Barrier Therapeutics 10Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2006


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

For the transition period from to

Commission File Number 000-50680

BARRIER THERAPEUTICS, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware (State or Other Jurisdiction of Incorporation)		22-3828030 (I.R.S. Employer Identification Number)

600 College Road East, Suite 3200
Princeton, NJ		08540
(Address of Principal Executive Offices)		(Zip Code)

(609) 945-1200
(Registrant’s Telephone Number, Including Area Code)

Not Applicable
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

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 þ No o

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.


Class		Outstanding as of November 3, 2006
Common Stock, par value $.0001		29,001,591 Shares

BARRIER THERAPEUTICS, INC.

INDEX


CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS			1

PART I — FINANCIAL INFORMATION			2

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS			2

CONSOLIDATED BALANCE SHEETS			2

CONSOLIDATED STATEMENTS OF OPERATIONS			3

CONSOLIDATED STATEMENTS OF CASH FLOWS			4

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS			5

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			14

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK			23

ITEM 4. CONTROLS AND PROCEDURES			23

PART II — OTHER INFORMATION			24

ITEM 1. LEGAL PROCEEDINGS			24

ITEM 1A. RISK FACTORS			24

ITEM 6. EXHIBITS			44

SIGNATURES			45
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER REQUIRED BY RULE 13A-14(A)
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER REQUIRED BY RULE 13A-14(A)
CERTIFICATION OF PRINCIPAL ACCOUNTING OFFICER REQUIRED BY RULE 13A-14(A)
SECTION 1350 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
SECTION 1350 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
SECTION 1350 CERTIFICATION OF PRINCIPAL ACCOUNTING OFFICER

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical facts or statements of current condition, this report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements contained in this report constitute our expectations or forecasts of future events as of the date this report was filed with the SEC and are not statements of historical fact. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Such statements may include words such as “anticipate,” “will,” “estimate,” “expect,” “project,” “intend,” “should,” “plan,” “believe,” “hope,” and other words and terms of similar meaning. In particular, these forward-looking statements include, among others, statements about:

	•		the trend of operating losses and the reasons for those losses;

	•		our spending on the clinical development of our product candidates;

	•		our plans regarding the development or regulatory path for any of our product candidates, particularly with respect to our Hyphanox™, Rambazole^™, and Azoline product candidates;

	•		the timing of the initiation or completion of any clinical trials, particularly with respect to our Hyphanox, Rambazole and Azoline product candidates;

	•		the timing of filing for regulatory approvals with governmental agencies;

	•		the commercialization of our products, particularly our Xolegel^™, Vusion^™ and Solagé^® products;

	•		the commercialization of any of our product candidates, if approved;

	•		the market success of our products and anticipated revenues associates with those products; and

	•		other statements regarding matters that are not historical facts or statements of current condition.

Any or all of our forward-looking statements in this report may turn out to be wrong. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, level of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Therefore, you should not place undue reliance on any such forward-looking statements. The factors that could cause actual results to differ from those expressed or implied by our forward-looking statements include our ability to:

	•		obtain substantial additional funds;

	•		obtain and maintain all necessary patents or licenses;

	•		market our Xolegel, Vusion and Solagé products and product candidates, if approved, and generate revenues;

	•		demonstrate the safety and efficacy of product candidates at each stage of development;

	•		meet applicable regulatory standards in the United States to commence or continue clinical trials, particularly with respect to our Hyphanox, Rambazole and Azoline product candidates;

	•		identify and initiate investigator sites for our clinical trials and complete enrollment in a timely manner;

	•		meet applicable regulatory standards and file for or receive required regulatory approvals;

	•		produce our drug products in commercial quantities at reasonable costs and compete successfully against other products and companies; and

	•		meet our obligations and required milestones under our license and other agreements, including our agreements with the Johnson & Johnson family of companies.

PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

BARRIER THERAPEUTICS, INC.

CONSOLIDATED BALANCE SHEETS


(Dollars in thousands)	September 30,			December 31,
	2006			2005
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	36,981		$	16,891
Marketable securities		33,499			61,229
Interest receivable		281			755
Receivables, net of allowances of $19 and $14, respectively		441			593
Finished goods inventories		833			380
Prepaid expenses and other current assets		2,414			1,227

Total current assets		74,449			81,075
Property and equipment, net		984			1,055
Product rights, net		2,517			2,780
Other assets		107			51

Total assets	$	78,057		$	84,961

Liabilities and stockholders’ equity
Current liabilities:
Notes payable, current portion	$	328		$	379
Accounts payable		3,233			3,110
Accrued expenses		7,281			4,146
Deferred revenue		480			637
Other current liabilities		10			18

Total current liabilities		11,332			8,290
Notes payable, long-term portion		169			405
Stockholders’ equity:
Common stock, $.0001 par value; 80,000,000 shares authorized; 28,996,685 issued and outstanding at September 30, 2006; and 24,095,875 issued and outstanding at December 31, 2005		3			2
Additional paid-in capital		256,063			228,490
Accumulated deficit		(189,386	)		(151,441	)
Deferred compensation		—			(532	)
Accumulated other comprehensive loss		(124	)		(253	)

Total stockholders’ equity		66,556			76,266

Total liabilities and stockholders’ equity	$	78,057		$	84,961

The accompanying notes are an integral part of these unaudited consolidated financial statements.

BARRIER THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(Dollars in thousands, except per share data)


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005
Revenues:
Net product revenues	$	1,963		$	155		$	3,383		$	460
Other revenues		153			471			286			1,291

Total revenues		2,116			626			3,669			1,751

Costs and expenses:
Cost of product revenues		351			163			1,050			348
Research and development		6,274			7,626			16,449			24,417
Selling, general and administrative		8,884			5,648			26,408			14,100

Total operating expenses		15,509			13,437			43,907			38,865

Loss from operations		(13,393	)		(12,811	)		(40,238	)		(37,114	)
Interest income		749			773			2,284			2,139
Interest expense		(14	)		(12	)		(48	)		(41	)

Net loss before cumulative effect of change in accounting principle		(12,658	)		(12,050	)		(38,002	)		(35,016	)
Cumulative effect of change in accounting principle		—			—			57			—

Net loss	$	(12,658	)	$	(12,050	)	$	(37,945	)	$	(35,016	)

Basic and diluted net loss before and after cumulative effect of change in accounting principle per share		($0.50	)		($0.50	)		($1.55	)		($1.49	)

Weighted-average shares outstanding—basic and diluted		25,097,056			23,962,649			24,437,535			23,536,482

The accompanying notes are an integral part of these unaudited consolidated financial statements.

BARRIER THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


(Dollars in thousands)	Nine months ended September 30,
	2006			2005
Operating activities
Net loss	$	(37,945	)	$	(35,016	)

Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		393			315
Amortization of product rights		263			232
Stock based compensation expense		3,789			1,056
Changes in operating assets and liabilities:
Prepaid expenses and other current assets		(1,187	)		281
Finished goods inventories		(453	)		(95	)
Receivables		152			(163	)
Interest receivable		474			137
Accounts payable and accrued expenses		3,258			(35	)
Deferred revenue		(157	)		(50	)
Other, net		2			(11	)

Net cash used in operating activities		(31,411	)		(33,349	)
Investing activities
Purchase of fixed assets		(322	)		(181	)
Purchase of product rights		—			(3,100	)
Purchase of marketable securities		(35,923	)		(70,145	)
Maturities of marketable securities		63,653			92,269

Net cash provided by investing activities		27,408			18,843
Financing activities
Repayment of notes payable		(287	)		(194	)
Proceeds from issuance of common stock, net		24,023			36,043
Proceeds from exercise of stock options and other benefit plans		366			575

Net cash provided by financing activities		24,102			36,424
Effect of exchange rate on cash and cash equivalents		(9	)		1

Net increase in cash and cash equivalents		20,090			21,919
Cash and cash equivalents, beginning of period		16,891			11,908

Cash and cash equivalents, end of period	$	36,981		$	33,827

The accompanying notes are an integral part of these unaudited consolidated financial statements.

BARRIER THERAPEUTICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Summary of Significant Accounting Policies

Organization, Description of Business

Barrier Therapeutics, Inc. (the “Company”) was incorporated in Delaware on September 17, 2001 and commenced active operations in May 2002. The Company is a pharmaceutical company focused on the development and commercialization of pharmaceutical products in the field of dermatology. The Company’s strategy is to develop a portfolio of innovative products that address major medical needs in the treatment of dermatological diseases and disorders. With the acquisition of the United States and Canadian rights to Solagé in February 2005, the Company commenced its planned principal operations of selling dermatology products and has transitioned from a company primarily focused on research and development to a company that also markets and sells pharmaceutical products. As a result, the Company no longer considers itself a development stage enterprise. The Company has offices in Princeton, New Jersey, Toronto, Canada and Geel, Belgium.

Since inception, the Company has relied primarily upon the sale of equity securities to fund operations, most recently through the Company’s initial public offering in April 2004, follow-on public offerings in February 2005 and September 2006. The Company believes that its existing resources should be sufficient to meet its capital and liquidity requirements for at least the next 12 months. However, the Company’s capital requirements will depend on many factors, including the success of its development and commercialization of the Company’s product candidates. Even if the Company succeeds in developing and commercializing one or more of its product candidates, it may never generate sufficient sales revenue to achieve or maintain profitability. There can be no assurance that the Company will be able to obtain additional capital when needed on acceptable terms, if at all.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three- and nine-month periods ended September 30, 2006 are not necessarily indicative of the results for the full year ending December 31, 2006. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2005 as filed with the Securities and Exchange Commission (“SEC”).

