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UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-K


ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934


For the Fiscal Year Ended December 31, 2004


Commission File Number 0-27406


CONNETICS CORPORATION


(Exact name of registrant as specified in its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 94-3173928                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|3160 Porter Drive                                                  |  | 94304                                   
|Palo Alto, California                                              |  | (zip code)                              
|(Address of principal executive offices)                           |  |                                         

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


þ o


þ


þ o






DOCUMENTS INCORPORATED BY REFERENCE












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Table of Contents


|                           |  |                                                                                                                       |  |      |    | 
|-------------------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                           |  |                                                                                                                       |  | Page |   
|                           |  |                                                                                                                       |  |      |   
|Forward-Looking Statements |  |                                                                                                                       |  |     
|PART I                    
|Item 1.                    |  | Business                                                                                                              |  |      | 1  | 
|                           |  | The Company                                                                                                           |  |      | 1  | 
|                           |  | Our Strategy                                                                                                          |  |      | 2  | 
|                           |  | Our Products                                                                                                          |  |      | 3  | 
|                           |  | Product Candidates and Clinical Trials                                                                                |  |      | 5  | 
|                           |  | Royalty-Bearing Products and Licensed
    Technology                                                                  |  |      | 6  | 
|                           |  | Sales and Marketing                                                                                                   |  |      | 8  | 
|                           |  | Competition                                                                                                           |  |      | 9  | 
|                           |  | Customers                                                                                                             |  |      | 10 | 
|                           |  | Research and Development and Product
    Pipeline                                                                     |  |      | 10 | 
|                           |  | Patents and Proprietary Rights                                                                                        |  |      | 11 | 
|                           |  | Trademarks                                                                                                            |  |      | 12 | 
|                           |  | Manufacturing                                                                                                         |  |      | 12 | 
|                           |  | Warehousing and Distribution                                                                                          |  |      | 12 | 
|                           |  | Government Regulation                                                                                                 |  |      | 12 | 
|                           |  | Marketing to Healthcare Professionals                                                                                 |  |      | 16 | 
|                           |  | Marketing Exclusivity                                                                                                 |  |      | 16 | 
|                           |  | Environmental Regulation                                                                                              |  |      | 16 | 
|                           |  | Employees                                                                                                             |  |      | 17 | 
|                           |  | Factors Affecting Our Business and
    Prospects                                                                      |  |      | 17 | 
|                           |  | Available Information                                                                                                 |  |      | 29 | 
|                           |  | Executive Officers of the Company                                                                                     |  |      | 29 | 
|Item 2.                    |  | Properties                                                                                                            |  |      | 31 | 
|Item 3.                    |  | Legal Proceedings                                                                                                     |  |      | 31 | 
|Item 4.                    |  | Submission of Matters to a Vote of Security Holders                                                                   |  |      | 31 | 
|PART II                   
|Item 5.                    |  | Market for the Companys Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities |  |      | 32 | 
|Item 6.                    |  | Selected Financial Data                                                                                               |  |      | 33 | 
|Item 7.                    |  | Managements Discussion and Analysis of Financial
    Condition and Results of Operations                             |  |      | 34 | 
|Item 7A.                   |  | Quantitative and Qualitative Disclosures About Market
    Risk                                                        |  |      | 49 | 
|Item 8.                    |  | Financial Statements and Supplementary Data                                                                           |  |      | 50 | 
|Item 9.                    |  | Changes in and Disagreements with Accountants on Accounting
    and Financial Information                             |  |      | 50 | 
|Item 9A.                   |  | Controls and Procedures                                                                                               |  |      | 50 | 
|Item 9B.                   |  | Other Information                                                                                                     |  |      | 50 | 



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|                                                                                                   |  |                                                                                                    |     |      |    | 
|-------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- | --- | ---- | -- | 
|                                                                                                   |  |                                                                                                    |     | Page |   
|                                                                                                   |  |                                                                                                    |     |      |   
|PART III                                                                                          
|Item 10.                                                                                           |  | Directors and Executive Officers                                                                   |     |      | 50 | 
|Item 11.                                                                                           |  | Executive Compensation                                                                             |     |      | 51 | 
|Item 12.                                                                                           |  | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters |     |      | 51 | 
|Item 13.                                                                                           |  | Certain Relationships and Related Transactions                                                     |     |      | 51 | 
|Item 14.                                                                                           |  | Principal Accounting Fees and Services                                                             |     |      | 51 | 
|PART IV                                                                                           
|Item 15.                                                                                           |  | Exhibits and Financial Statement Schedules                                                         |     |      | 52 | 
|Signatures                                                                                         |  |                                                                                                    | 53  |     
|Consolidated Financial Statements and
    Reports of Independent Registered Public Accounting Firm |  |                                                                                                    | F-1 |     
|Index to Exhibits                                                                                  |  |                                                                                                    |     |     
|EXHIBIT 10.12                                                                                     
|EXHIBIT 10.13                                                                                     
|EXHIBIT 10.53                                                                                     
|EXHIBIT 10.54                                                                                     
|EXHIBIT 10.55                                                                                     
|EXHIBIT 23.1                                                                                      
|EXHIBIT 31.1                                                                                      
|EXHIBIT 31.2                                                                                      
|EXHIBIT 32.1                                                                                      
|EXHIBIT 32.2                                                                                      





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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 public statements of our officers 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  for example, 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. These
include statements relating to future actions, prospective
products or product approvals, future performance or results of
current and anticipated products, sales efforts, expenses, the
outcome of contingencies such as legal proceedings, and
financial results.


Although we believe that 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 products, the progress of our product
development programs, developments with respect to clinical
trials and the regulatory approval process, and developments
relating to our sales and marketing capabilities. 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 not currently known to us, 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 including the Quarterly Reports on Form 10-Q to
be filed in 2005. 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.




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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, and our
principal executive offices are located at 3160 Porter Drive,
Palo Alto, California 94304. Our telephone number is
(650) 843-2800. Connetics®, Luxíq®,
OLUX® , Soriatane®,
VersaFoam® and the seven interlocking Cs
design are registered trademarks, and Evoclin Liquipatch VersaFoam-EFTM and Desilux are trademarks, of Connetics.
Velac® is a registered trademark of Yamanouchi
Europe B.V. 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.


tm






TM


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OUR STRATEGY






| |   |                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Maximizing Commercial Opportunities for OLUX, Luxíq,
    Soriatane and Evoclin. 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

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | are most likely to prescribe our products. We are able to
    effectively reach approximately 98% of our target audience. In
    March 2004, we acquired exclusive U.S. rights to
    Soriatane-brand acitretin, and in April 2004 we began promoting
    Soriatane to dermatologists for the treatment of severe
    psoriasis in adults. In October 2004, we received FDA approval
    for Evoclin, a foam formulation of clindamycin for the treatment
    of acne vulgaris. We launched Evoclin commercially in December
    2004 with availability of the product in 50g and 100g trade unit
    sizes.                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | 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. We concluded clinical trials in 2004 and subsequently
    submitted an NDA with the FDA for our product candidate Velac, a
    combination of 1% clindamycin, and 0.025% tretinoin in a gel
    formulation, for the potential treatment of acne vulgaris. The
    FDA accepted the Velac NDA for filing in October 2004 with a
    filing date of August 23, 2004. In September 2004, we
    commenced the Phase III clinical program for Desilux, a
    low-potency topical steroid, formulated with 0.05% desonide in
    our proprietary emollient foam delivery vehicle. The clinical
    program focuses on atopic dermatitis, and subject to a
    successful Phase III trial outcome, we plan to file an NDA
    for Desilux in the fourth quarter of 2005.
|
| |  | Broadening Our Product Portfolio Through Development, License
    or Acquisition. We believe that 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 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 product candidates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               




OUR PRODUCTS


OLUX and Luxíq Foams








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Soriatane












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Evoclin Foam







PRODUCT CANDIDATES AND CLINICAL TRIALS




Extina® Foam






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| |       
| | ------
| | Velac®





| |             
| | ------------
| | DesiluxFoam



OLUX-EF






| |                            
| | ---------------------------
| | Other Pipeline Formulations

Royalty-Bearing Products and
Licensed Technology  Liquipatch.





ROYALTY-BEARING PRODUCTS AND LICENSED TECHNOLOGY


Foam Technology.


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Aerosol Spray.


Liquipatch.


7



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Actimmune®





SALES AND MARKETING




www.connetics.com www.olux.com, www.luxiq.com,
www.soriatane.com, and www.evoclin.com






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COMPETITION




tm tm tm tm






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CUSTOMERS







RESEARCH AND DEVELOPMENT AND PRODUCT PIPELINE










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PATENTS AND PROPRIETARY RIGHTS












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TRADEMARKS







MANUFACTURING







WAREHOUSING AND DISTRIBUTION


Customers Note 2 of Notes
to Consolidated Financial Statements.





GOVERNMENT REGULATION


Generally  Product Development. Factors Affecting Our Business and
Prospects  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


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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 the potential new
    agent through laboratory experimentation and animal testing, to
    determine if it is reasonably safe 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,
    which the FDA must review before human clinical trials of an
    investigational drug can start. We have filed and will continue
    to be required to sponsor and file investigational new drug
    applications, and will be responsible for initiating and
    overseeing the clinical studies to demonstrate the safety and
    efficacy that are necessary to obtain FDA approval of our
    product candidates.
|
| |  | 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 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.                                                                                                        



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The rate of completion of our clinical trials depends upon,
    among other factors, the rate at which patients enroll in the
    study. Patient enrollment is a function of many factors,
    including the size of the patient population, the nature of the
    protocol, the proximity of patients to clinical sites, the
    eligibility criteria for the study, and the sometimes seasonal
    nature of certain dermatological conditions. Delays in planned
    patient enrollment may result in increased costs and delays,
    which could have a material adverse effect on our business. In
    addition, side effects or adverse events that are reported
    during clinical trials can delay, impede, or prevent marketing
    approval.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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,

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| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | together with the studies generated on our products. Generally,
    although the FDA evaluation of safety and efficacy is the same,
    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 FDA process may be longer for our future product
    candidates than it has been for our products to date.





Manufacturing.


Post-Approval Regulation.


Pharmacy Boards.


Fraud and Abuse Regulations.


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Medicaid and State Rebate Programs.






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Factors Affecting Our Business and
Prospects  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







MARKETING EXCLUSIVITY







ENVIRONMENTAL REGULATION






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EMPLOYEES







FACTORS AFFECTING OUR BUSINESS AND PROSPECTS




Risks Related To Our Business


Our operating results may fluctuate. This fluctuation could
cause financial results to be below expectations and the market
prices of our securities to decline.




If we do not obtain the capital necessary to fund our
operations, we will be unable to develop or market our
products.




If we do not sustain profitability, stockholders may lose
their investment.




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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,                                         
|
| |  | we may be contractually bound to terms that, in the future, are
    not commercially favorable to us, 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.





| |                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reported earnings per share may be more volatile because
    of the conversion provisions of our convertible senior notes or
    the exercise of outstanding stock options and warrants.





| |                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to protect our proprietary rights, competitors may
    be able to use our technologies, which would weaken our
    competitive position, reduce our revenues and increase our
    costs.





| |                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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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| |                                                                                     
| | ------------------------------------------------------------------------------------
| | We rely on our employees and consultants to keep our trade
    secrets confidential.





| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.



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| |                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | Evoclin 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.





| |                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The growth of our business depends in part on our ability to
    identify, acquire on favorable terms, and assimilate
    technologies, products or businesses.





| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties in and costs associated with the assimilation of
    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.                                                                             





| |                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------
| | Our future product revenues could be reduced by imports from
    countries where our products are available at lower prices.







| |                                                                                                         
| | --------------------------------------------------------------------------------------------------------
| | Our current and future indebtedness and debt service
    obligations may adversely affect our cash flow.



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Risks Related to Our Products




| |                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reliance on third-party manufacturers and suppliers and
    any manufacturing difficulties they encounter could delay future
    revenues from our product sales.







If our contract manufacturers fail to comply with cGMP
regulations, we may be unable to meet demand for our products
and may lose potential revenue.




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If our supply of finished products is interrupted, our
ability to maintain our inventory levels could suffer and future
revenues may be delayed.








| |                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------
| | We cannot sell our current products and product candidates if
    we do not obtain and maintain governmental approvals.







| |   |                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | testing and surveillance to monitor the product and its
    continued compliance with regulatory requirements,                                                          
|
| |  | submitting products for inspection and, if any inspection
    reveals that the product is not in compliance, prohibiting the
    sale of all products from the same lot,
|
| |  | suspending manufacturing,                                                                                                                                               
|
| |  | recalling products, and                                                                                                                                                 
|
| |  | withdrawing marketing approval.                                                                                                                                         



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| |   |                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | incur substantial expenses, including fines, penalties, legal
    fees and costs to comply with the FDAs requirements,                                                      
|
| |  | 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, and
|
| |  | 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.





Any factor adversely affecting the prescription volume
related to our products could harm our business, financial
condition and results of operations.






| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | manufacturing or supply interruptions;                                                                                                               
|
| |  | the development of new competitive pharmaceuticals and
    technological advances to treat the conditions addressed by our
    core branded products;

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| |   |                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------
| |  | marketing or pricing actions by one or more of our competitors;                                          
|
| |  | regulatory action by the FDA and other government regulatory
    agencies;                               
|
| |  | changes in the prescribing or procedural practices of
    dermatologists, pediatricians or podiatrists;  
|
| |  | changes in the reimbursement or substitution policies of
    third-party payors or retail pharmacies; and
|
| |  | product liability claims.                                                                                

We depend on a limited number of customers, and if we lose
any of them, our business could be harmed.






Orders for our products may increase or decrease depending on
the inventory levels held by our major customers. Significant
increases and decreases in orders from our major customers could
cause our operating results to vary significantly from quarter
to quarter.




The expenses associated with our clinical trials are
significant. 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.




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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.






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 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.




The termination of the agreement for the co- promotion of
OLUX and Luxíq to certain PCPs could negatively
impact our business.




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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.








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 stock price is volatile and the value of your investment
    could decline in value.





|       |  |      |       |  |     |   |       | 
|------ |  | ---- | ----- |  | --- | - | ----- | 
|Period |  | High |       |  | Low |  
|       |  |      |       |  |     |  
|2004   |  | $    | 29.92 |  |     | $ | 17.69 | 
|2003   |  | $    | 19.27 |  |     | $ | 12.30 | 

The trading price of our common stock could be subject to
significant fluctuations, which may adversely affect the price
at which you can sell our common stock.




28



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| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | clinical trial results and regulatory developments,                                                                             
|
| |  | quarterly variations in results,                                                                                                
|
| |  | business and product market cycles,                                                                                             
|
| |  | fluctuations in customer requirements,                                                                                          
|
| |  | the availability and utilization of manufacturing capacity,                                                                     
|
| |  | the timing of new product introductions,                                                                                        
|
| |  | the ability to develop and implement new technologies,                                                                          
|
| |  | the timing and amounts of royalties paid to us by third parties,
    and issues with the safety or effectiveness of our products






AVAILABLE INFORMATION


http://www.connetics.com ir@connetics.com .





EXECUTIVE OFFICERS OF THE COMPANY




|                       |  |     |    |  |          |                                                                                         
|---------------------- |  | --- | -- |  | -------- | ----------------------------------------------------------------------------------------
|Name                   |  | Age |    |  | Position
|                       |  |     |    |  |         
|Thomas G. Wiggans      |  |     | 53 |  |          | Chief Executive Officer and Director                                                    
|C. Gregory Vontz       |  |     | 44 |  |          | President and Chief Operating Officer                                                   
|John L. Higgins        |  |     | 34 |  |          | Chief Financial Officer; Executive Vice President, Finance and
    Corporate Development
|Katrina J. Church      |  |     | 43 |  |          | Executive Vice President, Legal Affairs; General Counsel and
    Secretary              
|Lincoln Krochmal, M.D. |  |     | 58 |  |          | Executive Vice President, Research and Product Development                              
|Matthew W. Foehr       |  |     | 32 |  |          | Senior Vice President, Technical Operations                                             
|Michael Miller         |  |     | 47 |  |          | Senior Vice President, Sales and Marketing and Chief Commercial
    Officer             
|Rebecca Sunshine       |  |     | 42 |  |          | Senior Vice President, Human Resources and Organizational
    Dynamics                  

Thomas Wiggans


29



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##### Table of Contents





Gregory Vontz


John Higgins


Katrina Church


Lincoln Krochmal, M.D.


