
    
    As
    
    
    Previously
    
    
    Reserve
    
    
    AsReported
    
    
    Adjustments
    
    
    Restated
    
    
    Reported
    
    
    Adjustments
    
    
    Restated(a)
    
    
    
    
    
    
    
    
    
    
    (b)Net product revenues:Soriatane
    
    $
    17,581
    
    
    $
    (1,217
    )
    
    $
    16,364
    
    
    $
    18,334
    
    
    $
    (591
    )
    
    $
    17,743OLUX Foam
    
    
    15,792
    
    
    
    (808
    )
    
    
    14,984
    
    
    
    14,033
    
    
    
    380
    
    
    
    14,413Evoclin Foam
    
    
    3,067
    
    
    
    (27
    )
    
    
    3,040
    
    
    
    7,037
    
    
    
    (79
    )
    
    
    6,958Luxíq Foam
    
    
    5,654
    
    
    
    67
    
    
    
    5,721
    
    
    
    5,835
    
    
    
    389
    
    
    
    6,224Other
    
    
    96
    
    
    
    
    
    
    
    96
    
    
    
    
    
    
    
    
    
    
    
    Total net product revenues
    
    
    42,190
    
    
    
    (1,985
    )
    
    
    40,205
    
    
    
    45,239
    
    
    
    99
    
    
    
    45,338Royalty and contract revenues
    
    
    181
    
    
    
    
    
    
    
    181
    
    
    
    130
    
    
    
    
    
    
    
    130Total net revenues
    
    
    42,371
    
    
    
    (1,985
    )
    
    
    40,386
    
    
    
    45,369
    
    
    
    99
    
    
    
    45,468Operating costs and expenses
    
    
    40,872
    
    
    
    
    
    
    
    40,872
    
    
    
    42,695
    
    
    
    
    
    
    
    42,695Income (loss) from operations
    
    
    1,499
    
    
    
    (1,985
    )
    
    
    (486
    )
    
    
    2,674
    
    
    
    99
    
    
    
    2,773Interest and other income
(expense), net
    
    
    (353
    )
    
    
    
    
    
    
    (353
    )
    
    
    (19
    )
    
    
    
    
    
    
    (19
    )Income (loss) before income taxes
    
    
    1,146
    
    
    
    (1,985
    )
    
    
    (839
    )
    
    
    2,655
    
    
    
    99
    
    
    
    2,754Income tax provision (benefit)
    
    
    105
    
    
    
    
    
    
    
    105
    
    
    
    153
    
    
    
    
    
    
    
    153Net income (loss)
    
    $
    1,041
    
    
    $
    (1,985
    )
    
    $
    (944
    )
    
    $
    2,502
    
    
    $
    99
    
    
    $
    2,601Net income (loss) per share:Basic
    
    $
    0.03
    
    
    
    
    
    
    $
    (0.03
    )
    
    $
    0.07
    
    
    
    
    
    
    $
    0.07Diluted
    
    $
    0.03
    
    
    
    
    
    
    $
    (0.03
    )
    
    $
    0.07
    
    
    
    
    
    
    $
    0.07Shares used to compute basic and
diluted net income (loss) per
share:Basic
    
    
    35,699
    
    
    
    
    
    
    
    35,699
    
    
    
    34,825
    
    
    
    
    
    
    
    34,825Diluted
    
    
    38,014
    
    
    
    
    
    
    
    35,699
    
    
    
    37,093
    
    
    
    
    
    
    
    37,093
 
 (a)
    
    The revenue reserves adjustment for the period ended March 31, 2005 includes $665,000
for rebate and chargeback adjustments and $1.3 million for returns.(b)
    
    The revenue reserves adjustment for the period ended June 30, 2005 includes a decrease
of $200,000 for rebate and chargeback adjustments partially offset by an increase of
$101,000 for returns. F-11




---



##### Table of Contents



Three Months Ended September 30, 2005
    
    
    Three Months Ended December 31, 2005(unaudited)
    
    
    (unaudited)As
    
    
    Revenue
    
    
    
    
    
    
    As
    
    
    RevenuePreviously
    
    
    Reserve
    
    
    As
    
    
    Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Restated
    
    
    Reported
    
    
    Adjustments
    
    
    Adjustments
    
    
    Restated(a)
    
    
    
    
    
    
    
    
    
    
    (b)
    
    
    (c)Net product revenues:Soriatane
    
    $
    23,077
    
    
    $
    (2,273
    )
    
    $
    20,804
    
    
    $
    13,603
    
    
    $
    1,350
    
    
    $
    
    
    
    $
    14,953OLUX Foam
    
    
    17,323
    
    
    
    (1,444
    )
    
    
    15,879
    
    
    
    14,646
    
    
    
    (1,913
    )
    
    
    
    
    
    
    12,733Evoclin Foam
    
    
    7,724
    
    
    
    (205
    )
    
    
    7,519
    
    
    
    6,851
    
    
    
    415
    
    
    
    
    
    
    
    7,266Luxíq Foam
    
    
    7,014
    
    
    
    (473
    )
    
    
    6,541
    
    
    
    5,599
    
    
    
    (1,466
    )
    
    
    
    
    
    
    4,133Other
    
    
    45
    
    
    
    
    
    
    
    45
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Total net product revenues
    
    
    55,183
    
    
    
    (4,395
    )
    
    
    50,788
    
    
    
    40,700
    
    
    
    (1,614
    )
    
    
    
    
    
    
    39,086Royalty and contract revenues
    
    
    158
    
    
    
    
    
    
    
    158
    
    
    
    483
    
    
    
    
    
    
    
    
    
    
    
    483Total net revenues
    
    
    55,341
    
    
    
    (4,395
    )
    
    
    50,946
    
    
    
    41,183
    
    
    
    (1,614
    )
    
    
    
    
    
    
    39,569Operating costs and expenses
    
    
    39,666
    
    
    
    
    
    
    
    39,666
    
    
    
    37,134
    
    
    
    
    
    
    
    4
    
    
    
    37,138Income (loss) from operations
    
    
    15,675
    
    
    
    (4,395
    )
    
    
    11,280
    
    
    
    4,049
    
    
    
    (1,614
    )
    
    
    (4
    )
    
    
    2,431Interest and other income
(expense), net
    
    
    160
    
    
    
    
    
    
    
    160
    
    
    
    413
    
    
    
    
    
    
    
    
    
    
    
    413Income (loss) before income taxes
    
    
    15,835
    
    
    
    (4,395
    )
    
    
    11,440
    
    
    
    4,462
    
    
    
    (1,614
    )
    
    
    (4
    )
    
    
    2,844Income tax provision (benefit)
    
    
    470
    
    
    
    
    
    
    
    470
    
    
    
    (10,588
    )
    
    
    
    
    
    
    (62
    )
    
    
    (10,650
    )Net income (loss)
    
    $
    15,365
    
    
    $
    (4,395
    )
    
    $
    10,970
    
    
    $
    15,050
    
    
    $
    (1,614
    )
    
    $
    58
    
    
    $
    13,494Net income (loss) per share:Basic
    
    $
    0.44
    
    
    
    
    
    
    $
    0.31
    
    
    $
    0.44
    
    
    
    
    
    
    
    
    
    
    $
    0.39Diluted
    
    $
    0.39
    
    
    
    
    
    
    $
    0.29
    
    
    $
    0.40
    
    
    
    
    
    
    
    
    
    
    $
    0.36Shares used to compute basic and
diluted net income (loss) per
share:Basic
    
    
    35,075
    
    
    
    
    
    
    
    35,075
    
    
    
    34,570
    
    
    
    
    
    
    
    
    
    
    
    34,570Diluted
    
    
    40,812
    
    
    
    
    
    
    
    40,812
    
    
    
    39,735
    
    
    
    
    
    
    
    
    
    
    
    39,735
 
 (a)
    
    The revenue reserves adjustment for the period ended September 30, 2005 includes
$3.9 million for rebate and chargeback adjustments and $496,000 for returns.(b)
    
    The revenue reserves adjustment for the period ended December 31, 2005 includes
$2.6 million for rebate and chargeback adjustments, partially offset by a decrease of
$986,000 for returns.(c)
    
    Income tax provision (benefit)  The adjustment of $62,000 represents the tax
effect of the adjustments.  December 31, 2004RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedAccounts receivable, net of cash discounts and allowances of $708 (a)
    
    $
    28,191
    
    
    $
    
    
    
    $
    
    
    
    $
    28,191Other current assets
    
    
    87,927
    
    
    
    
    
    
    
    20
    
    
    
    87,947Long-term assets
    
    
    147,159
    
    
    
    
    
    
    
    
    
    
    
    147,159Total assets
    
    
    263,277
    
    
    
    
    
    
    
    20
    
    
    
    263,297Product-related
accruals (a) (b) (c)
    
    
    18,426
    
    
    
    3,195
    
    
    
    
    
    
    
    21,621Other
current liabilities (c)
    
    
    26,511
    
    
    
    
    
    
    
    (147
    )
    
    
    26,364Long-term liabilities
    
    
    90,420
    
    
    
    
    
    
    
    
    
    
    
    90,420Total liabilities
    
    
    135,357
    
    
    
    3,195
    
    
    
    (147
    )
    
    
    138,405Accumulated deficit
    
    
    (111,173
    )
    
    
    (3,195
    )
    
    
    167
    
    
    
