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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2004 Commission file number: 0-27406 CONNETICS CORPORATION (Exact name of registrant as specified in its charter)
 Delaware
    
    94-3173928(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification Number)3290 West Bayshore
RoadPalo Alto, California
    
    94303(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (650) 843-2800 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [  ] As of May 3, 2004, 35,259,207 shares of the Registrants common stock at
$0.001 par value, were outstanding.




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CONNETICS CORPORATION TABLE OF CONTENTS PagePART I FINANCIAL INFORMATIONItem 1.
    
    Financial Statements
    
    
    3Condensed Consolidated Balance Sheets at March 31, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the Three Months ended March 31, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 4.
    
    Controls and Procedures
    
    
    19PART II OTHER INFORMATIONItem 2.
    
    Changes in
Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    20Item 6.
    
    Exhibits and Reports on Form 8K
    
    
    20(a) Exhibits
    
    
    20(b) Reports on Form 8K
    
    
    20Signatures
    
    
    
    
    22Exhibits
    
    
    
    
    23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements CONNETICS CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited) March 31,
    
    December 31,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    30,183
    
    
    $
    17,946Marketable
securities - current
    
    
    13,960
    
    
    
    96,716Restricted cash
    
    
    
    
    
    
    304Accounts receivable, net of allowances
    
    
    10,126
    
    
    
    2,594Inventory
    
    
    2,466
    
    
    
    1,035Prepaid and other current assets
    
    
    5,861
    
    
    
    3,779Total current assets
    
    
    62,596
    
    
    
    122,374Property and equipment, net
    
    
    5,608
    
    
    
    5,628Debt issuance costs, deposits and other assets
    
    
    5,243
    
    
    
    5,418Goodwill, net
    
    
    6,271
    
    
    
    6,271Other intangible assets, net
    
    
    132,557
    
    
    
    6,206Total assets
    
    $
    212,275
    
    
    $
    145,897LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    5,663
    
    
    $
    3,884Assumed liabilities related to acquisition of product rights
    
    
    4,123
    
    
    
    Accrued clinical trial costs
    
    
    555
    
    
    
    857Accrued payroll and related expenses
    
    
    2,831
    
    
    
    3,792Other accrued liabilities
    
    
    3,697
    
    
    
    1,594Total current liabilities
    
    
    16,869
    
    
    
    10,127Convertible senior notes, non-current
    
    
    90,000
    
    
    
    90,000Other non-current liabilities
    
    
    16
    
    
    
    16Commitments and contingenciesStockholders equity:Preferred stock
    
    
    
    
    
    
    Common stock
    
    
    35
    
    
    
    32Additional paid-in capital
    
    
    232,080
    
    
    
    174,080Deferred stock compensation
    
    
    (26
    )
    
    
    (31
    )Accumulated deficit
    
    
    (128,315
    )
    
    
    (130,188
    )Accumulated other comprehensive income
    
    
    1,616
    
    
    
    1,861Total stockholders equity
    
    
    105,390
    
    
    
    45,754Total liabilities and stockholders equity
    
    $
    212,275
    
    
    $
    145,897
 See accompanying notes to condensed consolidated financial statements. 3




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CONNETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited) Three Months EndedMarch 31,2004
    
    2003Revenues:Product
    
    $
    23,566
    
    
    $
    14,311Royalty
    
    
    1,353
    
    
    
    936License, contract and other
    
    
    63
    
    
    
    64Total revenues
    
    
    24,982
    
    
    
    15,311Operating costs and expenses:Cost of product revenues
    
    
    1,568
    
    
    
    1,072Amortization
of intangible assets
    
    
    1,272
    
    
    
    201Research and development
    
    
    4,441
    
    
    
    8,617Selling, general and administrative
    
    
    15,109
    
    
    
    10,903Total operating costs and expenses
    
    
    22,390
    
    
    
    20,793Income (loss) from operations
    
    
    2,592
    
    
    
    (5,482
    )Interest income
    
    
    348
    
    
    
    126Interest expense
    
    
    (875
    )
    
    
    (1
    )Other income, net
    
    
    51
    
    
    
    53Income (loss) before income taxes
    
    
    2,116
    
    
    
    (5,304
    )Income tax expense
    
    
    (243
    )
    
    
    (77
    )Net income (loss)
    
    $
    1,873
    
    
    $
    (5,381
    )Net income (loss) per share:Basic
    
    $
    0.06
    
    
    $
    (0.17
    )Diluted
    
    $
    0.05
    
    
    $
    (0.17
    )Shares used to calculate net income (loss) per shareBasic
    
    
    33,587
    
    
    
    31,286Diluted
    
    
    35,887
    
    
    
    31,286
 See accompanying notes to condensed consolidated financial statements. 4




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CONNETICS CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) Three Months EndedMarch 31,2004
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    1,873
    
    
    $
    (5,381
    )Adjustments to reconcile net income (loss) to net cash used in operating
activities:Depreciation
    
    
    377
    
    
    
    389Amortization of intangible assets
    
    
    1,272
    
    
    
    201Amortization
of convertible debt offering costs
    
    
    184
    
    
    
    Allowance for rebates, returns and chargebacks
    
    
    1,763
    
    
    
    720Stock compensation expense
    
    
    5
    
    
    
    4Changes in assets and liabilities:Accounts receivable
    
    
    (9,291
    )
    
    
    1,263Other assets
    
    
    (2,122
    )
    
    
    341Inventory
    
    
    (1,426
    )
    
    
    93Accounts payable
    
    
    1,391
    
    
    
    (2,415
    )Accrued and other current liabilities
    
    
    748
    
    
    
    (922
    )Net cash used in operating activities
    
    
    (5,226
    )
    
    
    (5,707
    )Cash flows from investing activities:Purchases of
marketable securities
    
    
    (1,712
    )
    
    
    (4,878
    )Sales and
maturities of marketable securities
    
    
    84,351
    
    
    
    9,677Purchases of property and equipment
    
    
    (356
    )
    
    
    (231
    )Acquisition
of product rights
    
    
    (123,212
    )
    
    
    Net cash provided by (used in) investing activities
    
    
    (40,929
    )
    
