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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q



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

For the Quarterly Period Ended September 30, 2002

Commission file number: 0-27406

CONNETICS CORPORATION

(Exact name of registrant as specified in its charter)


|                                                                       |  |                                               
|---------------------------------------------------------------------- |  | ----------------------------------------------
|Delaware(State or other jurisdiction of
incorporation or organization) |  | 94-3173928(IRS Employer
Identification Number)

3290 West Bayshore Road
Palo Alto, California 94303(Address of principal executive offices)

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 at least the past 90 days.  Yes [X]    No [   ]

As of
November 8, 2002, 31,077,201 shares of the Registrants common stock
were outstanding, at $0.001 par value.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                              | Item 4. Controls and Procedures                                                              
|PART II. OTHER INFORMATION   
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                    
|INDEX TO EXHIBITS            
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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CONNETICS CORPORATION

TABLE OF CONTENTS

|                             |                                                                                                                            |  |      |    | 
|---------------------------- | -------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                             |                                                                                                                            |  | Page
|                             |                                                                                                                            |  |     
|PART I FINANCIAL INFORMATION
|                            
|Item 1.                      | Condensed Consolidated Financial Statements                                                                                |  |      | 1  | 
|                             | Condensed Consolidated Balance Sheets at September 30, 2002 and December 31, 2001                                          |  |      | 1  | 
|                             | Condensed Consolidated Statements of Operations for the three months and the nine
months ended September 30, 2002 and 2001 |  |      | 2  | 
|                             | Condensed Consolidated Statements of Cash Flows for the nine months ended September
30, 2002 and 2001                      |  |      | 3  | 
|                             | Notes to Condensed Consolidated Financial Statements                                                                       |  |      | 4  | 
|Item 2.                      | Managements Discussion and Analysis of Financial Condition and Results of Operations                                      |  |      | 11 | 
|Item 3.                      | Quantitative and Qualitative Disclosures About Market Risks                                                                |  |      | 17 | 
|Item 4.                      | Controls and Procedures                                                                                                    |  |      | 17 | 
|                            
|PART II OTHER INFORMATION   
|                            
|Item 6.                      | Exhibits and Reports on Form 8-K                                                                                           |  |      | 17 | 
|                             | (a) Exhibits                                                                                                               |  |      | 17 | 
|                             | (b) Reports on Form 8-K                                                                                                    |  |      | 17 | 





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PART I. FINANCIAL INFORMATION




Item 1.Financial Statements




CONNETICS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)
(Unaudited)


|                                           |                                             |                            |        |               |        |              |        |          |        | 
|------------------------------------------ | ------------------------------------------- | -------------------------- | ------ | ------------- | ------ | ------------ | ------ | -------- | ------ | 
|                                           |                                             |                            |        | September 30, |        | December 31,
|                                           |                                             |                            |        | 2002          |        | 2001        
|                                           |                                             |                            |        |               |        |             
|ASSETS                                    
|Current assets:                            |                                             |                            |        |               |        |              |        |         
|                                           | Cash and cash equivalents                   |                            | $      | 4,901         |        |              | $      | 3,603    |       
|                                           | Short-term investments                      |                            |        | 24,130        |        |              |        | 42,734   |       
|                                           | Restricted cash                             |                            |        | 410           |        |              |        | 1,539    |       
|                                           | Accounts receivable, net                    |                            |        | 8,533         |        |              |        | 5,392    |       
|                                           | Other current assets                        |                            |        | 2,352         |        |              |        | 1,204    |       
|                                           |                                             |                            |        |               |        |              |        |         
|                                           |                                             | Total current assets       |        |               | 40,326 |              |        |          | 54,472 | 
|Property and equipment, net                |                                             |                            | 5,566  |               |        |              | 3,167  |         
|Restricted cash                            |                                             |                            | 300    |               |        |              | 600    |         
|Deposits and other assets                  |                                             |                            | 668    |               |        |              | 332    |         
|Goodwill, net                              |                                             |                            | 6,271  |               |        |              | 6,132  |         
|Other intangible assets, net               |                                             |                            | 6,876  |               |        |              | 7,624  |         
|                                           |                                             |                            |        |               |        |              |        |         
|Total assets                               |                                             | $                          | 60,007 |               |        | $            | 72,327 |         
|                                           |                                             |                            |        |               |        |              |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY      
|Current liabilities:                       |                                             |                            |        |               |        |              |        |         
|                                           | Accounts payable                            |                            | $      | 3,935         |        |              | $      | 3,636    |       
|                                           | Accrued payroll and related expenses        |                            |        | 2,450         |        |              |        | 2,599    |       
|                                           | Accrued process development expenses        |                            |        | 971           |        |              |        | 1,209    |       
|                                           | Other accrued current liabilities           |                            |        | 1,635         |        |              |        | 1,507    |       
|                                           | Notes payable                               |                            |        | 221           |        |              |        |         |       
|                                           | Other current liabilities                   |                            |        | 720           |        |              |        | 663      |       
|                                           | Current portion of deferred revenue         |                            |        | 457           |        |              |        | 832      |       
|                                           |                                             |                            |        |               |        |              |        |         
|                                           |                                             | Total current liabilities  |        |               | 10,389 |              |        |          | 10,446 | 
|Deferred revenue, net of current portion   |                                             |                            | 428    |               |        |              | 527    |         
|Stockholders equity:                      |                                             |                            |        |               |        |              |        |         
|                                           | Preferred stock                             |                            |        |              |        |              |        |         |       
|                                           | Common stock and additional paid-in capital |                            |        | 168,297       |        |              |        | 164,300  |       
|                                           | Deferred compensation                       |                            |        | (53           | )      |              |        | (69      | )     
|                                           | Accumulated deficit                         |                            |        | (120,477      | )      |              |        | (109,498 | )     
|                                           | Accumulated other comprehensive income      |                            |        | 1,423         |        |              |        | 6,621    |       
|                                           |                                             |                            |        |               |        |              |        |         
|                                           |                                             | Total stockholders equity |        |               | 49,190 |              |        |          | 61,354 | 
|                                           |                                             |                            |        |               |        |              |        |         
|Total liabilities and stockholders equity |                                             | $                          | 60,007 |               |        | $            | 72,327 |         
|                                           |                                             |                            |        |               |        |              |        |         

See accompanying notes to condensed consolidated financial statements.