Consolidation

The financial statements include the accounts of Barrier Therapeutics, Inc. and its wholly owned subsidiaries, Barrier Therapeutics, NV and Barrier Therapeutics Canada Inc. All significant intercompany transactions and balances are eliminated in consolidation.

Revenue Recognition

The Company records net product and other revenues based on revenue recognition criteria in Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements,” Emerging Issues Task Force (“EITF”) Issue 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) and Statement of Financial Accounting Standards No. 48 (“FAS 48”) “Revenue Recognition When Right of Return Exists.

Net Product Revenue.In the United States and Canada, the Company sells its products primarily to wholesalers and distributors, who, in turn, sell to pharmacies. The following are the Company’s revenue recognition policies.

At the time of a new product launch, the Company utilizes a pull-through sales method that recognizes revenue based on estimated prescription demand based on third party market research data and revenue for a normal level of wholesaler inventory based on estimated current prescription demand. Estimating the amount of returns and discounts for new products is based on specific facts and circumstances including acceptance rates of established products with similar marketing characteristics. At the time of a new product launch, absent the ability to make reliable estimates the Company defers revenue on sales to wholesalers until a reliable estimate of returns, discounts and related end user demand can be made. The Company monitors inventory levels at wholesalers and pharmacies to ensure these levels remain within normal levels. The Company estimates inventory at wholesalers based on historical sales to wholesalers, inventory data provided by these wholesalers and from third party market research data related to prescription trends and patient demand. Making these determinations involves estimating whether trends in past buying patterns are indicative of future product sales.

The Company records allowances for product returns, Medicaid, coupon rebates and other discounts at the time of product sale, and reports revenue net of such amounts. In determining allowances for product returns, Medicaid and coupon rebates, the Company must make significant judgments and estimates. For example, in determining these amounts, the Company must estimate prescription demand and the levels of inventory held by wholesalers. Making these determinations involves estimating whether trends in past buying patterns will predict future product sales.

The nature of allowances requiring critical accounting estimates, and the specific considerations the Company uses in estimating their amounts, are as follows:

•

Product returns. Customers have the right to return any unopened product during the 18-month period beginning six months prior to the labeled expiration date and ending 12 months after the labeled expiration date. As a result, in calculating the allowance for product returns, the Company must estimate the likelihood that product sold to wholesalers and pharmacies might remain in their inventory to within six months of expiration and analyze the likelihood that such product will be returned within 12 months after expiration.

In estimating the likelihood of product remaining in wholesalers’ inventory, the Company relies on information from wholesalers regarding their inventory levels, measured prescription demand as reported by third party sources and on internal sales data. The Company believes the information from wholesalers and third party sources is directionally reliable, but is unable to verify the accuracy of such data independently. The Company also considers wholesalers’ past buying patterns, estimated remaining shelf life of product previously shipped and the expiration dates of product currently being shipped. In estimating the likelihood of product return, the Company relies primarily on historic patterns of returns and estimated remaining shelf life of product previously shipped.

•

Medicaid rebates— In some states the Company participates or has applied to participate in the Federal Medicaid rebate program, as well as several state government-managed supplemental Medicaid rebate programs, which were developed to provide assistance to certain vulnerable and needy individuals and families. Under the Medicaid rebate program, the Company will pay a rebate to each participating state and local government for its products that their programs reimburse. For purposes of this discussion, discounts and rebates provided through these programs are considered Medicaid rebates and are included in our Medicaid rebate accrual.

The Company establishes an accrual in the amount equal to its estimate of Medicaid rebates attributable to its sales in the period in which the sale is recorded as revenue. Although the Company accrues a liability for estimated Medicaid rebates at the time the sale is recorded, the actual Medicaid rebate related to a sale may not be billed for months after the sale. The Company considers the then-current Medicaid rebate laws and interpretations; the historical and estimated future percentage of its products that are sold to Medicaid recipients by pharmacies, hospitals, and other retailers that buy from its customers; product pricing and current rebate

and/or discount contracts; and the levels of inventory in the distribution channel in determining the appropriate accrual amount. The Company analyzes the accrual at least quarterly and will adjust the balance as required.

•

Coupon rebates— From time to time the Company offers patients a limited time coupon discount on their purchases. The Company provides a mail-in rebate coupon to the patient with a proof of purchase. As a result of these rebate offers, at the time of product shipment, the Company must estimate the likelihood that products sold to wholesalers and pharmacies might be ultimately sold to a patient who redeems a coupon. The Company bases its estimates on the historic coupon redemption rates for similar products received from third party administrators, which detail historic patterns.

The Company will adjust its allowances for product returns, Medicaid, coupon rebates and other discounts based on its actual sales experience. The Company will continually monitor its allowances and make adjustments when it believes actual experience may differ from its estimates.

•

International distribution partners.Under agreements with international distribution partners, the Company plans to sell product to distribution partners at a contractual price. These partners generally have no rights of return after they have accepted shipment of the product.

Other Revenues.Contract revenues include license fees, royalties and other payments associated with collaborations with third parties. Revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured.

Revenue from non-refundable, upfront license fees where the Company has a continuing involvement is recognized ratably over the performance period. Royalties from licensees are based on third-party sales of licensed products and are recorded in accordance with contract terms when third-party results are reliably measurable and collectibility is reasonably assured. The Company periodically re-evaluates estimates of the performance period and revises assumptions as appropriate. These changes in assumptions may affect the amount of revenue recorded in the financial statements in future periods.

Grant revenues are recognized as the Company provides the services stipulated in the underlying grant based on the time and materials incurred. Amounts received in advance of services provided are recorded as deferred revenue and amortized as revenue when the services are provided.

Adoption of FAS 123(R)

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Accounting for Stock-Based Compensation” (FAS 123(R)) using the modified prospective method. FAS 123(R) requires companies to recognize compensation expense in an amount equal to the fair value of all share-based payments granted to employees. The Company commenced the new method of valuing stock-based compensation as prescribed by FAS 123(R) on all stock-based awards granted after the effective date. For the quarter ended September 30, 2006, the Company recorded an expense for stock based compensation of $0.9 million ($0.3 million recorded in research and development expense and $0.6 million recorded in selling, general and administrative expenses). For the nine months ended September 30, 2006, the Company recorded stock based compensation expense related to FAS 123(R) of $3.7 million ($1.1 million recorded in research and development expense and $2.6 million recorded in selling, general and administrative expenses).

As a result of adopting FAS 123(R), the Company’s net loss is larger than had it continued to account for share-based compensation under Accounting Principles Board Opinion 25 (APB 25). For the three- and nine-month period ended September 30, 2006, the Company’s net loss was approximately $0.9 and $3.7 million higher, respectively, than if the Company had continued to account for share-based compensation under APB 25.

expense for stock option grants made at an exercise price equal to or in excess of the fair market value of the stock at the date of grant. For pro forma purposes, the stock compensation expense was based on an accelerated vesting method. SFAS 123 pro forma information regarding net loss was required by SFAS 123, and had been determined as if the Company had accounted for its stock-based employee compensation under the fair value method prescribed in SFAS 123. The fair value of the options were estimated using the Black-Scholes pricing model. In addition, no compensation expense was recorded in the financial statements for shares purchased under the Company’s Employee Stock Purchase Plan as that plan was considered non-compensatory under APB 25.

In addition, prior to the adoption of FAS 123(R), the Company presented its unamortized portion of deferred compensation cost for nonvested stock options in the statement of changes in shareholders equity with a corresponding credit to additional paid in capital. Under FAS 123(R), an equity instrument is not considered to be issued until the instrument vests. Upon the adoption of FAS 123(R), the deferred compensation balance of $532,000 at December 31, 2005 was netted against additional paid in capital.

Application of APB 25 caused forfeitures to be recognized as incurred. Under FAS 123(R), an estimate of forfeitures must be made for the unvested awards outstanding as of the adoption date. As such, an adjustment to record the cumulative effect of a change in accounting principle is needed to reflect the compensation cost that would not have been recognized in prior periods had forfeitures been estimated during those periods. This adjustment applies only to compensation cost previously recognized in the financial statements for awards that are unvested on the adoption date. As such, the Company recognized a cumulative effect adjustment of $57,000 as of January 1, 2006 related to the accounting change for forfeitures.

Stock Compensation

Stock Option Plan

On April 26, 2002, the Company’s Board of Directors and stockholders approved the Company’s 2002 Equity Compensation Plan (the “2002 Plan”). In March 2004, the Company’s Board of Directors and stockholders approved the Company’s 2004 Equity Compensation Plan (the “2004” Plan). On that date, the outstanding options under the 2002 Plan were transferred to the 2004 Plan. No further options may be granted under the 2002 Plan. The 2002 Plan options will continue to be governed by their existing terms, unless the Board or its committee elects to extend one or more features of the 2004 Plan to these options. The options granted under the 2004 Plan and the 2002 Plan have substantially the same terms.

The 2004 Plan provides for the granting of options to purchase shares of the Company’s common stock to key employees, Directors, advisors and consultants at a price not less than the fair market value at the date of grant, or stock appreciation rights tied to the value of such common stock. The number of shares of common stock reserved for issuance under the 2004 Plan will automatically increase each year on the first trading day in January of each calendar year by an amount equal to 5% of the total number of shares of common stock outstanding on the last trading day in December, not in excess of 1,000,000 shares.

