##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-K


|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the Fiscal Year Ended December 31, 2005                                                 
|OR
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|   |  | For the Transition Period
    from           to                                             

Commission File Number: 0-27406


CONNETICS CORPORATION


(Exact name of registrant as specified in its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 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




o þ


o þ


þ o


S-K 10-K 10-K. o


12b-2


o þ o


12b-2 o þ






DOCUMENTS INCORPORATED BY REFERENCE


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










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##### 










Table of Contents


|                                                                                                   |  |                                                                                                                          |     |      |    | 
|-------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------ | --- | ---- | -- | 
|                                                                                                   |  |                                                                                                                          |     | Page |   
|                                                                                                   |  |                                                                                                                          |     |      |   
|Forward-Looking Statements                                                                         |  |                                                                                                                          |     |     
|PART I                                                                                            
|Item 1.                                                                                            |  | Business                                                                                                                 |     |      | 1  | 
|                                                                                                   |  | The Company                                                                                                              |     |      | 1  | 
|                                                                                                   |  | Our Strategy                                                                                                             |     |      | 3  | 
|                                                                                                   |  | Our Products                                                                                                             |     |      | 4  | 
|                                                                                                   |  | Product Candidates and Clinical Trials                                                                                   |     |      | 6  | 
|                                                                                                   |  | Royalty-Bearing Products and Licensed
    Technology                                                                     |     |      | 8  | 
|                                                                                                   |  | Sales and Marketing                                                                                                      |     |      | 9  | 
|                                                                                                   |  | Competition                                                                                                              |     |      | 10 | 
|                                                                                                   |  | Customers                                                                                                                |     |      | 10 | 
|                                                                                                   |  | Research and Development and Product
    Pipeline                                                                        |     |      | 11 | 
|                                                                                                   |  | Patents and Proprietary Rights                                                                                           |     |      | 11 | 
|                                                                                                   |  | Trademarks                                                                                                               |     |      | 12 | 
|                                                                                                   |  | Manufacturing                                                                                                            |     |      | 12 | 
|                                                                                                   |  | Warehousing and Distribution                                                                                             |     |      | 13 | 
|                                                                                                   |  | Government Regulation                                                                                                    |     |      | 13 | 
|                                                                                                   |  | Marketing to Healthcare Professionals                                                                                    |     |      | 16 | 
|                                                                                                   |  | Environmental Regulation                                                                                                 |     |      | 16 | 
|                                                                                                   |  | Employees                                                                                                                |     |      | 17 | 
|                                                                                                   |  | Available Information                                                                                                    |     |      | 17 | 
|                                                                                                   |  | Executive Officers of the Company                                                                                        |     |      | 17 | 
|Item 1A.                                                                                           |  | Risk Factors                                                                                                             |     |      | 19 | 
|Item 1B.                                                                                           |  | Unresolved Staff Comments                                                                                                |     |      | 29 | 
|Item 2.                                                                                            |  | Properties                                                                                                               |     |      | 29 | 
|Item 3.                                                                                            |  | Legal Proceedings                                                                                                        |     |      | 29 | 
|Item 4.                                                                                            |  | Submission of Matters to a Vote of
    Security Holders                                                                  |     |      | 30 | 
|                                                                                                  
|PART II                                                                                           
|Item 5.                                                                                            |  | Market for the Registrants Common
    Equity, Related Stockholder Matters and Issuer Purchases of
    Equity Securities |     |      | 30 | 
|Item 6.                                                                                            |  | Selected Financial Data                                                                                                  |     |      | 32 | 
|Item 7.                                                                                            |  | Managements Discussion and
    Analysis of Financial Condition and Results of Operations                                |     |      | 33 | 
|Item 7A.                                                                                           |  | Quantitative and Qualitative Disclosures
    About Market Risk                                                           |     |      | 48 | 
|Item 8.                                                                                            |  | Financial Statements and Supplementary
    Data                                                                          |     |      | 49 | 
|Item 9.                                                                                            |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure                                 |     |      | 49 | 
|Item 9A.                                                                                           |  | Controls and Procedures                                                                                                  |     |      | 49 | 
|Item 9B.                                                                                           |  | Other Information                                                                                                        |     |      | 51 | 
|                                                                                                  
|PART III                                                                                          
|Item 10.                                                                                           |  | Directors and Executive Officers of the
    Registrant                                                                   |     |      | 51 | 
|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                                                                       |     |      | 52 | 
|Item 14.                                                                                           |  | Principal Accountant Fees and
    Services                                                                               |     |      | 52 | 
|                                                                                                  
|PART IV                                                                                           
|Item 15.                                                                                           |  | Exhibits and Financial Statement
    Schedules                                                                           |     |      | 53 | 
|Signatures                                                                                         |  |                                                                                                                          | 54  |     
|Consolidated Financial Statements and
    Reports of Independent Registered Public Accounting Firm |  |                                                                                                                          | F-1 |     
|Index to Exhibits                                                                                  |  |                                                                                                                          |     |     
|EXHIBIT 10.13                                                                                     
|EXHIBIT 10.16                                                                                     
|EXHIBIT 10.19                                                                                     
|EXHIBIT 10.56                                                                                     
|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 our officers public statements
contain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, and
Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements give our current expectations or
forecasts of future events. Forward-looking statements may turn
out to be wrong. They can be affected by inaccurate assumptions
or by known or unknown risks and uncertainties. Many factors
mentioned in this Report, such as governmental regulation and
competition in our industry, will be important in determining
future results. No forward-looking statement can be guaranteed,
and actual results may vary materially from those anticipated in
any forward-looking statement.


You can identify forward-looking statements by the fact that
they do not relate strictly to historical or current events.
They use words such as anticipate,
estimate, expect, will,
may, intend, plan,
believe and similar expressions in connection with
discussion of future operating or financial performance.
Although we believe our plans, intentions and expectations
reflected in these forward-looking statements are reasonable, we
may not achieve these plans, intentions or expectations.


Forward-looking statements in this Report include, but are
not limited to, those relating to the commercialization of our
currently marketed and anticipated products, the progress of our
product development programs, developments with respect to
clinical trials and the regulatory approval process, the results
of our sales and marketing efforts, the outcome of contingencies
such as legal proceedings, and financial results. Actual
results, performance or achievements could differ materially
from those contemplated, expressed or implied by the
forward-looking statements contained in this Report. In
particular, this Report sets forth important factors that could
cause actual results to differ materially from our
forward-looking statements. These and other factors, including
general economic factors and business strategies, and other
factors we do not currently know, may be significant, now or in
the future, and the factors set forth in this Report may affect
us to a greater extent than indicated. All forward-looking
statements attributable to us or persons acting on our behalf
are expressly qualified in their entirety by the cautionary
statements set forth in this Report and in other documents that
we file from time to time with the Securities and Exchange
Commission, including our Quarterly Reports on
Form 10-Q. 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.





PART I







|        |         
|------- | --------
|Item 1. | Business




THE COMPANY


References in this Report to Connetics, the
Company, we, our and
us refer to Connetics Corporation, a Delaware
corporation, and its consolidated subsidiaries. Unless the
context specifically requires otherwise, these terms include
Connetics Australia Pty Ltd. and Connetics Holdings Pty Ltd.


Connetics was incorporated in Delaware in February 1993. Our
principal executive offices are located at 3160 Porter Drive,
Palo Alto, California 94304 and our telephone number is
(650) 843-2800.
Connetics®,
Luxíq®,
OLUX®,
Evoclin®,
Extina®,
Soriatane®,
VersaFoam®
and the seven interlocking Cs design are
registered trademarks, and
LiquipatchTM,
VersaFoam-EFTM,
DesiluxTM
and
PrimoluxTM
are trademarks, of Connetics.
Velac®
is a registered trademark of Astellas Pharma Europe B.V.
(formerly Yamanouchi Europe B.V.);
Rogaine®
is a registered trademark of Pfizer, Inc. (formerly Pharmacia
Corporation);
Lamisil®
is a registered trademark of Novartis Consumer Health SA. All
other trademarks or service marks appearing in this Report are
the property of their respective companies. We disclaim any
proprietary interest in the marks and names of others.


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® ® ® ®




®




tm tm tm ®


®


2



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | LiquipatchTM.
    In 2001, we entered into a global licensing agreement with
    Novartis Consumer Health SA for the use of our Liquipatch
    drug-delivery system in topical antifungal applications.
    Novartis anticipates initial European launch of a product using
    the Liquipatch technology in 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Rogaine®
    Foam. In 2002, we entered into a license agreement with
    Pfizer, Inc. (formerly Pharmacia Corporation) pursuant to which
    we granted Pfizer exclusive global rights, excluding Japan, to
    our proprietary foam drug delivery technology for use with
    Pfizers Rogaine hair loss treatment. The FDA approved
    Rogaine Foam in January 2006. Pfizer has not yet announced its
    launch plans.                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | OLUX Foam. In September 2004, we entered into a license
    agreement granting Pierre Fabre Dermatologie exclusive
    commercial rights to OLUX for Europe, excluding Italy, where the
    product is licensed to Mipharm S.p.A. The license agreement with
    Pierre Fabre also grants marketing rights for certain countries
    in South America and Africa. Pierre Fabre will market the
    product under different trade names. Under the terms of the
    license agreement with Pierre Fabre, we received an upfront
    license payment, and will receive milestone payments and
    royalties on product sales. Pierre Fabre will be responsible for
    costs associated with product manufacturing, sales, marketing,
    and distribution in its licensed territories. Pierre Fabre
    anticipates an initial launch of OLUX in select European markets
    in 2006.




OUR STRATEGY






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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Maximizing Commercial Opportunities for Our Marketed
    Products. We have a focused sales force dedicated to
    establishing our products as the standard of care for their
    respective indications. Our commercial strategy is to call on
    those medical professionals in dermatology who are most likely
    to prescribe products for the treatment of skin diseases or
    conditions. The reach of our dermatology sales force allows us
    to effectively reach approximately 98% of our dermatology target
    audience in 2005. With the acquisition of the PediaMed
    Pharmaceuticals, Inc. sales force, we have added
    87 individuals who, beginning in February 2006, will be
    targeting those pediatricians who prescribe dermatology products
    for the treatment of skin diseases or conditions.
|
| |  | Advancing the Development of Novel Dermatology Drugs. We
    plan to continue to leverage our investment in Connetics
    Australia and the CSB to enhance our ability to develop novel
    products and drug delivery technologies for the dermatology
    market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Broadening Our Product Portfolio Through Development, License
    or Acquisition. We believe we can leverage our
    dermatology-dedicated product development and commercial
    activities by acquiring or licensing additional products for the
    dermatology market. We regularly evaluate the licensing or
    acquisition of additional product candidates. We may also
    acquire additional technologies or businesses that we believe
    will enhance our research and development or commercial
    capabilities.                                                                                                                                                                                                                                                                                                  
|
| |  | Selective Collaborations that Leverage Our Technology. As
    we expand certain aspects of our development pipeline and
    delivery technologies, we may partner with pharmaceutical or
    biotech companies to gain access to additional marketing
    expertise, such as
    over-the-counter or
    non-U.S.markets,
    or physician groups on whom we do not currently call. Our
    approach to partnership will be on a selective basis, seeking to
    maintain the highest possible value of our products and product
    candidates.                                                                                                                                                                                                                                                                                 




OUR PRODUCTS


OLUX and Luxíq Foams


mild-to






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Soriatane






U.S.-based




Evoclin Foam




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PRODUCT CANDIDATES AND CLINICAL TRIALS




Desilux Foam






Primolux Foam


tm


Extina Foam




6



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®




Velac Gel






Other Pipeline Formulations


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


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ROYALTY-BEARING PRODUCTS AND LICENSED TECHNOLOGY


Foam Technology. (over-the


® ® ® ®




Liquipatch.


8



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Actimmune®.





SALES AND MARKETING




www.olux.com www.luxiq.com www.soriatane.com www.evoclin.com








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COMPETITION




® ® ® ® ® ® ® ® tm tm tm ® ® tm tm







CUSTOMERS




10



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RESEARCH AND DEVELOPMENT AND PRODUCT PIPELINE








scale-up





PATENTS AND PROPRIETARY RIGHTS




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TRADEMARKS


non-U.S.





MANUFACTURING




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WAREHOUSING AND DISTRIBUTION


Customers Note 2 of Notes
to Consolidated Financial Statements





GOVERNMENT REGULATION


Generally  Product Development. Risk
Factors  We may spend a significant amount of money
to obtain FDA and other regulatory approvals, which may never be
granted  We cannot sell our
current products and product candidates if we do not obtain and
maintain governmental approvals






FDA Approval.




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Preclinical Testing. Generally, a company must conduct
    preclinical studies before it can obtain FDA approval for a new
    therapeutic agent. The basic purpose of preclinical
    investigation is to gather enough evidence on a potential new
    agent through laboratory and animal testing to demonstrate there
    is a reasonable enough expectation of efficacy to justify
    exposing humans to the risk of adverse events associated with
    any new drug, and to demonstrate there are no safety signals
    that would suggest it would not be prudent to begin preliminary
    trials in humans. The sponsor of these studies submits the
    results to the FDA as a part of an investigational new drug
    application, or IND, that the FDA must review before human
    clinical trials of an investigational drug can start. FDA
    approval of new drug candidates requires an adequate
    demonstration of safety and efficacy in man. For each
    investigational product entering clinical trials, we are
    required to file an IND and perform our clinical studies to IND
    standards set by the FDA.

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| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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, together with the studies generated on our
    products. If studies previously submitted by another applicant
    and relied upon as part of 505(b)(2) application are found by
    the FDA not to be up to contemporary standards, it may be
    necessary to repeat them. The FDA may also require 505(b)(2)
    applicants to provide additional safety data that was not
    required at the time of the original application. Generally,
    however, the number of clinical trials required to support a
    505(b)(2) application, and the amount of information in the
    application itself, may be substantially less than that required
    to support a traditional NDA application. The 505(b)(2) process
    will not be available for all of our other product candidates,
    and as a result the drug development process may be longer for
    our future product candidates than it has been for our products
    to date. The FDA may also require an applicant to conduct
    post-approval studies or implement risk management programs that
    do not delay market entry but do increase product-related
    research and development costs.



Manufacturing.


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Post-Approval Regulation.


Pharmacy Boards.


Fraud and Abuse Regulations.








Medicaid and State Rebate Programs.


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Risk Factors  Our sales depend on payment
and reimbursement from third party payors, and if they reduce or
refuse payment or reimbursement, the use and sales of our
products will suffer, we may not increase our market share, and
our revenues and profitability will suffer  The growth of managed care organizations
and other third-party reimbursement policies may have an adverse
effect on our pricing policies and our margins





MARKETING TO HEALTHCARE PROFESSIONALS







ENVIRONMENTAL REGULATION


carbon-14.


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EMPLOYEES







AVAILABLE INFORMATION


10-K, 10-Q, 8-K, 10-K, 10-Q 8-K http://www.connetics.com 650-843-2800, e-mail ir@connetics.com





EXECUTIVE OFFICERS OF THE COMPANY




|                       |  |     |    |  |          |                                                                                         
|---------------------- |  | --- | -- |  | -------- | ----------------------------------------------------------------------------------------
|                      
|Name                   |  | Age |    |  | Position
|                      
|Thomas G. Wiggans      |  |     | 54 |  |          | Chairman of the Board and Chief Executive Officer                                       
|C. Gregory Vontz       |  |     | 45 |  |          | President and Chief Operating Officer                                                   
|John L. Higgins        |  |     | 35 |  |          | Chief Financial Officer; Executive Vice President, Finance and
    Corporate Development
|Katrina J. Church      |  |     | 44 |  |          | Executive Vice President, Legal Affairs; General Counsel and
    Secretary              
|Lincoln Krochmal, M.D. |  |     | 59 |  |          | Executive Vice President, Research and Product Development                              
|Matthew W. Foehr       |  |     | 33 |  |          | Senior Vice President, Technical Operations                                             
|                      

Thomas Wiggans


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Gregory Vontz


John Higgins


Katrina Church


Lincoln Krochmal, M.D.


Matthew Foehr


18



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|         |             
|-------- | ------------
|Item 1A. | Risk Factors



Risks Related to Our Business


We derive nearly all of our revenue from product sales, and
any decrease in our product sales would harm our business.






| |   |                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | manufacturing or supply interruptions,                                                                                                                                 
|
| |  | the development of new competitive pharmaceuticals to treat the
    conditions addressed by our products,                                                              
|
| |  | marketing or pricing actions by our competitors,                                                                                                                       
|
| |  | changes in the prescribing or procedural practices of
    dermatologists or pediatricians,                                                                             
|
| |  | changes in the reimbursement or substitution policies of
    third-party payors or retail pharmacies,                                                                  
|
| |  | the outcome of disputes relating to patents, and                                                                                                                       
|
| |  | changes in state and federal law that adversely affect our
    ability to market our products to dermatologists, pediatricians,
    and other healthcare professionals.



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





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





| |                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our commercial success depends in part on our ability and the
    ability of our licensors to obtain and maintain patent
    protection on technologies, to preserve trade secrets, and to
    operate without infringing the proprietary rights of others.



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®








| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Evoclin Foam represents a new product entry for us into the
    acne market and we may be unable to achieve desired market
    acceptance and sales of Evoclin Foam.





| |                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our total revenue depends on receiving royalties and contract
    payments from third parties, and we cannot control the amount or
    timing of those revenues.





| |   |                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | royalties generated from licensing arrangements may be
    insignificant or may fluctuate from period to period, and                                     
|
| |  | a loss of royalties could have a disproportionately large impact
    on our operating income in periods where the operating income is
    a small profit.

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





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





| |   |                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties in and costs associated with assimilating the
    operations, technologies, personnel and products of the acquired
    companies,                                                                                                                                                                   
|
| |  | assumption of known or unknown liabilities or other
    unanticipated events or circumstances, and                                                                                                                                                                                                               
|
| |  | risks of entering markets in which we have limited or no
    experience. For example, while the acquisition of the PediaMed
    sales organization will greatly expand our presence in the
    pediatric market, we cannot be certain pediatricians will
    respond favorably to our direct promotional efforts.





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

U.S.-based




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





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









| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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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Risks Related to Our Products




| |                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we rely on third-party manufacturers and suppliers,
    any manufacturing difficulties they encounter could delay future
    revenues from our product sales.