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CONNETICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)
(Unaudited)


|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |        |        | 
|------------------------------------------------ | -------------------------------------------- | -------------- | ------ | ------------------ | ------ | ----------------- | ------ | ------ | ----- | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                 |                                              |                |        | Three Months Ended |        | Nine Months Ended
|                                                 |                                              |                |        | September 30,      |        | September 30,    
|                                                 |                                              |                |        |                    |        |                  
|                                                 |                                              |                |        | 2002               |        | 2001              |        | 2002   |       | 2001
|                                                 |                                              |                |        |                    |        |                   |        |        |       |     
|Revenues:                                        |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|                                                 | Product                                      |                | $      | 12,449             |        |                   | $      | 7,650  |       |      | $       | 34,012 |        |   | $       | 21,882 |       
|                                                 | Royalty                                      |                |        | 741                |        |                   |        | 425    |       |      |         | 2,156  |        |   |         | 548    |       
|                                                 | License, contract and other                  |                |        | 451                |        |                   |        | 123    |       |      |         | 1,630  |        |   |         | 1,789  |       
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|                                                 |                                              | Total revenues |        |                    | 13,641 |                   |        |        | 8,198 |      |         |        | 37,798 |   |         |        | 24,219 | 
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Operating costs and expenses:                    |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|                                                 | Cost of product revenues                     |                |        | 1,116              |        |                   |        | 700    |       |      |         | 2,765  |        |   |         | 2,408  |       
|                                                 | Research and development                     |                |        | 7,014              |        |                   |        | 4,460  |       |      |         | 17,667 |        |   |         | 14,433 |       
|                                                 | Selling, general and administrative          |                |        | 8,497              |        |                   |        | 8,761  |       |      |         | 28,823 |        |   |         | 26,071 |       
|                                                 | Acquired in-process research and development |                |        |                   |        |                   |        |       |       |      |         | 2,000  |        |   |         | 1,080  |       
|                                                 | Charge for Relaxin and related liabilities   |                |        |                   |        |                   |        |       |       |      |         | 312    |        |   |         | 5,976  |       
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|                                                 | Total operating costs and expenses           |                |        | 16,627             |        |                   |        | 13,921 |       |      |         | 51,567 |        |   |         | 49,968 |       
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Loss from operations                             |                                              |                | (2,986 | )                  |        |                   | (5,723 | )      |       |      | (13,769 | )      |        |   | (25,749 | )     
|Interest and other income                        |                                              |                | 416    |                    |        |                   | 491    |        |       |      | 1,213   |        |        |   | 2,182   |       
|Gain on sale of investments                      |                                              |                | 516    |                    |        |                   |       |        |       |      | 2,086   |        |        |   | 122     |       
|Gain (loss) on foreign exchange forward contract |                                              |                |       |                    |        |                   |       |        |       |      |        |        |        |   | (554    | )     
|Gain on sale of Ridaura product line             |                                              |                |       |                    |        |                   |       |        |       |      |        |        |        |   | 8,055   |       
|Interest and other expense                       |                                              |                | (308   | )                  |        |                   | (21    | )      |       |      | (444    | )      |        |   | (27     | )     
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Loss before income taxes                         |                                              |                | (2,362 | )                  |        |                   | (5,253 | )      |       |      | (10,914 | )      |        |   | (15,971 | )     
|Income tax expense                               |                                              |                | (128   | )                  |        |                   | (165   | )      |       |      | (65     | )      |        |   | (469    | )     
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Net loss                                         |                                              | $              | (2,490 | )                  |        | $                 | (5,418 | )      |       | $    | (10,979 | )      |        | $ | (16,440 | )     
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Basic and diluted loss per share                 |                                              | $              | (0.08  | )                  |        | $                 | (0.18  | )      |       | $    | (0.36   | )      |        | $ | (0.55   | )     
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       
|Shares used to calculate loss per share          |                                              |                | 30,866 |                    |        |                   | 29,920 |        |       |      | 30,656  |        |        |   | 29,801  |       
|                                                 |                                              |                |        |                    |        |                   |        |        |       |      |         |        |        |   |         |       

See accompanying notes to condensed consolidated financial statements.

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CONNETICS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
(Unaudited)


|                                      |                                                                             |                                              |   |                   |        |      |   |         |        |  
|------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------- | - | ----------------- | ------ | ---- | - | ------- | ------ | -
|                                      |                                                                             |                                              |   | Nine Months Ended
|                                      |                                                                             |                                              |   | September 30,    
|                                      |                                                                             |                                              |   |                  
|                                      |                                                                             |                                              |   | 2002              |        | 2001
|                                      |                                                                             |                                              |   |                   |        |     
|Cash flows from operating activities: |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Net loss                                                                    |                                              | $ | (10,979           | )      |      | $ | (16,440 | )     
|                                      | Adjustments to reconcile net loss to net cash used in operating activities: |                                              |   |                   |        |      |   |         |       
|                                      |                                                                             | Depreciation and amortization                |   |                   | 1,541  |      |   |         | 1,339  |  
|                                      |                                                                             | Gain on sale of investment                   |   |                   | (2,086 | )    |   |         | (122   | )
|                                      |                                                                             | Gain on sale of Ridaura product line         |   |                   |       |      |   |         | (8,055 | )
|                                      |                                                                             | Stock compensation expense                   |   |                   | 170    |      |   |         | 1,568  |  
|                                      |                                                                             | Acquired in-process research and development |   |                   |       |      |   |         | 1,080  |  
|                                      |                                                                             | Loss on foreign exchange forward contract    |   |                   |       |      |   |         | 555    |  
|                                      | Changes in assets and liabilities, excluding effects of acquisition         |                                              |   |                   |        |      |   |         |       
|                                      |                                                                             | Accounts receivable                          |   |                   | (3,141 | )    |   |         | (8     | )
|                                      |                                                                             | Other assets                                 |   |                   | (941   | )    |   |         | (779   | )
|                                      |                                                                             | Accounts payable                             |   |                   | 298    |      |   |         | (1,348 | )
|                                      |                                                                             | Accrued and other current liabilities        |   |                   | (202   | )    |   |         | 1,843  |  
|                                      |                                                                             | Deferred revenue                             |   |                   | (474   | )    |   |         | 101    |  
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Net cash used in operating activities                                       |                                              |   | (15,814           | )      |      |   | (20,266 | )     
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|Cash flows from investing activities: |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Purchases of short-term investments                                         |                                              |   | (26,151           | )      |      |   | (40,439 | )     
|                                      | Sales and maturities of short-term investments                              |                                              |   | 41,595            |        |      |   | 26,289  |       
|                                      | Purchases of property and equipment                                         |                                              |   | (3,331            | )      |      |   | (762    | )     
|                                      | Proceeds from sale of Ridaura product line                                  |                                              |   |                  |        |      |   | 8,979   |       
|                                      | Acquisition of a business, net of cash acquired                             |                                              |   |                  |        |      |   | (16,611 | )     
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Net cash provided by (used in) investing activities                         |                                              |   | 12,113            |        |      |   | (22,544 | )     
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|Cash flows from financing activities: |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Restricted cash                                                             |                                              |   | 1,429             |        |      |   | (1,859  | )     
|                                      | Payment of notes payable                                                    |                                              |   | (322              | )      |      |   | (750    | )     
|                                      | Payments on obligations under capital leases                                |                                              |   |                  |        |      |   | (37     | )     
|                                      | Proceeds from issuance of common stock, net of issuance costs               |                                              |   | 3,844             |        |      |   | 1,020   |       
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Net cash provided by (used in) financing activities                         |                                              |   | 4,951             |        |      |   | (1,626  | )     
|                                      | Effect of foreign currency exchange rates on cash and cash equivalents      |                                              |   | 48                |        |      |   | (3      | )     
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Net change in cash and cash equivalents                                     |                                              |   | 1,298             |        |      |   | (44,439 | )     
|                                      | Cash and cash equivalents at beginning of period                            |                                              |   | 3,603             |        |      |   | 58,314  |       
|                                      |                                                                             |                                              |   |                   |        |      |   |        
|                                      | Cash and cash equivalents at end of period                                  |                                              | $ | 4,901             |        |      | $ | 13,875  |       
|                                      |                                                                             |                                              |   |                   |        |      |   |        

See accompanying notes to condensed consolidated financial statements.