The 2004 Plan is intended to encourage ownership of stock by employees, Directors, advisors and consultants of the Company and to provide additional incentives for them to promote the success of the Company’s business and is administered by the Board of Directors or committee consisting of members of the Board. Options granted pursuant to the 2004 Plan generally vest 25% after the first year, and the remaining 75% vest monthly over the next three years.

Employee Stock Purchase Plan

The Company established an Employee Stock Purchase Plan (the “ESPP”) in February 2004 which was approved by the stockholders in March 2004. The plan allows eligible employees the opportunity to acquire shares of Barrier’s common stock (the “Common Stock”) at periodic intervals through accumulated payroll deductions. These deductions will be applied at semi-annual intervals to purchase shares of Common Stock at a discount from the then current market price. The purchase price per share will be equal to 85% of the fair market value per share on the date in which the participant is enrolled, or, if lower, 85% of the fair market value per share on the semi-

annual purchase date. Semi-annual purchase dates are the last business day of January and July each year. Under FAS 123(R), the Company records compensation expense related to its ESPP.

Initially 200,000 shares were reserved for issuance. The number of shares reserved for the plan will be automatically increased each year on the first trading day in January by an amount equal to .5% of the total number of outstanding shares of common stock on the last trading day of December in the prior year, not to exceed 150,000 shares. There is a 1,500 share purchase limitation per participant and 75,000 aggregate purchase limitation per purchase date.

Deferred Stock Compensation

In connection with the grant of stock options to employees and directors, the Company recorded deferred stock compensation prior to the Company’s initial public offering (“IPO”) on May 4, 2004. Prior to January 1, 2006, the deferred compensation amounts were included as a reduction of stockholders’ equity and were being amortized over the vesting period of the individual options, generally four years, using an accelerated vesting method. The accelerated vesting method provides for vesting of portions of the overall award at interim dates and results in higher vesting in earlier years than straight-line vesting.

Stock Options

Stock options are granted to employees at exercise prices equal to the fair market value of the Company’s stock at date of grant. Stock options generally vest over four years and have a term of 10 years. Compensation cost is recognized over the requisite service period for each separately vesting portion of the stock option. The expense is recognized, net of forfeitures, over the vesting period of the options using an accelerated method. For the three- and nine-month period ended September 30, 2006, stock based compensation expense recognized was approximately $0.9 million and $3.7 million, respectively. The fair value of the options was estimated using the Black-Scholes pricing model with the following assumptions:


	Three months ended
	September 30,
	2006	2005
Risk-free interest rate	4.85%	3%
Dividend yield	0%	0%
Expected life	6.1 years	8.0 years
Volatility	67%	75%
Forfeiture rate	6.6%	N/A

The following table illustrates the effect on net income and earnings per share for the three- and nine-month period ended September 30, 2005 had the Company applied the fair value recognition provisions of SFAS 123 to all of its stock-based compensation plans.


	Three months			Nine months
	ended,			ended,
	September 30, 2005			September 30, 2005

Net loss, as reported	$	(12,050	)	$	(35,016	)
Add: Non-cash employee compensation as reported		195			731
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(1,162	)		(3,868	)


SFAS 123 pro forma net loss		(13,017	)		(38,153	)


Basic and diluted loss	$	(0.50	)	$	(1.49	)

Basic and diluted loss per share, SFAS 123 pro forma	$	(0.54	)	$	(1.62	)

The following table summarizes information about stock option activity for the nine-month period ended September 30, 2006:


				Options Outstanding
	Shares						Option		Weighted-
	Available			Number			Price		Average
	for			of			Per Share		Exercise
	Grant			Shares			Range		Price
Balance at December 31, 2005		817,010			1,819,587		$	0.60-19.98	$	8.32
Shares authorized		1,000,000			—			—		—
Options granted		(418,400	)		418,400		$	8.18-11.23	$	8.93
Options exercised		—			(14,782	)	$	0.60-4.00	$	1.65
Options forfeited		24,357			(24,357	)	$	1.00-16.50	$	9.79

Balance at March 31, 2006		1,422,967			2,198,848		$	0.60-19.98	$	8.47
Options granted		(123,400	)		123,400		$	5.40-9.48	$	6.43
Options exercised		—			(10,165	)	$	0.60-8.60	$	2.29
Options forfeited		60,135			(60,135	)	$	0.60-15.49	$	9.85

Balance at June 30, 2006		1,359,702			2,251,948		$	0.60-19.98	$	8.36
Options granted		(27,850	)		27,850		$	5.55-6.54	$	5.80
Options exercised		—			(5,457	)	$	0.60-4.00	$	2.55
Options forfeited		36,296			(36,296	)	$	1.00-16.74	$	12.70

Balance at September 30, 2006		1,368,148			2,238,045		$	0.60-19.98	$	8.27

The following table summarizes information about vested stock options outstanding:


	September 30,		December 31,
	2006		2005
Vested stock options		1,163,717		696,010
Weighted-average exercise price	$	6.74	$	4.68
Weighted-average contractual term		7.35		7.60

The following table summarizes information about stock options outstanding and exercisable at September 30, 2006:


	Outstanding						Exercisable
					Weighted-
			Weighted-		Average				Weighted-
			Average		Remaining				Average
	Number of		Exercise		Contractual		Number of		Exercise
Exercise Price	Options		Price		Life (years)		Options		Price
$0.60 — $1.50		509,040	$	0.85		6.3		449,289	$	0.81
3.00 — 4.00		139,356		3.62		7.3		118,962		3.59
4.01 — 8.00		352,562		7.16		8.3		135,559		7.98
8.01 — 10.00		547,400		9.01		9.3		163,356		8.97
10.01 — 14.00		270,400		12.32		8.1		193,597		12.31
14.01 — 20.00		419,287		16.22		8.4		187,954		16.01

		2,238,045		8.27		8.0		1,248,717		6.99

The difference between the number of vested stock options and the number of options exercisable relate to options granted to each non-employee, non-investor member of the Board of Directors. Stock options granted to Board members are immediately exercisable, but not immediately vested.

The weighted-average fair value of stock options granted for the three-month periods ended September 30, 2006 and 2005, was $5.80 and $9.23, respectively. The intrinsic value of stock options exercised was approximately $21,000 and $40,000 for the three-month periods ended September 30, 2006 and 2005, respectively. The total fair

value of shares vested during the three-month periods ended September 30, 2006 and 2005 was $611,000 and $451,000, respectively.

The weighted-average fair value of stock options granted for the nine- month periods ended September 30, 2006 and 2005, was $8.24 and $14.32, respectively. The intrinsic value of stock options exercised was approximately $207,000 and $2,420,000 for the nine-month periods ended September 30, 2006 and 2005, respectively. The total fair value of shares vested during the nine-month periods ended September 30, 2006 and 2005 was $2,906,000 and $2,142,000, respectively.

That total remaining unrecognized compensation costs related to unvested stock options was $3.5 million as of September 30, 2006 and will be amortized over the weighted-average remaining service period of 3.4 years.

The Company accounts for options issued to non-employees under SFAS No. 123 and EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” As such, the value of such options is periodically re-measured and income or expense is recognized during their vesting terms. The Company recorded $22,000 and $59,000, for the three-month periods ended September 30, 2006 and 2005, respectively and $105,000 and $325,000 for the nine-months ended September 30, 2006 and 2005, respectively.

3. Comprehensive Loss

The components of comprehensive loss are as follows:


	Three months ended September 30,						Nine months ended September 30,
	2006			2005			2006			2005

	(unaudited)						(unaudited)
Net loss		($12,658	)		($12,050	)		($37,945	)		($35,016	)

Foreign currency translation		(6	)		(6	)		(9	)		(8	)
Change in unrealized net gain/(loss) on marketable securities		63			10			138			58

Comprehensive loss		($12,601	)		($12,046	)		($37,816	)		($34,966	)

Accumulated other comprehensive loss equals the cumulative translation adjustment and unrealized net losses on marketable securities which are the only components of other comprehensive loss included in the Company’s financial statements.

4. Intangible Assets

On February 7, 2005, the Company entered into a Product Acquisition Agreement with Moreland Enterprises, Ltd. (“Moreland”). Under the terms of the Product Acquisition Agreement, the Company acquired the United States and Canadian rights to Solagé (mequinol 2%, tretinoin 0.01%) Topical Solution, and all existing finished goods inventory. The Company was assigned all U.S. and Canadian marketing authorizations, patents, and trademarks for the product. The patent rights include U.S. and Canadian patents covering the pharmaceutical composition of Solagé and methods of use until at least 2013.

The Company acquired the intellectual property and finished goods inventory for $3.1 million and will make future payments totaling up to an additional $2.0 million, if certain sales targets are met. The total initial purchase price was allocated $3.0 million to product rights and $61,000 to inventory. During 2005, the Company recorded a

liability and a corresponding increase to the intangible asset product rights of $100,000 for future amounts payable to Moreland based on product sales during the period. Product rights are being amortized on a straight-line basis over the life of the underlying patent, which expires in 2013.