    
    4,568Cash flows from financing activities:Restricted cash
    
    
    304
    
    
    
    313Proceeds from issuance of common stock, net of issuance costs
    
    
    57,007
    
    
    
    Proceeds from exercise of stock options and employee stock purchase plan,
net of repurchases of unvested shares
    
    
    1,093
    
    
    
    1,221Net cash provided by financing activities
    
    
    58,404
    
    
    
    1,534Effect of foreign currency exchange rate changes on cash and cash equivalents
    
    
    (12
    )
    
    
    38Net change in cash and cash equivalents
    
    
    12,237
    
    
    
    433Cash and cash equivalents at beginning of period
    
    
    17,946
    
    
    
    8,624Cash and cash equivalents at end of period
    
    $
    30,183
    
    
    $
    9,057
 See accompanying notes to condensed consolidated financial statements. 5




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation and Policies We have prepared the accompanying unaudited condensed consolidated
financial statements of Connetics Corporation (Connetics) in accordance with
accounting principles generally accepted in the United States for interim
financial information and pursuant to the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, the financial statements do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. We believe that we have included
all adjustments, consisting of normal recurring adjustments, considered
necessary for a fair presentation. We have reclassified certain prior year
balances to conform to the current year presentation. Operating results for the three months ended March 31, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. For a better understanding of Connetics and its financial
statements, we recommend reading these unaudited, condensed, consolidated
financial statements and notes in conjunction with the audited condensed consolidated
financial statements and notes to those financial statements for the year
ended December 31, 2003, which are included in our Annual Report on Form 10-K
as filed with the Securities and Exchange Commission. Principles of Consolidation The
accompanying condensed consolidated financial statements include the accounts of
Connetics Corporation, Connetics Holdings Pty Ltd., and Connetics Australia Pty
Ltd. (formerly Soltec Research Pty Ltd.). All significant intercompany accounts and
transactions have been eliminated in consolidation. Use of Estimates To prepare financial statements in conformity with accounting principles
generally accepted in the United States, management must make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates based
upon future events. We evaluate our estimates on an on-going basis. In particular, we
regularly evaluate estimates related to recoverability of accounts receivable
and inventory, revenue reserves, assumed liabilities related to
acquired product rights and accrued liabilities for clinical trial
activities. We base our estimates on historical experience and on various
other specific assumptions that we believe to be reasonable under the
circumstances. Those estimates and assumptions form the basis for making
judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Revenue Recognition Product Sales.We recognize revenue from product sales when there is
persuasive evidence that an arrangement exists, when title has passed, the
price is fixed or determinable, and collection of the resulting receivable is
reasonably assured. We recognize product revenue net of estimated allowances
for discounts, returns, rebates, and chargebacks. We are obligated to accept
from customers the return of pharmaceuticals that have reached their expiration
date. We authorize returns for damaged products and exchanges for expired
products in accordance with our return goods policy and procedures, and we
establish reserves for such amounts at the time of sale. To date we have not
experienced significant returns of damaged or expired product. Product shipping
and handling costs are included in the cost of product revenues. Royalty
Revenue.We collect royalties from licensees based on third-party sales.
We recognize royalties either in the quarter in which we receive the
royalty payment from the licensee or in which we can reasonably
estimate the royalty, which is typically
one quarter following the related sale by the licensee. Contract Revenue.We record contract revenue for research and development,
or R&D, as it is earned based on the performance requirements of the contract.
We recognize non-refundable contract fees for which no further performance
obligations exist, and for which Connetics has no continuing involvement, on
the earlier of when the payments are received or when collection is assured. 6




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If, at the time an agreement is executed, there remains significant risk
due to the incomplete state of the products development, we recognize revenue
from non-refundable upfront license fees ratably over the period in which we
have continuing development obligations. We recognize revenue associated with
substantial at risk performance milestones, as defined in the respective
agreements, based upon the achievement of the milestones. We recognize revenue
under R&D cost reimbursement contracts as the related costs are
incurred. When we receive advance payments in excess of amounts
earned, we classify them as
deferred revenue until they are earned. Cash Equivalents and Marketable Securities Cash and cash equivalents consist of cash on deposit with banks, money
market and other debt instruments with original maturities of 90 days or less
at the date of purchase. Investments with maturities beyond three months at
the date of acquisition are included in marketable securities. Marketable
securities are classified as available for sale at the time of purchase and are
carried at fair value, and we report unrealized gains and losses
thereon as a component
of other comprehensive income (loss) in stockholders equity. We determine the
cost of securities sold using the specific identification method Cash equivalents and investments are financial instruments that
potentially subject us to concentration of risk to the extent recorded on the
balance sheet. We believe we have established guidelines for investing our
excess cash relative to diversification and maturities that maintain safety and
liquidity. We invest our excess cash in debt instruments of the U.S.
Government and its agencies, and high-quality corporate issuers, and, by
policy, restrict our exposure to any single corporate issuer by imposing
concentration limits. To minimize the exposure due to adverse shifts in
interest rates, we maintain investments at an average maturity of generally
less than one year. Foreign Currency Connetics Australias functional currency is the Australian dollar. We
translate Connetics Australias local currency balance sheet into U.S. dollars
using the exchange rates in effect at the balance sheet date. For revenue and
expense accounts we use a weighted average exchange rate during the period.
Foreign currency translation adjustments are recorded in comprehensive income
(loss). Net gains and losses resulting from foreign exchange transactions are
included in the condensed consolidated statements of operations and were immaterial for
all periods presented. Income Taxes We account for income taxes using the asset and liability method. Under
this method, we recognize deferred tax assets and liabilities for the future
tax consequences attributable to differences between (1) the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases, and (2) operating loss and tax credit carryforwards. We
measure deferred tax assets and liabilities using enacted tax rates that are
expected to apply to taxable income in the years in which we anticipate those
temporary differences will be recovered or settled. We establish a valuation
allowance for the net deferred tax assets when realization is uncertain. Our income tax
provision relates primarily to the operations of our Australian subsidiary. Property and Equipment Property and equipment are stated at cost less accumulated depreciation.
We calculate depreciation using the straight-line method over the estimated
useful lives of the assets, generally three to five years. We are
depreciating equipment we have
purchased on behalf of our contract manufacturer using the
units of production method based on contractual minimum quantities to be
produced over the term of the agreement. We amortize leasehold improvements
and assets acquired under capital lease arrangements over the shorter of the
estimated useful lives of the assets or the lease term. 7




