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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

OR

For the transition period from                      to                     .

Commission File Number: 000-50855

Auxilium Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

(610) 239-8850

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

None

Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:

Common Stock, Par Value $0.01 Per Share

(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the last sale price for such stock on June 30, 2004: Not applicable because trading of the registrant’s common stock on the NASDAQ National Market did not commence until July 23, 2004.

As of March 31, 2005, the number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 20,680,650.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on June 8, 2005, to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Form 10-K.

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AUXILIUM PHARMACEUTICALS, INC.

FORM 10-K

December 31, 2004

TABLE OF CONTENTS

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This Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. All statements other than statements of historical information provided herein are forward-looking statements and may contain projections relating to financial results, economic conditions, trends and known uncertainties. These statements are not guarantees of future performance or events. Our actual results may differ materially from those discussed in the Report. You should review the “Factors That May Affect Our Future Results” section of this Report for a discussion of the important factors that could cause actual results to differ materially from those described in or implied by the forward-looking statements contained in this Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date hereof. We undertake no obligation to publicly reissue these forward-looking statements to reflect events or circumstances that arise after the date hereof.

PART I

Overview

We are a specialty pharmaceutical company that develops and markets products for urology and sexual health. We currently market one product with a sales organization of more than 100 people and have three products in development. Our marketed product, Testim^®, is a proprietary, topical 1% testosterone gel indicated for the treatment of hypogonadism. According to a 2001 article published in The Journal of Clinical Endocrinology & Metabolism, hypogonadism is a disorder that affects approximately 20% of the U.S. male population over age 50. We estimate there is a similar percentage of affected men in Europe. Hypogonadal men exhibit lower than normal levels of testosterone. Testosterone replacement therapy, or TRT, is the standard treatment for hypogonadism. According to IMS Health Inc., or IMS, a pharmaceutical market research firm, in 2004, U.S. TRT dollar sales grew by 15.2% to $459 million as compared to 2003, while total prescriptions grew by 6.1% to over 2.3 million as compared to 2003. U.S. TRT gel prescriptions grew at a greater rate, by 11.8% from 2003, according to IMS. According to the FDA, hypogonadism is often under diagnosed and under treated. We estimate about 5% of hypogonadal men currently receive TRT. Therefore, we believe the TRT market is poised to experience further growth due to increasing diagnosis and improving physician and patient awareness.

Testosterone gels constitute a substantial portion of the TRT market, representing 74.0% of dollar sales and 64.6% of total prescriptions in 2004, according to IMS. IMS reports that we have increased Testim’s share of monthly total testosterone gel prescriptions to 11.5% in December 2004. Since we launched Testim in the first quarter of 2003, total monthly Testim prescription units dispensed have increased from approximately 1,000 in March 2003 to approximately 19,800 in December 2004, according to IMS. Currently, there are two marketed testosterone gels, including Testim, and other TRT products include pills, injections, transdermal patches and a buccal tablet.

We believe Testim’s growth has been due to Testim’s favorable clinical profile, as well as the growth of the TRT market. We have conducted 13 clinical studies for Testim in over 1,600 patients, including five studies with currently marketed products. One single-dose study in 29 patients showed Testim produced 30% higher total testosterone absorption and 47% higher free testosterone absorption compared to another commercial gel. In the other two studies, Testim brought significantly more men with low testosterone to normalized 24-hour levels than a transdermal patch. We promote Testim with a sales organization of more than 100 people who call on prescribers of urology and sexual health drugs. We believe there is an opportunity to continue to increase sales of Testim through sales force detailing targeted to segmented physician groups, increased product awareness and label expansion.

In April 2005, we entered into a co-promotion agreement with Oscient Pharmaceuticals Corp., or Oscient. Under the terms of the agreement, Oscient will promote Testim to primary care physicians in the United States

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using its 250-person sales force, while Auxilium will continue to promote Testim using its specialty sales force that calls on urologists, endocrinologists and select primary care physicians. Oscient is obligated to commence co-promotion of Testim by May 9, 2005.

In February 2005, we entered into an additional license agreement for products with Formulation Technologies, L.L.C., also known as PharmaForm, our partner in development of transmucosal film product candidates. This new license agreement grants us the exclusive right to develop, manufacture and market eight products for the management of pain, including acute and chronic pain. Our first license agreement with PharmaForm dates back to June 2003 when we were granted a license to develop, make and sell products that contain hormones or that are used to treat urologic disorders and which incorporate PharmaForm’s oral transmucosal film technology. We are currently developing two product candidates using this technology: an androgen, or hormone, replacement therapy and a therapy to treat overactive bladder.

In June 2004, we in-licensed, from BioSpecifics Technologies Corp., or BioSpecifics Technologies, AA4500, an early Phase II product candidate for the treatment of Peyronie’s Disease that may also prove useful for the treatment of Dupuytren’s Disease. Peyronie’s Disease is the development of scar tissue in the shaft of the penis which can cause pain on erection and prevent normal intercourse. We believe no medical treatments have demonstrated efficacy for the symptoms of Peyronie’s Disease in controlled clinical trials. This disease predominantly affects men over age 50, according to an article published in International Journal of Impotence Research in 2002. Dupuytren’s Disease is a condition that causes a patient’s fingers to contract permanently, thereby impairing the functioning of the hand. Surgery is the only effective treatment at present. Due to the recurrent nature of the disease, multiple corrective surgeries become increasingly complex.

Urology and Sexual Health Market Opportunity

The urology market includes the treatment of diseases and disorders of the urinary tract and reproductive organs such as benign prostatic hypertrophy, or BPH. BPH is a benign prostate enlargement that results in obstruction of the urinary tract. The sexual health market includes the treatment of diseases and disorders associated with poor or non-functioning sexual organs such as hypogonadism, male or female sexual dysfunction, and Peyronie’s Disease. Physicians focused on these disorders include urologists, some endocrinologists, HIV treatment specialists, and a select group of internal medicine and primary care physicians. Our sales force calls on over 14,000 physicians practicing within these fields.

Until recently, treatment for many urologic and sexual health disorders was viewed as medically unnecessary. As a result, these disorders were under treated or not treated at all. This dynamic has changed as treatment options have improved and as physicians and patients have begun to appreciate the benefits of treatment. This increased awareness has resulted in marked growth in the drug categories for erectile dysfunction and BPH. For example, according to EvaluatePharma, a pharmaceutical market research firm, annual sales of erectile dysfunction drugs, such as Viagra, grew from less than $100 million to greater than $2 billion between 1997 and 2003. EvaluatePharma has reported that the BPH market, which includes products such as Proscar and Flomax, grew from approximately $450 million to over $3 billion from 1992 to 2003.

We believe there are numerous underdeveloped and unaddressed markets in the urologic and sexual health treatment markets that are poised for development and growth. We believe this growth will be driven by a number of factors, including the following:

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Hypogonadism Market

Hypogonadism is a disorder that affects approximately 20% of the U.S. male population over age 50. We estimate there is a similar percentage of affected men in Europe. Many hypogonadal men are becoming aware that their symptoms are not a normal part of aging and can be treated. Clinicians are also becoming more aware of the increased prevalence of low testosterone in several disease states. We believe that approximately 30% of Type 2 male diabetics, according to an article by Dhindsa, et al published in the Journal of Clinical Endocrinology and Metabolism in November 2004, and 50% of men with acquired immune deficiency syndrome, or AIDS, are hypogonadal, according to an article published by Dobs, et al in the American Journal of Medicine in March 1988. Furthermore, according to an article published by Shabsigh in the Journal of International Impotence Research in August 2003, approximately 10-20% of men diagnosed with erectile dysfunction, or ED, are reported to have hormonal abnormalities or low testosterone. Although the etiology and relationship of hypogonadism in these populations may differ, the symptoms remain similar.

According to an article published in The Journal of Urology in March 2000, hypogonadal men exhibit lower than normal levels of testosterone, resulting in a variety of symptoms including:

Restoring testosterone to normal levels through TRT can relieve these symptoms. TRT is typically a long-term treatment. According to IMS, in 2004, U.S. TRT dollar sales grew by 15.2% to $459 million as compared to 2003, while total prescriptions grew by 6.1% to over 2.3 million as compared to 2003. Gels comprise a majority of the TRT market due, primarily, to fewer side effects than are more commonly associated with the other types of TRT. According to IMS, in 2004, U.S. TRT gel prescriptions grew by 11.8% from 2003. Recently, routine testing of testosterone levels has become a more common part of men’s health evaluations by specialists, yet testosterone testing is still relatively new among the majority of primary care physicians. We estimate only about 5% of hypogonadal men currently receive TRT. We believe the TRT market will continue to grow through increasing diagnosis and increasing physician and patient awareness.

Testim

Testim is a proprietary, topical 1% testosterone gel that treats hypogonadism by raising testosterone blood levels back to normal for the 24-hour period following application. Testim is packaged in convenient, easy-to-open, single-use tubes. Patients apply Testim once a day to the upper arms and shoulders and its active ingredient, testosterone, is absorbed through the skin and into the bloodstream.

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We received FDA marketing approval for Testim in October 2002 and began selling it in the first quarter of 2003. We estimate total prescription units dispensed for Testim based on data provided by IMS. We combine data from IMS’ Nation Prescription Audit, or NPA, with estimates we derive from their National Sales Perspective, or NSP. NPA data covers prescriptions filled by retail pharmacies, mail order pharmacies and long-term care facilities, but does not cover prescriptions filled by non-retail outlets such as clinics, U.S. Federal facilities and HMOs. We estimate prescriptions filled in the non-retail channel based on shipments of Testim into that channel derived from IMS’ NSP data. Based on data from all reporting channels, we estimate that Testim quarterly prescription units dispensed were:

Testim’s Advantages

We believe that Testim’s growth can be attributed to the following:

Clinical data support the advantages of Testim. We have designed and conducted our clinical trials to provide prescribing physicians with comprehensive information regarding Testim’s benefits. Since 2001, we have completed 13 clinical studies involving 1,600 patients. We conducted five of these studies using Testim and other TRT products, including a transdermal patch and the other commercial gel. The results from these five studies taken together demonstrated that in patients with hypogonadism, testosterone levels are directly correlated with patient symptom improvement.

In 2001, we conducted our first clinical trial in 29 male patients with low testosterone in a single-dose study using Testim and another commercial gel. Testim-treated patients demonstrated 30% higher total testosterone absorption and 47% higher free, or readily available, testosterone absorption than in patients seen following application of another commercial gel. To build upon the Testim benefits demonstrated by this study, we conducted two Phase III clinical trials.

The first trial was conducted in the U.S. with 400 patients using Testim and a transdermal patch product. This trial was the largest placebo-controlled study ever conducted to evaluate the benefits and risks of

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testosterone replacement therapy. In this placebo-controlled study, we analyzed testosterone levels as well as a number of sexual function and body composition measurements. The results of this study have enabled us to provide comprehensive data to physicians regarding the benefits of Testim treatment as compared to pre-treatment levels. In this study, Testim normalized 24-hour testosterone levels in a substantially larger number of men than a transdermal patch.

The second trial was conducted in Europe with 200 patients using Testim and a transdermal patch. The European study confirmed the results of the U.S. study.

We continue to conduct clinical studies to enhance the Testim data and to address the full patient population that could benefit from its use. For example, we completed a study in over 600 patients in December 2003 that demonstrated that overall sexual function and mood improves significantly by the end of the first week of Testim treatment. In 2004, two open studies were also completed that explored the effect of one tube of Testim per day compared to a similar dose of another commercial gel. The first study, undertaken in approximately 150 aging hypogonadal men, demonstrated that patients treated with Testim had comparatively greater improvement in overall satisfaction with their sex life, sex drive, and sexual function. As a result of these improvements, fewer Testim treated patients required an increase to a higher dose as compared to patients treated with the other commercial gel. In the second study, undertaken in approximately 50 HIV-positive hypogonadal men, a similar yet more pronounced pattern of results was evidenced.

More cost effective and convenient. We believe, based on clinical data regarding testosterone levels in patients, market feedback from physicians, and the results of our recently completed comparator trials, that a higher percentage of patients are treated with only one tube of Testim per day (one dose per day) compared to another commercial gel. We believe that one tube of Testim per day is an advantage for patients, because of less volume of drug to apply, and for payors, because of lower cost.

Broad prescription coverage. Currently, we have broad third-party payor reimbursement for Testim and are covered by the majority of reimbursement plans. Our efforts to achieve third-party payor coverage have expanded as we grow our national accounts group. Testim has advantaged coverage status compared to another commercial gel with managed care plans covering over 100 million lives. Advantaged coverage generally means lower co-pays for patients.

Strategy

Our goal is to build a leading urology and sexual health pharmaceutical company. Our strategy for achieving this goal includes the following key elements:

Increase Testim market penetration. Through better physician targeting and greater sales efficiencies, we intend to improve our sales force effectiveness. We intend to continue to work with accredited education groups, thought leaders and professional organizations to better educate physicians about diagnosis and the benefits of TRT treatment, including Testim. We also have entered into two marketing and distribution collaborations with partners. Bayer, Inc., or Bayer, will market Testim in Canada and Ipsen Farmaceutica, B.V., or Ipsen, will market Testim in the rest of the world, excluding the U.S., Canada, Japan and Mexico.

Expand market opportunities for Testim. There are some diseases where low testosterone levels may have an impact on an underlying disease. Consequently, we are conducting Phase IV clinical trials to address Testim’s effect on a variety of conditions and to expand Testim’s marketing and, potentially, its prescribing information. For example, some men with erectile dysfunction are also hypogonadal. A Phase IV clinical trial, currently underway, evaluates the safety of concomitant treatment with PDE-5 inhibitor erectile dysfunction products (Viagra^®, Pfizer; Cialis^®, ICOS/Lilly; Levitra^®; Bayer/GSK/SGP) and Testim. In the fourth quarter of 2004, we began a clinical study in diabetic hypogonadal men to evaluate the impact of testosterone normalization on certain aspects of blood glucose control.

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Leverage our sales force. Many disorders in the urology and sexual health markets have patient populations which generate limited interest from large pharmaceutical companies. We are continually engaged in discussions with potential partners or licensors about product opportunities. We believe our sales force makes us attractive to companies who may wish to sell or partner their under-promoted or underdeveloped products. Through the addition of products and continuing sales efficiencies, we intend to improve profitability although the timing of such events is uncertain. We are evaluating opportunities to collaborate with a co-promotion partner or partners for the promotion of Testim in the U.S.

Successfully develop urology and sexual health products. We have an experienced development and regulatory team that has a proven track record. We intend to draw upon our track record and experience to identify and successfully develop product candidates, including our current product candidates. We believe these competencies also make us attractive to companies that wish to license or partner their urology or sexual health products for commercialization or development.

Product Development Pipeline

We have an experienced management and business development team. We have assembled a team for product development and regulatory affairs with a proven track record for bringing products to market. Our current product pipeline includes AA4500 for the treatment of Peyronie’s Disease, which may also prove useful for the treatment of Dupuytren’s Disease, an additional product for the treatment of hypogonadism, and a treatment for overactive bladder, a medical condition affecting both men and women characterized by urinary urgency and increased frequency of urination. All of these product candidates are in the early phases of development. None of our product candidates have progressed past the initial stages of Phase II clinical trials. We intend to leverage our sales force to commercialize these new products.

We target products that could be improved upon by more innovative, effective or easy to use products. We also target patient populations with an unmet need that have not yet attracted significant competitors.

AA4500

AA4500 is an enzyme which has been used in the treatment of excess collagen deposits. To date, it has been employed in early clinical trials to treat Peyronie’s Disease and Dupuytren’s Disease for which indications the product has been granted orphan drug status by the FDA. We believe that additional studies in these indications will commence sometime during the second half of 2005 or early 2006.

Peyronie’s Disease

Peyronie’s Disease is the development of scar tissue in the shaft of the penis which can cause pain on erection and prevent intercourse. Peyronie’s Disease is typically caused by trauma and affects men over 50 years old, according to an article published in International Journal of Impotence Research in 2002. Generally, Peyronie’s Disease is treated by urologists. We believe no medical treatments have demonstrated efficacy for Peyronie’s Disease in controlled clinical trials. Surgical treatment may be an option for some patients, although complications can arise and a loss of penile length can occur.

AA4500 is injected into the affected area in an out-patient procedure to soften and reduce the size of the scar tissue and straighten the curvature of the penis. BioSpecifics Technologies conducted early Phase II clinical work with AA4500 in patients with Peyronie’s Disease. Early clinical evidence indicates that the product reduces scar tissue size and the curvature of the penis. Additional dose optimization studies will be needed once a current Good Manufacturing Practices, or cGMP, manufacturing process is in place.

Dupuytren’s Disease

We believe AA4500 may have uses in disorders other than Peyronie’s Disease which involve scarring and collagen deposits such as Dupuytren’s Disease. Dupuytren’s Disease is a condition that affects the connective tissue that lies beneath the skin in the palm of the hand. The disease is progressive in nature. First, painful nodules develop

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in the palm as collagen deposits accumulate. As the disease progresses, the collagen deposits form a cord that stretches from the palm of the hand to the base of the finger. Once this cord develops, a Dupuytren’s patient’s fingers contract and the function of the hand is impaired. Surgery is the only effective treatment at present. Due to the recurrent nature of the disease, multiple corrective surgeries become increasingly complex.

AA4500 has been shown in early Phase II clinical studies conducted by BioSpecifics Technologies to be a promising option in the treatment of Dupuytren’s Disease. AA4500 is injected directly into the cord and the procedure is performed on an outpatient basis. We have not yet determined whether to partner or out-license AA4500 for Dupuytren’s Disease or to commercialize it ourselves in the U.S. market.

Transmucosal Film Technology Platform

We have developed a new oral transmucosal drug delivery system based on patented technology licensed from PharmaForm. The basis of this technology is a film that adheres to the upper gum. We have the exclusive right to use this technology platform in therapeutic products that contain hormones or that treat urologic disorders and in certain pain products. We currently are developing two product candidates using this technology: an androgen, or hormone, replacement therapy and a therapy to treat overactive bladder. In February 2005, we entered into an additional license agreement with PharmaForm where we were granted to exclusive rights to develop eight analgesic compounds using PharmaForm’s oral transmucosal delivery system. We believe the key benefits of these products could include high absorption, less frequent dosing and a relatively low cost of goods.

Androgen Replacement Film

We are developing an androgen replacement film for the treatment of hypogonadism using the transmucosal film technology. This product candidate may provide an important line extension for the Testim brand. If approved, the androgen replacement film will provide physicians with a novel treatment alternative. The most likely patient candidates for this treatment option are those that require more androgen than topical products can deliver in a single dose or patients who prefer a dosage form other than currently available treatments.