    (114,201
    )Other stockholders equity
    
    
    239,093
    
    
    
    
    
    
    
    
    
    
    
    239,093Total stockholders equity
    
    
    127,920
    
    
    
    (3,195
    )
    
    
    167
    
    
    
    124,892Total liabilities and stockholders equity
    
    $
    263,277
    
    
    $
    
    
    
    $
    20
    
    
    $
    263,297
 F-12




---



##### Table of Contents



(a)
    
    Accruals for product returns and chargebacks were previously netted against
accounts receivable and have been reclassified to product-related accruals.(b)
    
    Product-related accruals  the adjustment of $3.2 million represents $471,000 million
related to an increase in our rebates and chargebacks reserves and $2.7 million related to
an increase in our returns reserve.(c)
    
    Accruals for payments due to wholesalers under distribution
service agreements that were previously included as other accrued
liabilities have been reclassified to product-related accruals.  Year Ended December 31, 2004RevenueAs Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    142,059
    
    
    $
    (1,137
    )
    
    $
    
    
    
    $
    140,922Royalty and contract
    
    
    2,296
    
    
    
    
    
    
    
    
    
    
    
    2,296Total net revenues
    
    
    144,355
    
    
    
    (1,137
    )
    
    
    
    
    
    
    143,218Operating costs and expenses
    
    
    122,372
    
    
    
    
    
    
    
    (33
    )
    
    
    122,339Income (loss) from operations
    
    
    21,983
    
    
    
    (1,137
    )
    
    
    33
    
    
    
    20,879Interest and other income (expense), net
    
    
    (1,475
    )
    
    
    
    
    
    
    
    
    
    
    (1,475
    )Income (loss) before income taxes
    
    
    20,508
    
    
    
    (1,137
    )
    
    
    33
    
    
    
    19,404Income tax provision (benefit) (b)
    
    
    1,493
    
    
    
    
    
    
    
    (24
    )
    
    
    1,469Net income (loss)
    
    $
    19,015
    
    
    $
    (1,137
    )
    
    $
    57
    
    
    $
    17,935Net income (loss) per share:Basic
    
    $
    0.54
    
    
    
    
    
    
    
    
    
    
    $
    0.51Diluted
    
    $
    0.51
    
    
    
    
    
    
    
    
    
    
    $
    0.48Shares used to compute basic and diluted net income (loss) per share:Basic
    
    
    35,036
    
    
    
    
    
    
    
    
    
    
    
    35,036Diluted
    
    
    37,443
    
    
    
    
    
    
    
    
    
    
    
    37,443
 
 (a)
    
    Net product revenues  The adjustment of $1.1 million represents an increase in our
revenue reserves of $221,000 related to an increase in our rebates and chargebacks
reserve and $916,000 related to an increase in our returns reserve.(b)
    
    Income tax provision (benefit)  The adjustment of $24,000 represents the tax
effect of the adjustments. F-13




---



##### Table of Contents



Three Months Ended March 31, 2004
    
    
    Three Months Ended June 30, 2004(unaudited)
    
    
    (unaudited)Revenue
    
    
    
    
    
    
    AsAs Previously
    
    
    Reserve
    
    
    As
    
    
    Previously
    
    
    Revenue Reserve
    
    
    AsReported
    
    
    Adjustments
    
    
    Restated
    
    
    Reported
    
    
    Adjustments
    
    
    Restated(a)
    
    
    
    
    
    
    
    
    
    
    (b)Net product revenues:Soriatane
    
    $
    3,640
    
    
    $
    (8
    )
    
    $
    3,632
    
    
    $
    17,154
    
    
    $
    (136
    )
    
    $
    17,018OLUX Foam
    
    
    14,370
    
    
    
    (397
    )
    
    
    13,973
    
    
    
    15,223
    
    
    
    86
    
    
    
    15,309Luxíq Foam
    
    
    5,471
    
    
    
    (18
    )
    
    
    5,453
    
    
    
    5,614
    
    
    
    447
    
    
    
    6,061Other
    
    
    85
    
    
    
    
    
    
    
    85
    
    
    
    8
    
    
    
    
    
    
    
    8Total net product revenues
    
    
    23,566
    
    
    
    (423
    )
    
    
    23,143
    
    
    
    37,999
    
    
    
    397
    
    
    
    38,396Royalty and contract
    
    
    1,416
    
    
    
    
    
    
    
    1,416
    
    
    
    254
    
    
    
    
    
    
    
    254Total net revenues
    
    
    24,982
    
    
    
    (423
    )
    
    
    24,559
    
    
    
    38,253
    
    
    
    397
    
    
    
    38,650Operating costs and expenses
    
    
    22,574
    
    
    
    
    
    
    
    22,574
    
    
    
    29,541
    
    
    
    
    
    
    
    29,541Income (loss) from operations
    
    
    2,408
    
    
    
    (423
    )
    
    
    1,985
    
    
    
    8,712
    
    
    
    397
    
    
    
    9,109Interest and other income
(expense), net
    
    
    (292
    )
    
    
    
    
    
    
    (292
    )
    
    
    (608
    )
    
    
    
    
    
    
    (608
    )Income (loss) before income taxes
    
    
    2,116
    
    
    
    (423
    )
    
    
    1,693
    
    
    
    8,104
    
    
    
    397
    
    
    
    8,501Income tax provision (benefit)
    
    
    243
    
    
    
    
    
    
    
    243
    
    
    
    647
    
    
    
    
    
    
    
    647Net income (loss)
    
    $
    1,873
    
    
    $
    (423
    )
    
    $
    1,450
    
    
    $
    7,457
    
    
    $
    397
    
    
    $
    7,854Net income (loss) per share:Basic
    
    $
    0.06
    
    
    
    
    
    
    $
    0.04
    
    
    $
    0.21
    
    
    
    
    
    
    $
    0.22Diluted
    
    $
    0.05
    
    
    
    
    
    
    $
    0.04
    
    
    $
    0.19
    
    
    
    
    
    
    $
    0.21Shares used to compute basic and
diluted net income (loss) per
share:Basic
    
    
    33,587
    
    
    
    
    
    
    
    33,587
    
    
    
    35,242
    
    
    
    
    
    
    
    35,242Diluted
    
    
    35,887
    
    
    
    
    
    
    
    35,887
    
    
    
    41,627
    
    
    
    
    
    
    
    41,627
 
 (a)
    
    The revenue reserves adjustment for the period ended March 31, 2004 includes
$203,000 for rebate and chargeback adjustments and $220,000 for returns.(b)
    
    The revenue reserves adjustment for the period ended June 30, 2004 includes
$249,000 for returns, offset by a $646,000 decrease in our rebate and chargeback
liability. F-14




---



##### Table of Contents



Three Months Ended September 30, 2004
    
    
    Three Months Ended December 31, 2004(unaudited)
    
    
    (unaudited)As
    
    
    Revenue
    
    
    
    
    
    
    As
    
    
    RevenuePreviously
    
    
    Reserve
    
    
    As
    
    
    Previously
    
    
    Reserve
    
    
    Other
    
    
    AsReported
    
    
    Adjustments
    
    
    Restated
    
    
    Reported
    
    
    Adjustments
    
    
    Adjustments
    
    
    Restated(a)
    
    
    
    
    
    
    
    
    
    
    (b)Net product revenues:Soriatane
    
    $
    14,724
    
    
    $
    130
    
    
    $
    14,854
    
    
    $
    18,049
    
    
    $
    (91
    )
    
    $
    
    
    
    $
    17,958OLUX Foam
    
    
    15,962
    
    
    
    (250
    )
    
    
    15,712
    
    
    
    16,339
    
    
    
    (600
    )
    
    
    
    
    
    
    15,739Evoclin Foam
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,883
    
    
    
    (45
    )
    
    
    
    
    
    
    2,838Luxíq Foam
    
    
    6,281
    
    
    
    (96
    )
    
    
    6,185
    
    
    
    6,216
    
    
    
    (159
    )
    
    
    
    
    
    
    6,057Other
    
    
    32
    
    
    
    
    
    
    
    32
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Total net product revenues
    
    
    36,999
    
    
    
    (216
    )
    
    
    36,783
    
    
    
    43,495
    
    
    
    (895
    )
    
    
    
    
    
    
    42,600Royalty and contract revenues
    
    
    345
    
    
    
    
    
    
    
    345
    
    
    
    281
    
    
    
    
    
    
    
    
    
    
    
    281Total net revenues
    
    
    37,344
    
    
    
    (216
    )
    
    
    37,128
    
    
    
    43,776
    
    
    
    (895
    )
    
    
    
    
    
    
    42,881Operating costs and expenses
    
    
    33,132
    
    
    
    
    
    
    
    33,132
    
    
    
    37,125
    
    
    
    
    
    
    
    (33
    )
    
    
    37,092Income (loss) from operations
    
    
    4,212
    
    
    
    (216
    )
    
    
    3,996
    
    
    
    6,651
    
    
    
    (895
    )
    
    
    33
    
    
    
    5,789Interest and other income
(expense), net
    
    
    (373
    )
    
    
    
    
    
    
    (373
    )
    
    
    (202
    )
    
    
    
    
    
    
    
    
    
    
    (202
    )Income (loss) before income taxes
    
    
    3,839
    
    
    
    (216
    )
    
    
    3,623
    
    
    
    6,449
    
    
    