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Inventory Inventory consists primarily
of finished goods and is stated at the lower of cost (determined on a
first-in first-out method) and market. Effective
January 1, 2004, we began including in the cost of finished goods
inventory and samples inventory (included in prepaid and other
current assets) on the accompanying condensed consolidated balance
sheets, certain manufacturing support and
quality assurance costs which had previously been classified as
research and development expense. While we do not directly
manufacture any of our products, internal activities include the
oversight of third party manufacturing, process development, quality
assurance and quality control activities. Previously only third party
product manufacturing costs, depreciation based on a units of
production methodology on Connetics owned equipment at our
third-party manufacturers, product freight and distribution costs
from the third party that handles all of our product distribution activities, and
royalties were being captured in inventory and cost of goods sold.
In the first quarter of 2004, $763,000 in net income, or
approximately $0.02 per diluted share, is attributable to
capitalizing these costs in inventory and samples inventory. We have determined that the effect
of this change in accounting would not have had a material impact on
our financial statements in any prior quarterly or annual period. For
the three months ended March 31, 2004, $1.0 million of
costs which in previous periods had been included in research and
development expense were allocated as follows: (1) $37,000 was
charged to cost of goods sold, (2) $203,000 was charged to sales
expense (3) $397,000 was added to the value of commercial inventory,
and (4) $366,000 was added to the value of samples inventory. We have
determined that the effect of this change in accounting would not
have had a material impact on our financial statements in any prior
quarterly or annual period. Goodwill, Other Purchased Intangibles and Impairment of Long Lived Assets We record goodwill in a business combination when the purchase price of
the net tangible and intangible assets we acquire exceeds their fair value.
Under Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and
Other Intangible Assets, effective January 1, 2002, we are not required to
amortize goodwill and intangible assets with indefinite lives, but are required
to periodically review these assets for impairment. Intangible assets
determined to have definite lives are amortized over their useful lives,
generally ten years. SFAS 142
requires that we test goodwill for impairment on an annual basis or more
frequently if indicators of potential impairment exist. We performed the
annual test as of October 1, 2003, which did not result in an impairment
charge. We will perform this test on October 1 of each year or more frequently
if indicators of potential impairment exist. We periodically perform reviews to determine if the carrying value of
long-term assets, other than goodwill (purchased intangibles, property and
equipment), is impaired. The reviews look for the existence of facts or
circumstances, either internal or external, which indicate that the carrying
value of the asset cannot be recovered. Our reviews have indicated no such
impairment to date. If in the future we determine that impairment indicators
exist, we would use undiscounted cash flows to initially determine whether we
should recognize any impairment. If necessary, we would perform a subsequent
calculation to measure the amount of impairment loss based on the excess of the
carrying value over the fair value of the impaired assets. If quoted market
prices for the assets are not available, we would calculate the fair value
using the present value of estimated expected future cash flows or other
appropriate valuation methodologies. The cash flow calculation would be based
on managements best estimates, using appropriate assumption and projections at
the time. Stock-Based Compensation We use the intrinsic-value method of accounting for stock-based awards
granted to employees, as allowed under Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25) and related
interpretations. Accordingly, we do not recognize any compensation in our
financial statements in connection with stock options granted to employees when
those options have exercise prices equal to or greater than fair
market value of our common stock.
We also do not record any compensation expense in connection with our Employee
Stock Purchase Plan as long as the purchase price is not less than 85% of the
fair market value at the beginning or end of each offering period, whichever is
lower. For options granted to non-employees, we have determined compensation
expense in accordance with Statement of Financial Accounting
Standards (SFAS) No. 123 Accounting for
Stock-Based Compensation, as amended and Emerging Issues Task Force No.
96-18 (EITF 96-18), Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling Goods or Services, as the fair value of the consideration received or the fair value of the
equity instruments issued, whichever is more reliably measured. We
periodically re-measure the compensation expense for options granted to
non-employees as they vest. Although SFAS 123 allows us to continue to follow the present APB 25
guidelines, we are required to disclose pro formanet income
(loss) and basic and
diluted income (loss) per share as if we had applied the fair value based method to all
awards. 8




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Three Months EndedMarch 31,(in thousands except per share amounts):
    
    2004
    
    2003Net income (loss), as reported
    
    $
    1,873
    
    
    $
    (5,381
    )Add: Stock based compensation expense, included
in reported net income (loss)
    
    
    5
    
    
    
    4Deduct: Total stock-based employee compensation
expense determined under the fair value method
for all awards
    
    
    (2,855
    )
    
    
    (1,749
    )Pro forma net loss
    
    $
    (977
    )
    
    $
    (7126
    )Net income (loss) per share:Basic income (loss)  as reported
    
    $
    0.06
    
    
    $
    (0.17
    )Diluted income (loss)  as reported
    
    $
    0.05
    
    
    $
    (0.17
    )Basic income (loss) pro forma
    
    $
    (0.03
    )
    
    $
    (0.23
    )Diluted income (loss)  pro forma
    
    $
    (0.03
    )
    
    $
    (0.23
    )
 For purposes of this analysis, we estimate the fair value of each option
grant on the date of grant using the Black-Scholes option-pricing model. The
weighted average assumptions used in the model were as follows: Stock Option PlansThree Months EndedMarch 31,2004
    
    2003Expected stock volatility
    
    
    57.27
    %
    
    
    64.0
    %Risk-free interest rate
    
    
    2.25
    %
    
    
    6.25
    %Expected life (in years)
    
    
    3.43
    
    
    
    4.24Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
 Stock Purchase PlanThree Months EndedMarch 31,2004
    
    2003Expected stock volatility
    
    
    52.0
    %
    
    
    66.0
    %Risk-free interest rate
    
    
    1.58
    %
    
    
    4.97
    %Expected life (in years)
    
    
    1.56
    
    
    
