CONNETICS CORP
10-Q, 1997-08-13
PHARMACEUTICAL PREPARATIONS
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<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 JUNE 30, 1997


                         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 July 31, 1997, 10,961,586 shares of the Registrant's common stock were
outstanding, at $0.001 par value.


<PAGE>   2


                              CONNETICS CORPORATION

                          QUARTERLY REPORT ON FORM 10-Q
                       FOR THE PERIOD ENDED JUNE 30, 1997

                                TABLE OF CONTENTS



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

             Item 1.   Financial Statements
             <S>                                                                               <C>
                       Condensed Balance Sheets at June 30, 1997 and December 31,1996............3
                      
                       Condensed Statements of Operations for the three and six months ended
                       June 30, 1997 and 1996....................................................4

                       Condensed Statements of Cash Flows for the six months ended June 30,1997 
                       and 1996..................................................................5

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

             Item 2.   Management's Discussion and Analysis of Financial Condition 
                       and Results of Operations.................................................7

             Item 3.   Quantitative and Qualitative Disclosures About Market Risks..............10

PART II.     OTHER INFORMATION

             Item 1.   Legal Proceedings........................................................11

             Item 2.   Changes in Securities....................................................11

             Item 3.   Defaults Upon Senior Securities..........................................11

             Item 4.   Submission of Matters to a Vote of Security Holders......................11

             Item 5.   Other Information........................................................12

             Item 6.   Exhibits and Reports on Form 8-K.........................................12

                           Exhibits.............................................................12

                           Reports on Form 8-K..................................................12

SIGNATURE              .....................................................................    13
</TABLE>



<PAGE>   3


PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

                              CONNETICS CORPORATION

                            CONDENSED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                          JUNE 30,       DECEMBER 31,
                                                                            1997            1996
                                                                          --------        --------
                                                                         (UNAUDITED)
                                     ASSETS
<S>                                                                       <C>             <C>     
Current assets:
    Cash and cash equivalents                                             $  9,241        $ 14,555
    Short-term investments                                                  10,726           9,999
    Accounts and other receivables                                           1,481             428
    Prepaid expenses and other current assets                                  241             124
                                                                          --------        --------
        Total current assets                                                21,689          25,106

Property and equipment, net                                                  1,763           1,484
Notes receivable from related parties                                          310             301
Deposits and other assets                                                      210             250
License agreements and product rights                                       17,218          20,781
                                                                          --------        --------
                                                                          $ 41,190        $ 47,922
                                                                          ========        ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                      $  1,675        $  4,179
    Accrued and other current liabilities                                    3,271           2,023
    Accrued process development expenses                                       681           1,198
    Accrued payroll and related expenses                                       473             394
    Notes payable                                                            5,895               -
    Current portion of capital lease obligations, capital loans and          
      long-term debt                                                         2,916           2,408
                                                                          --------        --------
        Total current liabilities                                           14,911          10,202

Noncurrent portion of capital lease obligations, capital loans and           
  long-term debt                                                             1,965           3,062
Other long-term liabilities                                                  5,765          10,858
Redeemable convertible preferred stock, Series A                             1,750           2,000
Commitments
Stockholders' equity:
    Preferred stock                                                              -               -
    Common stock                                                                11               9
    Additional paid in capital                                              72,163          60,998
    Notes receivable from stockholders                                         (75)            (75)
    Deferred compensation, net                                              (1,043)         (1,315)
    Other                                                                        -              (3)
    Accumulated deficit                                                    (54,257)        (37,814)
                                                                          --------        --------
Total stockholders' equity                                                  16,799          21,800
                                                                          --------        --------
                                                                          $ 41,190        $ 47,922
                                                                          ========        ========
</TABLE>


                  See notes to condensed financial statements.