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





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



23



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##### Table of Contents





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





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









| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | change our methods of marketing and selling products,                                                                                                                    
|
| |  | take FDA-mandated corrective action, which could include placing
    advertisements or sending letters to physicians rescinding
    previous advertisements or promotion,
|
| |  | incur substantial expenses, including fines, penalties, legal
    fees and costs to comply with the FDAs requirements,                                                  
|
| |  | disrupt the distribution of products and stop sales until we are
    in compliance with the FDAs position.                                                              

24



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| |                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may spend a significant amount of money to obtain FDA and
    other regulatory approvals, which may never be granted. Failure
    to obtain such regulatory approvals could adversely affect our
    prospects for future revenue growth.





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





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





25



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##### Table of Contents









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



26



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##### Table of Contents







| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on the services of a single company to distribute our
    products to our customers. A delay or interruption in the
    distribution of our products could negatively impact our
    business.



Risks Related to Our Industry




| |                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------
| | We face intense competition, which may limit our commercial
    opportunities and limit our ability to generate revenues.









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



27



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| |                                                                  
| | -----------------------------------------------------------------
| | Our industry is subject to extensive governmental
    regulation.





| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | 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.





| |   |                                                    
| | - | ---------------------------------------------------
| |  | clinical trial results and regulatory developments,
|
| |  | quarterly variations in results,                   

28



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| |   |                                                                         
| | - | ------------------------------------------------------------------------
| |  | the timing of new product introductions,                                
|
| |  | competition, including both branded and generic,                        
|
| |  | business and product market cycles,                                     
|
| |  | fluctuations in customer requirements,                                  
|
| |  | the availability and utilization of manufacturing capacity,             
|
| |  | our 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.                





|       |  |      |       |  |     |   |       | 
|------ |  | ---- | ----- |  | --- | - | ----- | 
|       | 
|Period |  | High |       |  | Low |  
|       | 
|2005   |  | $    | 28.99 |  |     | $ | 12.00 | 
|2004   |  | $    | 29.92 |  |     | $ | 17.69 | 
|      






|         |                          
|-------- | -------------------------
|Item 1B. | Unresolved Staff Comments








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








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

®


29



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






PART II







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

Common Stock




|               |  |      |       |  |     |   |       | 
|-------------- |  | ---- | ----- |  | --- | - | ----- | 
|               | 
|               |  | High |       |  | Low |  
|               | 
|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 | 
|2005           |  |      |       |  |     |   |       | 
|First Quarter  |  | $    | 27.96 |  |     | $ | 22.02 | 
|Second Quarter |  |      | 28.99 |  |     |   | 15.13 | 
|Third Quarter  |  |      | 19.06 |  |     |   | 16.91 | 
|Fourth Quarter |  |      | 17.46 |  |     |   | 12.00 | 
|              





Issuer Purchases of Equity Securities


10b5-1


30



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##### Table of Contents



|         |                         |              |           |           |                 |   |              |                  |  |        |                 |           |  |  |   |            | 
|-------- | ----------------------- | ------------ | --------- | --------- | --------------- | - | ------------ | ---------------- |  | ------ | --------------- | --------- |  |  | - | ---------- | 
|         |                        
|         |                         | Approximate  |          
|         |                         | Total Number |           |           | Dollar Value of |  
|         |                         | of Shares    |           |           | Shares that May |  
|         |                         | Total        |           |           |                 |   | Purchased as |                  |  | Yet Be |                
|         |                         | Number of    |           |           | Average         |   |              | Part of Publicly |  |        | Purchased       |          
|         |                         | Shares       |           |           | Price Paid      |   |              | Announced Plans  |  |        | Under the Plans |          
|Period   |                         | Purchased    |           |           | Per Share       |   |              | or Programs      |  |        | or Programs     |          
|         |                        
|Month #1 |                         |              |           |           |                 |   |              |                  |  |        |                 |           |  |  |   |           
|         | (October 1  31, 2005)  |              |           | 0         |                 |   | $            |                 |  |        |                 | 0         |  |  | $ | 50,000,000 | 
|Month #2 |                         |              |           |           |                 |   |              |                  |  |        |                 |           |  |  |   |           
|         | (November 1  30, 2005) |              |           | 1,050,000 |                 |   | $            | 12.86            |  |        |                 | 1,050,000 |  |  | $ | 36,000,000 | 
|Month #3 |                         |              |           |           |                 |   |              |                  |  |        |                 |           |  |  |   |           
|         | (December 1  31, 2005) |              |           | 750,000   |                 |   | $            | 14.41            |  |        |                 | 750,000   |  |  | $ | 26,000,000 | 
|        
|Total    |                         |              | 1,800,000 |           |                 | $ | 13.51        |                  |  |        | 1,800,000       |           |  |  |   |           
|        



Recent Sales of Unregistered Securities


8-K


31



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##### Table of Contents








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



Connetics Corporation


Selected Consolidated Financial Data (in thousands, except
per share amounts)


|                                                                          |                                                                   |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |         |        |         |  
|------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------------------------------------------------------------- | ---------------------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | ---- | ------- | ------ | ------ | - | ------- | ------ | ------- | - | ------- | ------ | ------- | -
|                                                                          |                                                                  
|                                                                          |                                                                   | Years Ended December 31,                                      |                                   
|                                                                          |                                                                   |                                                               |                                   
|                                                                          |                                                                   | 2005                                                          |                                    |         | 2004    |         |   | 2003    |         |         | 2002 |         |        | 2001   |  
|                                                                          |                                                                  
|Consolidated Statements of Operations Data:                               |                                                                   |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |        
|                                                                          | Revenues:                                                         |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |         |       
|                                                                          |                                                                   | Product                                                       |                                    | $       | 183,312 |         |   | $       | 142,059 |         |      | $       | 66,606 |        |   | $       | 47,573 |         |   | $       | 30,923 |        
|                                                                          |                                                                   | Royalty and contract(1)                                       |                                    |         | 952     |         |   |         | 2,296   |         |      |         | 8,725  |        |   |         | 5,190  |         |   |         | 3,141  |        
|                                                                         
|                                                                          |                                                                   |                                                               | Total revenues                     |         |         | 184,264 |   |         |         | 144,355 |      |         |        | 75,331 |   |         |        | 52,763  |   |         |        | 34,064  |  
|                                                                          | Operating costs and expenses:                                     |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |         |       
|                                                                          |                                                                   | Cost of product revenues                                      |                                    |         | 16,438  |         |   |         | 12,656  |         |      |         | 5,129  |        |   |         | 4,190  |         |   |         | 3,123  |        
|                                                                          |                                                                   | Amortization of intangible assets(2)                          |                                    |         | 13,598  |         |   |         | 11,471  |         |      |         | 819    |        |   |         | 805    |         |   |         | 1,048  |        
|                                                                          |                                                                   | Research and development                                      |                                    |         | 31,896  |         |   |         | 21,539  |         |      |         | 30,109 |        |   |         | 25,821 |         |   |         | 19,156 |        
|                                                                          |                                                                   | Selling, general and administrative                           |                                    |         | 97,435  |         |   |         | 73,206  |         |      |         | 41,781 |        |   |         | 36,819 |         |   |         | 35,014 |        
|                                                                          |                                                                   | In-process research and development and milestone payments(3) |                                    |         | 1,000   |         |   |         | 3,500   |         |      |         |       |        |   |         | 4,350  |         |   |         | 1,080  |        
|                                                                          |                                                                   | Loss on program termination(4)                                |                                    |         |        |         |   |         |        |         |      |         |       |        |   |         | 312    |         |   |         | 1,142  |        
|                                                                         
|                                                                          |                                                                   |                                                               | Total operating costs and expenses |         |         | 160,367 |   |         |         | 122,372 |      |         |        | 77,838 |   |         |        | 72,297  |   |         |        | 60,563  |  
|                                                                          |                                                                   |                                                               | Income (loss) from operations      |         |         | 23,897  |   |         |         | 21,983  |      |         |        | (2,507 | ) |         |        | (19,534 | ) |         |        | (26,499 | )
|                                                                          | Gain on sale of investment                                        |                                                               |                                    |        |         |         |   |        |         |         |      |        |        |        |   | 2,086   |        |         |   | 122     |       
|                                                                          | Gain on sale of Ridaura product line(5)                           |                                                               |                                    |        |         |         |   |        |         |         |      |        |        |        |   |        |        |         |   | 8,002   |       
|                                                                          | Interest and other income (expense), net                          |                                                               |                                    | 201     |         |         |   | (1,475  | )       |         |      | (426    | )      |        |   | 1,039   |        |         |   | 1,978   |       
|                                                                         
|                                                                          | Income (loss) before income taxes                                 |                                                               |                                    | 24,098  |         |         |   | 20,508  |         |         |      | (2,933  | )      |        |   | (16,409 | )      |         |   | (16,397 | )     
|                                                                          | Income tax provision (benefit)                                    |                                                               |                                    | (9,860  | )       |         |   | 1,493   |         |         |      | 1,167   |        |        |   | 181     |        |         |   | 345     |       
|                                                                         
|                                                                          | Net income (loss)                                                 |                                                               | $                                  | 33,958  |         |         | $ | 19,015  |         |         | $    | (4,100  | )      |        | $ | (16,590 | )      |         | $ | (16,742 | )     
|                                                                         
|Net income (loss) per share:                                              |                                                                   |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |        
|                                                                          | Basic                                                             |                                                               | $                                  | 0.97    |         |         | $ | 0.54    |         |         | $    | (0.13   | )      |        | $ | (0.54   | )      |         | $ | (0.56   | )     
|                                                                         
|                                                                          | Diluted                                                           |                                                               | $                                  | 0.89    |         |         | $ | 0.51    |         |         | $    | (0.13   | )      |        | $ | (0.54   | )      |         | $ | (0.56   | )     
|                                                                         
|Shares used to compute basic and diluted net income (loss) per
    share: |                                                                   |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |        
|                                                                          | Basic                                                             |                                                               |                                    | 35,039  |         |         |   | 35,036  |         |         |      | 31,559  |        |        |   | 30,757  |        |         |   | 29,861  |       
|                                                                          | Diluted(6)                                                        |                                                               |                                    | 41,335  |         |         |   | 37,443  |         |         |      | 31,559  |        |        |   | 30,757  |        |         |   | 29,861  |       
|                                                                         
|Consolidated Balance Sheet Data:                                          |                                                                   |                                                               |                                    |         |         |         |   |         |         |         |      |         |        |        |   |         |        |         |   |        
|                                                                          | Cash, cash equivalents, marketable securities and restricted cash |                                                               | $                                  | 275,155 |         |         | $ | 76,346  |         |         | $    | 114,966 |        |        | $ | 33,788  |        |         | $ | 48,476  |       
|                                                                          | Working capital                                                   |                                                               |                                    | 256,420 |         |         |   | 71,181  |         |         |      | 112,247 |        |        |   | 25,185  |        |         |   | 44,026  |       
|                                                                          | Total assets                                                      |                                                               |                                    | 447,185 |         |         |   | 256,292 |         |         |      | 149,526 |        |        |   | 61,109  |        |         |   | 72,963  |       
|                                                                          | Convertible senior notes                                          |                                                               |                                    | 290,000 |         |         |   | 90,000  |         |         |      | 90,000  |        |        |   |        |        |         |   |        |       
|                                                                          | Total stockholders equity                                        |                                                               |                                    | 110,773 |         |         |   | 127,920 |         |         |      | 45,754  |        |        |   | 44,743  |        |         |   | 61,354  |       
|                                                                         

32



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






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



EXECUTIVE SUMMARY


Key Aspects of Our Business


®






| |   |                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | OLUX (clobetasol propionate) Foam, 0.05%, a super high-potency
    topical steroid prescribed for the treatment of steroid
    responsive dermatological diseases of the scalp and mild to
    moderate plaque-type psoriasis of non-scalp regions excluding
    the face and intertriginous areas;
|
| |  | Luxíq (betamethasone valerate) Foam, 0.12%, a mid-potency
    topical steroid prescribed for scalp dermatoses such as
    psoriasis, eczema and seborrheic dermatitis;                                                                                                                             
|
| |  | Soriatane (acitretin), an oral medicine for the treatment of
    severe psoriasis; and                                                                                                                                                                                                             
|
| |  | Evoclin (clindamycin phosphate) Foam, 1%, a topical treatment
    for acne vulgaris.                                                                                                                                                                                                               

33



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tm ® tm ®








Certain Events In 2005 And Recent Developments


Financing Matters.




out-of


Clinical Trials. tm


34



---



##### Table of Contents



®


tm


®


Marketing.


Litigation. ®


Licensing.


Acquisition of PediaMed Sales Organization.


35



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##### Table of Contents





RESULTS OF OPERATIONS




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



|                               |              |                                     |   |        |          |  |  |      |     |    |          |        |         |   |  |     |     |    |   |        |        | 
|------------------------------ | ------------ | ----------------------------------- | - | ------ | -------- |  |  | ---- | --- | -- | -------- | ------ | ------- | - |  | --- | --- | -- | - | ------ | ------ | 
|                               |             
|                               |              | Years Ended December 31,            |  
|                               |              |                                     |  
|                               |              | 2005                                |   |        | 2004     |  |  | 2003 |    
|                               |              |                                     |   |        |          |  |  |      |    
|(Dollars in thousands)         |              | $                                   |   |        | % Change |  |  | $    |     |    | % Change |        |         | $ | 
|                               |             
|Product revenues:              |              |                                     |   |        |          |  |  |      |     |    |          |        |         |   |  |     |     |    |   |       
|                               | Soriatane    |                                     | $ | 72,595 |          |  |  | 36   | %   |    | $        | 53,567 |         |   |  | 100 | %   |    | $ |       |       
|                               | OLUX Foam    |                                     |   | 61,794 |          |  |  | 0    | %   |    |          | 61,894 |         |   |  | 30  | %   |    |   | 47,538 |       
|                               | Evoclin Foam |                                     |   | 24,679 |          |  |  | NM   |     |    |          | 2,883  |         |   |  | 100 | %   |    |   |       |       
|                               | Luxíq Foam   |                                     |   | 24,102 |          |  |  | 2    | %   |    |          | 23,582 |         |   |  | 25  | %   |    |   | 18,857 |       
|                               | Other        |                                     |   | 142    |          |  |  | 7    | %   |    |          | 133    |         |   |  | (37 | )%  |    |   | 211    |       
|                              
|                               |              | Total product revenues              |   |        | 183,312  |  |  |      | 29  | %  |          |        | 142,059 |   |  |     | 113 | %  |   |        | 66,606 | 
|Royalty and contract revenues: |              |                                     |   |        |          |  |  |      |     |    |          |        |         |   |  |     |     |    |   |       
|                               | Royalty      |                                     |   | 571    |          |  |  | (69  | )%  |    |          | 1,839  |         |   |  | (76 | )%  |    |   | 7,788  |       
|                               | Contract     |                                     |   | 381    |          |  |  | (17  | )%  |    |          | 457    |         |   |  | (51 | )%  |    |   | 937    |       
|                              
|                               |              | Total royalty and contract revenues |   |        | 952      |  |  |      | (59 | )% |          |        | 2,296   |   |  |     | (74 | )% |   |        | 8,725  | 
|                              
|                               |              | Total revenues                      |   | $      | 184,264  |  |  |      | 28  | %  |          | $      | 144,355 |   |  |     | 92  | %  |   | $      | 75,331 | 
|                              







36



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



|                         |  |                          |        |               |          |  |   |      |               |   |          |  |  |               |   |   |          |   |       |  |  |  |   |  
|------------------------ |  | ------------------------ | ------ | ------------- | -------- |  | - | ---- | ------------- | - | -------- |  |  | ------------- | - | - | -------- | - | ----- |  |  |  | - | -
|                         | 
|                         |  | Years Ended December 31, |       
|                         |  |                          |       
|                         |  | 2005                     |        |               | 2004     |  |   | 2003 |              
|                         |  |                          |        |               |          |  |   |      |              
|                         |  |                          |        | As a % of Net |          |  |   |      | As a % of Net |   |          |  |  | As a % of Net |  
|                         |  |                          |        | Product       |          |  |   |      | Product       |   |          |  |  | Product       |  
|(Dollars in thousands)   |  | $                        |        |               | Revenues |  |   | $    |               |   | Revenues |  |  | $             |   |   | Revenues |  
|                         | 
|Cost of product revenues |  | $                        | 16,438 |               |          |  | 9 | %    |               | $ | 12,656   |  |  |               | 9 | % |          | $ | 5,129 |  |  |  | 8 | %
|                        



U.S.-based




37



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| |                                  
| | ---------------------------------
| | Amortization of Intangible Assets



|                                  |  |                          |        |          |  |      |     |          |  |   |        |  |  |  |    |  |  |   |     | 
|--------------------------------- |  | ------------------------ | ------ | -------- |  | ---- | --- | -------- |  | - | ------ |  |  |  | -- |  |  | - | --- | 
|                                 
|                                  |  | Years Ended December 31,
|                                  |  |                         
|                                  |  | 2005                     |        | 2004     |  | 2003
|                                  |  |                          |        |          |  |     
|(Dollars in thousands)            |  | $                        |        | % Change |  | $    |     | % Change |  | $
|                                 
|Amortization of intangible assets |  | $                        | 13,598 |          |  |      | 19% |          |  | $ | 11,471 |  |  |  | NM |  |  | $ | 819 | 
|                                 







| |                         
| | ------------------------
| | Research and Development



|                                  |  |                          |        |          |  |      |    |          |  |   |        |  |  |  |     |    |  |   |        | 
|--------------------------------- |  | ------------------------ | ------ | -------- |  | ---- | -- | -------- |  | - | ------ |  |  |  | --- | -- |  | - | ------ | 
|                                 
|                                  |  | Years Ended December 31,
|                                  |  |                         
|                                  |  | 2005                     |        | 2004     |  | 2003
|                                  |  |                          |        |          |  |     
|(Dollars in thousands)            |  | $                        |        | % Change |  | $    |    | % Change |  | $
|                                 
|Research and development expenses |  | $                        | 31,896 |          |  |      | 48 | %        |  | $ | 21,539 |  |  |  | (29 | )% |  | $ | 30,109 | 
|                                 







