8-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 8-K

CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

Date of Report (Date of earliest event reported): May 3, 2006

CONNETICS CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware	0-27406	94-3173928
(State or Other Jurisdiction of Incorporation)	(Commission File No.)	(IRS Employer Identification No.)

3160 Porter Drive, Palo Alto, California 94304

(Address of principal executive offices, including zip code)

(650) 843-2800

(Registrant’s telephone number, including area code)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

TABLE OF CONTENTS

	Item 2.02 Results of Operations and Financial Condition
	Item 4.02 Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review
	Item 9.01 Financial Statements and Exhibits
SIGNATURES
EXHIBIT INDEX
EXHIBIT 99.1

Item 2.02 Results of Operations and Financial Condition

     On May 3, 2006, Connetics Corporation, or the Company, issued a press release announcing its preliminary results for the quarter ended March 31, 2006, and its intent to restate financial results for prior periods. A copy of the earnings release is furnished as Exhibit 99.1 to this report.

Item 4.02 Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review

     On May 3, 2006, the Company concluded that its financial statements for the year ended December 31, 2005, and potentially additional periods, should no longer be relied upon. The Company has determined that its rebate reserves as of the end of 2005 were understated. Rebates are contractual discounts offered to government programs and private health plans which are eligible for rebates at the time prescriptions are dispensed, subject to various conditions. The Company records quarterly reserve provisions for rebates by estimating rebate liability for product sold, based on factors such as timing and terms of plans under contract, time to process rebates, product pricing, sales volumes, units held by distributors, and prescription trends. Upon review, the Company has concluded that the rebate rates and method used to calculate the rebate liability did not fully capture the impact of these factors in its historical provision. Accordingly, the Company plans to restate its financial statements for the year ended December 31, 2005, and potentially additional periods.

     The Company intends to file an amended Form 10-K for the year ended December 31, 2005 and any other required amendments to its annual and periodic reports, which will include the restated financial statements, as soon as practicable after the Company completes its internal review and restatement of its financial statements and the external audit process is completed. The Company does not expect that it will be able to complete this process and make these filings before May 10, 2006, the deadline for timely filing the Form 10-Q for the quarter ended March 31, 2006.

     The increase in the historical provision for rebate reserves will have the effect of decreasing revenues and earnings, accrued liabilities and retained earnings figures contained in our historical financial statements. We do not believe that this restatement will have an impact on the Company’s historical cash position or operating expenses.

     The Company and the audit committee of its board of directors have discussed the matters disclosed in this Current Report on Form 8-K with Ernst & Young LLP, the Company’s independent registered public accounting firm.

     Additionally, the Company is evaluating Management’s Report on Internal Control Over Financial Reporting set forth in Item 9A on page 49 of the Company’s 2005 Annual Report on Form 10-K. Although the Company has not yet completed its analysis of the impact of this situation on its internal controls over financial reporting, the need to restate prior period financial statements makes it highly likely that the Company had a material weakness in internal control over financial reporting as of December 31, 2005, and may have a material weakness in internal control over financial reporting as of other dates. A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The existence of one or more material weaknesses means the Company could not conclude that its internal controls over financial reporting were effective as of year end. If the Company were to conclude

that a material weakness existed as of December 31, 2005, it would expect to receive an adverse opinion on internal control over financial reporting from its independent registered public accounting firm.

     On May 3, 2006, the Company issued a press release announcing its intent to restate financial statements for prior periods. A copy of the press release disclosing the planned restatement is attached as Exhibit 99.1 and is incorporated in this Item 4.02 by reference.

Item 9.01 Financial Statements and Exhibits

(d) Exhibits

Exhibit No.	Description
99.1	Press Release dated May 3, 2006.

SIGNATURES

     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 hereunto duly authorized.

CONNETICS CORPORATION
By:	/s/ Katrina J. Church
	Katrina J. Church
	Executive Vice President, Legal Affairs General Counsel and Secretary

Date: May 3, 2006

EXHIBIT INDEX

Exhibit
Number	Description
99.1	Press Release dated May 3, 2006

EX-99.1

Exhibit 99.1

CONNETICS REPORTS PRELIMINARY RESULTS FOR FIRST QUARTER 2006

Company to Restate Past Financial Results to Reflect Increased Rebate Reserve

Adjusts 2006 Financial Guidance Due to Increased Product Competition

PALO ALTO, Calif. (May 3, 2006) – Connetics Corporation (Nasdaq: CNCT), a specialty pharmaceutical company that develops and commercializes dermatology products, today announced preliminary financial results for the first quarter of 2006 and its plans to restate financial results for prior periods.

