Auxilium Pharmaceuticals, Inc.

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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

As of November 1, 2006, the number of shares outstanding of the issuer’s common stock, $0.01 par value, was 35,304,070.

The accompanying unaudited consolidated financial statements include the accounts of Auxilium Pharmaceuticals, Inc. and its wholly owned subsidiaries (the Company), and have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) pertaining to Form 10-Q. Certain disclosures required for complete annual financial statements are not included herein. All significant intercompany accounts and transactions have been eliminated in consolidation. The information at September 30, 2006 and for the three and nine month periods ended September 30, 2006 and 2005 is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which, in the opinion of the Company’s management, are necessary to state fairly the financial information set forth herein. The December 31, 2005 balance sheet amounts and disclosures included herein have been derived from the Company’s December 31, 2005 audited consolidated financial statements. The interim results are not necessarily indicative of results to be expected for the full fiscal year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2005 included in the Company’s Annual Report on Form 10-K filed with the SEC.

Revenue Recognition. The Company sells Testim^® to pharmaceutical wholesalers, who have the right to return purchased product prior to the units being dispensed through patient prescriptions. Revenue for this product is recognized in accordance with Statement of Financial Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, and the SEC’s Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104 (together SAB No. 101). Among its criteria for revenue recognition from sale transactions where a buyer has a right of return, SFAS No. 48 requires the amount of future returns to be reasonably estimated. In order to develop a methodology, and provide a basis, for estimating future product returns on sales to its customers at the time of shipment, the Company has been tracking the Testim product return history, taking into consideration product expiration dating at time of shipment and inventory levels in the distribution channel. Based on the product return history gathered through the end of the first quarter of 2006, the Company determined it had the information to reasonably estimate customer returns and, therefore, in the first quarter of 2006, began recognizing revenue for Testim sales at the time of shipment of the product to customers. Prior to 2006, the Company was unable to reasonably estimate customer returns and, therefore, deferred the recognition of revenue on product shipments of Testim units until the units were dispensed through patient prescriptions because units dispensed are not subject to return. The Company estimated prescription units dispensed based on distribution channel data provided by external, independent sources. Revenue is also reduced for estimates of allowances for cash discounts, rebates and patient coupons based on historical experience, and current contract prices and terms with customers. If actual, or expected, customer returns and revenue allowances differ from previous estimates, adjustments of these estimates would be recognized in the period such facts become known.

As a result of the above-described change in revenue recognition, net revenues for the nine months ended September 30, 2006 include a one-time benefit of $1,198,000 (representing revenue previously deferred, net of estimated returns and allowances of $1,019,000) and the net loss for the nine months ended September 30, 2006 includes a one-time benefit of $702,000, or $0.02 per share (representing the one-time benefit in net revenues partially offset by the related cost of sales).

On January 1, 2006, the Company adopted SFAS No. 123R (revised 2004), Share-Based Payments, which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including employee stock options and employee stock purchases related to the Company’s employee stock purchase plan, based on estimated fair values. In its adoption of SFAS No. 123R, the Company applied the provisions of SAB No. 107 which was issued by the SEC in March 2005. Prior to January 1, 2006, the Company accounted for employee stock-based compensation using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, as permitted by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 amended the transition and disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation.

The Company adopted SFAS No. 123R using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s calendar year. The Company’s consolidated financial statements as of, and for the three and nine month periods ended, September 30, 2006 reflect the impact of the application of SFAS No.123R. In accordance with the modified prospective method, the Company’s consolidated financial statements for periods prior to 2006 have not been restated for, and therefore do not include, the effect of SFAS No. 123R.

SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized over the requisite service period as compensation expense in the consolidated statement of operations. The Company uses the Black-Scholes option pricing model (Black-Scholes model) to estimate the fair value of share-based grants and the straight-line method to amortize compensation expense over their vesting period. These methods were also utilized by the Company in preparing the pro forma disclosures required under SFAS No. 123 (see Note 6). Under the intrinsic value method, except for compensation expense related to restricted stock awards, no stock-based compensation expense had been recognized in the Company’s consolidated statements of operations prior to 2006.

Stock-based compensation expense recognized in the Company’s consolidated statement of operations for the three and nine month periods ended September 30, 2006 includes compensation expense for share-based payment awards granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, and the compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R and SAB No. 107. SFAS No. 123R requires forfeitures of stock-based awards prior to vesting to be estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeitures differ from the estimates. Therefore, stock-based compensation expense for the 2006 reflects management’s estimate of forfeitures. However, in the Company’s pro forma information for the periods prior to 2006, the Company accounted for forfeitures as they occurred.

Total stock-based compensation expense recognized in accordance with SFAS No. 123R for the three and nine month periods ended September 30, 2006 was $982,000 and $2,000,000, respectively. For the three months ended September 30, 2006, stock-based compensation expense for employee and director stock options, employee stock purchases and restricted stock awards was $844,000, $49,000 and $89,000, respectively. For the nine months ended September 30, 2006, stock-based compensation expense for employee and director stock options, employee stock purchases and restricted stock awards was $1,478,000, $132,000 and $390,000, respectively. Since the Company previously recognized the compensation expense related to restricted stock awards at their fair value on the applicable grant date in accordance with APB No. 25 and no future forfeitures of restricted stock awards are currently anticipated, the Company’s net loss for the three and nine month periods ended September 30, 2006 is $893,000 (or $0.03 per share) and $1,610,000 (or $0.05 per share), respectively, greater than if the Company had continued to account for share-based compensation under APB No. 25. As of January 1, 2006, the beginning balance of deferred compensation of $437,000 related to restricted stock grants was reclassified to additional paid-in capital as required by SFAS No. 123R. See Note 6 for additional information.

The Company’s determination of fair value of share-based payment awards on the grant date using the Black-Scholes model is significantly effected by assumptions concerning the Company’s stock price volatility and projected employee stock option exercise behavior. Given the Company’s limited history, such assumptions are principally based on the observed history of other companies and may not be reflective of the patterns the Company will experience. In addition, although the fair value of employee stock options is determined in accordance with SFAS No. 123R and SAB No. 107 using the Black-Scholes model, that value may not be indicative of the fair value observed in a willing buyer and willing seller market transaction.

On November 10, 2005, the Financial Accounting Standards Board (FASB) issued Staff Position No. FAS 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. This document provides alternative transition methods for calculating the tax effects of stock-based compensation pursuant to SFAS 123R. The Company is currently studying the alternatives provided in this document.

Net loss per common share is calculated in accordance with SFAS No. 128, Earnings Per Share. Under the provisions of SFAS No. 128, basic net loss per common share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period reduced, where applicable, for unvested outstanding restricted shares.

The following table sets forth the computation of basic and diluted net loss per common share (in thousands, except share and per share amounts):

Diluted net loss per common share is computed giving effect to all potentially dilutive securities, including stock options and warrants. Diluted net loss per common share for all periods presented is the same as basic net loss per common share because the potential common stock is anti-dilutive.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109”, which becomes effective for fiscal years beginning after December 15, 2006. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company is currently evaluating this interpretation to determine the effect the interpretation will have, if any, on the Company’s consolidated financial statements.