38



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##### Table of Contents





|                                                                                                              |  |                          |      |  |      |   |     |      |  |   |      | 
|------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ---- |  | ---- | - | --- | ---- |  | - | ---- | 
|                                                                                                              | 
|                                                                                                              |  | Years Ended December 31, |     
|                                                                                                              |  |                          |     
|(ICategory s)                                                                                                 |  | 2005                     |      |  | 2004 |   |     | 2003 | 
|                                                                                                              | 
|Preclinical and clinical research in the development of new
    dermatology products                          |  | $                        | 14.7 |  |      | $ | 6.4 |      |  | $ | 13.0 | 
|Optimization of manufacturing and process development for
    existing dermatology products                   |  |                          | 5.0  |  |      |   | 2.7 |      |  |   | 2.8  | 
|Quality assurance and quality control in the maintenance and
    enhancement of existing dermatology products |  |                          | 4.0  |  |      |   | 4.9 |      |  |   | 5.2  | 
|Manufacturing, process development and optimization of
    dermatology products under development             |  |                          | 3.7  |  |      |   | 3.6 |      |  |   | 2.1  | 
|Regulatory review of new and existing dermatology products                                                    |  |                          | 4.1  |  |      |   | 2.7 |      |  |   | 1.6  | 
|Basic research and formulation of new dermatology products                                                    |  |                          | 1.6  |  |      |   | 1.6 |      |  |   | 1.3  | 
|Quality assurance and quality control in the development of new
    dermatology products                      |  |                          | 1.5  |  |      |   | 1.8 |      |  |   | 2.0  | 
|                                                                                                             



|                                                                                 |  |               |               |  |                             |  |             |                          |  |   |             | 
|-------------------------------------------------------------------------------- |  | ------------- | ------------- |  | --------------------------- |  | ----------- | ------------------------ |  | - | ----------- | 
|                                                                                 | 
|                                                                                 |  | Estimated     |               |  |                            
|                                                                                 |  | Completion of |               |  | Accumulated Program-Related | 
|                                                                                 |  | Phase of      |               |  | Phase III                   |  |             | Research and Development | 
|Description                                                                      |  | Development   |               |  | Clinical Trials             |  |             | Expenses through 2005    | 
|                                                                                 | 
|Desiluxtm(desonide), VersaFoam-EF, 0.05%                                         |  |               | NDA filed     |  |                             |  | Completed   |                          |  | $ | 7.8 million | 
|Primolux (clobetasol propionate) VersaFoam-EF, 0.05%                             |  |               | Data Analysis |  |                             |  | Completed   |                          |  | $ | 6.0 million | 
|Extina®
    (ketoconazole) VersaFoam, 2%                                         |  |               | Phase III     |  |                             |  | August 2006 |                          |  | $ | 2.4 million | 
|Preclinical research and development for multiple dermatological
    indications |  |               | Preclinical   |  |                             |  | N/A         |                          |  | $ | 3.2 million | 
|                                                                                

Risk Factors  We
cannot sell our current products and product candidates if we do
not obtain and maintain governmental approvals,
 We may spend a significant amount of money to
obtain FDA and other regulatory approvals, which may never be
granted,  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.


39



---



##### Table of Contents





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



|                                             |  |                          |        |  |          |  |    |      |  |   |          |  |  |   |    |   |  |   |        | 
|-------------------------------------------- |  | ------------------------ | ------ |  | -------- |  | -- | ---- |  | - | -------- |  |  | - | -- | - |  | - | ------ | 
|                                             | 
|                                             |  | Years Ended December 31, |       
|                                             |  |                          |       
|                                             |  | 2005                     |        |  | 2004     |  |    | 2003 | 
|                                             |  |                          |        |  |          |  |    |      | 
|(Dollars in thousands)                       |  | $                        |        |  | % Change |  |    | $    |  |   | % Change |  |  | $ |   
|                                             | 
|Selling, general and administrative expenses |  | $                        | 97,435 |  |          |  | 33 | %    |  | $ | 73,206   |  |  |   | 75 | % |  | $ | 41,781 | 
|                                            





| |   |                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased direct and indirect promotional capabilities
    ($7.8 million),                                                                                     
|
| |  | increased marketing and sales activities such as advertising,
    tradeshows and conventions ($5.7 million),                                                   
|
| |  | increased expenses related to market research and product
    sampling ($4.6 million),                                                                         
|
| |  | increased labor and benefit expenses, primarily due to increased
    headcount in the marketing, general and administrative
    departments ($2.2 million), and
|
| |  | increased outside legal, audit and tax expenses
    ($1.0 million).                                                                                            





| |   |                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased direct and indirect promotional capabilities
    ($11.0 million),                                                                                
|
| |  | increased marketing and sales activities such as advertising,
    tradeshows and conventions ($4.1 million),                                               
|
| |  | increased labor and benefit expenses, primarily due to increased
    headcount in the marketing, general and administrative
    departments ($2.4 million),
|
| |  | increased outside legal, audit and tax expenses
    ($1.9 million),                                                                                        
|
| |  | increased expenses related to product sampling
    ($1.8 million), and                                                                                     
|
| |  | increased business insurance costs ($1.1 million).                                                                                                         





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



|                                                           |  |                          |       |  |          |  |     |      |  |   |          |  |  |   |    |  |  |  |   | 
|---------------------------------------------------------- |  | ------------------------ | ----- |  | -------- |  | --- | ---- |  | - | -------- |  |  | - | -- |  |  |  | - | 
|                                                           | 
|                                                           |  | Years Ended December 31, |      
|                                                           |  |                          |      
|                                                           |  | 2005                     |       |  | 2004     |  |     | 2003 | 
|                                                           |  |                          |       |  |          |  |     |      | 
|(Dollars in thousands)                                     |  | $                        |       |  | % Change |  |     | $    |  |   | % Change |  |  | $ |   
|                                                           | 
|In-process research and development and milestone payments |  | $                        | 1,000 |  |          |  | (71 | )%   |  | $ | 3,500    |  |  |   | NM |  |  |  |  | 
|                                                          



40



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##### Table of Contents









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

|                                         |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   |  |     |    |  |   |        |  
|---------------------------------------- | --------------------------- | ------------------------ | - | ------ | -------- |  |  | ---- | -- |  | -------- | ------ | - | - |  | --- | -- |  | - | ------ | -
|                                         |                            
|                                         |                             | Years Ended December 31, |  
|                                         |                             |                          |  
|                                         |                             | 2005                     |   |        | 2004     |  |  | 2003 |   
|                                         |                             |                          |   |        |          |  |  |      |   
|(Dollars in thousands)                   |                             | $                        |   |        | % Change |  |  | $    |    |  | % Change |        |   | $ | 
|                                         |                            
|Interest and other income (expense), net |                             |                          |   |        |          |  |  |      |    |  |          |        |   |   |  |     |    |  |   |       
|                                         | Interest income             |                          | $ | 6,981  |          |  |  | 485  | %  |  | $        | 1,194  |   |   |  | 23  | %  |  | $ | 972    |  
|                                         | Interest expense            |                          |   | (6,504 | )        |  |  | 134  | %  |  |          | (2,778 | ) |   |  | 70  | %  |  |   | (1,632 | )
|                                         | Other income (expense), net |                          |   | (276   | )        |  |  | (353 | )% |  |          | 109    |   |   |  | (53 | )% |  |   | 234    |  
|                                        

Interest Income.


Interest Expense.




| |                                          
| | -----------------------------------------
| | Provision for (Benefit from) Income Taxes

|                               |  |                          |        |   |          |  |    |      |  |   |          |  |  |   |    |   |  |   |       | 
|------------------------------ |  | ------------------------ | ------ | - | -------- |  | -- | ---- |  | - | -------- |  |  | - | -- | - |  | - | ----- | 
|                               | 
|                               |  | Years Ended December 31, |       
|                               |  |                          |       
|                               |  | 2005                     |        |   | 2004     |  |    | 2003 | 
|                               |  |                          |        |   |          |  |    |      | 
|(Dollars in thousands)         |  | $                        |        |   | % Change |  |    | $    |  |   | % Change |  |  | $ |   
|                               | 
|Income tax provision (benefit) |  | $                        | (9,860 | ) |          |  | NM |      |  | $ | 1,493    |  |  |   | 28 | % |  | $ | 1,167 | 
|                              





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Note 11 Notes to Consolidated Financial Statements


LIQUIDITY AND CAPITAL RESOURCES


|                                                 |  |              |         |  |          |  |     |   |  |   |        | 
|------------------------------------------------ |  | ------------ | ------- |  | -------- |  | --- | - |  | - | ------ | 
|                                                 | 
|                                                 |  | December 31, |        
|                                                 |  |              |        
|                                                 |  | 2005         |         |  | 2004     | 
|                                                 |  |              |         |  |          | 
|(Dollars in thousands)                           |  | $            |         |  | % Change |  |     | $ | 
|                                                 | 
|Cash, cash equivalents and marketable securities |  | $            | 271,096 |  |          |  | 275 | % |  | $ | 72,383 | 
|                                                



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





|                                                                       |  |                                                                                                                                                      
|---------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                      
|Fluctuation in Current Assets                                          |  | Explanation                                                                                                                                          
|                                                                      
|$17.3 million decrease  accounts receivable                           |  | Decrease is primarily a result of the timing of shipments in
    2005 versus 2004.                                                                   
|$16.1 million increase  prepaid expenses and
    other current assets |  | Includes a recorded tax asset of approximately
    $9.9 million; increases are primarily a result of growth in
    our business and related expenses.
|$2.4 million increase  inventory                                      |  |                                                                                                                                                      
|                                                                      

|                                                   |  |                                                                                                                                                                     
|-------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                  
|Increases in Liabilities                           |  | Explanation                                                                                                                                                         
|                                                  
|$1.6 million  product rebates and coupon accruals |  | Rebate and coupon accruals increased as a function of our
    increased product revenues. Other increases are a result of the
    increase in our business activity.
|$3.3 million  account payable                     |  |                                                                                                                                                                     
|$4.6 million  other accrued liabilities           |  |                                                                                                                                                                     
|                                                  

42



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| |                                                    
| | ---------------------------------------------------
| | Contractual Obligations and Commercial Commitments.



|                                   |  |                        |       |           |        |   |      |             |           |   |             |  |  |         |     |  |  |   |       | 
|---------------------------------- |  | ---------------------- | ----- | --------- | ------ | - | ---- | ----------- | --------- | - | ----------- |  |  | ------- | --- |  |  | - | ----- | 
|                                   | 
|                                   |  | Payments Due by Period |      
|                                   |  |                        |      
|                                   |  |                        |       | Less Than |        |   |      |             | More Than |  
|ContractualiObligations            |  | Total                  |       |           | 1 Year |   |      | 1  3 Years |           |   | 3  5 Years |  |  | 5 Years |    
|                                   | 
|Long-Term Debt Obligations(1)      |  | $                      | 311.9 |           |        | $ | 6.0  |             |           | $ | 100.9       |  |  | $       | 5.0 |  |  | $ | 200.0 | 
|Operating Lease Obligations(2)     |  |                        | 18.8  |           |        |   | 3.8  |             |           |   | 5.0         |  |  |         | 3.2 |  |  |   | 6.8   | 
|Purchase Obligations(3)(4)         |  |                        | 27.4  |           |        |   | 21.3 |             |           |   | 3.0         |  |  |         | 1.7 |  |  |   | 1.4   | 
|                                  
|Total Contractual Cash Obligations |  | $                      | 358.1 |           |        | $ | 31.1 |             |           | $ | 108.9       |  |  | $       | 9.9 |  |  | $ | 208.2 | 
|                                  



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | In March 2005, we issued $200 million of convertible senior
    notes due March 30, 2015 to qualified institutional buyers
    in a private placement. The notes bear interest at a rate of
    2.00% per annum for the initial five year period, which is
    payable in arrears on March 30 and September 30 of
    each year until March 30, 2010. We made the first interest
    payment on September 30, 2005. For the remaining five-year
    period commencing on March 30, 2010, we will pay contingent
    interest for six-month periods if the average trading price of a
    note is above a specified level for a specified period prior to
    the six-month period. No contingent interest is included in the
    table above. In addition, beginning on March 30, 2010, the
    original principal amount will be increased at a rate that
    provides holders with an aggregate annual yield to maturity of
    2.00%. The amounts reflected above include annual interest
    payments of approximately $4 million per year through 2009
    and $1 million for interest in 2010 assuming that the notes
    are redeemed or converted before maturity. No contingent
    interest or accretion is included in the table above as the debt
    is callable by the Company in 2010.
|
| |     | On May 28, 2003, we issued $90 million of
    2.25% convertible senior notes due May 30, 2008 in a
    private placement. 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 million per
    year, assuming that the notes are not redeemed or converted
    before maturity.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | (2) | In June 2004, we signed a series of non-cancelable facility
    lease agreements to lease approximately 96,000 square feet
    of space in Palo Alto, California that we occupied in February
    2005. We sublease an additional 19,447 square feet of
    office space which we have not occupied in Palo Alto; payment
    under this sublease commenced on January 1, 2006. Under our
    agreement with DPT, we are also obligated to pay approximately
    $56,000 per year in rent for the pro rataportion of
    DPTs facility allocated to the aerosol line. Under the DPT
    agreement, we will pay rent for the term of the agreement or as
    long as we own the associated assets,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

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| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     | whichever is longer. We also lease various automobiles and
    office equipment under similar leases, expiring through 2008.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | (3) | In March 2002 we entered into a manufacturing and supply
    agreement with DPT that requires minimum purchase commitments,
    beginning six months after the opening of the commercial
    production line and continuing for 10 years. Also in 2002
    we entered into a license agreement that requires minimum
    royalty payments beginning in 2005 and continuing for fifteen
    years, unless the agreement is terminated earlier by either
    party. In 2003, we entered into a five year service agreement
    for prescription information that requires minimum fees. We paid
    $14.9 million, $4.3 million and $2.2 million
    related to these agreements for the years ended
    December 31, 2005, 2004 and 2003, respectively.
|
| | (4) | Per our manufacturing and supply agreements with our three
    suppliers, KIK, DPT and Roche, we may incur penalties related to
    cancellation of purchase orders, including paying an amount
    equal to the entire cancelled purchase order. We did not incur
    any penalties related to the cancellation of purchase orders for
    KIK, DPT or Roche for the years ended December 31, 2005,
    2004 and 2003, respectively. We had approximately
    $19.0 million in outstanding open purchase orders to our
    suppliers at December 31, 2005 and the entire amount is
    included in the table in the Less Than 1 Year
    column.                                                                                                   





OFF-BALANCE SHEET ARRANGEMENTS


S-K)


RECENT ACCOUNTING PRONOUNCEMENTS




44



---



##### Table of Contents









CRITICAL ACCOUNTING POLICIES AND ESTIMATES




45



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##### Table of Contents





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
















46



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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,




47



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##### Table of Contents





| |                                           
| | ------------------------------------------
| | Provision for (Benefit from) Income Taxes.










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

Interest Rate Risk.


dollars in
thousands)


|                                        |  |      |         |   |      |   |        |      |  |   |        |   |      |   |            |  |  |       |   |  |            |   |         |   |  |   |         |  |  |   |         | 
|--------------------------------------- |  | ---- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | - | ---- | - | ---------- |  |  | ----- | - |  | ---------- | - | ------- | - |  | - | ------- |  |  | - | ------- | 
|                                        | 
|                                        |  | 2006 |         |   | 2007 |   |        | 2008 |  |   | 2009   |   | 2010 |   | Thereafter |  |  | Total |   |  | Fair Value |  
|                                        | 
|Assets:                                 |  |      |         |   |      |   |        |      |  |   |        |   |      |   |            |  |  |       |   |  |            |   |         |   |  |   |         |  |  |   |         | 
|Available-for-sale securities           |  | $    | 154,494 |   |      | $ | 83,757 |      |  | $ | 3,109  |   |      | $ |           |  |  | $     |  |  |            | $ |        |   |  | $ | 241,360 |  |  | $ | 240,524 | 
|Weighted average annual interest rate   |  |      | 3.44    | % |      |   | 4.31   | %    |  |   | 3.59   | % |      |   |           |  |  |       |  |  |            |   |        |   |  |   |        |  |  |   |        | 
|                                       
|Liabilities:                            |  |      |         |   |      |   |        |      |  |   |        |   |      |   |            |  |  |       |   |  |            |   |         |   |  |   |         |  |  |   |         | 
|2.25% Convertible Senior Notes Due 2008 |  |      |        |   |      |   |       |      |  | $ | 90,000 |   |      |   |           |  |  |       |  |  |            |   |        |   |  | $ | 90,000  |  |  | $ | 82,900  | 
|2.00% Convertible Senior Notes Due 2015 |  |      |        |   |      |   |       |      |  |   |       |   |      |   |           |  |  |       |  |  |            | $ | 200,000 |   |  | $ | 200,000 |  |  | $ | 154,500 | 
|Average interest rate                   |  |      |        |   |      |   |       |      |  |   | 2.25   | % |      |   |           |  |  |       |  |  |            |   | 2.00    | % |  |   |        |  |  |   |        | 
|                                       



48



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##### Table of Contents





Foreign Currency Exchange Risk.







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

Item 15(a) 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: 13a-15(e)) 10-K.


Managements Annual Report on Internal Control
Over Financial Reporting: 13a-15(f) 15d-15(f)).


Changes in Internal Control Over Financial
Reporting:


49



---



##### Table of Contents





Report of Independent Registered Public Accounting Firm




















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





50



---



##### Table of Contents








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






PART III







|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant

Election of Directors, Stock
Ownership, Corporate Governance, Report of the Audit Committee


Business  Executive Officers of the
Company, Stock Ownership


Report of the Audit Committee


Corporate
Governance


Stock Ownership  Section 16
(a) Beneficial Ownership Reporting Compliance


http://ir.connetics.com/governance/highlights.cfm 8-K







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








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

Stock Ownership


Equity
Compensation Plan Information


51



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##### Table of Contents








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

Certain Relationships and
Related Transactions







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

Audit and Other
Fees


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##### Table of Contents






PART IV







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

(a) Financial Statements.


|                                                                                                                          |  |      |     | 
|------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                          | 
|                                                                                                                          |  | Page |    
|                                                                                                                          | 
|Report of Independent Registered Public
    Accounting Firm                                                               |  |      | F-2 | 
|Consolidated Balance Sheets as of
    December 31, 2005 and 2004                                                          |  |      | F-3 | 
|Consolidated Statements of Operations for
    each of the three years in the period ended December 31,
    2005           |  |      | F-4 | 
|Consolidated Statements of
    Stockholders Equity for each of the three years in the
    period ended December 31, 2005 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for
    each of the three years in the period ended December 31,
    2005           |  |      | F-6 | 
|Notes to Consolidated Financial
    Statements                                                                            |  |      | F-7 | 
|                                                                                                                         

Financial Statement Schedules.