First Quarter Results
On a preliminary basis, net income for the first quarter ended March 31, 2006 was $0.8 million, or $0.02 earnings per share on a diluted basis, including stock-based compensation expense of $1.6 million, or $0.05 per diluted share, reflecting the adoption of SFAS 123R, accounting for stock-based compensation, as of January 1, 2006. On a non-GAAP basis excluding stock-based compensation, net income for the first quarter of 2006 was $2.4 million, or $0.07 per diluted share.

Total revenues for the first quarter of 2006 were $47.7 million, including Soriatane^® sales of $19.0 million, OLUX^® sales of $14.1 million, Evoclin^® sales of $8.0 million and Luxíq^® sales of $6.2 million. Royalty and contract revenues for the quarter were $0.4 million. These revenue amounts reflect the Company’s preliminary application of the revised rebate accounting described below.

Selling, general and administrative (SG&A) expenses for the first quarter of 2006 were $30.8 million. SG&A expenses included costs for the Company’s new pediatric sales organization which was acquired in the first quarter, and stock-based compensation of $1.3 million. Research and development (R&D) expenses for the first quarter of 2006 were $8.4 million, reflecting the Company’s late-stage clinical and regulatory activities, including the user fee for the NDA submission for Primolux™ and Extina^® clinical costs, as well as stock-based compensation of $349,000.

During the first quarter of 2006, the Company repurchased approximately 143,100 shares of its common stock for approximately $2.2 million, under its $50 million share repurchase program authorized in 2005. As of March 31, 2006, Connetics had cash and investments, including restricted cash of $248.3 million.

Restatement of Prior Periods to Adjust Rebate Reserves
Rebates are contractual discounts offered to government programs and to private health plans that are eligible for rebates at the time prescriptions are dispensed, subject to various conditions. The Company records quarterly reserve provisions for rebates by estimating rebate liability for product sold taking into consideration a number of factors including timing and terms of managed care contracts, time to process rebates, product pricing, sales volumes, units held by distributors and prescription trends. Upon review, the Company has concluded that the rebate rates and method used to calculate the rebate liability in prior periods did not fully capture the impact of these factors, and estimates that the cumulative impact of the change as of December 31, 2005 is approximately $8.0 million to $9.0 million. The estimated increased rebate reserve amount represents approximately 1.7% of cumulative total reported net sales for Connetics’ four products.

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By recording the additional rebate reserve to the balance sheet, aggregate historic net sales will be reduced by the amount of the reserve provision and net income and earnings per share will be reduced as well. A full analysis is underway to determine in which past periods the adjustment should be recorded and the amount of each such adjustment. Connetics is analyzing the restatement adjustments, and the estimated increased reserve amount described above is preliminary and subject to audit. The estimated increased rebate provision does not take into account any other potential adjustments in prior years that might arise. Connetics will file its Form 10-Q for the first quarter of 2006 with finalized first quarter results as well as its restated financial statements in amendments to prior reports with the Securities and Exchange Commission as soon as is practicable; the final reserve amount and the impact on prior-period revenues, net income and earnings per share will be available in these filings. The Form 10-Q for the first quarter of 2006 will be filed immediately after the restated prior year filings are amended.

In light of the restatement, investors should rely on Connetics’ forthcoming restated financial statements and other financial information rather than previously filed financial statements and other financial information.

Business Highlights
“We had a busy and productive first quarter hitting all-time prescription highs with Evoclin, submitting a New Drug Application (NDA) for Primolux and licensing a new product technology for development,” said Thomas G. Wiggans, Chief Executive Officer of Connetics. “In addition, we completed our acquisition of a pediatric sales force, which is now trained and in the field promoting Evoclin and Luxiq. While we have experienced increased pressure from recent competitive product launches, we remain focused on commercial success with our four marketed brands. We also are committed to product development, and our current product pipeline is larger than at any time in the Company’s history. We currently have more than 10 products in development, with three having the potential to be approved and launched during the coming 18 months. Clearly a short-term priority is to file our restated financial results, but the revised accounting does not affect our underlying business model or growth prospects.”

Significant activities in the first quarter of 2006 and subsequent weeks included:

• Acquiring the 80 territory sales organization of PediaMed Pharmaceuticals, Inc. This strategic acquisition leverages Connetics’ commercial portfolio into an important market where the Company previously had limited presence, and expands its sales force to approximately 200 representatives calling on dermatologists and pediatricians.

• In-licensing technology rights for a potential treatment for hyperhidrosis (excessive sweating), and initiating a formulation development program utilizing this technology.

• Submitting a Citizen Petition to the U.S. Food and Drug Administration (FDA) requesting that any generic products that reference Soriatane (acitretin) meet several criteria in addition to rigorous bioequivalency testing prior to approval.

• Submitting an NDA to the FDA for Primolux™, a super-high potency topical steroid for the treatment of psoriasis and atopic dermatitis, formulated with 0.05% clobetasol propionate in the Company’s proprietary VersaFoam-EF™ emulsion foam delivery vehicle.