                                      -3-


<PAGE>   4


                              CONNETICS CORPORATION

                       CONDENSED STATEMENTS OF OPERATIONS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                       THREE MONTHS ENDED                      SIX MONTHS ENDED
                                                             JUNE 30,                              JUNE 30,
                                                  ------------------------------        ------------------------------
                                                       1997             1996               1997               1996
                                                  ------------------------------        ------------------------------
<S>                                               <C>                <C>                <C>                <C>  
Product revenues                                  $     1,594        $        --        $     3,047        $        --

Operating Expenses:
    Cost of product sales                                 257                 --                483                 --
    License amortization                                1,781                 --              3,562                 --
    Research and development                            5,732              2,865             10,897
                                                                                                                 5,009
    General and administrative                          2,419              1,020              4,040              2,319
                                                  -----------        -----------        -----------        -----------
Total operating expenses                               10,189              3,885             18,982              7,328
Interest income                                           234                351                469                612
Interest expense                                         (443)              (236)              (895)              (500)
                                                  -----------        -----------        -----------        -----------
Net loss                                          $    (8,804)       $    (3,770)       $   (16,361)       $    (7,216)
                                                  ===========        ===========        ===========        ===========

Net loss per share                                $     (0.88)       $     (0.51)       $     (1.72)       $     (1.19)
                                                  ===========        ===========        ===========        ===========

Shares used to calculate net loss per share        10,008,838          7,380,048          9,543,209          6,085,462
                                                  ===========        ===========        ===========        ===========
</TABLE>


                  See notes to condensed financial statements.


                                      -4-


<PAGE>   5



                              CONNETICS CORPORATION

                       CONDENSED STATEMENTS OF CASH FLOWS
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                                 (IN THOUSANDS)
                                   (UNAUDITED)





<TABLE>
<CAPTION>
                                                                  SIX MONTHS ENDED
                                                                      JUNE 30,
                                                              -----------------------
                                                              1997             1996
                                                              --------        -------

<S>                                                            <C>             <C>    
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss                                                       (16,361)        (7,216)

Adjustments to reconcile net loss to
net cash used by operating activities:
    Depreciation and amortization                                3,919            313
    Amortization of deferred compensation                          258            369
    Accrued interest on notes payable                              553              -
    Changes in assets and liabilities:
        Current and other assets                                (1,187)           563
        Current and other liabilities                           (1,447)          (300)
                                                               -------        -------

Net cash used by operating activities                          (14,265)        (6,271)
                                                               -------        -------

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of short-term investments                            (10,147)       (25,575)
Sales and maturities of short-term investments, net              9,423         10,565
Capital expenditures                                              (586)          (302)
                                                               -------        -------

Net cash used in investing activities                           (1,310)       (15,312)
                                                               -------        -------

CASH FLOWS FROM FINANCING ACTIVITIES
Payment of notes payable                                             -         (2,205)
Proceeds from capital loans and long-term debt                     333            216
Payments of obligations under capital leases and capital        (1,003)          (190)
    loans
Proceeds from issuance of preferred and common stock,
    net of issuance costs                                       10,931         24,560
                                                               -------        -------

Net cash provided by financing activities                       10,261         22,381
                                                               -------        -------

Net change in cash and cash equivalents                         (5,314)           798
Cash and cash equivalents at beginning of period                14,555          9,023
                                                               =======        =======

Cash and cash equivalents at end of period                     $ 9,241        $ 9,821
                                                               =======        =======

SUPPLEMENTARY INFORMATION:
Interest paid                                                  $   342        $   619
                                                               =======        =======
</TABLE>


                  See notes to condensed financial statements.


                                      -5-


<PAGE>   6


                              CONNETICS CORPORATION

                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                  JUNE 30, 1997
                                   (UNAUDITED)


1.      BASIS OF PRESENTATION

The accompanying unaudited condensed financial statements of Connetics
Corporation (the "Company" or "Connetics") have been prepared 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, such financial statements do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accrual adjustments, considered necessary for a fair
presentation have been included. Operating results for the three and six month
periods ended June 30, 1997 are not necessarily indicative of the results that
may be expected for the year ending December 31, 1997.

These financial statements and notes should be read in conjunction with the
Company's audited financial statements and notes thereto for the year ended
December 31, 1996 included in the Company's Form 10-K Report.

2.      NET LOSS PER SHARE

Net loss per share is computed using the weighted average number of shares of
common stock outstanding. Common equivalent shares from stock options and
convertible preferred stock are excluded from the computation as their effect is
antidilutive, except that, pursuant to Securities and Exchange Commission Staff
Accounting Bulletins.