    (895
    )
    
    
    33
    
    
    
    5,587Income tax provision (benefit)
    
    
    144
    
    
    
    
    
    
    
    144
    
    
    
    459
    
    
    
    
    
    
    
    (24
    )
    
    
    435Net income (loss)
    
    $
    3,695
    
    
    $
    (216
    )
    
    $
    3,479
    
    
    $
    5,990
    
    
    $
    (895
    )
    
    $
    57
    
    
    $
    5,152Net income (loss) per share:Basic
    
    $
    0.10
    
    
    
    
    
    
    $
    0.10
    
    
    $
    0.17
    
    
    
    
    
    
    
    
    
    
    $
    0.14Diluted
    
    $
    0.10
    
    
    
    
    
    
    $
    0.09
    
    
    $
    0.16
    
    
    
    
    
    
    
    
    
    
    $
    0.13Shares used to compute basic and
diluted net income (loss) per
share:Basic
    
    
    35,510
    
    
    
    
    
    
    
    35,510
    
    
    
    35,695
    
    
    
    
    
    
    
    
    
    
    
    35,695Diluted
    
    
    38,064
    
    
    
    
    
    
    
    38,064
    
    
    
    38,172
    
    
    
    
    
    
    
    
    
    
    
    38,172
 
 (a)
    
    The revenue reserves adjustment for the period ended September 30, 2004 includes
$197,000 for rebate and chargebacks and $19,000 for returns.(b)
    
    The revenue reserves adjustment for the period ended December 31, 2005 includes
$467,000 for rebate and chargeback adjustments and $428,000 for returns.  Year Ended December 31, 2003RevenueAs
    
    
    Reserve
    
    
    Other
    
    
    AsPreviously Reported
    
    
    Adjustments
    
    
    Adjustments
    
    
    RestatedNet revenues:Product (a)
    
    $
    66,606
    
    
    $
    (167
    )
    
    $
    
    
    
    $
    66,439Royalty and contract
    
    
    8,725
    
    
    
    
    
    
    
    
    
    
    
    8,725Total net revenues
    
    
    75,331
    
    
    
    (167
    )
    
    
    
    
    
    
    75,164Operating costs and expenses
    
    
    77,838
    
    
    
    
    
    
    
    (76
    )
    
    
    77,762Income (loss) from operations
    
    
    (2,507
    )
    
    
    (167
    )
    
    
    76
    
    
    
    (2,598
    )Interest and other income (expense), net
    
    
    (426
    )
    
    
    
    
    
    
    
    
    
    
    (426
    )Income (loss) before income taxes
    
    
    (2,933
    )
    
    
    (167
    )
    
    
    76
    
    
    
    (3,024
    )Income tax provision (benefit) (b)
    
    
    1,167
    
    
    
    
    
    
    
    (34
    )
    
    
    1,133Net income (loss)
    
    $
    (4,100
    )
    
    $
    (167
    )
    
    $
    110
    
    
    $
    (4,157
    )Net income (loss) per share:Basic
    
    $
    (0.13
    )
    
    
    
    
    
    
    
    
    
    $
    (0.13
    )Diluted
    
    $
    (0.13
    )
    
    
    
    
    
    
    
    
    
    $
    (0.13
    )Shares used to compute basic and diluted
net income (loss) per share:Basic
    
    
    31,559
    
    
    
    
    
    
    
    
    
    
    
    31,559Diluted
    
    
    31,559
    
    
    
    
    
    
    
    
    
    
    
    31,559
 F-15




---



##### Table of Contents



(a)
    
    Net product revenues  The adjustment of $167,000 represents a decrease of
$431,000 to related to our rebates and chargebacks reserve, partially offset by an
increase in our returns reserves of $598,000 .(b)
    
    Income tax provision (benefit)  The adjustment of $34,000 represents
the tax effect of the adjustments.




Note 3. Summary of Significant Accounting Policies


Principles of Consolidation
  Use of Estimates
   F-16




---



##### Table of Contents



Revenue Recognition
   Gross-to-Net Sales Adjustments
  Returns
   F-17




---



##### Table of Contents



Managed Care Rebates
   Medicaid Rebates
   F-18




---



##### Table of Contents



Chargebacks
   Cash Discounts
  Other Adjustments
  Use of Information from External Sources
  F-19




---



##### Table of Contents



Use of Estimates in Reserves
  Product-Specific Revenue Recognition Matters  Evoclin
  Product-Specific Revenue Recognition Matters  Soriatane
  F-20




---



##### Table of Contents



Product-Specific Revenue Recognition Matters  OLUX
  Royalty Revenues
  Contract Revenues
   Cash Equivalents and Marketable Securities
  F-21




---



##### Table of Contents



Restricted Cash
  Foreign Currency
  Provision for (Benefit from) Income Taxes
 i.e.,
  F-22




---



##### Table of Contents



Property and Equipment
  Category
    
    TermLeasehold improvements
    
    Shorter of lease term or economic life, currently 10 yearsFurniture and equipment
    
    3 to 4 yearsComputer software and equipment
    
    3 to 5 years
 Inventory
   December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004Raw materials
    
    $
    1,649
    
    
    $
    677Finished goods, net of allowance for excess and obsolete inventory
    
    
    5,836
    
    
    
    4,343Total inventory
    
    $
    7,485
    
    
    $
    5,020
 debt issuance, deposits and other assets
  F-23




---



##### Table of Contents



Goodwill, Purchased Intangibles and Other Long-Lived Assets  Impairment Assessments
    Fair Value of Financial Instruments
   F-24




---



##### Table of Contents



Research and Development
  Certain Concentrations
     Percentage ofGross Product RevenuesYears Ended December 31,2005
    
    2004
    
    2003Customer
    
    (restated)
    
    (restated)
    
    (restated)McKesson
    
    
    36
    %
    
    
    29
    %
    
    
    30
    %Cardinal Health
    
    
    34
    %
    
    
    27
    %
    
    
    36
    %AmerisourceBergen
    
    
    11
    %
    
    
    16
    %
    
    
    15
    %Walgreens
    
    
    *
    
    
    
    *
    
    
    
    11
    %
 
 *
    
    less than 10% Percentage of OutstandingGross Accounts Receivableas of December 31,Customer
    
    2005
    
    2004U.S.-Based International Distributor
    
    
    41
    %
    
    
    *Cardinal Health
    
    
    30
    %
    
    
    21
    %McKesson
    
    
    *
    
    
    
    36
    %AmerisourceBergen
    
    
    *
    
    
    
    22
    %Walgreens
    
    
    *
    
    
    
    15
    %
 
 *
    
    less than 10% F-25




---



##### Table of Contents



Accumulated Comprehensive Income
  December 31,2005
    
    
    2004
    
    
    2003(in thousands)
    
    (restated)
    
    
    (restated)
    
    
    (restated)Net income
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )Foreign currency translation adjustment
    
    
    (152
    )
    
    
    126
    
    
    
    949Change in unrealized gain on
securities, net of reclassification
adjustments for realized gain (loss)
    
    
    (725
    )
    
    
    (583
    )
    
    
    (167
    )Comprehensive income
    
    $
    25,244
    
    
    $
    17,478
    
    
    $
    (3,375
    )
 Advertising
 .
 Net Income (Loss) Per Share
   Years Ended December 31,2005
    
    
    2004
    
    
    2003(In thousands except per share amounts):
    
    (restated)
    
    
    (restated)
    
    
    (restated)Net income (loss), as reported
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )Add: interest on convertible note
    
    
    2,761
    
    
    
    
    
    
    
    Net income (loss), diluted
    
    
    28,882
    
    
    
    17,935
    
    
    
    (4,157
    )Weighted average shares outstanding; Basic common shares
    
    
    35,039
    
    
    
    35,036
    
    
    
    31,559Effect of dilutive options
    
    
    2,093
    
    
    
    2,383
    
    
    
    Effect of dilutive warrants
    
    
    
    
    
    
    24
    
    
    
    Effect of convertible debt
    
    
    4,203
    
    
    
    
    
    
    
    Total weighted average diluted common shares
    
    $
    41,335
    
    
    $
    37,443
    
    
    $
    31,559Net income (loss) per share:Basic
    
    $
    0.75
    
    
    $
    0.51
    
    
    $
    (0.13
    )Diluted
    
    $
    0.70
    
    
    $
    0.48
    
    
    $
    (0.13
    )
 in thousands
 Years Ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003Warrants
    
    
    
    
    
    
    
    
    
    
    59Options
    
    
    1,574
    
    
    
    263
    
    
    
    5,986Convertible debt
    
    
    
    
    
    
    4,203
    
    
    
    4,203Total
    
    
    1,574
    
    
    
    4,466
    
    
    
    10,248
 F-26




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##### Table of Contents



Stock-Based Compensation
   pro
forma
 Years Ended December 31,2005
    
    
    2004
    
    
    2003(restated)
    
    
    (restated)
    
    
    (restated)(In thousands except per shareamounts):Net income (loss), as reported
    
    $
    26,121
    
    
    $
    17,935
    
    
    $
    (4,157
    )Add: Stock-based employee compensation expense, net of tax
    
    
    13
    
    
    
    18
    
    
    
    17Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of tax
    
    
    (20,864
    )
    
    
    (11,355
    )
    
    
    (9,834
    )Pro forma net income (loss)
    