Matthew Foehr


30



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##### Table of Contents



Michael Miller


Rebecca Sunshine







|        |           
|------- | ----------
|Item 2. | Properties








|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings








|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders



31



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PART II







|        |                                                                                                                  
|------- | -----------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Companys Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity Securities



|               |  |      |       |  |     |   |       | 
|-------------- |  | ---- | ----- |  | --- | - | ----- | 
|               |  | High |       |  | Low |  
|               |  |      |       |  |     |  
|2003           |  |      |       |  |     |   |       | 
|First Quarter  |  | $    | 16.75 |  |     | $ | 12.30 | 
|Second Quarter |  |      | 18.18 |  |     |   | 14.70 | 
|Third Quarter  |  |      | 18.74 |  |     |   | 14.24 | 
|Fourth Quarter |  |      | 19.27 |  |     |   | 16.00 | 
|2004           |  |      |       |  |     |   |       | 
|First Quarter  |  | $    | 24.91 |  |     | $ | 17.69 | 
|Second Quarter |  |      | 22.60 |  |     |   | 18.59 | 
|Third Quarter  |  |      | 28.09 |  |     |   | 19.46 | 
|Fourth Quarter |  |      | 29.92 |  |     |   | 20.30 | 







32



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data



Connetics Corporation


Selected Consolidated Financial Data


|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |       |         |        |         |       |        |        |         |  
|-------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ----------------------------- | ------ | ------- | ------- | ----- | ------ | ------ | ------ | ----- | ------- | ------ | ------- | ----- | ------- | ------ | ------- | ----- | ------ | ------ | ------- | -
|                                                                                       |                                                                                                 | Years Ended December 31,                                      |                              
|                                                                                       |                                                                                                 |                                                               |                              
|                                                                                       |                                                                                                 | 2004                                                          |                               |        | 2003    |         |       | 2002   |        |        | 2001  |         |        | 2000    |      
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       |                                                                                                 | (In thousands, except per share amounts)                      |                              
|Consolidated Statement of Operations Data:                                             |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |       |         |        |         |       |       
|                                                                                       | Revenues:                                                                                       |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |       |         |        |         |       |        |       
|                                                                                       |                                                                                                 | Product                                                       |                               | $      | 142,059 |         |       | $      | 66,606 |        |       | $       | 47,573 |         |       | $       | 30,923 |         |       | $      | 20,095 |        
|                                                                                       |                                                                                                 | Royalty and contract(1)                                       |                               |        | 2,296   |         |       |        | 8,725  |        |       |         | 5,190  |         |       |         | 3,141  |         |       |        | 20,679 |        
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       |                                                                                                 |                                                               | Total revenues                |        |         | 144,355 |       |        |        | 75,331 |       |         |        | 52,763  |       |         |        | 34,064  |       |        |        | 40,774  |  
|                                                                                       | Operating expenses:                                                                             |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |       |         |        |         |       |        |       
|                                                                                       |                                                                                                 | Cost of product revenues                                      |                               |        | 12,656  |         |       |        | 5,129  |        |       |         | 4,190  |         |       |         | 3,123  |         |       |        | 3,868  |        
|                                                                                       |                                                                                                 | Amortization of intangible assets(2)                          |                               |        | 11,471  |         |       |        | 819    |        |       |         | 805    |         |       |         | 1,048  |         |       |        |       |        
|                                                                                       |                                                                                                 | Research and development                                      |                               |        | 21,539  |         |       |        | 30,109 |        |       |         | 25,821 |         |       |         | 19,156 |         |       |        | 21,875 |        
|                                                                                       |                                                                                                 | Selling, general and administrative                           |                               |        | 73,206  |         |       |        | 41,781 |        |       |         | 36,819 |         |       |         | 35,014 |         |       |        | 26,673 |        
|                                                                                       |                                                                                                 | In-process research and development and milestone payments(3) |                               |        | 3,500   |         |       |        |       |        |       |         | 4,350  |         |       |         | 1,080  |         |       |        |       |        
|                                                                                       |                                                                                                 | Loss on program termination(4)                                |                               |        |        |         |       |        |       |        |       |         | 312    |         |       |         | 1,142  |         |       |        |       |        
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       |                                                                                                 |                                                               | Total operating expenses      |        |         | 122,372 |       |        |        | 77,838 |       |         |        | 72,297  |       |         |        | 60,563  |       |        |        | 52,416  |  
|                                                                                       |                                                                                                 |                                                               | Income (loss) from operations |        |         | 21,983  |       |        |        | (2,507 | )     |         |        | (19,534 | )     |         |        | (26,499 | )     |        |        | (11,642 | )
|                                                                                       | Gain on sale of investment(5)                                                                   |                                                               |                               |       |         |         |       |       |        |        |       | 2,086   |        |         |       | 122     |        |         |       | 42,967 |       
|                                                                                       | Gain on sale of Ridaura product line(6)                                                         |                                                               |                               |       |         |         |       |       |        |        |       |        |        |         |       | 8,002   |        |         |       |       |       
|                                                                                       | Interest and other income (expense) net                                                         |                                                               |                               | (1,475 | )       |         |       | (426   | )      |        |       | 1,039   |        |         |       | 1,978   |        |         |       | 1,873  |       
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       | Income (loss) before income taxes and cumulative effect of a
    change in accounting principle |                                                               |                               | 20,508 |         |         |       | (2,933 | )      |        |       | (16,409 | )      |         |       | (16,397 | )      |         |       | 33,198 |       
|                                                                                       | Income tax provision                                                                            |                                                               |                               | 1,493  |         |         |       | 1,167  |        |        |       | 181     |        |         |       | 345     |        |         |       | 1,010  |       
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       | Income (loss) before cumulative effect of
    change          in
    accounting principle       |                                                               |                               | 19,015 |         |         |       | (4,100 | )      |        |       | (16,590 | )      |         |       | (16,742 | )      |         |       | 32,188 |       
|                                                                                       | Cumulative effect of change in accounting principle, net of
    tax(7)                          |                                                               |                               |       |         |         |       |       |        |        |       |        |        |         |       |        |        |         |       | (5,192 | )     
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|                                                                                       | Net income (loss)                                                                               |                                                               | $                             | 19,015 |         |         | $     | (4,100 | )      |        | $     | (16,590 | )      |         | $     | (16,742 | )      |         | $     | 26,996 |       
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|Basic Earnings Per Share                                                              |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |       |         |        |         |       |       
|Income (loss) per share before cumulative effect of change in
    accounting principle |                                                                                                 | $                                                             | 0.54                          |        |         | $       | (0.13 | )      |        | $      | (0.54 | )       |        | $       | (0.56 | )       |        | $       | 1.13  |       
|Cumulative effect of change in accounting principle, net of tax                        |                                                                                                 |                                                               |                              |        |         |         |      |        |        |        |      |         |        |         |      |         |        |         | (0.18 | )     
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      
|Net income (loss) per share                                                            |                                                                                                 | $                                                             | 0.54                          |        |         | $       | (0.13 | )      |        | $      | (0.54 | )       |        | $       | (0.56 | )       |        | $       | 0.95  |       
|                                                                                       |                                                                                                 |                                                               |                               |        |         |         |       |        |        |        |       |         |        |         |      

33



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|                                                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |       |         |       |   |      |        |      | 
|-------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ---------------------------------------- | ---- | ------- | ---- | - | ----- | ------- | ----- | - | ----- | ------- | ----- | ---- | ----- | ------- | ----- | - | ---- | ------ | ---- | 
|                                                                                       |                                                                   | Years Ended December 31,                 |     
|                                                                                       |                                                                   |                                          |     
|                                                                                       |                                                                   | 2004                                     |      |         | 2003 |   |       | 2002    |       |   | 2001  |         |       | 2000 |      
|                                                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |      
|                                                                                       |                                                                   | (In thousands, except per share amounts) |     
|Diluted Earnings Per Share                                                            |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |       |         |       |   |      |       
|Income (loss) per share before cumulative effect of change in
    accounting principle |                                                                   | $                                        | 0.51 |         |      | $ | (0.13 | )       |       | $ | (0.54 | )       |       | $    | (0.56 | )       |       | $ | 1.07 |       
|                                                                                       | Cumulative effect of change in accounting principle, net of tax   |                                          |      |        |      |   |       |        |       |   |       |        |       |      |       |        |       |   |      | (0.17  | )   
|                                                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |      
|Net income (loss) per share                                                            |                                                                   | $                                        | 0.51 |         |      | $ | (0.13 | )       |       | $ | (0.54 | )       |       | $    | (0.56 | )       |       | $ | 0.90 |       
|                                                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |      
|                                                                                       | Shares used to calculate basic net earnings (loss) per share      |                                          |      | 35,036  |      |   |       | 31,559  |       |   |       | 30,757  |       |      |       | 29,861  |       |   |      | 28,447 |     
|                                                                                       | Shares used to calculate diluted net earnings (loss) per share    |                                          |      | 37,443  |      |   |       | 31,559  |       |   |       | 30,757  |       |      |       | 29,861  |       |   |      | 30,086 |     
|Pro forma amounts assuming the accounting change was applied
    retroactively:        |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |       |         |       |   |      |       
|                                                                                       | Net income (loss)                                                 |                                          | $    | 19,015  |      |   | $     | (4,100  | )     |   | $     | (16,590 | )     |      | $     | (16,742 | )     |   | $    | 32,188 |     
|                                                                                       | Earnings per share:                                               |                                          |      |         |      |   |       |         |       |   |       |         |       |      |       |         |       |   |      |        |     
|                                                                                       |                                                                   | Basic                                    |      | $       | 0.54 |   |       | $       | (0.13 | ) |       | $       | (0.54 | )    |       | $       | (0.56 | ) |      | $      | 1.13 | 
|                                                                                       |                                                                   | Diluted                                  |      | $       | 0.51 |   |       | $       | (0.13 | ) |       | $       | (0.54 | )    |       | $       | (0.56 | ) |      | $      | 1.07 | 
|                                                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |      
|Consolidated Balance Sheet Data:                                                       |                                                                   |                                          |      |         |      |   |       |         |       |   |       |         |       |      |       |         |       |   |      |       
|                                                                                       | Cash, cash equivalents, marketable securities and restricted cash |                                          | $    | 76,346  |      |   | $     | 114,966 |       |   | $     | 33,788  |       |      | $     | 48,476  |       |   | $    | 80,184 |     
|                                                                                       | Working capital                                                   |                                          |      | 71,094  |      |   |       | 112,247 |       |   |       | 25,185  |       |      |       | 44,026  |       |   |      | 71,030 |     
|                                                                                       | Total assets                                                      |                                          |      | 245,728 |      |   |       | 145,897 |       |   |       | 59,553  |       |      |       | 72,327  |       |   |      | 85,713 |     
|                                                                                       | Convertible senior notes                                          |                                          |      | 90,000  |      |   |       | 90,000  |       |   |       |        |       |      |       |        |       |   |      |       |     
|                                                                                       | Total stockholders equity                                        |                                          |      | 127,920 |      |   |       | 45,754  |       |   |       | 44,743  |       |      |       | 61,354  |       |   |      | 72,606 |     






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 10 years. Amortization charges for the Soriatane
    rights in 2004 were $10.6 million.                                                                                                                                                                                                                                                                  
|   
|(3) | In May 2002, we entered into an agreement with Yamanouchi
    Europe, B.V. to license Velac. In connection with this agreement
    we paid Yamanouchi 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. In the third
    quarter of 2004, we recorded an additional milestone payment of
    $3.5 million upon filing an NDA with the FDA.
|   
|(4) | In 2001, we recorded a net charge of $1.1 million
    representing costs accrued in connection with the reduction in
    workforce and the wind down of relaxin development contracts.                                                                                                                                                                                                                                                                                                   
|   
|(5) | In the fourth quarter of 2000, we recorded a
    $43.0 million gain on the sale of securities.                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(6) | In April 2001, we sold our rights to Ridaura including
    inventory to Prometheus Laboratories, Inc. 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 the sale of Ridaura.                                                                                                                                                                                     
|   
|(7) | Effective January 1, 2000, we changed our method of
    accounting for non-refundable license fees in accordance with
    Staff Accounting Bulletin 101, Revenue Recognition in
    Financial Statements.                                                                                                                                                                                                                                                                              






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations



OVERVIEW




| |                  
| | -----------------
| | Business Overview



34



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tm










| |                        
| | -----------------------
| | Summary of 2004 Results











35



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##### Table of Contents



CERTAIN EVENTS IN 2004












36



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##### Table of Contents









CRITICAL ACCOUNTING POLICIES AND ESTIMATES








| |                                                                                    
| | -----------------------------------------------------------------------------------
| | Revenue Recognition  Reserves for Discounts,
    Returns, Rebates and Chargebacks.







37



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| |                                                                                         
| | ----------------------------------------------------------------------------------------
| | Goodwill, Purchased Intangibles and Other Long-Lived
    Assets  Impairment Assessments

Goodwill and other Intangible
Assets,


Accounting for Impairment or Disposal of
Long-Lived Assets,






| |             
| | ------------
| | Income Taxes



38



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##### Table of Contents









RESULTS OF OPERATIONS




| |         
| | --------
| | Revenues



|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |    |     |    |   |       |        |        | 
|----------------------------------- | --------- | ------------------------ | ----- | ------ | -------- |  | --- | ---- | --- | - | -------- | ------ | ------ | - | -- | --- | -- | - | ----- | ------ | ------ | 
|                                    |           | Years Ended December 31, |      
|                                    |           |                          |      
|                                    |           | 2004                     |       |        | 2003     |  |     | 2002 |    
|                                    |           |                          |       |        |          |  |     |      |    
|                                    |           | $                        |       |        | % Change |  |     | $    |     |   | % Change |        |        | $ |   
|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |   
|                                    |           | (Dollars in thousands)   |      
|Product revenues:                   |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |    |     |    |   |       |       
|                                    | OLUX      |                          | $     | 61,894 |          |  |     | 30   | %   |   | $        | 47,538 |        |   |    | 47  | %  |   | $     | 32,339 |       
|                                    | Luxíq     |                          |       | 23,582 |          |  |     | 25   | %   |   |          | 18,857 |        |   |    | 25  | %  |   |       | 15,042 |       
|                                    | Soriatane |                          |       | 53,567 |          |  |     | 100  | %   |   |          |       |        |   |    |    |    |   |       |       |       
|                                    | Evoclin   |                          |       | 2,883  |          |  |     | 100  | %   |   |          |       |        |   |    |    |    |   |       |       |       
|                                    | Other     |                          |       | 133    |          |  |     | (37  | )%  |   |          | 211    |        |   |    | 10  | %  |   |       | 192    |       
|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |   
|                                    |           | Total product revenues   |       |        | 142,059  |  |     |      | 113 | % |          |        | 66,606 |   |    |     | 40 | % |       |        | 47,573 | 
|Royalty and contract revenues:      |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |    |     |    |   |       |       
|                                    | Royalty   |                          |       | 1,839  |          |  |     | (76  | )%  |   |          | 7,788  |        |   |    | 166 | %  |   |       | 2,926  |       
|                                    | Contract  |                          |       | 457    |          |  |     | (51  | )%  |   |          | 937    |        |   |    | (59 | )% |   |       | 2,264  |       
|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |   
|Total royalty and contract revenues |           |                          | 2,296 |        |          |  | (74 | )%   |     |   | 8,725    |        |        |   | 68 | %   |    |   | 5,190 |       
|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |   
|                                    |           | Total revenues           |       | $      | 144,355  |  |     |      | 92  | % |          | $      | 75,331 |   |    |     | 43 | % |       | $      | 52,763 | 
|                                    |           |                          |       |        |          |  |     |      |     |   |          |        |        |   |   