In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128), which requires the Company to simplify the calculation of earnings per
share ("EPS") and achieve comparability with the recently issued International
Accounting Standard No. 33, "Earnings Per Share." Statement No. 128 is effective
for both interim and annual financial statements for periods ending after
December 15, 1997. As a result, the Company will continue to compute EPS in
accordance with Accounting Principles Board ("APB") Opinion No. 15, "Earnings
Per Share," and will adopt and report on SFAS 128 new EPS basis in the fourth
quarter ended December 31, 1997. The impact of SFAS 128 is not expected to be
material to the Company's financial statements.

3.      LIQUIDITY AND FINANCIAL VIABILITY

In the course of its development activities, the Company has sustained
continuing operating losses and expects such losses to continue over at least
the next few years. The Company plans to continue to finance its operating
activities with a combination of stock sales, such as the initial public
offering completed in February 1996 and the self-managed private financings in
December 1996 and May 1997, payments from corporate partnering arrangements,
acquisition of revenue generating products such as Ridaura(R) and/or debt
financing. Ultimately, the Company's ability to continue as a going concern in
the near future is dependent upon obtaining substantial additional financings.


                                      -6-


<PAGE>   7


ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS

SPECIAL NOTE: EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED THEREIN, THE
FOLLOWING DISCUSSION CONSISTS OF FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES WHICH COULD CAUSE ACTUAL RESULTS OR EVENTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENTS. POTENTIAL RISKS AND
UNCERTAINTIES INCLUDE, WITHOUT LIMITATION, UNCERTAINTY OF PRODUCT DEVELOPMENT
AND MARKET ACCEPTANCE; UNCERTAINTY OF FUTURE RIDAURA(R) REVENUES; UNCERTAINTY OF
FUTURE PROFITABILITY; FUTURE CAPITAL REQUIREMENTS AND UNCERTAINTY OF FUTURE
FUNDING; AND RISKS ASSOCIATED WITH POSSIBLE FUTURE PRODUCT ACQUISITIONS.
ADDITIONAL INFORMATION CONCERNING THESE AND OTHER FACTORS THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD LOOKING STATEMENTS
IS CONTAINED UNDER THE HEADING "OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS"
COMMENCING ON PAGE 21 OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL
YEAR ENDED DECEMBER 31, 1996.

The following discussion should be read in conjunction with the unaudited
condensed financial statements and notes thereto included in Part I, Item 1 of
this Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in the Company's Form 10-K for the
year ended December 31, 1996.

OVERVIEW

Connetics Corporation acquires, develops and markets products in the areas of
rheumatology and dermatology. The Company acquired the U.S. and Canadian rights
to Ridaura(R) (auranofin), a treatment for rheumatoid arthritis, from SmithKline
Beecham Corporation and related entities ("SmithKline") in December 1996. Under
a related Transitional Services Agreement, customer orders and distribution for
Ridaura(R) will continue to be managed by SmithKline through 1997. The Company's
products under development include gamma interferon for the treatment of atopic
dermatitis and keloids; betamethasone mousse for the treatment of scalp
psoriasis and other scalp dermatoses; ConXn(TM) (relaxin) for the treatment of
scleroderma and other fibrotic disorders; and T-cell Receptor (TCR) peptide
vaccines for the treatment of multiple sclerosis and rheumatoid arthritis. The
Company's stockholders approved a change of the Company's name from "Connetics
Corporation" to "Connetics Corporation" at its annual meeting in May 1997.

In May 1997, the Company completed enrollment of a 190-patient Phase III
clinical trial of betamethasone mousse, a novel foam formulation for the
treatment of scalp psoriasis. The Phase III trial is a multicenter, randomized,
double-blind study comparing betamethasone mousse therapy against betamethasone
lotion. Primary endpoints include changes in the clinical signs of psoriasis:
plaque thickness, scaling, erythema, and global response to treatment as judged
by the investigator. Decreases in itching and the amount of scalp area affected
by disease, as well as patient assessment of improvement will also be evaluated.

Also in May 1997, the Company completed patient enrollment in its Phase I/II
clinical trial of its therapeutic vaccine for multiple sclerosis. The clinical
trial enrolled 100 patients with multiple sclerosis to evaluate safety and
immunogenicity. The vaccine is being developed to elicit a heightened immune
response against the pathogenic T-cells believed to cause multiple sclerosis.

The Company has completed in May 1997 the enrollment of a 40-patient
placebo-controlled, randomized, multicenter Phase II clinical trial of gamma
interferon in keloids, fibrotic growths, which affects approximately 3 million
Americans, that result from an abnormal healing response in the skin.