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(Unaudited)

1. Basis of Presentation and Policies

We have prepared the accompanying unaudited condensed consolidated
financial statements of Connetics Corporation (Connetics) in accordance with
generally accepted accounting principles 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. In our opinion, all adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation have been
included. Operating results for the nine months ended September 30, 2002 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2002. Certain prior year balances have been reclassified for
comparative purposes.

These interim results are not necessarily indicative of the results that
should be expected for the full year. For a better understanding of Connetics
and its financial statements, we recommend reading these unaudited, condensed,
consolidated financial statements and notes in conjunction with audited
financial statements and notes to those financial statements for the year ended
December 31, 2001, which are included in our Annual Report on Form 10-K/A as
filed with the Securities and Exchange Commission.

Principles of Consolidation

Effective April 20, 2001, we acquired Soltec Research Pty Ltd., or Soltec.
In October 2002, we changed Soltecs name to Connetics Australia Pty Ltd. The
accompanying unaudited condensed consolidated financial statements include the
accounts of Connetics and its wholly-owned subsidiary, Connetics Australia,
since April 20, 2001, the day following the acquisition. All significant
intercompany accounts and transactions are eliminated in consolidation.

Use of Estimates

Management makes estimates and assumptions when preparing financial
statements in conformity with accounting principles generally accepted in the
United States. These estimates and assumptions affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.

Revenue Recognition

Product Sales.We recognize revenue from product sales when there is
persuasive evidence that an arrangement exists, when title has passed,
generally upon shipment, the price is fixed or determinable, and collection of
the resulting receivable is reasonably assured. We recognize product revenue
net of allowances for estimated returns, rebates, and chargebacks. We are
obligated to accept from customers the return of pharmaceuticals that have
reached their expiration date. To date we have not experienced
significant returns of expired product. Product shipping and handling costs are
included in cost of product revenues.

Royalty Revenue. Royalties from licensees are based on third-party sales.
We recognize royalties in the quarter in which the royalty payment is either
received from the licensee or may be reasonably estimated, which is typically
one quarter following the related sale by the licensee.

Royalty expenses directly related to product sales are classified in cost
of product revenues. Royalty expenses related to agreements with Connetics
Australia are eliminated in consolidation.

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 obligation exists, and for which Connetics has no continuing
involvement, on the earlier of when the payments are received or when
collection is assured.

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

We recognize revenue from non-refundable upfront license fees ratably over
the period in which we have continuing development obligations when, at the
time the agreement is executed, there remains significant risk due to the
incomplete stage of the products development. Revenue associated with
substantial at risk performance milestones, as defined in the respective
agreements, is recognized based upon the achievement of the milestones. We
recognize revenue under R&D cost reimbursement contracts as the related costs
are incurred. Advance payments that we receive in excess of the amount earned
are classified as deferred revenue until they are earned.

Cash Equivalents and Short-term Investments

Cash and cash equivalents consist of cash on deposit with banks and money
market 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 and that mature within one year from the balance sheet date are
considered to be short-term investments. Short-term investments are classified
as available for sale at the time of purchase and are carried at fair value,
with unrealized gains and losses reported as a separate component of
stockholders equity. The cost of securities sold is based on 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 investment of 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 consolidated statement of operations and were immaterial for
the nine months ended September 30, 2002 and the year ended December 31, 2001.

Income Taxes

We recognized income tax expense of $128,000 for the three-month period
ended September 30, 2002 related to a foreign tax provision recorded by our
Australian subsidiary, Connetics Australia. We recognized a net income tax
expense of $65,000 for the nine month period ended September 30, 2002, that
reflects the foreign tax provision recorded by Connetics Australia of $605,000
reduced by the tax benefit of $540,000 previously recorded in the first quarter
of 2002. According to the provisions of the U.S. Job Creation and Worker
Assistance Act of 2002 enacted on March 9, 2002, taxpayers are allowed to carry
back net operating losses generated in 2001 and 2002 to offset alternative
minimum tax paid in the last five years. For the tax year ending December 31,
2001, the Company incurred a net operating loss of approximately $25 million of
which a portion of the net operating loss may be carried back to offset
approximately $540,000 of alternative minimum tax incurred in the tax year
ending December 31, 2000. We recognized income tax expense of $165,000 for the
three-month period ended September 30, 2001 and $469,000 for the nine-month
period ended September 30, 2001, all related to foreign tax provisions recorded
by Connetics Australia.

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets, generally three to five years. Leasehold
improvements and assets acquired under capital lease arrangements are amortized
over the shorter of the estimated useful lives of the assets or the lease term.

Impairment of Long Lived Assets

We periodically perform reviews to determine if the carrying value of
long-term assets (goodwill, purchased intangibles, property and equipment) is
impaired. The reviews look for existence of facts and circumstances, either
internal or external, which indicate that the carrying value of the asset
cannot be recovered. No such impairment has been indicated to date. If in the
future management determines the existence of impairment indicators, we would
use undiscounted cash flows to initially determine whether impairment should be
recognized. If necessary, we would perform subsequent calculations to measure
the amount of the 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, the fair value would be calculated 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 assumptions and projections at the time. Please
see discussion below under recent accounting pronouncements regarding SFAS 144
implementation.

Recent Accounting Pronouncements

SFAS 142.In July 2001 the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142). Under SFAS 142, effective January 1, 2002, we
are no longer 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 will continue
to be amortized over their useful lives. We adopted SFAS 142 effective January
1, 2002 and reclassified amounts to goodwill that were previously allocated to
assembled workforce. When we adopted SFAS 142, we ceased amortizing goodwill
previously representing an expense of approximately $700,000 per year. In
conjunction with the implementation of SFAS 142 we performed an impairment test
of goodwill as of January 1, 2002, which did not result in an impairment charge
at transition. We continue to monitor the carrying value of goodwill through
the required annual impairment tests. See also Note 4 Goodwill and Other
Intangible Assets.