In September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. This SAB applies to annual financial statements for fiscal years ending after November 15, 2006. This bulletin requires companies to evaluate the materiality of identified unadjusted errors on each financial statement and related disclosures using both the rollover, and the iron curtain, approach. The rollover approach quantifies misstatements based on the amount of the error originating in the current year income statement. The iron curtain approach quantifies misstatements based on the effects of correcting the misstatement existing in the balance sheet at end off the current year, irrespective of the misstatement’s year of origin. Adjustment of financial statements would be required if either approach resulted in a misstatement quantification that is material. The correction of financial statements for immaterial amounts would not require previously filed reports to be amended. The Company is currently evaluating the effect, if any, the adoption of SAB No. 108 will have on the Company’s consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which becomes effective for financial statements issued for fiscal years beginning after November 15, 2007. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is applicable to other accounting literature that requires fair value measurement and does not require any new fair value measurements. The Company is currently evaluating the effect, if any, the adoption of SFAS No. 157 will have on the Company’s consolidated financial statements.

On December 31, 2004, the Company entered into a 90-month lease agreement to move its headquarters facility to Malvern, Pennsylvania. The Company moved into the new office space in June 2005. The Company paid a $400,000 security deposit under this new lease in January 2005, which is included in other assets as of September 30, 2006. The Company received an allowance to improve the new facility of approximately $781,000. The Company has recorded the cost of the improvements as a fixed asset and the allowance as a deferred rent credit. The Company amortizes the leasehold improvement asset over the shorter of the life of the improvements or the life of the lease. The Company amortizes the deferred rent credit as a reduction of rent expense on a straight-line basis over the life of the lease. The new lease includes a period of free rent and escalating minimum rent payments. The Company records rent expense for the minimum lease payments on a straight-line basis.

As of June 1, 2006, the Company amended the Malvern lease agreement to expand its headquarters office space. This amendment is coterminous with the original lease agreement. The lease of the additional office space commenced in August 2006. Under the amendment, the Company received an additional $287,000 improvement allowance for the additional office space which has also been recorded as a fixed asset and a deferred rent credit.

On September 1, 2006, the Company entered into a lease agreement for an existing biologics manufacturing facility that has an initial term ending January 1, 2017 and that may be extended for two consecutive five year periods. The facility is being used to produce AA4500, an injectable enzyme that the Company is developing to treat Dupuytren’s contracture, a disease of the connective tissue that lies beneath the skin of the hand; Peyronie’s disease, which causes curvature of the penis when erect; and Frozen Shoulder Syndrome, a disorder of diminished shoulder motion. The Company maintains a bank letter of credit in the amount of $1,900,000 as a security deposit which is collateralized by a bank deposit of equal amount. This $1,900,000 bank deposit is included in other long-term assets at September 30, 2006. The lease provides free rent for the first three months and, thereafter, for escalating minimum rent payments. The Company records rent expense for the minimum lease payments on a straight-line basis. In addition, the lease provides an allowance for tenant improvements of up to $3,750,000 which would be amortized, including an interest factor, over the initial term of the lease. As of September 30, 2006, the Company had not requested any allowances for tenant improvements.

Future minimum lease payments under noncancellable operating leases for manufacturing facilities, office space, equipment and automobiles as of September 30, 2006 are as follows (in thousands):

In July 2005, the Company entered into an agreement with Cobra for the process development, scale up and manufacture of AA4500 for Phase II/III clinical trials (the Manufacturing Agreement). Through an agreement dated July 14, 2006 (the Amended Manufacturing Agreement), the Company and Cobra terminated the Manufacturing Agreement and agreed that Cobra will manufacture the AA4500 batches needed for clinical trials and for the biological license application (BLA) to be filed under the United States Federal Food, Drug and Cosmetic Act and related applicable regulations and will provide related services upon the Company’s request. The Amended Manufacturing Agreement was effective on April 1, 2006 and will expire on December 31, 2006. If all services under the Amended Manufacturing Agreement remaining as of September 30, 2006 are completed, then the Company will pay Cobra approximately $3,000,000.

On September 1, 2006, the Company entered into a letter agreement (the Termination Agreement) with Oscient Pharmaceuticals Corp. (Oscient) which sets forth the terms and conditions upon which Oscient and the Company mutually agreed to terminate the Co-Promotion Agreement between the parties, dated April 11, 2005 (the Co-Promotion Agreement), prior to the expiration of its initial term. Pursuant to the Termination Agreement, the Co-Promotion Agreement terminated at the close of business on August 31, 2006 with certain specified provisions surviving termination and Oscient ceased all promotion activities related to Testim at such time. The Company paid Oscient $1,800,000 for the early termination of the Co-Promotion Agreement which is included in selling, general, and administrative expenses for the three months ended September 30, 2006.

Under the Company’s 2006 Employee Stock Purchase Plan, as approved by the stockholders of the Company, employees may purchase shares of the Company’s common stock at a 15% discount through payroll deductions. Employees may contribute up to 10% of their compensation to the 2006 Employee Stock Purchase Plan. The purchase price is 85% of the fair value per share of common stock on the date the purchase period begins or the date on which the purchase period ends, whichever is lower. The plan restricts the maximum number of shares that an employee may purchase to 15,000 shares during each semi-annual purchase period and to $25,000 worth of common stock during each year. There is a maximum of 300,000 shares issuable under the 2006 Employee Stock Purchase Plan, all of which were available for future issuance as of September 30, 2006.

Under the Company’s 2004 Equity Compensation Plan (the 2004 Plan), as approved by the stockholders of the Company, qualified and nonqualified stock options and stock awards may be granted to employees, non-employee directors and service providers. In June 2006, the stockholders authorized the increase of shares authorized for issuance under the 2004 Plan to 6,000,000 shares. The Compensation Committee of the Board of Directors (the Compensation Committee) administers the 2004 Plan. The Compensation Committee determines who will receive stock options or awards. On October 27, 2006, the Compensation Committee delegated to each of the Company’s Chief Executive Officer and Chief Financial Officer the authority to grant stock options to newly hired employees below the Vice President level within specified parameters. To date, the Company has granted only nonqualified stock options and restricted stock awards under the 2004 Plan. Generally, stock options are granted with an exercise price equal to 100% of the market value of the common stock on the date of grant, have a ten year contractual term and vest no later than four years from the date of grant, with immediate vesting upon a change of control of the Company. The Company issues new shares of common stock upon exercise of stock options. At September 30, 2006, there were 1,884,863 shares available for future grants under the 2004 Plan.

The following tables summarize stock option activity for the three and nine month periods ended September 30, 2006:

During the three months ended September 30, 2006, the weighted-average grant-date fair value of options granted was $5.12, the total intrinsic value of options exercised was $29,000 and the total fair value of shares vested was $269,000.

During the nine months ended September 30, 2006, the weighted-average grant-date fair value of options granted was $5.60, the total intrinsic value of options exercised was $341,000 and the total fair value of shares vested was $2,723,000.

The aggregate intrinsic values in the preceding tables represent the total pretax intrinsic value, based on the Company’s stock closing price of $10.12 as of September 30, 2006, that would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of September 30, 2006 was 1,121,921.

The compensation cost of restricted stock awards is determined by their intrinsic value on the grant date. The following table summarizes the restricted stock activity for the three and nine month periods ended September 30, 2006:

On January 1, 2006, the Company adopted SFAS No. 123R, which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors, including stock options and employee stock purchases under the Company’s employee stock purchase plan, based on estimated fair values. Prior to the adoption of SFAS No. 123R, the Company accounted for stock-based awards to employees and directors using the intrinsic value method under APB No. 25 and provided pro forma information in accordance with SFAS No. 123 concerning the impact of a fair value measurement of share-based compensation. The fair value of each share-based award was estimated on the date of grant using the Black-Scholes model and applying the assumptions in the following table. The expected volatility is based on the blended historical volatility of peer group companies and, for 2006, the historical volatility of the Company. The Company uses the simplified calculation of expected option life, described in SAB No. 107, because the Company’s history is inadequate to determine a reasonable estimate of the option life. The dividend yield is determined based on the Company’s history to date and management’s estimate of dividends over the option life. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of the grant.