In June 1997, the Company released clinical data from its Phase II clinical
trial of ConXn(TM) for the treatment of scleroderma. The double-blind,
placebo-controlled study involved 64 patients randomized into one of two
treatment groups (25 or 100 (greek mu)g/kg/day), or placebo. In the group
receiving a dose of 25 (greek mu)g/kg/day, statistical significance was found in
skin score improvement, the primary clinical endpoint, 


                                      -7-



<PAGE>   8


and positive trends were seen in all other parameters. As suggested by previous
studies, the higher dose had no effect on the treatment group compared to
placebo. The Company is continuing its analysis of the data and will meet with
clinical investigators and the Food and Drug Administration to finalize its
plans for continued development.

There can be no assurance that any of the Company's potential products will be
successfully developed, receive the necessary regulatory approvals or be
successfully commercialized.

RESULTS OF OPERATIONS

The Company's revenues are derived from the sales of Ridaura(R) and were $1.6
million and $3.0 million for the three and six months ended June 30, 1997. The
Company had no revenue for the same periods in 1996 as all of its products were
in development stage.

Under related Transitional Services and Supply agreements between SmithKline and
the Company, SmithKline will manufacture and supply Ridaura(R) in final package
form and manage distribution of the product. The Company's cost of product sales
includes the cost of Ridaura(R) purchased from SmithKline and per-unit royalty
cost based on product sales. For the three and six months ended June 30, 1997,
the Company recorded $0.3 million and $0.5 million, respectively, in cost of
product sales and recorded amortization expense of $1.8 million and $3.6
million, respectively, associated with the acquisition of product rights to
Ridaura(R). No product cost was recorded for the three and six months ended June
30, 1996 as the Company was still in development stage without any revenue
generating product.

Research and development expenses were $5.7 million and $10.9 million for the
three and six months ended June 30, 1997, respectively, compared to $2.9 million
and $5.0 million for the same periods in 1996, respectively. The increase in
research and development expenses of $2.8 million and $5.9 million,
respectively, was primarily due to the 555 patient Phase III clinical trial of
gamma interferon for the treatment of atopic dermatitis, the Phase II clinical
trial of ConXn(TM) for the treatment of scleroderma, the Phase I/II clinical
trial of TCR peptide vaccines for the treatment of multiple sclerosis, the Phase
II clinical trial of gamma interferon for the treatment of keloids and the Phase
III clinical trial of betamethasone mousse for the treatment of scalp psoriasis,
all of which commenced subsequent to June 1996. Research and development
expenses are expected to decrease over the next two quarters due to the
completion of current clinical trial activities, however the decrease could be
offset by unanticipated additional expenses of on-going trials or by possible
acquisition of new technologies and products and initiation of new clinical
trials.

Selling, general and administrative expenses increased to $2.4 million and $4.0
million for the three and six months ended June 30, 1997, respectively, compared
to $1.0 million and $2.3 million for the same periods in 1996, respectively. The
increase was primarily due to the establishment of a new sales and marketing
organization, costs associated with the re-launching of Ridaura(R), increases in
personnel in the general and administrative functions, and legal expenses
associated with operating as a public company. Selling, general and
administrative expenses are expected to continue to increase primarily due to
expanded business development efforts, increased staffing of the sales
organization and costs associated with marketing Ridaura(R).

Interest income decreased to $234,000 and $469,000 in the three and six months
ended June 30, 1997, respectively, compared with $351,000 and $612,000 for the
corresponding periods in 1996, respectively, due to lower average cash and
investment balances held by the Company during the first half of 1997 than
during the comparable period in 1996. Interest earned in the future will depend
on Company funding cycles and prevailing interest rates. Interest expense
increased to $443,000 and $895,000 for the three and six months ended June 30,
1997, respectively, compared with $236,000 and $500,000 for the corresponding
periods in 1996. The increase in interest expense during the first six months of
1997 was due to imputed interest expense of $553,000 attributable to the
non-interest bearing $11.0 million promissory note payable to SmithKline for the
acquisition of U.S. and Canadian rights to Ridaura(R). This 


                                      -8-


<PAGE>   9


was offset in part by lower interest expense associated with lower balances
outstanding for obligations under capital leases and loans, and notes payable.

