<PAGE>   1

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q


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

                  FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001

                         Commission file number: 0-27406




                              CONNETICS CORPORATION
             (Exact name of registrant as specified in its charter)




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

                             3400 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 May 09, 2001, 29,778,546 shares of the Registrant's common stock were
outstanding, at $0.001 par value.

<PAGE>   2

                              CONNETICS CORPORATION
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                   Page
                                                                                   ----
<S>                                                                                <C>
PART I.   FINANCIAL INFORMATION

          Item 1. Condensed Consolidated Financial Statements

                  Condensed Consolidated Balance Sheets at March 31, 2001 and
                  December 31, 2000............................................     3

                  Condensed Consolidated Statements of Operations for the three
                  months ended March  31, 2001 and 2000........................     4

                  Condensed Consolidated Statements of Cash Flows for the three
                  months ended March 31, 2001 and 2000.........................     5

                  Notes to Condensed Consolidated Financial Statements.........     6

          Item 2. Management's Discussion and Analysis of Financial Condition
                  and Results of Operations....................................     9

          Item 3. Quantitative and Qualitative Disclosures About Market Risks..    24

PART II.  OTHER INFORMATION

          Item 6. Exhibits and Reports on Form 8-K.............................    24

                  (a) Exhibits.................................................    24

                  (b) Reports on Form 8-K......................................    24
</TABLE>


<PAGE>   3

PART I.        FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                              CONNETICS CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                       March 31,   December 31,
                                                         2001         2000
                                                      (unaudited)
                                                     -------------------------
                              ASSETS
<S>                                                  <C>             <C>
Current assets:
  Cash and cash equivalents                          $  47,950       $  58,577
  Short-term investments                                22,616          21,607
  Accounts receivable, net                               1,299           2,749
  Other current assets                                     547             545
                                                     -------------------------
          Total current assets                          72,412          83,478
Property and equipment, net                              1,765           1,807
Deposits and other assets                                  322             428
                                                     -------------------------
Total assets                                         $  74,499       $  85,713
                                                     =========================

                 LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                   $   3,653       $   5,115
  Accrued liabilities                                    2,629           2,715
  Current portion of deferred revenue                      132             132
  Accrued process development expenses                   1,017           1,389
  Accrued payroll and related expenses                   1,382           1,797
  Current portion of notes payable                          --             750
  Other current liabilities                                700             513
  Current portion of capital lease obligations              25              37
                                                     -------------------------
          Total current liabilities                      9,538          12,448

Deferred revenue                                           626             659

Stockholders' equity:
  Preferred stock                                           --              --
  Common stock and additional paid-in capital          159,421         159,242
  Deferred compensation                                    (16)            (21)
  Accumulated deficit                                  (97,643)        (92,756)
  Accumulated other comprehensive income                 2,573           6,141
                                                     -------------------------
          Total stockholders' equity                    64,335          72,606
                                                     -------------------------
Total liabilities and stockholders' equity           $  74,499       $  85,713
                                                     =========================
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                      -3-
<PAGE>   4

                              CONNETICS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                            Three Months Ended
                                                                  March 31
                                                         -----------------------
                                                           2001         2000
                                                         -----------------------
<S>                                                      <C>            <C>
Revenues:
  Product                                                $  7,655       $  5,666
  Contract                                                    804          7,937
                                                         -----------------------
        Total revenues                                      8,459         13,603
                                                         -----------------------

Operating costs and expenses:
  Cost of product revenues                                  1,105          1,799
  Research and development                                  4,352          6,145
  Selling, general and administrative                       7,612          5,519
                                                         -----------------------
  Total operating costs and expenses                       13,069         13,463
                                                         -----------------------
Income (loss) from operations                              (4,610)           140

Interest and other income                                   1,001            297
Gain on sale of investment                                    122            448
Interest and other expense                                 (1,401)          (100)
                                                         -----------------------
Income (loss) before cumulative effect of
  change in accounting principle                         $ (4,888)      $    785
                                                         =======================

Cumulative effect of change in accounting principle            --         (5,192)
                                                         -----------------------
Net loss                                                 $ (4,888)      $ (4,407)
                                                         =======================
Basic earnings per share:
Income (loss) per share before cumulative effect
  of change in accounting principle                      $  (0.16)      $   0.03

Cumulative effect of change in accounting principle            --       $  (0.19)
                                                         -----------------------
Net loss per share                                       $  (0.16)      $  (0.16)

Diluted earnings per share:
Income (loss) per share before cumulative effect
  of change in accounting principle                      $  (0.16)      $   0.03

Cumulative effect of change in accounting principle            --       $  (0.18)
                                                         -----------------------
Net loss per share                                       $  (0.16)      $  (0.15)

Basic shares used to calculate net income (loss)           29,705         26,627
                                                          =======================
Diluted shares used to calculate net income (loss)         29,705         28,412
                                                          ======================
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                      -4-
<PAGE>   5

                              CONNETICS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                                       Three Months Ended
                                                                             March 31,
                                                                        2001          2000
                                                                    -----------------------
<S>                                                                 <C>            <C>
Cash flows from operating activities:
     Net loss                                                       $ (4,888)      $ (4,407)

     Adjustments to reconcile net loss to net cash
        used in operating activities:
        Depreciation and amortization                                    213            170
        Gain on sale of investment                                      (122)          (448)
        Stock compensation expense                                        61            715
        Amortization of deferred compensation                              5              5
        Loss on foreign currency exchange contract                     1,394
     Changes in assets and liabilities:
        Accounts receivable                                            1,450            282
        Current and other assets                                         104           (165)
        Accounts payable                                              (1,462)        (2,025)
        Current and other liabilities                                 (2,080)        (1,022)
        Deferred revenue                                                 (33)         5,006
                                                                    -----------------------
     Net cash used in operating activities                            (5,358)        (1,889)
                                                                    -----------------------

Cash flows from investing activities:
     Purchases of short-term investments                             (12,464)        (1,458)
     Sales and maturities of short-term investments                    8,009          7,393
     Purchases of property and equipment                                (171)           (79)
                                                                    -----------------------
     Net cash provided by (used in) investing activities              (4,626)         5,856
                                                                    -----------------------
Cash flows from financing activities:
     Payment of notes payable                                           (750)          (989)
     Payments on obligations under capital leases and capital loans      (12)          (135)
     Proceeds from issuance of common stock, net issuance cost           119          1,218
                                                                    -----------------------
     Net cash provided by (used in) financing activities                (643)            94
                                                                    -----------------------
     Net change in cash and cash equivalents                         (10,627)         4,061
     Cash and cash equivalents at beginning of period                 58,577          8,460
                                                                    -----------------------
     Cash and cash equivalents at end of period                     $ 47,950       $ 12,521
                                                                    =======================
Supplementary information:
     Interest paid                                                  $      6       $     53

</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                      -5-
<PAGE>   6

                              CONNETICS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 MARCH 31, 2001
                                   (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 accrual adjustments, considered necessary for a fair presentation have
been included. Operating results for the three months ended March 31, 2001 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2001. Certain prior year balances have been reclassified for
comparative purposes.