The following table summarizes stock-based compensation expense for the three and nine month periods ended September 30, 2006 and 2005 (in thousands):

Pre-vesting forfeitures are estimated in the determination of total stock-based compensation cost based on Company experience. The estimate on pre-vesting forfeitures will be adjusted in future periods to the extent actual pre-vesting forfeitures differ, or are expected to differ, from such estimates. As of September 30, 2006, there was approximately $9,250,000 of total unrecognized stock-based compensation cost related to all share-based payments that will be recognized over the weighted-average period of 3.2 years. Future grants will add to this total, whereas future amortization and the vesting of existing grants will reduce this total.

The pro forma information presented in the following table assumes that compensation cost for employee and director service option grants and purchase rights under the Company’s 2004 Employee Stock Purchase Plan had been determined based on the fair value at the grant dates for those options, consistent with SFAS No. 123. On this basis, the net loss and net loss per common share for the three and nine months ended September 30, 2005 would have increased to the pro forma amounts indicated below (in thousands, except per share amounts):

The foreign currency translation amounts relate to the Company’s foreign subsidiary. The unrealized gain (loss) on available for sale securities relates to the Company’s short-term investments.

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

The following discussion is qualified in its entirety by, and should be read in conjunction with, the more detailed information set forth in the consolidated financial statements and the notes thereto appearing elsewhere in this report.

Certain statements in this quarterly report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements made with respect to our strategy, progress and timing of development programs and related trials, the efficacy of our product candidates, the commercial benefits available to us as a result of our agreements with third parties, future operations, financial position, future revenues, projected costs, prospects, plans and objectives of management and other statements regarding matters that are not historical facts and involve predictions. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance, achievements or prospects to be materially different from any future results, performance, achievements or prospects expressed in or implied by such forward-looking statements. In some cases you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “would,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “seem,” “seek,” “future,” “continue,” or “appear” or the negative of these terms or similar expressions, although not all forward-looking statements contain these identifying words. These forward-looking statements are subject to a number of risks and uncertainties including, among other things:

These risks are not exhaustive. For a more detailed discussion of risks and uncertainties, see “Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and “Item 1A – Risk Factors” of this quarterly report. Other sections of this quarterly report may include additional factors which could adversely impact the Company’s future results, performance, achievements and prospects. Moreover, the Company operates in a very competitive and rapidly changing environment. Given these risks and uncertainties, you should not place undue reliance on forward-looking statements. Although it believes that the expectations reflected in forward-looking statements are reasonable, the Company cannot guarantee that the future results, performance, achievements and prospects reflected therein will be achieved or occur. The Company qualifies all forward-looking statements by these cautionary statements.

We are a specialty biopharmaceutical company with a focus on developing and marketing products to urologists, endocrinologists, orthopedists and select primary care physicians. We currently have a sales and marketing organization of approximately 180 people. Our only marketed product, Testim, is a proprietary, topical 1% testosterone once-a-day gel indicated for the treatment of hypogonadism. Hypogonadism is defined as reduced or absent secretion of testosterone which can lead to symptoms such as loss of libido, adverse changes in body composition, irritability and poor concentration.

- AA4500, injectable enzyme for the treatment of Frozen Shoulder Syndrome (or Adhesive Capsulitis)

- two pain products using our transmucosal film delivery system (with rights to develop 6 other compounds for the treatment of pain)

In addition to the above, we have the rights to develop other hormone and urologic products using the transmucosal film technology and the option to license other indications for AA4500 other than dermal products for topical administration.

Our lead project is AA4500, an injectable enzyme. We have an option to license exclusive worldwide rights to all non-topical uses of AA4500, and we currently are pursuing three indications: Dupuytren’s contracture, Peyronie’s disease and Adhesive Capsulitis, or Frozen Shoulder Syndrome. We believe that AA4500 has completed Phase II of development for the treatment of Dupuytren’s contracture, and we expect to begin a pivotal Phase III study for AA4500 for the treatment of Dupuytren’s contracture by the end of 2006. We believe that AA4500 is in Phase II of development for the treatment of Peyronie’s disease and Frozen Shoulder Syndrome, and we expect to commence a Phase IIb dose optimization study for AA4500 for the treatment of Peyronie’s disease in 2007. Each of these diseases is characterized by patients suffering the debilitating effects and deformities associated with the

accumulation of connective tissue. Dupuytren’s contracture is a disease of the connective tissue that lies beneath the skin of the palm of the hand and causes this tissue to thicken and contract. As the condition progresses, a “cord” is formed affecting most commonly the ring and/or small finger(s), causing the finger(s) to contract, leaving the patient unable to fully extend the affected finger(s). Peyronie’s disease is a plaque or hard scar on the shaft of the penis that causes substantial distortion of the penis upon erection. Men suffering from Peyronie’s disease are often unable to engage in sexual intercourse due to the deformity of their erection. Frozen Shoulder Syndrome is a disease of diminished shoulder motion, characterized by restriction in both active and passive range of motion of the shoulder joint.

We have in-licensed a transmucosal film delivery system as a platform technology for the delivery of hormones and pharmaceutical products through the oral mucosal membrane. We have a project, which we refer to as AA4010, in Phase I of development for the treatment for overactive bladder using this film delivery system. We currently are seeking a partner to further develop this product candidate. Overactive bladder is a medical condition affecting both men and women characterized by urinary urgency and increased frequency of urination.

We also have two pain products using our transmucosal film delivery system in pre-clinical development. We also have rights to six additional pain products and products for hormone replacement and urologic disease using our transmucosal film delivery system.

In October 2006, we decided to discontinue the development of the current formulation of TestoFilm™, our testosterone replacement transmucosal film product candidate for the treatment of hypogonadism and reallocate resources to our lead development project, AA4500. Based on a recent evaluation, we determined that the current formulation of TestoFilm does not meet certain critical aspects of the target product profile and, as a result, would not be commercially viable.

We expanded our sales force to approximately 150 representatives after mutually agreeing with Oscient Pharmaceuticals Corp. to terminate our co-promotion agreement effective August 31, 2006. We believe that expanding our own sales force with employees consistently dedicated to Testim throughout the entire year will allow us to better control our promotional efforts for Testim.

In September 2006, we entered into a lease agreement for an existing biologics manufacturing facility in Horsham, Pennsylvania. We are using the facility to produce the active ingredient of AA4500 and have completed the initial engineering batch of AA4500. As of September 30, 2006, our future minimum lease payments during the initial, noncancellable term ending January 1, 2017 total approximately $24.0 million.

We have never been profitable and have incurred an accumulated deficit of $170.7 million as of September 30, 2006. We expect to incur significant operating losses for the foreseeable future. Commercialization expenses, development costs, and in-licensing milestone payments related to existing and new product candidates and to enhance our core technologies will continue to increase in the near term. In particular, we expect to incur increased costs for selling and marketing as we continue to market Testim, additional development and pre-commercialization costs for existing and new product opportunities, acquisition costs for new product opportunities and increased general and administration expense to support the infrastructure required to grow and operate as a public company. We will need to generate significant revenues to achieve profitability.