39



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| |                         
| | ------------------------
| | Cost of Product Revenues



|                         |  |                          |        |         |          |  |   |      |         |   |          |  |  |         |   |   |          |   |       |  |  |  |   |  
|------------------------ |  | ------------------------ | ------ | ------- | -------- |  | - | ---- | ------- | - | -------- |  |  | ------- | - | - | -------- | - | ----- |  |  |  | - | -
|                         |  | Years Ended December 31, |       
|                         |  |                          |       
|                         |  | 2004                     |        |         | 2003     |  |   | 2002 |        
|                         |  |                          |        |         |          |  |   |      |        
|                         |  |                          |        | As a %  |          |  |   |      | As a %  |   |          |  |  | As a %  |  
|                         |  |                          |        | of Net  |          |  |   |      | of Net  |   |          |  |  | of Net  |  
|                         |  |                          |        | Product |          |  |   |      | Product |   |          |  |  | Product |  
|                         |  | $                        |        |         | Revenues |  |   | $    |         |   | Revenues |  |  | $       |   |   | Revenues |  
|                         |  |                          |        |         |          |  |   |      |         |   |          |  |  |         |   |   |          |  
|                         |  | (Dollars in thousands)   |       
|Cost of product revenues |  | $                        | 12,656 |         |          |  | 9 | %    |         | $ | 5,129    |  |  |         | 8 | % |          | $ | 4,190 |  |  |  | 9 | %
|                         |  |                          |        |         |          |  |   |      |         |   |          |  |  |         |   |   |          |  



40



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Amortization of Intangible Assets




|                                  |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |   |   |  |   |     | 
|--------------------------------- |  | ------------------------ | ------ |  | -------- |  | -- | ---- |  | - | -------- |  |  | - | - | - |  | - | --- | 
|                                  |  | Years Ended December 31, |       
|                                  |  |                          |       
|                                  |  | 2004                     |        |  | 2003     |  |    |     
|                                  |  |                          |        |  |          |  |    | 2002 | 
|                                  |  | $                        |        |  | % Change |  |    | $    |  |   | % Change |  |  | $ |  
|                                  |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |  
|                                  |  | (Dollars in thousands)   |       
|Amortization of intangible assets |  | $                        | 11,471 |  |          |  | NM |      |  | $ | 819      |  |  |   | 2 | % |  | $ | 805 | 
|                                  |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |  





Research and Development




41



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|                                  |  |                          |        |  |          |  |     |      |  |   |          |  |  |   |    |   |  |   |        | 
|--------------------------------- |  | ------------------------ | ------ |  | -------- |  | --- | ---- |  | - | -------- |  |  | - | -- | - |  | - | ------ | 
|                                  |  | Years Ended December 31, |       
|                                  |  |                          |       
|                                  |  | 2004                     |        |  | 2003     |  |     | 2002 | 
|                                  |  |                          |        |  |          |  |     |      | 
|                                  |  | $                        |        |  | % Change |  |     | $    |  |   | % Change |  |  | $ |   
|                                  |  |                          |        |  |          |  |     |      |  |   |          |  |  |   |   
|                                  |  | (Dollars in thousands)   |       
|Research and development expenses |  | $                        | 21,539 |  |          |  | (29 | )%   |  | $ | 30,109   |  |  |   | 17 | % |  | $ | 25,821 | 
|                                  |  |                          |        |  |          |  |     |      |  |   |          |  |  |   |   







|                                                                                                              |  |               |     |  |      |   |      |      |  |   |     | 
|------------------------------------------------------------------------------------------------------------- |  | ------------- | --- |  | ---- | - | ---- | ---- |  | - | --- | 
|                                                                                                              |  | Years Ended   |    
|                                                                                                              |  | December 31,  |    
|                                                                                                              |  |               |    
|Category                                                                                                      |  | 2004          |     |  | 2003 |   |      | 2002 | 
|                                                                                                              |  |               |     |  |      |   |      |      | 
|                                                                                                              |  | (In millions) |    
|Preclinical and clinical research in the development of new
    dermatology products                          |  | $             | 6.4 |  |      | $ | 13.0 |      |  | $ | 7.4 | 
|Quality assurance and quality control in the maintenance and
    enhancement of existing dermatology products |  |               | 4.9 |  |      |   | 5.2  |      |  |   | 5.1 | 
|Optimization of manufacturing and process development for
    existing dermatology products                   |  |               | 2.7 |  |      |   | 2.8  |      |  |   | 3.9 | 
|Manufacturing, process development and optimization of
    dermatology products under development             |  |               | 3.6 |  |      |   | 2.1  |      |  |   | 2.7 | 
|Quality assurance and quality control in the development of new
    dermatology products                      |  |               | 1.8 |  |      |   | 2.0  |      |  |   | 1.9 | 
|Basic research and formulation of new dermatology products                                                    |  |               | 1.6 |  |      |   | 1.3  |      |  |   | 1.3 | 
|Regulatory review of new and existing dermatology products                                                    |  |               | 2.7 |  |      |   | 1.6  |      |  |   | 1.1 | 

42



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|                                                                                                                                                    |  |             |             |              |          |  |                      |                      |  |   |              | 
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | ----------- | ------------ | -------- |  | -------------------- | -------------------- |  | - | ------------ | 
|                                                                                                                                                    |  |             |             | Estimated    |          |  |                     
|                                                                                                                                                    |  |             |             | Completion   |          |  | Accumulated Program- |                     
|                                                                                                                                                    |  |             |             | of Phase III |          |  | Related Research and |                     
|                                                                                                                                                    |  | Phase of    |             |              | Clinical |  |                      | Development Expenses | 
|Description/Indication                                                                                                                              |  | Development |             |              | Trials   |  |                      | through 2004         | 
|                                                                                                                                                    |  |             |             |              |          |  |                      |                      | 
|Velac, a gel formulation of clindamycin and tretinoin for the
    treatment of acne (excluding license and milestone payments to
    Yamanouchi)    |  |             | NDA filed   |              |          |  | Completed            |                      |  | $ | 15.6 million | 
|Desiluxtm(desonide), VersaFoam-EF, 0.05%, a low-potency
    topical steroid formulated to treat atopic dermatitis                                   |  |             | Phase III   |              |          |  | late-2005            |                      |  | $ | 2.8 million  | 
|OLUX (clobetasol propionate) VersaFoam-EF, 0.05%, a high-potency
    topical steroid formulated to treat atopic dermatitis and plaque
    psoriasis |  |             | Preclinical |              |          |  | late-2005            |                      |  | $ | 1.3 million  | 
|Preclinical research and development for multiple dermatological
    indications                                                                    |  |             | Preclinical |              |          |  | N/A                  |                      |  | $ | 1.6 million  | 

Factors Affecting Our Business
and Prospects  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,  The
expenses associated with our clinical trials are significant. We
rely on third parties to conduct clinical trials for our product
candidates, and those third parties may not perform
satisfactorily,  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.


43



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| |                                             
| | --------------------------------------------
| | Selling, General and Administrative Expenses



|                                             |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |    |   |  |   |        | 
|-------------------------------------------- |  | ------------------------ | ------ |  | -------- |  | -- | ---- |  | - | -------- |  |  | - | -- | - |  | - | ------ | 
|                                             |  | Years Ended December 31, |       
|                                             |  |                          |       
|                                             |  | 2004                     |        |  | 2003     |  |    | 2002 | 
|                                             |  |                          |        |  |          |  |    |      | 
|                                             |  | $                        |        |  | % Change |  |    | $    |  |   | % Change |  |  | $ |   
|                                             |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |   
|                                             |  | (Dollars in thousands)   |       
|Selling, general and administrative expenses |  | $                        | 73,206 |  |          |  | 75 | %    |  | $ | 41,781   |  |  |   | 13 | % |  | $ | 36,819 | 
|                                             |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |   





| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 expenses related to product sampling
    ($1.8 million),                                                                                         
|
| |  | increased outside legal, audit and tax expenses
    ($1.9 million), and                                                                                    
|
| |  | increased business insurance costs ($1.1 million).                                                                                                         





| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased labor and benefit expenses due to increased headcount
    ($2.3 million),                                                                                
|
| |  | increased expenses related to product sampling and sales
    promotion programs ($1.8 million),                                                                    
|
| |  | increased cost of outside service and other fees primarily
    related to warehousing, distribution and production of sales and
    marketing materials ($600,000),
|
| |  | increased business development activities ($250,000), and                                                                                                          
|
| |  | increased outside legal expenses incurred ($185,000).                                                                                                              







| |                                                               
| | --------------------------------------------------------------
| | In-Process Research and Development and Milestone
    Payments



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|                                                           |  |                          |       |  |          |  |    |      |  |  |          |  |  |   |    |  |  |   |       | 
|---------------------------------------------------------- |  | ------------------------ | ----- |  | -------- |  | -- | ---- |  |  | -------- |  |  | - | -- |  |  | - | ----- | 
|                                                           |  | Years Ended December 31, |      
|                                                           |  |                          |      
|                                                           |  | 2004                     |       |  | 2003     |  |    | 2002 | 
|                                                           |  |                          |       |  |          |  |    |      | 
|                                                           |  | $                        |       |  | % Change |  |    | $    |  |  | % Change |  |  | $ |   
|                                                           |  |                          |       |  |          |  |    |      |  |  |          |  |  |   |   
|                                                           |  | (Dollars in thousands)   |      
|In-process research and development and milestone payments |  | $                        | 3,500 |  |          |  | NM |      |  |  |         |  |  |   | NM |  |  | $ | 4,350 | 
|                                                           |  |                          |       |  |          |  |    |      |  |  |          |  |  |   |   







| |                                         
| | ----------------------------------------
| | Interest and other income (expense), net

|                                         |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   |  |    |   |  |   |       |  
|---------------------------------------- | --------------------------- | ------------------------ | - | ------ | -------- |  |  | ---- | -- |  | -------- | ------ | - | - |  | -- | - |  | - | ----- | -
|                                         |                             | Years Ended December 31, |  
|                                         |                             |                          |  
|                                         |                             | 2004                     |   |        | 2003     |  |  | 2002 |   
|                                         |                             |                          |   |        |          |  |  |      |   
|                                         |                             | $                        |   |        | % Change |  |  | $    |    |  | % Change |        |   | $ | 
|                                         |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   | 
|                                         |                             | (Dollars in thousands)   |  
|Interest and other income (expense), net |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   |  |    |   |  |   |      
|                                         | Interest income             |                          | $ | 1,194  |          |  |  | 23   | %  |  | $        | 972    |   |   |  | 18 | % |  | $ | 823   |  
|                                         | Gain on sale of investment  |                          |   |       |          |  |  |     |    |  |          |       |   |   |  | NM |   |  |   | 2,086 |  
|                                         | Interest expense            |                          |   | (2,778 | )        |  |  | 70   | %  |  |          | (1,632 | ) |   |  | NM |   |  |   | (11   | )
|                                         | Other income (expense), net |                          |   | 109    |          |  |  | (53  | )% |  |          | 234    |   |   |  | 3  | % |  |   | 227   |  
|                                         |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   | 

Interest Income.


Interest Expense.


Income Taxes


|                     |  |                          |       |  |          |  |    |      |  |   |          |  |  |   |     |   |  |   |     | 
|-------------------- |  | ------------------------ | ----- |  | -------- |  | -- | ---- |  | - | -------- |  |  | - | --- | - |  | - | --- | 
|                     |  | Years Ended December 31, |      
|                     |  |                          |      
|                     |  | 2004                     |       |  | 2003     |  |    | 2002 | 
|                     |  |                          |       |  |          |  |    |      | 
|                     |  | $                        |       |  | % Change |  |    | $    |  |   | % Change |  |  | $ |    
|                     |  |                          |       |  |          |  |    |      |  |   |          |  |  |   |    
|                     |  | (Dollars in thousands)   |      
|Income tax provision |  | $                        | 1,493 |  |          |  | 28 | %    |  | $ | 1,167    |  |  |   | 545 | % |  | $ | 181 | 
|                     |  |                          |       |  |          |  |    |      |  |   |          |  |  |   |    

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Note 12 Notes to Consolidated Financial Statements


LIQUIDITY AND CAPITAL RESOURCES


|                                                 |  |                        |        |  |          |  |     |    |  |   |         | 
|------------------------------------------------ |  | ---------------------- | ------ |  | -------- |  | --- | -- |  | - | ------- | 
|                                                 |  | December 31,           |       
|                                                 |  |                        |       
|                                                 |  | 2004                   |        |  | 2003     | 
|                                                 |  |                        |        |  |          | 
|                                                 |  | $                      |        |  | % Change |  |     | $  | 
|                                                 |  |                        |        |  |          |  |     |    | 
|                                                 |  | (Dollars in thousands) |       
|Cash, cash equivalents and marketable securities |  | $                      | 72,383 |  |          |  | (37 | )% |  | $ | 114,662 | 
|                                                 |  |                        |        |  |          |  |     |    | 



| |                         
| | ------------------------
| | Sources and Uses of Cash







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Contractual Obligations and Commercial Commitments.


|                                   |                               |                        |       |           |        |   |      |             |           |   |             |   |  |         |      |   |  |   |      |   | 
|---------------------------------- | ----------------------------- | ---------------------- | ----- | --------- | ------ | - | ---- | ----------- | --------- | - | ----------- | - |  | ------- | ---- | - |  | - | ---- | - | 
|                                   |                               | Payments Due by Period |      
|                                   |                               |                        |      
|                                   |                               |                        |       | Less Than |        |   |      |             | More Than |  
|Contractual Obligations            |                               | Total                  |       |           | 1 Year |   |      | 1  3 Years |           |   | 3  5 Years |   |  | 5 Years |     
|                                   |                               |                        |       |           |        |   |      |             |           |   |             |   |  |         |     
|                                   |                               | (In millions)          |      
|Long-Term Debt Obligations(1)      |                               | $                      | 97.0  |           |        | $ | 2.0  |             |           | $ | 4.1         |   |  | $       | 90.9 |   |  | $ |     |  
|Operating Lease Obligations(2)     |                               |                        | 21.2  |           |        |   | 5.0  |             |           |   | 5.3         |   |  |         | 2.8  |   |  |   | 8.1  |  
|Purchase Obligations(3)(4)         |                               |                        | 19.8  |           |        |   | 11.5 |             |           |   | 4.3         |   |  |         | 1.7  |   |  |   | 2.3  |  
|Other Long-Term Liabilities        |                               |                        |       |           |        |   |      |             |           |   |             |   |  |         |      |   |  |   |      |  
|                                   | Reflected on the Registrants |                        |       |           |        |   |      |             |           |   |             |   |  |         |      |   |  |   |      |   | 
|                                   | Balance Sheet under GAAP      |                        |       |          |        |   |      |            |           |   |             |  |  |         |      |  |  |   |      |  | 
|                                   |                               |                        |       |           |        |   |      |             |           |   |             |   |  |         |     
|Total Contractual Cash Obligations |                               | $                      | 138.0 |           |        | $ | 18.5 |             |           | $ | 13.7        |   |  | $       | 95.4 |   |  | $ | 10.4 |  
|                                   |                               |                        |       |           |        |   |      |             |           |   |             |   |  |         |     






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On May 28, 2003, we issued $90 million of
    2.25% convertible senior notes due May 30, 2008 in a
    private offering. The notes are unsecured and rank equal to all
    of our future unsecured and unsubordinated debts. The 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 $2.0 million per
    year, assuming that the notes are not redeemed or converted
    before maturity.                                                                                                                                                    
|   
|(2) | We lease laboratory and office facilities under non-cancelable
    operating leases, which expire in April 2005. In June 2004, we
    signed a series of new non-cancelable facility lease agreements
    to lease approximately 96,000 square feet of space in Palo
    Alto, California that we moved into in February 2005. 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. These obligations are to
    be partially offset by $94,000 to be received from subleasing
    arrangements with third parties.
|   
|(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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | 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.                                                               
|   
|(4) | Per our manufacturing and supply agreements with our three
    suppliers, AccraPac, DPT and Roche, we may incur significant
    penalties related to cancellation of purchase orders, including
    paying an amount equal to the entire cancelled purchase order.
    We had approximately $9.6 million in outstanding open
    purchase orders to our suppliers at December 31, 2004 and
    the entire amount is included in the table in Year 2005.