SFAS 144. In October 2001, the FASB issued Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144), which establishes a single accounting model
for the impairment or disposal of long-lived assets, including discontinued
operations. SFAS 144 supercedes SFAS 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. SFAS 144
requires that long-lived assets to be disposed of by sale be measured at the
lower of carrying amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS 144 excludes from
the definition of long-lived assets goodwill and other intangibles that are not
amortized in accordance with SFAS 142. SFAS 144 also expands the reporting of
discontinued operations to include components of an entity that have been or
will be disposed of rather than limiting such discontinuance to a segment of a
business. SFAS 144 is effective for years ending after December 15, 2001. We
adopted SFAS 144 effective January 1, 2002, and experienced no impact on our
financial position or results of operations, to date as a result of the
adoption of this pronouncement.

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

SFAS 146. In July 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, Accounting for Costs Associated with Exit and Disposal
Activities (SFAS 146). This statement revises the accounting for exit and
disposal activities under Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity. A formal commitment to a plan to exit an activity or dispose
of long-lived assets will no longer be sufficient to record a one-time charge
for most exit and disposal costs. Instead, companies will record exit or
disposal costs when they are incurred and can be measured at fair value, rather
than when the company commits to such an activity. The provisions of SFAS 146
are effective prospectively for exit or disposal activities initiated after
December 31, 2002. Upon the adoption of SFAS 146, previously issued financial
statements shall not be restated. We will assess the impact of adoption of
SFAS 146 based on the nature of transactions ongoing at the adoption date.

2. Net Income (Loss) Per Share

We compute basic net income (loss) per common share by dividing net income
(loss) applicable to common stockholders by the weighted average of common
shares outstanding during the period. We compute diluted net income per share
using the weighted average of common and diluted equivalent stock options and
warrants outstanding during the period. We excluded all stock options and
warrants from the calculation of diluted loss per common share for the nine
months ended September 30, 2002 and September 30, 2001 because these securities
are anti-dilutive during these periods.

3. Comprehensive Loss

During the three and nine month periods ended September 30, 2002, total
comprehensive loss amounted to $2.4 million and $16.2 million, respectively,
compared to a comprehensive loss of $5.1 million and $17.5 million for the
comparable periods in 2001. The components of comprehensive loss for the three
and nine month periods ended September 30, 2002 and September 30, 2001 are as
follows:

|                                                                                                             |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                             |  | Three months ended |        | Nine months ended
|                                                                                                             |  | September 30,      |        | September 30,    
|                                                                                                             |  |                    |        |                  
|                                                                                                             |  | 2002               |        | 2001              |  | 2002 |        | 2001
|                                                                                                             |  |                    |        |                   |  |      |        |     
|                                                                                                             |  | (In thousands)    
|Net loss                                                                                                     |  | $                  | (2,490 | )                 |  | $    | (5,418 | )    |  | $ | (10,979 | ) |  | $ | (16,440 | )
|Foreign currency translation adjustment                                                                      |  |                    | (31    | )                 |  |      | (2     | )    |  |   | 48      |   |  |   | (3      | )
|Change in unrealized gain (loss) on
securities, net of reclassification
adjustments for realized gain (loss) |  |                    | 94     |                   |  |      | 348    |      |  |   | (5,246  | ) |  |   | (1,064  | )
|                                                                                                             |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                                           |  | $                  | (2,427 | )                 |  | $    | (5,072 | )    |  | $ | (16,177 | ) |  | $ | (17,507 | )
|                                                                                                             |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |         |  

4. Goodwill and Other Intangible Assets

In April 2001, we acquired Connetics Australia (then called Soltec) and
accounted for the acquisition using the purchase method of accounting.
Accordingly, the purchase price was allocated to the assets acquired and
liabilities assumed based on their estimated fair values on the acquisition
date. We purchased all of the shares of Connetics Australias capital stock
for cash of $16.9 million plus transaction costs of approximately $250,000.
The purchase price was allocated to: existing technology of $6.8 million,
goodwill of $6.6 million, tangible net assets assumed of $1.3 million, patents
and core technology of $1.2 million, acquired in-process research and
development of $1.1 million, and assembled workforce of $150,000.

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

When we adopted SFAS 142 effective January 1, 2002 we reclassified amounts
to goodwill that were previously allocated to assembled workforce. At that
time, we ceased amortizing goodwill previously representing an expense of
approximately $700,000 per year.

We will continue to amortize other intangible assets that meet the
criteria for separate recognition from goodwill over their useful lives. We
completed a transitional goodwill impairment test as of January 1, 2002 in the
second quarter of fiscal 2002, which did not result in an impairment charge.
SFAS 142 also requires that goodwill be tested for impairment on an annual
basis or more frequently if indicators of potential impairment exist. We are
still in the process of selecting the date on which to perform the annual test.

Changes in the carrying amount of goodwill for the nine-month period ended
September 30, 2002, is as follows (in thousands):

|                                                                             |  |   |       | 
|---------------------------------------------------------------------------- |  | - | ----- | 
|Balance as of December 31, 2001                                              |  | $ | 6,132 | 
|Reclassification of net intangible asset  assembled workforce into goodwill |  |   | 139   | 
|                                                                             |  |   |       | 
|Balance as of September 30, 2002                                             |  | $ | 6,271 | 
|                                                                             |  |   |       | 

The components of our other intangible assets at September 30, 2002, are
as follows (in thousands):

|                    |  |                |       |              |  |     |        |   |  |   |       | 
|------------------- |  | -------------- | ----- | ------------ |  | --- | ------ | - |  | - | ----- | 
|                    |  | Gross Carrying |       | Accumulated  |  |     |        |  
|                    |  | Amount         |       | Amortization |  | Net
|                    |  |                |       |              |  |    
|Existing technology |  | $              | 6,810 |              |  | $   | (993   | ) |  | $ | 5,817 | 
|Patents             |  |                | 1,307 |              |  |     | (248   | ) |  |   | 1,059 | 
|                    |  |                |       |              |  |     |        |   |  |   |       | 
|Total               |  | $              | 8,117 |              |  | $   | (1,241 | ) |  | $ | 6,876 | 
|                    |  |                |       |              |  |     |        |   |  |   |       | 

Amortization expense for our other intangible assets was $202,000 for the
three months ended September 30, 2002 and $609,000 for the nine months ended
September 30, 2002. For the comparable periods of the previous year we
reported, $191,000 and $381,000, respectively. The second quarter of 2001 was
the first quarter during 2001 that we recognized amortization expense.