Schedule II  Valuation and Qualifying
Accounts


|                        |      |            |           |           |                  |  |   |              |  |            |               |             |   |  |   |            | 
|----------------------- | ---- | ---------- | --------- | --------- | ---------------- |  | - | ------------ |  | ---------- | ------------- | ----------- | - |  | - | ---------- | 
|                        |     
|Allowance for Doubtful  |      |            | Additions |           |                  | 
|Accounts, Discounts,    |      | Balance at |           |           | Charged to       |  |   |             
|Returns and             |      | Start of   |           |           | Expense/Revenue  |  |   |              |  | Balance at |              
|Chargebacks             |      | Period     |           |           | Net of Reversals |  |   | Utilizations |  |            | End of Period |            
|                        |     
|Year ended December 31, |      |            |           |           |                  |  |   |              |  |            |               |             |   |  |   |           
|                        | 2005 |            | $         | 7,692,000 |                  |  | $ | 21,368,000   |  |            | $             | (18,293,000 | ) |  | $ | 10,767,000 | 
|                        | 2004 |            | $         | 1,404,000 |                  |  | $ | 11,473,000   |  |            | $             | (5,185,000  | ) |  | $ | 7,692,000  | 
|                        | 2003 |            | $         | 486,000   |                  |  | $ | 6,886,000    |  |            | $             | (5,968,000  | ) |  | $ | 1,404,000  | 
|                       



(b) Exhibits. See Index to Exhibits.


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


53



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##### Table of Contents






SIGNATURES






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



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

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



attorneys-in 10-K, attorney-in attorneys-in




|                                                      |  |                                                                                              |  |                |  | 
|----------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                             |  | Title                                                                                        |  | Date          
|                                                      |  |                                                                                              |  |               
|                                                     
|Principal Executive Officer:                          |  |                                                                                              |  |               
|                                                     
|/s/ Thomas G. WiggansThomas G. Wiggans                |  | Chairman of the Board
    and Chief Executive Officer                                        |  | March 13, 2006
|                                                     
|Principal Financial and Principal Accounting Officer: |  |                                                                                              |  |               
|                                                     
|/s/ John L. HigginsJohn L. Higgins                    |  | Chief Financial Officer;
    Executive Vice President,
    Finance and Corporate Development |  | March 13, 2006
|                                                     
|Directors:                                            |  |                                                                                              |  |               
|                                                     
|/s/ David E. CohenDavid E. Cohen                      |  | Director                                                                                     |  | March 13, 2006
|                                                     
|/s/ R. Andrew EckertR. Andrew Eckert                  |  | Director                                                                                     |  | March 13, 2006

54



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##### Table of Contents



|                                       |  |          |  |                |  | 
|-------------------------------------- |  | -------- |  | -------------- |  | 
|Signature                              |  | Title    |  | Date          
|                                       |  |          |  |               
|                                      
|/s/ Carl B. FeldbaumCarl B. Feldbaum   |  | Director |  | March 13, 2006
|                                      
|/s/ Denise M. GilbertDenise M. Gilbert |  | Director |  | March 13, 2006
|                                      
|/s/ John C. KaneJohn C. Kane           |  | Director |  | March 13, 2006
|                                      
|/s/ Thomas D. KileyThomas D. Kiley     |  | Director |  | March 13, 2006
|                                      
|/s/ Leon E. PanettaLeon E. Panetta     |  | Director |  | March 13, 2006
|                                      
|/s/ G. Kirk RaabG. Kirk Raab           |  | Director |  | March 13, 2006

55



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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                                                               |  |      | F-2 | 
|Consolidated Balance Sheets as of
    December 31, 2005 and 2004                                                          |  |      | F-3 | 
|Consolidated Statements of Operations for
    each the three years in the period ended December 31,
    2005              |  |      | F-4 | 
|Consolidated Statements of
    Stockholders Equity for each of the three years in the
    period ended December 31, 2005 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for
    each of the three years in the period ended December 31,
    2005           |  |      | F-6 | 
|Notes to Consolidated Financial
    Statements                                                                            |  |      | F-7 | 
|                                                                                                                         

F-1



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm
















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





F-2



---



##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED BALANCE SHEETS


(In thousands, except share and per share amounts)


|                                               |                                                                                                                                                                                                          |                            |                           |         |         |         |         |          |         |         | 
|---------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------- | ------- | ------- | ------- | ------- | -------- | ------- | ------- | 
|                                               |                                                                                                                                                                                                         
|                                               |                                                                                                                                                                                                          | December 31,               |                          
|                                               |                                                                                                                                                                                                          |                            |                          
|                                               |                                                                                                                                                                                                          | 2005                       |                           |         | 2004    |        
|                                               |                                                                                                                                                                                                         
|Assets                                         |                                                                                                                                                                                                          |                            |                           |         |         |         |         |         
|Current assets:                                |                                                                                                                                                                                                          |                            |                           |         |         |         |         |         
|                                               | Cash and cash equivalents                                                                                                                                                                                |                            | $                         | 29,988  |         |         | $       | 18,261   |        
|                                               | Marketable securities                                                                                                                                                                                    |                            |                           | 241,108 |         |         |         | 54,122   |        
|                                               | Restricted cash  current                                                                                                                                                                                |                            |                           | 1,000   |         |         |         | 1,000    |        
|                                               | Accounts receivable, net of allowances of $10,767 in 2005 and
    $7,692 in 2004                                                                                                                         |                            |                           | 863     |         |         |         | 21,206   |        
|                                               | Inventory                                                                                                                                                                                                |                            |                           | 7,485   |         |         |         | 5,020    |        
|                                               | Prepaid expenses                                                                                                                                                                                         |                            |                           | 8,384   |         |         |         | 7,561    |        
|                                               | Other current assets                                                                                                                                                                                     |                            |                           | 13,487  |         |         |         | 1,963    |        
|                                              
|                                               |                                                                                                                                                                                                          |                            | Total current assets      |         |         | 302,315 |         |          |         | 109,133 | 
|Property and equipment, net                    |                                                                                                                                                                                                          |                            | 14,438                    |         |         |         | 11,830  |         
|Restricted cash  long term                    |                                                                                                                                                                                                          |                            | 3,059                     |         |         |         | 2,963   |         
|Debt issuance costs, deposits and other assets |                                                                                                                                                                                                          |                            | 12,313                    |         |         |         | 3,707   |         
|Goodwill and other intangible assets, net      |                                                                                                                                                                                                          |                            | 115,060                   |         |         |         | 128,659 |         
|                                              
|Total assets                                   |                                                                                                                                                                                                          | $                          | 447,185                   |         |         | $       | 256,292 |         
|                                              
|Liabilities and Stockholders Equity           |                                                                                                                                                                                                          |                            |                           |         |         |         |         |         
|Current liabilities:                           |                                                                                                                                                                                                          |                            |                           |         |         |         |         |         
|                                               | Accounts payable                                                                                                                                                                                         |                            | $                         | 16,888  |         |         | $       | 14,531   |        
|                                               | Accrued liabilities related to acquisition of product rights                                                                                                                                             |                            |                           | 1,867   |         |         |         | 2,710    |        
|                                               | Accrued payroll and related expenses                                                                                                                                                                     |                            |                           | 6,042   |         |         |         | 5,746    |        
|                                               | Product rebate and coupon accruals                                                                                                                                                                       |                            |                           | 12,126  |         |         |         | 10,564   |        
|                                               | Accrued clinical trial costs                                                                                                                                                                             |                            |                           | 1,117   |         |         |         | 751      |        
|                                               | Other accrued liabilities                                                                                                                                                                                |                            |                           | 7,855   |         |         |         | 3,650    |        
|                                              
|                                               |                                                                                                                                                                                                          |                            | Total current liabilities |         |         | 45,895  |         |          |         | 37,952  | 
|Convertible senior notes                       |                                                                                                                                                                                                          |                            | 290,000                   |         |         |         | 90,000  |         
|Other non-current liabilities                  |                                                                                                                                                                                                          |                            | 517                       |         |         |         | 420     |         
|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;
    100,000,000 shares authorized; 36,751,458 and
    35,874,633 shares issued and 33,537,255 and 35,792,730
    outstanding at December 31, 2005 and 2004, respectively |                            |                           | 37      |         |         |         | 36       |        
|                                               | Treasury stock, at cost;
    3,214,203 and 81,903 at December 31, 2005 and 2004,
    respectively                                                                                                        |                            |                           | (60,447 | )       |         |         | (1,060   | )      
|                                               | Additional paid-in capital                                                                                                                                                                               |                            |                           | 247,871 |         |         |         | 238,726  |        
|                                               | Deferred stock compensation                                                                                                                                                                              |                            |                           |        |         |         |         | (13      | )      
|                                               | Accumulated deficit                                                                                                                                                                                      |                            |                           | (77,215 | )       |         |         | (111,173 | )      
|                                               | Accumulated other comprehensive income                                                                                                                                                                   |                            |                           | 527     |         |         |         | 1,404    |        
|                                              
|                                               |                                                                                                                                                                                                          | Total stockholders equity |                           |         | 110,773 |         |         |          | 127,920 |        
|                                              
|Total liabilities and stockholders equity     |                                                                                                                                                                                                          | $                          | 447,185                   |         |         | $       | 256,292 |         
|                                              

See accompanying Notes to Consolidated Financial
Statements.


F-3



---



##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF OPERATIONS


(In thousands, except per share amounts)


|                                                                          |                                                            |                                    |                |         |         |         |        |         |         |         |        |        |        |        | 
|------------------------------------------------------------------------- | ---------------------------------------------------------- | ---------------------------------- | -------------- | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------ | ------ | ------ | ------ | 
|                                                                          |                                                           
|                                                                          |                                                            | Years Ended December 31,           |               
|                                                                          |                                                            |                                    |               
|                                                                          |                                                            | 2005                               |                |         | 2004    |         |        | 2003    |        
|                                                                          |                                                           
|Revenues:                                                                 |                                                            |                                    |                |         |         |         |        |         |         |         |        |       
|                                                                          | Product                                                    |                                    | $              | 183,312 |         |         | $      | 142,059 |         |         | $      | 66,606 |       
|                                                                          | Royalty and contract                                       |                                    |                | 952     |         |         |        | 2,296   |         |         |        | 8,725  |       
|                                                                         
|                                                                          |                                                            |                                    | Total revenues |         |         | 184,264 |        |         |         | 144,355 |        |        |        | 75,331 | 
|Operating costs and expenses:                                             |                                                            |                                    |                |         |         |         |        |         |         |         |        |       
|                                                                          | Cost of product revenues                                   |                                    |                | 16,438  |         |         |        | 12,656  |         |         |        | 5,129  |       
|                                                                          | Amortization of intangible assets                          |                                    |                | 13,598  |         |         |        | 11,471  |         |         |        | 819    |       
|                                                                          | Research and development                                   |                                    |                | 31,896  |         |         |        | 21,539  |         |         |        | 30,109 |       
|                                                                          | Selling, general and administrative                        |                                    |                | 97,435  |         |         |        | 73,206  |         |         |        | 41,781 |       
|                                                                          | In-process research and development and milestone payments |                                    |                | 1,000   |         |         |        | 3,500   |         |         |        |       |       
|                                                                         
|                                                                          |                                                            | Total operating costs and expenses |                |         | 160,367 |         |        |         | 122,372 |         |        |        | 77,838 |       
|                                                                         
|Income (loss) from operations                                             |                                                            |                                    | 23,897         |         |         |         | 21,983 |         |         |         | (2,507 | )     
|Interest and other income (expense):                                      |                                                            |                                    |                |         |         |         |        |         |         |         |        |       
|                                                                          | Interest income                                            |                                    |                | 6,981   |         |         |        | 1,194   |         |         |        | 972    |       
|                                                                          | Interest expense                                           |                                    |                | (6,504  | )       |         |        | (2,778  | )       |         |        | (1,632 | )     
|                                                                          | Other income (expense), net                                |                                    |                | (276    | )       |         |        | 109     |         |         |        | 234    |       
|                                                                          |                                                            |                                    |                |         |         |         |        |         |        
|                                                                          | Income (loss) before income taxes                          |                                    |                | 24,098  |         |         |        | 20,508  |         |         |        | (2,933 | )     
|                                                                          | Income tax provision (benefit)                             |                                    |                | (9,860  | )       |         |        | 1,493   |         |         |        | 1,167  |       
|                                                                          |                                                            |                                    |                |         |         |         |        |         |        
|                                                                          | Net income (loss)                                          |                                    | $              | 33,958  |         |         | $      | 19,015  |         |         | $      | (4,100 | )     
|                                                                         
|Net income (loss) per share:                                              |                                                            |                                    |                |         |         |         |        |         |         |         |        |       
|                                                                          | Basic                                                      |                                    | $              | 0.97    |         |         | $      | 0.54    |         |         | $      | (0.13  | )     
|                                                                          | Diluted                                                    |                                    | $              | 0.89    |         |         | $      | 0.51    |         |         | $      | (0.13  | )     
|                                                                         
|Shares used to compute basic and diluted net income (loss) per
    share: |                                                            |                                    |                |         |         |         |        |         |         |         |        |       
|                                                                          | Basic                                                      |                                    |                | 35,039  |         |         |        | 35,036  |         |         |        | 31,559 |       
|                                                                          | Diluted                                                    |                                    |                | 41,335  |         |         |        | 37,443  |         |         |        | 31,559 |       
|                                                                         

See accompanying Notes to Consolidated Financial
Statements.


F-4



---



##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


(In thousands)


|                                                          |  |             |        |   |        |   |             |           |  |   |            |   |  |              |         |  |             |   |       |               |  |       |               |   |  |   |       |   |  |   |         |  
|--------------------------------------------------------- |  | ----------- | ------ | - | ------ | - | ----------- | --------- |  | - | ---------- | - |  | ------------ | ------- |  | ----------- | - | ----- | ------------- |  | ----- | ------------- | - |  | - | ----- | - |  | - | ------- | -
|                                                          | 
|                                                          |  | Number of   |        |   |        |   | Accumulated |           |  |  
|                                                          |  | Common      |        |   | Common |   |             | Treasury  |  |   | Additional |   |  | Deferred     |         |  |             |   | Other |               |  | Total |              
|                                                          |  | Shares      |        |   | Stock  |   |             | Stock, at |  |   | Paid-In    |   |  | Stock        |         |  | Accumulated |   |       | Comprehensive |  |       | Stockholders |  
|                                                          |  | Outstanding |        |   | Amount |   |             | Cost      |  |   | Capital    |   |  | Compensation |         |  | Deficit     |   |       | Income        |  |       | Equity        |  
|                                                          | 
|Balance at December 31, 2002                              |  |             | 31,180 |   |        | $ | 31          |           |  | $ | (458       | ) |  | $            | 170,227 |  |             | $ | (48   | )             |  | $     | (126,088      | ) |  | $ | 1,079 |   |  | $ | 44,743  |  
|Common stock issued under stock option and purchase plans |  |             | 674    |   |        |   | 1           |           |  |   | (186       | ) |  |              | 4,344   |  |             |   |      |               |  |       |              |   |  |   |      |   |  |   | 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  | )
|                                                         
|Balance at December 31, 2003                              |  |             | 31,885 |   |        |   | 32          |           |  |   | (644       | ) |  |              | 174,724 |  |             |   | (31   | )             |  |       | (130,188      | ) |  |   | 1,861 |   |  |   | 45,754  |  
|Common stock issued under stock option and purchase plans |  |             | 858    |   |        |   | 1           |           |  |   | (416       | ) |  |              | 6,763   |  |             |   |      |               |  |       |              |   |  |   |      |   |  |   | 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          |           |  |   | (1,060     | ) |  |              | 238,726 |  |             |   | (13   | )             |  |       | (111,173      | ) |  |   | 1,404 |   |  |   | 127,920 |  
|Common stock issued under stock option and purchase plans |  |             | 876    |   |        |   | 1           |           |  |   |           |   |  |              | 8,640   |  |             |   |      |               |  |       |              |   |  |   |      |   |  |   | 8,641   |  
|Repurchase of common stock                                |  |             | (3,132 | ) |        |   |            |           |  |   | (59,387    | ) |  |              |        |  |             |   |      |               |  |       |              |   |  |   |      |   |  |   | (59,387 | )
|Tax benefit on stock options                              |  |             |       |   |        |   |            |           |  |   |           |   |  |              | 505     |  |             |   |      |               |  |       |               |   |  |   |      |   |  |   | 505     |  
|Stock compensation expense                                |  |             |       |   |        |   |            |           |  |   |           |   |  |              |        |  |             |   | 13    |               |  |       |              |   |  |   |      |   |  |   | 13      |  
|Comprehensive income:                                     |  |             |        |   |        |   |             |           |  |   |            |   |  |              |         |  |             |   |       |               |  |       |               |   |  |   |       |   |  |   |         |  
|Net income                                                |  |             |       |   |        |   |            |           |  |   |           |   |  |              |        |  |             |   |      |               |  |       | 33,958        |   |  |   |      |   |  |   | 33,958  |  
|Unrealized loss on investments                            |  |             |       |   |        |   |            |           |  |   |           |   |  |              |        |  |             |   |      |               |  |       |              |   |  |   | (725  | ) |  |   | (725    | )
|Foreign currency translation adjustment                   |  |             |       |   |        |   |            |           |  |   |           |   |  |              |        |  |             |   |      |               |  |       |              |   |  |   | (152  | ) |  |   | (152    | )
|                                                          |  |             |        |   |        |   |             |           |  |   |            |   |  |              |         |  |             |   |       |               |  |       |               |  
|Total comprehensive income                                |  |             |        |   |        |   |             |           |  |   |            |   |  |              |         |  |             |   |       |               |  |       |               |   |  |   |       |   |  |   | 33,081  |  
|                                                         
|Balance at December 31, 2005                              |  |             | 33,537 |   |        | $ | 37          |           |  | $ | (60,447    | ) |  | $            | 247,871 |  |             | $ |      |               |  | $     | (77,215       | ) |  | $ | 527   |   |  | $ | 110,773 |  
|                                                         

See accompanying Notes to Consolidated Financial
Statements.