    1.31Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
 The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. This model also requires us to make highly
subjective assumptions, including the expected volatility of our stock.
Because our stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, we do not believe
that the existing models necessarily provide a reliable single measure of the
fair value of our options. The effects on pro formadisclosures of applying SFAS 123 are not likely
to be representative of the effects on reported results of future periods. 9




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2. Net Income (Loss) Per Share We compute basic net income (loss) per share by dividing net income (loss)
by the weighted average number of common shares outstanding during the period. We
compute diluted net income (loss) per share using the weighted average of all
potential shares of common stock outstanding during the period. For the three
months ended March 31, 2004 we included all dilutive stock options and warrants
in the calculation of diluted net income per share. We excluded convertible
debt because its effect is anti-dilutive. The following table shows a reconciliation of the denominator used in
basic and diluted net income (loss) per share computations (in thousands except share
amounts): Three Months EndedMarch 31,2004
    
    2003Numerator:Net income (loss)
    
    $
    1,873
    
    
    $
    (5,381
    )Denominator:Weighted-average shares outstanding used for
basic net income (loss) per share
    
    
    33,587
    
    
    
    31,286Effect of dilutive securities:Stock options
    
    
    2,262
    
    
    
    Warrants
    
    
    38
    
    
    
    Weighted-average shares used for diluted net
income (loss) per share
    
    
    35,887
    
    
    
    31,286
 3. Comprehensive Income (Loss) During the three months ended March 31, 2004, total comprehensive income
amounted to $1.6 million, compared to a total comprehensive loss of $5.6
million for the comparable period in 2003. The components of comprehensive
income (loss) are as follows (in thousands): Three Months EndedMarch 31,2004
    
    2003Net income (loss)
    
    $
    1,873
    
    
    $
    (5,381
    )Foreign currency translation adjustment
    
    
    (129
    )
    
    
    38Change in unrealized gain (loss) on securities,
net of reclassification adjustments for
realized gain (loss)
    
    
    (116
    )
    
    
    (224
    )Comprehensive income (loss)
    
    $
    1,628
    
    
    $
    (5,567
    )
 Accumulated other comprehensive loss included $744,000 of net unrealized
gains on investments and $872,000 of foreign currency translation adjustments
as of March 31, 2004 and $861,000 of unrealized gains on investments and $1.0
million of foreign currency translation adjustments as of December 31, 2003. 4. Goodwill and Purchased Intangible Assets 10




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There were no
changes in the carrying amount of goodwill during the three months ended March
31, 2004. The components of our other intangible assets at March 31, 2004, are
as follows (in thousands): Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    NetAcquired product rights
    
    $
    127,623
    
    
    $
    (1,064
    )
    
    $
    126,559Existing technology
    
    
    6,810
    
    
    
    (2,014
    )
    
    
    4,796Patents
    
    
    1,590
    
    
    
    (388
    )
    
    
    1,202Total
    
    $
    136,023
    
    
    $
    (3,466
    )
    
    $
    132,557
 Amortization expense for our other intangible assets was $1.3 million for
the three months ended March 31, 2004. For the same reporting period in the
prior year the amortization expense was $201,000. The expected future amortization expense of our other purchased intangible assets is
as follows (in thousands): Amortization ExpenseRemaining nine months in 2004
    
    $
    10,196For the year ending December 31, 2005
    
    
    13,595For the year ending December 31, 2006
    
    
    13,595For the year ending December 31, 2007
    
    
    13,595For the year ending December 31, 2008
    
    
    13,595For the year ending December 31, 2009
    
    
    13,595Thereafter
    
    
    54,386$
    132,557
 5. Guaranties and Indemnifications In
November 2002, the FASB issued Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others (FIN No. 45). FIN No. 45 requires that
upon issuance of a guarantee, the guarantor must recognize a liability for the
fair value of the obligations in assumes under that guarantee. Connetics enters into indemnification provisions under its agreements with
other companies in its ordinary course of business, typically with business
partners, contractors, clinical sites, insurers and customers. Under these
provisions Connetics generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party as a result of
our activities. These indemnification provisions generally survive termination
of the underlying agreement. In some cases, the maximum potential amount of
future payments Connetics could be required to make under these indemnification
provisions is unlimited. The estimated fair value of the indemnity obligations
of these agreements is minimal. Accordingly, we have no liabilities recorded
for these agreements as of March 31, 2004. We have not incurred material costs
to defend lawsuits or settle claims related to these indemnification
agreements. 6. Equity Issuance On February 13, 2004, we
completed a private placement of 3.0 million shares of our
common stock to accredited institutional investors at a price of
$20.25 per share, for net proceeds of approximately
$57.0 million. We used a portion of the net proceeds to pay for
the acquisition of the exclusive U.S. rights to Soriatane, and intend
to use the balance for general corporate purposes, including working
capital. 11




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7. Acquisition of
Soriatane Product Line On
February 6, 2004, we entered into a binding agreement with Roche
to acquire exclusive U.S. rights to Soriatane-brand acitretin,
an approved oral therapy for the treatment of severe psoriasis in
adults. The transaction closed on March 4, 2004, and we have
recognized revenue, net of applicable reserves, for all sales of the
product from that date. Under the terms of the purchase agreement, we
paid Roche a total of $123.0 million in cash at the closing to
acquire Soriatane. We also assumed certain liabilities in connection
with returns, rebates and chargebacks associated with prior sales of
Soriatane by Roche totaling $4.1 million, and purchased
Roches existing inventory of Soriatane at a cost of
approximately $1.5 million. The total value of the acquired product rights
was $127.6 million, including transaction related costs of
approximately $500,000. This amount is being amortized over the ten
year estimated useful life of Soriatane. 8. UCB Co-Promotion
Agreement We have entered into an
agreement with UCB Pharma, a subsidiary of UCB Group, pursuant to
which UCB Pharmas 400-person U.S. sales force will promote OLUX and
Luxiq to a segment of U.S. primary care physicians (PCPs). UCBs
focus will be on the approximately 10% of PCPs who are active
prescribers of dermatology products, including OLUX and Luxiq. The
purpose of the co-promotion agreement is to build value for the OLUX
and Luxiq brands with the additional benefit of ensuring appropriate
use of OLUX and Luxiq with the current PCP users. We estimate that,
historically, PCPs have written approximately 15% of prescriptions
for OLUX and Luxiq, even though we have promoted exclusively to
dermatologists. We
will record 100% of the
revenue from sales generated by promotional efforts of UCB and pay UCB a portion of revenue
as a promotion expense. UCB will bear the marketing costs for
promoting the products (including product samples, marketing
materials, etc.). The agreement is structured with a two-year
promotional period followed by a two-year tail of additional
compensation to UCB. We anticipate that the arrangement will be
earnings neutral in 2004. 12