The Company incurred net losses of $8.8 million and $16.4 million in the three
and six months ended June 30, 1997, respectively, compared with $3.8 million and
$7.2 million for the corresponding periods in 1996, respectively. The increase
of $5.0 million and $9.2 million in net losses, respectively, was primarily due
to a higher level of development stage activities and Ridaura(R) related sales
and marketing expenses, amortization costs and imputed interest expenses. The
increase in net loss was offset in part by revenue generated from the sale of
Ridaura(R) less cost of product sold. The Company expects to incur substantial
additional losses over the next few years and losses are expected to fluctuate
from period to period based on timing of product revenues, clinical material
purchases, possible acquisitions of new products and technologies, scale-up
activities and clinical activities.


LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations since inception through June 30, 1997
primarily through private sales of equity securities, proceeds from its initial
public offering in February 1996 and three self-managed financings, two in
December 1996 and one in May 1997.

Working capital decreased by $8.1 million to $6.8 million at June 30, 1997 from
$14.9 million at December 31, 1996; cash, cash equivalents and short-term
investments decreased by $4.6 million to $20.0 million at June 30, 1997 from
$24.6 million at December 31, 1996. The decrease in cash, cash equivalents and
short-term investments resulted primarily from a $3.0 million payment to
SmithKline for rights to Riduara(R) made in January 1997, $0.5 million in
consulting and legal fees associated with the acquisition of Riduara(R), and
$13.8 million in operating expenses of which approximately $7.7 million relates
to clinical trial activities. Partially offsetting the decrease during the first
half of 1997 was $1.8 million cash generated from Ridaura(R) product sales (net
of product costs) and $10.9 million cash generated from the sale of the
Company's common stock to certain accredited investors in May 1997. The decrease
in working capital was the result of lower cash, cash equivalents and short-term
investments, the now current portion of capital loans, long-term debt and $6.0
million note payable due to SmithKline in January 1998 for rights to Ridaura(R),
and increase in accrued liabilities of $1.3 million associated with clinical
trial activities, offset in part by lower accounts payable and accrued process
development expenses. The decrease in accounts payable and accrued process
development expenses of $3.0 million during the first half of 1997 was due to
payments of $3.0 million to SmithKline and $0.7 million for gamma interferon
material associated with the Phase III clinical trial, offset in part by higher
clinical trial activities.

Receivables at June 30, 1997 increased by $1.1 million to $1.5 million as
compared to $0.4 million at December 31, 1996 as a result of increased sales of
Ridaura(R). Total receivables for the first half of 1997 was $2.8 million of
which $1.3 million has been collected.

For the six months ended June 30, 1997, expenditures for equipment and leasehold
improvement totaled $0.6 million of which approximately $0.3 million was
financed through a capital loan arrangement. Total additions for property and
equipment for the period from inception to December 31, 1996 totaled $2.5
million of which $2.3 million was financed through capital lease and loan
arrangements. At June 30, 1997, the Company had invested $3.1 million in
property and equipment, and had approximately $0.6 million available for
borrowing under its capital loan arrangement.

At June 30, 1997, the Company had an aggregate of $16.5 million in future
obligations of principal payments under capital leases, loans, long-term debt
and other obligations, of which $8.7 million is to be paid within the next year.


                                      -9-


<PAGE>   10


The Company has a Structured Equity Line Flexible Financing Agreement (the
"Equity Line Agreement") with Kepler Capital LLC ("Kepler") that allows the
Company to access up to $25 million through sales of its Common Stock. The
equity line will be available for a three-year period beginning on or before
December 1, 1997. The Equity Line Agreement provides that the Company can, at
its option, obtain from $500,000 to $2,000,000 at any one time through a sale of
its Common Stock to Kepler, subject to the satisfaction of certain conditions,
including registration of shares for resale, minimum volume requirements, and a
minimum trading price of $7.00 per share over a specified period. In addition,
the Company must sell $500,000 of its Common Stock from time to time if the
price per share exceeds $10.00 and minimum volume requirements are met.