F-5



---



##### Table of Contents



CONNETICS CORPORATION





CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)


|                                      |                                                                                                                                                           |                                                   |   |          |         |   |   |          |         |   |   |          |        |  
|------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------- | - | -------- | ------- | - | - | -------- | ------- | - | - | -------- | ------ | -
|                                      |                                                                                                                                                          
|                                      |                                                                                                                                                           | Years Ended December 31,                          |  
|                                      |                                                                                                                                                           |                                                   |  
|                                      |                                                                                                                                                           |                                                   |  
|                                      |                                                                                                                                                           | 2005                                              |   |          | 2004    |   |   | 2003     |        
|                                      |                                                                                                                                                          
|Cash flows from operating activities: |                                                                                                                                                           |                                                   |   |          |         |   |   |          |         |   |   |         
|                                      | Net income (loss)                                                                                                                                         |                                                   | $ | 33,958   |         |   | $ | 19,015   |         |   | $ | (4,100   | )     
|                                      | Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities:                                                    |                                                   |   |          |         |   |   |          |         |   |   |          |       
|                                      |                                                                                                                                                           | Depreciation                                      |   |          | 1,773   |   |   |          | 1,433   |   |   |          | 1,422  |  
|                                      |                                                                                                                                                           | Amortization of intangible assets                 |   |          | 13,598  |   |   |          | 11,471  |   |   |          | 819    |  
|                                      |                                                                                                                                                           | Amortization of convertible senior notes offering |   |          | 1,271   |   |   |          | 708     |   |   |          | 430    |  
|                                      |                                                                                                                                                           | Allowances for discounts, returns and chargebacks |   |          | 3,075   |   |   |          | 5,882   |   |   |          | 962    |  
|                                      |                                                                                                                                                           | Stock compensation expense                        |   |          | 13      |   |   |          | 18      |   |   |          | 17     |  
|                                      | Changes in assets and liabilities:                                                                                                                        |                                                   |   |          |         |   |   |          |         |   |   |          |       
|                                      |                                                                                                                                                           | Accounts receivable                               |   |          | 17,279  |   |   |          | (21,274 | ) |   |          | (1,277 | )
|                                      |                                                                                                                                                           | Inventory                                         |   |          | (2,390  | ) |   |          | (3,631  | ) |   |          | (493   | )
|                                      |                                                                                                                                                           | Prepaids and other assets                         |   |          | (16,138 | ) |   |          | (4,702  | ) |   |          | (3,280 | )
|                                      |                                                                                                                                                           | Accounts payable                                  |   |          | 3,289   |   |   |          | 10,740  |   |   |          | (4,199 | )
|                                      |                                                                                                                                                           | Product rebate and coupon accruals                |   |          | 1,562   |   |   |          | 6,935   |   |   |          | 2,073  |  
|                                      |                                                                                                                                                           | Accrued and other current liabilities             |   |          | 4,190   |   |   |          | 2,633   |   |   |          | (146   | )
|                                      |                                                                                                                                                           | Deferred revenue                                  |   |          | 345     |   |   |          | 89      |   |   |          | (739   | )
|                                      |                                                                                                                                                           | Other non-current liabilities                     |   |          | 95      |   |   |          | 404     |   |   |          |       |  
|                                     
|                                      | Net cash provided by (used in) operating activities                                                                                                       |                                                   |   | 61,920   |         |   |   | 29,721   |         |   |   | (8,511   | )     
|                                     
|Cash flows from investing activities: |                                                                                                                                                           |                                                   |   |          |         |   |   |          |         |   |   |         
|                                      | Purchases of marketable securities                                                                                                                        |                                                   |   | (358,030 | )       |   |   | (62,472  | )       |   |   | (135,352 | )     
|                                      | Sales and maturities of marketable securities                                                                                                             |                                                   |   | 170,319  |         |   |   | 104,483  |         |   |   | 62,909   |       
|                                      | Purchases of property and equipment                                                                                                                       |                                                   |   | (4,515   | )       |   |   | (7,638   | )       |   |   | (959     | )     
|                                      | Transfer from (to) restricted cash                                                                                                                        |                                                   |   | (96      | )       |   |   | (3,659   | )       |   |   | 420      |       
|                                      | Acquisition of patent and product rights                                                                                                                  |                                                   |   |         |         |   |   | (123,529 | )       |   |   | (200     | )     
|                                     
|                                      | Net cash used in investing activities                                                                                                                     |                                                   |   | (192,322 | )       |   |   | (92,815  | )       |   |   | (73,182  | )     
|                                     
|Cash flows from financing activities: |                                                                                                                                                           |                                                   |   |          |         |   |   |          |         |   |   |         
|                                      | Proceeds from issuance of convertible senior notes, net of
    issuance costs                                                                             |                                                   |   | 193,085  |         |   |   |         |         |   |   | 86,316   |       
|                                      | 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 |                                                   |   | 8,641    |         |   |   | 6,476    |         |   |   | 4,312    |       
|                                      | Purchases of treasury stock                                                                                                                               |                                                   |   | (59,387  | )       |   |   |         |         |   |   |         |       
|                                     
|                                      | Net cash provided by financing activities                                                                                                                 |                                                   |   | 142,339  |         |   |   | 63,377   |         |   |   | 90,628   |       
|                                     
|                                      | Effect of foreign currency exchange rates on cash and cash
    equivalents                                                                                |                                                   |   | (210     | )       |   |   | 32       |         |   |   | 387      |       
|                                      | Net change in cash and cash equivalents                                                                                                                   |                                                   |   | 11,727   |         |   |   | 315      |         |   |   | 9,322    |       
|                                      | Cash and cash equivalents at beginning of year                                                                                                            |                                                   |   | 18,261   |         |   |   | 17,946   |         |   |   | 8,624    |       
|                                     
|                                      | Cash and cash equivalents at end of year                                                                                                                  |                                                   | $ | 29,988   |         |   | $ | 18,261   |         |   | $ | 17,946   |       
|                                     
|Supplementary information:            |                                                                                                                                                           |                                                   |   |          |         |   |   |          |         |   |   |         
|                                      | Interest paid                                                                                                                                             |                                                   | $ | 4,025    |         |   | $ | 2,030    |         |   | $ | 1,028    |       
|                                      | Income taxes paid                                                                                                                                         |                                                   | $ | 710      |         |   | $ | 1,061    |         |   | $ | 1,541    |       
|                                     

See accompanying Notes to Consolidated Financial
Statements.


F-6



---



##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


December 31, 2005




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

® ® ® ®




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



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





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







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

Product Revenues.


F-7



---



##### Table of Contents



















F-8



---



##### Table of Contents









Royalty Revenues.


Contract Revenues.






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





F-9



---



##### Table of Contents





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





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





| |                                          
| | -----------------------------------------
| | Provision for (Benefit from) Income Taxes







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



|                                |  |                                                           
|------------------------------- |  | ----------------------------------------------------------
|                               
|Category                        |  | Term                                                      
|                               
|Leasehold improvements          |  | Shorter of lease term or economic life, currently 10 years
|Furniture and equipment         |  | 3 to 4 years                                              
|Computer software and equipment |  | 3 to 5 years                                              
|                               

F-10



---



##### Table of Contents





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

first-in




|                                                                       |  |              |       |  |              |   |       | 
|---------------------------------------------------------------------- |  | ------------ | ----- |  | ------------ | - | ----- | 
|                                                                       | 
|                                                                       |  | December 31, |       |  | December 31, |  
|(in thousands)                                                         |  | 2005         |       |  | 2004         |  
|                                                                       | 
|Raw materials                                                          |  | $            | 1,649 |  |              | $ | 677   | 
|Finished goods, net of allowance for excess and obsolete
    inventory |  |              | 5,836 |  |              |   | 4,343 | 
|                                                                      
|Total inventory                                                        |  | $            | 7,485 |  |              | $ | 5,020 | 
|                                                                      

debt issuance, deposits and
other assets






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

Goodwill and other Intangible
Assets,


F-11



---



##### Table of Contents



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






| |                                    
| | -----------------------------------
| | Fair Value of Financial Instruments







| |                         
| | ------------------------
| | Research and Development





| |                       
| | ----------------------
| | Certain Concentrations







F-12



---



##### Table of Contents





|                  |  |                                |     |  |      |  |     |      |  |  |     | 
|----------------- |  | ------------------------------ | --- |  | ---- |  | --- | ---- |  |  | --- | 
|                  | 
|                  |  | Percentage of Product Revenues |    
|                  |  | Years Ended December 31,       |    
|                  |  |                                |    
|Customer          |  | 2005                           |     |  | 2004 |  |     | 2003 | 
|                  | 
|McKesson          |  |                                | 36% |  |      |  | 29% |      |  |  | 30% | 
|Cardinal Health   |  |                                | 34% |  |      |  | 27% |      |  |  | 36% | 
|AmerisourceBergen |  |                                | 11% |  |      |  | 16% |      |  |  | 15% | 
|Walgreens         |  |                                | *   |  |      |  | *   |      |  |  | 11% | 
|                 



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

|                                     |  |                           |     |  |      |  |     |      |  |  |     | 
|------------------------------------ |  | ------------------------- | --- |  | ---- |  | --- | ---- |  |  | --- | 
|                                     | 
|                                     |  | Percentage of Outstanding |    
|                                     |  | Accounts Receivable       |    
|                                     |  | as of December 31,        |    
|                                     |  |                           |    
|Customer                             |  | 2005                      |     |  | 2004 |  |     | 2003 | 
|                                     | 
|U.S.-Based International Distributor |  |                           | 41% |  |      |  | *   |      |  |  | *   | 
|Cardinal Health                      |  |                           | 30% |  |      |  | 21% |      |  |  | 36% | 
|McKesson                             |  |                           | *   |  |      |  | 36% |      |  |  | 28% | 
|AmerisourceBergen                    |  |                           | *   |  |      |  | 22% |      |  |  | 17% | 
|Walgreens                            |  |                           | *   |  |      |  | 15% |      |  |  | *   | 
|                                    



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



| |                                 
| | --------------------------------
| | Accumulated Comprehensive Income



|                                                                                                          |  |              |        |   |      |   |        |  
|--------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                                                                                                          | 
|                                                                                                          |  | December 31, |       
|                                                                                                          |  |              |       
|(in thousands)                                                                                            |  | 2005         |        |   | 2004 |  
|                                                                                                          | 
|Net income                                                                                                |  | $            | 33,958 |   |      | $ | 19,015 |  
|Foreign currency translation adjustment                                                                   |  |              | (152   | ) |      |   | 126    |  
|Change in unrealized gain on securities, net of reclassification
    adjustments for realized gain (loss) |  |              | (725   | ) |      |   | (583   | )
|                                                                                                         
|Comprehensive income                                                                                      |  | $            | 33,081 |   |      | $ | 18,558 |  
|                                                                                                         



| |            
| | -----------
| | Advertising

We expense advertising costs as we incur them.




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



F-13



---



##### Table of Contents





|                                             |                             |                          |        |        |      |   |        |        |  |   |        |        |  
|-------------------------------------------- | --------------------------- | ------------------------ | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | -
|                                             |                            
|                                             |                             | Years Ended December 31, |       
|                                             |                             |                          |       
|(In thousands except per share amounts):     |                             | 2005                     |        |        | 2004 |   |        | 2003   | 
|                                             |                            
|Net income (loss), as reported               |                             | $                        | 33,958 |        |      | $ | 19,015 |        |  | $ | (4,100 | )     
|Add: interest on convertible note            |                             |                          | 2,761  |        |      |   |       |        |  |   |       |       
|                                            
|Net income (loss), diluted                   |                             | $                        | 36,719 |        |      | $ | 19,015 |        |  | $ | (4,100 | )     
|                                            
|Weighted average shares outstanding;         |                             |                          |        |        |      |   |        |        |  |   |        |       
|                                             | Basic common shares         |                          |        | 35,039 |      |   |        | 35,036 |  |   |        | 31,559 |  
|                                             | Effect of dilutive options  |                          |        | 2,093  |      |   |        | 2,383  |  |   |        |       |  
|                                             | Effect of dilutive warrants |                          |        |       |      |   |        | 24     |  |   |        |       |  
|                                             | Effect of convertible debt  |                          |        | 4,203  |      |   |        |       |  |   |        |       |  
|                                            
|Total weighted average diluted common shares |                             |                          | 41,335 |        |      |   | 37,443 |        |  |   | 31,559 |       
|                                            
|Net income (loss) per share:                 |                             |                          |        |        |      |   |        |        |  |   |        |       
|                                             | Basic                       |                          | $      | 0.97   |      |   | $      | 0.54   |  |   | $      | (0.13  | )
|                                             | Diluted                     |                          | $      | 0.89   |      |   | $      | 0.51   |  |   | $      | (0.13  | )
|                                            

in thousands


|                 |       |                          |       |       |      |  |       |       |  |  |       |        | 
|---------------- | ----- | ------------------------ | ----- | ----- | ---- |  | ----- | ----- |  |  | ----- | ------ | 
|                 |      
|                 |       | Years Ended December 31, |      
|                 |       |                          |      
|(in thousands)   |       | 2005                     |       |       | 2004 |  |       | 2003  | 
|                 |      
|Warrants         |       |                          |      |       |      |  |      |       |  |  | 59    |       
|Options          |       |                          | 1,574 |       |      |  | 263   |       |  |  | 5,986 |       
|Convertible debt |       |                          |      |       |      |  | 4,203 |       |  |  | 4,203 |       
|                
|                 | Total |                          |       | 1,574 |      |  |       | 4,466 |  |  |       | 10,248 | 
|                

04-8,




| |                         
| | ------------------------
| | Stock-Based Compensation



96-18,


F-14



---



##### Table of Contents





pro forma Net
Income (Loss) Per Share


|                                                                                                                                    |                             |                                |         |        |      |   |         |        |  |   |         |        | 
|----------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | ------------------------------ | ------- | ------ | ---- | - | ------- | ------ |  | - | ------- | ------ | 
|                                                                                                                                    |                            
|                                                                                                                                    |                             | Years Ended December 31,       |        
|                                                                                                                                    |                             |                                |        
|                                                                                                                                    |                             | 2005                           |         |        | 2004 |   |         | 2003   | 
|                                                                                                                                    |                             |                                |        
|                                                                                                                                    |                             | (In thousands except per share |        
|                                                                                                                                    |                             | amounts):                      |        
|Net income (loss), as reported                                                                                                      |                             | $                              | 33,958  |        |      | $ | 19,015  |        |  | $ | (4,100  | )     
|Add: interest on convertible note, net of tax effect                                                                                |                             |                                | 2,761   |        |      |   |        |        |  |   |        |       
|                                                                                                                                   
|Net income (loss), diluted                                                                                                          |                             | $                              | 36,719  |        |      | $ | 19,015  |        |  | $ | (4,100  | )     
|Add: Stock-based employee compensation expense, net of tax                                                                          |                             |                                | 13      |        |      |   | 17      |        |  |   | 17      |       
|Deduct: Total stock-based employee compensation expense
    determined under fair value based method for all awards, net of
    tax |                             |                                | (20,864 | )      |      |   | (11,355 | )      |  |   | (9,834  | )     
|                                                                                                                                   
|Pro forma net income (loss)                                                                                                         |                             | $                              | 15,868  |        |      | $ | 7,677   |        |  | $ | (13,917 | )     
|                                                                                                                                   
|Weighted average shares outstanding:                                                                                                |                             |                                |         |        |      |   |         |        |  |   |         |       
|                                                                                                                                    | Basic common shares         |                                |         | 35,039 |      |   |         | 35,036 |  |   |         | 31,559 | 
|                                                                                                                                    | Effect of dilutive options  |                                |         | 2,318  |      |   |         | 2,828  |  |   |         |       | 
|                                                                                                                                    | Effect of dilutive warrants |                                |         |       |      |   |         | 24     |  |   |         |       | 
|                                                                                                                                    | Effect of convertible debt  |                                |         | 4,203  |      |   |         |       |  |   |         |       | 
|                                                                                                                                   
|Total weighted average diluted common shares                                                                                        |                             |                                | 41,560  |        |      |   | 37,888  |        |  |   | 31,559  |       
|                                                                                                                                   
|Net income (loss per) share:                                                                                                        |                             |                                |         |        |      |   |         |        |  |   |         |       
|Basic  as reported                                                                                                                 |                             | $                              | 0.97    |        |      | $ | 0.54    |        |  | $ | (0.13   | )     
|Diluted  as reported                                                                                                               |                             | $                              | 0.89    |        |      | $ | 0.51    |        |  | $ | (0.13   | )     
|Basic  pro forma                                                                                                                   |                             | $                              | 0.37    |        |      | $ | 0.22    |        |  | $ | (0.44   | )     
|Diluted  pro forma                                                                                                                 |                             | $                              | 0.38    |        |      | $ | 0.20    |        |  | $ | (0.44   | )     
|                                                                                                                                   



|                          |  |                    |      |   |                     |  |      |      |  |  |      |   |  |      |       |   |      |  |      |   |  |  |      |  
|------------------------- |  | ------------------ | ---- | - | ------------------- |  | ---- | ---- |  |  | ---- | - |  | ---- | ----- | - | ---- |  | ---- | - |  |  | ---- | -
|                          | 
|                          |  | Stock Option Plans |      |   | Stock Purchase Plan | 
|                          |  |                    |      |   |                     | 
|                          |  | 2005               |      |   | 2004                |  |      | 2003 |  |  | 2005 |   |  | 2004 |       |   | 2003 | 
|                          | 
|Expected stock volatility |  |                    | 47.1 | % |                     |  | 57.2 | %    |  |  | 60.6 | % |  |      | 51.67 | % |      |  | 54.7 | % |  |  | 57.5 | %
|Risk-free interest rate   |  |                    | 3.7  | % |                     |  | 3.2  | %    |  |  | 4.1  | % |  |      | 2.0   | % |      |  | 1.1  | % |  |  | 4.4  | %
|Expected life (in years)  |  |                    | 4.0  |   |                     |  | 3.4  |      |  |  | 3.2  |   |  |      | 1.18  |   |      |  | 1.5  |   |  |  | 1.4  |  
|Expected dividend yield   |  |                    | 0.0  | % |                     |  | 0.0  | %    |  |  | 0.0  | % |  |      | 0.0   | % |      |  | 0.0  | % |  |  | 0.0  | %
|                         