    $
    5,270
    
    
    $
    6,598
    
    
    $
    (13,974
    )Weighted average shares outstanding:Basic common shares
    
    
    35,039
    
    
    
    35,036
    
    
    
    31,559Effect of dilutive options
    
    
    2,318
    
    
    
    2,828
    
    
    
    Effect of dilutive warrants
    
    
    
    
    
    
    24
    
    
    
    Total weighted average diluted common shares
    
    
    37,357
    
    
    
    37,888
    
    
    
    31,559
 F-27




---



##### Table of Contents



Years Ended December 31,2005
    
    
    2004
    
    
    2003(restated)
    
    
    (restated)
    
    
    (restated)(In thousands except per shareamounts):Net
income (loss) per share:Basic  as reported
    
    $
    0.75
    
    
    $
    0.51
    
    
    $
    (0.13
    )Diluted  as reported
    
    $
    0.70
    
    
    $
    0.48
    
    
    $
    (0.13
    )Basic  pro forma
    
    $
    0.15
    
    
    $
    0.19
    
    
    $
    (0.44
    )Diluted  pro forma
    
    $
    0.14
    
    
    $
    0.17
    
    
    $
    (0.44
    )
  Stock Option Plans
    
    Stock Purchase Plan2005
    
    2004
    
    2003
    
    2005
    
    2004
    
    2003Expected stock volatility
    
    
    47.1
    %
    
    
    57.2
    %
    
    
    60.6
    %
    
    
    51.67
    %
    
    
    54.7
    %
    
    
    57.5
    %Risk-free interest rate
    
    
    3.7
    %
    
    
    3.2
    %
    
    
    4.1
    %
    
    
    2.0
    %
    
    
    1.1
    %
    
    
    4.4
    %Expected life (in years)
    
    
    4.0
    
    
    
    3.4
    
    
    
    3.2
    
    
    
    1.18
    
    
    
    1.5
    
    
    
    1.4Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
   Disclosure about Segments of an Enterprise and Related Information
   Recent Accounting Pronouncements
  F-28




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##### Table of Contents



F-29




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##### Table of Contents



Note 4. Cash Equivalents and Marketable Securities
 (in thousands)
 December 31, 2005Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate debt
    
    $
    125,329
    
    
    $
    12
    
    
    $
    (411
    )
    
    $
    124,930Government securities
    
    
    83,772
    
    
    
    20
    
    
    
    (277
    )
    
    
    83,515Structured product securities
    
    
    37,497
    
    
    
    14
    
    
    
    (195
    )
    
    
    37,316Equity securities
    
    
    197
    
    
    
    388
    
    
    
    
    
    
    
    585Money market funds
    
    
    521
    
    
    
    
    
    
    
    
    
    
    
    521Total
    
    
    247,316
    
    
    
    434
    
    
    
    (883
    )
    
    
    246,867Less amount classified as cash equivalents
    
    
    (5,759
    )
    
    
    
    
    
    
    
    
    
    
    (5,759
    )Total marketable securities
    
    $
    241,557
    
    
    $
    434
    
    
    $
    (883
    )
    
    $
    241,108
 December 31, 2004Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCorporate debt
    
    $
    32,971
    
    
    $
    3
    
    
    $
    (72
    )
    
    $
    32,902Government securities
    
    
    13,318
    
    
    
    
    
    
    
    (23
    )
    
    
    13,295Structured product securities
    
    
    7,268
    
    
    
    1
    
    
    
    (24
    )
    
    
    7,245Equity securities
    
    
    289
    
    
    
    391
    
    
    
    
    
    
    
    680Money market funds
    
    
    1,114
    
    
    
    
    
    
    
    
    
    
    
    1,114Total
    
    
    54,960
    
    
    
    395
    
    
    
    (119
    )
    
    
    55,236Less amount classified as cash equivalents
    
    
    (1,114
    )
    
    
    
    
    
    
    
    
    
    
    (1,114
    )Total marketable securities
    
    $
    53,846
    
    
    $
    395
    
    
    $
    (119
    )
    
    $
    54,122
 (in thousands)
 2005
    
    
    2004Amortized
    
    
    Estimated
    
    
    Amortized
    
    
    EstimatedCost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair ValueMature in less than one year
    
    $
    154,494
    
    
    $
    153,998
    
    
    $
    21,076
    
    
    $
    21,013Mature in one to three years
    
    
    86,866
    
    
    
    86,525
    
    
    
    19,264
    
    
    
    19,221Mature in over three years
    
    
    
    
    
    
    
    
    
    
    13,217
    
    
    
    13,208Total
    
    $
    241,360
    
    
    $
    240,523
    
    
    $
    53,557
    
    
    $
    53,442
   F-30




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##### Table of Contents



Note 5. Soriatane Product Line Acquisition and Distribution Agreement
   Note 6. Velac Gel
    F-31




---



##### Table of Contents



Note 7. Co-Promotion Agreements
   Note 8. Property and Equipment
 (in thousands):
 December 31,2005
    
    
    2004Leasehold improvements
    
    $
    6,992
    
    
    $
    7,705Laboratory and manufacturing equipment
    
    
    6,672
    
    
    
    5,952Computer equipment
    
    
    3,538
    
    
    
    2,324Furniture, fixtures and office equipment
    
    
    1,019
    
    
    
    1,333Land, building and building improvements
    
    
    748
    
    
    
    785Total
    
    
    18,969
    
    
    
    18,099Less accumulated depreciation and amortization
    
    
    (4,531
    )
    
    
    (6,269
    )Property and equipment, net
    
    $
    14,438
    
    
    $
    11,830
  Note 9. Goodwill and Other Intangible Assets
 (in
thousands)
 December 31, 2005
    
    
    December 31, 2004Gross
    
    
    
    
    
    
    
    
    
    
    GrossUseful Life
    
    
    Carrying
    
    
    Accumulated
    
    
    
    
    
    
    Carrying
    
    
    Accumulatedin Years
    
    
    Amount
    
    
    Amortization
    
    
    Net
    
    
    Amount
    
    
    Amortization
    
    
    NetAcquired product
rights
    
    10
    
    
    $
    127,652
    
    
    $
    (23,403
    )
    
    $
    104,249
    
    
    $
    127,652
    
    
    $
    (10,638
    )
    
    $
    117,014Existing technology
    
    10
    
    
    
    6,810
    
    
    
    (3,206
    )
    
    
    3,604
    
    
    
    6,810
    
    
    
    (2,525
    )
    
    
    4,285Patents
    
    10-13
    
    
    
    1,661
    
    
    
    (725
    )
    
    
    936
    
    
    
    1,661
    
    
    
    (572
    )
    
    
    1,089Goodwill
    
    Indefinite
    
    
    
    6,271
    
    
    
    
    
    
    
    6,271
    
    
    
    6,271
    
    
    
    
    
    
    
    6,271Total
    
    
    
    
    
    $
    142,394
    
    
    $
    (27,334
    )
    
    $
    115,060
    
    
    $
    142,394
    
    
    $
    (13,735
    )
    
    $
    128,659
 F-32




---



##### Table of Contents



(in
thousands)
 For the year ending:
 December 31, 2006
    
    $
    13,598December 31, 2007
    
    
    13,598December 31, 2008
    
    
    13,598December 31, 2009
    
    
    13,598December 31, 2010
    
    
    13,598Thereafter
    
    
    40,799Total
    
    $
    108,789
 Note 10. Convertible Senior Notes
 Terms of the 2005 Notes
  per
annum per annum
  F-33




---



##### Table of Contents



Terms of the 2003 Notes
   Offering Expenses
  Note 11. Stockholders Equity
 Stock Repurchase Program
  F-34




---



##### Table of Contents



Equity Issuance
  Warrants
    1995 Director Stock Option Plan
    Employee Stock Plans
  F-35




---



##### Table of Contents



2000 Stock Plan.
 Non-Officer Stock Option Plans.
 International Stock Incentive Plan.
 Inducement Stock Option Grants.
 Summary of All Option Plans and Non-Plan Grants.
 Outstanding OptionsWeightedShares
    
    
    
    
    
    
    AverageAvailable for
    
    
    Number of
    
    
    ExerciseGrant
    
    
    Shares
    
    
    PriceBalance, December 31, 2002
    
    
    739,191
    
    
    
    4,883,966
    
    
    $
    7.72Additional shares authorized
    
    
    1,937,016
    
    
    
    
    
    
    
    Options granted
    
    
    (1,759,888
    )
    
    
    1,759,888
    
    
    
    14.20Options exercised
    
    
    
    
    
    
    (554,274
    )
    
    
    5.69Options canceled
    
    
    102,260
    
    
    
    (103,323
    )
    
    
    9.97Balance, December 31, 2003
    
    
    1,018,579
    
    
    
    5,986,257
    
    
    $
    9.77Additional shares authorized
    
    
    958,501
    
    
    
    
    
    
    
    Options granted
    
    
    (1,777,968
    )
    
    
    1,777,968
    
    
    
    19.98Options exercised
    
    
    
    
    
    
    (753,346
    )
    
    
    6.83Options canceled
    
    
    172,970
    
    
    
    (172,970
    )
    
    
    14.01Balance, December 31, 2004
    
    
    372,082
    
    
    
    6,837,909
    
    
    $
    12.64Additional shares authorized
    
    
    1,675,356
    
    
    
    
    
    
    
    Options granted
    
    
    (1,730,887
    )
    