OFF-BALANCE SHEET ARRANGEMENTS




RECENT ACCOUNTING PRONOUNCEMENTS




48



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|         |                                                           
|-------- | ----------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk.


dollars in
thousands)


|                                        |  |      |        |   |      |   |        |      |  |   |       |   |  |      |        |   |            |   |     |       |  |   |            |   |  |   |        |  |  |   |         | 
|--------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ----- | - |  | ---- | ------ | - | ---------- | - | --- | ----- |  | - | ---------- | - |  | - | ------ |  |  | - | ------- | 
|                                        |  | 2005 |        |   | 2006 |   |        | 2007 |  |   | 2008  |   |  | 2009 |        |   | Thereafter |   |     | Total |  |   | Fair Value |  
|                                        |  |      |        |   |      |   |        |      |  |   |       |   |  |      |        |   |            |   |     |       |  |   |            |  
|Assets:                                 |  |      |        |   |      |   |        |      |  |   |       |   |  |      |        |   |            |   |     |       |  |   |            |   |  |   |        |  |  |   |         | 
|Available-for-sale securities           |  | $    | 21,075 |   |      | $ | 12,621 |      |  | $ | 6,643 |   |  | $    | 300    |   |            | $ | 901 |       |  | $ | 12,016     |   |  | $ | 53,556 |  |  | $ | 53,442  | 
|Weighted average annual interest rate   |  |      | 4.5    | % |      |   | 4.5    | %    |  |   | 2.3   | % |  |      | 1.2    | % |            |   | 2.4 | %     |  |   | 2.5        | % |  |   |       |  |  |   |        | 
|                                       
|Liabilities:                           
|2.25% Convertible Senior Notes Due 2008 |  |      |       |   |      |   |       |      |  |   |      |   |  | $    | 90,000 |   |            |   |    |       |  |   |           |   |  | $ | 90,000 |  |  | $ | 113,310 | 
|Average interest rate                   |  |      |       |   |      |   |       |      |  |   |      |   |  |      | 2.25   | % |            |   |    |       |  |   |           |   |  |   |       |  |  |   |        | 



Foreign Currency Exchange Risk.


49



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|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data

Item 15(a) for an Index to Consolidated
Financial Statements.







|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on Accounting
    and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and
Procedures:


Managements Annual Report on Internal Control
Over Financial Reporting:




Changes in Internal Control Over Financial
Reporting:







|         |                  
|-------- | -----------------
|Item 9B. | Other Information






PART III







|         |                                 
|-------- | --------------------------------
|Item 10. | Directors and Executive Officers







50



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http://ir.connetics.com/governance/highlights.cfm







|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters










|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accounting Fees and Services



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PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

(a) Financial Statements.


|                                                                                                                      |  |      |     | 
|--------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                      |  | Page |    
|                                                                                                                      |  |      |    
|Report of Independent Registered Public Accounting Firm on
    Internal Control over Financial Reporting              |  |      | F-2 | 
|Reports of Independent Registered Public Accounting Firm                                                              |  |      | F-3 | 
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                                          |  |      | F-4 | 
|Consolidated Statements of Operations for each of the three
    years in the period ended December 31, 2004           |  |      | F-5 | 
|Consolidated Statements of Stockholders Equity for each of
    the three years in the period ended December 31, 2004 |  |      | F-6 | 
|Consolidated Statements of Cash Flows for each of the three
    years in the period ended December 31, 2004           |  |      | F-8 | 
|Notes to Consolidated Financial Statements                                                                            |  |      | F-9 | 

Financial Statement Schedules




Schedule II  Valuation and Qualifying
Accounts


|                        |      |            |   |           |                  |  |   |              |  |            |               |             |   |  |   |            | 
|----------------------- | ---- | ---------- | - | --------- | ---------------- |  | - | ------------ |  | ---------- | ------------- | ----------- | - |  | - | ---------- | 
|Allowance for Doubtful  |      |            |   | Additions |                  |  |   |              | 
|Accounts, Discounts,    |      | Balance at |   |           | Charged to       |  |   |              |  |           
|Returns, Rebates and    |      | Start of   |   |           | Expense/Revenue  |  |   |              |  | Balance at |              
|Chargebacks             |      | Period     |   |           | Net of Reversals |  |   | Utilizations |  |            | End of Period |            
|                        |      |            |   |           |                  |  |   |              |  |            |               |            
|Year ended December 31, |      |            |   |           |                  |  |   |              |  |            |               |             |   |  |   |           
|                        | 2004 |            | $ | 5,032,977 |                  |  | $ | 29,793,533   |  |            | $             | (16,570,595 | ) |  | $ | 18,255,915 | 
|                        | 2003 |            | $ | 2,041,507 |                  |  | $ | 10,909,819   |  |            | $             | (7,918,349  | ) |  | $ | 5,032,977  | 
|                        | 2002 |            | $ | 975,318   |                  |  | $ | 5,353,368    |  |            | $             | (4,287,179  | ) |  | $ | 2,041,507  | 



(b) Exhibits. See Index to Exhibits.


(c) Financial Statements Schedules. See
Item 15(a)(2), above.


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SIGNATURES






| |                       
| | ----------------------
| | Connetics Corporation 
| | a Delaware corporation



| |     |                    
| | --- | -------------------
| | By: | /s/ John L. Higgins

| |                                   | 
| | --------------------------------- | 
| |                                   | 
| | John L. Higgins                   | 
| | Chief Financial Officer           | 
| | Executive Vice President, Finance | 
| | and Corporate Development         | 







|                                                      |  |                                                                                              |  |                |  | 
|----------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                             |  | Title                                                                                        |  | Date          
|                                                      |  |                                                                                              |  |               
|                                                     
|Principal Executive Officer:                          |  |                                                                                              |  |               
|                                                     
|/s/ Thomas G. WiggansThomas
    G. Wiggans            |  | Chief Executive Officer
    and Director                                                     |  | March 15, 2005
|                                                     
|Principal Financial and Principal Accounting Officer: |  |                                                                                              |  |               
|                                                     
|/s/ John L. HigginsJohn
    L. Higgins                |  | Chief Financial Officer;
    Executive Vice President,
    Finance and Corporate Development |  | March 15, 2005
|                                                     
|Directors:                                            |  |                                                                                              |  |               
|                                                     
|/s/ Alexander E. BarkasAlexander
    E. Barkas        |  | Director                                                                                     |  | March 15, 2005
|                                                     
|/s/ Eugene A. BauerEugene
    A. Bauer                |  | Director                                                                                     |  | March 15, 2005

53



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|                                           |  |                       |  |                |  | 
|------------------------------------------ |  | --------------------- |  | -------------- |  | 
|Signature                                  |  | Title                 |  | Date          
|                                           |  |                       |  |               
|                                          
|/s/ R. Andrew EckertR.
    Andrew Eckert   |  | Director              |  | March 15, 2005
|                                          
|/s/ Denise M. GilbertDenise
    M. Gilbert |  | Director              |  | March 15, 2005
|                                          
|/s/ John C. KaneJohn
    C. Kane           |  | Director              |  | March 15, 2005
|                                          
|/s/ Thomas D. KileyThomas
    D. Kiley     |  | Director              |  | March 15, 2005
|                                          
|/s/ Leon E. PanettaLeon
    E. Panetta     |  | Director              |  | March 15, 2005
|                                          
|/s/ G. Kirk RaabG.
    Kirk Raab           |  | Chairman of the Board |  | March 15, 2005

54



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##### Table of Contents






CONNETICS CORPORATION


Form 10-K


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS




|                                                                                                                          |  |      |     | 
|------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                          |  | Page |    
|                                                                                                                          |  |      |    
|Report of Independent Registered Public
    Accounting Firm on Internal Control over Financial Reporting                  |  |      | F-2 | 
|Report of Independent Registered Public
    Accounting Firm                                                               |  |      | F-3 | 
|Consolidated Balance Sheets as of
    December 31, 2004 and 2003                                                          |  |      | F-4 | 
|Consolidated Statements of Operations for
    each the three years in the period ended December 31,
    2004              |  |      | F-5 | 
|Consolidated Statements of
    Stockholders Equity for each of the three years in the
    period ended December 31, 2004 |  |      | F-6 | 
|Consolidated Statements of Cash Flows for
    each of the three years in the period ended December 31,
    2004           |  |      | F-8 | 
|Notes to Consolidated Financial
    Statements                                                                            |  |      | F-9 | 

F-1



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm on
Internal Control over Financial Reporting




















| |                          
| | -------------------------
| | /s/ Ernst & Young
    LLP





F-2



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm
















| |                          
| | -------------------------
| | /s/ Ernst & Young
    LLP





F-3



---



##### Table of Contents






CONNETICS CORPORATION


CONSOLIDATED BALANCE SHEETS


|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |         |         |          |    |         | 
|---------------------------------------------- | ----------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | -------- | ---- | ------- | ------- | -------- | -- | ------- | 
|                                               |                                                                                                 | December 31,                                                                                                                              |                                           
|                                               |                                                                                                 |                                                                                                                                           |                                           
|                                               |                                                                                                 | 2004                                                                                                                                      |                                            |          | 2003 |        
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                               |                                                                                                 | (In thousands, except                                                                                                                     |                                           
|                                               |                                                                                                 | share and per share                                                                                                                       |                                           
|                                               |                                                                                                 | amounts)                                                                                                                                  |                                           
|ASSETS                                        
|Current assets:                                |                                                                                                 |                                                                                                                                           |                                            |          |      |         |         |         
|                                               | Cash and cash equivalents                                                                       |                                                                                                                                           | $                                          | 18,261   |      |         | $       | 17,946   |   
|                                               | Marketable securities                                                                           |                                                                                                                                           |                                            | 54,122   |      |         |         | 96,716   |   
|                                               | Restricted cashcurrent                                                                         |                                                                                                                                           |                                            | 1,000    |      |         |         | 304      |   
|                                               | Accounts receivable, net of allowances of $18,256 and $5,033 in
    2004 and 2003, respectively |                                                                                                                                           |                                            | 10,642   |      |         |         | 2,594    |   
|                                               | Inventory                                                                                       |                                                                                                                                           |                                            | 4,605    |      |         |         | 1,035    |   
|                                               | Prepaid expenses                                                                                |                                                                                                                                           |                                            | 7,776    |      |         |         | 2,892    |   
|                                               | Other current assets                                                                            |                                                                                                                                           |                                            | 2,076    |      |         |         | 887      |   
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|Total current assets                           |                                                                                                 |                                                                                                                                           | 98,482                                     |          |      |         | 122,374 |         
|Property and equipment, net                    |                                                                                                 |                                                                                                                                           | 11,830                                     |          |      |         | 5,628   |         
|Restricted cashlong term                      |                                                                                                 |                                                                                                                                           | 2,963                                      |          |      |         |        |         
|Debt issuance costs, deposits and other assets |                                                                                                 |                                                                                                                                           | 3,794                                      |          |      |         | 5,418   |         
|Goodwill                                       |                                                                                                 |                                                                                                                                           | 6,271                                      |          |      |         | 6,271   |         
|Other intangible assets, net                   |                                                                                                 |                                                                                                                                           | 122,388                                    |          |      |         | 6,206   |         
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                               |                                                                                                 |                                                                                                                                           | Total assets                               |          | $    | 245,728 |         |          | $  | 145,897 | 
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                              
|LIABILITIES AND STOCKHOLDERS EQUITY          
|Current Liabilities:                           |                                                                                                 |                                                                                                                                           |                                            |          |      |         |         |         
|                                               | Accounts payable                                                                                |                                                                                                                                           | $                                          | 14,531   |      |         | $       | 3,884    |   
|                                               | Accrued liabilities related to acquisition of product rights                                    |                                                                                                                                           |                                            | 2,710    |      |         |         |         |   
|                                               | Accrued payroll and related expenses                                                            |                                                                                                                                           |                                            | 5,746    |      |         |         | 3,792    |   
|                                               | Accrued clinical trial costs                                                                    |                                                                                                                                           |                                            | 751      |      |         |         | 857      |   
|                                               | Other accrued liabilities                                                                       |                                                                                                                                           |                                            | 3,650    |      |         |         | 1,594    |   
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                               |                                                                                                 |                                                                                                                                           | Total current liabilities                  |          |      | 27,388  |         |          |    | 10,127  | 
|Convertible senior notes                       |                                                                                                 |                                                                                                                                           | 90,000                                     |          |      |         | 90,000  |         
|Other non-current liabilities                  |                                                                                                 |                                                                                                                                           | 420                                        |          |      |         | 16      |         
|Commitments and contingencies                  |                                                                                                 |                                                                                                                                           |                                            |          |      |         |         |         
|Stockholders equity:                          |                                                                                                 |                                                                                                                                           |                                            |          |      |         |         |         
|                                               | Preferred stock, $0.001 par value:                                                              |                                                                                                                                           |                                            |          |      |         |         |          |   
|                                               |                                                                                                 | 5,000,000 shares authorized; none issued or outstanding                                                                                   |                                            |          |     |         |         |          |   |        
|                                               | Common stock, $0.001 par value;                                                                 |                                                                                                                                           |                                            |          |      |         |         |          |   
|                                               |                                                                                                 | 50,000,000 shares authorized; 35,792,730 and
    31,885,404 shares issued and outstanding at
    December 31, 2004 and 2003, respectively |                                            |          | 36   |         |         |          | 32 |        
|                                               | Additional paid-in capital                                                                      |                                                                                                                                           |                                            | 237,666  |      |         |         | 174,080  |   
|                                               | Deferred stock compensation                                                                     |                                                                                                                                           |                                            | (13      | )    |         |         | (31      | ) 
|                                               | Accumulated deficit                                                                             |                                                                                                                                           |                                            | (111,173 | )    |         |         | (130,188 | ) 
|                                               | Accumulated other comprehensive income                                                          |                                                                                                                                           |                                            | 1,404    |      |         |         | 1,861    |   
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                               |                                                                                                 |                                                                                                                                           | Total stockholders equity                 |          |      | 127,920 |         |          |    | 45,754  | 
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        
|                                               |                                                                                                 |                                                                                                                                           | Total liabilities and stockholders equity |          | $    | 245,728 |         |          | $  | 145,897 | 
|                                               |                                                                                                 |                                                                                                                                           |                                            |          |      |        