We expect that quarterly and annual results of operations will fluctuate for the foreseeable future due to several factors including the overall growth of the androgen market, the timing and extent of research and development efforts, milestone payments liability and the outcome and extent of clinical trial activities. Our limited operating history makes accurate prediction of future operating results difficult.

As discussed in Note 1(b) to the Company’s unaudited consolidated financial statements contained herein and under the heading “Critical Accounting Policies and Significant Judgments and Estimates” set forth below, in the first quarter of 2006 the Company began recognizing revenue for Testim sales at the time of shipment of the product to customers. Prior to 2006, the recognition of revenue on shipments of Testim units to customers was deferred until the units were dispensed through patient prescriptions. As a result of this change in revenue recognition, net revenues for nine months ended September 30, 2006 include a one-time benefit of $1.2 million and the net loss for the nine months ended September 30, 2006 includes a one-time benefit of $0.7 million, or $0.02 per share.

In addition, as discussed in Note 1(c) to the Company’s unaudited consolidated financial statements contained herein, the Company adopted SFAS No. 123R effective January 1, 2006 using the modified prospective transition method, which requires the application of SFAS No. 123R as of January 1, 2006, the first day of the Company’s calendar year. The Company’s consolidated financial statements as of and for the three months and nine months ended September 30, 2006 reflect the application of SFAS No.123R. This accounting standard requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. In accordance with the modified prospective method, the Company’s consolidated financial statements for periods prior to 2006 have not been restated and do not include the effect of SFAS 123R. Prior to 2006, the Company recognized the compensation expense related to stock-based awards measured by the intrinsic value of the award at grant date in accordance with APB No. 25. As a result of this change, the Company’s net loss for the three and nine month periods ended September 30, 2006 is $0.9 million (or $0.03 per share) and $1.6 million (or $0.05 per share), respectively, higher than if the Company had continued to account for share-based compensation under APB No. 25.

Net revenues. Net revenues increased $6.4 million to $17.6 million for the quarter ended September 30, 2006 from $11.2 million for the comparable 2005 period. This increase in net revenues resulted primarily from substantial growth in Testim demand resulting from increased prescriptions and increases in pricing, net of discounts, rebates and coupons. According to National Prescription Audit (NPA) data from IMS Health (IMS), a pharmaceutical market research firm, Testim total prescriptions for the third quarter of 2006 grew 44.8% over the comparable period of 2005. We believe that Testim prescription growth in the 2006 period over the 2005 period was driven by physician and patient acceptance that Testim provides better patient outcomes, the shift in prescriptions away from the testosterone patch product and the other gel product to Testim, the continued focus of our sales force on the promotion of Testim to urologists, endocrinologists and select primary care physicians, and our co-promotion agreement with Oscient. Net revenues for the third quarter of 2006 benefited from price increases having a cumulative impact of 12% over the comparable 2005 period, which was partially offset by increases in wholesaler discounts due to increased distribution costs and product rebates as Testim became more widely prescribed by managed care providers.

Cost of goods sold. Cost of goods sold was $4.5 million and $3.3 million for the three months ended September 30, 2006 and 2005, respectively. The increase in cost of goods sold for the three months ended September 30, 2006 over the comparable period in 2005 was directly attributable to the increase in Testim revenue in the U.S. Gross margin on our net revenues was 74.6% in the third quarter of 2006 compared to 70.8% in the comparable 2005 period. Gross margin reflects the cost of product sold as well as royalty payments made to the Company’s licensor on the sales of Testim. The improvement in gross margin reflects the benefit of year-over-year price increases, a reduction in the royalty rate paid to the Company’s licensor and manufacturing cost reductions.

Research and development expenses. Research and development costs for the third quarter of 2006 were $8.5 million compared with $4.5 million for the comparable year-ago period. The increase in research and development costs was primarily due to the increased spending for development and manufacturing scale up for AA4500 and investment in developing TestoFilm, partially offset by a reduction in spending on Phase IV studies for Testim.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $17.1 million for the quarter ended September 30, 2006 compared with $10.7 million for the year-ago quarter. The increase was primarily due to higher investment in promotional spending for Testim, pre-launch marketing for AA4500, the $1.8 million cost to terminate our co-promotion agreement with Oscient Pharmaceuticals Corp. (Oscient) and, the additional stock compensation expense resulting from the adoption of SFAS 123R.

Interest income (expense), net. Interest income (expense), net was $0.6 million and $0.5 for the three months ended September 30, 2006 and 2005, respectively. Net interest income relates primarily to interest earned on cash, cash equivalents and short-term investments.

Net revenues. Net revenues increased $19.1 million to $49.0 million for the nine months ended September 30, 2006 from $29.9 million for the comparable 2005 period. The increase in net revenues resulted primarily from substantial growth in Testim demand resulting from increased prescriptions and increases in Testim pricing, net of discounts, rebates and coupons. According to NPA data from IMS, Testim total prescriptions for the first nine months of 2006 grew 46.8% over the comparable period of 2005. We believe that Testim prescription growth in the first nine months of 2006 over the 2005 period was driven by physician and patient acceptance that Testim provides better patient outcomes, the shift in prescriptions away from the testosterone patch product and the other gel product to Testim, the continued focus of our sales force on the promotion of Testim to urologists, endocrinologists and select primary care physicians, and our co-promotion agreement with Oscient. Net revenues for the first nine months of 2006 benefited from price increases having a cumulative impact of 10% over the comparable 2005 period, partially offset by increases in wholesaler discounts due to increased distribution costs and product rebates as Testim became more widely reimbursed by managed care providers. Net revenues for first nine months of 2006 also benefited from lower product returns and lower coupon usage as compared to the comparable 2005 period, as well as the change in revenue recognition. In the first quarter of 2006, the Company began recognizing revenue at the time that units are shipped to its wholesaler customers and recorded a one-time benefit in net revenues of $1.2 million.

Cost of goods sold. Cost of goods sold was $12.7 million and $9.3 million for the nine months ended September 30, 2006 and 2005, respectively. The increase in cost of goods sold for the nine months ended September 30, 2006 over the comparable period in 2005 was directly attributable to the increase in Testim revenue in the U.S. Gross margin on our net revenues was 74.0% in the first nine months of 2006 compared to 69.0% in the comparable 2005 period. Gross margin reflects the cost of product sold as well as royalty payments made to the Company’s licensor on the sales of Testim. The improvement in gross margin reflects the benefit of year-over-year price increases, a reduction in the royalty rate paid to the Company’s licensor and manufacturing cost reductions.

Research and development expenses. Research and development costs for the nine months ended September 30, 2006 were $25.7 million compared with $17.9 in the year ago period. The increase in

research and development expense in the first nine months of 2006 compared to the first nine months of 2005 was primarily due to the increased spending for development and manufacturing scale up for AA4500 and investment in developing TestoFilm, partially offset by a reduction in spending on Phase IV studies for Testim.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $45.5 million for the nine months ended September 30, 2006 compared with $30.4 million for the year-ago period. The increase was primarily due to higher investment in promotional spending, including the costs associated with the Company’s co-promotion agreement with Oscient which started in May 2005, pre-launch marketing of AA4500, and the additional stock compensation expense resulting from the adoption of SFAS 123R. The increase was also due to the $1.8 million the Company paid to Oscient in September 2006 for the early termination of the parties’ co-promotion agreement.

Interest income (expense), net. Interest income (expense), net was $1.7 million and $0.9 for the nine months ended September 30, 2006 and 2005, respectively. Net interest income relates primarily to interest earned on cash, cash equivalents and short-term investments.