The expected future amortization expense of our other intangible assets is
as follows (in thousands):

|                                                   |  |                      |       | 
|-------------------------------------------------- |  | -------------------- | ----- | 
|                                                   |  | Amortization Expense
|                                                   |  |                     
|For the nine month period ended September 30, 2002 |  | $                    | 609   | 
|Remaining three months in 2002                     |  |                      | 201   | 
|                                                   |  |                      |       | 
|Total for the year ended December, 31, 2002        |  | $                    | 810   | 
|For the year ended December 31, 2003               |  | $                    | 805   | 
|For the year ended December 31, 2004               |  | $                    | 805   | 
|For the year ended December 31, 2005               |  | $                    | 805   | 
|For the year ended December 31, 2006               |  | $                    | 805   | 
|For the year ended December, 31 2007               |  | $                    | 805   | 
|Thereafter                                         |  | $                    | 2,650 | 

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

SFAS 142 does not permit restatement of previously issued financial
statements. The following table sets forth pro formaoperating results and per
share information for Connetics for the three and nine month periods ended
September 30, 2001, as adjusted to exclude goodwill amortization expense.

|                                                                 |                                 |   |                    |      |                    |   |         |      | 
|---------------------------------------------------------------- | ------------------------------- | - | ------------------ | ---- | ------------------ | - | ------- | ---- | 
|                                                                 |                                 |   | Three Months       |      | Nine Months       
|                                                                 |                                 |   | Ended              |      | Ended             
|                                                                 |                                 |   | September 30, 2001 |      | September 30, 2001
|                                                                 |                                 |   |                    |      |                   
|Reported net loss                                                |                                 | $ | (5,418             | )    |                    | $ | (16,440 | )   
|                                                                 | Add back: goodwill amortization |   |                    | 168  |                    |   |         | 309  | 
|                                                                 |                                 |   |                    |      |                    |   |         |     
|Net loss excluding goodwill amortization                         |                                 |   | (5,250             | )    |                    |   | (16,131 | )   
|                                                                 |                                 |   |                    |      |                    |   |         |     
|Reported basic and diluted loss per share                        |                                 | $ | (0.18              | )    |                    | $ | (0.55   | )   
|                                                                 | Add back: goodwill amortization |   |                    | 0.00 |                    |   |         | 0.01 | 
|                                                                 |                                 |   |                    |      |                    |   |         |     
|Basic and diluted loss per share excluding goodwill amortization |                                 | $ | (0.18              | )    |                    | $ | (0.54   | )   
|                                                                 |                                 |   |                    |      |                    |   |         |     
|Shares used to calculate loss per share                          |                                 |   | 29,920             |      |                    |   | 29,801  |     

5. Licensing Agreement with Pharmacia

At the end of December 2001, we entered into an agreement granting
Pharmacia Corporation exclusive global rights, excluding Japan, to our
proprietary foam drug-delivery technology for use with Pharmacias Rogaine®
hair loss treatment. Under the agreement, Pharmacia paid an initial licensing
fee. They will also make milestone payments as well as royalty payments on
product sales. Pharmacia will be responsible for product development
activities and costs, and we have agreed to provide certain pre-clinical
development support. In connection with this agreement, we recognized $125,000
of contract revenue in the three month period ended September 30, 2002 from
amounts previously received and deferred. We recognized a total of $625,000 of
contract revenue in the nine month period ended September 30, 2002 related to
this agreement.

6. License for Liquipatch

In March 2002, Connetics Australia expanded its exclusive global license
to Novartis Consumer Health S.A. to cover Liquipatch drug-delivery system for
use in topical antifungal applications. Novartis exercised its right to expand
the license agreement, and will continue to be responsible for all product
development costs, and pay Connetics Australia license fees, milestone payments
and royalties on future product sales. We recognized contract revenue related
to this agreement of $580,000 in the quarter ended March 31, 2002 and $0 in
each of the quarters ended June 30, 2002 and September 30, 2002.

7. DPT Laboratories, Ltd.

In March 2002, we entered into an agreement with DPT Laboratories, Ltd. to
construct an aerosol filling line at DPTs plant on their premises in Texas.
The agreement is retroactive to November 1, 2001, to cover certain
pre-construction payments we made in December 2001. We are responsible for the
cost of the construction and the related equipment, which is currently expected
to be approximately $2.6 million. We are also obligated to pay rent for the
facility during the 10 year term of the agreement. To date we have incurred
approximately $56,000 in annual rent expense related to this agreement. DPT
and Connetics simultaneously entered into a manufacturing agreement

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CONNETICS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002
(Unaudited)

for DPT to manufacture and fill Connetics commercial aerosol products.
We are also party to a separate research and development agreement for the
manufacture of clinical supplies for our aerosol products and product
candidates.

8. Yamanouchi Europe B.V.

In May 2002, we entered into an agreement with Yamanouchi Europe B.V. to
license Velac® gel (a combination of 1% clindamycin, and 0.025% tretinoin). We
have licensed exclusive rights to develop and commercialize the product in the
U.S. and Canada, and have licensed non-exclusive rights in Mexico. Under the
terms of the agreement, we paid Yamanouchi an initial $2 million licensing fee
that we recognized as in-process research and development expense during the
quarter ended June 30, 2002, because the product remains in clinical
development and has no alternative future use.

9. Subsequent Event

On October 28, 2002, we announced that the U.S. Food and Drug
Administration (FDA) issued an approvable letter to Connetics for its
supplemental New Drug Application (sNDA) to expand label claims for OLUX to
include the treatment of non-scalp psoriasis. Final approval is subject to
finalization of ongoing discussions regarding product labeling. We continue to
anticipate final approval of the sNDA by calendar year end. OLUX is currently
approved as a treatment for steroid-responsive scalp dermatoses.

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|        |  |                                                                                      
|------- |  | -------------------------------------------------------------------------------------
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results
of Operations

This MD&A should be read in conjunction with the MD&A included in our
Annual Report on Form 10-K for the year ended December 31, 2001, 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 mentioned in this Report  for
example, governmental regulation and competition in our industry  will be
important in determining future results. No forward-looking statement can be
guaranteed, and actual results may vary materially from those anticipated in
any forward-looking statement. 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 in our Annual Report on Form 10-K/A. Our historical operating
results are not necessarily indicative of the results to be expected in any
future period.

Overview

Our 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 two pharmaceutical products, Luxíq® and OLUX®. Both products have
clinically proven therapeutic advantages and we are providing quality customer
service to physicians through our experienced sales and marketing staff. In
December 2001, we filed a supplemental New Drug Application, or sNDA, with the
FDA, requesting clearance to market OLUX for expanded usage. On October 28,
2002, we announced that the FDA issued an approvable letter in connection with
the sNDA to expand label claims for OLUX to include the treatment of non-scalp
psoriasis. Final approval is subject to finalization of ongoing discussions
regarding product labeling. We continue to anticipate final approval of the
sNDA by calendar year end.