The following information relates to acquired product rights as of September 30, 2006 and December 31, 2005:


(in thousands)	September 30, 2006				December 31, 2005
	Gross Carrying		Accumulated		Gross Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Product Rights	$	3,100	$	583	$	3,100	$	320

The Company recognized amortization expense of $88,000 for both the three months ended September 30, 2006 and 2005 and $263,000 and $232,000 for the nine months ended September 30, 2006 and 2005, respectively. Amortization expense for the remainder of 2006 will be $88,000 and will be $351,000 for each of the next five years. Effective January 1, 2006, the Company is obligated to pay a 5% royalty to Moreland under the Product Acquisition Agreement up to a maximum of $2 million through December 31, 2010. For the nine months ended September 30, 2006, the Company recorded approximately $56,000 of royalties in cost of product revenues based on the agreement.

5. Geographic Segments

The Company manages its business and operations as one segment and is focused on the development and commercialization of its product candidates and approved products for marketing. The Company operates in the United States, Belgium and Canada.

The following table presents financial information based on the geographic location of the facilities of the Company and for the periods ended (in thousands):


(in thousands)	Three months ended September 30				Nine months ended September 30
Net Product Revenues	2006		2005		2006		2005
United States	$	1,852	$	128	$	3,096	$	396
International		111		27		287		64

Total Net Product Revenues		1,963		155		3,383		460


Total Assets	September 30, 2006		December 31, 2005
United States	$	76,988	$	83,212
International		1,069		1,749

Total Assets		78,057		84,961


Property and equipment, net	September 30, 2006		December 31, 2005
United States	$	764	$	831
International		220		224

Total property and equipment, net		984		1,055

6. Legal Matters

In October 2005, a putative class action lawsuit was filed in the United States District Court for the District of New Jersey against the Company and certain of its officers on behalf of all persons who purchased or acquired securities of Barrier Therapeutics, Inc. between April 29, 2004 and June 29, 2005. At least four additional putative class action lawsuits have also been filed against the Company and certain of its officers, all pleading essentially the same allegations. In an Order entered on December 19, 2005, the Court consolidated these cases. By Order dated March 2, 2006, the Court appointed lead plaintiffs and approved co-lead counsel. On May 22, 2006, lead plaintiffs filed a Consolidated Class Action Complaint for Violations of Federal Securities Laws (“Complaint”). The

Complaint brings claims against the Company, certain of its officers and a director (collectively “Barrier”) and Morgan Stanley & Co., Inc. and J.P. Morgan Securities, Inc., underwriters for the Company’s initial public offering in 2004 and secondary offering in 2005, as well as Pacific Growth Equities, LLC, an underwriter for the Company’s secondary offering in 2005 (collectively “the Underwriters.”) The Complaint asserts that Barrier and the Underwriters violated Sections 11 and 12 of the Securities Act of 1933, that Barrier violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that the individual defendants are liable for controlling person liability under Section 15 of the Securities Act of 1933 and Section 20(a) of the Securities Exchange Act of 1934. The Complaint is based upon purported misstatements relating to Vusion and Hyphanox.

The Company filed a Motion to Dismiss the claims on August 25, 2006. On November 8, 2006, counsel for the lead plaintiffs voluntarily dismissed the lawsuit, in its entirety and with prejudice, by filing a stipulation of dismissal, in which the Company, the individual defendants and the underwriters joined, in the United States District Court for the District of New Jersey, without any payment by the Company or any of the defendants to the plaintiffs or their counsel. The Company expects the court to enter an order with respect to the filing promptly.

7. Sale of Common Stock

On September 14, 2006, the Company entered into an underwriting agreement (the “Underwriting Agreement”) with Pacific Growth Equities, LLC (“Pacific Growth”) pursuant to which the Company issued and sold an aggregate of 4,820,000 registered shares of its common stock at $5.25 per share, through a registered direct offering, for aggregate gross proceeds of approximately $25.3 million, before deducting approximately $1.3 million of estimated fees and expenses associated with the offering (the “Offering”). The shares of common stock offered by the Company in this transaction were registered under the Company’s registration statement (File No. 333-134214) on Form S-3, which was filed on May 17, 2006 and declared effective by the Securities and Exchange Commission on May 25, 2006. Pacific Growth acted as the sole underwriter for the Offering.

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

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

Overview

We are a pharmaceutical company focused on the development and commercialization of pharmaceutical products in the field of dermatology. Our strategy is to develop a portfolio of innovative products that address major medical needs in the treatment of dermatological diseases and disorders.

We currently market three pharmaceutical products in the United States, Xolegel (ketoconazole, USP) Gel 2%, Vusion (0.25% miconazole nitrate, 15% zinc oxide, and 81.35% white petrolatum) Ointment and Solagé (mequinol 2.0% and tretinoin 0.01%) Topical Solution. We also market our Solagé product in Canada, along with two other products for which we are the exclusive distributor in Canada: VANIQA (elflornithine HCI) Cream 13.9% and Denavir^® (penciclovir cream) 1%. We promote our marketed products through a sales force consisting of our own sales representatives and those of a contract sales organization. Since the approval of Vusion in February 2006, we increased our sales and marketing efforts significantly, including an increase from 21 to 60 U.S. sales representatives.

We have other product candidates in various stages of clinical development for the treatment of a range of dermatological conditions, including acne, psoriasis, onychomycosis and acute fungal infections, such as tinea versicolor. In addition, we have access to the classes of compounds claimed in the patents licensed to us under our license agreements with affiliates of Johnson & Johnson. We are currently conducting a screening program to search for new product candidates in the field of dermatology. The development of each of our product candidates involves significant risks. No assessment of the efficacy or safety of any product candidate can be considered definitive until all clinical trials needed to support a submission for marketing approval are completed.

We have financed our operations and internal growth almost entirely through proceeds from private placements of preferred stock, our initial public offering in the second quarter of 2004 and our follow-on public offerings in the first quarter of 2005 and in September 2006.

We were incorporated in September 2001 and commenced active operations in May 2002. Since our inception we have incurred significant losses. As of September 30, 2006, we had an accumulated deficit of $189.4 million. We plan to continue to invest in research and clinical development studies to develop our product candidates and screen for new product candidates. We also plan to seek marketing approvals for our products in various countries throughout the world, particularly in the United States, Canada and Europe. We expect to continue to spend significant amounts on the commercialization of our products, including the sales and marketing of Xolegel, Vusion and Solagé. Additionally, we plan to continue to evaluate possible acquisitions of development-stage or approved products that would fit within our growth strategy. Accordingly, we will need to generate significantly greater revenues to achieve and then maintain profitability.

Revenues consist of net product revenues and other revenues. Net product revenues consist of sales of our marketed products net of allowances for product returns, Medicaid and coupon rebates. In the United States and Canada, we sell our products primarily to wholesalers and distributors, who, in turn, sell to pharmacies. Other revenues include contract revenues such as license fees, royalties and other payments associated with collaborations with third parties.

Research and clinical development expenses represent:

	•		costs incurred for the conduct of our clinical trials,

	•		costs incurred in screening and pre-clinical testing of our product candidates,

	•		manufacturing development costs related to our clinical product candidates,

	•		personnel and related costs related to our research and product development activities (including stock based compensation expense as required under FAS 123(R)), and

	•		outside professional fees related to clinical development and regulatory matters.

We outsource the conduct of our clinical trials and all of our manufacturing development activities to third parties to maximize efficiency and minimize our internal overhead. We expense these research and development costs as they are incurred.

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

We expect to continue to incur net losses over the next several years as we continue our clinical development, apply for regulatory approvals, enter into arrangements with third parties for manufacturing and distribution services and market our products. We have a limited history of operations and anticipate that our quarterly results of operations will fluctuate for several reasons, including:

	•		the timing and extent of recognition of product and other revenues;

	•		the availability of coverage and reimbursement from third-party healthcare and state and federal government payors;

	•		the timing of any contract, license fee or royalty payments that we may receive or be required to make;

	•		the timing and outcome of our applications for regulatory approvals;

	•		the timing and extent of marketing and selling expenses;

	•		the timing and extent of our research and development efforts;

	•		the timing and extent of our adding new employees and infrastructure; and

	•		the timing and extent of employee stock grants and stock option grants.

Recent Developments

On November 8, 2006, counsel for the lead plaintiffs voluntarily dismissed, in its entirety and with prejudice, the putative securities class action lawsuit which had been brought against us, certain of our officers and certain of the underwriters for our 2004 initial public offering and 2005 secondary offering. Counsel for the lead plaintiffs filed the stipulation of dismissal, in which we, the individual defendants and the underwriters joined, in the United States District Court for the District of New Jersey, without any payment by us or any of the defendants to the plaintiffs or their counsel. We expect the court to enter an order with respect to the filing promptly.

Results of Operations

Three and nine months ended September 30, 2006 and September 30, 2005

Net Revenues. Net Revenues are summarized below:


(in thousands)	Three months ended				Nine months ended
	September 30,				September 30,
	2006		2005		2006		2005

Net product revenues
U.S.	$	1,852	$	128	$	3,096	$	396
International		111		27		287		64

Total net product revenues		1,963		155		3,383		460
Other revenues		153		471		286		1,291

Total net revenues	$	2,116	$	626	$	3,669	$	1,751

Total net revenue for the three months ended September 30, 2006 was $2.1 million as compared to $626,000 for the same period in 2005. Total net revenues for the nine months ended September 30, 2006 was $3.7 million an increase of $1.9 million, as compared to $1.8 million for the same period in 2005. Total net revenues growth during the three and nine month periods of 2006 as compared to the same periods in 2005 was primarily due to the launch of Vusion in the U.S. market.