        These condensed, consolidated financial statements and notes should be
read in conjunction with audited financial statements and notes to those
financial statements for the year ended December 31, 2000 included in our Annual
Report on Form 10-K as filed with the Securities and Exchange Commission.

Revenue Recognition

        Product Sales and Royalty Revenue. We recognize revenue from product
sales when there is persuasive evidence that an arrangement exists, when title
has passed upon shipment, the price is fixed and determinable, and
collectibility is reasonably assured. We establish 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.

        Contract revenue. We record contract revenue for research and
development 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.

        We recognize revenue from non-refundable upfront license fees under
collaborative agreements ratably over the development period when, at the time
the agreement is executed, the development period involves significant risk due
to the incomplete stage of the product's development.

        Revenue associated with performance milestones is recognized based upon
the achievement of the milestones, as defined in the respective agreements.

        Royalty expense directly related to product sales is classified in cost
of sales. We recorded royalty expense of $0.7 million for the quarter ended
March 31, 2001, and $1.0 million for the quarter ended March 31, 2000.


                                      -6-
<PAGE>   7

Recent Accounting Pronouncements

        As of January 1, 2001, Connetics adopted Financial Accounting Standards
Board Statements No. 133, "Accounting for Derivative Instruments and Hedging
Activities -- An Executive Overview of FASB Statement 133, as amended by FASB
137 and 138."

        As a result of the adoption of FAS 133, we recognize derivative
financial instruments in our financial statements at their fair value,
regardless of the purpose or intent for holding the instrument. Changes in the
fair value of derivative financial instruments are either recognized
periodically in income or in shareholders' equity as a component of
comprehensive income (loss) depending on whether the derivative financial
instrument qualifies for hedge accounting, and if so, whether it qualifies as a
fair value hedge or cash flow hedge.

        Connetics entered into a foreign currency exchange contract related to
our acquisition of Soltec Research Pty Ltd. ("Soltec"). That contract was
entered into in relation to a business combination and does not qualify as a
hedge under FAS 133; it expired on April 19, 2001, the closing date of the
acquisition. The purpose of the contract was to lock in to the purchase price
paid for Soltec. As of March 31, 2001, the loss on this contract was $1.4
million, which we recorded in the balance sheet and through the statement of
operations through interest and other expense. As the contract does not qualify
as a hedge, changes in fair value are recorded in the statement of operations.
The fair value was determined using the difference in the contract forward rate
and the current forward contract rate for a similar maturity discounted to
present value.

2.      NET LOSS PER SHARE

        We compute basic net income (loss) per common share using the weighted
average number of 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
option and warrants from the calculation of diluted loss per common share for
the three months ended March 31, 2001 because these securities are anti-dilutive
during this period. The following table sets forth the computations for basic
and diluted earnings per share.

<TABLE>
<CAPTION>
                                                          Three months ended
                                                              31, March
                                                       ---------------------
        (In thousand, except per share amounts)           2001       2000
                                                       ---------------------
        <S>                                            <C>         <C>

        Numerator for basic and diluted  earnings-
            per share-
               Net loss                                 $ (4,888)   $ (4,407)

        Denominator for basic earnings per share
               Weighted average shares                    29,705      26,627
        Effect of dilutive securities -
               Stock options and warrants                     --       1,785
                                                        --------------------
        Denominator for diluted earnings per share        29,705      28,412

        Net loss per share:
             Basic                                      $  (0.16)   $  (0.16)
                                                        ====================
             Diluted                                    $  (0.16)   $  (0.15)
                                                        ====================
</TABLE>


                                      -7-
<PAGE>   8

3.      COMPREHENSIVE INCOME (LOSS)

        During the three month period ended March 31, 2001, total comprehensive
loss amounted to $8.5 million, compared to comprehensive income of $16.5 million
for the same period in 2000. The components of comprehensive income (loss) for
the three month period ended March 31, 2001 and March 31, 2000 are as follows:

<TABLE>
<CAPTION>
                                                     Three months ended
                                                         March 31,
                                                  -----------------------
        (In thousands)                               2001         2000
                                                  -----------------------

        <S>                                       <C>            <C>
        Net loss                                  $ (4,888)      $ (4,407)
        Unrealized gain (loss) on securities        (3,568)        20,920
                                                  -----------------------
        Comprehensive income (loss)                 (8,456)      $ 16,513
                                                  =======================

</TABLE>


4.      ACTIMMUNE

               In 1998, we licensed from Genentech exclusive rights to
Actimmune, interferon gamma, for the United States and Japan. Interferon gamma
is one of a family of proteins involved in the regulation of the immune system
and has been shown to reduce the frequency and severity of certain infections.
We formed a subsidiary, InterMune Pharmaceuticals, Inc., to develop Actimmune
for various infections and fungal diseases. In April 1999, InterMune became an
independent company, and in March 2000, InterMune became a public company.
Effective April 1, 2000, we assigned to InterMune our remaining rights and
obligations under the license with Genentech and the corresponding supply
agreement. In exchange, InterMune paid us approximately $5.2 million; and
additional $0.9 million was paid to us at the end of March 2001. InterMune is
obligated to pay us a royalty on Actimmune sales beginning January 1, 2002. In
addition, we have retained the product rights for potential dermatological
applications. We recorded sales of Actimmune of approximately $1.8 million
during the first quarter of 2000; commencing in the second quarter of 2000,
InterMune acquired our remaining rights to sell Actimmune.


5.      SUBSEQUENT EVENTS

On April 19, 2001, Connetics completed the acquisition of Soltec Research Pty.
Ltd., a division of Australia based F.H. Faulding & Co Limited for Australian
$32 million or approximately U.S. $16.9 million. Connetics' two marketed
dermatology products and current development programs are based on technology
developed by Soltec. Soltec is a profitable company that possesses broad
intellectual property and patents on innovative topical delivery technologies.
In addition, Soltec has numerous license agreements with pharmaceutical
companies around the world. The acquisition of Soltec is expected to provide
Connetics with powerful product innovation and development capabilities, fuel an
extensive new product pipeline, and contribute revenue and profits to Connetics'
financial results.