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Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations This discussion and analysis should be read in conjunction with the MD&A
included in our Annual Report onForm 10-Kfor the year ended December 31,
2003, and with the unaudited condensed consolidated financial statements and
notes to financial statements included in this Report. Our disclosure and
analysis in this Report, in other reports that we file with the Securities and
Exchange Commission, in our press releases and in public statements of our
officers contain forward-looking statements within the meaning of Section 27A
of the Securities Act, and Section 21E of the Securities Exchange Act.
Forward-looking statements give our current expectations or forecasts of future
events. You can identify these statements by the fact that they do not relate
strictly to historical or current events. They use words such as anticipate,
estimate, expect, will, may, intend, plan, believe and similar
expressions in connection with discussion of future operating or financial
performance. These include statements relating to future actions, prospective
products or product approvals, future performance or results of current and
anticipated products, sales efforts, expenses, the outcome of contingencies
such as legal proceedings, and financial results. 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 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. Some of the factors that, in our view, could cause
actual results to differ are discussed under the caption Factors That May
Affect Future Results, Financial Condition and the Market Price of Securities
and under the caption Factors Affecting Our Business and
Prospects in our 2003 Annual Report onForm 10-K. Our historical operating results are
not necessarily indicative of the results to be expected in any future period. Overview Our commercial business is focused on the dermatology marketplace, which
is characterized by a large patient population that is served by relatively
small, and therefore more accessible, groups of treating physicians. We
currently market three pharmaceutical products, OLUX®, Luxíq®, and
Soriatane®-brand (acitretin). Our products have clinically proven therapeutic
advantages and we are providing quality customer service to physicians through
our experienced sales and marketing professionals. In addition to revenue from product sales, we receive royalties on sales
of RID®, Actimmune® and Ridaura® in the U.S., internationally on sales of
Banlice®, Milice®, and on a super-concentrated aerosol spray licensed worldwide
through March 31, 2004. On January 5, 2004 we reached an agreement to
terminate the license agreement with S.C. Johnson related to the
super-concentrated aerosol spray. We will cease receiving royalties under this
agreement after the first quarter of 2004. We recognized royalties of
$1.2 million in the quarter ended March 31, 2004 related to
this agreement. We have licenses with Novartis and
Pfizer, Inc., formerly Pharmacia Corporation, which have the potential to bear
royalties in the future depending on approval of their products for sale. In January 2004 we announced that we had completed patient enrollment in
both Phase III clinical trials related to Velac ® Gel (a
combination of 1% clindamycin and 0.025% tretinoin) for the treatment
of acne. 13




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On
February 13, 2004 we completed a private placement
of 3.0 million shares of common stock of the Company to
accredited investors at a price of $20.25 per
share for the aggregate net cash proceeds of approximately $56.9 million to
partially pay for the Soriatane® product line acquisition, and for general corporate
purposes, including working capital. On March 4, 2004, we announced we had completed the acquisition of the
exclusive U.S. rights to Roches Soriatane-brand (acitretin), an approved oral
therapy for the treatment of severe psoriasis in adults, for a total
purchase price of $127.6 million. Soriatane is a
once-daily oral medication, available in 10 mg and 25 mg capsules, for initial
and maintenance treatment of psoriasis in adults. Soriatane is a proven therapy, which has been studied in five types of
psoriasis, and has an extensive record of clinical use in more than one million
patients worldwide. Soriatane prescription grew in 2003 and U.S. net sales for
the product were approximately $41 million. We recorded an
intangible asset of approximately $127.6 million related to this
acquisition, which is being amortized over an estimated useful life
of 10 years. We
have entered into an agreement with UCB Pharma, a subsidiary of UCB
Group, pursuant to which UCB Pharmas 400-person U.S. sales
force will promote OLUX and Luxiq to a segment of U.S. primary care
physicians (PCPs). UCBs focus will be on the
approximately 10% of PCPs who are active prescribers of
dermatology products, including OLUX and Luxiq. The purpose of the
co-promotion agreement is to build value for the OLUX and Luxiq
brands with the additional benefit of ensuring appropriate use of
OLUX and Luxiq with the current PCP users. We estimate that,
historically, PCPs have written approximately 15% of
prescriptions for OLUX and Luxiq, even though we have promoted
exclusively to dermatologists. We
will book 100% of the revenue from sales generated by UCB and pay UCB
a portion of revenue as a promotion expense. UCB will bear the
marketing costs for selling to its customers. The agreement is
structured with a two-year promotional period followed by a two-year
tail of additional compensation to UCB. We anticipate that the
arrangement will be earnings neutral in 2004. 14




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Critical Accounting Policies There have been no material changes to our critical accounting policies,
which are included in our Annual Report on Form 10-K for the year ended December 31, 2003. Results of Operations Revenues Three Months EndedMarch 31,(In thousands)2004
    
    2003Product Revenues:OLUX
    
    $
    14,370
    
    
    $
    9,875Luxíq
    
    
    5,471
    
    
    
    4,388Soriatane
    
    
    3,640
    
    
    
    Other
    
    
    85
    
    
    
    48Total product revenues
    
    
    23,566
    
    
    
    14,311Royalty, license and contract:Royalty
    
    
    1,353
    
    
    
    936Relaxin related contract revenue
    
    
    
    
    
    
    33Pfizer (formerly Pharmacia)
    
    
    11
    
    
    
    31Other contract
    
    
    52
    
    
    
    Total royalty, license and contract revenues
    
    
    1,416
    
    
    