Net Product Revenues.Net product revenues increased $1.8 million for the three months ended September 30,2006 versus the same period in 2005. The increase mostly reflects the launch of Vusion in the U.S. as well as increased sales from our other commercial products in the U.S. and Canada. Net product revenues increased $2.9 million for the nine months ended September 30, 2006 compared to the same period in 2006 primarily due to launch of Vusion. We expect product revenues to increase throughout 2007, as we expand the market for all of our products and we continue the U.S. launch of Xolegel.

Other Revenues.Other revenues consist of grant revenues from a Belgian research grant and milestone payments for certain product rights which are amortized over the estimated service period. Other revenues declined $318,000 for the three months ended September 30, 2006 compared to the same period in 2005, and $1.0 million for the nine months ended September 30, 2006 as compared to the same period in 2006. We expect quarterly grant revenues to remain at the current levels through 2007.

Cost of Product Revenues.Total cost of product revenues including cost of finished goods, distribution expenses, and amortization expenses related to our commercial products was $351,000, or 18% of net product revenue, for the third quarter of 2006, as compared to $163,000, or 105% of net product revenues, for the same period in 2005. This increase is attributable the significant growth in product revenue mostly from Vusion sales. Total cost of product revenues for the nine months ended September 30, 2006 increased $702,000 compared to the same period in 2005 due to higher sales volumes, primarily related to Vusion, and the recording of a $206,000 allowance for inventory obsolescence in Europe.

Research and Development Expenses.

Total research and development expenses decreased $1.4 million and $8.0 million, respectively for the three and nine months periods ended September 30, 2006 compared to the same periods in 2005, primarily due to lower project spending during in 2006.

Below is a summary of our research and development expenses:


(in thousands)	Three months ended							Nine months ended
	September 30,							September 30,
	2006		2005		Variance			2006		2005		Variance

Marketed Products	$	845	$	2,195		(1,350	)	$	1,984	$	4,879		(2,895	)
Hyphanox		680		412		268			1,701		4,601		(2,900	)
Liarozole		615		267		348			1,400		1,092		308
Other clinical stage products		1,711		2,034		(323	)		3,532		5,253		(1,721	)
Research and preclinical stage products costs		177		296		(119	)		498		1,146		(648	)
Internal costs		2,246		2,422		(176	)		7,334		7,446		(112	)

Total research and development expenses	$	6,274	$	7,626		(1,352	)	$	16,449	$	24,417		(7,968	)

In the preceding table, research and development expenses are set forth in the following seven categories:

	•		Marketed Products — Expenses for third quarter 2006 decreased due primarily to the absence of Xolegel development costs related to completion of our long-term safety study and NDA filing fees last year. Expenses for the nine months ending September 30, 2006 compared to the nine months ended September 30, 2005 decreased mostly related to the absence, in 2006, of the Xolegel long-term safety trial and other regulatory filing expenses on both Xolegel and Vusion in 2005.

	•		Hyphanox— Expenses in the three months ended September 30, 2006 compared to the three months ended September 30, 2005 increased. Our increased costs for Hyphanox in 2006 were primarily related to preparation of and start-up work on our Phase 3 study in onychomycosis. We expect these expenses to increase as we continue patient enrollment. The costs for this product in the third quarter of 2005 were primarily related to the completion of a Phase 3 clinical trial for the treatment of vaginal candidiasis. Hyphanox expenses for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 decreased primarily due to the absence of the 2005 Phase 3 clinical cost for vaginal candidiasis.

	•		Liarozole— Expenses for three months ending September 30, 2006 compared to the three months ended September 30, 2005 increased primarily due to our Phase 2/3 trial for the treatment of lamellar ichthyosis being conducted outside of the United States. Liarozole expenses for nine months ending September 30, 2006 compared to nine months ended September 30, 2005 increased primarily due to the Phase 2/3 trial for the treatment of lamellar ichthyosis in 2006, offset in part by manufacturing expenses occurring in 2005, which did not reoccur in 2006. Our costs for Liarozole in 2005 also related to the cost of the review of historical clinical data, clinical supplies and the manufacturing of the active ingredient.

	•		Other clinical stage product candidates — Other clinical stage product candidate costs for three months ending September 30, 2006 decreased compared to the same period in 2005. This quarterly decrease was primarily due to lower Azoline spending offset in part by higher spending on Rambazole. Other clinical stage product candidates costs for nine months ending September 30, 2006 cost decreased compared to the same period in 2005. This nine month decrease was primarily due to lower Rambazole spending offset in part by higher spending on Azoline. Spending on Rambazole and Azoline in both periods related primarily to manufacturing development and pre-clinical studies. We expect expenses for these products to increase in the

remainder of 2006 and into 2007 as we incur increased costs related to our Phase 2b studies for oral Rambazole and Azoline.

	•		Research and preclinical stage product costs—Our costs for research and preclinical stage product candidates for three months ending September 30, 2006 declined as compared to the corresponding period in 2005. Research and preclinical stage product costs for nine months, ending September 30, 2006 costs declined as compared to the corresponding period in 2005. This decline is partially due to completion of work under a Belgian research grant. These expenses generally encompass direct expenses relating to the development of our research and preclinical product candidates, including Ecalcidene, which was discontinued last year, and the screening of molecules to identify new product candidates.

	•		Internal costs— Internal research and development expenses, including personnel and related costs and stock compensation, decreased for the three months ending September 30, 2006 as compared to the corresponding period in 2005. The decrease is due to lower personnel and related costs offset partially by $277,000 of stock compensation expense under FAS 123(R) in the third quarter 2006. Internal costs for nine months ending September 30, 2006 costs were comparable to the corresponding period in 2005. The costs during the nine months ended September 30, 2006 reflects lower personnel, consulting and related costs offset in part by $1.1 million of stock compensation expense under FAS 123(R).

We anticipate that research and development expenses will increase as we begin to incur additional expenses for our mid-stage pipeline as we move toward larger and more expensive Phase 2 and Phase 3 trials and devote additional resources to our earlier stage research and preclinical projects. We also expect our personnel and related expenses for research and development to remain at current levels or increase as necessary to support our development activities.

Selling, general and administrative expense.Selling, general and administrative expenses totaled $8.9 million for the three months ended September 30, 2006, an increase of $3.2 million over the corresponding period in 2005. Selling, general and administrative expenses increased $12.3 million for the nine months ended September 30, 2006 compared to the same period in 2005. Our U.S. sales force, which was launched during the middle of 2005 and expanded from 21 to 60 sales associates last quarter, accounted for $2.2 million of this increase for the third quarter 2006 compared to the same period in 2005, and $6.7 million of this increase for the nine months ended September 30, 2006 as compared to the same period in 2005. In addition, brand marketing and market research expenses increased $497,000 for the third quarter 2006 compared to the same period in 2005, and $3.0 million for the nine months ended September 30, 2006 as compared to the same period in 2005. This increase is due to costs related to the recent launch of Vusion, pre-launch expenses for Xolegel, and support of our other commercial products in the U.S., Canada and Europe. Additionally, $649,000 of stock compensation expense was recorded under FAS 123(R) in the third quarter 2006 and $2.6 million for the nine months ended September 30, 2006.

We expect sales force costs and brand marketing and market research costs will remain at current levels and may increase as we support the launch of Xolegel and continue to invest in our commercial products. If we were to acquire or in-license additional products the related sales and marketing costs may also increase. We expect corporate administrative costs to increase modestly as required to support the growth of the Company.

Interest and other income, net of interest expense.Interest and other income, net of expense, totaled $735,000 for the three months ended September 30, 2006, a decrease of $26,000 as compared to the corresponding period in 2005. This decrease was due to lower investment balances partially offset by higher interest rates.Interest income, net of expense, totaled $2.2 million for the nine months ended September 30, 2006, an increase of $138,000 as compared to the corresponding period in 2005. This increase was the result of higher interest rates, partially offset by lower investment balances.

Liquidity and Capital Resources

Sources of Liquidity.Since our inception, we have funded our operations principally from issuances of our convertible preferred stock, the proceeds from our initial public offering of common stock, our two follow-on public offerings of common stock. In our most recent follow-on public offering, we issued and sold, through a registered direct offering, 4,820,000 shares of our common stock for net proceeds of approximately $24 million. Prior to that we raised net proceeds of approximately $36.1 million from our follow-on public offering in February 2005 and $67.9 million from our initial public offering in May 2004. Prior to becoming a public company, we issued preferred stock, including notes converted into preferred stock. All of the preferred stock that we issued converted to common stock in connection with our initial public offering. Through all of these offerings we have raised an aggregate net cash proceeds of approximately $128 million.

At September 30, 2006, we had cash, cash equivalents and marketable securities totaling $70.5 million and net working capital of $63.1 million.

Cash Flows.At September 30, 2006, we had $36.9 in cash and cash equivalents, as compared to $16.9 million at December 31, 2005.

Cash used in operating activities for the first nine months of 2006 was $31.4 million, mostly related to our $37.9 million net loss resulting primarily from our spending on commercial operations, research and development and corporate administration offset in part by $4.4 million non-cash expenses for depreciation, amortization of product rights and stock-based compensation. In addition, our payables and accruals have increased $3.3 million since year-end 2005 reflecting expenses related to clinical trial and sales and marketing activities. This favorable cash item was partially offset by an increase of $1.2 million of prepaid expenses. In 2005 cash used in operating activities was $33.3 million mostly related to the $35.0 million net loss from operations reflecting spending levels on research and development activities.