The Company believes that its existing cash and cash equivalents, short-term
investments, cash generated from the sale of Ridaura(R), and funds available
under the capital loan and the structured equity line, will be sufficient to
fund the Company's operating expenses and capital requirements through 1997. The
Company's future capital uses and requirements are expected to increase in
future periods and will depend on numerous factors, including the progress of
its research and development programs, the progress of clinical and
advanced-stage clinical testing, the time and costs involved in obtaining
regulatory approvals, the cost of filing, prosecuting, and enforcing patent
claims and other intellectual property rights, competing technological and
market developments, the ability of the Company to establish collaborative
arrangements, the possible acquisition of new products and technologies, and the
development of commercialization activities. As a result, the Company will
require substantial additional funds prior to reaching profitability and may
attempt to raise additional funds through equity or debt financings,
collaborative arrangements with corporate partners or from other sources. There
can be no assurance that additional funding will be available for the Company to
finance its ongoing operations on acceptable terms if at all.



ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

    Not Applicable.


                                      -10-


<PAGE>   11


PART II.  OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

    None.

ITEM 2.    CHANGES IN SECURITIES

    On May 14, 1997, the Company sold 1,810,000 shares of its Common Stock to
    several accredited investors at a price of $6.05 per share and also issued
    warrants to purchase an aggregate of 905,000 shares of Common Stock at an
    exercise price of $9.08 per share to such investors. No underwriter was
    involved in this private placement. The shares and warrants were issued
    under an exemption from registration pursuant to Rule 506 under Regulation D
    of the Securities Act of 1933 as amended. No general solicitation or
    advertisement was made in connection with this private placement.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

    None.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    On May 14, 1997, the Company held its annual meeting of stockholders. At the
    meeting, the stockholders approved the following matters by the following
    votes:

    1)   Election of the following directors:


<TABLE>
<CAPTION>
                                                    FOR          WITHHELD

         <S>                                    <C>              <C>   
         G. Kirk Raab                            6,692,040        15,282
         Thomas G. Wiggans                       6,701,722         5,600
         Eugene A. Bauer, M.D.                   6,701,722         5,600
         Alexander E. Barkas, Ph.D.              6,701,340         5,982
         Brian H. Dovey                          6,652,622        64,700
         John C. Kane                            6,701,722         5,600
         Thomas D. Kiley, Esq.                   6,690,422        16,900
         Kenneth B. Plumlee                      6,692,722        14,600
         Joseph J. Ruvane, Jr.                   6,701,222         6,100
</TABLE>


    2)   Approval of amendments to the Company's 1994 Stock Plan to increase the
         number of shares issuable thereunder to an aggregate of 2,500,000
         shares and to allow for option grants to non-employee directors.


                       FOR           AGAINST        ABSTAIN

                     4,252,247       844,164         216,425


    3)   Approval of an amendment to the Company's Certificate of Incorporation
         to change the Company's name to "Connetics Corporation".


                       FOR           AGAINST        ABSTAIN

                     6,687,690        13,792           5,840


                                      -11-


<PAGE>   12




    4)   Ratification of the appointment of Ernst & Young LLP to serve as the
         Company's independent auditors for the fiscal year ending December 31,
         1997.


                       FOR           AGAINST        ABSTAIN

                     6,679,722        22,360           5,240


ITEM 5.    OTHER INFORMATION

    On August 5, 1997, the Company announced results from its Phase III clinical
    trial with betamethasone mousse, a novel foam formulation of betamethasone
    valerate, demonstrated statistically significant improvement over placebo
    for the treatment of scalp psoriasis, a condition that affects approximately
    three million Americans. The Company intends to file a New Drug Application
    (NDA) with the Food and Drug Administration (FDA) to market the product for
    use in all steroid-responsive dermatoses, including psoriasis, in the first
    quarter 1998.

    The 190-patient, placebo-controlled, randomized, double-blind, multi-center
    Phase III study demonstrated that patients treated with betamethasone
    mousse, administered twice-daily for 28 days, experienced a statistically
    significant improvement over patients in the groups treated with
    betamethasone lotion or placebo in all primary endpoints, including
    erythema, plaque thickness and scaling. In addition, study investigators
    completed a physicians global assessment which showed that overall, 71% of
    patients treated with the mousse formulation had complete or almost complete
    clearance compared with 46% for lotion and 18% for placebo. Both
    betamethasone mousse and lotion were generally well tolerated.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)     Exhibits.


   11.1       Statement of Net Loss Per Share
   27.1       Financial Data Schedule (EDGAR - filed version only)




(b)     Reports on Form 8-K.