During the second quarter of 2002, we announced the initiation of two
Phase III clinical programs. The first program is for Actiza, a formulation
of 1% clindamycin in the Companys proprietary foam delivery system, for the
treatment of acne. The clinical program for Actiza consists of two Phase III
trials in which patients will be treated for 12 weeks in a double-blinded
placebo and active controlled format. Subject to successful outcome of these
trials, we intend to submit a new Drug Application to the FDA in late 2003.
The second clinical program is for Extina, a formulation of 2% ketoconazole in
the Companys proprietary foam delivery system, for the treatment of seborrheic
dermatitis. The four week, double-blinded, placebo and active controlled trial
is designed to include 600 patients at 28 centers. Subject to a successful
outcome of this trial, we intend to submit a New Drug Application to the FDA in
2003.

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Results of Operations

Revenues

|                                             |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |        |        |        | 
|-------------------------------------------- | ------------------------------ | -------------- | -------------- | ------ | ------------------ | ------ | ----------------- | ----- | ----- | ----- | ----- | ------ | ------ | ------ | ----- | ------ | ------ | ------ | 
|                                             |                                |                |                |        | Three Months Ended |        | Nine months Ended
|                                             |                                |                |                |        | September 30,      |        | September 30,    
|                                             |                                |                |                |        |                    |        |                   |      
|                                             |                                |                |                |        | 2002               |        | 2001              |       | 2002  |       | 2001 
|                                             |                                |                |                |        |                    |        |                   |       |       |       |      
|                                             |                                |                |                |        | (In thousands)    
|Revenues                                     |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |       
|                                             | Product:                       |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |        |       
|                                             |                                | OLUX®          |                |        | 8,532              |        |                   |       | 4,100 |       |       |        | 23,059 |        |       |        | 9,022  |       
|                                             |                                | Luxíq®         |                |        | 3,875              |        |                   |       | 3,500 |       |       |        | 10,849 |        |       |        | 10,795 |       
|                                             |                                | Other          |                |        | 42                 |        |                   |       | 50    |       |       |        | 104    |        |       |        | 50     |       
|                                             |                                | Ridaura®       |                |        |                   |        |                   |       |      |       |       |        |       |        |       |        | 2,015  |       
|                                             |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |       
|                                             | Total product revenues         |                |                | 12,449 |                    |        |                   | 7,650 |       |       |       | 34,012 |        |        |       | 21,882 |       
|                                             | License, contract and royalty: |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |        |       
|                                             |                                | Royalty        |                |        | 741                |        |                   |       | 425   |       |       |        | 2,156  |        |       |        | 548    |       
|                                             |                                | Novartis       |                |        |                   |        |                   |       |      |       |       |        | 580    |        |       |        |       |       
|                                             |                                | Pharmacia      |                |        | 125                |        |                   |       |      |       |       |        | 625    |        |       |        |       |       
|                                             |                                | InterMune      |                |        | 250                |        |                   |       |      |       |       |        | 250    |        |       |        | 771    |       
|                                             |                                | Celltech       |                |        |                   |        |                   |       |      |       |       |        |       |        |       |        | 756    |       
|                                             |                                | Other contract |                |        | 76                 |        |                   |       | 123   |       |       |        | 175    |        |       |        | 262    |       
|                                             |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |       
|Total license, contract and royalty revenues |                                |                | 1,192          |        |                    |        | 548               |       |       |       | 3,786 |        |        |        | 2,337 |       
|                                             |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |       
|                                             |                                |                | Total revenues |        |                    | 13,641 |                   |       |       | 8,198 |       |        |        | 37,798 |       |        |        | 24,219 | 
|                                             |                                |                |                |        |                    |        |                   |       |       |       |       |        |        |        |       |       

Our product revenues were $12.4 million for the three months ended
September 30, 2002, and $34.0 million for the nine months ended September 30,
2002, compared to $7.7 million and $21.9 million for the three and nine months
ended September 30, 2001. The increase in total product revenues for the three
and nine months ended September 30, 2002 was primarily due to continued sales
growth in the number of units of OLUX sold. In April 2001 we sold our rights
to Ridaura, including inventory, to Prometheus Laboratories, Inc. for $9.0
million in cash plus a royalty on annual sales in excess of $4.0 million for
the next five years. We have recognized zero royalty revenue to date as a
result of this transaction. We recognized product revenue on sales of Ridaura
until the April 2001 sale of that product line to Prometheus.

Contract and royalty revenues were $1.2 million for the three month period
ended September 30, 2002 and $3.8 million for the nine month period ended
September 30, 2002, compared to $548,000 and $2.3 million for the three and
nine months ended September 30, 2001. The increase in year-to-date contract
and royalty revenue is attributable to income received under contract and
royalty agreements entered into by Connetics Australia, following the
acquisition of that company in April 2001. We expect contract revenues to
fluctuate significantly depending on achieving milestones under existing
agreements, and on new business opportunities.

Effective April 1, 2000 we assigned to InterMune, Inc. (formerly InterMune
Pharmaceuticals, Inc.) our remaining rights and obligations under a license
with Genentech for Actimmune and the corresponding supply agreement. In
exchange, InterMune paid us approximately $5.2 million, which included the
prepayment of a $1.0 million obligation owed in 2002. An additional $942,000
was paid the end of March 2001, and was offset by related product rebates and
chargebacks of $171,000. In August 2002, we entered into an agreement with
InterMune, Inc. to terminate our exclusive option for certain rights in the
dermatology field in exchange for an up-front, non-refundable payment of
$250,000. We recognized the full amount of this revenue in the three months
ended September 30, 2002.

Cost of Product Revenues

Our cost of product revenues includes the costs of manufacturing Luxíq and
OLUX and (until April 2001) Ridaura, royalty payments based on a percentage of
our product revenues and product freight and distribution costs from CORD
Logistics, Inc., the third party that handles all of our product distribution
activities. Miza Pharmaceuticals (formerly CCL Pharmaceuticals) manufactures
Luxíq and OLUX for us in England. We qualified one new vendor and are in the
process of qualifying one additional vendor to manufacture these products for
us in the United States. We recorded costs of product revenues of $1.1 million
and $2.8 million, respectively for the three

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and nine months ended September 30, 2002, compared to $700,000 and $2.4
million for the three and nine months ended September 30, 2001. The cost of
product revenues as a percent of product revenues decreased for the nine month
period ended September 30, 2002 compared to the nine month period ended
September 30, 2001. This is primarily due to the change in product mix arising
from the discontinued sales of Ridaura effective April 1, 2001.