Cash provided by investing activities for the nine months ended September 30, 2006 was $27.4 million. This was primarily attributable to $27.7 million of net proceeds from marketable securities transactions offset slightly by fixed asset purchases. Cash provided by investing activities for the first nine months ended September 30, 2005 was $18.8 primarily related to $22.1 million net proceeds from marketable securities offset by $3.1 million used to purchase product rights for Solagé. Our investing activities reflect investments in marketable securities and purchases of fixed assets necessary for operations. We plan to continue utilizing third parties to manufacture our products and to conduct laboratory-based research; therefore, we do not expect to make significant capital expenditures for the foreseeable future.

Net cash provided by financing activities was $24.1 million for the first nine months ended September 30, 2006, related to proceeds from a registered direct offering in September 2006 with net proceeds of approximately $24.0 million, employee stock option exercises and purchase of common stock in our Employee Stock Purchase Plan offset by repayment of notes payable. In the first nine months of 2005, net cash provided by financing activities was $36.4 million primarily related to $36.1 million net proceeds from our follow-on offering.

We expect that our existing cash, cash equivalents and marketable securities at September 30, 2006 will be sufficient to fund our anticipated operating expenses, debt obligations and capital requirements for at least the next 12 months. We currently have no additional commitments or arrangements for any additional financing to fund the commercialization of our marketed products and the research, development and commercial launch of our product candidates. We will require additional funding in order to continue our commercialization efforts and our research and development programs, including preclinical studies and clinical trials of our product candidates, pursue regulatory approvals for our product candidates, pursue the commercial launch of our product candidates, expand our sales and marketing capabilities and for general corporate purposes. Our future capital requirements will depend on many factors, including:


	•		the success of our development and commercialization of our product candidates;

	•		the scope and results of our clinical trials;


	•		advancement of other product candidates into clinical development;

	•		potential acquisition or in-licensing of other products or technologies;

	•		the timing of, and the costs involved in, obtaining regulatory approvals;

	•		the costs of manufacturing activities;

	•		the availability of coverage and reimbursement from third-party healthcare and state and federal government payors; and

	•		the costs of commercialization activities, including product marketing, sales and distribution and related working capital needs.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which 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. On an ongoing basis, we evaluate our estimates and assumptions. 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. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 1 to our consolidated financial statements, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating our reported financial results.

Revenue Recognition

We record net product and other revenues based on revenue recognition criteria in Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements,” Emerging Issues Task Force (“EITF”) Issue 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) and Statement of Financial Accounting Standards No 48 (“FAS 48”) “Revenue Recognition When Right of Return Exists.

Net Product Revenue.In the United States and Canada, we sell our products primarily to wholesalers and distributors, who, in turn, sell to pharmacies. The following are the Company’s revenue recognition policies.

At the time of a new product launch, we utilize a pull-through sales method that recognizes revenue based on estimated prescription demand based on third party market research data and revenue for a normal level of wholesaler inventory based on our estimated current prescription demand. Estimating the amount of returns and discounts for new products is based on specific facts and circumstances including acceptance rates of established products with similar marketing characteristics. At the time of a new product launch, absent the ability to make reliable estimates we defer revenue on sales to wholesalers until we can make reliable estimates of returns, discounts and related end user demand. We monitor our inventory levels at our wholesalers and pharmacies to ensure these levels remain within normal levels. We estimate inventory at wholesalers based on historical sales to wholesalers, inventory data provided to us by these wholesalers and from third party market research data related to prescription trends and patient demand. Making these determinations involves estimating whether trends in past buying patterns are indicative of future product sales.

We record allowances for product returns, Medicaid, coupon rebates and other discounts at the time of product sale, and report revenue net of such amounts. In determining allowances for product returns, Medicaid and coupon rebates, we must make significant judgments and estimates. For example, in determining these amounts, we estimate prescription demand and the levels of inventory held by wholesalers. Making these determinations involves estimating whether trends in past buying patterns will predict future product sales.

The nature of our allowances requiring critical accounting estimates, and the specific considerations we use in estimating their amounts, are as follows:

•

Product returns. Our customers have the right to return any unopened product during the 18-month period beginning six months prior to the labeled expiration date and ending 12 months after the labeled expiration date. As a result, in calculating the allowance for product returns, we must estimate the likelihood that product sold to wholesalers and pharmacies might remain in their inventory to within six months of expiration and analyze the likelihood that such product will be returned within 12 months after expiration.

In estimating the likelihood of product remaining in our wholesalers’ inventory, we rely on information from our wholesalers regarding their inventory levels, measured prescription demand as reported by third party sources and on internal sales data. We believe the information from our wholesalers and third party sources is directionally reliable, but we are unable to verify the accuracy of such data independently. We also consider our wholesalers’ past buying patterns, estimated remaining shelf life of product previously shipped and the expiration dates of product currently being shipped. In estimating the likelihood of product return, we rely primarily on historic patterns of returns and estimated remaining shelf life of product previously shipped.

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Medicaid Rebates— In some states we participate or have applied to participate in the Federal Medicaid rebate program, as well as several state government-managed supplemental Medicaid rebate programs, which were developed to provide assistance to certain vulnerable and needy individuals and families. Under the Medicaid rebate program, we pay a rebate to each participating state and local government for our products that their programs reimburse. For purposes of this discussion, discounts and rebates provided through these programs are considered Medicaid rebates and are included in our Medicaid rebate accrual.

We establish an accrual in the amount equal to our estimate of Medicaid rebates attributable to our sales in the period in which we record the sale as revenue. Although we accrue a liability for estimated Medicaid rebates at the time we record the sale, the actual Medicaid rebate related to a sale may not be billed to us until several months after the sale. We consider the then-current Medicaid rebate laws and interpretations; the historical and estimated future percentage of our products that are sold to Medicaid recipients by pharmacies, hospitals, and other retailers that buy from our customers; our product pricing and current rebate and/or discount contracts; and the levels of inventory in the distribution channel in determining the appropriate accrual amount. We analyze the accrual at least quarterly and will adjust the balance as required.

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Coupon Rebates— From time to time we offer patients a limited time coupon discount on their purchases. We provide a mail-in rebate coupon to the patient with a proof of purchase. As a result of these rebate offers, at the time of product shipment, we must estimate the likelihood that products sold to wholesalers and pharmacies might be ultimately sold to a patient who redeems a coupon. We base our estimates on the historic coupon redemption rates for similar products we receive from third party administrators, which detail historic patterns.

We will adjust our allowances for product returns, Medicaid, coupon rebates and other discounts based on our actual sales experience. We continually monitor our allowances and make adjustments when we believe actual experience may differ from our estimates.

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International Distribution Partners.Under our agreements with international distribution partners, we plan to sell our product to our distribution partners at a contractual price. These partners generally have no rights of return after they have accepted shipment of the product.

arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured.

Revenue from non-refundable, upfront license fees where we have a continuing involvement is recognized ratably over the performance period. Royalties from licensees are based on third-party sales of licensed products and are recorded in accordance with contract terms when third-party results are reliably measurable and collectibility is reasonably assured. We periodically re-evaluate our estimates of the performance period and revise our assumptions as appropriate. These changes in assumptions may affect the amount of revenue recorded in our financial statements in future periods.

Stock-based Compensation

As a result of adopting FAS 123(R), the Company’s net loss is larger than had it continued to account for share-based compensation under Accounting Principles Board Opinion 25 (APB 25). For the three- and nine-month period ended September 30, 2006, the Company’s net loss was approximately $0.9 and $3.7 million higher, respectively than if the Company had continued to account for share-based compensation under APB 25.

Prior to January 1, 2006, as allowed by SFAS 123, the Company had applied the intrinsic value-based method of accounting prescribed in APB 25 and its related interpretations, and, accordingly, did not recognize compensation expense for stock option grants made at an exercise price equal to or in excess of the fair market value of the stock at the date of grant. For pro forma purposes, the stock compensation expense was based on an accelerated vesting method. SFAS 123 pro forma information regarding net loss was required by SFAS 123, and had been determined as if the Company had accounted for its stock-based employee compensation under the fair value method prescribed in SFAS 123. The fair value of the options were estimated using the Black-Scholes pricing model. In addition, no compensation expense was recorded in the financial statements for shares purchased under the Company’s Employee Stock Purchase Plan as that plan was considered non-compensatory under APB 25.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Our exposure to market risk is limited to our cash, cash equivalents and marketable securities. We invest in high-quality financial instruments, primarily money market funds, federal agency notes, corporate debt securities and United States treasury notes, with the effective duration of the portfolio less than one year, which we believe are subject to limited credit risk. We currently do not hedge our interest rate exposure. Due to the short-term nature of our investments, we do not believe that we have any material exposure to interest rate risk arising from our investments.

Most of our transactions are conducted in United States dollars, although we do have some agreements with vendors located outside the United States. Transactions under some of these agreements are conducted in United States dollars, subject to adjustment based on significant fluctuations in currency exchange rates. Transactions under other of these agreements are conducted in the local foreign currency. We have a wholly-owned subsidiary, Barrier Therapeutics, N.V., which is located in Geel, Belgium and a wholly owned subsidiary, Barrier Therapeutics Canada Inc., which is located in Toronto, Canada. Except for funding being received under our grant from a Belgian governmental agency, which is denominated in Euros and locally earned interest income, all research costs incurred by Barrier Therapeutics, N.V. are funded under a service agreement with Barrier Therapeutics, Inc. from investments denominated in dollars. Our Canadian subsidiary, Barrier Therapeutics Canada, Inc. became operational in the third quarter of 2005. While we expect that there will be some income from sales of products during the next year which will be denominated in Canadian dollars, most of the funding for these operations will also come from investments denominated in dollars. Therefore, we are subject to currency fluctuations and exchange rate gains and losses on these transactions. If the exchange rate undergoes a change of 10%, we do not believe that it would have a material impact on our results of operations or cash flows.