        The following Reports on Form 8-K were filed during the three months
        ended June 30, 1997:


        The Company filed a current report on 8-K dated May 23, 1997 reporting
        the Company's change in name from Connective Therapeutics, Inc. to
        Connetics Corporation; the Private Placement to certain accredited
        investors of 1,936,357 shares of the Company's Common Stock; and the
        Adoption of a Stockholder Rights Plan. Such disclosure was provided
        under Item 5 (Other Events) of Form 8-K. No financial statements were
        filed with this report.

        The Company also filed a current report on 8-K dated June 5, 1997
        reporting the results from its Phase II clinical trial of ConXn(TM).
        Such disclosure was provided under Item 5 (Other Events) of Form 8-K. No
        financial statements were filed with this report.


                                      -12-


<PAGE>   13


                                    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/        CYNTHIA M. BUTITTA
                                  ----------------------------------------     
                                             Cynthia M. Butitta
                                 Vice President, Finance and Administration
                                         and Chief Financial Officer

Date:   August 13, 1997


                                      -13-


<PAGE>   14


                               INDEX TO EXHIBITS


<TABLE>
<CAPTION>
     EXHIBIT   
     NUMBER                                  EXHIBITS
     -------                                 --------
      <S>                                    <C>                   
       11.1                                  Statement of Net    
                                             Loss Per Share

       27.1                                  Financial Data Schedule   
</TABLE>



<PAGE>   1


                                                                    EXHIBIT 11.1


                              CONNETICS CORPORATION
                STATEMENTS RE: COMPUTATION OF NET LOSS PER SHARE
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)





<TABLE>
<CAPTION>
                                                                    THREE MONTHS ENDED              SIX MONTHS ENDED
                                                                         JUNE 30,                       JUNE 30,
                                                                 ------------------------        ------------------------
                                                                    1997            1996            1997           1996
                                                                 --------        --------        --------        --------
<S>                                                              <C>             <C>             <C>             <C>  
HISTORICAL                                                                                                              
Weighted average shares of common stock outstanding                10,009           7,380           9,543           6,085
                                                                 --------        --------        --------        --------
Total shares used in computing net loss per share                  10,009           7,380           9,543           6,085
                                                                 ========        ========        ========        =========    
Net loss                                                         $ (8,804)       $ (3,771)       $(16,361)       $ (7,216)
Convertible preferred stock, Series A preferred dividends             (35)              -             (81)              -
                                                                 --------        --------        --------        --------
NET LOSS USED IN COMPUTING NET LOSS PER SHARE                    $ (8,839)       $ (3,771)       $(16,442)       $ (7,216)
                                                                 ========        ========        ========        =========    

HISTORICAL NET LOSS PER SHARE                                    $  (0.88)       $  (0.51)       $  (1.72)       $  (1.19)
                                                                 ========        ========        ========        =========    
</TABLE>

<TABLE> <S> <C>

<ARTICLE> 5
<MULTIPLIER> 1,000
       
<S>                             <C>
<PERIOD-TYPE>                   3-MOS
<FISCAL-YEAR-END>                          DEC-31-1997
<PERIOD-START>                             APR-01-1997
<PERIOD-END>                               JUN-30-1997
<CASH>                                           9,241
<SECURITIES>                                    10,726
<RECEIVABLES>                                    1,481
<ALLOWANCES>                                         0
<INVENTORY>                                          0
<CURRENT-ASSETS>                                21,689
<PP&E>                                           3,127
<DEPRECIATION>                                   1,364
<TOTAL-ASSETS>                                  41,190
<CURRENT-LIABILITIES>                           14,911
<BONDS>                                              0
                            1,750
                                          0
<COMMON>                                            11
<OTHER-SE>                                      71,045
<TOTAL-LIABILITY-AND-EQUITY>                    41,190
<SALES>                                          1,594
<TOTAL-REVENUES>                                 1,594
<CGS>                                              257
<TOTAL-COSTS>                                      257
<OTHER-EXPENSES>                                 9,932
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                                 443
<INCOME-PRETAX>                                (8,804)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                                  0
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                                   (8,804)
<EPS-PRIMARY>                                   (0.88)
<EPS-DILUTED>                                   (0.88)
        

</TABLE>


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