Since inception through September 30, 2006, we have financed our product development, operations and capital expenditures primarily from private and public sales of equity securities. Since inception through September 30, 2006, we received net proceeds of approximately $218.5 million from the IPO, private and public sales of equity securities and the exercise of stock options. We had $58.9 million and $31.4 million in cash and cash equivalents as of September 30, 2006 and December 31, 2005, respectively. As of September 30, 2006 and December 31, 2005, we also had $8.4 million and $25.4 million, respectively, in short-term investments.

We believe that our current financial resources and sources of liquidity will be adequate to fund our anticipated operations until at least March 2008. We may, however, need to raise additional funds prior to this time in order to enhance our sales and marketing efforts for additional products we may acquire, fund the construction or improvement of manufacturing facilities or products in development, whether owned by the Company or a third party, 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 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 April 2006, we filed a shelf registration statement with the SEC to allow for the potential future sale by us, from time to time, in one or more offerings, of up to $100 million of certain debt and equity instruments specified therein. We utilized this shelf registration statement for our registered direct offering in September 2006 in which we sold 5,500,000 shares of our common stock at a price of $8.50 per share. As a result, $53.3 million of this shelf registration statement remains available for future utilization. We believe it is good corporate policy to maintain an effective shelf registration statement.

Cash used in operations was $30.0 million and $21.1 million for the nine months ended September 30, 2006 and 2005, respectively. In both periods, cash used in operations results primarily from operating losses.

Cash provided by investing activities was $13.8 million for the nine months ended September 30, 2006 compared to cash used of $14.7 million for the nine months ended September 30, 2005. Cash provided by investing activities in the 2006 period and the 2005 period relates primarily to the net effect of purchases and redemptions of short-term investments, together with our investments in property and equipment and, in 2006, the investment of $1.9 million to secure the lease of a manufacturing facility.

Cash provided by financing activities was $43.8 million and $39.9 million for the nine months ended September 30, 2006 and 2005, respectively. Cash provided by financing activity in the 2006 period results primarily from the $43.3 million in net proceeds we received in the September 2006 registered direct offering and the cash receipts from stock option exercises and employee stock purchases, partially offset by debt payments on debt financings. Cash provided by financing for the 2005 period results primarily from the $39.0 million in net proceeds we received from the June 2005 private placement and from cash receipts from stock option exercises and employee stock purchases, partially offset by debt payments on debt financings.

The following table summarizes our future payment obligations and commitments as of September 30, 2006 (in thousands):

The contractual commitments reflected in this table exclude $27.7 million of contingent milestone payments that we may be obligated to pay in the future. We do not expect to pay any of these contingent milestone payments through September 30, 2007. These remaining milestones relate primarily to manufacturing process development, filing of regulatory applications and receipt of regulatory approval. The above table also excludes future royalty payments and wholesaler distribution fees because they are contingent on product sales.

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

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. Prior to the units being dispensed through patient prescriptions, these companies have the right to return Testim for any reason for up to one-year after product expiration. Revenue for this product is recognized in accordance with Statement of Financial Accounting Standards (SFAS) No. 48, Revenue Recognition When Right of Return Exists, and Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104 (together SAB No. 101). Among its criteria for revenue recognition from sale transactions where a buyer has a right of return, SFAS No. 48 requires the amount of future returns to be reasonably estimated. In order to develop a methodology, and provide a basis, for estimating future product returns on sales to our customers at the time of shipment, we have been tracking the Testim product return history, taking into consideration product expiration dating at time of shipment and levels of inventory in the wholesale channel. Based on the product return history gathered through the end of the first quarter of 2006, we now believe we have the information to reasonably estimate customer returns and, therefore, in the first quarter of 2006, began recognizing revenue for Testim sales at the time of shipment of the product to our customers. Prior to 2006, we were unable to reasonably estimate customer returns and, therefore, deferred the recognition of revenue on product shipments of Testim units until the units were dispensed through patient prescriptions because units dispensed through prescriptions are not subject to return. We estimated prescription units dispensed based on distribution channel data provided by external, independent sources.

In addition, we must make estimates for discounts and rebates provided to third-party payers and coupons provided to patients. Testim is covered by Medicare, Medicaid and numerous independent insurance and pharmacy benefit managers (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. As Testim becomes more widely used and as we continue to add managed care and PBMs, actual results may differ from our previous estimates. To date, our estimates have not resulted in any material adjustments to our operating results.

For revenues associated with licensing agreements, we use revenue recognition criteria outlined in Staff Accounting Bulletin (SAB) No. 101 and Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Accordingly, revenues from licensing agreements are recognized based on the performance requirements of the underlying agreement. We entered into license and distribution agreements with each of Ipsen Farmaceutica, B.V. (Ipsen) and Bayer, Inc. (Bayer) to market and distribute Testim worldwide, excluding the U.S., Mexico and Japan. Under these agreements, the distributor and the licensee are each required to purchase Testim from us and make up-front, milestone and royalty payments. Under these agreements, the distributor and the licensee may each cancel the agreements if there is a breach of contract or if any party files for bankruptcy. Only milestone payments for product supply price reductions are refundable if we subsequently increase the supply price; otherwise, no up-front or milestone payments are refundable in any instance. Product shipments are subject to return and refund only if the product does not comply with technical specifications or if any of the agreements are terminated due to our nonperformance. We are obligated under the agreements to provide multiple deliverables, including the license/product distribution rights, regulatory filing services and commercial product supply. Under EITF No. 00-21, all deliverables under each of these agreements are treated as single units of accounting as the Company does not have evidence to support that the consideration for the undelivered item, Testim units to be shipped, is at fair value. We have deferred revenue recognition for non-refundable up-front and milestone payments until at least the first product shipment under each agreement.

Upon product shipment, non-refundable up-front and milestone revenue is recognized as revenue on a straight line basis over the remaining contract term. The amortization period for the agreement with Ipsen is based upon contractual terms and is currently estimated to be 17 years. The Company has started to amortize milestones received over this period since the first product has been shipped. When earned by us in future periods, additional milestone payments achieved will be amortized over the remaining period. Refundable milestone payments will be deferred and only included in the revenue recognition equation with non-refundable milestone consideration when the refund right effectively lapses. No product shipments have been made to Bayer and, therefore, no revenue relating to upfront or milestone payments have been recognized.

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.

Valuation of Equity Instruments used in Stock-Based Compensation. Effective January 1, 2006, we account for stock-based compensation costs in accordance with SFAS No. 123R, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including stock options and employee stock purchases related to the 2004 Employee Stock Purchase Plan. Under SFAS No. 123R, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. The determination of fair value of share-based payment awards on the grant date requires significant judgment. Assumptions concerning our stock price volatility and projected employee exercise behavior over the contractual life of the award can significantly impact the estimated fair value of an award. Given the limited history of our Company, such assumptions are principally based on the observed

history of other companies, which may not be reflective of the patterns we will experience. If our actual experience differs significantly from the assumptions used to compute stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little expense for our share-based payment awards.

We are subject to market risks in the normal course of our business, including changes in interest rates and exchange rates. There have been no significant changes in our exposure to market risks since December 31, 2005. Refer to “Item 7 A. Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended December 31, 2005 for additional information.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to our Chief Executive Officer and Chief Financial Officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms.

No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information contained in this Report, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005 in evaluating our business, financial position and future prospects. The information presented below updates and supplements those risk factors for events, changes and developments since the filing of that Form 10-K and should be read in conjunction with the risks and other information contained in that Form 10-K. The risks described in our Form 10-K, as updated below, are not the only risks facing the Company. Additional risks that we do not presently know or that we currently believe are immaterial could also materially adversely affect our business, financial position, future results and prospects.