ITEM 4. CONTROLS AND PROCEDURES

Management, with the participation of our Chief Executive Officer, Chief Financial Officer and Principal Accounting 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, Chief Financial Officer and Principal Accounting Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

Change in Internal Control Over Financial Reporting

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.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In October 2005, a putative class action lawsuit was filed in the United States District Court for the District of New Jersey against us and certain of our officers on behalf of all persons who purchased or acquired securities of Barrier Therapeutics, Inc. between April 29, 2004 and June 29, 2005. At least four additional putative class action lawsuits have also been filed against us and certain of our officers, all pleading essentially the same allegations. In an Order entered on December 19, 2005, the Court consolidated these cases. By Order dated March 2, 2006, the Court appointed lead plaintiffs and approved co-lead counsel. On May 22, 2006, lead plaintiffs filed a Consolidated Class Action Complaint for Violations of Federal Securities Laws (“Complaint”). The Complaint brings claims against us, certain of our officers and a director, and Morgan Stanley & Co., Inc. and J.P. Morgan Securities, Inc., underwriters for our initial public offering in 2004 and secondary offering in 2005, as well as Pacific Growth Equities, LLC, an underwriter for our secondary offering in 2005 (collectively “the Underwriters.”) The Complaint asserts that we and the Underwriters violated Sections 11 and 12 of the Securities Act of 1933, that we violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and that the individual defendants are liable for controlling person liability under Section 15 of the Securities Act of 1933 and Section 20(a) of the Securities Exchange Act of 1934. The Complaint is based upon purported misstatements relating to Vusion and Hyphanox.

We filed a Motion to Dismiss the claims on August 25, 2006. On November 8, 2006, counsel for the lead plaintiffs voluntarily dismissed the lawsuit, in its entirety and with prejudice, by filing a stipulation of dismissal, in which we, the individual defendants and the underwriters joined, in the United States District Court for the District of New Jersey, without any payment by us or any of the defendants to the plaintiffs or their counsel. We expect the court to enter an order with respect to the filing promptly.

ITEM 1A. RISK FACTORS

RISKS RELATED TO OUR BUSINESS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below before purchasing our securities. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall, and you may lose all or part of the money you paid to buy our securities.

Risks Related to Our Financial Results and Need for Additional Financing

We have incurred losses since inception and anticipate that we will continue to incur losses for the foreseeable future.

Since our inception in September 2001, we have incurred significant operating losses and, as of September 30, 2006, we had an accumulated deficit of $189.4 million. We currently market Xolegel, Vusion and Solagé in the United States and Solagé, VANIQA and Denavir in Canada. Our product pipeline includes several product candidates in various stages of clinical development. Prior to our acquisition of Solagé in February 2005, we had generated no revenues from the sale of our products. We expect to continue to incur significant operating expenses and anticipate that our expenses may increase substantially in the foreseeable future as we:

	•		conduct additional clinical trials;

	•		conduct research and development on existing and new product candidates;

	•		seek regulatory approvals for our product candidates;

	•		commercialize our products;

	•		hire additional clinical, scientific, sales and marketing, management and compliance personnel;

	•		add operational, financial and management information systems; and

	•		identify and in-license or acquire additional compounds, technologies, marketed products or businesses.

We need to generate significant revenue to achieve profitability. We may never generate sufficient sales revenue to achieve and then maintain profitability. We expect to incur operating losses for the foreseeable future.

We will need substantial additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or commercialization efforts.

As of September 30, 2006, we had cash, cash equivalents and marketable securities of $70.5 million. We believe that our existing cash resources and our interest on these funds will be sufficient to meet our projected operating requirements for at least the next 12 months. We currently have no additional commitments or arrangements for any additional financing to fund the commercialization of our marketed products and the research, development and commercial launch of our product candidates. We will require additional funding in order to continue our commercialization efforts and our research and development programs, including preclinical studies and clinical trials of our product candidates, pursue regulatory approvals for our product candidates, pursue the commercial launch of our products, expand our sales and marketing capabilities and for general corporate purposes. Our future capital requirements will depend on many factors, including:

	•		the success of our commercialization of our marketed products;

	•		the costs of commercialization activities, including manufacturing, product marketing, sales and distribution, compliance, and related working capital needs;

	•		the advancement and success of the development of our product candidates, including clinical trial results;

	•		our ability to advance early stage compounds into clinical development;

	•		the timing of, and the costs involved in, obtaining regulatory approvals;

	•		the costs of manufacturing activities for our clinical trials;

	•		the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other intellectual property-related costs, including any possible litigation costs;

	•		our ability to establish and maintain collaborative and other strategic arrangements; and

	•		potential acquisition or in-licensing of other technologies, products or businesses.

Adequate financing may not be available on terms acceptable to us, if at all. We may continue to seek additional capital through public or private equity offerings, debt financings or collaborative arrangements and licensing agreements.

If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions such as incurring additional debt, making capital expenditures or declaring dividends. Any debt financing that we raise or additional equity we may sell may contain terms that are not favorable to us or our common stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it will be necessary to relinquish some rights to our technologies or our product candidates or grant licenses on terms that may not be favorable to us. Lack of funding could adversely affect our ability to pursue our business. For example, if adequate funds are not available, we may be required to curtail significantly or eliminate one or more of our product development programs.

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

Variations in our quarterly operating results are difficult to predict and may fluctuate significantly from period to period. We are a relatively new company and our sales prospects are uncertain as we have only recently commenced our commercialization efforts. In the U.S. we currently only have three FDA-approved products: Solagé, Vusion and Xolegel. We cannot predict with certainty the timing of level of sales on these products in the future. If our quarterly sales or operating results fall below expectations of investors or securities analysts, the price of our common stock could decline substantially.

Risks Related to Development of Product Candidates

We will not be able to commercialize our product candidates if our preclinical studies do not produce successful results or if our clinical trials do not demonstrate safety and efficacy in humans.

We intend to market our products in the United States and in various other countries. As a result, we will need to obtain separate regulatory approvals in most jurisdictions. Before obtaining regulatory approval for the sale of our product candidates, we must conduct extensive preclinical studies and clinical trials to demonstrate the safety and efficacy in humans of our product candidates. Preclinical studies and clinical trials are expensive, can take many years and have uncertain outcomes. In addition, the regulatory approval procedures vary among countries and additional testing may be required in some jurisdictions.

Our success will depend on the success of our currently ongoing clinical trials and subsequent clinical trials that have not yet begun. It may take several years to complete the clinical trials of a product, and a failure of one or more of our clinical trials can occur at any stage of testing. We believe that the development of each of our product candidates involves significant risks at each stage of testing. If clinical trial difficulties and failures arise, our product candidates may never be approved for sale or become commercially viable. We do not believe that any of our product candidates have alternative uses if our current development activities are unsuccessful.

There are a number of difficulties and risks associated with clinical trials. These difficulties and risks may result in the failure to receive regulatory approval to sell our product candidates or the inability to commercialize any of our product candidates. For instance, we may discover that a product candidate does not exhibit the expected therapeutic results in humans, may cause harmful side effects or have other unexpected characteristics that may delay or preclude regulatory approval or limit commercial use if approved. For example, in June 2005, we announced that our Hyphanox product candidate failed to reach the primary endpoint in its Phase 3, non-inferiority trial for the treatment of vaginal candidiasis. Consequently, the results of this trial were not sufficient to support a filing for regulatory approval for Hyphanox in that indication. The risk of clinical trial failure is even greater where the product candidate contains a new chemical entity, such as Azoline, Rambazole and Hivenyl, and where the product candidate uses a novel mechanism of action, such as Rambazole.

In addition, the possibility exists that:

	•		the results from early clinical trials may not be statistically significant or predictive of results that will be obtained from expanded, advanced clinical trials;

	•		institutional review boards or regulators, including the FDA, may hold, suspend or terminate our clinical research or the clinical trials of our product candidates for various reasons, including noncompliance with regulatory requirements or if, in their opinion, the participating subjects are being exposed to unacceptable health risks;

	•		subjects may drop out of our clinical trials;

	•		our preclinical studies or clinical trials may produce negative, inconsistent or inconclusive results, and we may decide, or regulators may require us, to conduct additional preclinical studies or clinical trials; and

•

the cost of our clinical trials may be greater than we currently anticipate.

For example, the FDA has placed our Liarozole and oral Rambazole product candidates on clinical hold. Moreover, due to the expected costs and time required to address the FDA’s request for significant additional safety data and other requirements for Liarozole, we have placed the further U.S. development of this product candidate on hold. We may never complete the development of Liarozole in the U.S.

With respect to some of our product candidates, we expect to rely on the data and results of pre-clinical tests and clinical trials that were performed by or on behalf of Janssen Pharmaceutica Products, L.P. and its affiliates prior to our acquisition of these product candidates. It is possible that these trial results may not be predictive of the results of the clinical trials that we conduct for our product candidates. In addition, the results of these prior clinical trials may not be acceptable to the FDA or similar foreign regulatory authorities because the data may be incomplete, outdated or not otherwise acceptable for inclusion in our submissions for regulatory approval.