F-4



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##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                            |                                                            |                                 |         |         |      |  |        |        |   |  |         |         |  
|----------------------------------------------------------- | ---------------------------------------------------------- | ------------------------------- | ------- | ------- | ---- |  | ------ | ------ | - |  | ------- | ------- | -
|                                                            |                                                            | Years Ended December 31,        |        
|                                                            |                                                            |                                 |        
|                                                            |                                                            | 2004                            |         |         | 2003 |  |        | 2002   |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|                                                            |                                                            | (In thousands, except per share |        
|                                                            |                                                            | amounts)                        |        
|Revenues:                                                   |                                                            |                                 |         |         |      |  |        |        |   |  |         |        
|                                                            | Product                                                    |                                 | $       | 142,059 |      |  | $      | 66,606 |   |  | $       | 47,573  |  
|                                                            | Royalty and contract                                       |                                 |         | 2,296   |      |  |        | 8,725  |   |  |         | 5,190   |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|Total revenues                                              |                                                            |                                 | 144,355 |         |      |  | 75,331 |        |   |  | 52,763  |        
|Operating costs and expenses:                               |                                                            |                                 |         |         |      |  |        |        |   |  |         |        
|                                                            | Cost of product revenues                                   |                                 |         | 12,656  |      |  |        | 5,129  |   |  |         | 4,190   |  
|                                                            | Amortization of intangible assets                          |                                 |         | 11,471  |      |  |        | 819    |   |  |         | 805     |  
|                                                            | Research and development                                   |                                 |         | 21,539  |      |  |        | 30,109 |   |  |         | 25,821  |  
|                                                            | Selling, general and administrative                        |                                 |         | 73,206  |      |  |        | 41,781 |   |  |         | 36,819  |  
|                                                            | In-process research and development and milestone payments |                                 |         | 3,500   |      |  |        |       |   |  |         | 4,350   |  
|                                                            | Loss on program termination                                |                                 |         |        |      |  |        |       |   |  |         | 312     |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|Total operating costs and expenses                          |                                                            |                                 | 122,372 |         |      |  | 77,838 |        |   |  | 72,297  |        
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|Income (loss) from operations                               |                                                            |                                 | 21,983  |         |      |  | (2,507 | )      |   |  | (19,534 | )      
|Interest and other income (expense):                        |                                                            |                                 |         |         |      |  |        |        |   |  |         |        
|                                                            | Interest income                                            |                                 |         | 1,194   |      |  |        | 972    |   |  |         | 823     |  
|                                                            | Gain on sale of investment                                 |                                 |         |        |      |  |        |       |   |  |         | 2,086   |  
|                                                            | Interest expense                                           |                                 |         | (2,778  | )    |  |        | (1,632 | ) |  |         | (11     | )
|                                                            | Other income (expense), net                                |                                 |         | 109     |      |  |        | 234    |   |  |         | 227     |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|                                                            | Income (loss) before income taxes                          |                                 |         | 20,508  |      |  |        | (2,933 | ) |  |         | (16,409 | )
|                                                            | Income tax provision                                       |                                 |         | 1,493   |      |  |        | 1,167  |   |  |         | 181     |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|                                                            | Net income (loss)                                          |                                 | $       | 19,015  |      |  | $      | (4,100 | ) |  | $       | (16,590 | )
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|Net income (loss) per share                                 |                                                            |                                 |         |         |      |  |        |        |   |  |         |        
|                                                            | Basic                                                      |                                 | $       | 0.54    |      |  | $      | (0.13  | ) |  | $       | (0.54   | )
|                                                            | Diluted                                                    |                                 | $       | 0.51    |      |  | $      | (0.13  | ) |  | $       | (0.54   | )
|                                                            |                                                            |                                 |         |         |      |  |        |        |  
|Shares used to compute basic and diluted net loss per share |                                                            |                                 |         |         |      |  |        |        |   |  |         |        
|                                                            | Basic                                                      |                                 |         | 35,036  |      |  |        | 31,559 |   |  |         | 30,757  |  
|                                                            | Diluted                                                    |                                 |         | 37,443  |      |  |        | 31,559 |   |  |         | 30,757  |  
|                                                            |                                                            |                                 |         |         |      |  |        |        |  



F-5



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##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |   |   |       |        |   |   |         |         |  
|--------------------------------------------------------- | ---------------------------------------------------------------------------- | -------------- | ------ | - | ------ | - | -- | ---------- |  | - | ------------ | - | ----------- | ----------- | --- | ----- | ------------- | - | -------- | ------------- | - | - | ----- | ------ | - | - | ------- | ------- | -
|                                                          |                                                                              | Number of      |        |   |        |   |    |            |  |   |              |   | Accumulated |             |     |      
|                                                          |                                                                              | Common         |        |   | Common |   |    | Additional |  |   | Deferred     |   |             |             |     | Other |               |   | Total    |              
|                                                          |                                                                              | Shares         |        |   | Stock  |   |    | Paid-in    |  |   | Stock        |   |             | Accumulated |     |       | Comprehensive |   |          | Stockholders |  
|                                                          |                                                                              | Outstanding    |        |   | Amount |   |    | Capital    |  |   | Compensation |   |             | Deficit     |     |       | Income        |   |          | Equity        |  
|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  
|                                                          |                                                                              | (In thousands) |       
|Balance at December 31, 2001                              |                                                                              |                | 30,257 |   |        | $ | 30 |            |  | $ | 164,270      |   |             | $           | (69 | )     |               | $ | (109,498 | )             |   | $ | 6,621 |        |   | $ | 61,354  |        
|Common stock issued under stock option and purchase plans |                                                                              |                | 659    |   |        |   | 1  |            |  |   | 3,449        |   |             |             |    |       |               |   |         |               |   |   |      |        |   |   | 3,450   |        
|Issuance of common stock pursuant to license agreements   |                                                                              |                | 1      |   |        |   |   |            |  |   | 12           |   |             |             |    |       |               |   |         |               |   |   |      |        |   |   | 12      |        
|Exercise of warrants                                      |                                                                              |                | 263    |   |        |   |   |            |  |   | 1,683        |   |             |             |    |       |               |   |         |               |   |   |      |        |   |   | 1,683   |        
|Stock compensation expense                                |                                                                              |                |       |   |        |   |   |            |  |   | 355          |   |             |             | 21  |       |               |   |         |               |   |   |      |        |   |   | 376     |        
|Comprehensive loss:                                       |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |   |   |       |        |   |   |         |        
|                                                          | Net loss                                                                     |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          | (16,590       | ) |   |       |       |   |   |         | (16,590 | )
|                                                          | Reclassification adjustment for realized gain on sale of equity
    security |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |   |   |       | (2,086 | ) |   |         | (2,086  | )
|                                                          | Unrealized gain on investments                                               |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |   |   |       | (3,532 | ) |   |         | (3,532  | )
|                                                          | Foreign currency translation adjustment                                      |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |   |   |       | 76     |   |   |         | 76      |  
|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  
|Total comprehensive loss                                  |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |   |   |       |        |   |   | (22,132 | )      
|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  
|Balance at December 31, 2002                              |                                                                              |                | 31,180 |   |        |   | 31 |            |  |   | 169,769      |   |             |             | (48 | )     |               |   | (126,088 | )             |   |   | 1,079 |        |   |   | 44,743  |        
|Common stock issued under stock option and purchase plans |                                                                              |                | 674    |   |        |   | 1  |            |  |   | 4,158        |   |             |             |    |       |               |   |         |               |   |   |      |        |   |   | 4,159   |        
|Exercise of warrants                                      |                                                                              |                | 31     |   |        |   |   |            |  |   | 153          |   |             |             |    |       |               |   |         |               |   |   |      |        |   |   | 153     |        
|Stock compensation expense                                |                                                                              |                |       |   |        |   |   |            |  |   |             |   |             |             | 17  |       |               |   |         |               |   |   |      |        |   |   | 17      |        
|Comprehensive loss:                                       |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |   |   |       |        |   |   |         |        
|                                                          | Net loss                                                                     |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          | (4,100        | ) |   |       |       |   |   |         | (4,100  | )
|                                                          | Unrealized loss on investments                                               |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |   |   |       | (167   | ) |   |         | (167    | )
|                                                          | Foreign currency translation adjustment                                      |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |   |   |       | 949    |   |   |         | 949     |  
|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  
|Total comprehensive loss                                  |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |   |   |       |        |   |   | (3,318  | )      
|                                                          |                                                                              |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  

F-6



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##### Table of Contents



CONNETICS CORPORATION


CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY  Continued


|                                                          |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  |   |       |      |   |   |         |        |  
|--------------------------------------------------------- | --------------------------------------- | -------------- | ------ | - | ------ | - | -- | ---------- |  | - | ------------ | - | ----------- | ----------- | --- | ----- | ------------- | - | -------- | ------------- |  | - | ----- | ---- | - | - | ------- | ------ | -
|                                                          |                                         | Number of      |        |   |        |   |    |            |  |   |              |   | Accumulated |             |     |      
|                                                          |                                         | Common         |        |   | Common |   |    | Additional |  |   | Deferred     |   |             |             |     | Other |               |   | Total    |              
|                                                          |                                         | Shares         |        |   | Stock  |   |    | Paid-in    |  |   | Stock        |   |             | Accumulated |     |       | Comprehensive |   |          | Stockholders | 
|                                                          |                                         | Outstanding    |        |   | Amount |   |    | Capital    |  |   | Compensation |   |             | Deficit     |     |       | Income        |   |          | Equity        | 
|                                                          |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               | 
|                                                          |                                         | (In thousands) |       
|Balance at December 31, 2003                              |                                         |                | 31,885 |   |        |   | 32 |            |  |   | 174,080      |   |             |             | (31 | )     |               |   | (130,188 | )             |  |   | 1,861 |      |   |   | 45,754  |       
|Common stock issued under stock option and purchase plans |                                         |                | 858    |   |        |   | 1  |            |  |   | 6,347        |   |             |             |    |       |               |   |         |               |  |   |      |      |   |   | 6,348   |       
|Tax benefit on stock options                              |                                         |                |       |   |        |   |   |            |  |   | 213          |   |             |             |    |       |               |   |         |               |  |   |      |      |   |   | 213     |       
|Issuance of common stock through private placement        |                                         |                | 3,000  |   |        |   | 3  |            |  |   | 56,901       |   |             |             |    |       |               |   |         |               |  |   |      |      |   |   | 56,904  |       
|Exercise of warrants                                      |                                         |                | 50     |   |        |   |   |            |  |   | 125          |   |             |             |    |       |               |   |         |               |  |   |      |      |   |   | 125     |       
|Stock compensation expense                                |                                         |                |       |   |        |   |   |            |  |   |             |   |             |             | 18  |       |               |   |         |               |  |   |      |      |   |   | 18      |       
|Comprehensive income:                                     |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  |   |       |      |   |   |         |       
|                                                          | Net income                              |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          | 19,015        |  |   |       |     |   |   |         | 19,015 |  
|                                                          | Unrealized loss on investments          |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |  |   |       | (583 | ) |   |         | (583   | )
|                                                          | Foreign currency translation adjustment |                |        |  |        |   |    |           |  |   |              |  |             |             |     |      |               |   |          |              |  |   |       | 126  |   |   |         | 126    |  
|                                                          |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               | 
|Total comprehensive income                                |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               |  |   |       |      |   |   | 18,558  |       
|                                                          |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               | 
|Balance at December 31, 2004                              |                                         |                | 35,793 |   |        | $ | 36 |            |  | $ | 237,666      |   |             | $           | (13 | )     |               | $ | (111,173 | )             |  | $ | 1,404 |      |   | $ | 127,920 |       
|                                                          |                                         |                |        |   |        |   |    |            |  |   |              |   |             |             |     |       |               |   |          |               | 



F-7



---



##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |       |        |   |         |        |       |  
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------- | ------------------------------------- | -------- | ------ | ------- | - | -------- | ----- | ------ | - | ------- | ------ | ----- | -
|                                      |                                                                                                                                                           | Years Ended December 31,                                   |                                      
|                                      |                                                                                                                                                           |                                                            |                                      
|                                      |                                                                                                                                                           | 2004                                                       |                                       |          | 2003   |         |   | 2002     |      
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      |                                                                                                                                                           | (In thousands)                                             |                                      
|Cash flows from operating activities: |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |       |        |   |        
|                                      | Net income (loss)                                                                                                                                         |                                                            | $                                     | 19,015   |        |         | $ | (4,100   | )     |        | $ | (16,590 | )     
|                                      | Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities:                                                    |                                                            |                                       |          |        |         |   |          |       |        |   |         |       
|                                      |                                                                                                                                                           | Depreciation                                               |                                       |          | 1,433  |         |   |          | 1,422 |        |   |         | 1,285  |      
|                                      |                                                                                                                                                           | Amortization of intangible assets                          |                                       |          | 11,471 |         |   |          | 819   |        |   |         | 810    |      
|                                      |                                                                                                                                                           | Amortization of debt issuance costs                        |                                       |          | 708    |         |   |          | 430   |        |   |         |       |      
|                                      |                                                                                                                                                           | Allowances for discounts, returns, rebates and chargebacks |                                       |          | 12,725 |         |   |          | 2,994 |        |   |         | 1,173  |      
|                                      |                                                                                                                                                           | Gain on sale of investment                                 |                                       |          |       |         |   |          |      |        |   |         | (2,086 | )    
|                                      | Stock compensation expense                                                                                                                                |                                                            |                                       | 18       |        |         |   | 17       |       |        |   | 388     |       
|                                      | Changes in assets and liabilities:                                                                                                                        |                                                            |                                       |          |        |         |   |          |       |        |   |         |       
|                                      |                                                                                                                                                           |                                                            | Accounts receivable                   |          |        | (21,179 | ) |          |       | (1,236 | ) |         |        | (70   | )
|                                      |                                                                                                                                                           |                                                            | Inventory                             |          |        | (3,526  | ) |          |       | (334   | ) |         |        | 29    |  
|                                      |                                                                                                                                                           |                                                            | Other assets                          |          |        | (4,810  | ) |          |       | (3,439 | ) |         |        | (960  | )
|                                      |                                                                                                                                                           |                                                            | Accounts payable                      |          |        | 10,740  |   |          |       | (4,199 | ) |         |        | 4,119 |  
|                                      |                                                                                                                                                           |                                                            | Accrued and other current liabilities |          |        | 2,633   |   |          |       | (146   | ) |         |        | (3    | )
|                                      |                                                                                                                                                           |                                                            | Deferred revenue                      |          |        | 89      |   |          |       | (739   | ) |         |        | (600  | )
|                                      |                                                                                                                                                           |                                                            | Other non-current liabilities         |          |        | 404     |   |          |       |       |   |         |        |      |  
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      | Net cash provided by (used in) operating activities                                                                                                       |                                                            |                                       | 29,721   |        |         |   | (8,511   | )     |        |   | (12,505 | )     
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|Cash flows from investing activities: |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |       |        |   |        
|                                      | Purchases of marketable securities                                                                                                                        |                                                            |                                       | (62,472  | )      |         |   | (135,352 | )     |        |   | (32,573 | )     
|                                      | Sales and maturities of marketable securities                                                                                                             |                                                            |                                       | 104,483  |        |         |   | 62,909   |       |        |   | 47,335  |       
|                                      | Purchases of property and equipment                                                                                                                       |                                                            |                                       | (7,638   | )      |         |   | (959     | )     |        |   | (3,907  | )     
|                                      | Acquisition of patent and product rights                                                                                                                  |                                                            |                                       | (123,529 | )      |         |   | (200     | )     |        |   |        |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      | Net cash provided by (used in) investing activities                                                                                                       |                                                            |                                       | (89,156  | )      |         |   | (73,602  | )     |        |   | 10,855  |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|Cash flows from financing activities: |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |       |        |   |        
|                                      | Transfer from (to) restricted cash                                                                                                                        |                                                            |                                       | (3,659   | )      |         |   | 420      |       |        |   | 1,415   |       
|                                      | Proceeds from issuance of convertible senior notes, net of
    issuance costs                                                                             |                                                            |                                       |         |        |         |   | 86,316   |       |        |   |        |       
|                                      | Proceeds 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 |                                                            |                                       | 6,476    |        |         |   | 4,312    |       |        |   | 5,133   |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      | Net cash provided by financing activities                                                                                                                 |                                                            |                                       | 59,718   |        |         |   | 91,048   |       |        |   | 6,548   |       
|                                      | Effect of foreign currency exchange rates on cash and cash
    equivalents                                                                                |                                                            |                                       | 32       |        |         |   | 387      |       |        |   | 123     |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      | Net change in cash and cash equivalents                                                                                                                   |                                                            |                                       | 315      |        |         |   | 9,322    |       |        |   | 5,021   |       
|                                      | Cash and cash equivalents at beginning of year                                                                                                            |                                                            |                                       | 17,946   |        |         |   | 8,624    |       |        |   | 3,603   |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|                                      | Cash and cash equivalents at end of year                                                                                                                  |                                                            | $                                     | 18,261   |        |         | $ | 17,946   |       |        | $ | 8,624   |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      
|Supplementary information:            |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |       |        |   |        
|                                      | Interest paid                                                                                                                                             |                                                            | $                                     | 2,030    |        |         | $ | 1,028    |       |        | $ | 11      |       
|                                      | Income taxes paid                                                                                                                                         |                                                            | $                                     | 1,061    |        |         | $ | 1,541    |       |        | $ | 654     |       
|                                      |                                                                                                                                                           |                                                            |                                       |          |        |         |   |          |      



F-8



---



##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2004




|        |                                            
|------- | -------------------------------------------
|Note 1. | Organization and Development of the Company

tm




|        |                                           
|------- | ------------------------------------------
|Note 2. | Summary of Significant Accounting Policies



| |                            
| | ---------------------------
| | Principles of Consolidation





| |                 
| | ----------------
| | Use of Estimates







| |                    
| | -------------------
| | Revenue Recognition

Product Revenues.


F-9



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






Royalty Revenues.