• Receiving issuance of a second U.S. patent that covers Connetics’ emulsion foam vehicle. This newly issued patent, along with one issued in 2004, provides patent protection for products incorporating Connetics’ VersaFoam-EF formulation. Desilux™ and Primolux are based on the VersaFoam-EF technology. An NDA has been submitted for each product.

• Presenting eight posters at the American Academy of Dermatology’s 64^th annual meeting, demonstrating Connetics commitment to innovation, and the depth and breadth of its development

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capability.

• Also, in January 2006 technology developed by Connetics was approved for sale. Pfizer received FDA approval for Men’s Rogaine^® (minoxidil, 5%) foam using Connetics’ VersaFoam^® technology. Connetics anticipates receiving initial royalties from sales of this product beginning in late 2006.

Financial Guidance
For the second quarter of 2006, Connetics projects total revenues of $50.5 million to $52.5 million. Second quarter operating expenses, including depreciation, are projected to be in the range of $37 million to $38 million. Connetics projects earnings per share on a diluted basis for the second quarter of 2006 of $0.07 to $0.09, including an estimated $1.6 million or approximately $0.04 per diluted share impact from expensing stock-based compensation. Non-GAAP diluted EPS for the second quarter of 2006 excluding expense for stock-based compensation is projected to be in the range of $0.11 to $0.13.

Based on information currently available to the Company, Connetics is lowering 2006 revenue guidance. Total revenues are now expected to be $211 million to $217 million, compared with prior guidance of $221 million to $225 million, reflecting increased competition in the psoriasis market. Total operating expenses for 2006, including depreciation, are unchanged and projected to be between $146 million and $148 million. Diluted EPS for 2006 is projected to be in the range of $0.44 to $0.50, including an estimated $6.8 million or $0.17 per diluted share in stock-based compensation expense. This diluted EPS forecast assumes a 38% tax rate and a diluted “If-Converted” share count of approximately 39.7 million shares. This compares with previous guidance for 2006 diluted EPS of $0.49 to $0.53. Non-GAAP diluted EPS for 2006 excluding the expense for stock-based compensation is projected to be in the range of $0.61 to $0.67, compared with prior guidance of $0.67 to $0.71. This financial guidance reflects the Company’s preliminary application of the new accounting methodology for rebate reserves.

The Company’s financial guidance is based on a number of factors involving estimates and assumptions, and changes in these factors would affect actual future results. These factors include, among others, current and projected prescription information; sales trend data of the Company’s products; the potential generic availability of, and competitive threats to, the Company’s products; size, reach and call frequency of the Company’s selling organization; status, timing and progression of the Company’s development projects; current and projected spending levels to support sales, marketing, development and administrative activities; and other risk factors discussed in Connetics’ publicly filed documents. The above guidance does not take into account the potential impact of other components of Connetics’ growth strategy, including possible future acquisitions of products, businesses and/or technologies.

Conference Call
Connetics management will host a conference call to discuss the Company’s financial performance today at 4:30 p.m. Eastern time/1:30 p.m. Pacific time. To participate in the live call, domestic callers should dial (888) 328-2575, international callers should dial (706) 643-0459 or the web cast can be accessed from the investor relations section of the Company’s website at www.connetics.com. A telephone replay can be accessed for 48 hours beginning today at 6:30 p.m. Eastern time/3:30 p.m. Pacific time by dialing (800) 642-1687 from the U.S., or (706) 645-9291 from outside the U.S. The Conference ID# is 8090667. The internet replay of the call will be available for 30 days at www.connetics.com.

About Connetics
Connetics Corporation is a specialty pharmaceutical company focused on the development and commercialization of innovative therapeutics for the dermatology market. Connetics has branded its proprietary foam drug delivery vehicle VersaFoam^®. The Company’s marketed products are OLUX^® (clobetasol propionate) Foam, 0.05%; Luxiq^® (betamethasone valerate) Foam, 0.12%; Soriatane^® (acitretin) capsules; and Evoclin^® (clindamycin) Foam, 1%. Connetics is developing Desilux™ (desonide) VersaFoam-EF, 0.05%, a low-potency topical steroid formulated to treat atopic dermatitis; Primolux™ (clobetasol propionate) VersaFoam-EF, 0.05%, a super high-potency topical steroid formulation to treat atopic dermatitis and plaque psoriasis; Extina^® (ketoconazole) VersaFoam-HF, 2%, to

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treat seborrheic dermatitis; and Velac^® (a combination of 1% clindamycin and 0.025% tretinoin) Gel, to treat acne. Connetics’ product formulations are designed to improve the management of dermatological diseases and provide significant product differentiation. In Connetics’ marketed products, these formulations have earned wide acceptance by both physicians and patients due to their clinical effectiveness, high quality and cosmetic elegance. For more information about Connetics and its products, please visit www.connetics.com.