We have conducted four Phase I studies in Europe with the androgen replacement film in 60 men with low testosterone. Our studies demonstrated that the androgen replacement film was well tolerated and the drug was well absorbed with approximately 80% of the drug delivered and available to the body. The film provided significantly increased levels of the androgen within one hour of application. Although the trial results were positive, no assessment of the efficacy or safety of a product candidate can be considered definitive until all clinical trials needed to support a submission for marketing approval are complete. Success in earlier trials or studies does not mean that subsequent trials or testing will confirm earlier findings. A Phase II proof-of-principle study was initiated in late 2004 in which hypogonadal men will be treated for 14 days. We believe top-line results will be available in the second quarter of 2005. We completed a manufacturing scale-up batch in the fourth quarter of 2004.

Overactive Bladder Film

According to an article published in The Journal of Urology in August 2002, overactive bladder affects an estimated 13 million people in the U.S. We believe this disorder tends to be underreported by those who suffer from it despite the negative effects on their lives. We estimate sales of pharmaceutical products for overactive bladder exceeded $1.0 billion in 2004. Our focus will be on a portion of this market that could be served by our sales force. We may also seek to partner with other companies to access the broader overactive bladder market.

A leading oral treatment option for overactive bladder is oxybutynin in both immediate release, or IR, and extended release forms. We believe the major limitation of these drugs is their side effects such as dry mouth, gastrointestinal disorders, difficulty in concentration and visual disturbances. A recently introduced transdermal patch, which is applied once every three days, appears to have equivalent efficacy to oral medications such as oxybutynin IR but with better tolerability, except for skin reactions at patch application sites, according to an article published in The Journal of Urology in August 2002.

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We are developing oxybutynin transmucosal film formulations using the film technology licensed from PharmaForm. We believe the transmucosal film delivery of oxybutynin may provide equal or improved efficacy, and may limit the side effects seen with other overactive bladder therapies. However, no assessment of the efficacy or safety of a product candidate can be considered definitive until all clinical trials needed to support a submission for marketing approval are complete. Success in earlier trials or studies does not mean that subsequent trials or testing will confirm earlier findings. We are exploring both short-acting and long-acting formulations. Laboratory scale formulations have been produced and are currently being evaluated. We initiated the first Phase I study in December 2004, and commenced patient dosing in January 2005.

Other Non-Clinical Development

In February 2005, we signed a license agreement with PharmaForm for the use of eight analgesic compounds in the transmucosal film delivery system. We believe the next step will be to evaluate data from formulation feasibility and non-clinical studies.

Pain therapeutics are also frequently prescribed by many of the physicians that our sales force currently calls on. We may seek to partner broader pain opportunities.

Sales, Marketing and Distribution

We have an experienced sales and marketing organization in the U.S. of more than 100 people and associated support staff. We have a sales automation system that allows us to track our selling efforts and analyze the effectiveness of our various programs. Our medical sales consultants are based in or around metropolitan areas that we believe have sufficient density of potential prescribers and patients. They target urologists, endocrinologists, HIV specialists and selected primary care physicians. Within these categories, our sales force calls on physicians that are prescribers of TRT products.

In addition, we actively seek out relationships with third-party payors in order to establish Testim as a preferred TRT product. We intend to continue to improve our status with managed care providers based upon Testim’s demonstrated clinical advantages.

We use a third-party distributor, ICS, a division of AmerisourceBergen, for commercial distribution activities. The majority of our sales in the U.S. are to pharmaceutical wholesalers that, in turn, distribute product to chain and other retail pharmacies, hospitals, mail-order drug providers and other institutional customers. Approximately 87% of Testim purchases are from four customers: Cardinal Health, McKesson, AmerisourceBergen and Walgreens. Outside of the U.S., we currently rely on third-parties to market, sell and distribute Testim and any of our product candidates for which we receive marketing approval from any foreign jurisdictions. For Canada, we have an agreement with Bayer to market and distribute Testim. We have entered into an agreement with Ipsen for the rest of the world, excluding the U.S., Canada, Japan and Mexico.

Co-Promote Agreement, Licensing Arrangements and Collaborations

We have entered into a co-promotion agreement for Testim in the United States.

Oscient Pharmaceuticals

In April 2005, we entered into a co-promotion agreement with Oscient. The agreement provides that Oscient will have the exclusive right to co-promote Testim jointly with us to primary care physicians in the United States using its 250-person sales force, while we will continue to promote Testim using our specialty sales force that calls on urologists, endocrinologists and select primary care physicians. Under the terms of the agreement, Oscient is obligated to commence co-promotion of Testim by May 9, 2005. We will compensate Oscient for its co-promotion services by paying Oscient a specified percentage of the gross profit from Testim sales attributable

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to primary care physicians in the United States generated by the combined sales force, that exceeds a specified sales threshold. The initial term of the agreement ends on April 30, 2007 and Oscient may extend the agreement for two consecutive two-year periods for a cumulative total of up to six years, provided that certain milestones for each extension have been met by Oscient.

Auxilium and Oscient will jointly develop a promotion plan which sets forth the responsibilities of both parties with respect to the marketing and promotion of Testim in the U.S. primary care physician market. The budget for the promotion plan will be determined jointly by Auxilium and Oscient on an annual basis and each party will share equally in the expenses. Each party will be responsible for the costs associated with its own sales force. Auxilium currently estimates that the total projected budget, that will be shared equally, for marketing and promotion of Testim in the primary care physician market in the U.S. will be approximately $10.5 million in 2005 and approximately $13.0 million in 2006.

We have entered into agreements for the in-licensing of technology and products. Additionally, we have secured collaboration partners for the sale of Testim in geographic locations where we do not have our own sales force. We intend to pursue other licensing agreements and collaborations in the future.

Bentley Pharmaceuticals

We entered into two separate license agreements with Bentley Pharmaceuticals, Inc., or Bentley, that give us access to Bentley’s patented transdermal gel technology. In May 2000, Bentley granted us an exclusive, worldwide, royalty-bearing license to make and sell products incorporating Bentley’s formulation technology that contains testosterone. The term of this agreement is determined on a country by country basis and extends until the later of patent right termination in a country or 10 years from the date of first commercial sale. We produce Testim under this license. Bentley has filed a new patent application in the U.S., Europe and Japan, which, if issued, could provide additional patent protection for Testim. In May 2001, Bentley granted to us similar rights for a product containing another hormone, the term of which is perpetual. Under these agreements, we are required to make up-front and milestone payments to Bentley upon contract signing, the decision to develop the underlying product, and the receipt of FDA approval.

In addition to our royalty obligations, to date, we have paid Bentley $0.6 million of up-front payments and milestones under our in-license agreements. If all events under our Bentley in-license agreements occur, we would be obligated to pay a maximum of an additional $1.0 million in milestone payments. The timing of the above payments, if any, is uncertain.

PharmaForm

In June 2003, we further expanded our drug delivery technology portfolio by entering into a license agreement with PharmaForm. Under this agreement, PharmaForm granted to us an exclusive, worldwide, royalty-bearing license to develop, make and sell products that contain hormones or that are used to treat urologic disorders incorporating PharmaForm’s oral transmucosal film technology for which there is an issued patent in the U.S. The term of this license agreement is for the life of the licensed patents.

In February 2005, we entered into an additional License Agreement with PharmaForm. Under this agreement, we were granted exclusive, worldwide royalty-bearing rights to develop, manufacture and market eight analgesic compounds using PharmaForm’s proprietary transmucosal film technology for the management of pain, including acute and chronic pain. The compounds that may be developed include opioids as well other types of analgesics.

In 2005, we paid an up-front payment of $0.5 million and could make up to an additional $21.2 million contingent milestone payments if all underlying events for these eight products occur. In addition, we will have on-

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going royalty payment obligations to PharmaForm. We do not anticipate making any additional milestone payments to PharmaForm through December 31, 2005. The timing of the remaining payments, if any, is uncertain.

To speed the development of products using the licensed technology from PharmaForm, we have entered into a separate research and development agreement with PharmaForm on a fee for service basis. We will be the sole owner of any intellectual property rights developed in connection with this agreement. We expect to incur at least $0.7 million under the research and development agreement through December 31, 2005.

BioSpecifics Technologies

In June 2004, we entered into a license and development agreement with BioSpecifics Technologies under which we were granted exclusive worldwide rights to develop with BioSpecifics Technologies, and market and sell, certain products containing BioSpecifics Technologies’ enzyme. Our licensed rights concern the development of products, other than dermal formulations labeled for topical administration, and we intend to develop such products for the treatment of Peyronie’s Disease and Dupuytren’s Disease, provided that we may expand the agreement, at our option, to cover other indications as they are developed by BioSpecifics Technologies or by us. The agreement requires us to make an up-front payment and payments upon the achievement of certain milestones. The term of this agreement is determined on a country by country and product by product basis for the longer of the patent life, the expiration of any regulatory exclusivity period or 12 years. We may terminate the agreement with 90 days written notice. Under the terms of the agreement, BioSpecifics Technologies is responsible for supplying clinical and commercial product supplies; we, however, have the right to qualify a back-up supplier. We are in the process of qualifying a back-up supplier and negotiating the terms of an agreement with this back-up supplier for the production of clinical supply of AA4500, our Peyronie’s and Dupuytren’s Diseases product candidate. Upon completion of the qualification process, we expect to rely on this back-up supplier, rather than BioSpecifics Technologies, for our clinical supply of AA4500. We do not anticipate paying BioSpecifics Technologies the manufacturing process development milestones under our agreement.

We have paid BioSpecifics Technologies an aggregate of $5.0 million of up-front and milestone payments and if all events under our BioSpecifics Technologies in-license agreement occur, we would be obligated to pay a maximum of an additional $10.5 million in milestone payments. In addition, we will have on-going royalty payment obligations to BioSpecifics Technologies. Additional milestone obligations may be due if we exercise an option to license and develop AA4500 for additional medical indications. We anticipate making $3.0 million of milestone payments to BioSpecifics Technologies during 2005. The timing of the remaining payments, if any, is uncertain.

Bayer

We entered into an exclusive marketing and distribution agreement with Bayer in December 2003 to commercialize Testim in Canada. This agreement is effective for the life of the Bentley patent. The expiration of the Bentley patent in Canada is January 5, 2010. Bayer has a large commercial presence in Canada that includes approximately 450 sales representatives. We filed for regulatory approval of Testim in Canada in March 2004 and will not be able to sell Testim in Canada until regulatory approval is granted. The terms of this agreement require Bayer to purchase all Canadian Testim supply from us and to make up-front, milestone and royalty payments. The milestone payments are due upon contract signing, filing for regulatory approval in Canada, the first sale of Testim in Canada and upon achieving specified sales levels. The royalty payments are based on net product revenue and are similar to the royalty payments due to Bentley.

Ipsen

We entered into a license and distribution agreement with Ipsen in March 2004. This agreement is exclusive and royalty-bearing for the longer of ten years from the date of first commercial sale by country or the life of the Bentley patent, including any newly issued patents. The European patent that we license from Bentley for Testim expires in 2006. Bentley has filed a new patent application in the U.S., Europe and Japan, which, if issued, could

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provide additional patent protection for Testim. Ipsen is a European pharmaceutical company with a worldwide commercial presence and a strong urology focus. Ipsen currently has operations in 110 countries and has approximately 3,700 employees. Under this agreement, we granted Ipsen an exclusive license to use and sell Testim on a worldwide basis outside the U.S., Canada, Mexico and Japan. The United Kingdom was the first country outside of the U.S. where regulatory approval to market Testim was obtained. A mutual recognition application based on the United Kingdom approval was initiated on March 30, 2004 in order to obtain additional European approvals. The procedure was completed on June 28, 2004 and resulted in scientific approval in the following 14 additional countries: Belgium, Denmark, Finland, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain and Sweden. Marketing approvals are issued in these countries once local administrative procedures to finalize the packaging text have been completed. To date, marketing approvals have been issued in Belgium, Denmark, Finland, Germany, Iceland, the Netherlands, Norway, Portugal, Spain and Sweden. Testim was launched in Germany in January 2005. Under the terms of our agreement, Ipsen will seek regulatory approval in those non-European Union countries in which it wishes to sell our product. The terms of this agreement require Ipsen to purchase all Testim supply from us or exercise their conditional option for a technology transfer and to make up-front, milestone and royalty payments. The milestone payments are due upon contract signing, regulatory approval, product launch in various countries and supply price reductions. The royalty payments are based on net product revenue and are similar to royalty payments due to Bentley.

We do not anticipate sales of Testim outside of the U.S. pursuant to our collaborations with Bayer and Ipsen to have a material impact on our revenues or profitability. We believe that the primary benefit of these agreements is the demonstration of our global development and commercialization capabilities to future licensors, as well as providing us with up-front and milestone payments and opportunities for manufacturing efficiencies through increased sales of Testim.

Through December 31, 2004, we have collected $8.1 million in up-front and milestone fees from Bayer and Ipsen. We can potentially collect up to an additional $9.5 million in milestone fees under the Ipsen collaboration and up to $1.6 million under the Bayer collaboration, if all underlying events occur. The timing of the above payments, if any, is uncertain.

Manufacturing

We currently use, and expect to continue to depend on, contract manufacturers to manufacture Testim. We also anticipate that we will depend on contract manufacturers to manufacture any products for which we receive marketing approval, and to produce sufficient quantities of our product candidates for use in preclinical and clinical studies. Our manufacturers may encounter production difficulties, may not perform as agreed or may terminate their agreements with us.

The manufacture of pharmaceutical products requires significant expertise and capital investment. We believe our reliance on contract manufacturing helps us control our expenses as the construction, maintenance and insurance of pharmaceutical manufacturing facilities requires large amounts of capital.

Testim is manufactured for us by DPT Laboratories under the terms of a manufacturing and supply agreement that we entered into in May 2002. Pursuant to the terms of the agreement, we pay DPT for manufacturing fees, which are renegotiated at the beginning of each calendar year, and for materials. This agreement expires at the end of 2005, but may be extended by mutual agreement of the parties or upon DPT’s acceptance of a purchase order after expiration of the initial term. DPT may terminate the agreement only upon our insolvency or bankruptcy or upon our breach of the agreement. In the event of a breach or if we cannot renew our manufacturing agreement with DPT or otherwise enter into a commercially viable agreement with another manufacturer, our business will suffer. We are continuing to explore the qualification of alternate contract manufacturers.

Testosterone, a non-animal derived hormone, is currently available to us from only two sources. We purchase testosterone from both sources but do not have an agreement with either of these suppliers. We acquire

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pentadecalactone, or CPD, a critical ingredient for the manufacture of Testim, from a single source. We endeavor to maintain an adequate inventory of the key ingredients of Testim. If we are unable to obtain any of these ingredients, in particular CPD, on a timely basis or on commercially reasonable terms, our business will suffer.

BioSpecifics Technologies is responsible for supplying clinical and commercial product supplies of AA4500, our Peyronie’s and Dupuytren’s Diseases product candidate. Under the terms of our agreement with BioSpecifics Technologies, we have the right to qualify a back-up supplier. We are in the process of qualifying a back-up supplier and negotiating the terms of agreement with this back-up supplier for production of our clinical supply of AA4500. Upon completion of the qualification process, we expect to rely on this back-up supplier, rather than BioSpecifics Technologies, for our clinical supply of AA4500.

Our contract manufacturers are subject to an extensive governmental regulation process. Regulatory authorities in our markets require that drugs be manufactured, packaged and labeled in conformity with cGMP. The cGMP requirements govern quality control of the manufacturing process and documentation policies and procedures. We have established an internal quality control and quality assurance program, including a set of standard operating procedures and specifications.

We do not have alternative manufacturing plans in place at this time. The number of third-party manufacturers with the expertise, required regulatory approvals and facilities to manufacture bulk drug substance on a commercial scale is extremely limited, and it would take a significant amount of time to arrange and receive regulatory approval for alternative arrangements. We may not be able to contract for manufacturing on acceptable terms, if at all.

Competition

We face competition in North America, Europe and elsewhere from major pharmaceutical companies, specialty pharmaceutical companies and biotechnology firms, universities and other research institutions and government agencies that are developing and commercializing pharmaceutical products. Many of our competitors have substantially greater financial, technical and human resources than we have and may, subsequently, develop products that are more effective, safer or less costly than any that have been or are being developed by us. Our success will depend on our ability to acquire, develop and commercialize products and our ability to establish and maintain markets for Testim or any products for which we receive marketing approval.

The primary competition for Testim in the testosterone gel market is AndroGel, marketed by Solvay Pharmaceuticals. Solvay is a much larger company than we are with greater resources and greater ability to promote its products through a larger sales force. AndroGel was launched three years before Testim and, according to IMS, has a much larger share of the testosterone gel market than we do and also accounted for approximately 58% of total TRT prescriptions in 2004. Testim also competes with other forms of testosterone replacement therapies such as oral treatments, patches, injectables and a buccal tablet. Generally, transdermal gels are more expensive than patches and injectables. AndroDerm is a transdermal testosterone patch marketed by Watson Pharmaceuticals. AndroDerm is the leading patch product and accounted for approximately 13% of total TRT prescriptions in 2004. Many of our competitors, such as Solvay, have substantially greater financial, technical and human resources than we have. These resources may be used to more effectively develop, market or acquire products and technologies. On January 31, 2005 Solvay announced a partnership with ICOS to co-promote AndroGel. We believe, based on public disclosures, that the agreement is for the U.S. and extends through at least 2006 with a renewal option. Additional mergers and acquisitions in the pharmaceutical industry may result in even more resources being concentrated in our competitors. Competition may increase further as a result of advances made in the commercial applicability of technologies and greater availability of capital for investment in these fields. In addition, our competitors are developing new TRT treatments.

In July 2003 at least two companies, Watson and Par Pharmaceuticals, filed abbreviated new drug applications, or ANDAs, with the FDA to be approved as generics for AndroGel. In response to these ANDAs,

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Solvay filed patent infringement lawsuits against these two companies to block the approval and marketing of the generic products. Any generic for AndroGel will not be a generic for Testim. On November 1, 2004, Par Pharmaceuticals’ partner, Paddock Laboratories, received tentative approval of its ANDA from the FDA but cannot market its generic of AndroGel^® until the Solvay action is resolved and until final approval is received from the FDA. The final approval of either or both of these ANDAs would result in increased competition for Testim, most likely, at lower prices.