        On April 30, 2001, Connetics sold its rights to Ridaura(R) to Prometheus
Laboratories Inc., a private company based in San Diego, for $9.0 million plus a
royalty on annual sales in excess of $4.0 million for the next five years.
Ridaura(R) is a prescription product for the treatment of rheumatoid arthritis.


                                      -8-
<PAGE>   9

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, 2000, and with the
unaudited condensed consolidated financial statements and notes to financial
statements included in this report. Except for historical information, the
discussion in this report contains forward-looking statements that involve risks
and uncertainties. When used in this report, the words "anticipate," "believe,"
"estimate," "will," "intend" and "expect" and similar expressions identify
forward-looking statements. Although we believe that our plans, intentions and
expectations reflected in these forward-looking statements are reasonable, these
plans, intentions, or expectations may not be achieved. 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. Our
historical operating results are not necessarily indicative of the results to be
expected in any future period.

OVERVIEW

   Through the end of the first quarter of 2001 we marketed three pharmaceutical
products. In May 2000, the FDA granted us clearance to market OLUX(TM) Foam
(clobetasol propionate), 0.05% for the treatment of moderate to severe scalp
dermatoses. We launched OLUX on November 6, 2000. Our commercial business is
focused on the dermatology marketplace, which is characterized by a large
patient population that is served by relatively small, and therefore more
accessible, groups of treating physicians. We are offering two dermatology
products with clinically proven therapeutic advantages and are providing quality
customer service to physicians through our experienced sales and marketing
staff. We also sell a third product Ridaura, a product to treat rheumatoid
arthritis.

   In addition to our commercial business, we are developing a biotechnology
product that has the potential to treat multiple diseases. Our product is a
recombinant form of a natural hormone called relaxin. Relaxin reduces the
hardening, or fibrosis, of skin and organ tissue, dilates existing blood vessels
and stimulates new blood vessel growth. We currently have clinical trials
underway with relaxin for infertility. We intend to develop relaxin for other
indications.

   On October 8, 2000, we announced that our pivotal trial for relaxin for the
treatment of scleroderma failed to reach its primary endpoint. We have
discontinued our development program related to relaxin for scleroderma. We are
conducting an earlier stage clinical trial of relaxin for the treatment of
infertility. We maintain North American rights for relaxin and have entered into
collaborative relationships for this program for markets outside of the United
States. In October 2000, our partners in Japan and Europe notified us that they
would terminate our relaxin development agreements with them in accordance with
the termination provisions of the respective agreements and as of December 31,
2000, we have no further development obligations under either agreement.
Consequently, the rights for relaxin in Japan have reverted to us, and the
European rights will revert to us in April 2001.

   Following the end of the first quarter, we completed the acquisition of
Soltec Research Pty. Ltd., from Australian based F.H. Faulding & Co Limited and
the sale of our Ridaura product line to Prometheus Laboratories Inc. The
acquisition of Soltec was announced on March 20, 2001, and was completed on
April 19, 2001. The sale of the Ridaura product line was completed on April 30,
2001.

                                      -9-
<PAGE>   10

RESULTS OF OPERATIONS

    REVENUES

<TABLE>
<CAPTION>
                                                 Three Months Ended
                                                     March 31,
                                               --------------------
        Revenues (In thousands)                 2001        2000
                                               --------------------

         <S>                                  <C>          <C>

             Product:
                Luxiq                          $ 3,895      $ 2,259
                Ridaura                          2,021        1,650
                Olux                             1,739           --
                Actimmune                           --        1,757
                                               --------------------
             Total product revenues              7,655        5,666

             Contract:
                Celltech                            --        6,127
                Suntory Ltd.                        --           47
                F.H. Faulding & Co., Ltd.           20           --
                Paladin Labs, Inc.                  13          213
                InterMune                          771        1,500
                Immune Response Corp.               --           50
                                               --------------------
             Total contract revenues               804        7,937
                                               --------------------
                    Total revenues             $ 8,459      $13,603
                                               ====================
</TABLE>

        Our product revenues for the three months ended March 31, 2001, were
$7.7 million, compared to $5.7 million for the three months ended March 31,
2000. The increase in total product revenues was due to continued sales growth
of Luxiq and Olux, which we began marketing in April 1999 and November 2000,
respectively. As part of the agreement with InterMune, effective April 1, 2000
we did not record Actimmune sales beginning with the second quarter of 2000.

        Contract revenues for the three month period ended March 31, 2001 were
$0.8 million, compared to $7.9 million the three month period ended March 31,
2000. The decrease in contract revenue for the three month period ended March
31, 2001, is mainly due to the receipt of one-time license payments in the first
quarter of 2000, a milestone payment of $5.0 million from a former
collaborative partner for relaxin, in the first quarter of 2000, and $1.5
million paid by InterMune, for relaxin, in the first quarter of 2000 in
conjunction with our sublicense agreement. We do not expect to receive contract
revenues in the foreseeable future.

        InterMune purchased the remaining United States commercial rights and
revenue to Actimmune effective April 1, 2000. As part of the transaction,
InterMune paid $5.2 million in 2000 which included the prepayment of a $1.0
million obligation owed in 2002. In March 2001 Intermune made a final payment on
this arrangement to Connetics in the amount $ 0.9 million which has been offset
by related rebates and chargebacks of $0.1 million.

        Our cost of product revenues for 2001 includes the costs of Luxiq,
Ridaura and Olux, royalty payments on these products based on a percentage of
our product revenues, and product freight and distribution costs from our
distributor. We recorded cost of product revenues of $1.1 million for the three
months ended March 31, 2001, compared to $1.8 million for the three months ended
March 31, 2000. The decrease in cost of product revenues for the first three
months of 2001 over the first three months of 2000 is primarily due to the sale
of our remaining rights to Actimmune sales, effective April 1, 2000 under the
agreement with Intermune.


                                      -10-
<PAGE>   11


    RESEARCH AND DEVELOPMENT

        Research and development expenses were $4.4 million for the three month
period ended March 31, 2001, compared to $6.1 million for the comparable period
in 2000. The decrease in expenses was due to prior year expenses including costs
for manufacturing scale up for relaxin; and little clinical trial activity going
on compared with 2000 Phase III trial activity for scleroderma.

        We expect research and development expenses to remain consistent over
the next few quarters, due to the impact of the removal of the majority of
expenses related to the development of relaxin for scleroderma and the ramp up
of relaxin clinical trial activities for new disease indications.

    SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

        Selling, general and administrative expenses increased to $7.7 million
for the three month period ended March 31, 2001, compared to $5.5 million for
the comparable period in 2000. The increase in expenses was due to increased
headcount and increased market research and sales promotions costs related to
the Olux launch. We expect selling, general and administrative expenses to
increase slightly during the remainder of fiscal 2001 due to expansion of
dermatology sales force in Q2 2001.

        INTEREST INCOME (EXPENSE)

        Interest and other income were $1.0 million for the three month period
ended March 31, 2001, compared with $0.3 million for the comparable period in
2000. The increase in interest income was due to higher cash and short-term
investment balances for the period ended March 31, 2001 compared to the same
period in 2000. Interest and other expense was $1.4 million for the three month
period ended March 31, 2001, compared with $0.1 million for the comparable
period in 2000. The increase in interest and other expense resulted from the
loss of $1.4 million on a foreign currency exchange contract that was entered
into in February 2001 in connection with the Soltec acquisition and was
partially offset by lower interest expense associated with lower balances
outstanding for obligations under capital leases and notes payable.

    NET LOSS

        Net loss was $4.9 million for the three month period ended March 31,
2001, compared to a net loss of $4.4 million for the comparable period in 2000.
The increase in net losses was primarily attributable to the net effect of the
following;

    -   an at-risk milestone payment of $5.0 million and a $1.0 million
        quarterly development payment received from Celltech in 2000 in
        connection with our agreement for the development of relaxin, partially
        offset by;

    -   increased product revenues in 2001 primarily due to sales growth of
        Luxiq and Qlux, which we began marketing in April 1999 and November
        2000, respectively;

    -   loss on the foreign currency exchange contract of $1.4 million entered
        into in February 2001;

    -   payment of $0.9 million from InterMune in connection with our revenue
        adjustment agreement with InterMune.

    -   reduced research and development expenses in 2001 as a result of
        decreased clinical trial activity and manufacturing scale up costs
        associated with relaxin, partially offset by;

    -   increased selling, general and administrative expenses in 2001 related
        to increased headcount and market research and sales promotions costs
        associated with the Olux launch.

                                      -11-
<PAGE>   12

        We expect to incur losses for the remainder of 2001 and the foreseeable
future. These losses are expected to fluctuate from period to period based on
timing of product revenues, clinical material purchases, clinical trial
expenses, and possible acquisitions of new products and technologies.

LIQUIDITY AND CAPITAL RESOURCES

        We have financed our operations to date primarily through proceeds from
equity financings, collaborative arrangements with corporate partners and bank
loans. At March 31, 2001, cash, cash equivalents and short-term investments
totaled $70.6 million compared to $80.2 million at December 31, 2000. Our
investments 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
three month period ended March 31, 2001 and 2000, was $5.4 million and $1.9
million, respectively. Net loss of $4.9 million for the first three months of
2001 was affected by non-cash charges of $0.2 million of depreciation and
amortization expense and $1.4 million in other expense related to the to Soltec
foreign currency exchange contract. Cash outflow for the first three months of
2001 was primarily for operating activities which included a decrease of $1.5
million in accounts payable and reduction of $2.0 million in other current
liabilities.

        Cash flows from investing activities. Investing activities used $4.6
million in cash during the three month period ended March 31, 2001, due in part
to sales of $8.0 million of short-term investments offset by $12.5 million of
short term investment purchases.

        Cash flows from financing activities. Cash used by financing activities
of $0.6 million for the three months ended March 31, 2001 included a $0.8
million bank loan payment, offset by $0.1 million in proceeds from issuance of
common stock.

        Working Capital. Working capital decreased by $8.1 million to $62.9
million at March 31, 2001 from $71.0 million at December 31, 2000. The decrease
in working capital was due to use of our cash in operations, and payment of debt
obligations

        We believe our existing cash, cash equivalents and short-term
investments 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.

FACTORS THAT MAY AFFECT FUTURE RESULTS, FINANCIAL CONDITION AND THE MARKET PRICE
OF SECURITIES

       Please also read Items 1 and 3 in our 2000 Annual Report on Form 10-K
where we have described our business and the challenges and risks we may face in
the future.

        Our results of operation have varied widely in the past, and they could
continue to vary significantly from quarter to quarter due to a number of
factors, including those listed below. Any shortfall in revenues would have an
immediate impact on our earnings per share, which could adversely affect the
market price of our common stock. Our operating expenses, which


                                      -12-
<PAGE>   13

include sales and marketing, research and development and general and
administrative expenses, are based on our expectations of future revenues and
are relatively fixed in the short term. Accordingly, if revenues fall below our
expectations, we will not be able to reduce our spending rapidly in response to
such a shortfall. Due to the foregoing factors, we believe that
quarter-to-quarter comparisons of our results of operations are not a good
indication of our future performance.

RISKS RELATED TO OUR BUSINESS

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

   Until the first quarter of fiscal year 2000, we lost money every year since
our inception. We had net losses of $27.3 million in 1999, net income of $27.0
million in 2000. If we exclude a gain of $43.0 million on sales of stock we held
in InterMune, and the associated income tax, our net loss for 2000 would have
been $15.0 million. We also had 2000 a net loss of 4.9 million for the three
months ended March 31, 2001. Our accumulated deficit was $97.6 million at March
31, 2001. We may incur additional losses during the next few years. If we do not
sustain the profitability we achieved in 2000, our stock price may decline.

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

   We currently believe that our available cash resources will be sufficient to
fund our operating and working capital requirements for the next 18 months.
Accordingly, we may need to raise additional funds through public or private
financings, strategic relationships or other arrangements. 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. If we are unable to
successfully complete development and commercialization of relaxin, we may never
achieve profitability.

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

   Our commercial success depends in part on our ability and the ability of our
licensors to protect our technology and processes. The foam technology used in
our Luxiq(R) and OLUX(TM) products is covered by one issued patent. In addition,
the patents in our relaxin patent portfolio begin to expire in 2002 in foreign
countries and 2005 in the United States. Patent expiration dates range from 2002
to 2017.

   We are pursuing several U. S. patent applications, although we cannot be sure
that any of these patents will ever be issued. We also have acquired rights
under certain patents and patent applications in connection with our licenses to
distribute products and from the assignment of rights to patents and patent
applications from certain of our consultants and officers. These patents and
patent applications may be subject to claims of rights by third parties. If
there are conflicting claims to the same patent or patent application, we may
not prevail and, even if we do have some rights in a patent or application,
those rights may not be sufficient for the marketing and distribution of
products covered by the patent or application.