    
    1,730,887
    
    
    
    22.05Options exercised
    
    
    
    
    
    
    (713,747
    )
    
    
    8.93Options canceled
    
    
    474,797
    
    
    
    (474,797
    )
    
    
    18.90Balance, December 31, 2005
    
    
    791,348
    
    
    
    7,380,252
    
    
    $
    14.80Exercisable, December 31, 2003
    
    
    
    
    
    
    3,330,208
    
    
    $
    7.64Exercisable, December 31, 2004
    
    
    
    
    
    
    3,799,398
    
    
    $
    9.20Exercisable, December 31, 2005
    
    
    
    
    
    
    6,525,829
    
    
    $
    14.69
 F-36




---



##### Table of Contents



Options Outstanding
    
    
    Options ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedRemaining
    
    
    Average
    
    
    
    
    
    
    AverageRange of
    
    Number of
    
    
    Life (in
    
    
    Exercise
    
    
    Number of
    
    
    ExerciseExercise Prices
    
    Shares
    
    
    years)
    
    
    Price
    
    
    Shares
    
    
    Price$0.00  $2.92
    
    
    4,496
    
    
    
    0.24
    
    
    $
    0.45
    
    
    
    4,496
    
    
    $
    0.45$2.93  $5.84
    
    
    636,336
    
    
    
    4.09
    
    
    
    4.51
    
    
    
    636,336
    
    
    
    4.51$5.85  $8.75
    
    
    1,111,468
    
    
    
    3.63
    
    
    
    7.56
    
    
    
    1,077,321
    
    
    
    7.54$8.76  $11.67
    
    
    314,867
    
    
    
    4.99
    
    
    
    10.34
    
    
    
    294,573
    
    
    
    10.31$11.68  $14.59
    
    
    1,846,066
    
    
    
    6.38
    
    
    
    12.34
    
    
    
    1,453,334
    
    
    
    12.24$14.60  $17.51
    
    
    371,988
    
    
    
    7.57
    
    
    
    16.42
    
    
    
    178,135
    
    
    
    16.49$17.52  $20.43
    
    
    1,481,616
    
    
    
    7.55
    
    
    
    18.30
    
    
    
    1,358,219
    
    
    
    18.35$20.44  $23.34
    
    
    310,896
    
    
    
    8.21
    
    
    
    21.83
    
    
    
    310,896
    
    
    
    21.83$23.35  $26.26
    
    
    1,032,582
    
    
    
    8.85
    
    
    
    23.78
    
    
    
    1,032,582
    
    
    
    23.78$26.27  $29.18
    
    
    269,937
    
    
    
    8.83
    
    
    
    27.34
    
    
    
    179,937
    
    
    
    27.01$0.00  $29.18
    
    
    7,380,252
    
    
    
    6.51
    
    
    $
    14.80
    
    
    
    6,525,829
    
    
    $
    14.69
  1995 Employee Stock Purchase Plan.
 Common Shares Reserved for Future Issuance
  December 31,2005
    
    
    20041994 Stock Plan
    
    
    533,168
    
    
    
    721,0421995 Directors Stock Option Plan
    
    
    677,500
    
    
    
    757,8001998 Supplemental Stock Plan
    
    
    38,500
    
    
    
    39,8832000 Stock Plan
    
    
    4,817,758
    
    
    
    3,994,6232000 Non-Officer Stock Plan
    
    
    230,679
    
    
    
    293,856International Stock Incentive Plan
    
    
    225,282
    
    
    
    229,0102002 Employee Stock Plan
    
    
    1,019,217
    
    
    
    1,144,281Non-plan stock options
    
    
    29,496
    
    
    
    29,496Inducement Grants
    
    
    600,000
    
    
    
    Subtotal Stock Option Plans and Inducement Grants
    
    
    8,171,600
    
    
    
    7,209,9911995 Employee Stock Purchase Plan
    
    
    443,826
    
    
    
    423,251Convertible senior notes
    
    
    11,385,450
    
    
    
    4,203,450Total
    
    
    20,000,876
    
    
    
    11,836,692
 F-37




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##### Table of Contents



Stockholder Rights Plan
  Note 12. Income Taxes
 (in thousands)
 Years Ended December 31,2005

(restated)
    
    

2004

(restated)
    
    

2003

(restated)Domestic
    
    $
    16,882
    
    
    $
    18,411
    
    
    $
    (8,752
    )Foreign
    
    
    (683
    )
    
    
    993
    
    
    
    5,728Total
    
    $
    16,199
    
    
    $
    19,404
    
    
    $
    (3,024
    )
 (in thousands)
 Years Ended December 31,2005
    
    
    2004
    
    
    2003CurrentFederal
    
    $
    902
    
    
    $
    1,164
    
    
    $
    330State
    
    
    647
    
    
    
    426
    
    
    
    Foreign
    
    
    (841
    )
    
    
    150
    
    
    
    983Total Current
    
    
    708
    
    
    
    1,740
    
    
    
    1,313DeferredFederal
    
    
    (9,921
    )
    
    
    
    
    
    
    State
    
    
    
    
    
    
    
    
    
    
    Foreign
    
    
    (709
    )
    
    
    (271
    )
    
    
    (180
    )Total Deferred
    
    
    (10,630
    )
    
    
    (271
    )
    
    
    (180
    )Total
    
    $
    (9,922
    )
    
    $
    1,469
    
    
    $
    1,133
 F-38




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##### Table of Contents



(in thousands)
 Years Ended December 31,2005
    
    
    2004
    
    
    2003Provision (benefit) at U.S. federal statutory rate
    
    $
    5,669
    
    
    $
    6,597
    
    
    $
    (1,030
    )Unbenefited losses (utilization of net operating losses)
    
    
    (10,366
    )
    
    
    (14,096
    )
    
    
    520Timing differences not currently benefited
    
    
    3,884
    
    
    
    7,335
    
    
    
    State taxes, net of federal benefit
    
    
    519
    
    
    
    282
    
    
    
    Non-deductible amortization
    
    
    282
    
    
    
    274
    
    
    
    270Alternative minimum tax
    
    
    592
    
    
    
    829
    
    
    
    Foreign taxes
    
    
    (1,364
    )
    
    
    (121
    )
    
    
    803US withholding tax
    
    
    364
    
    
    
    334
    
    
    
    330Change in valuation allowance
    
    
    (9,921
    )
    
    
    
    
    
    
    Other
    
    
    419
    
    
    
    35
    
    
    
    240Total
    
    $
    (9,922
    )
    
    $
    1,469
    
    
    $
    1,133
   (in
thousands)
 December 31,2005
    
    
    2004Deferred tax assets:Net operating loss carryforwards
    
    $
    24,000
    
    
    $
    24,200Research and other tax credits
    
    
    9,000
    
    
    
    6,400Capitalized research expenses
    
    
    2,100
    
    
    
    4,000Capitalized license and acquired technology
    
    
    11,300
    
    
    
    4,700Accruals and reserves
    
    
    16,800
    
    
    
    9,900Foreign currency translation
    
    
    
    
    
    
    700Other
    
    
    1,000
    
    
    
    800Total deferred tax assets
    
    
    64,200
    
    
    
    50,700Valuation allowance
    
    
    (47,200
    )
    
    
    (47,900
    )Net deferred tax assets
    
    
    17,000
    
    
    
    2,800Deferred tax liabilities:Convertible debt interest
    
    
    (3,000
    )
    
    
    Prepaid expenses
    
    
    (500
    )
    
    
    (400
    )Soriatane property acquisition
    
    
    (700
    )
    
    
    (1,100
    )Unrealized gain on marketable securities
    
    
    (700
    )
    
    
    (100
    )Other
    
    
    (600
    )
    
    
    Net deferred tax liabilities
    
    
    (5,500
    )
    
    
    (1,600
    )Total net deferred tax assets
    
    $
    11,500
    
    
    $
    1,200
   F-39




---



##### Table of Contents



Note 13. Commitments
     F-40




---



##### Table of Contents



(in thousands)
 Years Ending
    
    
    
    
    
    ContractualDecember 31:
    
    Operating Leases
    
    
    Commitments
    
    
    Total2006
    
    $
    3,796
    
    
    $
    2,247
    
    
    $
    6,0432007
    
    
    3,052
    
    
    
    2,172
    
    
    
    5,2242008
    
    
    1,964
    
    
    
    850
    
    
    
    2,8142009
    
    
    1,722
    
    
    
    850
    
    
    
    2,5722010
    
    
    1,468
    
    
    
    850
    
    
    
    2,318Thereafter
    
    
    6,794
    
    
    
    1,375
    
    
    
    8,169$
    18,796
    
    
    $
    8,344
    
    
    $
    27,140
   Note 14. Guarantees and Indemnifications
   Note 15. Retirement Savings Plan
  F-41




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##### Table of Contents



Note 16. Related Party Transactions
  Note
17. PediaMed Sales Organization Acquisition
  Note 18. Subsequent Events
 SEC Investigation
  Notices
of Default Under Senior Convertible Notes
    Consequences Resulting From Not Filing Our Form 10-Q by July 25, 2006
 per annum
  NASDAQ Notice
  Note 19. Quarterly Financial Data (unaudited)
 (in thousands, except share and per share amounts)
 2005 QuartersFirst
 (Restated)
    

Second

(Restated)
    

Third

(Restated)
    