Other pharmaceutical companies may develop generic versions of any products that we commercialize that are not subject to patent protection or other proprietary rights. Governmental and other cost containment pressures may result in physicians writing prescriptions for these generic products.

In addition to potential generic competition, several other pharmaceutical companies have TRT products in development that may be approved for marketing in the U.S. Cellegy Pharmaceuticals submitted a new drug application, or NDA, to the FDA for the approval of a testosterone gel that the FDA rejected in 2003. In April 2004, clinical results from a Phase I study with several formulations of testosterone gels by Cellegy were published. In addition, BioSante Pharmaceuticals licensed a testosterone gel in 2000 which is currently reported to be in late stage development. MacroChem has also developed a testosterone gel that is currently in Phase I studies. Other new treatments are being sought for TRT, including a new class of drugs called Selective Androgen Receptor Modulators, or SARMs. SARMs are in the early stages of development and their future impact on the treatment of testosterone deficiency is unknown.

Finally, we face extensive competition in the acquisition or in-licensing of pharmaceutical products to enhance our portfolio of products. A number of more established companies, which have strategies to in-license or acquire products, may have competitive advantages as may other emerging companies taking similar or different approaches to product acquisitions. In addition, a number of established research-based pharmaceutical and biotechnology companies may acquire products in late stages of development to augment their internal product lines. These established companies may have a competitive advantage over us due to their size, resources and experience.

Government Regulation

Government authorities in the U.S., at the federal, state, and local level, and foreign countries extensively regulate, among other things, the following areas relating to our products and product candidates:

All of our products require regulatory approval by government agencies prior to commercialization. In particular, human therapeutic products are subject to rigorous preclinical and clinical trials and other approval procedures of the FDA and similar regulatory authorities in foreign countries. Various federal, state, local, and foreign statutes and regulations also govern testing, manufacturing, safety, labeling, storage and record-keeping related to such products and their marketing. The process of obtaining these approvals and the compliance with federal, state, local, and foreign statutes and regulations require the expenditure of substantial time and financial resources. In addition, the current regulatory and political environment at FDA could lead to increased data requirements which could impact regulatory timelines and costs.

We have received marketing approval for Testim for the indication of hypogonadism in the U.S. and the United Kingdom. We have applied for marketing approval for Testim in Canada and have filed a marketing authorization approval for Testim under the European Union’s mutual recognition procedure. The mutual

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recognition application based on the United Kingdom approval was initiated on March 30, 2004. The procedure was completed on June 28, 2004 and resulted in scientific approval in the following 14 additional countries: Belgium, Denmark, Finland, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain and Sweden. Marketing approvals are issued in these countries once local administrative procedures to finalize the packaging text have been completed. To date marketing approvals have been issued in Belgium, Denmark, Finland, Germany, Iceland, the Netherlands, Norway, Portugal, Spain and Sweden. Testim was launched in Germany in January 2005. None of our other product candidates has received marketing approval.

U.S. Government Regulation

In the U.S., the FDA regulates drugs under the Federal Food, Drug, and Cosmetic Act and implementing regulations. If we fail to comply with the applicable requirements at any time during the product development process, approval process, or after approval, we may become subject to administrative or judicial sanctions. These sanctions could include:

Currently there is a substantial amount of congressional and administrative review of the FDA and the regulatory approval process for drug candidates in the U.S. As a result, there may be significant changes made to the regulatory approval process in the U.S.

Any agency enforcement action could have a material adverse effect on us.

The steps required before a drug may be marketed in the U.S. include:

Preclinical studies generally are conducted in laboratory animals to evaluate the potential safety and activity of a product. Violation of the FDA’s good laboratory practices regulations can, in some cases, lead to invalidation of the studies, requiring these studies to be replicated. In the U.S., drug developers submit the results of preclinical trials, together with manufacturing information and analytical and stability data, to the FDA as part of the IND, which must become effective before clinical trials can begin in the U.S. An IND becomes effective 30 days after receipt by the FDA unless before that time the FDA raises concerns or questions about the proposed

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clinical trials outlined in the IND. In that case, the IND sponsor and the FDA must resolve any outstanding FDA concerns or questions before clinical trials can proceed. If these concerns or questions are unresolved, the FDA may not allow the clinical trials to commence.

Clinical trials involve the administration of the investigational product candidate or approved products to human subjects under the supervision of qualified investigators. Clinical trials are conducted under protocols detailing, among other things, the objectives of the study, the parameters to be used in assessing the safety and the effectiveness of the drug. Typically, clinical evaluation involves a time-consuming and costly three-phase sequential process, but the phases may overlap. Each trial must be reviewed, approved and conducted under the auspices of an independent institutional review board, and each trial must include the patient’s informed consent. The following sets forth a brief description of the typical phases of clinical trials:

Clinical testing may not be completed successfully within any specified time period, if at all. The FDA closely monitors the progress of each of the first three phases of clinical trials that are conducted in the U.S. and may, at its discretion, reevaluate, alter, suspend or terminate the testing based upon the data accumulated to that point and the FDA’s assessment of the risk/benefit ratio to the patient. The FDA can also provide specific guidance on the acceptability of protocol design for clinical trials. The FDA or we may suspend or terminate clinical trials at any time for various reasons, including a finding that the subjects or patients are being exposed to an unacceptable health risk. The FDA can also request additional clinical trials be conducted as a condition to product approval. During all clinical trials, physicians monitor the patients to determine effectiveness and to observe and report any reactions or other safety risks that may result from use of the drug candidate.

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Assuming successful completion of the required clinical trial, drug developers submit the results of preclinical studies and clinical trials, together with other detailed information including information on the manufacture and composition of the product, to the FDA, in the form of an NDA, requesting approval to market the product for one or more indications. In most cases, the NDA must be accompanied by a substantial user fee. The FDA reviews an NDA to determine, among other things, whether a product is safe and effective for its intended use.

Before approving an application, the FDA will inspect the facility or facilities where the product is manufactured. The FDA will not approve the application unless cGMP compliance is satisfactory. The FDA will issue an approval letter if it determines that the application, manufacturing process and manufacturing facilities are acceptable. If the FDA determines that the application, manufacturing process or manufacturing facilities are not acceptable, it will outline the deficiencies in the submission and will often request additional testing or information. Notwithstanding the submission of any requested additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval and refuse to approve the application by issuing a “not approvable” letter.

The testing and approval process requires substantial time, effort and financial resources, which may take several years to complete. The FDA may not grant approval on a timely basis, or at all. We may encounter difficulties or unanticipated costs in our efforts to secure necessary governmental approvals, which could delay or preclude us from marketing our products. Furthermore, the FDA may prevent a drug developer from marketing a product under a label for its desired indications or place other conditions on distribution as a condition of any approvals, which may impair commercialization of the product. After approval, some types of changes to the approved product, such as adding new indications, manufacturing changes and additional labeling claims, are subject to further FDA review and approval.

If the FDA approves the new drug application, the drug can be marketed to physicians to prescribe in the U.S. After approval, the drug developer must comply with a number of post-approval requirements, including delivering periodic reports to the FDA, submitting descriptions of any adverse reactions reported, and complying with drug sampling and distribution requirements. The holder of an approved NDA is required to provide updated safety and efficacy information and to comply with requirements concerning advertising and promotional labeling. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval. Drug manufacturers and their subcontractors are required to register their facilities and are subject to periodic unannounced inspections by the FDA to assess compliance with cGMP which imposes procedural and documentation requirements relating to quality assurance and quality control. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintain compliance with cGMP and other aspects of regulatory compliance. The FDA may require post-market testing and surveillance to monitor the product’s safety or efficacy, including additional studies to evaluate long-term effects.

In addition to studies requested by the FDA after approval, a drug developer may conduct other trials and studies to explore use of the approved compound for treatment of new indications, which require FDA approval or new labeling claims. The purpose of these trials and studies is to broaden the application and use of the drug and its acceptance in the medical community.

We use, and will continue to use, third-party manufacturers to produce our products in clinical and commercial quantities. Future FDA inspections may identify compliance issues at our facilities or at the facilities of our contract manufacturers that may disrupt production or distribution, or require substantial resources to correct. In addition, discovery of problems with a product or the failure to comply with requirements may result in restrictions on a product, manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary or FDA-initiated action that could delay further marketing. Newly discovered or developed safety or effectiveness data may require changes to a product’s approved labeling, including the addition of new warnings and contraindications. Also, new government requirements may be established that could delay or prevent regulatory approval of our products under development.

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The Controlled Substances Act imposes various registration, record-keeping and reporting requirements, procurement and manufacturing quotas, labeling and packaging requirements, security controls, prescription and order form requirements and restrictions on prescription refills on some kinds of pharmaceutical products. A principal factor in determining the particular requirements of this act, if any, applicable to a product is its actual or potential abuse profile. A pharmaceutical product may be listed as a Schedule I, II, III, IV or V substance, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest. Testosterone, the active drug substance in Testim, has been scheduled under the Controlled Substances Act as a Schedule III substance. All regular Schedule III drug prescriptions must be signed by a physician and may not be refilled. Furthermore, the amount of Schedule III substances we can obtain for clinical trials and commercial distribution is limited by the DEA and our quota may not be sufficient to complete clinical trials or meet commercial demand, if any. In addition to federal scheduling, Testim is subject to state controlled substance regulation, and may be placed in more restrictive schedules than those determined by the U.S. Drug Enforcement Agency and the FDA. However, to date, testosterone has not been placed in a more restrictive schedule by any state.

Foreign Regulation

Whether or not we obtain FDA approval for a product, we must obtain approval of a clinical trial or product by the comparable regulatory authorities of foreign countries before we can commence clinical trials or marketing of the product in those countries. The approval process varies from country to country, and the time may be longer or shorter than that required for FDA approval. The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement also vary greatly from country to country. Although governed by the applicable country, clinical trials conducted outside of the U.S. typically are administered with the three-phase sequential process that is discussed above under “Government Regulation.” However, the foreign equivalent of an IND is not a prerequisite to performing pilot studies or Phase I clinical trials.

Under European Union regulatory systems, we may submit marketing authorization applications either under a centralized or decentralized procedure. The centralized procedure which is available for medicines produced by biotechnology or which are highly innovative, provides for the grant of a single marketing authorization that is valid for all European Union member states. This authorization is a marketing authorization approval, or MAA. The decentralized procedure provides for mutual recognition of national approval decisions. Under this procedure, the holder of a national marketing authorization for a product may submit an application to the remaining member states. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval. This procedure is referred to as the mutual recognition procedure, or MRP.

We received approval for Testim in the United Kingdom in June 2003. A mutual recognition application based on the United Kingdom approval was initiated on March 30, 2004. The procedure was completed on June 28, 2004 and resulted in scientific approval in the following 14 additional countries: Belgium, Denmark, Finland, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain and Sweden. Marketing approvals will be issued in these countries once local administrative procedures to finalize the packaging text have been completed. To date marketing approvals have been issued in Belgium, Denmark, Finland, Germany, Iceland, the Netherlands, Norway, Portugal, Spain and Sweden. Testim was launched in Germany in January 2005. In addition, in March 2004, we filed an application for Testim market authorization in Canada.

Furthermore, regulatory approval of prices is required in most countries other than the U.S. We face the risk that the resulting prices would be insufficient to generate an acceptable return to us or our collaborators.

Third-party Reimbursement and Pricing Controls

In the U.S. and elsewhere, sales of pharmaceutical products depend in significant part on the availability of reimbursement to the consumer from third-party payors, such as government and private insurance plans. To date, we have not experienced any problems with third-party payors; however, third-party payors are increasingly

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challenging the prices charged for medical products and services. It is and will be time consuming and expensive for us to go through the process of seeking reimbursement from Medicaid, Medicare and private payors. Our products may not be considered cost effective, and coverage and reimbursement may not be available or sufficient to allow us to sell our products on a competitive and profitable basis. The passage of the Medicare Prescription Drug and Modernization Act of 2003 imposes new requirements for the distribution and pricing of prescription drugs which may affect the marketing of our products.

In many foreign markets, including the countries in the European Union, pricing of pharmaceutical products is subject to governmental control. In the U.S., there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing control. While we cannot predict whether such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a material adverse effect on our business, financial condition and profitability.

Patents and Proprietary Rights

Our success will depend in part on our ability to protect our existing products and the products we acquire or in-license by obtaining and maintaining a strong proprietary position both in the U.S. and in other countries. To develop and maintain such a position, we intend to continue relying upon patent protection, trade secrets, know-how, continuing technological innovations and licensing opportunities. In addition, we intend to seek patent protection whenever available for any products or product candidates and related technology we develop or acquire in the future.

We do not own any patents. We rely on patent protection of our licensors and on our trade secrets to maintain our competitive protection.

Bentley. We have licensed the underlying technology for Testim, our only approved product, from Bentley. The patent that we license from Bentley for Testim expires in June 2008 in the U.S., November 2006 in Europe and January 2010 in Canada. This patent covers methods and compositions for administering drugs, such as testosterone, across the skin and mucus membranes. Bentley has submitted a patent application for an additional formulation patent for Testim that, if issued, would provide us with further market protection around the world until approximately 2020. Testosterone, the active ingredient in Testim, does not have patent protection and is included in competing TRT products.

BioSpecifics Technologies. We licensed AA4500, our product candidate for the treatment of Peyronie’s Disease, from BioSpecifics Technologies. In addition to the marketing exclusivity which comes with its orphan drug status, the enzyme underlying this product candidate is covered by two use patents in the U.S., one for the treatment of Peyronie’s Disease and one for the treatment of Dupuytren’s Disease. The Peyronie’s patent expires in 2019 and the Dupuytren’s patent expires in 2014. The Dupuytren’s patent will be the subject of a reexamination proceeding or a reissue application in the U. S. Patent and Trademark Office, or USPTO, for the purpose of submitting prior art that was not previously submitted during the prosecution of the Dupuytren’s patent. As a result, the patent may or may not be allowed by the USPTO, and therefore, may or may not be valid and enforceable. Both patents are limited to the use of the enzyme for the treatment of Peyronie’s Disease and Dupuytren’s Disease within certain dose ranges. While we believe that dose optimization trials will demonstrate that effective dosing will fall within the patented range, currently, there is not enough data to establish whether the ultimate approved product will be covered by the patents. Foreign patents also cover these products in certain countries.

PharmaForm. We have licensed the transmucosal film technology for our androgen replacement and overactive bladder product candidates from PharmaForm. In addition, we recently obtained a license from PharmaForm for eight analgesic compounds for pain management using the transmucosal film technology. The U.S. patent that we license from PharmaForm expires in 2020.

The scope of the intellectual property rights held by pharmaceutical firms involve complex legal, scientific and factual questions and consequently are generally uncertain. In addition, the coverage claimed in a patent

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application can be significantly reduced before the patent is issued. Consequently, we do not know whether any of our current patent applications, or the products or product candidates we develop, acquire or license will result in the issuance of patents or, if any patents are issued, whether they will provide significant proprietary protection or will be challenged, circumvented or invalidated. Because patent applications in the U.S. and some other jurisdictions are sometimes maintained in secrecy until patents issue, and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain of the priority of inventions covered by pending patent applications. Moreover, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office or a foreign patent office to determine priority of invention, or in opposition proceedings in a foreign patent office, either of which could result in substantial cost to us, even if the eventual outcome is favorable to us. There can be no assurance that the patents, if issued and challenged, in a court of competent jurisdiction would be found valid or enforceable. An adverse outcome could subject us to significant liabilities to third-parties, require disputed rights to be licensed from third-parties or require us to cease using such technology.

Although we believe these patent applications, if they issue as patents, will provide a competitive advantage, the patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions. We may not be able to develop patentable products or processes, and may not be able to obtain patents from pending applications. Even if patent claims are allowed, the claims may not issue, or in the event of issuance, may not be sufficient to protect our technology. In addition, any patents or patent rights we obtain may be circumvented, challenged or invalidated by our competitors.

While we attempt to ensure that our product candidates and the methods we employ to manufacture them do not infringe other parties’ patents and proprietary rights, competitors or other parties may assert that we infringe on their proprietary rights. Additionally, because patent prosecution can proceed in secret prior to issuance of a patent, third-parties may obtain other patents without our knowledge prior to the issuance of patents relating to our product candidates which they could attempt to assert against us.

Although we believe that our product candidates, production methods and other activities do not currently infringe the intellectual property rights of third-parties, we cannot be certain that a third-party will not challenge our position in the future. If a third-party alleges that we are infringing its intellectual property rights, we may need to obtain a license from that third-party, but there can be no assurance that any such license will be available on acceptable terms or at all. Any infringement claim that results in litigation could result in substantial cost to us and the diversion of management’s attention away from our core business and could also prevent us from marketing our products. To enforce patents issued to us or to determine the scope and validity of other parties’ proprietary rights, we may also become involved in litigation or in interference proceedings declared by the United States Patent and Trademark Office, which could result in substantial costs to us or an adverse decision as to the priority of our inventions. We may be involved in interference and/or opposition proceedings in the future. We believe there will continue to be significant litigation in our industry regarding patent and other intellectual property rights.

We also rely on trade secret protection for our confidential and proprietary information. No assurance can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology, or that we can meaningfully protect our trade secrets.

It is our policy to require our employees, consultants, outside scientific collaborators, sponsored researchers and other advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third-parties except in specific circumstances. In the case of employees, the agreements provide that all inventions conceived by the individual shall be our exclusive property. There can be no assurance, however, that these agreements will provide meaningful protection or adequate remedies for our trade secrets in the event of unauthorized use or disclosure of such information.

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Orphan Drug Status

The Orphan Drug provisions of the Federal Food, Drug, and Cosmetic Act provide incentives to drug and biologics suppliers to develop and supply drugs for the treatment of rare diseases, currently defined as diseases that affect fewer than 200,000 individuals in the U.S. or, for a disease that affects more than 200,000 individuals in the U.S. and for which there is no reasonable expectation that the cost of developing and making available in the U.S. a drug for such disease or condition will be recovered from its sales in the U.S. Under these provisions, a supplier of a designated orphan product can seek tax benefits, and the holder of the first FDA approval of a designated orphan product will be granted a seven year period of marketing exclusivity for that product for the orphan indication. The marketing exclusivity of an orphan drug would prevent other sponsors from obtaining approval of the same drug for the same indication without demonstrating that it is clinically superior. It would not prevent other drugs from being approved for the same indication.