   The patents and applications in which we have an interest may be challenged
as to their validity or enforceability. Challenges may result in potentially
significant harm to our business.


                                      -13-
<PAGE>   14

The cost of responding to these challenges and the inherent costs to defend the
validity of our patents, including the prosecution of infringements and the
related litigation, could be substantial whether or not we are successful. Such
litigation also could require a substantial commitment of management's time. A
judgment adverse to us in any patent interference, litigation or other
proceeding arising in connection with these patent applications could materially
harm our business.

   The ownership of a patent or an interest in a patent does not always provide
significant protection. Others may independently develop similar technologies or
design around the patented aspects of our technology. We only conduct patent
searches to determine whether our products infringe upon any existing patents,
when we think such searches are appropriate. As a result, the products and
technologies we currently market, and those we may market in the future, may
infringe on patents and other rights owned by others. If we are unsuccessful in
any challenge to the marketing and sale of our products or technologies, we may
be required to license the disputed rights, if the holder of those rights is
willing, or to cease marketing the challenged products, or to modify our
products to avoid infringing upon those rights. Under these circumstances, we
may not be able to obtain a license to such intellectual property on favorable
terms, if at all. We may not succeed in any attempt to redesign our products or
processes to avoid infringement.

Our current product revenue will not cover the cost of fully developing and
commercializing relaxin.

   Product revenue from sales of our marketed products does not cover the full
cost of developing relaxin and other products in our pipeline. Historically, we
have depended on licensing agreements with our corporate partners to
successfully develop and commercialize our products. We also generate revenue by
licensing our products to third parties for specific territories and
indications. Our reliance on licensing arrangements with third parties carries
several risks, including the possibilities that:

   -  a product development contract may expire or a relationship may be
      terminated, and we will not be able to attract a satisfactory alternative
      corporate partner within a reasonable time;

   -  a corporate partner involved in the development of our products does not
      commit sufficient capital to successfully develop our products; and

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

If any of these risks occurs, we may not be able to successfully develop our
products.

We depend on third parties to protect and maintain our patent portfolio.

   Nearly our entire patent portfolio is licensed from third parties, who are
responsible to varying degrees for the prosecution and maintenance of those
patents. Our success will depend on our ability, or the ability of our
licensors, to obtain and maintain patent protection on technologies, to preserve
trade secrets, and to operate without infringing the proprietary rights of
others. It is possible that before any of our products in development can be
commercialized, the related patents may have expired or be close to expiration,
thus reducing any advantage of the patent.


                                      -14-
<PAGE>   15

Moreover, composition of matter patent protection, which gives patent protection
for a compound or a composition, may not be available for some of our product
candidates.

If we do not successfully commercialize relaxin, we may lose fundamental
intellectual property rights to the product.

   Licenses with Genentech, Inc. and The Howard Florey Institute of Experimental
Physiology and Medicine require us to use our best efforts to commercialize
relaxin. Our failure to successfully commercialize relaxin may result in the
reversion of our rights under these licenses to Genentech and the Florey
Institute. The termination of these agreements and subsequent reversion of
rights could cause us to lose fundamental intellectual property rights to
relaxin. This would prohibit us from continuing our relaxin development
programs.

We are subject to foreign exchange risks which may increase our operational
expenses.

   We make payments to Boehringer Ingelheim for the production of relaxin in
Austrian schillings, and to CCL Pharmaceuticals for the production of Luxiq and
OLUX in pounds sterling. If the U.S. dollar depreciates against the schilling or
the pound, the payments that we must make will increase, which will increase our
expenses. We do not currently hedge our foreign currency exposure related to
these Agreements.

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

   We rely on trade secrets and unpatented proprietary know-how and continuing
technological innovation in developing and manufacturing our products. We
require each of our employees, consultants and advisors to enter into
confidentiality agreements prohibiting them from taking our proprietary
information and technology or from using or disclosing proprietary information
to third parties except in specified circumstances. The agreements also provide
that all inventions conceived by an employee, consultant or advisor, to the
extent appropriate for the services provided during the course of the
relationship, shall be our exclusive property, other than inventions unrelated
to us and developed entirely on the individual's own time. Nevertheless, these
agreements may not provide meaningful protection of our trade secrets and
proprietary know-how if they are used or disclosed. Despite all of the
precautions we may take, people who are not parties to confidentiality
agreements may obtain access to our trade secrets or know-how. In addition,
others may independently develop similar or equivalent trade secrets or
know-how.

Our use of hazardous materials exposes us to the risk of environmental
liabilities, and we may incur substantial additional costs to comply with
environmental laws.

   Our research and development activities involve the controlled use of
hazardous materials, chemicals and various radioactive materials. We are subject
to laws and regulations governing the use, storage, handling and disposal of
these materials and certain waste products. In the event of accidental
contamination or injury from these materials, we could be liable for any damages
that result and any liability could exceed our resources. We may also be
required to incur significant costs to comply with environmental laws and
regulations as our research activities increase.


                                      -15-
<PAGE>   16

RISKS RELATED TO OUR PRODUCTS

Manufacturing difficulties could delay commercialization of our products or
future revenues from product sales.

   We depend on third parties to manufacture our products, and each product is
manufactured by a sole source manufacturer. Boehringer Ingelheim Austria GmbH,
GlaxoSmithKline, and CCL Pharmaceuticals are our sole source manufacturers for
our products. All of our contractors must comply with the applicable FDA good
manufacturing practice regulations, which include quality control and quality
assurance requirements as well as the corresponding maintenance of records and
documentation. Manufacturing facilities are subject to ongoing periodic
inspection by the FDA and corresponding state agencies, including unannounced
inspections, and must be licensed before they can be used in commercial
manufacturing of our products. If our sole source manufacturers cannot provide
us with our product requirements in a timely and cost-effective manner, if the
product they are able to supply cannot meet commercial requirements for shelf
life, or if they are not able to comply with the applicable good manufacturing
practice regulations and other FDA regulatory requirements, our sales of
marketed products could be reduced and we could suffer delays in the progress of
clinical trials for products under development. We do not have control over our
third-party manufacturers' compliance with these regulations and standards. In
addition, any commercial dispute with any of our sole source suppliers could
result in delays in the manufacture of product, and affect our ability to
commercialize our products.

If we are unable to contract with third parties to manufacture and distribute
our products in sufficient quantities, on a timely basis, or at an acceptable
cost, we may be unable to meet demand for our products and may lose potential
revenues.