    1,000Total
Revenues
    
    $
    24,982
    
    
    $
    15,311
 Our product revenues were $23.6 million for the three months ended March
31, 2004, compared to $14.3 million for the three months ended March 31, 2003.
Total net product sales increased 65% in the first three months of 2004 as
compared to the same period in the prior year. The introduction of Soriatane
to our product portfolio in March 2004 accounted for 26% of the increase in
product sales. Increased sales volumes accounted for a 17% increase in the
net product sales in the first quarter of 2004 compared to the same period in
2003. Higher sales prices for our OLUX and Luxiq product lines accounted for
the remaining 22% of the increase in net product sales in the three months
ended March 31, 2004 compared to the same period in 2003. Royalty, license and contract revenues were $1.4 million for the three
months ended March 31, 2004, compared to $1.0 million for the three months
ended March 31, 2003. Royalty, license and contract revenue was higher for the
first quarter of 2004 compared to the first quarter of 2003 primarily due to
$1.2 million of royalties recognized from S.C. Johnson in
connection with the January 5, 2004 termination
agreement related to their concentrated aerosol spray which
was marketed in the U.S. and internationally. Cost of Product Revenues Our cost of product revenues includes the third party costs of
manufacturing OLUX and Luxíq, the cost of Soriatane inventory
acquired from Roche, depreciation costs associated with
Connetics-owned equipment located at the DPT facility in Texas, allocation of
overhead, royalty payments based on a percentage of our product revenues, and
product freight and distribution 15




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costs from Cardinal Health Specialty Pharmaceutical Services (formerly
CORD Logistics, Inc.), the third party that handles all of our product
distribution activities. Currently, DPT Laboratories, Ltd., and AccraPac
Group, Inc. manufacture commercial supplies of OLUX and Luxíq. We recorded
costs of product revenues of $1.6 million for the three months ended March 31,
2004, compared to $1.1 million for the three months ended March 31, 2003. The
increase in the cost of product revenues in the three months ended March 31,
2004 compared to the same period in 2003 is primarily attributable to the
introduction of Soriatane to our product portfolio in March 2004 as well as an
increase in sales volume of our OLUX and Luxiq products. Effective
January 1, 2004, we began including in the cost of
finished goods inventory and prepaid sample cost, certain
manufacturing support and quality assurance costs which had
previously been classified as research and development expense. While
we do not directly manufacture any of our products, internal
activities include the oversight of third party manufacturing,
process development, quality assurance and quality control
activities. Previously only third party product manufacturing costs,
depreciation based on a units of production methodology on Connetics
owned equipment at our third-party manufacturers, product freight and
distribution costs from the third party that handles all of our product
distribution activities, and royalties were being captured in
inventory and cost of goods sold. We have determined that the effect
of this change in accounting would not have had a material impact on
our financial statements in any prior quarterly or annual period. For
the three months ended March 31, 2004, $1.0 million of
costs which in previous periods had been included in research and
development expense were allocated as follows: (1) $37,000 was
charged to cost of goods sold, (2) $203,000 was charged to sales
expense (3) $397,000 was added to the value of commercial inventory,
and (4) $366,000 was added to the value of samples inventory. We have
determined that the effect of this change in accounting would not have
had a material impact on our financial statements in any prior
quarterly or annual period. Research and Development Research and development expenses include costs of personnel to support
our research and development activities, costs of preclinical studies, costs of
conducting our clinical trials, such as clinical investigator fees, monitoring
costs, data management and drug supply costs, external research programs, and
an allocation of facilities costs, salaries and benefits, and overhead costs
such as rent, supplies and utilities. In the three months ended March 31, 2004
we incurred costs associated with two Velac trials in various stages of
completion. During the first quarter of 2003 we incurred cost associated with
concurrent trials in Velac, Actiza, and Extina which were also in
varying
stages of completion. Research and development expenses were $4.4 million for the three months
ended March 31, 2004 and $8.6 million for the three months ended March 31,
2003. The decrease is primarily related to a reduction of
$3.2 million of costs related to
clinical trials activities underway in 2003 as well as a
$1.0 million change in classification from research
and development costs to cost of goods sold, inventory, and selling expense. While Connetics does not directly manufacture any
of its products, internal research and development activities include
manufacturing associated costs such as the oversight of third-party
manufacturing, process development, and quality assurance and quality control
activities. Selling, General and Administrative Expenses Selling, general and administrative expenses were $15.1 million for the
three months ended March 31, 2004, compared to $11.1 million for the comparable
period in 2003. For the three months ended March 31, 2004 the overall increase
in expenses, compared with the same period in 2003 was primarily related to a
$1.3 million increase in employee-related costs due to increased headcount, an
increase of approximately $1.7 million in 16