Fourth

(Restated)Total net revenues
    
    $
    40,386
    
    
    $
    45,468
    
    
    $
    50,946
    (1)
    
    $
    39,569
    (2)Cost of product revenues (excluding amortization of acquired
product rights)
    
    
    3,748
    
    
    
    4,982
    
    
    
    4,183
    
    
    
    3,379Operating expenses
    
    
    37,124
    
    
    
    37,713
    
    
    
    35,483
    
    
    
    33,759Operating income (loss)
    
    
    (486
    )
    
    
    2,773
    
    
    
    11,280
    
    
    
    2,431Net income (loss)
    
    
    (944
    )
    
    
    2,601
    
    
    
    10,970
    
    
    
    13,494Basic net income (loss) per share
    
    
    (0.03
    )
    
    
    0.07
    
    
    
    0.31
    
    
    
    0.39Diluted net income (loss) per share
    
    
    (0.03
    )
    
    
    0.07
    
    
    
    0.29
    
    
    
    0.36Shares used to calculate basic net income (loss) per share
    
    
    35,699
    
    
    
    34,825
    
    
    
    35,075
    
    
    
    34,570Shares used to calculate diluted net income (loss) per share
    
    
    35,699
    
    
    
    37,093
    
    
    
    40,812
    
    
    
    39,735
 
 (1)
    
    The third quarter of 2005 net product revenues for Soriatane include a $4.6 million
reduction of estimated reserves for returns and government rebates recorded from the time of
acquisition through June 30, 2005.(2)
    
    The fourth quarter of 2005 net product revenues for all products include a $3.5 million
increase in rebate and chargeback accruals related to an increased estimate of units in the
distribution channel at December 31, 2005. F-42




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##### Table of Contents



2004 QuartersFirst
    
    
    Second
    
    
    Third
    
    
    Fourth(Restated)
    
    
    (Restated)
    
    
    (Restated)
    
    
    (Restated)Total net revenues
    
    $
    24,559
    (1)
    
    $
    38,650
    (2)
    
    $
    37,128
    (3)
    
    $
    42,881Cost of product revenues (excluding amortization of acquired
product rights)
    
    
    1,568
    
    
    
    3,578
    
    
    
    3,067
    
    
    
    4,410Operating expenses
    
    
    21,006
    
    
    
    25,963
    
    
    
    30,065
    
    
    
    32,682Operating income
    
    
    1,985
    
    
    
    9,109
    
    
    
    3,996
    
    
    
    5,789Net income
    
    
    1,450
    
    
    
    7,854
    
    
    
    3,479
    
    
    
    5,152Basic net income per share
    
    
    0.04
    
    
    
    0.22
    
    
    
    0.10
    
    
    
    0.14Diluted net income per share
    
    
    0.04
    
    
    
    0.21
    
    
    
    0.09
    
    
    
    0.13Shares used to calculate basic net income per share
    
    
    33,587
    
    
    
    35,242
    
    
    
    35,510
    
    
    
    35,695Shares used to calculate diluted net income per share
    
    
    35,887
    
    
    
    41,627
    
    
    
    38,064
    
    
    
    38,172
 
 (1)
    
    In the first quarter of 2004, we received a one-time royalty payment in the amount of $1.2
million in connection with the S.C. Johnson license agreement.(2)
    
    In early March 2004, we acquired exclusive U.S. rights to Soriatane. Sales of Soriatane
accounted for most of the increase in sales over the first quarter. Operating expenses
increased in the second quarter compared to the first, primarily related to the Soriatane
acquisition and in support of the increased Soriatane sales, including a $2.1 million increase
in amortization of intangible assets resulting from the acquisition and $2.4 million for
selling, general, and administrative expenses.(3)
    
    In the third quarter of 2004, operating expenses included a $3.5 million milestone payment
due under our license agreement for Velac upon our filing an NDA with the FDA. F-43




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##### Table of Contents



Connetics Corporation
 
 Index to Exhibits
 [Item 15(b)]
 ExhibitNumber
    
    Description2.1*
    
    Purchase and Sale Agreement dated February 2, 2004 between Connetics and
Hoffmann-La Roche Inc. (previously filed as Exhibit 10.41 to the Companys
Annual Report on Form 10-K for the year ended December 31, 2003).2.2*
    
    Asset Purchase Agreement dated as of April 9, 2001 between Connetics and
Prometheus Laboratories, Inc. (previously filed as Exhibit 2.1 to the
Companys Current Report on Form 8-K dated April 30, 2001 and filed with
the Commission on May 11, 2001).2.3*
    
    Asset Acquisition Agreement dated January 4, 2006 between Connetics and
PediaMed Pharmaceuticals, Inc. (previously filed as Exhibit 2.1 to the
Companys Current Report on Form 8-K dated January 4, 2006 and filed with
the Commission on January 10, 2006).3.1*
    
    Amended and Restated Certificate of Incorporation (previously filed as an
exhibit to the Companys Form S-1 Registration Statement No. 33-80261).3.2*
    
    Certificate of Amendment of the Companys Amended and Restated Certificate
of Incorporation, filed with the Delaware Secretary of State on May 15,
1997 (previously filed as Exhibit 3.7 to the Companys Current Report on
Form 8-K dated and filed May 23, 1997).3.3*
    
    Certificate of Designation of Rights, Preferences and Privileges of Series
B Participating Preferred Stock, filed with the Delaware Secretary of State
on May 15, 1997 (previously filed as Exhibit A to Exhibit 1 to the
Companys Form 8-A filed on May 23, 1997).3.4*
    
    Certificate of Elimination of Rights, Preferences and Privileges of
Connetics Corporation, filed with the Delaware Secretary of State on
December 11, 2001 (previously filed as Exhibit 3.5 to the Companys Annual
Report on Form 10-K/A filed for the year ended December 31, 2001).3.5*
    
    Certificate of Designation of Terms of Series C Preferred Stock of
Connetics Corporation, filed with the Delaware Secretary of State on March
22, 2005 (previously filed as Exhibit 3.1 to the Companys Current Report
on Form 8-K dated March 22, 2005 and filed with the Commission on June 6,
2005).3.6*
    
    Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of Connetics Corporation, filed with the Delaware Secretary
of State on May 18, 2005 (previously filed as Exhibit 4.7 to the Companys
Registration Statement on Form S-1 filed with the Commission on June 20,
2005, Registration Statement No. 333-125982).3.7*
    
    Certificate of Elimination of Rights, Preferences and Privileges of Series
C Preferred Stock of Connetics Corporation, filed with the Delaware
Secretary of State on May 18, 2005 (previously filed as Exhibit 3.2 to the
Companys Current Report on Form 8-K dated March 22, 2005 and filed with
the Commission on June 6, 2006).3.8*
    
    Amended and Restated Bylaws (previously filed as Exhibit 3.2 to the
Companys Form 8-A/A filed with the Commission on November 28, 2001).4.1*
    
    Form of Common Stock Certificate (previously filed as Exhibit 4.1 to the
Companys Annual Report on Form 10-K for the year ended December 31, 1998).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    Description4.2*
    
    Amended and Restated Preferred Stock Rights Agreement, dated as of
November 21, 2001, between Connetics and EquiServe Trust Company, N.A.,
including the form of Rights Certificate and the Summary of Rights attached
thereto as Exhibits A and B, respectively (previously filed as Exhibit 4.1
to the Companys Form 8-A/A filed with the Commission on November 28,
2001).4.3*
    
    Indenture, dated as of May 28,
2003, between Connetics and J.P.
Morgan Trust Company, National
Association, as Trustee, including
the forms of the notes (previously
filed as Exhibit 4.1 to the
Companys Quarterly Report on Form
10-Q for the quarter ended June
30, 2003).4.4*
    
    Indenture dated March 23, 2005,
between Connetics and J.P. Morgan
Trust Company, National
Association, as Trustee, including
the forms of the Notes (previously
filed as Exhibit 4.1 to the
Companys Current Report on Form
8-K dated March 23, 2005 and filed
with the Commission on March 25,
2005).4.5*
    
    Registration Rights Agreement,
dated March 23, 2005, between
Connetics and Goldman, Sachs &
Co., on behalf of itself, CIBC
World Markets Corp., Lazard Freres
& Co. LLC, Piper Jaffray & Co. and
Roth Capital Partners, LLC
(previously filed as Exhibit 4.2
to the Companys Current Report on
Form 8-K dated March 23, 2005 and
filed with the Commission on March
25, 2005).4.6*
    
    Registration Rights Agreement,
dated as of May 28, 2003, between
Connetics and Goldman, Sachs &
Co., C.E. Unterberg, Towbin (a
California Limited Partnership),
CIBC World Markets Corp., Thomas
Weisel Partners LLC and U.S.
Bancorp Piper Jaffray Inc., as
representatives (previously filed
as Exhibit 4.2 to the Companys
Quarterly Report on Form 10-Q for
the quarter ended June 30, 2003).Management Contracts, Consulting Agreements and Compensatory Plans and Arrangements10.1*(M)
    
    Form of Indemnification Agreement
between Connetics and Directors
and Officers of the Company
(previously filed as Exhibit 10.1
to the Companys Form S-1
Registration Statement No.
33-80261).10.2*(M)
    
    Employment Agreement dated June 9,
1994 between Connetics and Thomas
Wiggans (previously filed as an
exhibit to the Companys Form S-1
Registration Statement No.
33-80261).10.3*(M)
    