   We have no manufacturing or distribution facilities for any of our products.
Instead, we contract with third parties to manufacture our products for us. We
have manufacturing agreements with the following companies:

   -  CCL Pharmaceuticals, a Division of CCL Industries Limited, a U.K.
      corporation, for Luxiq and OLUX;

   -  Boehringer Ingelheim Austria GmbH for relaxin; and

   -  GlaxoSmithKline for Ridaura.

   Typically, these manufacturing contracts are short-term. We are dependent
upon renewing agreements with our existing manufacturers or finding replacement
manufacturers to satisfy our requirements. As a result, we cannot be certain
that manufacturing sources will continue to be available or that we can continue
to out-source the manufacturing of our products on reasonable or acceptable
terms.

   Any loss of a manufacturer or any difficulties which could arise in the
manufacturing process could significantly affect our inventories and supply of
products available for sale. In each case, our products are made by a sole
source of supply. If these third parties are unable or unwilling to produce our
products in sufficient quantities, with appropriate quality, and under
commercially reasonably terms, it could have a negative effect on our sales
margins and market share, as well


                                      -16-
<PAGE>   17

as our overall business and financial results. If we are unable to supply
sufficient amounts of our products on a timely basis, our market share could
decrease and, correspondingly, our profitability could decrease.

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

   The FDA requires that all manufacturers used by pharmaceutical companies
comply with the FDA's regulations, including those cGMP regulations applicable
to manufacturing processes. The cGMP validation of a new facility and the
approval of that manufacturer for a new drug product may take a year or more
before manufacture can begin at the facility. Delays in obtaining FDA validation
of a replacement manufacturing facility could cause an interruption in the
supply of our products. Although we have business interruption insurance
covering the loss of income for up to $6.0 million, which may mitigate the harm
to our business from the interruption of the manufacturing of products caused by
certain events, the loss of a manufacturer could still have a negative effect on
our sales, margins and market share, as well as our overall business and
financial results.

If our supply of finished products is interrupted, our ability to maintain our
inventory levels could suffer.

   We try to maintain inventory levels that are no greater than necessary to
meet our current projections. Any interruption in the supply of finished
products could hinder our ability to timely distribute finished products. If we
are unable to obtain adequate product supplies to satisfy our customers' orders,
we may lose those orders and our customers may cancel other orders and stock and
sell competing products. This in turn could cause a loss of our market share and
negatively affect our revenues.

   We cannot be certain that supply interruptions will not occur or that our
inventory will always be adequate. Numerous factors could cause interruptions in
the supply of our finished products including shortages in raw material required
by our manufacturers, changes in our sources for manufacturing, our failure to
timely locate and obtain replacement manufacturers as needed and conditions
effecting the cost and availability of raw materials.

If we do not obtain and maintain governmental approvals for our products, we
cannot sell these products for their intended diseases.

   Pharmaceutical companies are subject to heavy regulation by a number of
national, state and local agencies. Of particular importance is the FDA in the
United States. It has jurisdiction over all of our business and administers
requirements covering testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of our products.
Failure to comply with applicable regulatory requirements could, among other
things, result in fines; suspensions of regulatory approvals of products;
product recalls; delays in product distribution, marketing and sale; and civil
or criminal sanctions.

   The process of obtaining and maintaining regulatory approvals for
pharmaceutical and biological drug products, and obtaining and maintaining
regulatory approvals to market these products for new indications, is lengthy,
expensive and uncertain. The manufacturing and marketing of drugs are subject to
continuing FDA and foreign regulatory review, and later discovery of previously
unknown problems with a product, manufacturing process or facility may


                                      -17-
<PAGE>   18

result in restrictions, including withdrawal of the product from the market. Our
products receive FDA review regarding their safety and effectiveness. However,
the FDA is permitted to revisit and change its prior determinations and we
cannot be sure that the FDA will not change its position with regard to the
safety or effectiveness of our products. If the FDA's position changes, we may
be required to change our labeling or formulations, or cease to manufacture and
market the challenged products. Even before any formal regulatory action, we
could voluntarily decide to cease distribution and sale or recall any of our
products if concerns about the safety or effectiveness develop.

   To market our products in countries outside of the United States, we and our
partners must obtain similar approvals from foreign regulatory bodies. The
foreign regulatory approval process includes all of the risks associated with
obtaining FDA approval, and approval by the FDA does not ensure approval by the
regulatory authorities of any other country. The process of obtaining these
approvals is time consuming and requires the expenditure of substantial
resources.

   In recent years, various legislative proposals have been offered in Congress
and in some state legislatures that include major changes in the health care
system. These proposals have included price or patient reimbursement constraints
on medicines and restrictions on access to certain products. We cannot predict
the outcome of such initiatives, and it is difficult to predict the future
impact of the broad and expanding legislative and regulatory requirements
affecting us.

We may spend a significant amount of money to obtain FDA and other regulatory
approvals, which may never be granted.

   The process of obtaining FDA and other regulatory approvals is lengthy and
expensive. To obtain approval, we must show in preclinical and clinical trials
that our products are safe and effective, and the marketing and manufacturing of
pharmaceutical products are subject to rigorous testing procedures. The FDA
approval processes require substantial time and effort, the FDA continues to
modify product development guidelines, and the FDA may not grant approval on a
timely basis or at all. Clinical trial data can be the subject of differing
interpretation, and the FDA has substantial discretion in the approval process.
The FDA may not interpret our clinical data the way we do. The FDA may also
require additional clinical data to support approval. The FDA can take between
one and two years to review new drug applications and biologics license
applications, or longer if significant questions arise during the review
process. We may not be able to obtain FDA approval to conduct clinical trials or
to manufacture and market any of the products we develop, acquire or license.
Moreover, the costs to obtain approvals could be considerable and the failure to
obtain or delays in obtaining an approval could have a significant negative
effect on our business performance and financial results. Even if we obtain
approval from the FDA, the FDA is authorized to impose post-marketing
requirements such as:

   -  testing and surveillance to monitor the product and its continued
      compliance with regulatory requirements;

   -  submitting products for inspection and, if any inspection reveals that the
      product is not in compliance, the prohibition of the sale of all products
      from the same lot;

   -  suspending manufacturing;

   -  recalling products; and


                                      -18-
<PAGE>   19

   -  withdrawing marketing clearance.