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increased activities
related to tradeshows, sales meetings, product samples, and market
research. Interest and other income (expense), net Interest income was $348,000 for the three months ended March 31, 2004,
compared to $126,000 for the three months ended March 31, 2003. The increase
in interest income during the three months ended March 31, 2004 compared to the
same period in 2003 was the result of higher average cash and investment balances in
connection with the money we raised by issuing $90 million of convertible
senior notes in May 2003, as well as the $56.9 million net receipts from a
private placement of common stock in February 2004, partially offset by lower market interest rates on
investments. Interest
expense was $875,000 for the three months ended March 31, 2004,
compared to $1,000 for the three months ended March 31, 2003. The increase in
interest expense during the first three months of 2004 compared to the same
period in 2003 was directly related to the interest expense associated with the
convertible senior notes issued in the second quarter of 2003. Income Taxes We recognized an income tax expense of $243,000 for the three months ended
March 31, 2004 primarily related to the foreign tax provision recorded by
Connetics Australia. We also recorded a tax provision of $61,000 for
domestic income taxes
during the first quarter of 2004 as we had a profitable first quarter and
anticipate that we will be profitable for the full year of 2004. In the three
months ended March 31, 2003 we recognized income tax expense of $77,000 related
to Connetics Australia. Liquidity and Capital Resources Sources and Use of Cash.We have financed our operations to date
primarily through proceeds from equity and debt financings, collaborative
arrangements with corporate partners, bank loans, and product revenues. At
March 31, 2004 cash, cash equivalents and short term investments
totaled $44.1 million compared to $114.7 million at December 31, 2003. Our
cash balances are held in a variety of interest-bearing instruments including
high-grade obligations, commercial paper, obligations of the U.S. Government and State and
Local agencies papers, and money market accounts. Cash used in operating activities.Cash used in operations for the three
months ended March 31, 2004 was $5.2 million compared to $5.7 million for the
three months ended March 31, 2003. Net income of $1.9 million for the three
months ended March 31, 2004 was affected by non-cash charges of $1.8 million of
depreciation and amortization expense and $1.8 million of increased reserves
related to product returns, chargebacks, rebates and coupon programs. Cash
usage was primarily affected by an increase in gross accounts receivable of
approximately $9.3 million of which $5.0 million is directly attributable to
receivables related to the Soriatane product line sales for March 2004. The
balance of the change in accounts receivable is related to the timing of sales
on our OLUX and Luxiq, and collection of outstanding amounts. Cash
usage was also affected by an increase in other assets of $3.5 million
primarily related to various prepaid activities including payments in connection
with our UCB co-promotion agreement,
insurance, samples inventory and sales and marketing activities, as
well as an
increase in accounts payable and other accrued and current
liabilities of $2.1
million primarily due to the timing of payments and other business activities. Cash flows provided by (used in) investing activities.Cash flows used in
investing activities was $40.9 million for the three months ended March
31, 2004, compared to cash flows provided by investing activities of $4.6
million for the three months ended March 31, 2003. The increase in cash used
in investing activities is primarily the result of $123.2 million
spent in the first quarter of 2004 for
the product line acquisition of Soriatane, partially offset by
$84.4 million from maturities and sales of marketable securities necessary to fund such acquisition. Cash flows from financing activities.Financing activities provided $58.4
million for the three months ended March 31, 2004 and $1.5 million for the
three months ended March 31, 2003. This increase is primarily due 17




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to net cash proceeds of
$57.0 million from a private placement of our common stock in
February 2004, not including, amounts accrued but not paid as of
March 31, 2004. Working Capital.
Working capital
decreased by $66.5 million to $45.7
million at March 31, 2004 from $112.2 million at December 31, 2003, primarily
due to the cash used to fund the acquisition of exclusive U.S. rights to Soriatane
and related inventory in March 2004 as well as the assumption of approximately
$4.1 million in liabilities associated with the Soriatane acquisition. The
amounts related to the acquisition were partially offset by net
proceeds of $57.0 million from a private placement of our common
stock in February 2004. Contractual Obligations and Commercial Commitments.There have been no
material changes in our contractual obligations and commercial commitments
since December 31, 2003. Our commitments, including those disclosed in the
Annual Report on Form 10-K for the year ended December 31, 2003, consist
primarily of operating lease agreements for our facilities as well as minimum
purchase commitments under one of our contract manufacturing agreements. Restricted Cash and Cash Equivalents.In the three months ended March 31,
2004, the final $304,000 was released from a previously restricted certificate
of deposit related to security for our facilities rent. As of March 31, 2004
none of our cash balance is restricted. We believe our existing cash, cash equivalents and short-term investments,
cash generated from product sales and collaborative arrangements with corporate
partners, will be sufficient to fund our operating expenses, debt obligations
and capital requirements through at least the next 12 months. Our future
capital uses and requirements depend on numerous factors, including the
progress of our research and development programs, the progress of clinical
testing, the time and costs involved in obtaining regulatory approvals, the
cost of filing, prosecuting, and enforcing patent claims and other intellectual
property rights, competing technological and market developments, the level of
product revenues, and the possible acquisition of new products and
technologies. A key element of our strategy is to in-license or acquire
additional marketed or late-stage development products. A portion of the funds
needed to acquire, develop and market any new products may come from our
existing cash, which will result in fewer resources available to our current
products and clinical programs. We continually evaluate various business
development opportunities, including the possibility of acquiring or
in-licensing other products. If we successfully reach agreements with third
parties, these transactions may require us to use some of our available cash,
or to raise additional cash by liquidating some of our investment portfolio
and/or raising additional funds through equity or debt financings in connection
with the transaction. Factors that May Affect Future Results, Financial Condition and the Market
Price of Securities Please also read Item 1 in our Annual Report on Form 10-K
for the year ended December 31, 2003, where we have
described our business and the challenges and risks we may face in the future. There are many factors that affect our business and results of operations,
some of which are beyond our control. In our Annual Report on Form 10-K
we list some of the important factors that may
cause the actual results of our operations in future periods to differ
materially from the results currently expected or desired. Due to these
factors, we believe that quarter-to-quarter comparisons of our results of
operations are not a good indication of our future performance. The factors
discussed in our reports filed with the Securities and Exchange Commission,
including our Annual Report on Form 10-K in particular under the
caption Factors Affecting Our Business and Prospects, should be carefully
considered when evaluating our business and prospects. Our Business Strategy May Cause Fluctuating Operating Results Our operating results and financial condition may fluctuate from quarter
to quarter and year to year depending upon the relative timing of events or
uncertainties that may arise. For example, the following events or occurrences
could cause fluctuations in our financial performance from period to period:  
    
    changes in the levels we spend to develop new product lines,  
    
    changes in the amounts we spend to promote our products, 18




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
    
    changes in treatment practices of physicians that currently prescribe our products,  
    
    changes in reimbursement policies of health plans and other similar
health insurers, including changes that affect newly developed or newly
acquired products,  
    
    forward-buying patterns by wholesalers that may result in significant
quarterly swings in revenue reporting,  
    
    increases in the cost of raw materials used to manufacture our products,  
    
    the development of new competitive products by others,  
    
    the mix of products that we sell during any time period,  
    
    our responses to price competition, and  
    
    fluctuations in royalties paid by third parties. 
 Item 3.Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in the reported market risks or
foreign currency exchange risks from those reported under Item 7A, Quantitative
and Qualitative Disclosures About Market Risk in our annual report on Form 10-K
for the year ended December 31, 2003. 
 Item 4.Controls and Procedures Our management, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, performed an evaluation of
the effectiveness of the design and operation of Connetics disclosure controls
and procedures. This evaluation was performed as of March 31, 2004. Our
disclosure controls and procedures are designed with the objective of ensuring
that information required to be disclosed in our reports filed under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms. Based on their
evaluation, the CEO and CFO concluded that our disclosure controls and
procedures were effective in timely alerting them to material information
required to be included in our periodic SEC reports. In addition, our CEO and
CFO concluded that during the quarter ended March 31, 2004, there has been no
change in our internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 19