Contract Revenues.






| |                                           
| | ------------------------------------------
| | Cash Equivalents and Marketable Securities





F-10



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                
| | ---------------
| | Restricted Cash





| |                 
| | ----------------
| | Foreign Currency





| |             
| | ------------
| | Income Taxes





| |                       
| | ----------------------
| | Property and Equipment





| |          
| | ---------
| | Inventory





F-11



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                     
| | ------------------------------------
| | Goodwill and Other Intangible Assets

Goodwill and other Intangible
Assets,


Accounting for Impairment or Disposal of
Long-Lived Assets,


Fair Value of Financial Instruments






Research and Development




Certain Concentrations




F-12



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|                  |  |                       |    |   |      |  |    |      |  |  |    |  
|----------------- |  | --------------------- | -- | - | ---- |  | -- | ---- |  |  | -- | -
|                  |  | Percentage of Product |   
|                  |  | Revenues Years Ended  |   
|                  |  | December 31,          |   
|                  |  |                       |   
|Customer          |  | 2004                  |    |   | 2003 |  |    | 2002 | 
|                  |  |                       |    |   |      |  |    |      | 
|McKesson          |  |                       | 29 | % |      |  | 30 | %    |  |  | 26 | %
|Cardinal Health   |  |                       | 27 | % |      |  | 36 | %    |  |  | 43 | %
|AmerisourceBergen |  |                       | 16 | % |      |  | 15 | %    |  |  | 23 | %
|Walgreens         |  |                       | *  |   |      |  | 11 | %    |  |  | *  |  






|  |              
|- | -------------
|* | less than 10%

|                  |  |                      |    |   |      |  |    |      |  |  |    |  
|----------------- |  | -------------------- | -- | - | ---- |  | -- | ---- |  |  | -- | -
|                  |  | Percentage of        |   
|                  |  | Outstanding Accounts |   
|                  |  | Receivable as of     |   
|                  |  | December 31,         |   
|                  |  |                      |   
|Customer          |  | 2004                 |    |   | 2003 |  |    | 2002 | 
|                  |  |                      |    |   |      |  |    |      | 
|McKesson          |  |                      | 36 | % |      |  | 28 | %    |  |  | 6  | %
|Cardinal Health   |  |                      | 21 | % |      |  | 36 | %    |  |  | 54 | %
|AmerisourceBergen |  |                      | 22 | % |      |  | 17 | %    |  |  | 37 | %
|Walgreens         |  |                      | 15 | % |      |  | *  |      |  |  | *  |  






|  |              
|- | -------------
|* | less than 10%

Comprehensive Income (Loss)




Advertising




F-13



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Stock-Based Compensation






pro forma


|                                                                                                                                    |  |                                |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                                    |  | Years Ended December 31,       |        
|                                                                                                                                    |  |                                |        
|                                                                                                                                    |  | 2004                           |         |   | 2003 |   |         | 2002 | 
|                                                                                                                                    |  |                                |         |   |      |   |         |      | 
|                                                                                                                                    |  | (In thousands except per share |        
|                                                                                                                                    |  | amounts):                      |        
|Net income (loss), as reported                                                                                                      |  | $                              | 19,015  |   |      | $ | (4,100  | )    |  | $ | (16,590 | )
|Add: stock-based employee compensation expense, net of tax                                                                          |  |                                | 17      |   |      |   | 17      |      |  |   | 21      |  
|Deduct: Total stock-based employee compensation expense
    determined under fair value based method for all awards, net of
    tax |  |                                | (11,355 | ) |      |   | (9,834  | )    |  |   | (4,535  | )
|                                                                                                                                    |  |                                |         |   |      |   |         |      | 
|Pro forma net income (loss)                                                                                                         |  | $                              | 7,677   |   |      | $ | (13,917 | )    |  | $ | (21,104 | )
|                                                                                                                                    |  |                                |         |   |      |   |         |      | 
|Net income (loss per) share:                                                                                                        |  |                                |         |   |      |   |         |      |  |   |         |  
|Basic  as reported                                                                                                                 |  | $                              | 0.54    |   |      | $ | (0.13   | )    |  | $ | (0.54   | )
|Diluted  as reported                                                                                                               |  | $                              | 0.51    |   |      | $ | (0.13   | )    |  | $ | (0.54   | )
|Basic  pro forma                                                                                                                   |  | $                              | 0.22    |   |      | $ | (0.44   | )    |  | $ | (0.69   | )
|Diluted  pro forma                                                                                                                 |  | $                              | 0.21    |   |      | $ | (0.44   | )    |  | $ | (0.69   | )
|                                                                                                                                    |  |                                |         |   |      |   |         |      | 



|                          |  |                    |      |   |                     |  |      |      |  |  |      |   |  |      |      |   |      |  |      |   |  |  |      |  
|------------------------- |  | ------------------ | ---- | - | ------------------- |  | ---- | ---- |  |  | ---- | - |  | ---- | ---- | - | ---- |  | ---- | - |  |  | ---- | -
|                          |  | Stock Option Plans |      |   | Stock Purchase Plan | 
|                          |  |                    |      |   |                     | 
|                          |  | 2004               |      |   | 2003                |  |      | 2002 |  |  | 2004 |   |  | 2003 |      |   | 2002 | 
|                          |  |                    |      |   |                     |  |      |      |  |  |      |   |  |      |      |   |      | 
|Expected stock volatility |  |                    | 57.2 | % |                     |  | 60.6 | %    |  |  | 65.3 | % |  |      | 54.7 | % |      |  | 57.5 | % |  |  | 77.3 | %
|Risk-free interest rate   |  |                    | 3.2  | % |                     |  | 4.1  | %    |  |  | 4.6  | % |  |      | 1.1  | % |      |  | 4.4  | % |  |  | 5.6  | %
|Expected life (in years)  |  |                    | 3.4  |   |                     |  | 3.2  |      |  |  | 3.5  |   |  |      | 1.5  |   |      |  | 1.4  |   |  |  | 1.3  |  
|Expected dividend yield   |  |                    | 0.0  | % |                     |  | 0.0  | %    |  |  | 0.0  | % |  |      | 0.0  | % |      |  | 0.0  | % |  |  | 0.0  | %



F-14



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




pro forma




| |                            
| | ---------------------------
| | Net Income (Loss) Per Share





|                                             |                             |                                |        |        |      |   |        |        |   |   |         |        |  
|-------------------------------------------- | --------------------------- | ------------------------------ | ------ | ------ | ---- | - | ------ | ------ | - | - | ------- | ------ | -
|                                             |                             | Years Ended December 31,       |       
|                                             |                             |                                |       
|                                             |                             | 2004                           |        |        | 2003 |   |        | 2002   |  
|                                             |                             |                                |        |        |      |   |        |        |  
|                                             |                             | (In thousands except per share |       
|                                             |                             | amounts):                      |       
|Net income (loss)                            |                             | $                              | 19,015 |        |      | $ | (4,100 | )      |   | $ | (16,590 | )     
|                                             |                             |                                |        |        |      |   |        |        |  
|Weighted average shares outstanding          |                             |                                |        |        |      |   |        |        |   |   |         |       
|                                             | Basic common shares         |                                |        | 35,036 |      |   |        | 31,559 |   |   |         | 30,757 |  
|                                             | Effect of dilutive options  |                                |        | 2,383  |      |   |        |       |   |   |         |       |  
|                                             | Effect of dilutive warrants |                                |        | 24     |      |   |        |       |   |   |         |       |  
|                                             |                             |                                |        |        |      |   |        |        |  
|Total weighted average diluted common shares |                             |                                | 37,443 |        |      |   | 31,559 |        |   |   | 30,757  |       
|                                             |                             |                                |        |        |      |   |        |        |  
|Net income (loss) per share:                 |                             |                                |        |        |      |   |        |        |   |   |         |       
|                                             | Basic                       |                                | $      | 0.54   |      |   | $      | (0.13  | ) |   | $       | (0.54  | )
|                                             | Diluted                     |                                | $      | 0.51   |      |   | $      | (0.13  | ) |   | $       | (0.54  | )
|                                             |                             |                                |        |        |      |   |        |        |  



|                 |  |                          |           |  |      |  |           |      |  |  |           | 
|---------------- |  | ------------------------ | --------- |  | ---- |  | --------- | ---- |  |  | --------- | 
|                 |  | Years Ended December 31, |          
|                 |  |                          |          
|                 |  | 2004                     |           |  | 2003 |  |           | 2002 | 
|                 |  |                          |           |  |      |  |           |      | 
|Warrants         |  |                          |          |  |      |  | 59,177    |      |  |  | 90,427    | 
|Options          |  |                          | 262,750   |  |      |  | 5,986,257 |      |  |  | 4,883,966 | 
|Convertible Debt |  |                          | 4,203,450 |  |      |  | 4,203,450 |      |  |  |          | 



| |                                                                       
| | ----------------------------------------------------------------------
| | Disclosure about Segments of an Enterprise and Related
    Information



F-15



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








| |                                 
| | --------------------------------
| | Recent Accounting Pronouncements





|        |                                           
|------- | ------------------------------------------
|Note 3. | Cash Equivalents and Marketable Securities

(in thousands)


|                                           |                             |                   |        |        |            |   |       |            |  |   |            |      |   |   |        |        | 
|------------------------------------------ | --------------------------- | ----------------- | ------ | ------ | ---------- | - | ----- | ---------- |  | - | ---------- | ---- | - | - | ------ | ------ | 
|                                           |                             | December 31, 2004 |       
|                                           |                             |                   |       
|                                           |                             |                   |        | Gross  |            |   | Gross |            |  |  
|                                           |                             | Amortized         |        |        | Unrealized |   |       | Unrealized |  |   | Estimated  |     
|                                           |                             | Cost              |        |        | Gains      |   |       | Losses     |  |   | Fair Value |     
|                                           |                             |                   |        |        |            |   |       |            |  |   |            |     
|Corporate debt                             |                             | $                 | 32,971 |        |            | $ | 3     |            |  | $ | (72        | )    |   | $ | 32,902 |       
|Government securities                      |                             |                   | 13,318 |        |            |   |      |            |  |   | (23        | )    |   |   | 13,295 |       
|Asset backed securities                    |                             |                   | 7,268  |        |            |   | 1     |            |  |   | (24        | )    |   |   | 7,245  |       
|Equity securities                          |                             |                   | 289    |        |            |   | 391   |            |  |   |           |      |   |   | 680    |       
|Money market funds                         |                             |                   | 1,114  |        |            |   |      |            |  |   |           |      |   |   | 1,114  |       
|                                           |                             |                   |        |        |            |   |       |            |  |   |            |     
|                                           | Total                       |                   |        | 54,960 |            |   |       | 395        |  |   |            | (119 | ) |   |        | 55,236 | 
|Less amount classified as cash equivalents |                             |                   | (1,114 | )      |            |   |       |            |  |   |            |      |   |   | (1,114 | )     
|                                           |                             |                   |        |        |            |   |       |            |  |   |            |     
|                                           | Total marketable securities |                   | $      | 53,846 |            |   | $     | 395        |  |   | $          | (119 | ) |   | $      | 54,122 | 
|                                           |                             |                   |        |        |            |   |       |            |  |   |            |     

F-16



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                           |                             |                   |         |         |            |   |       |            |  |   |            |     |   |   |         |         | 
|------------------------------------------ | --------------------------- | ----------------- | ------- | ------- | ---------- | - | ----- | ---------- |  | - | ---------- | --- | - | - | ------- | ------- | 
|                                           |                             | December 31, 2003 |        
|                                           |                             |                   |        
|                                           |                             |                   |         | Gross   |            |   | Gross |            |  |  
|                                           |                             | Amortized         |         |         | Unrealized |   |       | Unrealized |  |   | Estimated  |    
|                                           |                             | Cost              |         |         | Gains      |   |       | Losses     |  |   | Fair Value |    
|                                           |                             |                   |         |         |            |   |       |            |  |   |            |    
|Corporate debt                             |                             | $                 | 53,165  |         |            | $ | 17    |            |  | $ | (41        | )   |   | $ | 53,141  |        
|Government securities                      |                             |                   | 35,387  |         |            |   | 7     |            |  |   | (11        | )   |   |   | 35,383  |        
|Asset backed securities                    |                             |                   | 7,016   |         |            |   | 7     |            |  |   | (2         | )   |   |   | 7,021   |        
|Equity securities                          |                             |                   | 289     |         |            |   | 882   |            |  |   |           |     |   |   | 1,171   |        
|Money market funds                         |                             |                   | 12,894  |         |            |   |      |            |  |   |           |     |   |   | 12,894  |        
|                                           |                             |                   |         |         |            |   |       |            |  |   |            |    
|                                           | Total                       |                   |         | 108,751 |            |   |       | 913        |  |   |            | (54 | ) |   |         | 109,610 | 
|Less amount classified as cash equivalents |                             |                   | (12,894 | )       |            |   |       |            |  |   |            |     |   |   | (12,894 | )      
|                                           |                             |                   |         |         |            |   |       |            |  |   |            |    
|                                           | Total marketable securities |                   | $       | 95,857  |            |   | $     | 913        |  |   | $          | (54 | ) |   | $       | 96,716  | 
|                                           |                             |                   |         |         |            |   |       |            |  |   |            |    

(in thousands)


|                             |       |           |        |        |            |   |        |           |  |   |            |        |  |   |        |        | 
|---------------------------- | ----- | --------- | ------ | ------ | ---------- | - | ------ | --------- |  | - | ---------- | ------ |  | - | ------ | ------ | 
|                             |       | 2004      |        |        | 2003       |  
|                             |       |           |        |        |            |  
|                             |       | Amortized |        |        | Estimated  |   |        | Amortized |  |   | Estimated  |       
|                             |       | Cost      |        |        | Fair Value |   |        | Cost      |  |   | Fair Value |       
|                             |       |           |        |        |            |   |        |           |  |   |            |       
|Mature in less than one year |       | $         | 21,076 |        |            | $ | 21,013 |           |  | $ | 50,550     |        |  | $ | 50,971 |       
|Mature in one to three years |       |           | 19,264 |        |            |   | 19,221 |           |  |   | 20,590     |        |  |   | 20,746 |       
|Mature in over three years   |       |           | 13,217 |        |            |   | 13,208 |           |  |   | 23,797     |        |  |   | 23,828 |       
|                             |       |           |        |        |            |   |        |           |  |   |            |       
|                             | Total |           | $      | 53,557 |            |   | $      | 53,442    |  |   | $          | 94,937 |  |   | $      | 95,545 | 
|                             |       |           |        |        |            |   |        |           |  |   |            |       







|        |                                                                   
|------- | ------------------------------------------------------------------
|Note 4. | Soriatane® Product Line Acquisition and
    Distribution Agreement



F-17



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|        |                             
|------- | ----------------------------
|Note 5. | Yamanouchi License Agreement







|        |                           
|------- | --------------------------
|Note 6. | Royalty-Bearing Agreements

Pfizer License Agreement




Other
Licenses for Foam Technology






F-18



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Licenses
for Liquipatch Technology




S.C.
Johnson License Agreement




InterMune




Relaxin Agreement






|        |                     
|------- | --------------------
|Note 7. | UCB Pharma Agreement



F-19



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|        |                       
|------- | ----------------------
|Note 8. | Property and Equipment

(in
thousands):


|                                               |       |              |        |        |      |   |        |        | 
|---------------------------------------------- | ----- | ------------ | ------ | ------ | ---- | - | ------ | ------ | 
|                                               |       | December 31, |       
|                                               |       |              |       
|                                               |       | 2004         |        |        | 2003 |  
|                                               |       |              |        |        |      |  
|Laboratory and manufacturing equipment         |       | $            | 5,952  |        |      | $ | 5,073  |       
|Leasehold improvements                         |       |              | 7,705  |        |      |   | 2,982  |       
|Computer equipment                             |       |              | 2,324  |        |      |   | 2,250  |       
|Furniture, fixtures and office equipment       |       |              | 1,333  |        |      |   | 1,284  |       
|Land, building and building improvements       |       |              | 785    |        |      |   | 736    |       
|                                               |       |              |        |        |      |  
|                                               | Total |              |        | 18,099 |      |   |        | 12,325 | 
|Less accumulated depreciation and amortization |       |              | (6,269 | )      |      |   | (6,697 | )     
|                                               |       |              |        |        |      |  
|Property and equipment, net                    |       | $            | 11,830 |        |      | $ | 5,628  |       
|                                               |       |              |        |        |      |  





|        |                                     
|------- | ------------------------------------
|Note 9. | Goodwill and Other Intangible Assets