   In its regulation of advertising, the FDA from time to time issues
correspondence to pharmaceutical companies alleging that some advertising or
promotional practices are false, misleading or deceptive. The FDA has the power
to impose a wide array of sanctions on companies for such advertising practices,
and the receipt of correspondence from the FDA alleging these practices can
result in the following:

   -  incurring substantial expenses, including fines, penalties, legal fees and
      costs to comply with the FDA's requirements;

   -  changes in the methods of marketing and selling products;

   -  taking FDA-mandated corrective action, which may include placing
      advertisements or sending letters to physicians rescinding previous
      advertisements or promotion; and

   -  disruption in the distribution of products and loss of sales until
      compliance with the FDA's position is obtained.

If Luxiq and OLUX do not achieve or sustain market acceptance, our revenues will
not increase and may not cover our operating expenses.

   Our future revenues will depend upon dermatologist and patient acceptance of
Luxiq and OLUX. Factors that could affect acceptance of Luxiq and OLUX include:

   -  satisfaction with existing alternative therapies;

   -  the effectiveness of our sales and marketing efforts;

   -  undesirable and unforeseeable side effects; and

   -  the cost of the product as compared with alternative therapies.

   Since we have only had approval to sell Luxiq for two years, and we only
began selling OLUX in November 2000, we cannot predict the potential long-term
patient acceptance of either product.

If we are unable to develop alternative delivery systems for relaxin, patients
that do not suffer from severe diseases may not be willing to use the current
drug delivery system.

   In addition to demonstrating that relaxin is safe and effective in our
current clinical trials, we must meet several additional major development
objectives for relaxin. In particular, we may need to develop an alternative
means of delivering the drug. In our current clinical trials, relaxin is being
delivered through the use of an infusion pump. For a serious and life
threatening condition, this method of delivery may be acceptable. However, for
the indications we are studying, such as treatment of infertility and peripheral
arterial disease, we may need to develop an alternative delivery system. The
known biological properties of the relaxin molecule may decrease the
availability of certain delivery systems. If we are not able to develop a
suitable alternative delivery system for relaxin, we may be unable to market
relaxin effectively for indications that are not life threatening, such as
infertility, and the commercial potential of


                                      -19-
<PAGE>   20

relaxin would be seriously harmed. Our inability to develop relaxin to its full
commercial potential would harm our future prospects and revenue growth and our
stock price would likely decline.

We rely on third parties to conduct clinical trials for our products, and those
third parties may not perform satisfactorily.

   We do not have the ability to independently conduct clinical studies, and we
rely on third parties to perform this function. If these third parties do not
perform satisfactorily, we may not be able to locate acceptable replacements or
enter into favorable agreements with them, if at all. If we are unable to rely
on clinical data collected by others, we could be required to repeat clinical
trials, which could significantly delay commercialization and require
significantly greater capital.

If we are unable to develop new products, our expenses may increase without any
immediate return on the investment.

   We currently have a variety of new products in various stages of research and
development and are working on possible improvements, extensions and
reformulations of some existing products. These research and development
activities, as well as the clinical testing and regulatory approval process,
which must be completed before commercial quantities of these developments can
be sold, will require significant commitments of personnel and financial
resources. Delays in the research, development, testing or approval processes
will cause a corresponding delay in revenue generation from those products.
Regardless of whether they are ever released to the market, the expense of such
processes will have already been incurred.

   We reevaluate our research and development efforts regularly to assess
whether our efforts to develop a particular product or technology are
progressing at a rate that justifies our continued expenditures. On the basis of
these reevaluations, we have abandoned in the past, and may abandon in the
future, our efforts on a particular product or technology. There can be no
certainty that any product we are researching or developing will ever be
successfully released to the market. If we fail to take a product or technology
from the development stage to market on a timely basis, we may incur significant
expenses without a near-term financial return.

If we do not successfully integrate new products, we may not be able to sustain
revenue growth and we may not be able to compete effectively.

   When we acquire or develop new products and product lines, we must be able to
integrate those products and product lines into our systems for marketing, sales
and distribution. If these products or product lines are not integrated
successfully, the potential for growth is limited. The new products we acquire
or develop could have channels of distribution, competition, price limitations
or marketing acceptance different from our current products. As a result, we do
not know whether we will be able to compete effectively and obtain market
acceptance in any new product categories. After acquiring or developing a new
product, we may need to significantly increase our sales force and incur
additional marketing, distribution and other operational expenses. These
additional expenses could negatively affect our gross margins and operating
results. In addition, many of these expenses could be incurred prior to the
actual distribution of new products. Because of this timing, if the new products
are not accepted by the market or if they are not competitive with similar
products distributed by others, the ultimate success of the acquisition or
development could be substantially diminished.


                                      -20-
<PAGE>   21

RISKS RELATED TO OUR INDUSTRY

We face intense competition, which may limit our commercial opportunities and
our ability to become profitable.

   The pharmaceutical and biotechnology industries are highly competitive.
Competition in our industry occurs on a variety of fronts, including developing
and bringing new products to market before others, developing new technologies
to improve existing products, developing new products to provide the same
benefits as existing products at less cost and developing new products to
provide benefits superior to those of existing products.

   Most of our competitors are large, well-established companies in the fields
of pharmaceuticals and health care. Many of these companies have substantially
greater financial, technical and human resources than we have to devote to
marketing, sales, research and development and acquisitions. Some of these
competitors have more collective experience than we do in undertaking
preclinical testing and human clinical trials of new pharmaceutical products and
obtaining regulatory approvals for therapeutic products. As a result, they have
a greater ability to undertake more extensive research and development,
marketing and pricing policy programs. It is possible that our competitors may
develop new or improved products to treat the same conditions as our products
treat or make technological advances reducing their cost of production so that
they may engage in price competition through aggressive pricing policies to
secure a greater market share to our detriment. Our commercial opportunities
will be reduced or eliminated if our competitors develop and market products
that are more effective, have fewer or less severe adverse side effects or are
less expensive than our products. These competitors also may develop products
that make our current or future products obsolete. Any of these events could
have a significant negative impact on our business and financial results,
including reductions in our market share and gross margins.

   Physicians may not adopt our products over competing products, and our
products may not offer an economically feasible alternative to existing modes of
therapy.

   Our products compete with generic pharmaceuticals, which claim to offer
equivalent benefit at a lower cost. In some cases, insurers and other health
care payment organizations try to encourage the use of these less expensive
generic brands through their prescription benefits coverages and reimbursement
policies. These organizations may make the generic alternative more attractive
to the patient by providing different amounts of reimbursement so that the net
cost of the generic product to the patient is less than the net cost of our
prescription brand product. Aggressive pricing policies by our generic product
competitors and the prescription benefits policies of insurers could cause us to
lose market share or force us to reduce our margins in response.