In the European Union, incentives for suppliers to develop medicinal products for the treatment of rare diseases are provided pursuant to the Orphan Medicinal Products Regulation. Orphan medicinal products are those products designed to diagnose, treat or prevent a condition which occurs so infrequently that the cost of developing and bringing the product to the market would not be recovered by the expected sale of the product. In the European Union, the criterion for designation is a prevalence of the relevant condition in no more than 5 per 10,000 of the population. The incentives include, among others, a reduction in the fees payable in respect of the marketing authorization application, protocol assistance for clinical trials in support of the application, and marketing exclusivity once the authorization is granted. In the European Union, marketing exclusivity is granted to products with an orphan drug designation for a period of 10 years during which the European Union will not accept another application for a marketing authorization for the same therapeutic indication in respect of a similar medicinal product, unless the second applicant can show its product is safer, more effective or otherwise clinically superior. A similar medicinal product is defined as a medicinal product containing a similar active substance as contained in the authorized orphan medicinal product.

The FDA granted orphan drug status to AA4500 in the U.S. for each of the treatments of Peyronie’s and Dupuytren’s Diseases, and we may file applications with the FDA requesting a transfer of the orphan drug designations from the current holder to us. Orphan drug status means that another application to market the same drug for the same indication may not be approved, except in limited circumstances, for a period of up to seven years in the U.S.

The Hatch-Waxman Act

Under the U.S. Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act, newly approved drugs and indications benefit from a statutory period of non-patent marketing exclusivity. The Hatch-Waxman Act provides five year marketing exclusivity to the first applicant to gain approval of an NDA for a new chemical entity, meaning that the FDA has not previously approved any other new drug containing the same active ingredient. The Hatch-Waxman Act prohibits an abbreviated new drug application, or ANDA, where the applicant does not own or have a legal right of reference to all the data required for approval, to be submitted by another company for another version of such drug during the five year exclusive period. Protection under the Hatch-Waxman Act will not prevent the filing or approval of another full NDA, however, the applicant would be required to conduct its own adequate and well-controlled clinical trials to demonstrate safety and effectiveness. The Hatch-Waxman Act also provides three years of marketing exclusivity for the approval of new NDAs with new clinical trials for previously approved drugs and supplemental NDAs, for example, for new indications, dosages, or strengths of an existing drug, if new clinical investigations are essential to the approval. This three year exclusivity covers only the new changes associated with the supplemental NDA and does not prohibit the FDA from approving ANDAs for drugs containing the original active ingredient or indications.

The Hatch-Waxman Act also permits a patent extension term of up to five years as compensation for patent term lost during product development and the FDA regulatory review process. However, patent extension cannot extend the remaining term of a patent beyond a total of 14 years. The patent term restoration period is generally

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one-half the time between the effective date of an IND and the submission date of an NDA, plus the time between the submission date of an NDA and the approval of that application. Only one patent applicable to an approved drug is eligible for the extension and it must be applied for prior to expiration of the patent. The U.S. Patent and Trademark Office, in consultation with the FDA, reviews and approves the application for patent term extension.

Employees

As of December 31, 2004, we had 166 employees, of which 25 were in research and development, 113 were in sales and marketing and 28 were in general and administration. We believe that our relations with our employees are good and we have no history of work stoppages. Generally, our employees are at-will employees. However, we have entered into employment agreements with certain of our executive officers.

We currently lease approximately 16,274 square feet of space for our headquarters in Norristown, Pennsylvania under a lease that expires on January 31, 2006.

On December 31, 2004, we entered into a lease agreement for a new headquarters in Malvern, Pennsylvania. The facility consists of approximately 31,092 square feet of which approximately 26,130 square feet will be dedicated to office space and approximately 4,962 square feet will be dedicated to warehousing and packaging operations. The initial term of the lease is 90 months. The initial term will not begin until the landlord has substantially completed certain improvements to the facility. The landlord currently projects that these improvements will be completed in the summer of 2005.

We are not engaged in any material legal proceedings.

No matters were submitted to the vote of stockholders through the solicitation of proxies or otherwise during the quarter ended December 31, 2004.

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PART II

Market Information

Auxilium Pharmaceuticals, Inc. common stock began trading on the NASDAQ National Market on July 23, 2004 under the symbol “AUXL”. Prior to that time there had been no market for our common stock. The following table sets forth the high and low closing sales prices per share for our common stock for the periods indicated, as reported by the NASDAQ National Market:

Holders of Record

As of March 31, 2005, there were approximately 75 holders of record of our common stock. Because many of such shares are held by brokers and other institutions on behalf of stockholders, the Company is unable to estimate the total number of stockholders represented by these record holders.

Dividends

We have never paid or declared any cash dividends on our common stock. We currently intend to retain any earnings for future growth and, therefore, do not expect to pay cash dividends in the foreseeable future.

Securities Authorized for Issuance Under Equity Compensation Plans.

The information under the heading “Executive Compensation — Equity Compensation Plan Information” in our definitive Proxy Statement for our Annual Meeting of Stockholders to be held on June 8, 2005, to be filed with the SEC, is incorporated herein by reference.

Recent Sales of Unregistered Securities

During the quarter ended December 31, 2004, we did not issue any unregistered shares of our common stock.

Use of Proceeds From Registered Securities

On July 28, 2004, we sold 5,500,000 shares of our common stock in our initial public offering at a price of $7.50 per share pursuant to a Registration Statement on Form S-1 (the “Registration Statement”) (Registration No. 333-114685), which was declared effective by the Securities and Exchange Commission on July 23, 2004. After deducting expenses of the offering, we received net offering proceeds of approximately $36.5 million. During the period from the offering through December 31, 2004, we have used the net proceeds from our initial public offering as follows:

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The foregoing amounts represent management’s reasonable estimate of the amount of net offering proceeds applied to such activity instead of the actual amount of net offering proceeds used. The remainder of the proceeds have been invested in short-term investment-grade securities and money market accounts. None of the net proceeds were directly or indirectly paid to: (i) any of our directors, officers or their associates; (ii) any person(s) owning 10% or more of any class of our equity securities; or (iii) any of our affiliates.

SELECTED CONSOLIDATED FINANCIAL DATA

(In thousands, except share and per share data)

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this Report. The consolidated statements of operations data for the years ended December 31, 2004, 2003 and 2002 and the consolidated balance sheet data as of December 31, 2004 and 2003 have been derived from our audited consolidated financial statements and related notes, which are included elsewhere in this Report. The consolidated statement of operations data for the years ended December 31, 2001 and 2000 and the consolidated balance sheet data as of December 31, 2002, 2001 and 2000 have been derived from audited financial statements which do not appear in this Report. The historical results presented are not necessarily indicative of results to be expected in any future period.

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You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing at the end of this Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the “Factors That May Affect Our Future Results” section of this Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We are a specialty pharmaceutical company dedicated to the development and commercialization of pharmaceutical products focused on urology and sexual health. Our goal is to develop and commercialize a portfolio of products that treat diseases and disorders relating to urology and sexual health. Testim, our only marketed product, is a testosterone replacement therapy, or TRT, for the treatment of hypogonadism and is approved for sale in the U.S. and has received scientific approval in 15 additional countries. Testim has received marketing approval in 11 of these 15 countries. In January 2005, Testim was launched in Germany. Testosterone gels, which include Testim, represented 4.6% of total TRT prescriptions dispensed in 2004.

We are developing other existing product candidates to treat other urologic and sexual health disorders that we hope to commercialize. We actively pursue opportunities to in-license additional products that we believe will build out our product pipeline. We have assembled an experienced team responsible for additional product development and regulatory affairs for North America and Europe. We have established our own sales and marketing organization, with more than 100 sales and marketing professionals that cover the U.S., calling on physicians who are prescribers of urology and sexual health products. In April 2005, we entered into a co-promotion agreement with Oscient Pharmaceuticals Corp., or Oscient, under which Oscient will promote Testim to primary care physicians in the U.S. using its 250-person sales force.

We launched Testim in the first quarter of 2003 in the U.S. through our sales and marketing force. Total monthly Testim prescription units dispensed have grown from approximately 1,000 in March 2003 to approximately 19,800 in December 2004. In 2004, four customers accounted for approximately 87% of Testim’s product shipments.

We will need to generate significant revenues to achieve profitability. We expect to generate revenues primarily from sales of our marketed products. While we have various product candidates in development and we may in-license or acquire additional products, we expect our revenues to be substantially dependent on Testim product sales for the foreseeable future. We also expect to receive milestone payments under existing licensing and distribution agreements, but we do not anticipate that these will become a significant source of our revenues.

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We focus on opportunities to in-license or acquire new products that we believe we can develop into products that could be sold by our existing sales and marketing organization. We are also seeking opportunities to leverage our sales and marketing organization by acquiring, in-licensing or co-promoting marketed products, which may lead to additional revenues.

Since we commenced operations in the fourth quarter of 1999, we have sustained significant operating losses. As of December 31, 2004, we had an accumulated deficit of $99.3 million. Based on our current product portfolio, we expect to continue to incur significant operating losses for the next several years principally due to:

There are occasional opportunities to acquire a marketed product or late-stage product which we may pursue. In addition, we may acquire earlier stage products where we could incur substantial additional R&D expenses in order to reach commercialization. The current regulatory and political environment could also lead to increased data requirements which could impact regulatory timelines and costs. In addition, we would expect to make up-front and milestone payments, and enter into royalty arrangements, to in-license or acquire these products. If we acquire, in-license or co-promote marketed products from third-parties, then we would expect to incur substantial up-front, milestone or royalty payments.

Net Revenues. To date, all of our net revenues have been generated by the sale of Testim. We expect Testim to continue to be the primary source of our net revenues. We sell Testim to pharmaceutical wholesalers and some chain drug stores. These companies have the right to return Testim. As a result, we recognize revenue based on prescription units dispensed to patients, since they are not subject to return. We will continue to recognize revenue upon prescription units dispensed until we have sufficient history to estimate product returns. When we are able to reasonably estimate our product returns, we will recognize a one-time increase in net revenue related to the recognition of revenue previously deferred, net of appropriate allowances for cash discounts, rebates, patient coupons and product returns. We continue to gather experience with our returns and believe that we will be in a position to reasonably estimate returns during 2005. We do not anticipate sales of Testim outside of the U.S., pursuant to our agreements with Bayer and Ipsen, to have a material impact on our revenues or profitability. In addition to the up-front and milestone payments these agreements afford us, we believe they also benefit us by providing opportunities for manufacturing efficiencies through increased sales of Testim, as well as, making us an attractive partner to future licensors by providing us with global development and commercialization capabilities. We may seek to generate additional revenues from the expansion of Testim into new markets and the commercialization of new products. Our co-promotion agreement with Oscient, which commences in May 2005, may generate additional Testim revenues.

We are a relatively new company and our sales prospects are uncertain. We expect our revenues to fluctuate due to:

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Cost of Goods Sold. All of our cost of goods sold currently relate to the sale of Testim. Cost of goods sold consists of:

We do not anticipate any material changes in our gross margin rate in the U.S. We anticipate our gross margins for sales outside the U.S. to be markedly lower than those seen in the U.S. This is due to a combination of factors which include the terms of our distribution agreements with Bayer and Ipsen and the royalty payments due to our licensor.

Research and Development. Research and development expenses consist of:

Since our inception through December 31, 2004, we have spent $25.2 million on Testim, $3.4 million on our androgen replacement and overactive bladder transmucosal films and $5.5 million on AA4500 for Peyronie’s and Dupuytren’s Diseases. These amounts represent our external research and development costs, including up-front and milestone payments, for these projects. We do not allocate salaries or administrative expenses to development projects. Due to the significant risks and uncertainties inherent in the clinical development and regulatory approval processes, the cost to complete projects in development cannot be reasonably estimated. Currently, Testim is marketed, our androgen replacement transmucosal film is in Phase II, our overactive bladder transmucosal film is in Phase I, our Peyronie’s and Dupuytren’s Diseases product candidates are both at Phase II stage and we are in the process of selecting which initial pain transmucosal film product candidates to move into the formulation stage. Results from clinical trials may not be favorable. Further, data from clinical trials is subject to varying interpretation, and may be deemed insufficient by the regulatory bodies reviewing applications for marketing approvals. As such, clinical development and regulatory programs are subject to risks and changes that may significantly impact cost projections and timelines. We expect our research and development expenses for our current products to significantly increase as a result of Phase IV clinical trials for Testim and the further development of AA4500 for Peyronie’s and Dupuytren’s Diseases, our androgen replacement transmucosal film, our overactive bladder transmucosal film and our pain transmucosal films. In addition, the current regulatory and political environment at FDA could lead to increased data requirements which could impact regulatory timelines and costs. We would expect further significant increases in our expenditures to develop any other potential new product candidates that we would in-license or acquire.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel, marketing and promotion costs, professional fees and facilities

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costs. We anticipate significant increases in selling and marketing expenses due to the co-promote agreement signed with Oscient in April 2005. In addition, we anticipate increases in selling, general and administrative expenses due to sales and marketing costs associated with Testim, hiring of additional personnel, possible other co-promotion agreements, investor relations and other activities associated with operating as a publicly traded company.

Results of Operations

Years ended December 31, 2004, 2003 and 2002

Net revenues. Net revenues were $27.0 million, $8.8, and $0 for 2004, 2003 and 2002, respectively. Net revenues consist solely of product revenues resulting from approximately 203,900 and 70,300 prescription units dispensed in 2004 and 2003, respectively. We believe that the increase in net revenues and underlying prescription units is the result of many factors, including: 2004 was the first complete year of product sales as we launched Testim in the first quarter of 2003; growth in the TRT gel market; growth in our market share and new prescriptions; increased effectiveness of our sales and marketing organization; positioning of Testim’s attributes versus the category leader; price increases and contribution of better formulary positions with managed care providers. While Testim continued to gain market share throughout the year, the annual rate of growth in the overall gel segment slowed. The annual growth rate in total gel prescriptions was 11.8% in 2004 versus 34.4% in 2003. Net revenues for Testim product sales are reflected net of cash discounts, rebates and patient coupons. Shipments in the U.S. not recognized as revenue, net of anticipated cash discounts, were $3.7 million and $4.3 million at December 31, 2004 and 2003, respectively and are reflected in deferred revenue, current portion.

Cost of goods sold. Cost of goods sold were $8.1 million, $3.8 million and $0.1 million for 2004, 2003 and 2002, respectively. The increase in cost of goods sold for 2004 over 2003 was directly attributable to the increase in Testim prescription revenue. Cost of goods sold in 2004 and 2003 would have been approximately $0.5 million and $0.3 million higher, respectively, had purchases of a key raw material not been charged-off in 2002. Gross margin on our net product sales was 69.9% in 2004 compared to 57.4% in 2003. The improvement in gross margin in 2004 over 2003 resulted primarily from fixed manufacturing costs spread across an increased number of units sold. Gross margin would have been 68.1% for 2004 and 54.5% for 2003 had purchases of a key raw material not been charged-off in 2002. In 2002, we purchased approximately $0.9 million of this raw material prior to FDA approval of Testim and, based on our policy, charged the purchase price to research and development expense because we would have had no alternative use for the raw material if Testim were not approved. As of December 31, 2004, we did not have any of the raw material with zero book value remaining in inventory. In addition, although we had no revenues in 2002, we incurred start-up costs related to Testim production.

Research and development expense. Research and development expense was $16.0 million, $7.2 million and $14.1 million for 2004, 2003 and 2002, respectively. The increase in 2004 over 2003 was due primarily to $5.0 million in up-front and milestone payments made to BioSpecifics Technologies for the in-license of AA4500, our Peyronie’s and Dupuytren’s Diseases product candidate, and $0.5 million of additional development expenses for AA4500. In addition, the increase in 2004 over 2003 is a result of the $2.0 million increase in development expenses on our androgen replacement and overactive bladder transmucosal film product candidates and $0.5 million increase in expenses associated with the Testim European regulatory filing and Testim clinical trials. The decrease in 2003 compared to 2002 was due primarily to approximately $8.0 million of incremental costs incurred in 2002 in connection with the completion of the Testim extension studies and the expense of Testim raw materials purchased prior to FDA approval. The 2003 decrease was partially offset by newly initiated Testim Phase IV studies of $0.7 million and the beginning of the development of our androgen replacement and overactive bladder transmucosal film product candidates of $0.7 million.

Selling, general and administrative expenses. Selling, general and administrative expenses were $31.2 million, $27.5 million and $5.6 million for 2004, 2003 and 2002, respectively. The increase in 2004 over 2003 was due primarily to a $2.4 million increase in general and administrative expenses and a $1.3 million increase in

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selling and marketing expenses. The increase in general and administrative expenses results from additional hiring of key personnel, relocation and recruitment expenses and incremental costs associated with operating as a publicly traded company. The increase in selling and marketing expenses results from compensation and related expenses for our professional sales organization being greater in 2004 versus 2003 due to higher headcount and incentive compensation related to sales volume achievements. The increase in 2003 compared to 2002 was primarily the result of hiring and training our professional sales organization and the marketing campaign in connection with the launch of Testim.

Interest income (expense), net. Interest income (expense), net was $(0.2) million, $(1.0) million and $0.3 million for 2004, 2003 and 2002, respectively. The net expense in 2004 and 2003 relates primarily to non-cash amortization of deferred debt issuance costs related to a line of credit and to interest paid on the line of credit. The line of credit was entered into in May 2003 and repaid and terminated in March 2004. Although we arranged for a replacement line of credit with Comerica Bank, the weighted average borrowings on the replacement line in 2004 were significantly lower than under the previously existing line in 2003 in an attempt to control interest costs. The debt issuance costs were the result of warrants issued to investors to guarantee the line of credit. There were no borrowings under debt facilities in 2002.

Other income. Other income for 2003 was $1.7 million due to a one-time gain from the settlement of a lawsuit with a vendor.

Dividends and accretion on redeemable convertible preferred stock. Dividends accrued and accretion on redeemable convertible preferred stock and dividends paid to warrant holders were $0.6 million, $4.4 million, and $4.9 million for 2004, 2003 and 2002, respectively. The decreases in 2004 compared to 2003 and 2003 compared to 2002 were both due to the termination and cancellation of the accumulated dividend provisions of our preferred stock in connection with the private placement of shares of our series D preferred stock in October 2003. In April 2004, we removed a variable feature of our outstanding warrants to purchase series D preferred stock and fixed both the amount of warrants and the exercise price of the warrants. As a result, we recorded a $0.2 million deemed dividend in the second quarter of 2004 for the increase in the fair value of the warrants attributable to the amendments of the warrant terms. We anticipate no future dividends and accretion on redeemable convertible preferred stock as all previously outstanding shares of this stock were converted into our common stock in connection with our initial public offering.