(in thousands)


|                        |  |             |       |                   |                |   |                  |              |  |   |         |   |                |        |         |             |              |   |       |     |  |   |        |   |  |   |       | 
|----------------------- |  | ----------- | ----- | ----------------- | -------------- | - | ---------------- | ------------ |  | - | ------- | - | -------------- | ------ | ------- | ----------- | ------------ | - | ----- | --- |  | - | ------ | - |  | - | ----- | 
|                        |  |             |       | December 31, 2004 |                |   | December 31,2003 |             
|                        |  |             |       |                   |                |   |                  |             
|                        |  | Useful Life |       |                   | Gross Carrying |   |                  | Accumulated  |  |   |         |   | Gross Carrying |        |         | Accumulated |              |   |      
|                        |  | in Years    |       |                   | Amount         |   |                  | Amortization |  |   | Net     |   |                | Amount |         |             | Amortization |   |       | Net | 
|                        |  |             |       |                   |                |   |                  |              |  |   |         |   |                |        |         |             |              |   |       |     | 
|Acquired product rights |  |             | 10    |                   |                | $ | 127,652          |              |  | $ | (10,638 | ) |                | $      | 117,014 |             |              | $ |      |     |  | $ |       |   |  | $ |      | 
|Existing technology     |  |             | 10    |                   |                |   | 6,810            |              |  |   | (2,525  | ) |                |        | 4,285   |             |              |   | 6,810 |     |  |   | (1,844 | ) |  |   | 4,966 | 
|Patents                 |  |             | 10-13 |                   |                |   | 1,661            |              |  |   | (572    | ) |                |        | 1,089   |             |              |   | 1,590 |     |  |   | (350   | ) |  |   | 1,240 | 
|                        |  |             |       |                   |                |   |                  |              |  |   |         |   |                |        |         |             |              |   |       |     | 
|Total                   |  |             |       |                   |                | $ | 136,123          |              |  | $ | (13,735 | ) |                | $      | 122,388 |             |              | $ | 8,400 |     |  | $ | (2,194 | ) |  | $ | 6,206 | 
|                        |  |             |       |                   |                |   |                  |              |  |   |         |   |                |        |         |             |              |   |       |     | 



(in thousands)


|                                      |  |   |         | 
|------------------------------------- |  | - | ------- | 
|For the year ending December 31, 2005 |  | $ | 13,598  | 
|For the year ending December 31, 2006 |  |   | 13,598  | 
|For the year ending December 31, 2007 |  |   | 13,598  | 
|For the year ending December 31, 2008 |  |   | 13,598  | 
|For the year ending December 31, 2009 |  |   | 13,598  | 
|Thereafter                            |  |   | 54,398  | 
|                                      |  |   |        
|Total                                 |  | $ | 122,388 | 
|                                      |  |   |        

F-20



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|         |                         
|-------- | ------------------------
|Note 10. | Convertible Senior Notes









|         |                     
|-------- | --------------------
|Note 11. | Stockholders Equity

Equity Issuance




Warrants








F-21



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


1995 Director Stock Option Plan








Employee Stock Plans




2000 Stock Plan.


Non-Officer Stock Option Plans.


F-22



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


International Stock Incentive Plan.


Summary of All Option Plans.


|                           |                              |                  |           |                     |           |  |           |                  |   |   |       |       | 
|-------------------------- | ---------------------------- | ---------------- | --------- | ------------------- | --------- |  | --------- | ---------------- | - | - | ----- | ----- | 
|                           |                              |                  |           | Outstanding Options |          
|                           |                              |                  |           |                     |          
|                           |                              | Shares Available |           |                     | Number of |  |           | Weighted Average |  
|                           |                              | for Grant        |           |                     | Shares    |  |           | Exercise Price   |  
|                           |                              |                  |           |                     |           |  |           |                  |  
|Balance, December 31, 2001 |                              |                  | 981,846   |                     |           |  | 4,221,556 |                  |   | $ | 6.10  |      
|                           |                              |                  |           |                     |           |  |           |                  |  
|                           | Additional shares authorized |                  |           | 909,312             |           |  |           |                 |   |   |       |      | 
|                           | Options granted              |                  |           | (1,400,378          | )         |  |           | 1,400,378        |   |   |       | 11.71 | 
|                           | Options exercised            |                  |           |                    |           |  |           | (469,246         | ) |   |       | 5.20  | 
|                           | Options canceled             |                  |           | 248,411             |           |  |           | (268,722         | ) |   |       | 7.60  | 
|                           |                              |                  |           |                     |           |  |           |                  |  
|Balance, December 31, 2002 |                              |                  | 739,191   |                     |           |  | 4,883,966 |                  |   |   | 7.72  |      
|                           |                              |                  |           |                     |           |  |           |                  |  
|                           | Additional shares authorized |                  |           | 1,937,016           |           |  |           |                 |   |   |       |      | 
|                           | Options granted              |                  |           | (1,759,888          | )         |  |           | 1,759,888        |   |   |       | 14.20 | 
|                           | Options exercised            |                  |           |                    |           |  |           | (554,274         | ) |   |       | 5.69  | 
|                           | Options canceled             |                  |           | 102,260             |           |  |           | (103,323         | ) |   |       | 9.97  | 
|                           |                              |                  |           |                     |           |  |           |                  |  
|Balance, December 31, 2003 |                              |                  | 1,018,579 |                     |           |  | 5,986,257 |                  |   |   | 9.77  |      
|                           |                              |                  |           |                     |           |  |           |                  |  
|                           | Additional shares authorized |                  |           | 958,501             |           |  |           |                 |   |   |       |      | 
|                           | Options granted              |                  |           | (1,777,968          | )         |  |           | 1,777,968        |   |   |       | 19.98 | 
|                           | Options exercised            |                  |           |                    |           |  |           | (753,346         | ) |   |       | 6.83  | 
|                           | Options canceled             |                  |           | 172,970             |           |  |           | (172,970         | ) |   |       | 14.01 | 
|                           |                              |                  |           |                     |           |  |           |                  |  
|Balance, December 31, 2004 |                              |                  | 372,082   |                     |           |  | 6,837,909 |                  |   | $ | 12.64 |      
|                           |                              |                  |           |                     |           |  |           |                  |  



|                         |  |                     |           |                  |                     |  |     |                  |  |   |           |  |  |                  |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ---------------- | ------------------- |  | --- | ---------------- |  | - | --------- |  |  | ---------------- | --------- |  |  | - | ----- | 
|                         |  | Options Outstanding |           |                  | Options Exercisable | 
|                         |  |                     |           |                  |                     | 
|                         |  |                     |           | Weighted Average |                     |  |     |                  | 
|                         |  | Number of           |           |                  | Remaining Life      |  |     | Weighted Average |  |   | Number of |  |  | Weighted Average |          
|Range of Exercise Prices |  | Shares              |           |                  | (in years)          |  |     | Exercise Price   |  |   | Shares    |  |  | Exercise Price   |          
|                         |  |                     |           |                  |                     |  |     |                  |  |   |           |  |  |                  |          
|$ 0.44 - $ 5.84          |  |                     | 880,350   |                  |                     |  | 5.4 |                  |  | $ | 4.40      |  |  |                  | 866,412   |  |  | $ | 4.40  | 
|$ 5.85 - $11.67          |  |                     | 1,693,297 |                  |                     |  | 5.0 |                  |  | $ | 8.29      |  |  |                  | 1,543,329 |  |  | $ | 8.21  | 
|$11.68 - $17.51          |  |                     | 2,312,224 |                  |                     |  | 7.7 |                  |  | $ | 12.94     |  |  |                  | 1,236,021 |  |  | $ | 12.66 | 
|$17.52 - $23.34          |  |                     | 1,691,788 |                  |                     |  | 9.0 |                  |  | $ | 18.71     |  |  |                  | 153,636   |  |  | $ | 18.38 | 
|$23.35 - $29.18          |  |                     | 260,250   |                  |                     |  | 9.8 |                  |  | $ | 26.74     |  |  |                  |          |  |  |   |      | 
|                         |  |                     |           |                  |                     |  |     |                  |  |   |           |  |  |                  |          
|$ 0.44 - $29.18          |  |                     | 6,837,909 |                  |                     |  | 7.1 |                  |  | $ | 12.64     |  |  |                  | 3,799,398 |  |  | $ | 9.20  | 
|                         |  |                     |           |                  |                     |  |     |                  |  |   |           |  |  |                  |          

1995 Employee Stock Purchase Plan.


F-23



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




Common Shares Reserved for Future Issuance




|                                   |       |              |           |            |      |  |           |            | 
|---------------------------------- | ----- | ------------ | --------- | ---------- | ---- |  | --------- | ---------- | 
|                                   |       | December 31, |          
|                                   |       |              |          
|                                   |       | 2004         |           |            | 2003 | 
|                                   |       |              |           |            |      | 
|1994 Stock Plan                    |       |              | 721,042   |            |      |  | 980,617   |           
|1995 Employee Stock Purchase Plan  |       |              | 423,251   |            |      |  | 216,320   |           
|1995 Directors Stock Option Plan   |       |              | 757,800   |            |      |  | 815,000   |           
|1998 Supplemental Stock Plan       |       |              | 39,883    |            |      |  | 52,383    |           
|2000 Stock Plan                    |       |              | 3,994,623 |            |      |  | 3,285,396 |           
|2000 Non-Officer Stock Plan        |       |              | 293,856   |            |      |  | 367,612   |           
|International Stock Incentive Plan |       |              | 229,010   |            |      |  | 246,155   |           
|2002 Employee Stock Plan           |       |              | 1,144,281 |            |      |  | 1,228,177 |           
|Non-plan stock options             |       |              | 29,496    |            |      |  | 29,496    |           
|Common stock warrants              |       |              |          |            |      |  | 59,177    |           
|Convertible senior notes           |       |              | 4,203,450 |            |      |  | 4,203,450 |           
|                                   |       |              |           |            |      | 
|                                   | Total |              |           | 11,836,692 |      |  |           | 11,483,783 | 
|                                   |       |              |           |            |      | 

Stockholder Rights Plan




F-24



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|         |             
|-------- | ------------
|Note 12. | Income Taxes

(in
thousands)


|               |         |                          |       |       |      |   |       |       |   |   |     |      |  
|-------------- | ------- | ------------------------ | ----- | ----- | ---- | - | ----- | ----- | - | - | --- | ---- | -
|               |         | Years Ended December 31, |      
|               |         |                          |      
|               |         | 2004                     |       |       | 2003 |   |       | 2002  |  
|               |         |                          |       |       |      |   |       |       |  
|Current        |         |                          |       |       |      |   |       |       |   |   |     |     
|               | Foreign |                          | $     | 150   |      |   | $     | 1,017 |   |   | $   | 467  |  
|               | Federal |                          |       | 1,171 |      |   |       | 330   |   |   |     | (211 | )
|               | State   |                          |       | 426   |      |   |       |      |   |   |     | (75  | )
|               |         |                          |       |       |      |   |       |       |  
|Total Current  |         |                          | 1,747 |       |      |   | 1,347 |       |   |   | 181 |     
|               |         |                          |       |       |      |   |       |       |  
|Deferred       |         |                          |       |       |      |   |       |       |   |   |     |     
|               | Foreign |                          |       | (254  | )    |   |       | (180  | ) |   |     |     |  
|               | Federal |                          |       |      |      |   |       |      |   |   |     |     |  
|               | State   |                          |       |      |      |   |       |      |   |   |     |     |  
|               |         |                          |       |       |      |   |       |       |  
|Total Deferred |         |                          | (254  | )     |      |   | (180  | )     |   |   |    |     
|               |         |                          |       |       |      |   |       |       |  
|Total          |         | $                        | 1,493 |       |      | $ | 1,167 |       |   | $ | 181 |     
|               |         |                          |       |       |      |   |       |       |  

(in thousands)


|                                                         |  |                          |         |   |      |   |       |      |  |   |        |  
|-------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ----- | ---- |  | - | ------ | -
|                                                         |  | Years Ended December 31, |        
|                                                         |  |                          |        
|                                                         |  | 2004                     |         |   | 2003 |   |       | 2002 | 
|                                                         |  |                          |         |   |      |   |       |      | 
|Provision (benefit) at U.S. federal statutory rate       |  | $                        | 7,108   |   |      | $ | (960  | )    |  | $ | (5,600 | )
|Unbenefited losses (utilization of net operating losses) |  |                          | (14,066 | ) |      |   | 450   |      |  |   | 4,900  |  
|Timing differences not currently benefited               |  |                          | 6,814   |   |      |   |      |      |  |   |       |  
|State taxes, net of federal benefit                      |  |                          | 281     |   |      |   |      |      |  |   | (75    | )
|Non-deductible stock based compensation                  |  |                          | 6       |   |      |   | 10    |      |  |   | 100    |  
|Non-deductible amortization                              |  |                          | 274     |   |      |   | 270   |      |  |   | 300    |  
|Alternative minimum tax                                  |  |                          | 827     |   |      |   |      |      |  |   | (542   | )
|Foreign taxes                                            |  |                          | (104    | ) |      |   | 837   |      |  |   | 467    |  
|US withholding tax                                       |  |                          | 334     |   |      |   | 330   |      |  |   | 331    |  
|Other                                                    |  |                          | 19      |   |      |   | 230   |      |  |   | 300    |  
|                                                         |  |                          |         |   |      |   |       |      | 
|Total                                                    |  | $                        | 1,493   |   |      | $ | 1,167 |      |  | $ | 181    |  
|                                                         |  |                          |         |   |      |   |       |      | 





F-25



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


(in thousands)


|                              |                                             |              |         |        |      |   |         |        |  
|----------------------------- | ------------------------------------------- | ------------ | ------- | ------ | ---- | - | ------- | ------ | -
|                              |                                             | December 31, |        
|                              |                                             |              |        
|                              |                                             | 2004         |         |        | 2003 |  
|                              |                                             |              |         |        |      |  
|Deferred tax assets:          |                                             |              |         |        |      |   |         |       
|                              | Net operating loss carryforwards            |              | $       | 24,200 |      |   | $       | 38,200 |  
|                              | Research and other tax credits              |              |         | 6,400  |      |   |         | 5,200  |  
|                              | Capitalized research expenses               |              |         | 4,000  |      |   |         | 5,200  |  
|                              | Capitalized license and acquired technology |              |         | 4,700  |      |   |         | 2,100  |  
|                              | Accruals and reserves                       |              |         | 8,800  |      |   |         | 2,600  |  
|                              | Foreign currency translation                |              |         | 700    |      |   |         | 485    |  
|                              | Other                                       |              |         | 800    |      |   |         | 1,100  |  
|                              |                                             |              |         |        |      |  
|Total deferred tax assets     |                                             |              | 49,600  |        |      |   | 54,885  |       
|Valuation allowance           |                                             |              | (46,800 | )      |      |   | (53,600 | )     
|                              |                                             |              |         |        |      |  
|Net deferred tax assets       |                                             |              | 2,800   |        |      |   | 1,285   |       
|                              |                                             |              |         |        |      |  
|Deferred tax liabilities:     |                                             |              |         |        |      |   |         |       
|                              | Prepaid expenses                            |              |         | (400   | )    |   |         | (200   | )
|                              | Soriatane property acquisition              |              |         | (1,100 | )    |   |         |       |  
|                              | Unrealized gain on marketable securities    |              |         | (100   | )    |   |         | (300   | )
|                              |                                             |              |         |        |      |  
|Net deferred tax liabilities  |                                             |              | (1,600  | )      |      |   | (500    | )     
|                              |                                             |              |         |        |      |  
|Total net deferred tax assets |                                             | $            | 1,200   |        |      | $ | 785     |       
|                              |                                             |              |         |        |      |  











|         |            
|-------- | -----------
|Note 13. | Commitments



F-26



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








(in thousands)


|                          |      |           |        |       |             |   |        |       |  |   |        |       | 
|------------------------- | ---- | --------- | ------ | ----- | ----------- | - | ------ | ----- |  | - | ------ | ----- | 
|                          |      | Operating |        |       | Contractual |   |        |      
|Years Ending December 31: |      | Leases    |        |       | Commitments |   |        | Total | 
|                          |      |           |        |       |             |   |        |       | 
|                          | 2005 |           | $      | 4,965 |             |   | $      | 1,875 |  |   | $      | 6,840 | 
|                          | 2006 |           |        | 2,788 |             |   |        | 2,172 |  |   |        | 4,960 | 
|                          | 2007 |           |        | 2,476 |             |   |        | 2,172 |  |   |        | 4,648 | 
|                          | 2008 |           |        | 1,402 |             |   |        | 850   |  |   |        | 2,252 | 
|                          | 2009 |           |        | 1,383 |             |   |        | 850   |  |   |        | 2,233 | 
|Thereafter                |      |           | 8,175  |       |             |   | 2,225  |       |  |   | 10,400 |      
|                          |      |           |        |       |             |   |        |       | 
|                          |      | $         | 21,189 |       |             | $ | 10,144 |       |  | $ | 31,333 |      
|                          |      |           |        |       |             |   |        |       | 







|         |                                
|-------- | -------------------------------
|Note 14. | Guarantees and Indemnifications