F-15



---



##### Table of Contents





out-of




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







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





out-of


F-16



---



##### Table of Contents



Accounting Changes and Error Corrections Accounting Changes Reporting Accounting Changes in Interim Financial
Statements






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

(in thousands)


|                                           |                             |                   |         |         |            |   |       |            |  |   |            |      |   |   |         |         | 
|------------------------------------------ | --------------------------- | ----------------- | ------- | ------- | ---------- | - | ----- | ---------- |  | - | ---------- | ---- | - | - | ------- | ------- | 
|                                           |                            
|                                           |                             | December 31, 2005 |        
|                                           |                             |                   |        
|                                           |                             |                   |         | Gross   |            |   | Gross |            |  |  
|                                           |                             | Amortized         |         |         | Unrealized |   |       | Unrealized |  |   | Estimated  |     
|                                           |                             | Cost              |         |         | Gains      |   |       | Losses     |  |   | Fair Value |     
|                                           |                            
|Corporate debt                             |                             | $                 | 125,329 |         |            | $ | 12    |            |  | $ | (411       | )    |   | $ | 124,930 |        
|Government securities                      |                             |                   | 83,772  |         |            |   | 20    |            |  |   | (277       | )    |   |   | 83,515  |        
|Structured product securities              |                             |                   | 37,497  |         |            |   | 14    |            |  |   | (195       | )    |   |   | 37,316  |        
|Equity securities                          |                             |                   | 197     |         |            |   | 388   |            |  |   |           |      |   |   | 585     |        
|Money market funds                         |                             |                   | 521     |         |            |   |      |            |  |   |           |      |   |   | 521     |        
|                                          
|                                           | Total                       |                   |         | 247,316 |            |   |       | 434        |  |   |            | (883 | ) |   |         | 246,867 | 
|Less amount classified as cash equivalents |                             |                   | (5,759  | )       |            |   |      |            |  |   |           |      |   |   | (5,759  | )      
|                                          
|                                           | Total marketable securities |                   | $       | 241,557 |            |   | $     | 434        |  |   | $          | (883 | ) |   | $       | 241,108 | 
|                                          

F-17



---



##### Table of Contents



|                                           |                             |                   |        |        |            |   |       |            |  |   |            |      |   |   |        |        | 
|------------------------------------------ | --------------------------- | ----------------- | ------ | ------ | ---------- | - | ----- | ---------- |  | - | ---------- | ---- | - | - | ------ | ------ | 
|                                           |                            
|                                           |                             | 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 |       
|Structured product 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 | 
|                                          

(in thousands)


|                             |       |           |         |         |            |   |         |           |  |   |            |        |  |   |        |        | 
|---------------------------- | ----- | --------- | ------- | ------- | ---------- | - | ------- | --------- |  | - | ---------- | ------ |  | - | ------ | ------ | 
|                             |      
|                             |       | 2005      |         |         | 2004       |  
|                             |       |           |         |         |            |  
|                             |       | Amortized |         |         | Estimated  |   |         | Amortized |  |   | Estimated  |       
|                             |       | Cost      |         |         | Fair Value |   |         | Cost      |  |   | Fair Value |       
|                             |       |           |         |         |            |   |         |           |  |   |            |       
|                             |      
|Mature in less than one year |       | $         | 154,494 |         |            | $ | 153,998 |           |  | $ | 21,076     |        |  | $ | 21,013 |       
|Mature in one to three years |       |           | 86,866  |         |            |   | 86,525  |           |  |   | 19,264     |        |  |   | 19,221 |       
|Mature in over three years   |       |           |        |         |            |   |        |           |  |   | 13,217     |        |  |   | 13,208 |       
|                            
|                             | Total |           | $       | 241,360 |            |   | $       | 240,523   |  |   | $          | 53,557 |  |   | $      | 53,442 | 
|                            



03-1, other-than-temporary




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



F-18



---



##### Table of Contents





U.S.-based




|        |          
|------- | ---------
|Note 5. | Velac Gel









|        |                        
|------- | -----------------------
|Note 6. | Co-Promotion Agreements





F-19



---



##### Table of Contents





|        |                       
|------- | ----------------------
|Note 7. | Property and Equipment

(in
thousands):


|                                               |       |              |        |        |      |   |        |        | 
|---------------------------------------------- | ----- | ------------ | ------ | ------ | ---- | - | ------ | ------ | 
|                                               |      
|                                               |       | December 31, |       
|                                               |       |              |       
|                                               |       | 2005         |        |        | 2004 |  
|                                               |      
|Leasehold improvements                         |       | $            | 6,992  |        |      | $ | 7,705  |       
|Laboratory and manufacturing equipment         |       |              | 6,672  |        |      |   | 5,952  |       
|Computer equipment                             |       |              | 3,538  |        |      |   | 2,324  |       
|Furniture, fixtures and office equipment       |       |              | 1,019  |        |      |   | 1,333  |       
|Land, building and building improvements       |       |              | 748    |        |      |   | 785    |       
|                                              
|                                               | Total |              |        | 18,969 |      |   |        | 18,099 | 
|Less accumulated depreciation and amortization |       |              | (4,531 | )      |      |   | (6,269 | )     
|                                              
|Property and equipment, net                    |       | $            | 14,438 |        |      | $ | 11,830 |       
|                                              





|        |                                     
|------- | ------------------------------------
|Note 8. | Goodwill and Other Intangible Assets

(in thousands)


|                        |  |                   |            |  |                   |   |         |              |  |   |         |   |          |        |         |             |              |   |         |     |  |   |         |   |  |   |         | 
|----------------------- |  | ----------------- | ---------- |  | ----------------- | - | ------- | ------------ |  | - | ------- | - | -------- | ------ | ------- | ----------- | ------------ | - | ------- | --- |  | - | ------- | - |  | - | ------- | 
|                        | 
|                        |  | December 31, 2005 |            |  | December 31, 2004 |  
|                        |  |                   |            |  |                   |  
|                        |  | Gross             |            |  |                   |   | Gross   |              |  |  
|                        |  | Useful Life       |            |  | Carrying          |   |         | Accumulated  |  |   |         |   | Carrying |        |         | Accumulated |              |   |        
|                        |  | in Years          |            |  | Amount            |   |         | Amortization |  |   | Net     |   |          | Amount |         |             | Amortization |   |         | Net | 
|                        | 
|Acquired product rights |  |                   | 10         |  |                   | $ | 127,652 |              |  | $ | (23,403 | ) |          | $      | 104,249 |             |              | $ | 127,652 |     |  | $ | (10,638 | ) |  | $ | 117,014 | 
|Existing technology     |  |                   | 10         |  |                   |   | 6,810   |              |  |   | (3,206  | ) |          |        | 3,604   |             |              |   | 6,810   |     |  |   | (2,525  | ) |  |   | 4,285   | 
|Patents                 |  |                   | 10-13      |  |                   |   | 1,661   |              |  |   | (725    | ) |          |        | 936     |             |              |   | 1,661   |     |  |   | (572    | ) |  |   | 1,089   | 
|Goodwill                |  |                   | Indefinite |  |                   |   | 6,271   |              |  |   |        |   |          |        | 6,271   |             |              |   | 6,271   |     |  |   |        |   |  |   | 6,271   | 
|                       
|Total                   |  |                   |            |  |                   | $ | 142,394 |              |  | $ | (27,334 | ) |          | $      | 115,060 |             |              | $ | 142,394 |     |  | $ | (13,735 | ) |  | $ | 128,659 | 
|                       



(in thousands)


|                     |                   |   |         |        | 
|-------------------- | ----------------- | - | ------- | ------ | 
|                     |                  
|For the year ending: |                   |   |         |       
|                     | December 31, 2006 |   | $       | 13,598 | 
|                     | December 31, 2007 |   |         | 13,598 | 
|                     | December 31, 2008 |   |         | 13,598 | 
|                     | December 31, 2009 |   |         | 13,598 | 
|                     | December 31, 2010 |   |         | 13,598 | 
|                     | Thereafter        |   |         | 40,799 | 
|                     |                   |   |        
|Total                |                   | $ | 108,789 |       
|                    



|        |                         
|------- | ------------------------
|Note 9. | Convertible Senior Notes



F-20



---



##### Table of Contents













F-21



---



##### Table of Contents





|         |                     
|-------- | --------------------
|Note 10. | Stockholders Equity

Stock Repurchase Program




Equity Issuance




Warrants








1995 Director Stock Option Plan








Employee Stock Plans




F-22



---



##### Table of Contents





2000 Stock Plan.


Non-Officer Stock Option Plans.


International Stock Incentive Plan.


Inducement Stock Option Grants.


F-23



---



##### Table of Contents



Summary of All Option Plans and Non-Plan Grants.


|                               |                              |                     |           |            |           |  |           |           |   |   |       |       | 
|------------------------------ | ---------------------------- | ------------------- | --------- | ---------- | --------- |  | --------- | --------- | - | - | ----- | ----- | 
|                               |                             
|                               |                              | Outstanding Options |          
|                               |                              |                     |          
|                               |                              |                     |           | Weighted   |          
|                               |                              | Shares              |           |            |           |  | Average   |          
|                               |                              | Available for       |           |            | Number of |  |           | Exercise  |  
|                               |                              | Grant               |           |            | Shares    |  |           | Price     |  
|                               |                             
|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 |      
|                              
|                               | Additional shares authorized |                     |           | 1,675,356  |           |  |           |          |   |   |       |      | 
|                               | Options granted              |                     |           | (1,730,887 | )         |  |           | 1,730,887 |   |   |       | 22.05 | 
|                               | Options exercised            |                     |           |           |           |  |           | (713,747  | ) |   |       | 8.93  | 
|                               | Options canceled             |                     |           | 474,797    |           |  |           | (474,797  | ) |   |       | 18.90 | 
|                              
|Balance, December 31, 2005     |                              |                     | 791,348   |            |           |  | 7,380,252 |           |   | $ | 14.80 |      
|                              
|Exercisable, December 31, 2003 |                              |                     |           |            |           |  | 3,330,208 |           |   | $ | 7.64  |      
|Exercisable, December 31, 2004 |                              |                     |           |            |           |  | 3,799,398 |           |   | $ | 9.20  |      
|Exercisable, December 31, 2005 |                              |                     |           |            |           |  | 6,525,829 |           |   | $ | 14.69 |      
|                              



|                |  |                     |           |           |                     |  |          |          |  |   |           |          |  |          |           |  |  |   |       | 
|--------------- |  | ------------------- | --------- | --------- | ------------------- |  | -------- | -------- |  | - | --------- | -------- |  | -------- | --------- |  |  | - | ----- | 
|                | 
|                |  | Options Outstanding |           |           | Options Exercisable | 
|                |  |                     |          
|                |  |                     |           | Weighted  |                     |  |         
|                |  |                     |           | Average   |                     |  | Weighted |          |  |   |           | Weighted | 
|Range           |  |                     |           | Remaining |                     |  | Average  |          |  |   |           | Average  | 
|of              |  | Number of           |           |           | Life (in            |  |          | Exercise |  |   | Number of |          |  | Exercise |          
|Exercise Prices |  | Shares              |           |           | years)              |  |          | Price    |  |   | Shares    |          |  | Price    |          
|                | 
|$ 0.00  $ 2.92 |  |                     | 4,496     |           |                     |  | 0.24     |          |  | $ | 0.45      |          |  |          | 4,496     |  |  | $ | 0.45  | 
|$ 2.93  $ 5.84 |  |                     | 636,336   |           |                     |  | 4.09     |          |  |   | 4.51      |          |  |          | 636,336   |  |  |   | 4.51  | 
|$ 5.85  $ 8.75 |  |                     | 1,111,468 |           |                     |  | 3.63     |          |  |   | 7.56      |          |  |          | 1,077,321 |  |  |   | 7.54  | 
|$ 8.76  $11.67 |  |                     | 314,867   |           |                     |  | 4.99     |          |  |   | 10.34     |          |  |          | 294,573   |  |  |   | 10.31 | 
|$11.68  $14.59 |  |                     | 1,846,066 |           |                     |  | 6.38     |          |  |   | 12.34     |          |  |          | 1,453,334 |  |  |   | 12.24 | 
|$14.60  $17.51 |  |                     | 371,988   |           |                     |  | 7.57     |          |  |   | 16.42     |          |  |          | 178,135   |  |  |   | 16.49 | 
|$17.52  $20.43 |  |                     | 1,481,616 |           |                     |  | 7.55     |          |  |   | 18.30     |          |  |          | 1,358,219 |  |  |   | 18.35 | 
|$20.44  $23.34 |  |                     | 310,896   |           |                     |  | 8.21     |          |  |   | 21.83     |          |  |          | 310,896   |  |  |   | 21.83 | 
|$23.35  $26.26 |  |                     | 1,032,582 |           |                     |  | 8.85     |          |  |   | 23.78     |          |  |          | 1,032,582 |  |  |   | 23.78 | 
|$26.27  $29.18 |  |                     | 269,937   |           |                     |  | 8.83     |          |  |   | 27.34     |          |  |          | 179,937   |  |  |   | 27.01 | 
|               
|$ 0.00  $29.18 |  |                     | 7,380,252 |           |                     |  | 6.51     |          |  | $ | 14.80     |          |  |          | 6,525,829 |  |  | $ | 14.69 | 
|               



1995 Employee Stock Purchase Plan.


F-24



---



##### Table of Contents





Common Shares Reserved for Future Issuance




|                                                  |  |              |            |  |      |  |            | 
|------------------------------------------------- |  | ------------ | ---------- |  | ---- |  | ---------- | 
|                                                  | 
|                                                  |  | December 31, |           
|                                                  |  |              |           
|                                                  |  | 2005         |            |  | 2004 | 
|                                                  | 
|1994 Stock Plan                                   |  |              | 533,168    |  |      |  | 721,042    | 
|1995 Directors Stock Option Plan                  |  |              | 677,500    |  |      |  | 757,800    | 
|1998 Supplemental Stock Plan                      |  |              | 38,500     |  |      |  | 39,883     | 
|2000 Stock Plan                                   |  |              | 4,817,758  |  |      |  | 3,994,623  | 
|2000 Non-Officer Stock Plan                       |  |              | 230,679    |  |      |  | 293,856    | 
|International Stock Incentive Plan                |  |              | 225,282    |  |      |  | 229,010    | 
|2002 Employee Stock Plan                          |  |              | 1,019,217  |  |      |  | 1,144,281  | 
|Non-plan stock options                            |  |              | 29,496     |  |      |  | 29,496     | 
|Inducement Grants                                 |  |              | 600,000    |  |      |  |           | 
|                                                 
|Subtotal Stock Option Plans and Inducement Grants |  |              | 8,171,600  |  |      |  | 7,209,991  | 
|                                                 
|1995 Employee Stock Purchase Plan                 |  |              | 443,826    |  |      |  | 423,251    | 
|Convertible senior notes                          |  |              | 11,385,450 |  |      |  | 4,203,450  | 
|                                                 
|Total                                             |  |              | 20,000,876 |  |      |  | 11,836,692 | 
|                                                 

Stockholder Rights Plan




F-25



---



##### Table of Contents







|         |             
|-------- | ------------
|Note 11. | Income Taxes

(in thousands)


|         |  |                          |        |   |      |   |        |      |  |   |        |  
|-------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|         | 
|         |  | Years Ended December 31, |       
|         |  |                          |       
|         |  | 2005                     |        |   | 2004 |   |        | 2003 | 
|         | 
|Domestic |  | $                        | 24,565 |   |      | $ | 19,459 |      |  | $ | (8,774 | )
|Foreign  |  |                          | (467   | ) |      |   | 1,049  |      |  |   | 5,841  |  
|        
|Total    |  | $                        | 24,098 |   |      | $ | 20,508 |      |  | $ | (2,933 | )
|        

(in thousands)


|               |         |                          |         |        |      |   |       |       |   |   |       |       |  
|-------------- | ------- | ------------------------ | ------- | ------ | ---- | - | ----- | ----- | - | - | ----- | ----- | -
|               |        
|               |         | Years Ended December 31, |        
|               |         |                          |        
|               |         | 2005                     |         |        | 2004 |   |       | 2003  |  
|               |        
|Current        |         |                          |         |        |      |   |       |       |   |   |       |      
|               | Federal |                          | $       | 917    |      |   | $     | 1,171 |   |   | $     | 330   |  
|               | State   |                          |         | 646    |      |   |       | 426   |   |   |       |      |  
|               | Foreign |                          |         | (859   | )    |   |       | 150   |   |   |       | 1,017 |  
|              
|Total Current  |         |                          | 704     |        |      |   | 1,747 |       |   |   | 1,347 |      
|              
|Deferred       |         |                          |         |        |      |   |       |       |   |   |       |      
|               | Federal |                          |         | (9,921 | )    |   |       |      |   |   |       |      |  
|              
|               | State   |                          |         |       |      |   |       |      |   |   |       |      |  
|              
|               | Foreign |                          |         | (643   | )    |   |       | (254  | ) |   |       | (180  | )
|              
|Total Deferred |         |                          | (10,564 | )      |      |   | (254  | )     |   |   | (180  | )    
|              
|Total          |         | $                        | (9,860  | )      |      | $ | 1,493 |       |   | $ | 1,167 |      
|              

(in
thousands)


|                                                         |  |                          |         |   |      |   |         |      |  |   |       |  
|-------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ----- | -
|                                                         | 
|                                                         |  | Years Ended December 31, |        
|                                                         |  |                          |        
|                                                         |  | 2005                     |         |   | 2004 |   |         | 2003 | 
|                                                         | 
|Provision (benefit) at U.S. federal statutory rate       |  | $                        | 8,434   |   |      | $ | 7,108   |      |  | $ | (960  | )
|Unbenefited losses (utilization of net operating losses) |  |                          | (10,292 | ) |      |   | (14,066 | )    |  |   | 450   |  
|Timing differences not currently benefited               |  |                          | 1,124   |   |      |   | 6,814   |      |  |   |      |  
|State taxes, net of federal benefit                      |  |                          | 519     |   |      |   | 281     |      |  |   |      |  
|Non-deductible amortization                              |  |                          | 282     |   |      |   | 274     |      |  |   | 270   |  
|Alternative minimum tax                                  |  |                          | 586     |   |      |   | 827     |      |  |   |      |  
|Foreign taxes                                            |  |                          | (1,393  | ) |      |   | (104    | )    |  |   | 837   |  
|US withholding tax                                       |  |                          | 382     |   |      |   | 334     |      |  |   | 330   |  
|Change in valuation allowance                            |  |                          | (9,921  | ) |      |   |        |      |  |   |      |  
|Other                                                    |  |                          | 419     |   |      |   | 25      |      |  |   | 240   |  
|                                                        
|Total                                                    |  | $                        | (9,860  | ) |      | $ | 1,493   |      |  | $ | 1,167 |  
|                                                        