At December 31, 2004, we had federal net operating loss carryforwards of approximately $80.5 million, which will expire in 2019 through 2024, if not utilized. In addition, we had state net operating loss carryforwards of approximately $65.4 million, of which $40.0 million relate to Pennsylvania. The Pennsylvania state net operating losses are subject to a $2.0 million annual limitation for 20 years and expire in 2009 through 2024. At December 31, 2004, we had federal research and development credits of approximately $1.2 million that will expire in 2020 through 2024, if not utilized.

The Internal Revenue Code provides for a limitation on the annual use of net operating loss and research and development tax credit carryforwards following certain ownership changes that could limit our ability to utilize these carryforwards. We may have experienced various ownership changes, as a result of past financings. Accordingly, our ability to utilize the aforementioned carryforwards may be limited. Additionally, U.S. tax laws limit the time during which these carryforwards may be applied against future taxes; therefore we may not be able to take full advantage of these carryforwards for federal income tax purposes.

Liquidity and Capital Resources

Since inception, we have financed our product development, operations and capital expenditures primarily from private and public sales of equity securities. Since inception through December 31, 2004, we received approximately $133.9 million from the IPO, private sales of equity securities, the exercise of stock options and purchases of stock under our Employee Stock Purchase Plan. Since launching Testim in 2003, net revenue from

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the sales of Testim has become a source of cash, a trend that we believe will continue. We had approximately $32.7 million and $28.4 million in cash and cash equivalents as of December 31, 2004 and 2003, respectively. As of December 31, 2004, we also had $14.1 million in short-term investments. On July 28, 2004, we completed our initial public offering. We sold 5,500,000 shares of our common stock in the IPO at a price of $7.50 per share, resulting in gross proceeds of $41.2 million. In connection with the IPO, we paid $2.9 million in underwriting discounts and commissions to underwriters and incurred approximately $1.8 million in other offering expenses. After deducting the underwriting discounts and commissions and offering expenses, we received net proceeds from the offering of approximately $36.5 million. On July 28, 2004 the holder of warrants to purchase 80,000 shares of our Series B redeemable convertible preferred stock exercised its warrant for $0.1 million. Immediately prior to the closing of the IPO, all outstanding shares of our redeemable convertible preferred stock converted into shares of our common stock.

We believe that our current financial resources and sources of liquidity will be adequate to fund our operations for the next 19 months from December 31, 2004. We may, however, need to raise additional funds prior to this time in order to enhance our sales and marketing efforts for additional products or potentially as part of a co-promotional plan for Testim, fund our product development, including clinical trials, commercialize any product candidates that receive regulatory approval, and acquire or in-license approved products or product candidates or technologies for development. Insufficient funds may cause us to delay, reduce the scope of, or eliminate one or more of our planned development, commercialization or expansion activities. Our future capital needs and the adequacy of our available funds will depend on many factors, including the effectiveness of our sales and marketing activities, the cost of clinical studies and other actions needed to obtain regulatory approval of our products in development, and the timing and cost of any acquisitions. If additional funds are required, we may raise such funds from time to time through public or private sales of equity or debt securities or from bank or other loans. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could materially adversely impact our growth plans and our financial condition or results of operations. Additional equity financing, if available, may be dilutive to the holders of our common stock and may involve significant cash payment obligations and covenants that restrict our ability to operate our business.

In March 2004, we terminated our existing bank line of credit and entered into a replacement $5.0 million line of credit with Comerica that expired in March 2005. This facility bore interest at an annual rate of prime plus 0.5%. We are evaluating whether to pursue a new line of credit. In addition, we have two equipment loans with General Electric Capital Corporation totaling $0.8 million outstanding at December 31, 2004. The equipment facilities bear interest at a weighted-average rate of 9.3% per annum.

Sources and Uses of Cash

Cash used in operations was $16.8 million, $26.5 million and $21.3 million for 2004, 2003 and 2002, respectively. For 2004 and 2003, Testim product sales and up-front and milestone payments generated approximately $34.9 million and $11.8 million in cash receipts, respectively. Negative operating cash flows during 2004 result from operating losses offset primarily by $8.1 million of cash collections of up-front and milestone payments. Negative operating cash flows during 2003 and 2002 were caused primarily by operating losses.

Cash used in investing activities was $15.3 million, $1.1 million and $1.8 million for 2004, 2003 and 2002, respectively. Cash used in investing activities for 2004 relates primarily to the purchase of short-term investments with part of the proceeds from our initial public offering. Cash used in investing activities for 2003 and 2002 relates primarily to the purchase of manufacturing equipment, office furniture and computer equipment, and the build-out of a manufacturing line for Testim. The decrease in cash used in investing activities in 2003 compared to 2002 is primarily related to the purchase and construction of manufacturing equipment and the manufacturing line in 2002.

Cash provided by financing activities was $36.4 million, $43.8 million and $15.4 million in 2004, 2003 and 2002, respectively. Cash provided by financing activities in 2004 was related primarily to the initial public

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offering of common stock. During 2003, we received $43.0 million from the private placement of shares of our series D preferred stock and an additional $10.4 million primarily from a line of credit offset by a $9.5 million certificate of deposit reflected as restricted cash to secure borrowing under a line of credit agreement. During 2002, we received $15.4 million from the private placement of our series C preferred stock.

Our actual cash needs might vary materially from those now planned because of a number of factors, including:

We might seek additional debt or equity financing or both to fund our operations or product acquisitions. If we increase our debt levels, we might be restricted in our ability to raise additional capital and might be subject to financial and restrictive covenants. Our stockholders may experience dilution as a result of the issuance of additional equity securities. This dilution may be significant depending upon the amount of equity securities that we issue and the prices at which we issue any securities.

In 2004, we received $8.1 million in payments from existing agreements for Testim in other territories and at December 31, 2004 are due an additional $0.4 million included in accounts receivable-other. These receipts are the result of up-front and milestone payments primarily related to contract signings and regulatory approvals and are reflected in deferred revenue, long-term at December 31, 2004. In addition, we could receive as much as an additional $3.8 million in 2005 if certain regulatory approvals are received outside the U.S. We might also enter into additional arrangements with corporate partners that could provide us with additional funding in the form of equity, debt, licensing, milestone or royalty payments. We might not be able to enter into such arrangements or raise any additional funds on terms favorable to us or at all.

In June 2004, we entered into an agreement with BioSpecifics Technologies in which we were granted an exclusive license to develop, manufacture and market an enzyme (AA4500) for the treatment of Peyronie’s Disease and Dupuytren’s Disease. Under the terms of the agreement, BioSpecifics Technologies is responsible for supplying clinical and commercial product supplies; we however, have the right to qualify a back-up supplier. We are in the process of qualifying a back-up supplier and negotiating the terms of agreement with this back-up

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supplier for the production of our clinical supply of AA4500. Upon completion of the qualification process, we expect to rely on this back-up supplier, rather than BioSpecifics Technologies, for our clinical supply of AA4500. As a result, we do not anticipate paying BioSpecifics Technologies the manufacturing process development milestones under our agreement. Under this agreement we paid up-front and milestone payments totaling $5.0 million through December 31, 2004 and we anticipate making additional milestone payments of $3.0 million through December 31, 2005. Additional milestone obligations may be due if we exercise an option to license and develop this enzyme for additional medical indications.

In February 2005, we entered into an agreement with PharmaForm in which we were granted an exclusive sub-license to develop, manufacture and market eight separate pain products under the licensed transmucosal film technology. In 2005 we paid an up-front payment of $0.5 million and could make up to an additional $21.2 million of contingent milestone payments if all underlying events occur. In addition to these new licenses, we engaged PharmaForm to provide research and development services related to these pain products for four years. We expect to incur at least $700,000 under the services agreement through December 31, 2005, but do not anticipate making any additional milestone payments over the same time period.

In April 2005, we entered into a co-promotion agreement with Oscient under which Oscient will promote Testim to primary care physicians in the U.S. using its 250-person sales force. We are obligated to share Testim promotional expenses with Oscient and to pay Oscient a co-promotion fee based on a specified percentage of the gross profit from Testim sales attributable to primary care physicians in the U.S., that exceeds a specified sales threshold. The specific percentage is based upon Testim sales levels attributable to primary care physicians and the marketing expenses incurred by Oscient in connection with the promotion of Testim under the Agreement. We anticipate that there will be no net impact on overall liquidity, but if any Testim revenues from the co-promotional efforts lag behind the fees and expenses due Oscient, there will be a negative impact on our operating cash flows.

In addition, we paid a $0.7 million judgment in April 2004, which was accrued as of December 31, 2003.

Contractual Commitments

We are involved with in-licensing of products which are generally associated with payments to the partner from whom we have licensed the product. Such payments frequently take the form of:

We may also out-license products, for which we hold the rights, to other companies for commercialization in other territories, or at times, for other uses. When this happens, typically there is:

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The following summarizes our contractual commitments as of December 31, 2004 (in thousands):

The contractual commitments reflected in this table exclude $33.2 million of contingent milestone payments that we may be obligated to pay in the future, including amounts due under a new license agreement for eight pain products entered into in February 2005. We expect to pay approximately $3.5 million of these contingent milestone payments through December 31, 2005. These remaining milestones relate primarily to manufacturing process development, contract anniversaries, filing of regulatory applications and receipt of regulatory approval. Of the $33.2 million of contingent milestone payments, we do not anticipate paying BioSpecifics Technologies $3.0 million in manufacturing process development milestones. The above table also excludes future royalty payments and wholesaler distribution fees because they are contingent on product sales. In addition, the above table excludes any co-promotional expenses and fees that may be due Oscient because they are contingent upon combined promotional expenditures and future product sales to primary care physicians, respectively.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations, which are based on our consolidated financial statements, have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We are subject to uncertainties that may cause actual results to differ from these estimates, such as changes in the healthcare environment, competition, legislation and regulation. We believe the following accounting policies, which have been discussed with our audit committee, are the most critical because they involve the most significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition. We sell Testim to pharmaceutical wholesalers and chain drug stores. These companies have the right to return Testim for any reason up to one-year after product expiration. As a result of Testim’s launch in the first quarter of 2003, we do not have sufficient sales history to estimate product returns. In accordance with Statement of Financial Accounting Standards (SFAS) No. 48, we defer recognition of revenue

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on product shipments of Testim to our customers until such time as Testim units are dispensed through patient prescriptions, since they are not subject to return. Under SFAS No. 48, we cannot recognize revenue on product shipments until we can reasonably estimate returns relating to these shipments. We estimate the volume of prescription units dispensed at pharmacies based on data provided by external, independent sources. These sources poll pharmacies, hospitals, mail order and other retail outlets for Testim prescriptions and project this sample on a national level. We will continue to recognize revenue based on prescription units until we have sufficient history to estimate product returns. When we are able to reasonably estimate our product returns, we will recognize a one-time increase in net revenue related to the recognition of revenue previously deferred, net of appropriate allowances for cash discounts, rebates, patient coupons and product returns. We continue to gather experience with our returns and believe that we will be in a position to reasonably estimate returns during 2005. In addition, we must make estimates for rebates provided to third-party payers and coupons provided to patients. Testim is covered by Medicaid and numerous independent insurance and pharmacy benefit managers, or PBMs. Some of these programs have negotiated rebates. We obtain estimates of prescription units dispensed under the various rebate programs from the same external sources discussed above. We make estimates of the rebates based on the external-source reports of volumes and actual contract terms. In addition, we provide coupons to physicians for use with prescriptions as promotional incentives. We utilize a contract service provider to process and pay claims to patients for actual coupon usage. The timing of processing coupon invoices from this service provider is delayed. We make estimates of actual coupon usage based on previous experience. As Testim becomes more widely used and as we continue to add managed care and PBM contracts, our estimates may result in differences to actual results. To date, our estimates have not resulted in any material adjustments to our operating results.

We have licensed out to Ipsen the right to market and distribute Testim worldwide, excluding the U.S., Canada, Mexico and Japan. We have entered into a distribution agreement with Bayer for Canada. Under these agreements, Bayer and Ipsen are each required to purchase Testim from us and make up-front, milestone and royalty payments. We are obligated under the agreements to provide multiple deliverables; the license/product distribution rights, regulatory filing services and commercial product supply. Under Emerging Issues Task Force (EITF) No. 00-21, Revenue Arrangements with Multiple Deliverables, the deliverables under each of these agreements are treated as single units of accounting as we do not have evidence to support that the consideration for the undelivered item, Testim units to be shipped, is at fair value. Revenue for Testim units shipped will be recognized upon product shipment, subject to our ability to reasonably estimate product returns. We will defer revenue recognition for up-front and milestone payments until at least the first product shipment under each agreement. Up-front and milestone revenue will be recognized over the distribution term based on Testim units shipped. We will need to estimate the total Testim units to be shipped under the agreements. As a result, we plan on utilizing independent appraisers to help us determine the useful life of Testim in markets where we anticipate Testim units shipped to be material. We will use this information along with market penetration data from independent sources to estimate the total Testim units to be shipped. Periodically, we will reevaluate these estimates and adjust on a prospective basis the amortization of the up-front and milestone payments. We will disclose the reasons for any significant changes in our future estimates. If we are unable to reasonably estimate the total units to be shipped, the amortization of the deferred revenue will not be recognized as revenue until we are able to make a reasonable estimate.

Inventory Valuation. We rely on a single source supplier for one of the key ingredients in Testim. As a result, we have purchased a substantial safety stock of this ingredient on which we have limited shelf-life data. We continue to perform stability testing on the ingredient to determine its maximum shelf-life. In addition, our finished goods inventory has a definitive shelf-life. We estimate that the demand for Testim will be such that the raw materials and finished goods on hand will ultimately be used in future production and sold to our customers. As a result, we have not recorded a material valuation allowance for potential excess inventory as of December 31, 2004. We will continually evaluate the demand for Testim and the data from the stability testing to determine whether an allowance for excess inventory is warranted.

Valuation of Equity Instruments used in Stock-Based Compensation. We account for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (APB) Opinion No. 25,

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Accounting for Stock Issued to Employees, and related interpretations and have adopted the disclosure-only provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of SFAS No. 123, Accounting of Stock-Based Compensation. The disclosure-only provisions of SFAS No. 148 require us to disclose pro forma net loss applicable to common stockholders and net loss per common share as if we accounted for employee stock options at fair value. SFAS No. 123 also requires us to estimate the value of purchase rights granted to employees under our 2004 Employee Stock Purchase Plan for inclusion in the SFAS 148 pro forma disclosure. In addition, we account for stock-based compensation to non-employees using the fair-value method in accordance with SFAS No. 123 and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in conjunction with Selling, Goods or Services. Our disclosure under SFAS No. 148 and our accounting under EITF Issue No. 96-18 require us to estimate the value of equity instruments issued. We utilize the Black-Scholes option-pricing model to value stock options issued to employees and non-employees and purchase rights granted to employees under our 2004 Employee Stock Purchase Plan. The Black-Scholes option-pricing model requires us to make assumptions of the estimated life of the underlying options, the anticipated volatility of the price of our common stock, the risk-free interest rate and the expected dividend yield of our common stock.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R revises SFAS No. 123 and supersedes APB Opinion No. 25. Generally the approach in SFAS No. 123R is similar to the approach described in SFAS No. 123. SFAS No. 123R requires that all share-based payments to employees, including grants of employee stock options, be recognized in the statement of operations based on their grant-date fair values over the period during which employees are required to provide services in exchange for the award. In addition, under SFAS No. 123R our 2004 Employee Stock Purchase Plan will be considered compensatory. Pro forma disclosure of stock-based compensation under fair values methods is no longer an alternative. SFAS No. 123R provides guidance on how to determine the grant-date fair value for awards of equity instruments as well as alternative methods of adopting its requirements. On April 14, 2005, the Securities and Exchange Commission delayed the effective date of SFAS No. 123R to the beginning of the first fiscal year after June 15, 2005. As a result, we anticipate adopting SFAS No. 123R on January 1, 2006. As we currently account for employee stock-based compensation under the intrinsic value method permitted under APB Opinion No. 25, the adoption of SFAS No. 123R will result in significant additional compensation charges in our statements of operations, although it will have no impact on our overall financial position.

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Factors That May Affect Our Future Results

In addition to the other information included in this Report, the following factors should be considered in evaluating our business and future prospects. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial position or results of operations. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from what we projected. There may be additional risks that we do not presently know or that we currently believe are immaterial which could also impair our business or financial position.

Risks Related to Our Financial Results and Need for Additional Financing

We have incurred significant losses since our inception and may not achieve profitability in the foreseeable future.

We have incurred significant losses since our inception, including net losses of $28.5 million for the year ended December 31, 2004. As of December 31, 2004, we had an accumulated deficit of $99.3 million. Our only approved product is Testim. We expect to continue to make substantial expenditures related to the marketing and selling of Testim. As we launched Testim in the first quarter of 2003, we cannot be certain how effective our marketing and selling programs will be in the future. We continue to expand and enhance the marketing and selling of Testim. In April 2005, we entered into an agreement with Oscient for the co-promotion of Testim to primary care physicians in the U.S. As a result, marketing and selling expenses may increase substantially in the future. In addition, we expect to continue to incur substantial expenses, including milestone payments, as we:

Accordingly, we expect to continue to incur substantial additional losses for the foreseeable future. In order to achieve and maintain profitability, we will need to generate significantly greater revenues from Testim and any other product candidate for which we receive marketing approval. As a result, we are unsure when we will become profitable, if at all. If we fail to achieve profitability within the time frame expected by investors, the value of our common stock may decline substantially.

Because we have a limited operating history, our future results are unpredictable, and therefore, our common stock is a highly speculative investment.

We commenced operations in the fourth quarter of 1999 and have a very limited operating history for you to evaluate our business. Accordingly, you must consider our prospects in light of the risks and difficulties encountered by companies in their early stages. In order to address these risks, we must:

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In addition, due to our limited operating history, we have minimal experience with product returns. If returns are higher than expected, our operating results could be materially harmed.

All of our revenues to date have been generated from the sale of Testim, and, if sales of Testim do not grow, we will not become profitable.

Our only product with marketing approval is Testim and our product revenues to date have been generated solely from the sale of Testim. Until such time as we develop, acquire or in-license additional products that are approved for marketing, we will continue to rely on Testim for all of our revenues. Accordingly, our success depends significantly on our ability to increase sales of Testim. Our sales and marketing efforts or those of our co-promotion partner may not be successful in increasing prescriptions for Testim. Sales of Testim are subject to the following risks, among others:

For the foreseeable future, if we are unable to grow Testim sales, we will be unable to increase our revenues or achieve profitability and we may be forced to delay or change our current plans to develop other product candidates.