Research and Development

Research and development expenses include salaries and benefits,
laboratory supplies, external research programs, clinical studies and allocated
overhead costs such as rent, supplies and utilities. In addition to clinical
site payments, clinical costs include costs of manufacturing clinical supplies
and costs associated with product stability studies. Research and development
expenses were $7.0 million for the three month period ended September 30, 2002,
and $17.7 million for the nine month period ended September 30, 2002, compared
to $4.5 million and $14.4 million for the comparable periods in 2001. During
the second quarter of 2002, we announced the initiation of two Phase III
clinical programs. The first program is for Actiza, a formulation of 1%
clindamycin in the Companys proprietary foam delivery system, for the
treatment of acne. The clinical program for Actiza consists of two Phase III
trials in which patients will be treated for 12 weeks in a double-blinded
placebo and active controlled format. Subject to successful outcome of these
trials, we intend to submit a New Drug Application to the FDA in late 2003.
The second clinical program is for Extina, a formulation of 2% ketoconazole in
the Companys proprietary foam delivery system, for the treatment of seborrheic
dermatitis. The four week, double-blinded, placebo and active controlled trial
is designed to include 600 patients at 28 centers. Subject to a successful
outcome of this trial, we intend to submit a New Drug Application to the FDA in
2003.

In addition to our commercial business, we own the rights to a recombinant
form of a natural hormone called relaxin. On May 23, 2001, we announced our
decision to reduce our investment in the development of relaxin and to search
for licensing opportunities or other strategic alternatives for the product.
We eliminated 27 employee positions related to relaxin. In the second quarter
of 2001, we recorded a $6.0 million charge, which represented $0.5 million
accrued in connection with the reduction in workforce as well as $5.5 million
for our estimate of our potential exposure for the wind down of relaxin
development contracts. In December 2001, we reached an amicable settlement
related to our relaxin manufacturing agreement with Boehringer Ingelheim. As a
result of this settlement, in the fourth quarter of 2001, we reversed $4.9
million of the amount we originally accrued in the second quarter of 2001. The
net amount recognized as a one-time charge for relaxin and related liabilities
in the year ended December 31, 2001 was $1.1 million. In June 2002, we
recorded an additional $312,000 expense representing the final payment due for
satisfaction of the final deliverables under the Boehringer Ingelheim
settlement.

We expect research and development expenses for our internally funded
activities to remain at the same level or increase for the next few quarters,
as we continue to develop our current products for new indications, as well as
continue to engage in new product discovery and development activities,
including the clinical trial activity stated above. We are unable to predict
the total level of spending on any particular development program because of
the uncertainty of clinical study programs and the timing of FDA approval.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $8.5 million for the
three months ended September 30, 2002, and $28.8 million for the nine months
ended September 30, 2002, compared to $8.8 million and $26.1 million for the
three and nine month periods September 30, 2001. The increase in expenses in
the nine month period ended September 30, 2002 was due to increased headcount
and increased market research and sales promotions costs related to the launch
of OLUX and Luxíq 50 gram units, OLUX and Luxíq physician samples, higher sales
commissions resulting from increased sales levels, as well as the amortization
of intangible assets associated with the acquisition of Connetics Australia,
over their estimated useful lives.

We expect selling, general and administrative expenses to remain
consistent or be slightly higher in 2002 due to the commencement of marketing
efforts relating to the anticipated outcome of clinical trials for antifungal
foam and anti-acne foam.

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Acquired In-Process Research and Development

In May 2002, we entered into an agreement with Yamanouchi Europe B.V. to
license Velac® gel (a first in class combination of 1% clindamycin, and 0.025%
tretinoin). We have licensed exclusive rights to develop and commercialize the
product in the U.S. and Canada, and have licensed non-exclusive rights in
Mexico. Under the terms of the agreement, we paid Yamanouchi an initial $2.0
million licensing fee, which we recorded as an in-process research and
development expense during the quarter ended June 30, 2002, because the product
remains in clinical development and has no alternative future use.

In April 2001, we completed the acquisition of Soltec for approximately
$16.9 million. In October 2002, we changed Soltecs name to Connetics
Australia Pty Ltd. We accounted for this transaction using the purchase method
and allocated $1.1 million of the purchase price to in-process research and
development, based on an independent valuation, and the balance to the tangible
assets of Connetics Australia, existing developed technology and goodwill.
Acquired in-process research and development consisted of several projects,
which involved the use of novel technologies to improve the delivery of drugs.
The projects were and still are in various stages of development and are
subject to substantial risks, and did not have alternative future uses. The
value of the in-process research and development was determined by an
independent valuation expert using a discounted cash flow analysis with a rate
of 20%. In addition, the stage of completion of each project was considered in
determining the value.

Sale of Ridaura

In April 2001, we sold our rights to Ridaura® including inventory and
identified liabilities to Prometheus Laboratories Inc. for $9.0 million in cash
plus a royalty on annual sales in excess of $4.0 million for the next five
years. Ridaura® is a prescription pharmaceutical product for the treatment of
rheumatoid arthritis. We accrued approximately $900,000 for transaction
related costs and contractual liabilities incurred as of the date of the sale.
After recognizing the above amounts, we recorded a gain on $8.1 million on this
transaction.

Gain on sale of investments

Gain on the sale of investments was $516,000 for the three month period
ended September 30, 2002 and $2.1 million for the nine month period ended
September 30, 2002, compared to $0 and $122,000 for comparable periods in 2001.
The gains are the result of sales of shares of InterMune, Inc. stock held by
Connetics.

Interest and other income (expense)

Interest and other income were $416,000 for the three month period ended
September 30, 2002, and $1.2 million for the nine month period ended September
30, 2002, compared with $491,000 and $2.2 million for the comparable periods in
2001. The decrease in interest income during the three and nine month periods
ended September 30, 2002 is due to lower interest rates during this period
compared to the same period in 2001, as well as lower cash and investment
balances. Other income also includes amounts received under sublease
agreements that were entered into in the third quarter of 2001 and the second
quarter of 2002.

Interest and other expense was $308,000 for the three month period ended
September 30, 2002, and $444,000 for the nine month period ended September 30,
2002, compared with $21,000 and $27,000 for the same periods in 2001. The
increase in interest and other expense for three and nine months ended
September 30, 2002 compared to the same period in 2001 is primarily the result
of the financing of business and director and officer liability insurance,
which in prior years we paid for in cash instead of financed. Other expense
also includes rents and maintenance related expenses paid on leased properties that are now subleased to third
parties.

Gain (loss) on foreign exchange forward contract

In February 2001, Connetics entered into a foreign exchange forward
contract in connection with the Connetics Australia acquisition. During the
first quarter of 2001 we recorded a loss on this contract of $1.4 million.
This loss was partially offset in the second quarter of 2001 when a gain of
$840,000 was recorded on this same contract. The contract was terminated at
the closing date of the Connetics Australia acquisition in the second quarter
of 2001.