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:

In addition, if product returns are higher than expected, our operating results could be materially harmed.

All of our revenues to date have been generated from the sale or out-licensing of Testim, and, if these revenues do not grow, and we cannot commercialize new products, 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 and out-licensing 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 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 are unable to meet our needs for additional funding 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:

We believe that our existing cash resources and interest on these funds will be sufficient to meet our anticipated operating requirements until at least March 2008. 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:

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, manufacture 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 facilities for testing or manufacture of products as well as refusal to approve products for commercialization. Noncompliance with any applicable regulatory requirements also can result in 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 seeking regulatory approval for our products or product candidates. Such changes may increase our costs and adversely affect 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 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 or any product, 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:

We will incur increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance and other matters.

Our compliance with recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 (SOA), and rules adopted or proposed by the Securities and Exchange Commission and by The Nasdaq Global Market, will result in increased costs to us as we evaluate the implications of any new rules and respond to their requirements. Although we are not required to issue an evaluation of our internal control over financial reporting under Section 404 of SOA until March 2007, preparations for the issuance of this report have already resulted in increased costs to us, which will increase further. If we are not able to issue an evaluation of our internal control over financial reporting as required or we or our independent registered public accounting firm determine that our internal control over financial reporting is not effective, this shortcoming could have an adverse effect on our business and financial results and the price of our common stock could be negatively affected. The new rules could make it more difficult or more costly for us to obtain certain

types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees and as executive officers. We cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs to comply with these rules and regulations.

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 and its co-promotion partners. AndroGel was launched approximately three years before Testim. 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. Androderm^{^®} is a transdermal testosterone patch marketed by Watson Pharmaceuticals, or Watson. Many of our competitors, such as Solvay and Watson, have substantially greater resources than we have. These resources may be used to more effectively develop, market or acquire products and technologies. Additional mergers, acquisitions and strategic alliances 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 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 more substantial research and development capabilities and experience, and more substantial management, manufacturing, distribution, marketing and financial resources, than we do. Accordingly, our competitors may:

Other new treatments are being sought for hypogonadism, including a new isomer of an old product for centrally mediated treatment of primary hypogonadism as well as a new class of drugs called Selective Androgen Receptor Modulators (SARMs). These products are in the early stages of development and their future impact on the treatment of testosterone deficiency 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.

The primary competition for Testim is AndroGel, marketed by Solvay, and its co-promotion partners. Pursuant to separate settlements of patent litigation in September 2006, no generic to AndroGel will be sold until 2015. Any generic for AndroGel will not be a generic for Testim, since Testim is BX rated (or non-substitutable) with AndroGel. 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.

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

The commercialization of Testim and the clinical testing, manufacture and commercialization of our product candidates, if approved, 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 to be 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 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, our product candidate for the treatment of Dupuytren’s contracture, Peyronie’s disease and Adhesive Capsulitis, or Frozen Shoulder Syndrome, is 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 bacteriophage contamination with the fermentation. Although we believe that our safety procedures for using, storing, handling, manufacturing 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.

We do not have experience in manufacturing pharmaceutical products and may encounter difficulties in the manufacture of the active ingredient of AA4500 at our facility in Horsham, PA (the “Horsham Facility”) which could materially adversely affect our results of operations or delay or disrupt our development timelines for AA4500.

The manufacture of pharmaceutical products requires significant expertise and capital investment. Although we leased the Horsham Facility in order to have direct control over the manufacturing of the active ingredient of AA4500, we do not have experience in manufacturing AA4500 or any other pharmaceutical product. We may encounter difficulties with the manufacture of the active ingredient of AA4500 which could materially adversely affect our results of operations or delay or disrupt our development timelines for AA4500. These problems may include:

Furthermore, our manufacturing operations expose us to a variety of significant risks, including:

If we are unable to gain regulatory approval for AA4500, we may not have an alternate use for the Horsham Facility but will be required to make payments under our lease.

We have entered into a ten-year lease for the Horsham Facility. If we are unable to gain regulatory approval for AA4500, we may not have an alternate use for the manufacturing facility but will be required to make payments under our lease. As of September 30, 2006, the future minimum lease payments of this lease during its initial noncancellable term total approximately $24.0 million.

The Horsham Facility is subject to regulatory oversight, which may delay or disrupt our development and commercialization efforts for AA4500.

We must ensure that all of the processes, methods, equipment and facilities employed in the manufacture of AA4500 at the Horsham Facility are compliant with the current Good Manufacturing Practices (cGMP). The cGMP requirements govern quality control of the manufacturing process and documentation policies and procedures. Compliance with cGMP requires record keeping and quality control to assure that the product meets applicable specifications and other requirements. The Horsham Facility will be subject to inspection by regulatory agencies upon the manufacture of AA4500 that is used in a clinical trial or the filing for approval of AA4500 with regulatory authorities. If an inspection by regulatory authorities indicates that there are deficiencies including non-compliance with regulatory requirements, we could be required to take remedial actions, stop production or close the Horsham Facility, which would disrupt the manufacturing processes, limit the supplies of AA4500 and delay clinical trials and subsequent licensure. If we fail to comply with these requirements, we may not be permitted to sell our products or may be limited in the jurisdictions in which we are permitted to sell them.

Following approval of AA4500 for commercialization and licensure of the Horsham Facility, noncompliance with any applicable regulatory requirements may result in refusal by regulatory authorities to allow use of AA4500 made at the Horsham Facility in clinical trials, refusal of the government to allow distribution of AA4500 for commercialization, 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.

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

Since we currently 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 currently do not manufacture Testim or any of our product candidates, except for the active ingredient for AA4500. Testim is manufactured for us by DPT Laboratories, Ltd. (DPT) under a contract that expires on December 31, 2010. We have qualified a back-up supplier to manufacture Testim.

We have contracted with Cobra Biologics Ltd. (Cobra) for the production of our clinical supply of AA4500, our product candidate for the treatment of Dupuytren’s contracture, Peyronie’s disease and Frozen Shoulder Syndrome, and we have contracted with Althea Technologies, Inc. (Althea) to fill and lyophilize the AA4500 bulk substance produced by Cobra, manufacture placebo and produce sterile diluent.

The manufacture of pharmaceutical products requires significant expertise and capital investment. DPT, Cobra, Althea, our back-up supplier for Testim, or any other third-party manufacturer may encounter difficulties in production. These problems may include:

DPT, PharmaForm, Cobra, Althea, 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 or our ability to produce AA4500 or other product candidates for clinical trials.

Under our contract with DPT, DPT is required to qualify its Lakewood, New Jersey facility as a secondary site for the production of Testim. Prior to DPT’s qualification of the Lakewood facility, we are permitted to qualify a back-up supplier, and we have done so. 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.

Any of these factors could increase our costs and result in us being unable to effectively commercialize or develop our products. Furthermore, if DPT, our back-up supplier for Testim 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.

Approximately 93% of our product shipments are to only three 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 93% of our product shipments during the nine months ended September 30, 2006 were to only three customers: Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation. 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 manage any turnover that occurs in our sales force. For some market opportunities, we may need to enter into co-promotion agreements 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 future co-promotion or similar licensing arrangements with third parties in a timely manner, or on acceptable terms. To the extent that we enter into future co-promotion or other licensing arrangements, our product revenues may 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 or our future partners may not devote sufficient resources to our products. 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.