If we fail to raise additional funds in the future, we may be required to limit, scale back or cease our operations.

Our operations to date have generated substantial and increasing needs for cash. Our negative cash flows from operations are expected to continue for at least the foreseeable future. Our strategy contains elements that we will not be able to execute without outside funding. Specifically, we may need to raise additional capital to:

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We believe that our existing cash resources and interest on these funds will be sufficient to meet our projected operating requirements for the next 19 months. Our future funding requirements will depend on many factors, including:

These factors could result in variations from our currently projected operating and liquidity requirements. If our existing resources are insufficient to satisfy our liquidity requirements, we may need to borrow money or sell additional equity or debt securities. We may not be able to borrow money on commercially reasonable terms. Moreover, the terms of the sale of any equity or debt securities may not be acceptable to us and could result in substantial dilution of your investment. If we are unable to obtain this additional financing, we may be required to:

Our revenues, operating results and cash flows may fluctuate in future periods and we may fail to meet investor expectations, which may cause the price of our common stock to decline.

Variations in our quarterly operating results are difficult to predict and may fluctuate significantly from period to period. We are a relatively new company and our sales prospects are uncertain. We have been selling Testim, our only approved product, since the first quarter of 2003 and cannot predict with certainty the timing or level of sales of Testim in the future. If our quarterly sales or operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. In addition to the

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other factors discussed under these “Factors That May Affect Our Future Results,” specific factors that may cause fluctuations in our operating results include:

Forecasting our revenues is further complicated by difficulties in estimating inventory levels at our wholesaler and chain drug store customers, prescription levels, the timing of purchases by wholesalers and retailers to replenish inventory and the occurrence and amount of product returns. As a result of these factors, we believe that period-to-period comparisons of our operating results are not a good indication of our future performance.

Risks Related to Development of Our Product Candidates

We may not be able to develop product candidates into viable commercial products, which would impair our ability to grow and could cause a decline in the price of our stock.

The process of developing product candidates involves a high degree of risk and may take several years. Product candidates that appear promising in the early phases of development may fail to reach the market for several reasons, including:

Success in preclinical and early clinical trials does not ensure that large-scale clinical trials will be successful. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. The length of time necessary to complete clinical trials and to submit an application for marketing approval for a final decision by a regulatory authority varies significantly and may be difficult to predict. Currently, there is substantial congressional and administrative review of the regulatory approval process for drug candidates in the U.S. Any changes to the U.S. regulatory approval process could significantly increase the timing or cost of regulatory approval for our product candidates making further development uneconomical or impossible.

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In addition, developing product candidates is very expensive and will have a significant impact on our ability to generate profits. Factors affecting our product development expenses include:

Our product development efforts also could result in large and immediate write-offs, significant milestone payments, incurrence of debt and contingent liabilities or amortization of expenses related to intangible assets, any of which could negatively impact our financial results. Additionally, if we are unable to develop our product candidates into viable commercial products, we may remain reliant solely on Testim sales for our revenues, potentially limiting our growth opportunities.

If clinical trials for our product candidates are delayed, we would be unable to commercialize our product candidates on a timely basis, which would materially harm our business.

Clinical trials that we may conduct may not begin on time or may need to be restructured after they have begun. Clinical trials can be delayed or may need to be restructured for a variety of reasons, including delays or restructuring related to:

Prior to commencing clinical trials in the U.S., we must have an effective IND for each of our product candidates. An IND has been filed by BioSpecifics Technologies for our Peyronie’s Disease product candidate. An IND has been filed and is effective for our androgen replacement transmucosal film product candidate; however, INDs have not been filed for our overactive bladder transmucosal film or pain transmucosal film product candidates. We will not be able to commence clinical trials in the U.S. for these product candidates until we file, and the FDA fails to object to, an IND for each candidate.

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Our primary product candidates that are in development are our AA4500 product for the treatment of Peyronie’s and Dupuytren’s Diseases, our androgen replacement transmucosal film, overactive bladder transmucosal film and pain transmucosal film product candidates. We believe that these product candidates have significant milestones to reach, including the successful filing of INDs for our overactive bladder transmucosal film and our pain transmucosal film, and completion of clinical trials for each product candidate, before commercialization. If we experience delays in or termination of clinical trials or if the cost or timing of the regulatory approval process in the U.S. increases, our financial results and the commercial prospects for our product candidates will be adversely impacted. In addition, our product development costs would increase and our ability to generate additional revenue from new products could be impaired.

Adverse events in our clinical trials may force us to stop development of our product candidates or prevent regulatory approval of our product candidates, which could materially harm our business.

Patients participating in the clinical trials of our product candidates may experience serious adverse health events. A serious adverse health event includes death, a life-threatening condition, hospitalization, disability, congenital anomaly, or a condition requiring intervention to prevent permanent impairment or damage. The occurrence of any of these events could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA, or other regulatory authorities, denying approval of our product candidates for any or all targeted indications. An institutional review board or independent data safety monitoring board, the FDA, other regulatory authorities or we may suspend or terminate clinical trials at any time. Our product candidates may prove not to be safe for human use. Any delay in the regulatory approval of our product candidates could increase our product development costs and allow our competitors additional time to develop or market competing products. If our product candidates do not receive the necessary regulatory approval, we may remain reliant on sales of Testim as our sole source of revenue.

Our failure to successfully in-license or acquire additional technologies, product candidates or approved products would impair our ability to grow.

We intend to in-license, acquire, develop and market additional products and product candidates so that we are not solely reliant on Testim sales for our revenues. Because we have limited internal research capabilities, we are dependent upon pharmaceutical and biotechnology companies and other researchers to sell or license products or technologies to us. The success of this strategy depends upon our ability to identify, select and acquire the right pharmaceutical product candidates, products and technologies. To date, we have in-licensed the formulation technology underlying Testim from Bentley, the transmucosal film technology underlying our androgen replacement transmucosal film, overactive bladder transmucosal film and pain transmucosal film product candidates from PharmaForm and the enzyme underlying AA4500 from BioSpecifics Technologies.

We may not be able to successfully identify any other commercial products or product candidates to in-license, acquire or internally develop. Moreover, negotiating and implementing an economically viable in-licensing arrangement or acquisition is a lengthy and complex process. Other companies, including those with substantially greater financial, marketing and sales resources, may compete with us for the in-licensing or acquisition of product candidates and approved products. We may not be able to acquire or in-license the rights to additional product candidates and approved products on terms that we find acceptable, or at all. If we are unable to in-license or acquire additional commercial products or product candidates we may be reliant solely on Testim sales for revenues. As a result, our ability to grow our business or increase our profits could be severely limited.

If we engage in any acquisition, we will incur a variety of costs, and we may never realize the anticipated benefits of the acquisition.

Since our inception, we have acquired the underlying technology for Testim and all of our product candidates through in-licensing arrangements. The underlying technology for Testim has been licensed from Bentley. The underlying technology for our androgen replacement, overactive bladder and pain therapy

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transmucosal film product candidates has been licensed from PharmaForm. AA4500, our product candidate for Peyronie’s and Dupuytren’s Diseases, has been licensed from BioSpecifics Technologies. One of our strategies for business expansion is the acquisition of additional products and product candidates. We may attempt to acquire these product candidates, or other potentially beneficial technologies, through in-licensing or the acquisition of businesses, services or products that we believe are a strategic fit with our business. If we undertake an acquisition, the process of integrating any newly acquired business, technology, service or product into our existing operations could be expensive and time consuming and may result in unforeseen operating difficulties and expenditures and may divert significant management attention from our ongoing business operations. Moreover, we may fail to realize the anticipated benefits of any acquisition for a variety of reasons, such as an acquired product candidate proving to not be safe or effective in later clinical trials. We may fund any future acquisition by issuing equity or debt securities, which could dilute your ownership percentage or limit our financial or operating flexibility as a result of restrictive covenants related to new debt. Acquisition efforts can consume significant management attention and require substantial expenditures, which could detract from our other programs. In addition, we may devote resources to potential acquisitions that are never completed. If we are unable to acquire and successfully integrate product candidates through in-licensing or the acquisition of businesses, services or products, we may remain reliant solely on Testim sales for revenue. In pursuing our acquisition strategy, we have expended significant management time, consulting costs and legal expenses without consummating a transaction.

Risks Related to Regulatory Approval of Our Product Candidates

We are subject to numerous complex regulatory requirements and failure to comply with these regulations, or the cost of compliance with these regulations, may harm our business.

The testing, development and manufacturing and distribution of our products are subject to regulation by numerous governmental authorities in the U.S., Europe and elsewhere. These regulations govern or affect the testing, manufacture, safety, labeling, storage, record-keeping, approval, distribution, advertising and promotion of Testim and our product candidates, as well as safe working conditions and the experimental use of animals. Noncompliance with any applicable regulatory requirements can result in refusal of the government to approve products for marketing, criminal prosecution and fines, recall or seizure of products, total or partial suspension of production, prohibitions or limitations on the commercial sale of products or refusal to allow the entering into of federal and state supply contracts. FDA and comparable governmental authorities have the authority to withdraw product approvals that have been previously granted. Currently, there is a substantial amount of congressional and administrative review of the FDA and the regulatory approval process for drug candidates in the U.S. As a result, there may be significant changes made to the regulatory approval process in the U.S. In addition, the regulatory requirements relating to the manufacturing, testing, and promotion, marketing and distribution of our products may change in the U.S. or the other jurisdictions in which we may have obtained or be seeing regulatory approval for our products or product candidates. Such changes may increase our costs and adversely effect our operations.

Testosterone is listed by the U.S. Drug Enforcement Agency, or DEA, as a Schedule III substance under the Controlled Substances Act of 1970. The DEA classifies substances as Schedule I, II, III, IV or V substances, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest risk. Our transmucosal film product candidates may also involve the use of scheduled substances. Scheduled substances are subject to DEA regulations relating to manufacturing, storage, distribution and physician prescription procedures. For example, all regular Schedule III drug prescriptions must be signed by a physician and may not be refilled. Furthermore, the amount of Schedule III substances we can obtain for clinical trials and commercial distribution is limited by the DEA and our quota may not be sufficient to complete clinical trials or meet commercial demand, if any.

Entities must be registered annually with the DEA to manufacture, distribute, dispense, import, export, and conduct research using controlled substances. State controlled substance laws also require registration for similar activities. In addition, the DEA requires entities handling controlled substances to maintain records and file

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reports, follow specific labeling and packaging requirements, and provide appropriate security measures to control against diversion of controlled substances. Failure to follow these requirements can lead to significant civil and/or criminal penalties and possibly even lead to a revocation of a DEA registration.

Products containing controlled substances may generate public controversy. As a result, these products may have their marketing rights or regulatory approvals withdrawn. Political pressures and adverse publicity could lead to delays in, and increased expenses for, and limit or restrict the introduction and marketing of our product candidates. For some scheduled substances, the FDA may require us to develop a comprehensive risk management program to reduce the inappropriate use of our products and product candidates, including the manner in which they are marketed and sold, so as to reduce the risk of improper patient selection and diversion or abuse of the product. Developing such a program in consultation with the FDA may be a time-consuming process and could delay approval of any of our product candidates. Such a program or delays of any approval from the FDA could increase our product development costs and may allow our competitors additional time to develop or market competing products.

Additionally, failure to comply with or changes to the regulatory requirements that are applicable to Testim or our other product candidates may result in a variety of consequences, including the following:

If our product candidates are not demonstrated to be sufficiently safe and effective, they will not receive regulatory approval and we will be unable to commercialize them.

Other than Testim, all of our other product candidates are in preclinical or clinical development and have not received regulatory approval from the FDA or any foreign regulatory authority. BioSpecifics Technologies has filed an IND for our Peyronie’s Disease product candidate. An IND has been filed and is effective for our androgen replacement transmucosal film product candidate; however, INDs have not been filed for our overactive bladder or pain transmucosal film product candidates. The regulatory approval process typically is extremely expensive, takes many years and the timing or likelihood of any approval cannot be accurately predicted.

As part of the regulatory approval process, we must conduct preclinical studies and clinical trials for each product candidate to demonstrate safety and efficacy. The number of preclinical studies and clinical trials that will be required varies depending on the product candidate, the indication being evaluated, the trial results and regulations applicable to any particular product candidate.

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The results of preclinical studies and initial clinical trials of our product candidates do not necessarily predict the results of later-stage clinical trials. Product candidates in later stages of clinical trials may fail to show the desired safety and efficacy despite having progressed through initial clinical trials. We cannot assure you that the data collected from the preclinical studies and clinical trials of our product candidates will be sufficient to support FDA or other regulatory approval. In addition, the continuation of a particular study after review by an institutional review board or independent data safety monitoring board does not necessarily indicate that our product candidate will achieve the clinical endpoint.

The FDA and other regulatory agencies can delay, limit or deny approval for many reasons, including:

Any delay in, or failure to receive, approval for any of our product candidates or the failure to maintain regulatory approval for Testim could prevent us from growing our revenues or achieving profitability.

Our corporate compliance program cannot guarantee that we are in compliance with all potentially applicable regulations.

We are a relatively small company and we rely heavily on third-parties to conduct many important functions. As a pharmaceutical company, we are subject to a large body of legal and regulatory requirements. In addition, as a publicly traded company we are subject to significant regulations, some of which have either only recently been adopted or are currently proposals subject to change. We cannot assure you that we are or will be in compliance with all potentially applicable laws and regulations. Failure to comply with all potentially applicable laws and regulations could lead to the imposition of fines, cause the value of our common stock to decline, impede our ability to raise capital or lead to the de-listing of our stock.

Risks Related to Commercialization

If medical doctors do not prescribe our products or the medical profession does not accept our products, our ability to grow our revenues will be limited.

Our business is dependent on market acceptance of our products by physicians, healthcare payors, patients and the medical community. Medical doctors’ willingness to prescribe our products depends on many factors, including:

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Even though we have received regulatory approval for Testim, and even if we receive regulatory approval and satisfy the above criteria for any of our other product candidates, physicians may not prescribe our products if we do not promote our products effectively. Factors that could affect our success in marketing our products include:

If any of our products or product candidates fails to achieve market acceptance, we may not be able to market and sell the products successfully, which would limit our ability to generate revenue and could harm our business.

If testosterone replacement therapies are perceived to create or create health risks, our sales of Testim may decrease and our operations may be harmed.

Recent studies of female hormone replacement therapy products have reported an increase in health risks. As a result of such studies, some companies that sell or develop female hormone replacement products have experienced decreased sales of these products, and in some cases, a decline in the value of their stock. Publications have, from time to time, suggested potential health risks associated with testosterone replacement therapy. Potential health risks were described in various articles, including a 2002 article published in Endocrine Practice and a 1999 article published in the International Journal of Andrology. The potential health risks detailed were fluid retention, sleep apnea, breast tenderness or enlargement, increased red blood cells, development of clinical prostate disease, increased cardiovascular disease risk and the suppression of sperm production. It is possible that studies on the effects of TRT could demonstrate these or other health risks. This, as well as negative publicity about the risks of hormone replacement therapy, including TRT, could adversely affect patient or prescriber attitudes and impact Testim sales. In addition investors may become concerned about these issues and decide to sell our common stock. These factors could adversely affect our business and the price of our common stock.

Testim competes in a very competitive market, and if we are unable to compete effectively with the other companies that produce products for the treatment of urologic or sexual health disorders, our ability to generate revenues will be limited.

The primary competition for Testim is AndroGel^®, marketed by Solvay Pharmaceuticals. AndroGel^® was launched approximately three years before Testim and, according to IMS, has a much larger share of the testosterone gel market than we do and also accounted for approximately 58% of total testosterone prescriptions for the quarter ended December 31, 2004. Furthermore, Solvay is a much larger company than we are with greater resources and greater ability to promote its product through a larger sales force. Testim also competes with other forms of testosterone replacement therapies such as oral treatments, patches, injectables and a buccal tablet. Generally, Testim is more expensive than patches and injectables. AndroDerm^® is a transdermal testosterone patch marketed by Watson Pharmaceuticals. AndroDerm^® is the leading patch product and accounted for approximately 12% of total testosterone prescriptions for the quarter ended December 31, 2004. Many of our competitors, such as Solvay and Watson, have substantially greater financial, technical and human resources than we have. These resources may be used to more effectively develop, market or acquire products and technologies. Additional mergers and acquisitions in the pharmaceutical industry may result in even more resources being concentrated in our competitors. Competition may increase further as a result of advances made in the commercial applicability of technologies and greater availability of capital for investment in these fields. In addition, our competitors are developing new testosterone treatment therapies.

The pharmaceutical industry is highly competitive. Our success will depend on our ability to acquire, develop and commercialize products and our ability to establish and maintain markets for Testim or any products

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for which we receive marketing approval. Potential competitors in North America, Europe and elsewhere include major pharmaceutical companies, specialty pharmaceutical companies and biotechnology firms, universities and other research institutions and government agencies. Many of our competitors have substantially greater research and development capabilities and experience, and greater management, manufacturing, distribution, marketing and financial resources, than we do. Accordingly, our competitors may:

Other new treatments are being sought for TRT, including a new class of drugs called Selective Androgen Receptor Modulators, or SARMs. SARMs are in the early stages of development and their future impact on TRT is unknown.

If other pharmaceutical companies develop generic versions of any products that compete with our commercialized products or any of our products, our business may be adversely affected.

Other pharmaceutical companies may develop generic versions of any products that compete with our commercialized products or any of our products that are not subject to patent protection or other proprietary rights. For example, because the ingredients of Testim are commercially available to third-parties, it is possible that competitors may design formulations, propose dosages or develop methods of administration that would be outside the scope of the claims of one or more, or of all, of the patent rights that we in-license. This would enable their products to effectively compete with Testim. Governmental and other pressures to reduce pharmaceutical costs may result in physicians writing prescriptions for these generic products. Increased competition from the sale of competing generic pharmaceutical products could cause a material decrease in revenue from our products. Additionally, if a generic form of Testim is approved and sold in the U.S., our co-promotion partner for Testim may terminate our co-promotion agreement which could cause a material decrease in revenue from Testim.