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PART II. OTHER INFORMATION 
 Item 2.Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities. 
  We do not have a plan or program to repurchase shares of our
common stock. Prior to 2000, however, we have accepted a total of
46,708 shares of our common stock surrendered by our chief executive
officer as partial repayments of loans totaling approximately
$321,000 plus accrued interest. 
 Item 6.Exhibits and Reports on Form 8-K 
  (a)
    
    Exhibits. 2.1
    
    Sale and Purchase Agreement dated
February 2, 2004 between Connetics and Hoffmann-La Roche
(incorporated by reference to Exhibit 10.41 to the
Companys Annual Report on Form 10-K for the year ended
December 31, 2003 (Commission File No. 0-27406))10.1
    
    Stock Purchase Agreement dated as
of February 11, 2004 by and among Connetics and the Purchasers
listed on Appendix A to the Stock Purchase Agreement
(incorporated by reference to Exhibit 99.1 to the Company's
Registration Statement on Form S-3 (Registration
No. 333-113894) filed on March 24, 2004)10.2
    
    Credit and Guaranty Agreement dated
as of February 6, 2004 between Connetics and Goldman Sachs
Credit Partners L.P. (incorporated by reference to Exhibit 99.1
to the Companys Current Report on Form 8-K dated
February 6, 2004 and filed on February 9, 2004 (Commission
File No. 0-27406))31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 135032.2
    
    Certification of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
 
  (b)
    
    Reports on Form 8-K.
We filed or furnished the following Current Reports
on Form 8-K during the quarter ended March 31, 2004. The information
furnished under Item 12, Results of
Operations and Financial Condition is not deemed to be filed for
purposes of Section 18 of the Securities Exchange Act of 1934.  (i)
    
    Current Report on Form 8-K dated January 8, 2004, filed
with the Securities and Exchange Commission on January 9, 2004,
under Item 5, Other Events, and Item 7, Financial Statements &
Exhibits.(ii)
    
    Current Report on Form 8-K dated January 27, 2004,
furnished to the Securities and Exchange Commission on January 27,
2004, under Item 7, Financial Statements and Exhibits, and Item 12, Results of
Operations and Financial Condition.(iii)
    
    Current Report on Form 8-K dated January 5, 2004,
filed with the Securities and Exchange Commission on January 27,
2004, under Item 5, Other Events.(iv)
    
    Current Report on Form 8-K dated February 6, 2004,
furnished to the Securities and Exchange Commission on February
9, 2004, under Item 5, Other Events, and Item 7, Financial
Statements, Pro Forma Financial Information & Exhibits.(v)
    
    Current Report on Form 8-K dated February 9, 2004,
filed with the Securities and Exchange Commission on March 8,
2004, under Item 5, Other Events and Item 7, Financial
Statements, Pro Forma Financial Information & Exhibits.(vi)
    
    Current Report on Form 8-K dated February 12, 2004,
filed with the Securities and Exchange Commission on February 13,
2004, under Item 5, Other Events and Item 7, Financial
Statements, Pro Forma Financial Information & Exhibits.(vii)
    
    Current Report on Form 8-K dated February 25, 2004,
filed with the Securities and Exchange
Commission on February 27, 2004, under Item 5, Other Events.(viii)
    
    Current Report on Form 8-K dated March 4, 2004, filed with the
Securities and Exchange
Commission on March 5, 2004, under Item 5, Other Events.(ix)
    
    Current Report on Form 8-K dated March 4, 2004, filed with the Securities and
Exchange
Commission on March 9, 2004, under Item 5, Other Events.(x)
    
    Current Report on Form 8-K dated March 4, 2004, filed with the
Securities and Exchange
Commission on March 16, 2004, under Item 2, Acquisition or Disposition of
Assets, Item 7,
Financial Statements Pro Forma Financial Information & Exhibits. 20




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(xi)
    
    Current Report on Form 8-K dated March 8, 2004, filed with the
Securities and Exchange
Commission on March 10, 2004, under Item 5, Other Events.(xii)
    
    Current Report on Form 8-K dated March 11, 2004, filed with
the Securities and Exchange
Commission on March 15, 2004, under Item 5, Other Events.(xiii)
    
    Current Report on Form 8-K dated March 23, 2004, filed with the
Securities and Exchange
Commission on March 24, 2004, under Item 5, Other Events, Item 7,
Financial Statements &
Exhibits 21




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized. Connetics CorporationBy:
    
    /s/ John L. HigginsJohn L. HigginsExec. Vice President, Finance and
Corporate Development and Chief
Financial Officer (Principal Financial and Accounting
Officer and Duly Authorized Officer of the 
Registrant)
 Date: May 10, 2004 22




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INDEX TO EXHIBITS ExhibitNumber
    
    Description2.1
    
    Sale and Purchase Agreement dated
February 2, 2004 between Connetics and Hoffmann-La Roche
(incorporated by reference to Exhibit 10.41 to the Companys
Annual Report on Form 10-K for the year ended December 31,
2003 (Commission File No. 0-27406))10.1
    
    Stock Purchase Agreement dated as
of February 11, 2004 by and among Connetics and the Purchasers
listed on Appendix A to the Stock Purchase Agreement
(incorporated by reference to Exhibit 99.1 to the Companys
Registration Statement on Form S-3 (Registration
No. 333-113894) filed on March 24, 2004)10.2
    
    Credit and Guaranty Agreement dated
as of February 6, 2004 between Connetics and Goldman Sachs
Credit Partners L.P. (incorporated by reference to Exhibit 99.1 to
the Companys Current Report on Form 8-K dated February 6,
2004 and filed on February 9, 2004 (Commission File
No. 0-27406))31.1
    
    Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 135032.2
    
    Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
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