Note: Rogaine^® is a registered trademark of Pfizer, Inc. (formerly Pharmacia Corporation). Nothing in this press release should be construed to reflect commercial timing for this product.

Forward Looking Statements
Except for historical information, this press release includes “forward-looking statements” within the meaning of the Securities Litigation Reform Act. In particular, there can be no assurances as to when Connetics will be able to complete its restatement and file restated financial statements and amended reports with the Securities and Exchange Commission or the potential effects of any delays in such filings. All statements included in this press release that address activities, events or developments that Connetics expects, believes or anticipates will or may occur in the future, including, particularly, statements about its restatement and amended Securities and Exchange Commission filings, sales growth of its product portfolio, revenues resulting from product sales and global licenses, the timing and impact of approvals, earnings estimates, future financial performance and financial guidance, are forward-looking statements. All forward-looking statements are based on assumptions made by Connetics’ management based on its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond Connetics’ control, and which could cause actual results or events to differ materially from those expressed in such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, risks and other factors that are discussed in documents filed by Connetics with the Securities and Exchange Commission from time to time, including Connetics’ Annual Report on Form 10-K for the year ended December 31, 2005. Forward-looking statements represent the judgment of the Company’s management as of the date of this release, and Connetics disclaims any intent or obligation to update any forward-looking statements.

Contacts:
Connetics Corporation	Lippert/Heilshorn & Associates
John Higgins, CFO	Don Markley or Bruce Voss
(650) 843-2800	(310) 691-7100
jhiggins@connetics.com	dmarkley@lhai.com
Press Release Code: CNCT-F

Tables Follow

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CONNETICS CORPORATION
Preliminary Condensed Consolidated Statement of Operations
(In thousands, except share and per share amounts)
(Unaudited)

	Three Months
	Ended March 31
	2006
Revenues:
Product	$	47,267
Royalty and contract		394
Total revenues		47,661
Operating costs and expenses:
Cost of product revenues		3,700
Research and development		8,417
Selling, general and administrative		30,812
Amortization of intangible assets		3,902
Total operating costs and expenses		46,831
Income from operations		830
Interest and other income (expense), net		429
Provision for income taxes		(491	)
Net income	$	768
Net income per share:
Basic	$	0.02
Diluted	$	0.02
Shares used to calculate net income per share:
Basic		33,646
Diluted		35,076

CONNETICS CORPORATION
Reconciliation of GAAP to Non-GAAP Earnings Per Share
(In thousands, except share and per share amounts)
(Unaudited)

     On January 1, 2006, we adopted SFAS 123(R) and recorded stock-based compensation expense during the three months ended March 31, 2006. The table below presents net income excluding stock-based compensation, which is a Non-GAAP measure used by the Company when evaluating its financial results as well as for internal planning and forecasting purposes. This Non-GAAP measure should not be considered a substitute for or superior to financial measures calculated in accordance with GAAP. The following is a reconciliation of our GAAP and non-GAAP net income (in thousands, except per share amounts):

Net income (GAAP)	$	768
Stock-based compensation expense:
Selling, general and administrative		1,279
Research and development		349
Total stock-based compensation expense		1,628
Net income excluding stock-based
Compensation expense (Non-GAAP) (1)	$	2,396
Shares used in per share calculation – diluted (Non- GAAP)		35,076
Net income per share – diluted, excluding stock-based Compensation expense (Non-GAAP)	$	0.07

(1) Due to the Company’s deferred tax assets being offset by a valuation allowance, there is no tax impact from the stock-based compensation expense.

CONNETICS CORPORATION
Preliminary Condensed Consolidated Balance Sheet
(In thousands)
(Unaudited)

	March 31,
	2006
Assets
Assets:
Cash, cash equivalents and investments	$	244,198
Restricted cash		4,059
Accounts receivable and other current assets		46,366
Other intangible assets, net		123,697
Property and equipment, net		14,296
Other long-term assets		11,981
Total assets	$	444,597
Liabilities and Stockholders’ Equity
Liabilities and stockholders’ equity:
Current liabilities (1)	$	48,700
Long-term liabilities		290,526
Stockholders’ equity (1)		105,371
Total liabilities and stockholders’ equity	$	444,597

(1) Current Liabilities have been increased and Stockholders’ Equity has been decreased by $8.5 million, the mid-point of the $8.0 million to $9.0 million estimate for increased rebate reserves, compared to the December 31, 2005 Balance Sheet included in the filed 2005 Form 10-K. This preliminary number represents an estimate of the incremental rebate reserve and related cumulative net income impact as of December 31, 2005.

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