The primary competition for Testim is AndroGel^®, marketed by Solvay Pharmaceuticals. We are aware of at least two companies, Watson and Par Pharmaceutical, that have filed abbreviated new drug applications, or ANDAs, with the FDA to be approved as generics of AndroGel^®. Solvay has filed patent infringement lawsuits against these two companies to block the approval and marketing of the generic products. On November 1, 2004, Par Pharmaceutical’s partner, Paddock Laboratories, received tentative approval of its ANDA from the FDA, but cannot market its generic of AndroGel^® until the Solvay action is resolved and until final approval is received from the FDA. The final approval of either or both of these ANDAs would result in increased competition for Testim at lower prices.

If third-party payors do not reimburse customers for Testim or any of our product candidates that are approved for marketing, they might not be used or purchased, and our revenues and profits will not grow.

Our revenues and profits depend heavily upon the availability of coverage and reimbursement for the use of Testim, and any of our product candidates that are approved for marketing, from third-party healthcare and state and federal government payors, both in the U.S. and in foreign markets. Reimbursement by a third-party payor may depend upon a number of factors, including the third-party payor’s determination that use of a product is:

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Since reimbursement approval for a product is required from third-party and government payors, seeking this approval, particularly when seeking approval for a preferred form of reimbursement over other competitive products, is a time-consuming and costly process. Third-party payors may require cost-benefit analysis data from us in order to demonstrate the cost-effectiveness of any product we might bring to market. For any individual third-party payor, we may not be able to provide data sufficient to gain reimbursement on a similar or preferred basis to competitive products or at all. Once reimbursement at an agreed level is approved by a third-party payor, we may lose that reimbursement entirely or we may lose the similar or better reimbursement we receive compared to competitive products. As reimbursement is often approved for a period of time, this risk is greater at the end of the time period, if any, for which the reimbursement was approved. To date, we have not experienced any problems with third-party payors. This does not mean that we will not experience any problems with third-party payors in the future.

International commercialization of Testim and our product candidates faces significant obstacles.

As with Testim, we may plan to commercialize some of our product candidates internationally through collaborative relationships with foreign partners. We have limited foreign regulatory, clinical and commercial resources. We may not be able to enter into collaboration agreements with appropriate partners for important foreign markets on acceptable terms, or at all. Future collaborations with foreign partners may not be effective or profitable for us.

If our co-promotion partnership does not increase Testim sales, our gross profit may be negatively affected, which could cause the price of our common stock to decline.

In April 2005, we entered into a co-promotion agreement with Oscient. Under the terms of the agreement, Oscient will promote Testim to primary care physicians in the U.S. using its 250-person sales force, while we will continue to promote Testim using our specialty sales force that calls on urologists, endocrinologists and select primary care physicians. We will compensate Oscient for its co-promotion services by paying Oscient a specified percentage of the gross profit from Testim sales attributable to primary care physicians in the U.S. generated by the combined sales force that exceeds a specified sales threshold. If we are unable to effectively utilize the combined sales forces or if the additional selling efforts do not increase Testim sales, our gross profit may be negatively affected, which may cause our stock price to decline.

Healthcare reform measures could adversely affect our business.

The business and financial condition of pharmaceutical companies are affected by the efforts of governmental and third-party payors to contain or reduce the costs of healthcare. In the U.S. and in foreign jurisdictions there have been, and we expect that there will continue to be, a number of legislative and regulatory proposals aimed at changing the healthcare system. For example, in some countries other than the U.S., pricing of prescription drugs is subject to government control, and we expect proposals to implement similar controls in the U.S. to continue. The pendency or approval of such proposals could result in a decrease in our stock price or limit our ability to raise capital or to obtain strategic partnerships or licenses.

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

The commercialization of Testim and the clinical testing and, if approved, commercialization of our product candidates involves significant exposure to product liability claims. We have clinical trial and product liability insurance that covers Testim and the clinical trials of our other product candidates that we believe is adequate in both scope and amount and has been placed with what we believe are reputable insurers. We are self-insured for the first $1.0 million of liability under these policies. Our product liability policies have been written on a claims-made basis. If any of our product candidates are approved for marketing, we may seek additional coverage. We cannot predict all of the adverse health events that Testim or our product candidates may cause. As a result, our current and future coverages may not be adequate to protect us from all the liabilities that we may incur. If losses

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from product liability claims exceed our insurance coverage, we may incur substantial liabilities that exceed our financial resources. Whether or not we were ultimately successful in product liability litigation, such litigation could consume substantial amounts of our financial and managerial resources, and might result in adverse publicity, all of which would impair our business. We may not be able to maintain our clinical trial insurance or product liability insurance at an acceptable cost, if at all, and this insurance may not provide adequate coverage against potential claims or losses. If we are required to pay a product liability claim, we may not have sufficient financial resources and our business and results of operations may be harmed.

We may be exposed to liability claims associated with the use of hazardous materials and chemicals.

Our research and development activities and our commercial product, Testim, involve the use of testosterone and large amounts of alcohol which are classified as hazardous materials and chemicals. AA4500 is

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a biologic product. Biologic products may present a manufacturing health hazard due to risk of infection with the bacterial cell line used to produce the product or with potential viral contamination with the fermentation. Although we believe that our safety procedures for using, storing, handling and disposing of these materials comply with federal, state and local laws and regulations, we cannot completely eliminate the risk of accidental injury or contamination from these materials. In the event of such an accident, we could be held liable for any resulting damages and any liability could materially adversely affect our business, financial condition and results of operations. In addition, the federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous or radioactive materials and waste products may require us to incur substantial compliance costs that could materially adversely affect our business and financial condition. To our knowledge, we have not been the subject of any investigation by any agency or authority for failure to comply with any rules or regulations applicable to hazardous materials or chemicals. We do not maintain specific insurance for the handling of biological, hazardous and radioactive materials. We have contracts with third-party providers for the storage and disposal of hazardous waste and believe that any claims against us in these areas would be the responsibility of these third-parties. However, we may be held responsible for these claims despite the fact that we have contracted with third-parties for the storage and disposal of hazardous waste. If we are exposed to these types of claims, we could be held responsible for liabilities that exceed our financial resources, which could severely affect our operations.

Risks Related to Our Dependence on Third-Party Manufacturers and Service Providers

Since we rely on third-party manufacturers and suppliers, we may be unable to control the availability or cost of manufacturing our products, which could adversely affect our results of operations.

We do not manufacture Testim or any of our product candidates and have no current plan to develop any capacity to do so. We have contracted with DPT Laboratories to manufacture Testim through December 31, 2005. BioSpecifics Technologies is responsible for supplying clinical and commercial product supplies of AA4500; we however, have the right to qualify a back-up supplier. We are in the process of qualifying a back-up supplier and negotiating the terms of agreement with this back-up supplier for the production of our clinical supply of AA4500, our Peyronie’s and Dupuytren’s Diseases product candidate. Upon completion of the qualification process, we expect to rely on this back-up supplier, rather than BioSpecifics Technologies, for our clinical supply of AA4500. We plan to contract with one or more third-party manufacturers to manufacture our transmucosal film product candidates. The manufacture of pharmaceutical products requires significant expertise and capital investment. DPT Laboratories, any back-up supplier for AA4500, or any other third-party manufacturer may encounter difficulties in production. These problems may include:

DPT, any back-up supplier for AA4500, or any of our other third-party manufacturers may not perform as agreed or may terminate its agreement with us, which would adversely impact our ability to produce and sell Testim.

Our contract with DPT Laboratories to manufacture Testim expires on December 31, 2005. We do not have alternative manufacturing plans in place at this time. If there is an interruption in the supply of Testim, our co-promotion partner for Testim may terminate our co-promotion agreement and in that event, we would be obligated to make a payment to Oscient the amount of which depends on when the supply interruption occurs. The number of third-party manufacturers with the expertise, required regulatory approvals and facilities to manufacture bulk drug substance on a commercial scale is extremely limited, and it would take a significant amount of time to arrange and receive regulatory approval for alternative arrangements. We may not be able to contract for the manufacturing of Testim on acceptable terms, if at all, which would materially impair our business.

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Any of these factors could increase our costs and result in us being unable to effectively commercialize our products. Furthermore, if DPT or any other third-party manufacturer fails to deliver the required commercial quantities of finished product on a timely basis and at commercially reasonable prices, we may be unable to meet the demand for our products and we may lose potential revenues.

We rely on a single source supplier and a limited number of suppliers for two of the primary ingredients for Testim and the loss of any of these suppliers could prevent us from selling Testim, which would materially harm our business.

We rely on third-party suppliers for our supply of testosterone and pentadecalactone, or CPD, two key ingredients of Testim. Testosterone is available to us from only two sources. We rely exclusively on one outside source for our supply of CPD. We do not have any agreements with these suppliers regarding these key ingredients. If either of the two sources that produce testosterone stops manufacturing it, or if we are unable to procure testosterone on commercially favorable terms, we may be unable to continue to produce or sell Testim on commercially viable terms, if at all. In addition, if our third-party source of CPD stops manufacturing pharmaceutical grade CPD, or does not make CPD available to us on commercially favorable terms, we may be unable to continue to produce or sell Testim on commercially viable terms, if at all. Furthermore, the limited number of suppliers of testosterone and CPD may provide such companies with greater opportunity to raise their prices. Any increase in price for testosterone or CPD may reduce our gross margins.

Due to our reliance on contract research organizations or other third-parties to assist us in conducting clinical trials, we are unable to directly control all aspects of our clinical trials.

Currently, we rely in part on three third-parties to conduct our clinical trials for the expansion of Testim and the development of our product candidates. As a result, we have had and will continue to have less control over the conduct of the clinical trials, the timing and completion of the trials and the management of data developed through the trial than would be the case if we were relying entirely upon our own staff. Communicating with outside parties can also be challenging, potentially leading to mistakes as well as difficulties in coordinating activities. Outside parties may:

These factors may adversely affect their willingness or ability to conduct our trials. We may experience unexpected cost increases that are beyond our control. Problems with the timeliness or quality of the work of a contract research organization may lead us to seek to terminate the relationship and use an alternative service provider. However, making this change may be costly and may delay our trials, and contractual restrictions may make such a change difficult or impossible. Our contracts with the contract research organizations on which we currently rely are each terminable upon 30-days prior written notice. If we must replace any of these contract research organizations or any other contract research organization we may use in the future to conduct our clinical trials, our trials may have to be suspended until we find another contract research organization that offers comparable services. The time that it takes us to find alternative organizations may cause a delay in the commercialization of our product candidates or may cause us to incur significant expenses to replicate data that may be lost. Although we do not believe that the contract research organizations on which we rely offer services that are not available elsewhere, it may be difficult to find a replacement organization that can conduct our trials in an acceptable manner and at an acceptable cost. Any delay in or inability to complete our clinical trials could significantly compromise our ability to secure regulatory approval of the relevant product candidate and preclude our ability to commercialize the product, thereby limiting our ability to generate revenue from the sales of products other than Testim, which may result in a decrease in our stock price.

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Our third-party manufacturers are subject to regulatory oversight, which may delay or disrupt our development and commercialization efforts.

Third-party manufacturers of our products or product candidates must ensure that all of the processes, methods and equipment are compliant with the current Good Manufacturing Practices, or cGMP, and conduct extensive audits of vendors, contract laboratories and suppliers. The cGMP requirements govern quality control of the manufacturing process and documentation policies and procedures. Compliance by third-party manufacturers with cGMP requires record keeping and quality control to assure that the product meets applicable specifications and other requirements. Manufacturing facilities are subject to inspection by regulatory agencies at any time. If an inspection by regulatory authorities indicates that there are deficiencies, third-party manufacturers could be required to take remedial actions, stop production or close the facility, which would disrupt the manufacturing processes and limit the supplies of Testim or our product candidates. If they fail to comply with these requirements, we also may be required to curtail the clinical trials of our product candidates, which are also supplied by these manufacturers, and may not be permitted to sell our products or may be limited in the jurisdictions in which we are permitted to sell them.

Approximately 87% of our product shipments are to only four customers; if any of these customers refuse to distribute Testim on commercially favorable terms, or at all, our business will be adversely affected.

We sell Testim to wholesale drug distributors and chain drug stores who generally sell products to retail pharmacies, hospitals and other institutional customers. We do not promote Testim to these customers, and they do not determine Testim prescription demand. However, approximately 87% of our product shipments are to only four customers: Cardinal Health, Inc., McKesson Corporation, AmerisourceBergen Corporation and Walgreen Co. Our business would be harmed if any of these customers refused to distribute Testim or refuse to purchase Testim on commercially favorable terms to us.

It is possible that wholesalers could decide to change their policies or fees, or both, at some time in the future. This could result in their refusal to distribute smaller volume products, or cause higher product distribution costs, lower margins or the need to find alternative methods of distributing products. Such alternative methods may not exist or may not be economically viable.

If we are unable to grow our sales, marketing or distribution capabilities or enter into agreements with third-parties to perform some of these functions, we will not be able to grow our business.

As an organization, we have a limited history in sales, marketing and distribution. To directly market and distribute Testim or any of our product candidates which receive regulatory approval, we must continue to enhance our sales and marketing efforts. For our direct sales efforts, we will need to hire additional salespeople in order to grow and to manage any turnover that occurs in our sales force. For some market opportunities, we may need to enter into co-promotion or other licensing arrangements with pharmaceutical or biotechnology firms in order to increase the commercial success of our products. We may not be able to grow our direct sales, marketing and distribution capabilities or enter into co-promotion or similar licensing arrangements with third-parties in a timely manner, or on acceptable terms. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and some or all of the revenues we receive will depend upon the efforts of third-parties, and these efforts may not be successful. Additionally, building marketing and distribution capabilities may be more expensive than we anticipate, requiring us to divert capital from other intended purposes or preventing us from building our marketing and distribution capabilities to the desired levels.

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Risks Related to Intellectual Property

If we breach any of the agreements under which we license commercialization rights to products or technology from others, we could lose license rights that are critical to our business.

We are a party to a number of license agreements by which we have rights to use the intellectual property of third-parties that are necessary for us to operate our business. In particular, we have obtained the exclusive right to develop and commercialize Testim pursuant to a license agreement with Bentley. Bentley may unilaterally terminate the agreement if we fail to make payments under this agreement and this failure continues for a period of 30 days following written notice to us by Bentley. If the agreement is properly terminated by Bentley, we may not be able to manufacture or sell Testim.

Additionally, we have obtained exclusive rights to make and sell products that are used for hormone replacement, to treat any type of urologic disorder or as a pain therapy incorporating PharmaForm’s oral transmucosal film technology. This agreement continues for the life of the licensed patent rights. Either party may terminate this agreement under certain events of bankruptcy or insolvency by the other party. PharmaForm may unilaterally terminate this agreement if:

If our agreement with PharmaForm is properly terminated by PharmaForm, we may not be able to execute our strategy to develop, manufacture or sell transmucosal film products. To the extent that unpatented PharmaForm trade secrets are necessary for the manufacture of the oral transmucosal product candidates, our license to such trade secrets would expire with the expiration of the licensed patents in 2020 or later and potentially impair our continued commercialization of our oral transmucosal product candidates thereafter.

We have also obtained exclusive worldwide rights from BioSpecifics Technologies to develop, market and sell products other than dermal formulations labeled for topical administration, where the products contain BioSpecifics Technologies’ enzyme for the treatment of Peyronie’s Disease and Dupuytren’s Disease. We may expand the agreement, at our option, to license products which contain BioSpecifics Technologies’ enzyme for other indications, excluding dermal formulations labeled for topical administration, as they are developed by BioSpecifics Technologies or by us. This agreement continues on a product by product and country by country basis until the later of:

Upon expiration of the agreement pursuant to the preceding sentence, we will have a fully paid-up license to the products developed under the agreement. Either party may terminate this agreement in the event of bankruptcy or insolvency by the other party. Additionally, either party may terminate this agreement if the other party is in material breach of its obligations under the agreement which continues for a period of 90 days following receipt of written notice of such material breach. We may terminate this agreement in its entirety, or on a country by country basis, on an indication by indication basis, or on a product by product basis, at any time upon 90 days prior written notice to BioSpecifics Technologies. If this agreement is properly terminated by BioSpecifics Technologies, we may not be able to execute our strategy to develop and commercialize our Peyronie’s and Dupuytren’s Diseases product candidate or to develop and commercialize future product candidates utilizing BioSpecifics Technologies’ enzyme.

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We expect to enter into additional licenses in the future. These licenses may impose various development, commercialization, funding, royalty, diligence or other obligations on us. If we breach any of these obligations, the licensor may have the right to terminate the license or render the license non-exclusive, which could make it impossible for us to develop, manufacture or sell the products covered by the license.

Disputes may arise with respect to our licensing agreements regarding manufacturing, development and commercialization of any products relating to our in-licensed intellectual property, including Testim. These disputes could lead to delays in or termination of the development, manufacture and commercialization of Testim or our product candidates or to litigation.

We have only limited patent protection for Testim and our product candidates, and we may not be able to obtain, maintain and protect proprietary rights necessary for the development and commercialization of Testim or our product candidates.

Our business and competitive positions are dependent upon our ability to obtain and protect our proprietary position for Testim and our product candidates in the U.S., Europe and elsewhere. Because of the substantial length of time and expense associated with development of new products, we, along with the rest of the biopharmaceutical industry, place considerable importance on obtaining and maintaining patent protection for new technologies, products and processes. The patent positions of pharmaceutical, biopharmaceutical and biotechnology companies, including ours, are generally uncertain and involve complex legal and factual questions. Our and our licensors’ patents and patent applications may not protect our technologies and products because, among other things:

We attempt to protect our intellectual property position by filing or obtaining licenses to patent applications and, where appropriate, patent applications in other countries related to our proprietary technology, inventions and improvements that are important to the development of our business. Currently, neither Testim nor our product candidates are covered by composition of matter patents. Our BioSpecifics Technologies product candidate is covered by a method of use patent. Our PharmaForm transmucosal film product candidates are covered by a formulation patent in the U.S. only. This patent expires in 2020. Testosterone, the active ingredient in Testim, is off-patent and is included in competing TRT products. The U.S. patent that we license from Bentley covers the formulation of Testim and expires in June 2008. The European patents that we license from Bentley for Testim expire in 2006. Bentley has filed a new patent application in the U.S., Europe and Japan which, if issued, could provide additional patent protection for Testim. AA4500 licensed from BioSpecifics Technologies is covered by two method of use patents in the U.S., one for the treatment of Peyronie’s Disease and one for the treatment of Dupuytren’s Disease. The Peyronie’s patent expires in 2019 and the Dupuytren’s patent expires in 2014. Both patents are limited to the use of AA4500 for the treatment of Peyronie’s Disease and Dupuytren’s Disease with certain dose ranges and/or concentration ranges. Currently there is not enough data to establish whether any ultimate approved product for Peyronie’s Disease or Dupuytren’s Disease will be covered by these patents. Foreign patents and pending applications may also cover these products in certain countries depending upon the concentration and dosage ranges of such products. Some countries will not grant patents on patent applications that are filed after the public sale or disclosure of the material claimed in the patent application. The

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U.S., by contrast, allows a one year grace period after public disclosure in which to file a patent application. Because the European patent application was filed after Testim went on the market in the U.S., our ability to obtain additional patent protection outside of the U.S. may be limited.