    Form of Notice of Stock Option
Grant to G. Kirk Raab dated
January 28, 1997 (previously filed
as Exhibit 10.4 to the Companys
Annual Report on Form 10-K/A for
the year ended December 31, 2001).10.4*(M)
    
    Form of Notice of Stock Option
Grant to G. Kirk Raab dated July
30, 1997 (previously filed as
Exhibit 10.5 to the Companys
Annual Report on Form 10-K/A for
the year ended December 31, 2001).10.5*(M)
    
    Restricted Common Stock Purchase
Agreement dated November 5, 1998
between Connetics and G. Kirk Raab
(previously filed as Exhibit 10.59
to the Companys Annual Report on
Form 10-K for the year ended
December 31, 1998).10.6*(M)
    
    Restricted Common Stock Purchase
Agreement dated March 9, 1999
between Connetics and G. Kirk Raab
(previously filed as Exhibit 10.5
to the Companys Quarterly Report
on Form 10-Q for the quarter ended
March 31, 1999).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    Description10.7*(M)
    
    Restricted Common Stock Purchase
Agreement dated March 9, 1999
between Connetics and Thomas G.
Wiggans (previously filed as
Exhibit 10.6 to the Companys
Quarterly Report on Form 10-Q for
the quarter ended March 31, 1999).10.8*(M)
    
    Form of Change in Control
Agreement between Connetics and
key employees of the Company
(previously filed as Exhibit 10.12
to the Companys Annual Report on
Form 10-K/A for the year ended
December 31, 2001).10.9*(M)
    
    Form of Change in Control
Agreement between Connetics and
Outside Directors of the Company
(previously filed as Exhibit 10.13
to the Companys Registration
Statement on Form S-1 filed with
the Commission on June 20, 2005,
Registration Statement No.
333-125982).10.10*(M)
    
    Change in Control Agreement dated
January 1, 2002 between Connetics
and Thomas G. Wiggans (previously
filed as Exhibit 10.14 to the
Companys Registration Statement
on Form S-1 filed with the
Commission on June 20, 2005,
Registration Statement No.
333-125982).10.11*(M)
    
    Consulting Agreement dated August
22, 2005, between Connetics and G.
Kirk Raab (previously filed as
Exhibit 10.1 to the Companys
Current Report on Form 8-K dated
August 22, 2005 and filed with the
Commission on August 25, 2005).10.12*(M)
    
    Consulting Agreement dated January
31, 2006, between Connetics and
David Cohen, M.D. (previously
filed as Exhibit 10.1 to the
Companys Current Report on Form
8-K dated January 31, 2006 and
filed with the Commission on
February 3, 2006).10.13(M)
    
    Form of Restricted Stock Purchase
Award dated February 1, 2006
between Connetics and each of
Thomas G. Wiggans, C. Gregory
Vontz, John L. Higgins, Lincoln
Krochmal and Katrina J. Church.10.14*(M)
    
    Fourth Amendment to Consulting
Agreement dated December 31, 2004
between Connetics and Eugene A.
Bauer, M.D. (previously filed as
Exhibit 10.13 to the Companys
Annual Report on Form 10-K for the
year ended December 31, 2004).10.15*(M)
    
    Consultant Change of Control
Agreement dated January 1, 2002
between Connetics and G. Kirk Raab
(previously filed as Exhibit 10.15
to the Companys Registration
Statement on Form S-1 filed with
the Commission on June 20, 2005,
Registration Statement No.
333-125982).10.16*(M)
    
    Summary Compensation Information
for Named Executive Officers and
Directors (previously filed as
Exhibit 10.16 to the Companys
Annual Report on Form 10-K for the
year ended December 31, 2005).10.17*(M)
    
    Description of Compensation
Payable to Non-Employee Directors
(previously filed as Exhibit 10.8
to the Companys Quarterly Report
on Form 10-Q for the quarter ended
June 30, 2005).Stock Plans and Agreements10.18*(M)
    
    1994 Stock Plan (as amended
through May 1999) and form of
Option Agreement (previously filed
as Exhibit 4.1 to the Companys
Form S-8 Registration Statement
No. 333- 85155).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    Description10.19*
    
    1995 Employee Stock Purchase Plan
(as amended and restated through
October 13, 2005), and form of
Subscription Agreement (previously
filed as Exhibit 10.16 to the
Companys Annual Report on Form
10-K for the year ended December
31, 2005).10.20*(M)
    
    1998 Supplemental Stock Plan
(previously filed as Exhibit 10.60
to the Companys Annual Report on
Form 10-K for the year ended
December 31, 1998).10.21*(M)
    
    Stock Plan (2000) and form of
Option Agreement (previously filed
as Exhibit 4.4 to the Companys
Form S-8 Registration Statement
No. 333-85155).10.22(M)
    
    Form of Restricted Stock Purchase
Award under the Companys Stock
Plan (2000)(see Exhibit 10.13
above).10.23*
    
    International Stock Incentive Plan
(previously filed as Exhibit 4.1
to the Companys Form S-8
Registration Statement No.
333-61558).10.24*
    
    2000 Non-Officer Employee Stock
Plan (previously filed as Exhibit
4.3 to the Companys Form S-8
Registration Statement No.
333-46562).10.25*
    
    2002 Non-Officer Employee Stock
Plan (as amended through May 2003)
(previously filed as Exhibit 99.1
to the Companys Current Report on
Form 8-K dated February 9, 2004
and filed with the Commission on
March 8, 2004).10.26*(M)
    
    1995 Directors Stock Option Plan
(as amended through February 10,
2005) (previously filed as Exhibit
10.7 to the Companys Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2005).10.27*(M)
    
    Non-Qualified Stock Option
Agreement dated April 13, 2005
between Connetics and James A.
Trah (previously filed as Exhibit
10.3 to the Companys Quarterly
Report on Form 10-Q for the
quarter ended March 31, 2005).10.28*(M)
    
    Non-Qualified Stock Option
Agreement dated May 16, 2005
between Connetics and Michael
Eison (previously filed as Exhibit
10.25 to the Companys
Registration Statement on Form
S-1 filed with the Commission on
June 20, 2005, Registration
Statement No. 333-125982).10.29*(M)
    
    Non-Qualified Stock Option
Agreement dated July 11, 2005
between Connetics and Stefan
Weiss, M.D. (previously filed as
Exhibit 10.6 to the Companys
Quarterly Report on Form 10-Q for
the quarter ended June 30, 2005).10.30*(M)
    
    Non-Qualified Stock Option
Agreement dated August 5, 2005
between Connetics and Scott W.
Meggs (previously filed as Exhibit
10.27 to the Companys Amendment
No. 2 to Form S-1 Registration
Statement No. 333-125982, filed
with the Commission on August 26,
2005).10.31*(M)
    
    Non-Qualified Stock Option
Agreement dated August 22, 2005
between Connetics and Luis C. Pena
(previously filed as Exhibit 10.28
to the Companys Amendment No. 2
to Form S-1 Registration Statement
No. 333-125982, filed with the
Commission on August 26, 2005).10.32*(M)
    
    Non-Qualified Stock Option
Agreement dated September 30, 2005
between Connetics and Claudette S.
MacMillan (previously filed as
Exhibit 10.1 to the Companys
Current Report on Form 8-K dated
September 30, 2005 and filed with
the Commission on October 4,
2005).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    Description10.33*(M)
    
    Non-Qualified Stock Option
Agreement dated November 7, 2005
between Connetics and Srabasti
Mukherjee (previously filed as
Exhibit 10.1 to the Companys
Current Report on Form 8-K dated
November 7, 2005 and filed with
the Commission on November 10,
2005).10.34*(M)
    
    Non-Qualified Stock Option
Agreement dated December 15, 2005
between Connetics and Gary Cain
(previously filed as Exhibit 10.1
to the Companys Current Report on
Form 8-K dated December 15, 2005
and filed with the Commission on
December 16, 2005).10.35*(M)
    
    Non-Qualified Stock Option
Agreement dated January 3, 2006
between Connetics and David Burch
(previously filed as Exhibit 10.1
to the Companys Current Report on
Form 8-K dated January 3, 2006 and
filed with the Commission on
January 10, 2006).10.36*(M)
    
    Non-Qualified Stock Option
Agreement dated January 9, 2006
between Connetics and Brian Davis
(previously filed as Exhibit 10.2
to the Companys Current Report on
Form 8-K dated January 3, 2006 and
filed with the Commission on
January 10, 2006).10.37*(M)
    
    Form of Non-Qualified Stock Option
Agreement between Connetics and
certain non-executive employees
hired in connection with
Connetics acquisition of PediaMed
Pharmaceuticals, Inc.s sales
organization (previously filed as
Exhibit 10.1 to the Companys
Current Report on Form 8-K dated
and filed with the Commission on
February 1, 2006).10.38*(M)
    
    Non-Qualified Stock Option
Agreement dated February 26, 2006
between Connetics and Freddie Park
(previously filed as Exhibit 10.1
to the Companys Current Report on
Form 8-K dated February 6, 2006
and filed with the Commission on
February 7, 2006).License Agreements10.39*
    
    License Agreement dated June 14,
1996 between Connetics and Soltec
Research Pty Ltd (previously filed
as Exhibit 10.28 to the Companys
Quarterly Report on Form 10-Q for
the quarter ended June 30, 1996).10.40*
    