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 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 in our development activities. Our employment agreements with our executive officers are terminable on short notice or no notice. The loss of key employees 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 further commercialization of Testim or the development and commercialization of our product candidates. If we are unable to attract and retain qualified and talented senior management personnel, our business may suffer.

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 have resulted in unfavorable accounting charges and may require us to change our compensation practices. Any change in our

compensation practices may adversely affect 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 also have an employee stock purchase plan under which employees can purchase our common stock at a discount. The FASB has recently announced new rules for recording expense for the fair value of stock options and purchase rights under employee stock purchase plans. As a result of these new rules, commencing on January 1, 2006, we began expensing the fair value of stock options and purchase rights under our employee stock purchase plan, 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 September 30, 2006, we had 212 full-time and four part-time employees. In order to continue to expand Testim’s sales and commercialize our other product candidates, we currently anticipate that we will need to add some 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.

Prior to our 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. We cannot assure you that an active trading market for our common stock will exist at any time. Holders of our common stock may not be able to sell shares quickly or at the market price if trading in our common stock is not active. Substantially all of our outstanding shares of our common stock are eligible for sale in the public market. For the 30 days prior to the end of the period covered by this Report, our average daily trading volume was approximately 373,000 shares. Sales of a substantial number of shares of our common stock in the public market, or the perception in the market that 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. In addition, the market price of our common stock could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

Furthermore, market prices for securities of pharmaceutical, biotechnology and specialty pharmaceutical companies have been particularly volatile in recent years. The broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. 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.

As of September 30, 2006, stock options to purchase 3,360,246 shares of common stock and warrants to purchase 3,289,033 shares of common stock were outstanding. In addition, as of September 30, 2006 a total of 1,884,863 stock options are available for grant under our 2004 Equity Compensation Plan. A total of 4,510,954 of the outstanding options and warrants are “in the money” and exercisable as of September 30, 2006. “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.

At September 30, 2006, we believe that our executive officers, directors and our stockholders who beneficially own more than 5% of our outstanding common stock, and their affiliates, in the aggregate, beneficially own shares representing approximately 58% 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 any of these stockholders were to choose to act together, they may be able to control matters submitted to our stockholders for approval, as well as our management and affairs. For example, if any of these individuals chose to act together, they could 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.

The following table summarizes the Company’s purchases of its common stock for the three months ended September 30, 2006:

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

AUXILIUM PHARMACEUTICALS, INC.

/s/ Armando Anido

Armando Anido

Chief Executive Officer and President

(Principal Executive Officer)

AUXILIUM PHARMACEUTICALS, INC.

/s/ James E. Fickenscher

James E. Fickenscher

Chief Financial Officer

(Principal Financial and Accounting Officer)


PART I FINANCIAL INFORMATION		3

Item 1.	Financial Statements	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Cash Flows	5
	Consolidated Statement of Stockholders’ Equity	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	28

PART II OTHER INFORMATION		29

Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 6.	Exhibits	44

SIGNATURES		45


	September 30, 2006 (Unaudited)			December 31, 2005
Assets
Current assets:
Cash and cash equivalents	$	58,934		$	31,380
Short-term investments		8,425			25,350
Accounts receivable, trade, net		8,263			4,614
Accounts receivable, other		457			200
Inventories		2,623			4,387
Prepaid expenses and other current assets		2,690			2,365

Total current assets		81,392			68,296
Property and equipment, net		4,545			3,690
Other assets		2,515			709

Total assets	$	88,452		$	72,695

Liabilities and Stockholders’ Equity
Current liabilities:
Notes payable, current portion	$	60		$	260
Accounts payable		3,796			5,109
Accrued expenses		19,530			12,841
Deferred revenue, current portion		685			2,911
Deferred rent, current portion		81			123

Total current liabilities		24,152			21,244

Notes payable, long-term portion		21			65

Deferred revenue, long-term portion		10,569			10,671

Deferred rent, long-term portion		1,102			842

Commitments and contingencies (Note 5)
Stockholders’ equity:
Preferred stock, $0.01 par value per share, 5,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.01 par value per share; authorized 120,000,000 shares; issued 35,307,688 and 29,241,482 shares at September 30, 2006 and December 31, 2005, respectively		353			292
Additional paid-in capital		223,104			177,429
Accumulated deficit		(170,705	)		(137,515	)
Deferred compensation		—			(437	)
Treasury stock at cost: 13,377 shares at September 30, 2006		(113	)		—
Accumulated other comprehensive income		(31	)		104

Total stockholders’ equity		52,608			39,873

Total liabilities and stockholders’ equity	$	88,452		$	72,695


	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Net revenues	$	17,640		$	11,230		$	49,005		$	29,866

Operating expenses:
Cost of goods sold		4,484			3,279			12,721			9,256
Research and development		8,450			4,524			25,677			17,851
Selling, general and administrative		17,120			10,714			45,499			30,427

Total operating expenses		30,054			18,517			83,897			57,534

Loss from operations		(12,414	)		(7,287	)		(34,892	)		(27,668	)
Interest income (expense), net		645			467			1,697			923
Other income (expense), net		(1	)		(248	)		5			(464	)

Net loss	$	(11,770	)	$	(7,068	)	$	(33,190	)	$	(27,209	)

Basic and diluted net loss per common share	$	(0.39	)	$	(0.24	)	$	(1.13	)	$	(1.16	)

Weighted average common shares outstanding		30,081,510			29,066,266			29,472,146			23,492,339


	Nine Months Ended September 30,
	2006			2005
Cash flows from operating activities:
Net loss	$	(33,190	)	$	(27,209	)
Adjustments to reconcile net loss to net cashused in operating activities:
Stock-based compensation		2,000			317
Depreciation and amortization		762			819
Interest income accrued on notes receivablefrom stockholders		—			(1	)
Change in fair value of financing-related liability		—			248
Changes in operating assets and liabilities:
Accounts receivable, trade and other		(3,906	)		(304	)
Inventories		1,764			(760	)
Prepaid expenses and other current assets		(296	)		(98	)
Accounts payable and accrued expenses		5,227			3,690
Deferred revenue		(2,328	)		1,973
Deferred rent		(60	)		224

Net cash used in operating activities		(30,027	)		(21,101	)

Cash flows from investing activities:
Redemptions of short-term investments		70,350			22,275
Purchases of short-term investments		(53,425	)		(36,075	)
Purchases of property and equipment		(1,268	)		(946	)
Increase in other assets		(1,900	)		—

Net cash provided by (used in) investing activities		13,757			(14,746	)

Cash flows from financing activities:
Proceeds from shares issued in public offering, net of transaction costs net of transaction costs		43,323			—
Proceeds from shares issued in private placement, net of transaction costs net of transaction costs		—			33,045
Proceeds from financing-related liability		—			6,161
Payments on debt financings		(246	)		(316	)
Employee Stock Purchase Plan purchases		239			271
Proceeds from exercise of common stock options		611			723
Purchase of treasury shares		(113	)

Net cash provided by financing activities		43,814			39,884

Effect of exchange rate changes on cash		10			(11	)

Increase (decrease) in cash and cash equivalents		27,554			4,026
Cash and cash equivalents, beginning of period		31,380			32,707