F-26



---



##### Table of Contents



(in thousands)


|                              |                                             |              |         |        |      |   |         |        |  
|----------------------------- | ------------------------------------------- | ------------ | ------- | ------ | ---- | - | ------- | ------ | -
|                              |                                            
|                              |                                             | December 31, |        
|                              |                                             |              |        
|                              |                                             | 2005         |         |        | 2004 |  
|                              |                                            
|Deferred tax assets:          |                                             |              |         |        |      |   |         |       
|                              | Net operating loss carryforwards            |              | $       | 24,000 |      |   | $       | 24,200 |  
|                              | Research and other tax credits              |              |         | 9,000  |      |   |         | 6,400  |  
|                              | Capitalized research expenses               |              |         | 2,100  |      |   |         | 4,000  |  
|                              | Capitalized license and acquired technology |              |         | 11,300 |      |   |         | 4,700  |  
|                              | Accruals and reserves                       |              |         | 12,400 |      |   |         | 8,800  |  
|                              | Foreign currency translation                |              |         |       |      |   |         | 700    |  
|                              | Other                                       |              |         | 1,000  |      |   |         | 800    |  
|                             
|Total deferred tax assets     |                                             |              | 59,800  |        |      |   | 49,600  |       
|Valuation allowance           |                                             |              | (42,800 | )      |      |   | (46,800 | )     
|                             
|Net deferred tax assets       |                                             |              | 17,000  |        |      |   | 2,800   |       
|                             
|Deferred tax liabilities:     |                                             |              |         |        |      |   |         |       
|                              | Convertible debt interest                   |              |         | (3,000 | )    |   |         |       |  
|                              | Prepaid expenses                            |              |         | (500   | )    |   |         | (400   | )
|                              | Soriatane property acquisition              |              |         | (700   | )    |   |         | (1,100 | )
|                              | Unrealized gain on marketable securities    |              |         | (700   | )    |   |         | (100   | )
|                              | Other                                       |              |         | (600   | )    |   |         |       |  
|                             
|Net deferred tax liabilities  |                                             |              | (5,500  | )      |      |   | (1,600  | )     
|                             
|Total net deferred tax assets |                                             | $            | 11,500  |        |      | $ | 1,200   |       
|                             













F-27



---



##### Table of Contents





|         |            
|-------- | -----------
|Note 12. | Commitments









(in thousands)


|             |  |                  |             |  |             |   |       |       |  |   |        | 
|------------ |  | ---------------- | ----------- |  | ----------- | - | ----- | ----- |  | - | ------ | 
|             | 
|Years Ending |  |                  | Contractual |  |             |  
|December 31: |  | Operating Leases |             |  | Commitments |   |       | Total | 
|             | 
|2006         |  | $                | 3,796       |  |             | $ | 2,247 |       |  | $ | 6,043  | 
|2007         |  |                  | 3,052       |  |             |   | 2,172 |       |  |   | 5,224  | 
|2008         |  |                  | 1,964       |  |             |   | 850   |       |  |   | 2,814  | 
|2009         |  |                  | 1,722       |  |             |   | 850   |       |  |   | 2,572  | 
|2010         |  |                  | 1,468       |  |             |   | 850   |       |  |   | 2,318  | 
|Thereafter   |  |                  | 6,794       |  |             |   | 1,375 |       |  |   | 8,169  | 
|            
|             |  | $                | 18,796      |  |             | $ | 8,344 |       |  | $ | 27,140 | 
|            





F-28



---



##### Table of Contents







|         |                                
|-------- | -------------------------------
|Note 13. | Guarantees and Indemnifications







|         |                        
|-------- | -----------------------
|Note 14. | Retirement Savings Plan





|         |                           
|-------- | --------------------------
|Note 15. | Related Party Transactions





|         |                 
|-------- | ----------------
|Note 16. | Subsequent Event



F-29



---



##### Table of Contents





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

(in thousands, except share and per share amounts)


|                                                      |            |               |        |       |        |   |        |       |  |   |        |        |  |   |        |        | 
|----------------------------------------------------- | ---------- | ------------- | ------ | ----- | ------ | - | ------ | ----- |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                                      |           
|                                                      |            | 2005 Quarters |       
|                                                      |            |               |       
|                                                      |            | First         |        |       | Second |   |        | Third |  |   | Fourth |       
|                                                      |           
|Total revenues                                        |            | $             | 42,371 |       |        | $ | 45,369 | (1)   |  | $ | 55,341 | (2)    |  | $ | 41,183 | (3)   
|Cost of product revenues                              |            |               | 3,766  |       |        |   | 4,982  |       |  |   | 4,183  |        |  |   | 3,507  |       
|Operating expenses                                    |            |               | 37,106 |       |        |   | 37,713 |       |  |   | 35,483 |        |  |   | 33,627 |       
|Operating income                                      |            |               | 1,499  |       |        |   | 2,674  |       |  |   | 15,675 |        |  |   | 4,049  |       
|                                                      | Net income |               |        | 1,041 |        |   |        | 2,502 |  |   |        | 15,365 |  |   |        | 15,050 | 
|Basic net income per share                            |            |               | 0.03   |       |        |   | 0.07   |       |  |   | 0.44   |        |  |   | 0.44   |       
|Diluted net income per share                          |            |               | 0.03   |       |        |   | 0.07   |       |  |   | 0.39   |        |  |   | 0.40   |       
|Shares used to calculate basic net income per share   |            |               | 35,699 |       |        |   | 34,825 |       |  |   | 35,075 |        |  |   | 34,570 |       
|Shares used to calculate diluted net income per share |            |               | 38,014 |       |        |   | 37,093 |       |  |   | 40,812 |        |  |   | 39,735 |       
|                                                     



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In the second quarter of 2005, our wholesaler customers
    returned an unexpectedly high amount of expiring and expired
    OLUX. These return levels were significantly above historical
    levels. Based on our analysis, we recorded a charge to product
    revenues of $2.3 million in the second quarter for expired
    and estimated expiring products at our customers associated with
    product sales recorded in prior periods.
|   
|(2) | The third quarter of 2005 product revenues for Soriatane
    include a $7.0 million reduction of estimated reserves for
    returns and government rebates recorded from the time of
    acquisition through June 30, 2005.                                                                                                                                                                                                                   
|   
|(3) | In the fourth quarter of 2005 we reduced Medicaid reserves by
    $1.0 million and increased returns reserves by
    $0.5 million for Evoclin based on the history of the
    product during the first year of commercialization; this change
    resulted in a net increase to revenues of $0.5 million.                                                                                                                                     

|                                                      |            |               |        |       |        |   |        |       |  |   |        |       |  |   |        |       | 
|----------------------------------------------------- | ---------- | ------------- | ------ | ----- | ------ | - | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                                      |           
|                                                      |            | 2004 Quarters |       
|                                                      |            |               |       
|                                                      |            | First         |        |       | Second |   |        | Third |  |   | Fourth |      
|                                                      |           
|Total revenues                                        |            | $             | 24,982 | (1)   |        | $ | 38,253 | (2)   |  | $ | 37,344 | (3)   |  | $ | 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 diluted net income per share |            |               | 35,887 |       |        |   | 41,627 |       |  |   | 38,064 |       |  |   | 38,172 |      
|                                                     



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In the first quarter of 2004, we received a one-time royalty
    payment in the amount of $1.2 million in connection with
    the S.C. Johnson license agreement.                                                                                                                                                                                                                                                                                                                                                                              
|   
|(2) | In early March 2004, we acquired exclusive
    U.S. rights to Soriatane. Sales of Soriatane accounted for
    most of the increase in sales over the first quarter. Operating
    expenses increased in the second quarter compared to the first,
    primarily related to the Soriatane acquisition and in support of
    the increased Soriatane sales, including a $2.1 million
    increase in amortization of intangible assets resulting from the
    acquisition and $2.4 million for selling, general, and
    administrative expenses.
|   
|(3) | In the third quarter of 2004, operating expenses included a
    $3.5 million milestone payment due under our license
    agreement for Velac upon our filing an NDA with the FDA.                                                                                                                                                                                                                                                                                                                                                              

F-30



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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 to the Companys Annual Report on
    Form 10-K for the year ended December 31, 2003).                                                                                                                                                                     
|       
|        | 2 | .2*   |             | Asset Purchase Agreement dated as of April 9, 2001 between
    Connetics and Prometheus Laboratories, Inc. (previously filed
    as Exhibit 2.1 to the Companys Current Report on
    Form 8-K dated April 30, 2001 and filed with the
    Commission on May 11, 2001).                                                                                                                              
|       
|        | 2 | .3*(C) |             | Asset Acquisition Agreement dated January 4, 2006 between
    Connetics and PediaMed Pharmaceuticals, Inc. (previously
    filed as Exhibit 2.1 to the Companys Current Report
    on Form 8-K dated January 4, 2006 and filed with the
    Commission on January 10, 2006).                                                                                                                         
|       
|        | 3 | .1*    |             | Amended and Restated Certificate of Incorporation (previously
    filed as an exhibit to the Companys Form S-1
    Registration Statement No. 33-80261).                                                                                                                                                                                                                                             
|        | 3 | .2*    |             | Certificate of Amendment of the Companys Amended and
    Restated Certificate of Incorporation, filed with the Delaware
    Secretary of State on May 15, 1997 (previously filed as
    Exhibit 3.7 to the Companys Current Report on
    Form 8-K dated and filed May 23, 1997).                                                                                                                   
|       
|        | 3 | .3*    |             | Certificate of Designation of Rights, Preferences and Privileges
    of Series B Participating Preferred Stock, filed with the
    Delaware Secretary of State on May 15, 1997 (previously
    filed as Exhibit A to Exhibit 1 to the Companys
    Form 8-A filed on May 23, 1997).                                                                                                                  
|       
|        | 3 | .4*    |             | Certificate of Elimination of Rights, Preferences and Privileges
    of Connetics Corporation, filed with the Delaware Secretary of
    State on December 11, 2001 (previously filed as
    Exhibit 3.5 to the Companys Annual Report on Form
    10-K/A filed for the year ended December 31, 2001).                                                                                                
|       
|        | 3 | .5*    |             | Certificate of Designation of Terms of Series C Preferred
    Stock of Connetics Corporation, filed with the Delaware
    Secretary of State on March 22, 2005 (previously filed
    as Exhibit 3.1 to the Companys Current Report on
    Form 8-K dated March 22, 2005 and filed with the
    Commission on June 6, 2005).                                                                          
|       
|        | 3 | .6*    |             | Certificate of Amendment of the Amended and Restated Certificate
    of Incorporation of Connetics Corporation, filed with the
    Delaware Secretary of State on May 18, 2005 (previously
    filed as Exhibit 4.7 to the Companys Registration
    Statement on Form S-1 filed with the Commission on
    June 20, 2005, Registration Statement
    No. 333-125982).                               
|       
|        | 3 | .7*    |             | Certificate of Elimination of Rights, Preferences and Privileges
    of Series C Preferred Stock of Connetics Corporation, filed
    with the Delaware Secretary of State on May 18, 2005
    (previously filed as Exhibit 3.2 to the Companys
    Current Report on Form 8-K dated March 22, 2005 and
    filed with the Commission on June 6, 2006).                                               
|       
|        | 3 | .8*    |             | Amended and Restated Bylaws (previously filed as
    Exhibit 3.2 to the Companys Form 8-A/ A filed
    with the Commission on November 28, 2001).                                                                                                                                                                                                                                                    
|        | 4 | .1*    |             | Form of Common Stock Certificate (previously filed as
    Exhibit 4.1 to the Companys Annual Report on
    Form 10-K for the year ended December 31, 1998).                                                                                                                                                                                                                                          
|       
|        | 4 | .2*    |             | Amended and Restated Preferred Stock Rights Agreement, dated as
    of November 21, 2001, between Connetics and EquiServe Trust
    Company, N.A., including the form of Rights Certificate and the
    Summary of Rights attached thereto as Exhibits A and B,
    respectively (previously filed as Exhibit 4.1 to the
    Companys Form 8-A/A filed with the Commission on
    November 28, 2001).
|       
|        | 4 | .3*    |             | Indenture, dated as of May 28, 2003, between Connetics and
    J.P. Morgan Trust Company, National Association, as
    Trustee, including the forms of the notes (previously filed
    as Exhibit 4.1 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2003).                                                                                                        



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                                                                                                                           
|------- | -- | ------- | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 4  | .4*     |             | Indenture dated March 23, 2005, between Connetics and
    J.P. Morgan Trust Company, National Association, as
    Trustee, including the forms of the Notes (previously filed
    as Exhibit 4.1 to the Companys Current Report on
    Form 8-K dated March 23, 2005 and filed with the
    Commission on March 25, 2005).                                                                                               
|       
|        | 4  | .5*     |             | Registration Rights Agreement, dated March 23, 2005,
    between Connetics Corporation and Goldman, Sachs & Co.,
    on behalf of itself, CIBC World Markets Corp., Lazard
    Freres & Co. LLC, Piper Jaffray & Co. and Roth
    Capital Partners, LLC (previously filed as Exhibit 4.2
    to the Companys Current Report on Form 8-K dated
    March 23, 2005 and filed with the Commission on
    March 25, 2005).   
|       
|        | 4  | .6*     |             | Registration Rights Agreement, dated as of May 28, 2003,
    between Connetics and Goldman, Sachs & Co., C.E.
    Unterberg, Towbin (a California Limited Partnership), CIBC World
    Markets Corp., Thomas Weisel Partners LLC and U.S. Bancorp
    Piper Jaffray Inc., as representatives (previously filed as
    Exhibit 4.2 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2003).
|       
|        |    |         |             | Management Contracts, Consulting Agreements and Compensatory
    Plans and Arrangements                                                                                                                                                                                                                                                                                                                                   
|        | 10 | .1*(M)  |             | Form of Indemnification Agreement between Connetics and
    Directors and Officers of the Company (previously filed as
    Exhibit 10.1 to the Companys Form S-1
    Registration Statement No. 33-80261).                                                                                                                                                                                                               
|       
|        | 10 | .2*(M)  |             | Employment Agreement dated June 9, 1994 between Connetics
    and Thomas Wiggans (previously filed as an exhibit to the
    Companys Form S-1 Registration Statement
    No. 33-80261).                                                                                                                                                                                                                                  
|       
|        | 10 | .3*(M)  |             | Form of Notice of Stock Option Grant to G. Kirk Raab dated
    January 28, 1997 (previously filed as Exhibit 10.4
    to the Companys Annual Report on Form 10-K/A for the
    year ended December 31, 2001).                                                                                                                                                                                                            
|       
|        | 10 | .4*(M)  |             | Form of Notice of Stock Option Grant to G. Kirk Raab dated
    July 30, 1997 (previously filed as Exhibit 10.5 to
    the Companys Annual Report on Form 10-K/A for the
    year ended December 31, 2001).                                                                                                                                                                                                               
|       
|        | 10 | .5*(M)  |             | Restricted Common Stock Purchase Agreement dated
    November 5, 1998 between Connetics and G. Kirk Raab
    (previously filed as Exhibit 10.59 to the Companys
    Annual Report on Form 10-K for the year ended
    December 31, 1998).                                                                                                                                                                                
|       
|        | 10 | .6*(M)  |             | Restricted Common Stock Purchase Agreement dated March 9,
    1999 between Connetics and G. Kirk Raab (previously filed as
    Exhibit 10.5 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended March 31, 1999).                                                                                                                                                                                     
|       
|        | 10 | .7*(M)  |             | Restricted Common Stock Purchase Agreement dated March 9,
    1999 between Connetics and Thomas G. Wiggans (previously
    filed as Exhibit 10.6 to the Companys Quarterly
    Report on Form 10-Q for the quarter ended March 31,
    1999).                                                                                                                                                                            
|       
|        | 10 | .8*(M)  |             | Form of Change in Control Agreement between Connetics and key
    employees of the Company (previously filed as
    Exhibit 10.12 to the Companys Annual Report on
    Form 10-K/A for the year ended December 31, 2001).                                                                                                                                                                                                
|       
|        | 10 | .9*(M)  |             | Form of Change in Control Agreement between Connetics and
    Outside Directors of the Company (previously filed as
    Exhibit 10.13 to the Companys Registration Statement
    on Form S-1 filed with the Commission on June 20, 2005,
    Registration Statement No. 333-125982).                                                                                                                                     
|       
|        | 10 | .10*(M) |             | Change in Control Agreement dated January 1, 2002 between
    Connetics and Thomas G. Wiggans (previously filed as
    Exhibit 10.14 to the Companys Registration Statement
    on Form S-1 filed with the Commission on June 20, 2005,
    Registration Statement No. 333-125982).                                                                                                                                      
|       
|        | 10 | .11*(M) |             | Consulting Agreement dated August 22, 2005, between
    Connetics and G. Kirk Raab (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated August 22, 2005 and filed with the
    Commission on August 25, 2005).                                                                                                                                                                     