    License Agreement dated January 1,
1998 between Connetics and Soltec
Research Pty Ltd (previously filed
as Exhibit 10.57 to the Companys
Annual Report on Form 10-K for the
year ended December 31, 1997).10.41*
    
    License Agreement (Ketoconazole)
dated July 14, 1999 between
Connetics and Soltec Research Pty
Ltd (previously filed as Exhibit
10.4 to the Companys Quarterly
Report on Form 10-Q for the
quarter ended June 30, 1999).10.42*
    
    License Agreement dated September
29, 2004 between Connetics and
Pierre Fabre Dermatologie
(previously filed as Exhibit 10.1
to our Current Report on Form 8-K
dated September 29, 2004 and filed
with the Commission on October 4,
2004).10.43*
    
    License and Development Agreement
between Connetics and Pharmacia &
Upjohn Company, dated December 21,
2001 (previously filed as Exhibit
99.1 to the Companys Current
Report on Form 8-K/A-2 dated
December 21, 2001, filed with the
Commission on July 12, 2002).10.44*
    
    License and Development Agreement
between Connetics and Yamanouchi
Europe B.V., dated May 13, 2002
(previously filed as Exhibit 10.2
to the Companys Quarterly Report
on Form 10-Q for the quarter ended
June 30, 2002).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    DescriptionReal Property10.45*
    
    Lease between Connetics and Renault & Handley Employees Investment Co., dated June 28, 1999
(previously filed as Exhibit 10.39 to the Companys Annual Report on Form 10-K/A for the year ended
December 31, 2001).10.46*
    
    Industrial Building Lease dated December 16, 1999, between Connetics and West Bayshore Associates
(previously filed as Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).10.47*
    
    Assignment and Assumption of Lease between Connetics and Respond.com, dated August 21, 2001
(previously filed as Exhibit 10.3 to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).10.48*
    
    Agreement dated August 21, 2001, between Connetics and Respond.com (previously filed as Exhibit 10.4
to the Companys Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).10.49*
    
    Sublease agreement between Connetics (sublessor) and Tolerian, Inc., dated June 20, 2002 (previously
filed as Exhibit 10.1 to the Companys Quarterly Report for the quarter ended June 30, 2002).10.50*
    
    Sublease Agreement between the Board of Trustees of the Leland Stanford Junior University and Incyte
Pharmaceuticals, Inc., dated May 6, 2004 (previously filed as Exhibit 10.2 to the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2004).10.51*
    
    Sublease Consent between The Board of Trustees of the Leland Stanford Junior University and Incyte
Corporation and Connetics Corporation, dated May 6, 2004 (previously filed as Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).10.52*
    
    Agreement Regarding Sublease and Lease between The Board of Trustees of the Leland Stanford Junior
University and Connetics Corporation, dated May 6, 2004 (previously filed as Exhibit 10.4 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2004).10.53*
    
    First Amendment to Lease between The Board of Trustees of the Leland Stanford Junior University and
Incyte Corporation, dated May 6, 2004 (previously filed as Exhibit 10.5 to the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2004).10.54*
    
    Sublease Agreement for 1841 Page Mill Road, Palo Alto, California, dated August 9, 2004 and effective
April 4, 2005 between Connetics and Incyte Corporation (previously filed as Exhibit 10.2 to the
Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 2005).10.55*
    
    Industrial Building Lease Between West Bayshore Associates and Connetics Corporation, dated September
2004 (previously filed as Exhibit 99.1 to the Companys Quarterly Report on Form 10-Q for the quarter
ended September 30, 2004).10.56*
    
    Sublease Consent between The Board of Trustees of the Leland Stanford Junior University and Interval
Research Corporation, Incyte Corporation, and Connetics Corporation dated March 15, 2005 (previously
filed as Exhibit 10.56 to the Companys Annual Report on Form 10-K for the year ended December 31,
2005).Exhibit Index




---



##### Table of Contents



ExhibitNumber
    
    DescriptionOther Agreements10.57*
    
    Agreement dated December 9, 1999 between Connetics and Soltec Research Pty Ltd (previously filed as
Exhibit 10.75 to the Companys Annual Report on Form 10-K for the year ended December 31, 1999).10.58*
    
    Asset Purchase Agreement dated as of April 9, 2001, between Connetics and Prometheus Laboratories,
Inc. (see Exhibit 2.2 above).10.59*
    
    Facilities Contribution Agreement between Connetics and DPT Laboratories, Ltd., with retroactive
effect to November 1, 2001 (previously filed as Exhibit 10.55 to the Companys Annual Report on Form
10-K/A (Amendment No. 2) for the year ended December 31, 2001).10.60*
    
    Manufacturing and Supply Agreement between Connetics and DPT Laboratories, Ltd., dated March 12, 2002
(previously filed as Exhibit 10.56 to the Companys Annual Report on Form 10-K/A (Amendment No. 2) for
the year ended December 31, 2001).10.61*
    
    Distribution Agreement between Connetics and CORD Logistics, Inc., dated January 1, 2001, as amended
September 1, 2001, September 3, 2003, and September 24, 2003 (previously filed as Exhibit 10.51 to the
Companys Annual Report on Form 10-K/A (Amendment No. 2) for the year ended December 31, 2002).10.62*
    
    Amended and Restated Manufacturing and Supply Agreement dated April 24, 2003 between Connetics and
AccraPac Group, Inc. (previously filed as Exhibit 10.1 to the Companys Quarterly Report on Form
10-Q/A (Amendment No. 1) for the quarter ended March 31, 2003).10.63*
    
    Purchase and Sale Agreement dated February 2, 2004 between Connetics and Hoffmann-LaRoche Inc. (see
Exhibit 2.1 above).10.64*
    
    Amendment to Facilities Contribution Agreement between DPT Laboratories, Ltd. and Connetics
Corporation, dated August 18, 2004 (previously filed at Exhibit 10.1 to the Companys Quarterly Report
on Form 10-Q for the quarter ended September 30, 2004).10.65*
    
    Amended and Restated Manufacturing and Supply Agreement between DPT Laboratories, Ltd. and Connetics
Corporation, dated August 18, 2004 (previously filed as Exhibit 10.2 to the Companys Quarterly Report
on Form 10-Q for the quarter ended September 30, 2004).10.66*
    
    Distribution Services Agreement between Cardinal Health, Inc. and Connetics Corporation, dated
December 1, 2004 (previously filed as Exhibit 10.53 to the Companys Annual Report on Form 10-K for
the year ended December 31, 2004).10.67*
    
    Core Distribution Agreement between McKesson Corporation and Connetics Corporation, dated December 23,
2004 (previously filed as Exhibit 10.54 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).10.68*
    
    Service Agreement dated March 1, 2005 between Connetics and Ventiv Pharma Services, LLC (previously
filed as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the quarter ended March 31,
2005).10.69*
    
    Amendment to Distribution Services Agreement dated December 22, 2005 between Connetics and Cardinal
Health, Inc. (previously filed at Exhibit 10.2 to the Companys Current Report on Form 8-K dated
December 22, 2005 and filed with the Commission on December 23, 2005).Exhibit Index




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##### Table of Contents



ExhibitNumber
    
    Description10.70*
    
    Amendment to Core Distribution Agreement dated December 22, 2005, between Connetics and McKesson
Corporation (previously filed at Exhibit 10.4 to the Companys Current Report on Form 8-K dated
December 22, 2005 and filed with the Commission on December 23, 2005).10.71*
    
    First Amendment to Service Agreement dated December 30, 2005 between Connetics and Ventiv Commercial
Services, LLC (previously filed at Exhibit 10.2 to the Companys Current Report on Form 8-K dated
December 30, 2005 and filed with the Commission on January 6, 2006).10.72*
    
    Asset Acquisition Agreement dated January 4, 2006 between Connetics and PediaMed Pharmaceuticals, Inc.
(see Exhibit 2.3 above).10.73*
    
    Distribution Services Agreement dated September 30, 2005 between Connetics and AmerisourceBergen Drug
Corporation (previously filed as Exhibit 10.1 to the Companys Current Report on Form 8-K dated
September 30, 2005 and filed with the Commission on October 6, 2005).21*
    
    Subsidiaries (previously filed as Exhibit 21 to the Companys Annual Report on Form 10-K for the year
ended December 31, 2003).23.1
    
    Consent of Independent Registered Public Accounting Firm.31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.32.2
    
    Certification by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.
 Key to Exhibit Index Footnotes:
 The Commission file number for our Exchange Act filings referenced above is 0-27406.
 
 *
    
    Incorporated by this reference to the previous filing, as indicated.(M)
    
    This item is a management compensatory plan or arrangement required to be listed as an
exhibit to this Report pursuant to Item 601(b)(10)(iii) of Regulation S-K.(C)
    
    We have omitted certain portions of this Exhibit and have requested confidential treatment of
such portions from the SEC.
    
    We have requested and the SEC has granted confidential treatment for certain portions of this
Exhibit.
    
    The certifications attached as Exhibits 32.1 and 32.2 that accompany this Annual Report on
Form 10-K/A, are not deemed filed with the Securities and Exchange Commission and are not to
be incorporated by reference into any filing of Connetics Corporation under the Securities Act
of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before
or after the date of this Annual Report on Form 10-K/A, irrespective of any general
incorporation language contained in such filing. Exhibit Index