Cash and cash equivalents, end of period	$	58,934		$	36,733


	Common stock				Additional paid-in capital			Accumulated deficit			Treasury Stock			Deferred compensation			Accumulated other comprehensive Income
	Shares		Amount		Additional paid-in capital			Accumulated deficit			Shares	Cost		Deferred compensation			Accumulated other comprehensive Income
Balance, January 1, 2006	29,241,482		$	292	$	177,429		$	(137,515	)	—	$		$	(437	)	$	104
Public offering, net of transaction costs	5,500,000			55		43,268			—		—		—		—			—
Issuance of restricted stock	200,000			2		(2	)		—		—		—		—			—
Cashless exercise of common stock warrants	181,109			2		(2	)		—		—		—		—			—
Exercise of common stock options	124,666			1		610			—		—		—		—			—
Employee Stock Purchase Plan purchases	60,544			1		238			—		—		—		—			—
Cancellation of resticted stock	(113	)		—		—			—		—		—		—			—
Stock-based compensation	—			—		2,000			—		—		—		—			—
Reclassification of deferred compensation	—			—		(437	)		—		—		—		437			—
Treasury stock acquisition	—			—		—			—		13,377		113		—			—
Foreign currency translation adjustment	—			—		—			—		—		—		—			—
Unrealized loss on available for sale securities	—			—		—			—		—		—		—			(135	)
Net loss	—			—		—			(33,190	)					—			—

Balance, September 30, 2006	35,307,688		$	353	$	223,104		$	(170,705	)	13,377	$	113	$	—		$	(31	)


Large accelerated filer ¨		Accelerated filer ¨		Non-accelerated filer x


	September 30, 2006		December 31, 2005
Raw materials	$	1,364	$	1,258
Work-in-process		72		1,422
Finished goods		1,187		1,491
Inventory subject to return		—		216

	$	2,623	$	4,387


	September 30, 2006		December 31, 2005
Payroll and related expenses	$	4,192	$	3,672
Milestone and royalty expenses		4,038		2,846
Research and development expenses		2,632		2,018
Sales and marketing expenses		1,382		777
Testim coupon and rebate accrual		5,364		2,214
Other expenses		1,922		1,314

	$	19,530	$	12,841


	September 30, 2006			December 31, 2005
Equipment promissory notes	$	81		$	327
Less unamortized discount		—			(2	)
Less current portion of notes payable		(60	)		(260	)

Notes payable, long-term portion	$	21		$	65


October 1, 2006 to September 30, 2007		$2,793
October 1, 2007 to September 30, 2008		$3,111
October 1, 2008 to September 30, 2009		$2,839
October 1, 2009 to September 30, 2010		$2,916
October 1, 2006 to September 30, 2011		$3,006
October 1, 2011 and thereafter		$14,357


	Three Months Ended September 30, 2006
Stock options	Shares		Weighted average exercise price		Weighted average remaining contractual life (in years)	Aggregate intrinsic value
Options outstanding:
Outstanding at July 1, 2006	2,903,090		$	6.97
Granted	500,000			7.81
Exercised	(10,868	)		7.06
Canceled	(31,976	)		8.85

Outstanding at September 30, 2006	3,360,246		$	7.08	7.78	$	10,611,089

Exercisable at September 30, 2006	1,285,501		$	6.29	5.19	$	5,310,343


	Nine Months Ended September 30, 2006
Stock options	Shares		Weighted average exercise price		Weighted average remaining contractual life (in years)	Aggregate intrinsic value
Options outstanding:
Outstanding at December 31, 2005	2,101,498		$	5.92
Granted	1,598,750			8.55
Exercised	(124,666	)		4.90
Canceled	(215,336	)		8.00

Outstanding at September 30, 2006	3,360,246		$	7.08	7.78	$	10,611,089

Exercisable at September 30,2006	1,285,501		$	6.29	5.19	$	5,310,343


Nonvested shares	Shares		Weighted average grant-date fair value
Nonvested at December 31, 2005	81,451		$	6.64
Vested	(48,794	)		7.50
Cancelled	(113	)		7.50

Nonvested at June 30, 2006	32,544			5.35
Grants	200,000			7.81

Nonvested at September 30, 2006	232,544		$	7.47


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Stock-based compensation expense:
Research and development	$	89	$	—	$	390	$	—
Selling, general and administrative		893		51		1,610		232

Total	$	982	$	51	$	2,000	$	232


	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Net loss applicable to common stockholders, as reported	$	(7,068	)	$	(27,209	)
Add: total stock based employee compensation expense recognized under the intrinsic value based method		51			232
Deduct: total stock based employee compensation expense determined under fair value based method		(2,383	)		(3,270	)

Pro forma net loss applicable to common stockholders	$	(9,400	)	$	(30,247	)

Net loss per common share:
Basic and diluted, as reported	$	(0.24	)	$	(1.16	)

Basic and diluted, pro forma	$	(0.32	)	$	(1.29	)


	Payments Due By Period
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Long-term debt obligations	$	81	$	60	$	21	$	—	$	—
Operating lease obligations	$	29,022		2,793		5,950		5,922		14,357
Purchase obligations (1)	$	950		190		380		380

	$	30,053	$	3,043	$	6,351	$	6,302	$	14,357


Period	Total Number of Shares (or Units) Purchased		Average Price Paid Per Share (or Unit)		Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
July 1, 2006 to July 31, 2006	None			Not applicable	Not applicable	Not applicable
August 1, 2006 to August 31, 2006	None			Not applicable	Not applicable	Not applicable
September 1, 2006 to September 30, 2006	9,033	⁽¹⁾	$	8.20	Not applicable	Not applicable

Total	9,033	⁽¹⁾	$	8.20	Not applicable	Not applicable


Exhibit No.		Description of Exhibit

10.1		Lease Agreement, dated September 1, 2006, between the Registrant and ARE-PA Region No. 6, LLC (Filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 5, 2006, File No. 000-50855, and incorporated by reference herein).

10.2		Letter Agreement, dated September 1, 2006, between the Registrant and Oscient Pharmaceuticals, Inc. (Filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on September 5, 2006, File No. 000-50855, and incorporated by reference herein).

10.3		Placement Agency Agreement, dated September 14, 2006, by and among the Registrant, Thomas Weisel Partners LLC and Roth Capital Partners, LLC. (Filed as Exhibit 1.1 to the Registrant’s Current Report on Form 8-K filed on September 15, 2006, File No. 000-50855, and incorporated by reference herein).

31.1		Certification of Armando Anido, the Registrant’s Principal Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

31.2		Certification of James E. Fickenscher, the Registrant’s Principal Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

32		Certification of Armando Anido, the Registrant’s Principal Executive Officer, and James E. Fickenscher, the Registrant’s Principal Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).


Exhibit No.		Description

10.1		Lease Agreement, dated September 1, 2006, between the Registrant and ARE-PA Region No. 6, LLC (Filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on September 5, 2006, File No. 000-50855, and incorporated by reference herein).

10.2		Letter Agreement, dated September 1, 2006, between the Registrant and Oscient Pharmaceuticals, Inc. (Filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on September 5, 2006, File No. 000-50855, and incorporated by reference herein).

10.3		Placement Agency Agreement, dated September 14, 2006, by and among the Registrant, Thomas Weisel Partners LLC and Roth Capital Partners, LLC. (Filed as Exhibit 1.1 to the Registrant’s Current Report on Form 8-K filed on September 15, 2006, File No. 000-50855, and incorporated by reference herein).

31.1		Certification of Armando Anido, the Registrant’s Principal Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

31.2		Certification of James E. Fickenscher, the Registrant’s Principal Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a).

32		Certification of Armando Anido, the Registrant’s Principal Executive Officer, and James E. Fickenscher, the Registrant’s Principal Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).