F-27



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|         |                        
|-------- | -----------------------
|Note 15. | Retirement Savings Plan





|         |                           
|-------- | --------------------------
|Note 16. | Related Party Transactions





|         |                                     
|-------- | ------------------------------------
|Note 17. | Quarterly Financial Data (unaudited)

(in thousands, except per share amounts)


|                                                            |            |               |        |       |           |   |        |          |  |   |        |       |  |   |        |       | 
|----------------------------------------------------------- | ---------- | ------------- | ------ | ----- | --------- | - | ------ | -------- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                                            |            | 2004 Quarters |       
|                                                            |            |               |       
|                                                            |            | First(1)      |        |       | Second(2) |   |        | Third(3) |  |   | Fourth |      
|                                                            |            |               |        |       |           |   |        |          |  |   |        |      
|Total revenues                                              |            | $             | 24,982 |       |           | $ | 38,253 |          |  | $ | 37,344 |       |  | $ | 43,776 |      
|Cost of product revenues                                    |            |               | 1,568  |       |           |   | 3,578  |          |  |   | 3,067  |       |  |   | 4,443  |      
|Operating expenses                                          |            |               | 21,006 |       |           |   | 25,963 |          |  |   | 30,065 |       |  |   | 32,682 |      
|Operating income                                            |            |               | 2,408  |       |           |   | 8,712  |          |  |   | 4,212  |       |  |   | 6,651  |      
|                                                            | Net income |               |        | 1,873 |           |   |        | 7,457    |  |   |        | 3,695 |  |   |        | 5,990 | 
|Basic net income per share                                  |            |               | 0.06   |       |           |   | 0.21   |          |  |   | 0.10   |       |  |   | 0.17   |      
|Diluted net income per share                                |            |               | 0.05   |       |           |   | 0.19   |          |  |   | 0.10   |       |  |   | 0.16   |      
|Shares used to calculate basic net income per share         |            |               | 33,587 |       |           |   | 35,242 |          |  |   | 35,510 |       |  |   | 35,695 |      
|Shares used to calculate fully diluted net income per share |            |               | 35,887 |       |           |   | 41,627 |          |  |   | 38,064 |       |  |   | 38,172 |      
|                                                            |            |               |        |       |           |   |        |          |  |   |        |      

F-28



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)







|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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, which we also reached
    agreement to terminate in the first quarter.                                                                                                                                                                                                                                                                                                          
|   
|(2) | In early March of 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.                                                                                                                                                                                                                                                                                                                                                                 

|                                                                       |                   |               |        |        |           |   |        |             |   |   |        |       |  |   |        |       | 
|---------------------------------------------------------------------- | ----------------- | ------------- | ------ | ------ | --------- | - | ------ | ----------- | - | - | ------ | ----- |  | - | ------ | ----- | 
|                                                                       |                   | 2003 Quarters |       
|                                                                       |                   |               |       
|                                                                       |                   | First         |        |        | Second(1) |   |        | Third(2)(3) |   |   | Fourth |      
|                                                                       |                   |               |        |        |           |   |        |             |   |   |        |      
|Total revenues                                                         |                   | $             | 15,311 |        |           | $ | 19,970 |             |   | $ | 19,712 |       |  | $ | 20,338 |      
|Cost of product revenues                                               |                   |               | 1,072  |        |           |   | 1,185  |             |   |   | 1,388  |       |  |   | 1,484  |      
|Operating expenses                                                     |                   |               | 19,721 |        |           |   | 19,411 |             |   |   | 16,374 |       |  |   | 17,203 |      
|Operating income (loss)                                                |                   |               | (5,482 | )      |           |   | (626   | )           |   |   | 1,950  |       |  |   | 1,651  |      
|                                                                       | Net income (loss) |               |        | (5,381 | )         |   |        | (1,856      | ) |   |        | 1,616 |  |   |        | 1,521 | 
|Basic net income (loss) per share                                      |                   |               | (0.17  | )      |           |   | (0.06  | )           |   |   | 0.05   |       |  |   | 0.05   |      
|Diluted net income (loss) per share                                    |                   |               | (0.17  | )      |           |   | (0.06  | )           |   |   | 0.05   |       |  |   | 0.05   |      
|Shares used to calculate basic net income (loss) per share             |                   |               | 31,286 |        |           |   | 31,519 |             |   |   | 31,648 |       |  |   | 31,781 |      
|Shares used to calculate fully diluted net income (loss) per
    share |                   |               | 31,286 |        |           |   | 31,519 |             |   |   | 33,607 |       |  |   | 33,759 |      
|                                                                       |                   |               |        |        |           |   |        |             |   |   |        |      






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 the S.C. Johnson license agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   
|(2) | In the third quarter of 2003, we recognized $761,000 of
    relaxin related revenue associated with the execution of the
    agreement with BAS Medical in July 2003. Of the relaxin related
    revenue $661,000 represented previously deferred revenue
    associated with relaxin license agreements with other parties
    that was fully recognized upon the execution of the BAS Medical
    agreement.                                                                                                                                                                                                                                                  
|   
|(3) | Operating expenses decreased in the third quarter of 2003
    when compared to the second quarter of 2003 mainly due to
    decreased clinical trial activity of $712,000, decreased
    manufacturing expenses of $977,000 primarily related to a
    one-time reversal of a previously recorded liability of $576,000
    for clinical trial materials, as well as the timing of various
    process and product development activities, a $416,000 decrease
    in QA/ QC expenses due to the timing of stability and release
    testing, and a $605,000 decrease in product samples and sales
    promotion expenses related to the timing of the programs.

F-29



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##### Table of Contents



Connetics Corporation





Index to Exhibits


[Item 15(b)]


|        |    |        |             |                                                                                                                                                                                                                                                                                                                                                                             
|------- | -- | ------ | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |        |            
|Number  |    |        | Description
|        |    |        |            
|        | 2  | .1*    |             | Purchase and Sale Agreement dated February 2, 2004
    between Connetics and Hoffmann  La Roche Inc.
    (previously filed as Exhibit 10.41 of the Companys Annual
    Report on Form 10-K for the year ended December 31,
    2003)                                                                                                                                      
|        | 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, as 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, as 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*    |             | Amended and Restated Bylaws (previously filed as
    Exhibit 3.2 to the Companys Form 8-A/A filed
    November 28, 2001)                                                                                                                                                                                                                                                   
|       
|        | 3  | .5*    |             | Certificate of Elimination of Rights, Preferences and Privileges
    of Connetics Corporation, as 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 for the year ended December 31, 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)                                                                                                                                                                                                                 
|       
|        | 4  | .2*    |             | Amended and Restated Preferred Stock Rights Agreement, dated as
    of November 21, 2001, between the Company 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 November 28, 2001)
|       
|        | 4  | .3*    |             | Indenture, dated as of May 28, 2003, between Connetics and
    J.P. Morgan Trust Company, National Association, including
    therein 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)                                                                                   
|        |    |        |             | Management and Consulting Agreements                                                                                                                                                                                                                                                                                                                                        
|       
|        | 10 | .1*(M) |             | Form of Indemnification Agreement with the Companys
    directors and officers (previously filed as an exhibit 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) |             | Letter Agreement with G. Kirk Raab dated October 1, 1995
    (previously filed as an exhibit to the Companys
    Form S-1 Registration Statement No. 33-80261)                                                                                                                                                                                                             
|       
|        | 10 | .4*(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 | .5*(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 | .6*(M) |             | Restricted Common Stock Purchase Agreement dated
    November 5, 1998 between the Company 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 | .7*(M) |             | Restricted Common Stock Purchase Agreement dated March 9,
    1999 between the Company 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)                                                                                                                                  



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                   
|------- | -- | ------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .8*(M)  |             | Restricted Common Stock Purchase Agreement dated March 9,
    1999 between the Company 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 | .9*(M)  |             | Consulting Agreement effective April 1, 2000 between the
    Company and Leon Panetta (previously filed as
    Exhibit 10.77 to the Companys Annual Report on Form
    10-K for the year ended December 31, 2000)                                                
|       
|        | 10 | .10*(M) |             | Form of Change in Control Agreement between the Company 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 | .11*(M) |             | Consulting Agreement dated January 1, 2002, as amended
    effective January 1, 2003, between Connetics and Eugene
    Bauer, M.D. (previously filed as Exhibit 10.12 to
    the Companys Annual Report on Form 10-K for the year ended
    December 31, 2002)   
|       
|        | 10 | .12(M)  |             | Consulting Agreement dated January 1, 2002, as amended
    effective December 31, 2003, between Connetics and Eugene
    Bauer, M.D.                                                                                                                              
|       
|        | 10 | .13(M)  |             | Consulting Agreement dated January 1, 2002, as amended
    effective December 31, 2004, between Connetics and Eugene
    Bauer, M.D.                                                                                                                              
|        |    |         |             | Stock Plans and Equity Agreements                                                                                                                                                                                                                                 
|       
|        | 10 | .14(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)                                                                           
|       
|        | 10 | .15(M)* |             | 1995 Employee Stock Purchase Plan (as amended through December
    2002), and form of Subscription Agreement (previously filed
    as Exhibit 99.1 to the Companys Form S-8
    Registration Statement No. 333-102619)                                           
|       
|        | 10 | .16*(M) |             | 1995 Directors Stock Option Plan (as amended through
    May 2003), and form of Option Agreement (previously filed as
    Exhibit 99.2 to the Companys Current Report on Form
    8-K dated February 9, 2004 and filed with the Commission on
    March 8, 2004)
|       
|        | 10 | .17*    |             | Structured Equity Line Flexible Financing Agreement dated
    January 2, 1997 between Connetics and Kepler Capital LLC
    (previously filed as Exhibit 10.1 to the Companys
    Form S-3 Registration Statement No. 333-45002 as filed
    on November 7, 2000) 
|       
|        | 10 | .18*    |             | Registration Rights Agreement dated January 2, 1997 between
    Connetics and Kepler Capital LLC (previously filed as
    Exhibit 10.43 to the Companys Annual Report on Form
    10-K for the year ended December 31, 1996)                                     
|       
|        | 10 | .19*(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 | .20*(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 | .21*    |             | International Stock Incentive Plan (previously filed as
    Exhibit 4.1 to the Companys Form S-8
    Registration Statement No. 333-61558)                                                                                                                       
|       
|        | 10 | .22*    |             | 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 | .23*    |             | 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 | .24*    |             | 1995 Employee Stock Purchase Plan (as amended and restated
    through May 7, 2004) and form of Subscription Agreement
    (previously filed as Exhibit 10.1 to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    June 30, 2004)          
|        |    |         |             | License Agreements                                                                                                                                                                                                                                                
|       
|        | 10 | .25*   |             | Soltec License Agreement dated June 14, 1996 (previously
    filed as Exhibit 10.28 to the Companys Quarterly
    Report on Form 10-Q for the quarter ended June 30, 1996)                                                                                       
|       
|        | 10 | .26*   |             | License Agreement dated January 1, 1998 between Connetics
    and Soltec Research Pty Limited (previously filed as
    Exhibit 10.57 to the Companys Annual Report on Form
    10-K for the year ended December 31, 1997)                                        



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                                                                                                                          
|------- | -- | ------- | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .27*   |             | License Agreement (Ketoconazole) dated July 14, 1999
    between the Company 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 | .28*(C) |             | License Agreement with Pierre Fabre Dermatologie and Connetics
    Corporation, dated September 29, 2004 (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)                                                                                                                                                      
|       
|        |    |         |             | Real Property                                                                                                                                                                                                                                                                                                                                                                                                            
|       
|        | 10 | .29*    |             | 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 | .30*    |             | 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 | .31*    |             | 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 | .32*    |             | 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 | .33*    |             | 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 | .34*    |             | 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 | .35*    |             | 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 | .36*    |             | 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 | .37*    |             | 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)                                                                                                                                          
|        |    |         |             | Other Agreements                                                                                                                                                                                                                                                                                                                                                                                                         
|       
|        | 10 | .38*    |             | 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)
|       
|        | 10 | .39*   |             | Agreement dated December 9, 1999 between the Company 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 | .40*   |             | Share Sale Agreement dated March 21, 2001 among the
    Company, F. H. Faulding & Co. Ltd., Faulding
    Healthcare, and Connetics Australia Pty Ltd. (previously
    filed as Exhibit 2.1 to the Companys Current Report
    on Form 8-K dated March 20, 2001 and filed with the Commission
    on April 2, 2001)                                                                                                      
|       
|        | 10 | .41*   |             | Asset Purchase Agreement dated as of April 9, 2001, by and
    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)                                                                                                                                          



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                               
|------- | -- | ------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .42*   |             | 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 | .43*   |             | 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 | .44*   |             | 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 SEC on July 12, 2002)                                                   
|       
|        | 10 | .45*   |             | 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)                                                                                          
|       
|        | 10 | .46*    |             | 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 | .47*   |             | 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 | .48*    |             | Credit and Guaranty Agreement dated as of February 6, 2004
    between Connetics and Goldman Sachs Credit Partners L.P.
    (previously filed as Exhibit 99.1 to the Companys
    Current Report on Form 8-K dated February 6, 2004, filed
    with the Commission on February 9, 2004)                                      
|       
|        | 10 | .49     |             | Purchase and Sale Agreement dated February 2, 2004 between
    Connetics and Hoffmann-La Roche Inc. (see Exhibit
    2.1)                                                                                                                                                                                                     
|       
|        | 10 | .50*    |             | Stock Purchase Agreement dated as of February 11, 2004 by
    and among Connetics and the Purchasers listed on Appendix A to
    the Stock Purchase Agreement (previously filed as
    Exhibit 99.1 to the Companys Registration Statement
    on Form S-3 (Registration No. 333-113894) filed on
    March 24, 2004)        
|       
|        | 10 | .51*(C) |             | 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 | .52*(C) |             | 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 | .53(C)  |             | Distribution Services Agreement between Cardinal Health, Inc.
    and Connetics Corporation dated December 1, 2004.                                                                                                                                                                                                           
|       
|        | 10 | .54(C)  |             | Core Distribution Agreement between McKesson Corporation and
    Connetics Corporation dated December 23, 2004.                                                                                                                                                                                                               
|       
|        | 10 | .55(M)  |             | Summary Compensation Information for Named Executive Officers
    and Directors                                                                                                                                                                                                                                               
|       
|        | 99 | .1*     |             | 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)                                                                             
|       
|        | 21 | *       |             | Subsidiaries of the Company (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                                                                                                                                                                                                     



---



##### Table of Contents



|        |    |    |             |                                                                                                                                     
|------- | -- | -- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    |            
|Number  |    |    | Description
|        |    |    |            
|       
|        | 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, 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 Form 10-K, irrespective of any
    general incorporation language contained in such filing.

Index to Exhibits