If third party payors will not provide coverage or reimburse patients for the
use of our products, our revenues and profitability will suffer.

   Our products' commercial success is substantially dependent on whether
third-party reimbursement is available for the use of our products by hospitals,
clinics and doctors. Medicare, Medicaid, health maintenance organizations and
other third-party payors may not authorize or otherwise budget for the
reimbursement of our products. In addition, they may not view our products as
cost-effective and reimbursement may not be available to consumers or may


                                      -21-
<PAGE>   22

not be sufficient to allow our products to be marketed on a competitive basis.
Likewise, legislative proposals to reform health care or reduce government
programs could result in lower prices for or rejection of our products. Changes
in reimbursement policies or health care cost containment initiatives that limit
or restrict reimbursement for our products may cause our revenues to decline.

If managed care organizations and other third-party reimbursement policies do
not cover our products, we may not increase our market share and our revenues
and profitability will suffer.

   Our operating results and business success depends in large part on the
availability of adequate third-party payor reimbursement to patients for our
prescription-brand products. These third-party payors include governmental
entities (such as Medicaid), private health insurers and managed care
organizations. Over 70% of the U.S. population now participates in some version
of managed care. Because of the size of the patient population covered by
managed care organizations, marketing of prescription drugs to them and the
pharmacy benefit managers that serve many of these organizations has become
important to our business. Managed care organizations and other third-party
payors try to negotiate the pricing of medical services and products to control
their costs. Managed care organizations and pharmacy benefit managers typically
develop formularies to reduce their cost for medications. Formularies can be
based on the prices and therapeutic benefits of the available products. Due to
their lower costs, generics are often favored. The breadth of the products
covered by formularies varies considerably from one managed care organization to
another, and many formularies include alternative and competitive products for
treatment of particular medical conditions. Exclusion of a product from a
formulary can lead to its sharply reduced usage in the managed care organization
patient population. Payment or reimbursement of only a portion of the cost of
our prescription products could make our products less attractive, from a
net-cost perspective, to patients, suppliers and prescribing physicians. We
cannot be certain that the reimbursement policies of these entities will be
adequate for our products to compete on a price basis. If our products are not
included within an adequate number of formularies or adequate reimbursement
levels are not provided, or if those policies increasingly favor generic
products, our market share and gross margins could be negatively affected, as
could our overall business and financial condition.

If product liability lawsuits are brought against us, we may incur substantial
costs.

   Our industry faces and inherent risk of product liability claims from
allegations that our products resulted in adverse effects to the patient or
others. These risks exist even with respect to those products that are approved
for commercial sale by the FDA and manufactured in facilities licensed and
regulated by the FDA. Our insurance may not provide adequate coverage against
potential product liability claims or losses. We also cannot be certain that our
current coverage will continue to be available in the future on reasonable
terms, if at all. Even if we are ultimately successful in product liability
litigation, the litigation would consume substantial amounts of our financial
and managerial resources, and might create adverse publicity, all of which would
impair our ability to generate sales. If we were found liable for any product
liability claims in excess of our coverage or outside of our coverage, the cost
and expense of such liability could severely damage our business, financial
condition and profitability.


                                      -22-
<PAGE>   23

RISKS RELATED TO OUR STOCK

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

   The market prices for securities of biotechnology companies like our company
have been and are likely to continue to be highly volatile. As a result,
investors in these companies often buy at very high prices only to see the price
drop substantially a short time later, resulting in an extreme drop in value in
the stock holdings of these investors. In addition, the volatility could result
in securities class action litigation. Any litigation would likely result in
substantial costs, and divert our management's attention and resources.

If our officers, directors and principal stockholders act together, they may be
able to control our management and operations and they may make decisions that
are not in the best interests of other stockholders.

   Our directors, executive officers and principal stockholders and their
affiliates currently beneficially own in the aggregate approximately 55% of our
outstanding common stock. Accordingly, they collectively have the ability to
substantially influence the outcome of all matters requiring stockholder
approval, including the election of directors, and any merger, consolidation, or
sale of all or substantially all of our assets. They may exercise this ability
in a manner that advances their best interests and not necessarily those of
other stockholders. This concentration of ownership may also have the effect of
delaying, deferring or preventing a change in control of our company, even if
the change in control would be beneficial to other stockholders.

Our charter documents and Delaware law contain provisions that could delay or
prevent an acquisition of us, even if the acquisition would be beneficial to our
stockholders.

   Our certificate of incorporation authorizes our board of directors to issue
undesignated preferred stock and to determine the rights, preferences,
privileges and restrictions of the preferred stock without further vote or
action by our stockholders. The issuance of preferred stock could make it more
difficult for third parties to acquire a majority of our outstanding voting
stock. We also have a stockholder rights plan, which entitles existing
stockholders to rights, including the right to purchase shares of preferred
stock, in the event of an acquisition of 15% or more of our outstanding common
stock, or an unsolicited tender offer for such shares. The existence of the
rights plan could delay, prevent, or make more difficult a merger or tender
offer or proxy contest involving us. Other provisions of Delaware law and of our
charter documents, including a provision eliminating the ability of stockholders
to take actions by written consent, could also delay or make difficult a merger,
tender offer or proxy contest involving us. Further, our stock option and
purchase plans generally provide for the assumption of such plans or
substitution of an equivalent option of a successor corporation or,
alternatively, at the discretion of the board of directors, exercise of some or
all of the option stock, including non-vested shares, or acceleration of vesting
of shares issued pursuant to stock grants, upon a change of control or similar
event.


                                      -23-
<PAGE>   24

ITEM 3.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        There have been no material changes in the reported market risks since
December 31, 2000 except for the foreign currency exchange risk related to the
foreign currency exchange contract Connetics entered into during the quarter
ended March 31, 2001.


PART II.  OTHER INFORMATION


ITEM 6.        EXHIBITS AND REPORTS ON FORM 8-K

(a)     Exhibits.  None

(b)     Reports on Form 8-K.

        (i)       We filed a Current Report on Form 8-K on April 2, 2001, as
                  amended by a filing on May 4, 2001, in connection with our
                  acquisition of Soltec Research Pty Ltd.

        (ii)      We filed a Current Report on Form 8-K on May 11, 2001, in
                  connection with the sale of our Ridaura(R) product line to
                  Prometheus Laboratories, Inc.


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<PAGE>   25

                                    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. Higgins
                                              Exec. Vice President, Finance and
                                              Administration and Chief Financial
                                              Officer

Date:   May 15, 2001


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