The standards that the U.S. Patent and Trademark Office, or USPTO, and its foreign counterparts use to grant patents are not always applied predictably or uniformly and can change. Limitations on patent protection in some countries outside the U.S., and the differences in what constitutes patentable subject matter in these countries, may limit the protection we seek outside of the U.S. For example, methods of treating humans are not patentable subject matter in many countries outside of the U.S. In addition, laws of foreign countries may not protect our intellectual property to the same extent as would laws of the U.S. In determining whether or not to seek a patent or to license any patent in a particular foreign country, we weigh the relevant costs and benefits, and consider, among other things, the market potential of our product candidates in the jurisdiction, and the scope and enforceability of patent protection afforded by the law of the jurisdiction. Failure to obtain adequate patent protection for our proprietary product candidates and technology would impair our ability to be commercially competitive in these markets. Accordingly, we do not know the degree of future protection for our proprietary rights or the breadth of claims allowed in any patents issued to us or others.

We intend to seek patent protection whenever it is available for any products or product candidates we acquire in the future. However, any patent applications for future products may not issue as patents, and any patent issued on such products may be challenged, invalidated, held unenforceable or circumvented. Furthermore, the claims in patents which have been issued on products we may acquire in the future may not be sufficiently broad to prevent third-parties from commercializing competing products. If we fail to obtain adequate patent protection for our products, our ability to compete could be impaired.

Technology in-licensed by us is important to our business. We may not control the patent prosecution, maintenance or enforcement of some of our in-licensed technology. Accordingly, we may be unable to exercise the same degree of control over this intellectual property as we would over our internally developed intellectual property. For example, in-licensed patents for which our rights are limited to a particular field of use could be or become licensed in other fields to other licensees and, therefore, become subject to enforcement by such other licensees without our participation. Consequently, such licensed patents could be held invalid or unenforceable or could have claims construed in a manner adverse to our interests in litigation, which we would not control or to which we would not be a party. If any of the intellectual property rights of our licensors is found to be invalid, this could have a material adverse impact on our operations.

The Dupuytren’s patent will be the subject of a reexamination proceeding or a reissue application in the USPTO for the purpose of submitting prior art that was not previously submitted during the prosecution of the Dupuytren’s patent. As a result, the patent may not be allowed by the USPTO, and therefore, may not be valid and enforceable.

If we are not able to protect and control unpatented trade secrets, know-how and other technological innovation, we may suffer competitive harm. We also rely on trade secrets, know-how and technology, which are not protected by patents, to maintain our competitive position. However, trade secrets are difficult to protect. To maintain the confidentiality of trade secrets and proprietary information, we generally seek to enter into confidentiality agreements with our employees, consultants and collaborators upon the commencement of a relationship with us. However, we may not obtain these agreements in all circumstances. Nor can we guarantee that these agreements will provide meaningful protection, that these agreements will not be breached, or that we will have an adequate remedy for any such breach. In addition, adequate remedies may not exist in the event of unauthorized use or disclosure of this information. Others may have developed, or may develop in the future, substantially similar or superior know-how and technology. The loss or exposure of our trade secrets, know-how and other proprietary information, as well as independent development of similar or superior know-how, could harm our operating results, financial condition and future growth prospects. Many of our employees and consultants were, and many of our consultants may currently be, parties to confidentiality agreements with other

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companies. Although our confidentiality agreements with these employees and consultants require that they do not bring to us, or use without proper authorization, any third-party’s proprietary technology, if they violate their agreements, we could suffer claims or liabilities.

We may have to engage in costly litigation to enforce or protect our proprietary technology or to defend challenges to our proprietary technology by our competitors, which may harm our business, results of operations, financial condition and cash flow.

The pharmaceutical field is characterized by a large number of patent filings involving complex legal and factual questions, and, therefore, we cannot predict with certainty whether our licensed patents will be enforceable. Competitors may have filed applications for or have been issued patents and may obtain additional patents and proprietary rights related to products or processes that compete with or are similar to ours. We may not be aware of all of the patents potentially adverse to our interests that may have been issued to others. Litigation may be necessary to protect our proprietary rights, and we cannot be certain that we will have the required resources to pursue litigation or otherwise to protect our proprietary rights.

Our ability to market our products may be impaired by the intellectual property rights of third-parties.

Our commercial success will depend in part on not infringing the patents or proprietary rights of third-parties. We are aware of competing intellectual property relating to the testosterone gel market. While we currently believe we have freedom to operate in the testosterone gel market, others may challenge our position in the future. We are also aware of at least one third-party patent relating to BioSpecifics Technologies’ enzyme which may impair BioSpecifics Technologies’ freedom to operate in the manufacture of AA4500. There has been, and we believe that there will continue to be, significant litigation in the pharmaceutical industry regarding patent and other intellectual property rights.

Third-parties could bring legal actions against us claiming damages and seeking to enjoin clinical testing, manufacturing and marketing of the affected product or products. A third-party might request a court to rule that the patents we in-license are invalid or unenforceable. In such a case, even if the validity or enforceability of those patents were upheld, a court might hold that the third-party’s actions do not infringe the patent we in-license thereby, in effect, limiting the scope of our patent rights. If we become involved in any litigation, it could consume a substantial portion of our resources, regardless of the outcome of the litigation. If any of these actions are successful, in addition to any potential liability for damages, we could be required to obtain a license to continue to manufacture or market the affected product, in which case we may be required to pay substantial royalties or grant cross-licenses to our patents. However, there can be no assurance that any such license will be available on acceptable terms or at all. Ultimately, we could be prevented from commercializing a product, or forced to cease some aspect of our business operations, as a result of patent infringement claims, which could harm our business.

We may not be able to obtain or maintain orphan drug exclusivity for our product candidates for the treatment of urologic and sexual health disorders, and our competitors may obtain orphan drug exclusivity prior to us, which could significantly harm our business.

Some jurisdictions, including Europe and the U.S., may designate drugs for relatively small patient populations as orphan drugs. The FDA granted orphan drug status to our product candidate in the U.S. for the treatment of Peyronie’s Disease, and we plan on filing an application with the FDA requesting a transfer of the orphan drug designation from the current holder to us. Orphan drug designation must be requested before submitting an application for marketing authorization. Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process, but does make the product eligible for orphan drug exclusivity and specific tax credits in the U.S. Generally, if a product with an orphan drug designation subsequently receives the first marketing approval for the indication for which it has such designation, the product is entitled to orphan drug exclusivity. Orphan drug exclusivity means that another

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application to market the same drug for the same indication may not be approved, except in limited circumstances, for a period of up to 10 years in Europe and for a period of seven years in the U.S. Obtaining orphan drug designations and orphan drug exclusivity for our product candidates for the treatment of urologic and sexual health disorders, including Peyronie’s Disease, may be critical to the success of these product candidates. Our competitors may obtain orphan drug exclusivity for products competitive with our product candidates before we do, in which case we would be excluded from that market. Even if we obtain orphan drug exclusivity for any of our product candidates, we may not be able to maintain it. For example, if a competitive product is shown to be clinically superior to our product, any orphan drug exclusivity we have obtained will not block the approval of such competitive product. In addition, even if we obtain orphan drug exclusivity for any of our product candidates, a viable commercial market may never develop and we may never derive any meaningful revenues from the sales of these products.

If Testim or our future products or product candidates infringe the intellectual property of our competitors or other third parties, we may be required to pay license fees or cease these activities and pay damages, which could significantly harm our business.

Even if we have our own patents which protect our products, Testim and our product candidates may nonetheless infringe the patents or violate the proprietary rights of third-parties. In these cases, we may be required to obtain-licenses to patents or proprietary rights of others in order to continue to sell and use Testim and develop and commercialize our product candidates. We may not, however, be able to obtain any licenses required under any patents or proprietary rights of third-parties on acceptable terms, or at all. Even if we were able to obtain rights to a third-party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors potential access to the same intellectual property.

Third-parties may assert patent or other intellectual property infringement claims against us, or our licensors or collaborators, with respect to technologies used in potential product candidates. Any claims that might be brought against us relating to infringement of patents may cause us to incur significant expenses and, if successfully asserted against us, may cause us to pay substantial damages. We may not have sufficient resources to effectively litigate these claims. Even if we were to prevail, any litigation could be costly and time-consuming and could divert the attention of our management and key personnel from business operations. In addition, any patent claims brought against our licensors or collaborators could affect their ability to carry out their obligations to us.

Furthermore, if a patent infringement suit were brought against us, or our licensors or collaborators, the development, manufacture or potential sale of product candidates claimed to infringe a third-party’s intellectual property may have to cease or be delayed. Ultimately, we may be unable to commercialize one or more of our product candidates, our patent claims may be substantially limited or may have to cease some portion of our operations as a result of patent infringement claims, which could severely harm our business.

Risks Related to Employees and Growth

If we are not able to retain our current management team or attract and retain qualified scientific, technical and business personnel, our business will suffer.

We are dependent on the members of our management team, in particular, our Chief Executive Officer, Gerri Henwood, for our business success. In addition, an important element of our strategy is to leverage the development, regulatory and commercialization expertise of our current management, including Ms. Henwood, in our development activities. We currently carry a $1.0 million key-man life insurance policy on the life of Ms. Henwood. Our employment agreements with our executive officers are terminable on short notice or no notice. The loss of any one of our executive officers may result in a significant loss in the knowledge and experience that we, as an organization, possess and could cause significant delays, or outright failure, in the development and further commercialization of Testim or our product candidates. Since October 2004, three members of our senior management have left our employ. If we are unable to attract and retain qualified and talented senior management personnel, our business may suffer.

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To grow we will need to hire a significant number of qualified commercial, scientific and administrative personnel. However, there is intense competition for human resources, including management in the technical fields in which we operate, and we may not be able to attract and retain qualified personnel necessary for the successful commercialization of Testim and the development and commercialization of our product candidates. As we grow, the inability to attract new employees when needed or to retain existing employees could severely limit our growth and harm our business.

Changes in the expensing of stock-based compensation will result in unfavorable accounting charges and may require us to change our compensation practices. Any change in our compensation practices may adversely effect our ability to attract and retain qualified scientific, technical and business personnel.

We rely heavily on stock options to compensate existing employees and attract new employees. We currently are not required to record stock-based compensation charges if the employee’s stock option exercise price equals or exceeds the fair value of our common stock at the date of grant. We also have an employee stock purchase plan under which employees can purchase our common stock at a discount. The Financial Accounting Standards Board has recently announced new rules for recording expense for the fair value of stock options and purchase rights under employee stock purchase plans. The Securities and Exchange Commission delayed the effective date for the new rules until the beginning of the first fiscal year after June 15, 2005. As a result, we will be required to change our accounting policy to record expense for the fair value of stock options and purchase rights under our employee stock purchase plan on January 1, 2006, thereby increasing our operating expenses and reported losses. Although we intend to continue to include various forms of equity in our compensation plans, if the extent to which we use forms of equity in our plans is reduced due to the negative effects on earnings, it may be difficult for us to attract and retain qualified scientific, technical and business personnel.

Our operations may be impaired unless we can successfully manage our growth.

As of December 31, 2004 we had 166 employees. In order to continue to expand Testim’s sales and commercialize our other product candidates, we currently anticipate that we will need to in the range of 10% to 15% additional managerial, selling, operational, financial and other employees to our existing departments over each of the next two years. Expansion may place, a significant strain on our management, operational and financial resources. Moreover, higher than expected market growth of Testim, the acquisition or in-licensing of additional products, as well as the development and commercialization of our other product candidates or marketing arrangements with third parties, could accelerate our hiring needs beyond our current expectations. To manage further growth, we will be required to continue to improve existing, and implement additional, operational and financial systems, procedures and controls, and hire, train and manage additional employees. Our current and planned personnel, systems, procedures and controls may not be adequate to support our anticipated growth and we may not be able to hire, train, retain, motivate and manage required personnel. Our failure to manage growth effectively could limit our ability to achieve our business goals. In addition, our direct sales force consists of relatively newly hired employees. Turnover in our direct sales force or marketing team could adversely affect Testim and future product sales growth.

Risks Related to Stock Market Price

Our stock price is likely to be volatile, and the market price of our common stock may drop below the current price.

Prior to our recent initial public offering in July 2004, there was no public market for our common stock. Since our initial public offering, our stock price has, at times, been volatile.

Market prices for securities of pharmaceutical, biotechnology and specialty pharmaceutical companies have been particularly volatile. Some of the factors that may cause the market price of our common stock to fluctuate include:

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If any of these risks occurs, it could cause our stock price to fall and may expose us to class action lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

A significant portion of our total outstanding common stock is restricted from resale but may be sold into the market. Sales of a substantial number of shares of our common stock in the public market, or the perception in the market that the holders of a large number of shares intend to sell shares, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities, even if our business is doing well.

As of March 9, 2005, we have 20,651,050 shares of common stock outstanding, of which 15,085,345 shares, or 73.0%, are restricted securities under Rule 144 of the General Rules and Regulations under the Securities Act of 1933 or by the provisions of grants under our 2004 Equity Compensation Plan. On March 9, 2005, 8,756,943 shares of common stock were freely tradable under Rule 144(k) and 6,187,610 shares of common stock were eligible for resale under Rule 144, subject to volume limitations.

In addition, holders of 14,058,482 shares of our common stock have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. In addition, holders of outstanding warrants representing the right to purchase approximately 1,732,676 shares of our common stock have these same rights with respect to the underlying common stock upon exercise of these warrants. Furthermore, all shares of common stock that we may issue under our 2004 Equity Compensation Plan and our 2004 Employee Stock Purchase Plan can be freely sold in the public market upon issuance, subject to lock-up agreements.

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Possible dilutive effect of outstanding options and warrants.

As of December 31, 2004, stock options to purchase 1,858,700 shares of common stock and warrants to purchase 1,732,676 shares of common stock were outstanding. In addition, as of December 31, 2004 a total of 780,983 stock options are available for grant under our 2004 Equity Compensation Plan. A total of 726,706 of the outstanding options and warrants are “in the money” and exercisable as of December 31, 2004. “In the money” means that the current market price of the common stock is above the exercise price of the shares subject to the warrant or option. The issuance of common stock upon the exercise of these options and warrants could adversely affect the market price of the common stock or result in substantial dilution to our existing stockholders.

Our executive officers, directors and major stockholders have the ability to control all matters submitted to stockholders for approval.

Our executive officers, directors and stockholders who beneficially own more than 5% of our outstanding common stock, and their affiliates, in the aggregate, beneficially own shares representing approximately 77% of our common stock. Beneficial ownership includes shares over which an individual or entity has investment or voting power and includes shares that could be issued upon the exercise of options and warrants within 60 days. As a result, if these stockholders were to choose to act together, they would be able to control all matters submitted to our stockholders for approval, as well as our management and affairs. For example, these individuals, if they chose to act together, will control the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of our company on terms that other stockholders may desire.

Provisions in our certificate of incorporation and bylaws and under Delaware law may prevent or frustrate a change in control in management that stockholders believe is desirable.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include:

The affirmative vote of the holders of at least two-thirds of our shares of capital stock entitled to vote is necessary to amend or repeal the above provisions of our certificate of incorporation. In addition, absent approval of our board of directors, our bylaws may only be amended or repealed by the affirmative vote of the holders of at least two-thirds of our shares of capital stock entitled to vote.

In addition, Section 203 of the General Corporation Law of the State of Delaware prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns or within the last three years has owned 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent a change in control of our company.

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We do not use derivative financial instruments or derivative commodity instruments for trading purposes or any other purpose. Our financial instruments consist of cash, cash equivalents, short-term investments, restricted cash, trade accounts receivable, accounts payable and long-term obligations. We consider investments that, when purchased, have a remaining maturity of 90 days or less to be cash equivalents.

We invest in marketable securities in accordance with our investment policy. The primary objectives of our investment policy are to preserve principal, maintain proper liquidity to meet operating needs and maximize yields. Our investment policy specifies credit quality standards for our investments. The maximum allowable duration of a single issue is three months. Our investment policy permits us to invest in Auction Rate Securities (ARS) with maturities of greater than three months, provided that the interest reset date, the date in which the ARS may be readily liquidated to a market maker, for the ARS is less than three months. As the underlying maturity date of our ARS investments is greater than three months, and as we classify these investments as available for sale, we classify our ARS investments as short-term investments on our consolidated balance sheet.

Our investment portfolio is subject to interest rate risk and will fall in value in the event market interest rates increase. All our cash, cash equivalents and short-term investments at December 31, 2004, amounting to approximately $46.8 million, were maintained in bank demand accounts, money market accounts, U.S. government backed securities and ARS. We do not hedge our interest rate risks as we believe reasonably possible near-term changes in interest rates would not materially affect our results of operations, financial position or cash flows.

Transactions relating to Auxilium UK, Limited are recorded in pounds sterling. Upon consolidation of this subsidiary into our consolidated financial statements, we translate the balance sheet asset and liability accounts to the U.S. dollar based on exchange rates as of the balance sheet date; balance sheet equity accounts are translated into the U.S. dollar at historical exchange rates; and all statements of operations and cash flows amounts are translated into the U.S. dollar at the average exchange rates for the period. Exchange gains or losses resulting from the translation are included as a separate component of stockholders’ equity (deficit). In addition, we conduct clinical trials in the Netherlands, exposing us to cost increases if the U.S. dollar declines in value compared to the euro. We do not hedge our foreign exchange risks as we believe reasonably possible near-term fluctuations of exchange rates would not materially affect our results of operations, financial position or cash flows.

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AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Auxilium Pharmaceuticals, Inc.:

We have audited the accompanying consolidated balance sheets of Auxilium Pharmaceuticals, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, redeemable convertible preferred stock, stockholders’ equity (deficit) and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Auxilium Pharmaceuticals, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

Philadelphia, Pennsylvania

April 15, 2005

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AUXILIUM PHARMACEUTICALS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share amounts)