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Income Taxes

We recognized income tax expense of $128,000 for the three month period
ended September 30, 2002 related to a foreign tax provision recorded by our
Australian subsidiary, Connetics Australia. We recognized a net income tax
expense of $65,000 for the nine month period ended September 30, 2002, that
reflects the foreign tax provision recorded by Connetics Australia of $605,000
reduced by a tax benefit of $540,000 recorded in the first quarter of 2002.
According to the provisions of the U.S. Job Creation and Worker Assistance Act
of 2002 enacted on March 9, 2002, taxpayers are allowed to carry back net
operating losses generated in 2001 and 2002 to offset alternative minimum tax
paid in the last five years. For the tax year ending December 31, 2001, the
Company incurred a net operating loss of approximately $25 million of which a
portion of the net operating loss may be carried back to offset approximately
$540,000 of alternative minimum tax incurred in the tax year ending December
31, 2000. We recognized income tax expense of $165,000 for the three month
period ended September 30, 2001, and $469,000 for the nine month period ended
September 30, 2001, all related to foreign tax provisions recorded by Connetics
Australia.

Net Loss

We expect to incur losses for the remainder of 2002 and into 2003. These
losses are expected to fluctuate from period to period based on timing of
product revenues, sales and marketing expenses, clinical material purchases,
clinical trial expenses, and possible acquisitions of new products and
technologies.

Liquidity and Capital Resources

Sources and Use of Cash.We have financed our operations to date
primarily through proceeds from equity financings, sale of investments,
collaborative arrangements with corporate partners, bank loans, gross margins
and product revenues. At September 30, 2002, cash, cash equivalents and
short-term investments totaled $29.0 million compared to $46.3 million at
December 31, 2001. Our cash balances are held in a variety of interest-bearing
instruments including high-grade corporate bonds, commercial paper and money
market accounts.

Cash flows from operating activities.Cash used in operations for the
nine month period ended September 30, 2002 and September 30, 2001 was $ 15.8
million and $ 20.3 million, respectively. Cash used in operations for the
first nine months of 2002 was comprised primarily of net loss of $11.0, an
increase in accounts receivable of $3.1 million and $2.1 million gain on the
sale of investments, offset by depreciation and amortization of $1.5 million.

Cash flows from investing activities.Investing activities provided $12.1
million in cash during the nine month period ended September 30, 2002, due
primarily to the sale of $41.6 million of short-term investments offset by
$26.2 million of short term investment purchases. In addition, we invested
approximately $2.5 million in construction and equipment costs related to the
aerosol filling line at DPT and to the addition of lab space at Connetics
Australia.

Cash flows from financing activities.Financing activities provided $5.0
million for the nine months ended September 30, 2002, including $1.4 million
representing the release of previously restricted certificates of deposit from
our controlled disbursements account, security for building rent, and
collateral on certain officers personal bank loans. We also received $3.8
million in proceeds from the issuance of common stock, net of costs, during the
nine month period ended September 30, 2002.

Working Capital.Working capital decreased by $14.1 million to $29.9
million at September 30, 2002 from $44.0 million at December 31, 2001. Our
working capital primarily decreased as we used cash in operations and in the
construction of the aerosol filling line at DPT.

Contractual Obligations and Commercial Commitments.There have been no material changes in the contractual
obligations and commercial commitments since December 31, 2001.
As of September 30, 2002, we had no off-balance sheet financial
arrangements and have no significant commitments other than those
disclosed in

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the Annual Report on Form 10-K/A for the year ended December 31, 2001,
consisting primarily of operating lease agreements for our facilities as well
as some purchase commitments under our contract manufacturing agreements.

Restricted Cash and Cash Equivalents.In the nine month period ended
September 30, 2002, $1.4 million was released from previously restricted
certificates of deposit from our controlled disbursements account, security for
building rent, and collateral on certain officers personal bank loans. As of
September 30, 2002, $710,000 of our total cash and cash equivalents balance was
restricted cash, held in various certificates of deposit, for specific
purposes.

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 building and qualifying a new aerosol
filling facility, 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. Therefore such capital uses and requirements
may increase in future periods. As a result, we may require additional funds
prior to reaching profitability and may attempt to raise additional funds
through equity or debt financings, collaborative arrangements with corporate
partners or from other sources. We are currently evaluating a number of
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 issuing stock in connection with the transaction.

We currently have no commitments for any additional financings. If we
need to raise additional money to fund our operations, funding may not be
available to us on acceptable terms, or at all. If we are unable to raise
additional funds when needed, we may not be able to market our products as
planned or continue development of our other products, or we could be required
to delay, scale back or eliminate some or all of our research and development
programs.

Factors that May Affect Future Results, Financial Condition and the Market
Price of Securities

Please also read Item 1 in our 2001 Annual Report on Form 10-K/A 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/A 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/A
for the year ended December 31, 2001, in particular under the caption Factors
That May Affect Future Results, Financial Condition and the Market Price of
Securities, 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 amount we spend to promote our products,                            
|
| |  |  | changes in treatment practices of physicians that currently prescribe our products,

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| |  |  | 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, and                                                                                                  
|
| |  |  | our responses to price competition.                                                                                                                           




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 since December 31, 2001.




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 within 90 days before the filing
date of this quarterly report. 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 the companys disclosure controls and procedures
were effective in timely alerting them to material information
required to be included in our periodic SEC reports.
There have been no significant changes in Connetics internal controls or in
other factors that could significantly affect internal controls since their
evaluation.




PART II. OTHER INFORMATION




Item 6.Exhibits and Reports on Form 8-K

(a)  Exhibits.

|     |  |                                                                                                    
|---- |  | ---------------------------------------------------------------------------------------------------
|99.1 |  | Certification by Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|    
|99.2 |  | Certification by Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

(b)  Reports on Form 8-K.

We filed the following Current Reports on Form 8-K during the quarter ended
September 30, 2002:



| | (i)  |  | We filed an amended Current Report on Form 8-K/A-2 dated December 21,
2001, with the Securities and Exchange Commission on July 12, 2002, under
Item 5, Other Events, and Item 7, Financial Statements and Exhibits.
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (ii) |  | We filed a Current Report on Form 8-K dated September 12, 2002, with the
Securities and Exchange Commission on September 16, 2002, under Item 5,
Other Events.                                                      

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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 CORPORATION                                                                             
|
| | By:                                                                                                | /s/ JOHN L. HIGGINS
| |                                                                                                   
| | John L. HigginsExec. Vice President, Finance and
Corporate Development and Chief
Financial Officer

Date: November 13, 2002

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CERTIFICATION BY CHIEF EXECUTIVE OFFICER

I, Thomas G. Wiggans, certify that:

1. I have reviewed this annual report on Form 10-Q of Connetics Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6. The registrants other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002

/s/ Thomas G. Wiggans

---

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CERTIFICATION BY CHIEF FINANCIAL OFFICER

I, John L. Higgins, certify that:

1. I have reviewed this annual report on Form 10-Q of Connetics Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                                        

5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants
internal controls; and                                                                                                                                        

6. The registrants other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002

/s/ John L. Higgins

---

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INDEX TO EXHIBITS

|        |  |                                                                                                   
|------- |  | --------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                   
|Number  |  | Description                                                                                       
|        |  |                                                                                                   
|99.1    |  | Certification by Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
|        |  |                                                                                                   
|99.2    |  | Certification by Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002

21