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                           
|------- | -- | ------- | ----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .12*(M) |             | Consulting Agreement dated January 31, 2006, between
    Connetics and David Cohen, M.D. (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated January 31, 2006 and filed with the
    Commission on February 3, 2006).                             
|       
|        | 10 | .13(M)  |             | Form of Restricted Stock Purchase Award dated February 1,
    2006 between Connetics and each of Thomas G. Wiggans, C. Gregory
    Vontz, John L. Higgins, Lincoln Krochmal and Katrina J. Church.                                                                                        
|       
|        | 10 | .14*(M) |             | Fourth Amendment to Consulting Agreement dated December 31,
    2004 between Connetics and Eugene A. Bauer, M.D. (previously
    filed as Exhibit 10.13 to the Companys Annual Report
    on Form 10-K for the year ended December 31, 2004).                                            
|       
|        | 10 | .15*(M) |             | Consultant Change of Control Agreement dated January 1,
    2002 between Connetics and G. Kirk Raab (previously filed as
    Exhibit 10.15 to the Companys Registration Statement
    on Form S-1 filed with the Commission on June 20,
    2005, Registration Statement No. 333-125982).
|       
|        | 10 | .16(M)  |             | Summary Compensation Information for Named Executive Officers
    and Directors.                                                                                                                                                                                                          
|       
|        | 10 | .17*(M) |             | Description of Compensation Payable to Non-Employee
    Directors(previously filed as Exhibit 10.8 to the
    Companys Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2005).                                                                                           
|       
|        |    |         |             | Stock Plans and Agreements                                                                                                                                                                                                                                                                
|        | 10 | .18*(M) |             | 1994 Stock Plan (as amended through May 1999) and form of Option
    Agreement (previously filed as Exhibit 4.1 to the
    Companys Form S-8 Registration Statement
    No. 333-85155).                                                                                                  
|        | 10 | .19     |             | 1995 Employee Stock Purchase Plan (as amended and restated
    through October 13, 2005), and form of Subscription
    Agreement.                                                                                                                                                         
|       
|        | 10 | .20*(M) |             | 1998 Supplemental Stock Plan (previously filed as
    Exhibit 10.60 to the Companys Annual Report on
    Form 10-K for the year ended December 31, 1998).                                                                                                                                
|       
|        | 10 | .21*(M) |             | Stock Plan (2000) and form of Option Agreement
    (previously filed as Exhibit 4.4 to the Companys
    Form S-8 Registration Statement No. 333-85155).                                                                                                                                  
|       
|        | 10 | .22(M)  |             | Form of Restricted Stock Purchase Award under the Companys
    Stock Plan (2000)(see Exhibit 10.13 above).                                                                                                                                                                               
|       
|        | 10 | .23*    |             | International Stock Incentive Plan (previously filed as
    Exhibit 4.1 to the Companys Form S-8
    Registration Statement No. 333-61558).                                                                                                                                              
|       
|        | 10 | .24*    |             | 2000 Non-Officer Employee Stock Plan (previously filed as
    Exhibit 4.3 to the Companys Form S-8
    Registration Statement No. 333-46562).                                                                                                                                            
|       
|        | 10 | .25*    |             | 2002 Non-Officer Employee Stock Plan (as amended through May
    2003) (previously filed as Exhibit 99.1 to the
    Companys Current Report on Form 8-K dated
    February 9, 2004 and filed with the Commission on
    March 8, 2004).                                                  
|       
|        | 10 | .26*(M) |             | 1995 Directors Stock Option Plan (as amended through
    February 10, 2005) (previously filed as Exhibit 10.7 to
    the Companys Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2005).                                                                               
|       
|        | 10 | .27*(M) |             | Non-Qualified Stock Option Agreement dated April 13, 2005
    between Connetics and James A. Trah (previously filed as
    Exhibit 10.3 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended March 31, 2005).                                                         
|       
|        | 10 | .28*(M) |             | Non-Qualified Stock Option Agreement dated May 16, 2005
    between Connetics and Michael Eison (previously filed as
    Exhibit 10.25 to the Companys Registration Statement
    on Form S-1 filed with the Commission on June 20,
    2005, Registration Statement No. 333-125982).    
|       
|        | 10 | .29*(M) |             | Non-Qualified Stock Option Agreement dated July 11, 2005
    between Connetics and Stefan Weiss, M.D. (previously filed as
    Exhibit 10.6 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2005).                                                      



---



##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                                                                          
|------- | -- | ------- | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .30*(M) |             | Non-Qualified Stock Option Agreement dated August 5, 2005
    between Connetics and Scott W. Meggs (previously filed as
    Exhibit 10.27 to the Companys Amendment No. 2 to
    Form S-1 Registration Statement No. 333-125982, filed
    with the Commission on August 26, 2005).                                                                                     
|       
|        | 10 | .31*(M) |             | Non-Qualified Stock Option Agreement dated August 22, 2005
    between Connetics and Luis C. Pena (previously filed as
    Exhibit 10.28 to the Companys Amendment No. 2 to
    Form S-1 Registration Statement No. 333-125982, filed
    with the Commission on August 26, 2005).                                                                                      
|       
|        | 10 | .32*(M) |             | Non-Qualified Stock Option Agreement dated September 30,
    2005 between Connetics and Claudette S. MacMillan (previously
    filed as Exhibit 10.1 to the Companys Current Report
    on Form 8-K dated September 30, 2005 and filed with
    the Commission on October 4, 2005).                                                                                     
|       
|        | 10 | .33*(M) |             | Non-Qualified Stock Option Agreement dated November 7, 2005
    between Connetics and Srabasti Mukherjee (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated November 7, 2005 and filed with the
    Commission on November 10, 2005).                                                                                           
|       
|        | 10 | .34*(M) |             | Non-Qualified Stock Option Agreement dated December 15,
    2005 between Connetics and Gary Cain (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated December 15, 2005 and filed with the
    Commission on December 16, 2005).                                                                                                  
|       
|        | 10 | .35*(M) |             | Non-Qualified Stock Option Agreement dated January 3, 2006
    between Connetics and David Burch (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated January 3, 2006 and filed with the
    Commission on January 10, 2006).                                                                                                     
|       
|        | 10 | .36*(M) |             | Non-Qualified Stock Option Agreement dated January 9, 2006
    between Connetics and Brian Davis (previously filed as
    Exhibit 10.2 to the Companys Current Report on
    Form 8-K dated January 3, 2006 and filed with the
    Commission on January 10, 2006).                                                                                                     
|       
|        | 10 | .37*(M) |             | Form of Non-Qualified Stock Option Agreement between Connetics
    and certain non-executive employees hired in connection with
    Connetics acquisition of PediaMed Pharmaceuticals,
    Inc.s sales organization (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated and filed with the Commission on February 1,
    2006).
|       
|        | 10 | .38*(M) |             | Non-Qualified Stock Option Agreement dated February 26,
    2006 between Connetics and Freddie Park (previously filed as
    Exhibit 10.1 to the Companys Current Report on
    Form 8-K dated February 6, 2006 and filed with the
    Commission on February 7, 2006).                                                                                                 
|       
|        |    |         |             | License Agreements                                                                                                                                                                                                                                                                                                                                                       
|        | 10 | .39*   |             | License Agreement dated June 14, 1996 between Connetics and
    Soltec Research Pty Ltd (previously filed as
    Exhibit 10.28 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 1996).                                                                                                                                                  
|       
|        | 10 | .40*   |             | License Agreement dated January 1, 1998 between Connetics
    and Soltec Research Pty Ltd (previously filed as
    Exhibit 10.57 to the Companys Annual Report on
    Form 10-K for the year ended December 31, 1997).                                                                                                                                                  
|       
|        | 10 | .41*   |             | License Agreement (Ketoconazole) dated July 14, 1999
    between Connetics and Soltec Research Pty Ltd (previously
    filed as Exhibit 10.4 to the Companys Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    1999).                                                                                                                                
|       
|        | 10 | .42*   |             | License Agreement dated September 29, 2004 between
    Connetics and Pierre Fabre Dermatologie (previously filed as
    Exhibit 10.1 to our Current Report on Form 8-K dated
    September 29, 2004 and filed with the Commission on
    October 4, 2004).                                                                                                               
|       
|        | 10 | .43*   |             | License and Development Agreement between Connetics and
    Pharmacia & Upjohn Company, dated December 21, 2001
    (previously filed as Exhibit 99.1 to the Companys
    Current Report on Form 8-K/ A-2 dated December 21,
    2001, filed with the Commission on July 12, 2002).                                                                                     
|       
|        | 10 | .44*   |             | License and Development Agreement between Connetics and
    Yamanouchi Europe B.V., dated May 13, 2002 (previously
    filed as Exhibit 10.2 to the Companys Quarterly
    Report on Form 10-Q for the quarter ended June 30,
    2002).                                                                                                                                



---



##### Table of Contents



|        |    |       |             |                                                                                                                                                                                                                                                                                                         
|------- | -- | ----- | ----------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |       |            
|Number  |    |       | Description
|        |    |       |            
|       
|        |    |       |             | Real Property                                                                                                                                                                                                                                                                                           
|        | 10 | .45*  |             | Lease between Connetics and Renault & Handley
    Employees Investment Co., dated June 28, 1999
    (previously filed as Exhibit 10.39 to the Companys
    Annual Report on Form 10-K/A for the year ended
    December 31, 2001).                                                                    
|       
|        | 10 | .46*  |             | Industrial Building Lease dated December 16, 1999, between
    Connetics and West Bayshore Associates (previously filed as
    Exhibit 10.2 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended September 30,
    2001).                                                           
|       
|        | 10 | .47*  |             | Assignment and Assumption of Lease between Connetics and
    Respond.com, dated August 21, 2001 (previously filed as
    Exhibit 10.3 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended September 30,
    2001).                                                                 
|       
|        | 10 | .48*  |             | Agreement dated August 21, 2001, between Connetics and
    Respond.com (previously filed as Exhibit 10.4 to the
    Companys Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2001).                                                                                              
|       
|        | 10 | .49*  |             | Sublease agreement between Connetics (sublessor) and
    Tolerian, Inc., dated June 20, 2002 (previously filed as
    Exhibit 10.1 to the Companys Quarterly Report for the
    quarter ended June 30, 2002).                                                                                          
|       
|        | 10 | .50*  |             | Sublease Agreement between the Board of Trustees of the Leland
    Stanford Junior University and Incyte Pharmaceuticals, Inc.,
    dated May 6, 2004 (previously filed as Exhibit 10.2
    to the Companys Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2004).                    
|       
|        | 10 | .51*  |             | Sublease Consent between The Board of Trustees of the Leland
    Stanford Junior University and Incyte Corporation and Connetics
    Corporation, dated May 6, 2004 (previously filed as
    Exhibit 10.3 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2004).      
|       
|        | 10 | .52*  |             | Agreement Regarding Sublease and Lease between The Board of
    Trustees of the Leland Stanford Junior University and Connetics
    Corporation, dated May 6, 2004 (previously filed as
    Exhibit 10.4 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended June 30, 2004).       
|       
|        | 10 | .53*  |             | First Amendment to Lease between The Board of Trustees of the
    Leland Stanford Junior University and Incyte Corporation, dated
    May 6, 2004 (previously filed as Exhibit 10.5 to
    the Companys Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2004).                        
|       
|        | 10 | .54*  |             | Sublease Agreement for 1841 Page Mill Road, Palo Alto,
    California, dated August 9, 2004 and effective
    April 4, 2005 between Connetics and Incyte Corporation
    (previously filed as Exhibit 10.2 to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    March 31, 2005).
|       
|        | 10 | .55*  |             | Industrial Building Lease Between West Bayshore Associates and
    Connetics Corporation, dated September 2004 (previously filed
    as Exhibit 99.1 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended September 30,
    2004).                                                  
|       
|        | 10 | .56   |             | Sublease Consent between The Board of Trustees of the Leland
    Stanford Junior University and Interval Research Corporation,
    Incyte Corporation, and Connetics Corporation dated
    March 15, 2005.                                                                                              
|       
|        |    |       |             | Other Agreements                                                                                                                                                                                                                                                                                        
|        | 10 | .57* |             | Agreement dated December 9, 1999 between Connetics and
    Soltec Research Pty Ltd (previously filed as
    Exhibit 10.75 to the Companys Annual Report on
    Form 10-K for the year ended December 31, 1999).                                                                                        
|       
|        | 10 | .58* |             | Asset Purchase Agreement dated as of April 9, 2001, between
    Connetics and Prometheus Laboratories, Inc. (see
    Exhibit 2.2 above).                                                                                                                                                                
|       
|        | 10 | .59* |             | Facilities Contribution Agreement between Connetics and DPT
    Laboratories, Ltd., with retroactive effect to November 1,
    2001 (previously filed as Exhibit 10.55 to the
    Companys Annual Report on Form 10-K/A (Amendment
    No. 2) for the year ended December 31, 2001).                   



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##### Table of Contents



|        |    |         |             |                                                                                                                                                                                                                                                                                                                                
|------- | -- | ------- | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |         |            
|Number  |    |         | Description
|        |    |         |            
|       
|        | 10 | .60*   |             | Manufacturing and Supply Agreement between Connetics and DPT
    Laboratories, Ltd., dated March 12, 2002 (previously
    filed as Exhibit 10.56 to the Companys Annual Report
    on Form 10-K/ A (Amendment No. 2) for the year ended
    December 31, 2001).                                                               
|       
|        | 10 | .61*    |             | Distribution Agreement between Connetics and CORD Logistics,
    Inc., dated January 1, 2001, as amended September 1,
    2001, September 3, 2003, and September 24, 2003
    (previously filed as Exhibit 10.51 to the Companys
    Annual Report on Form 10-K/A (Amendment No. 2) for the
    year ended December 31, 2002).
|       
|        | 10 | .62*   |             | Amended and Restated Manufacturing and Supply Agreement dated
    April 24, 2003 between Connetics and AccraPac Group, Inc.
    (previously filed as Exhibit 10.1 to the Companys
    Quarterly Report on Form 10-Q/A (Amendment No. 1) for
    the quarter ended March 31, 2003).                                            
|       
|        | 10 | .63*    |             | Purchase and Sale Agreement dated February 2, 2004 between
    Connetics and Hoffmann-LaRoche Inc. (see
    Exhibit 2.1 above).                                                                                                                                                                                                
|       
|        | 10 | .64*   |             | Amendment to Facilities Contribution Agreement between DPT
    Laboratories, Ltd. and Connetics Corporation, dated
    August 18, 2004 (previously filed at Exhibit 10.1
    to the Companys Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2004).                                                     
|       
|        | 10 | .65*   |             | Amended and Restated Manufacturing and Supply Agreement between
    DPT Laboratories, Ltd. and Connetics Corporation, dated
    August 18, 2004 (previously filed as Exhibit 10.2
    to the Companys Quarterly Report on Form 10-Q for the
    quarter ended September 30, 2004).                                            
|       
|        | 10 | .66*   |             | Distribution Services Agreement between Cardinal Health, Inc.
    and Connetics Corporation, dated December 1, 2004
    (previously filed as Exhibit 10.53 to the Companys
    Annual Report on Form 10-K for the year ended
    December 31, 2004).                                                                          
|       
|        | 10 | .67*   |             | Core Distribution Agreement between McKesson Corporation and
    Connetics Corporation, dated December 23, 2004
    (previously filed as Exhibit 10.54 to the Companys
    Annual Report on Form 10-K for the year ended
    December 31, 2004).                                                                              
|       
|        | 10 | .68*(C) |             | Service Agreement dated March 1, 2005 between Connetics and
    Ventiv Pharma Services, LLC (previously filed as
    Exhibit 10.1 to the Companys Quarterly Report on
    Form 10-Q for the quarter ended March 31, 2005).                                                                                                    
|       
|        | 10 | .69*(C) |             | Amendment to Distribution Services Agreement dated
    December 22, 2005 between Connetics and Cardinal Health,
    Inc. (previously filed at Exhibit 10.2 to the
    Companys Current Report on Form 8-K dated
    December 22, 2005 and filed with the Commission on
    December 23, 2005).                                
|       
|        | 10 | .70*(C) |             | Amendment to Core Distribution Agreement dated December 22,
    2005, between Connetics and McKesson Corporation (previously
    filed at Exhibit 10.4 to the Companys Current Report
    on Form 8-K dated December 22, 2005 and filed with the
    Commission on December 23, 2005).                                        
|       
|        | 10 | .71*(C) |             | First Amendment to Service Agreement dated December 30,
    2005 between Connetics and Ventiv Commercial Services, LLC
    (previously filed at Exhibit 10.2 to the Companys
    Current Report on Form 8-K dated December 30, 2005 and
    filed with the Commission on January 6, 2006).                                    
|       
|        | 10 | .72*(C) |             | Asset Acquisition Agreement dated January 4, 2006 between
    Connetics and PediaMed Pharmaceuticals, Inc. (see
    Exhibit 2.3 above).                                                                                                                                                                                        
|       
|        | 10 | .73*(C) |             | Distribution Services Agreement dated September 30, 2005
    between Connetics and AmerisourceBergen Drug Corporation
    (previously filed as Exhibit 10.1 to the Companys
    Current Report on Form 8-K dated September 30, 2005
    and filed with the Commission on October 6, 2005).                                    
|       
|        | 21 | *       |             | Subsidiaries (previously filed as Exhibit 21 to the
    Companys Annual Report on Form 10-K for the year
    ended December 31, 2003).                                                                                                                                                                                        
|       
|        | 23 | .1      |             | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                      



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##### Table of Contents



|        |    |    |             |                                                                                                                                      
|------- | -- | -- | ----------- | -------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |    |            
|Number  |    |    | Description
|        |    |    |            
|       
|        | 31 | .1 |             | Certification of Chief Executive Officer pursuant to
    Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley
    Act of 2002.       
|       
|        | 31 | .2 |             | Certification of Chief Financial Officer pursuant to
    Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley
    Act of 2002.       
|       
|        | 32 | .1 |             | Certification by Chief Executive Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002,
    18 U.S.C. Section 1350.
|       
|        | 32 | .2 |             | Certification by Chief Financial Officer pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002,
    18 U.S.C. Section 1350.

Key to Exhibit Index Footnotes:


The Commission file number for our Exchange Act filings
referenced above is
0-27406.







| |   |                                                                         
| | - | ------------------------------------------------------------------------
| | * | Incorporated by this reference to the previous filing, as
    indicated.



|    |                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(M) | This item is a management compensatory plan or arrangement
    required to be listed as an exhibit to this Report pursuant to
    Item 601(b)(10)(iii) of
    Regulation S-K.



|    |                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------
|(C) | We have omitted certain portions of this Exhibit and have
    requested confidential treatment of such portions from the SEC.



| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | We have requested and the SEC has granted confidential treatment
    for certain portions of this Exhibit.



| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The certifications attached as Exhibits 32.1 and 32.2 that
    accompany this Annual Report on
    Form 10-K, 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.