If we do not receive regulatory approval to sell our product candidates or cannot successfully commercialize our product candidates, we would not be able to grow revenues in future periods, which would result in significant harm to our financial position and adversely impact our stock price.

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

Planned clinical trials may not begin on time, may take longer to complete than anticipated, or may need to be restructured after they have begun. Clinical trials can be delayed for a variety of reasons, including delays related to:

	•		obtaining an effective investigational new drug application, or IND, or regulatory approval to commence a clinical trial;

	•		identifying and engaging a sufficient number of clinical trial sites;

	•		negotiating acceptable clinical trial agreement terms with prospective trial sites;

	•		obtaining institutional review board approval to conduct a clinical trial at a prospective site;

	•		recruiting qualified subjects to participate in clinical trials;

	•		competition in recruiting clinical investigators;

	•		shortage or lack of availability of supplies of drugs for clinical trials;

	•		the need to repeat clinical trials as a result of inconclusive results or poorly executed testing;

	•		the placement of a clinical hold on a study;

	•		the failure of third parties conducting and overseeing the operations of our clinical trials to perform their contractual or regulatory obligations in a timely fashion; and

	•		exposure of clinical trial subjects to unexpected and unacceptable health risks or noncompliance with regulatory requirements, which may result in suspension of the trial.

The risk of delay is greater for large scale clinical trials such as our Phase 3 trial for Hyphanox in toenail onychomycosis. This is because studies which have a greater number of patients and investigator sites are more likely to experience one or more of the occurrences identified above. If we are not able to identify and engage a sufficient number of investigator sites or enroll a sufficient number of patients in our Hyphanox Phase 3 study in a timely manner, the completion of that trial would be delayed.

We believe that our product candidates have significant milestones to reach, including the successful completion of clinical trials, before commercialization. If we continue to have significant delays in or termination of clinical trials, our financial results and the commercial prospects for our product candidates or any other products that we may develop will be adversely impacted. In addition, our product development costs would increase and our ability to generate revenue could be impaired.

If we are wrong in our assessment of the stages of clinical development of our initial product candidates, we may need to perform preclinical studies or clinical trials that we did not anticipate, which would result in additional product development costs for us and delays in filing for regulatory approval for our product candidates.

We acquired the rights to our initial product candidates from Janssen Pharmaceutica Products, L.P., Johnson & Johnson Consumer Companies, Inc. and Ortho-McNeil Pharmaceutical, Inc., each a Johnson & Johnson company. Prior to this acquisition, they had conducted preclinical studies and clinical trials on several of our product candidates. For our product candidates for which we are not currently conducting a clinical trial, we have made an assessment as to whether the next clinical trial that we will perform will be a Phase 1, Phase 2 or Phase 3 clinical trial based on the results of these preclinical studies and clinical trials. We may be wrong in our assessment of the stages of clinical development of our initial product candidates for several reasons, including that the data we obtained from the previous trials may be outdated or otherwise no longer acceptable for our purposes or to the FDA or similar regulatory authorities in connection with applications that we may file for regulatory approval. If our current assessments prove to be inaccurate, we will likely have to perform additional preclinical studies or clinical trials, which will require us to expend additional resources and may delay filing for regulatory approval for that product.

Risks Related to Regulatory Approval of Our Product Candidates

We may not receive regulatory approvals for our product candidates or approvals may be delayed, either of which could materially harm our business.

Government authorities in the United States and foreign countries extensively regulate the development, testing, manufacture, distribution, marketing and sale of our product candidates and our ongoing research and development activities. Our failure to receive regulatory approval, or failure to receive regulatory approval within the anticipated timeframe, for our product candidates could significantly adversely affect future revenues.

The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved. According to the FDA, a Phase 1 clinical trial typically takes several months to complete, a Phase 2 clinical trial typically takes several months to two years to complete and a Phase 3 clinical trial typically takes one to four years to complete. Moreover, Phase 3 clinical trials may not directly follow successful completion of Phase 2 clinical trials. For instance, under recently revised guidelines of the International Conference on Harmonization, or ICH, the FDA may require a cardiovascular safety study at the expected dose and an elevated dose prior to initiating Phase 3 clinical trials.

Industry sources report that the preparation and submission of new drug applications, or NDAs, which are required for regulatory approval, generally take six months to one year to complete after completion of a pivotal clinical trial. Industry sources also report that approximately 10 to 15% of all NDAs accepted for filing by the FDA are rejected and that FDA approval, if granted, usually takes approximately one year after submission, although it may take longer if additional information is required by the FDA. Accordingly, we cannot assure you that the FDA will approve any NDA that we may file. In addition, the Pharmaceutical Research and Manufacturers of America reports that only one out of five product candidates that enter clinical trials will ultimately be approved by the FDA for commercial sale.

In particular, human therapeutic products are subject to rigorous preclinical studies, clinical trials and other approval procedures of the FDA and similar regulatory authorities in foreign countries. The FDA regulates, among other things, the development, testing, manufacture, safety, efficacy, record keeping, labeling, storage, approval, advertising, promotion, sale and distribution of pharmaceutical products. Securing FDA approval requires the

submission of extensive preclinical and clinical data, information about product manufacturing processes and inspection of facilities and supporting information to the FDA for each therapeutic indication to establish the product candidate’s safety and efficacy. Varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent regulatory approval of a product candidate. For example in May 2005, the FDA issued a not approvable letter for Vusion. Although the FDA ultimately approved our Vusion product in February 2006, the FDA’s initial interpretation of our data and resulting not approvable letter resulted in delay of approximately nine months.

Changes in the FDA approval process during the development period or changes in regulatory review for each submitted product application may also cause delays in the approval or result in rejection of an application. In addition, recent withdrawals of approved products by major pharmaceutical companies may result in a renewed focus on safety at the FDA, which may result in delays in the approval process.

The FDA has substantial discretion in the approval process and may reject our data or disagree with our interpretations of regulations or our clinical trial data or ask for additional information at any time during their review, which could result in one or more of the following:

	•		delays in our ability to submit an NDA;

	•		the refusal by the FDA to file any NDA we may submit;

	•		requests for additional studies or data;

	•		delays of an approval; or

	•		the rejection of an application.

Any FDA or other regulatory approval of our product candidates, once obtained, may be withdrawn, including for failure to comply with regulatory requirements, an increase in, or appearance of new, adverse events, or if clinical or manufacturing problems follow initial marketing. If our product candidates are marketed abroad, they will also be subject to extensive regulation by foreign governments.

In addition, any proposed brand name that we intend to use for our product candidates will require approval from the FDA. The FDA typically conducts a rigorous review of proposed product names, including an evaluation of potential for confusion with other product names. The FDA may also object to a product name if it believes the name inappropriately implies medical claims.

Any failure to receive the regulatory approvals necessary to commercialize our product candidates would severely harm our business. The process of obtaining these approvals and the subsequent compliance with appropriate domestic and foreign statutes and regulations require spending substantial time and financial resources. If we fail to obtain or maintain, or encounter delays in obtaining or maintaining, regulatory approvals, it could adversely affect the marketing of any product candidate we develop, our ability to receive product or royalty revenues, and our liquidity and capital resources.

If we fail to comply with regulatory requirements, regulatory agencies may take action against us, which could significantly harm our business.

Our marketed products, along with the manufacturing processes, post-approval clinical data, labeling, advertising and promotional activities for these products, are subject to continual requirements and review by the FDA and other regulatory bodies. With respect to our product candidates being developed, even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval or contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the product.

In addition, regulatory authorities subject a marketed product, its manufacturer and the manufacturing facilities to continual review and periodic inspections. We will be subject to ongoing FDA requirements, including required

submissions of safety and other post-market information and reports, registration requirements, cGMP regulations, requirements regarding the distribution of samples to physicians and recordkeeping requirements. The cGMP regulations include requirements relating to quality control and quality assurance, as well as the corresponding maintenance of records and documentation. We rely on the compliance by our contract manufacturers with cGMP regulations and other regulatory requirements relating to the manufacture of products. We are also subject to state laws and registration requirements covering the distribution of our products. Regulatory agencies may change existing requirements or adopt new requirements or policies. We may be slow to adapt or may not be able to adapt to these changes or new requirements. Because many of our products contain ingredients that also are marketed in over-the-counter drug products, there is a risk that the FDA or an outside third party at some point would propose that our products be distributed over-the-counter rather than by prescription potentially affecting third-party and government reimbursement for our products.

Later discovery of previously unknown problems with our products, manufacturing processes or failure to comply with regulatory requirements, may result in any of the following:

	•		restrictions on our products or manufacturing processes;

	•		warning letters;

	•		withdrawal of the products from the market;

	•		voluntary or mandatory recall;

	•		fines;

	•		suspension or withdrawal of regulatory approvals;

	•		suspension or termination of any of our ongoing clinical trials;

	•		refusal to permit the import or export of our products;

	•		refusal to approve pending applications or supplements to approved applications that we submit;

	•		product seizure; and

	•		injunctions or the imposition of civil or criminal penalties.

Some of our product candidates are based on new chemical entities that have not been extensively tested in humans, which may affect our ability or the time we require to obtain necessary regulatory approvals.

Some of our product candidates are based on new chemical entities that have not been extensively tested in humans. The regulatory requirements governing these types of products may be less well defined or more rigorous than for conventional products. As a result, we may experience a longer and more expensive regulatory process in connection with obtaining regulatory approvals of these types of product candidates.

This risk is particularly applicable to our Liarozole and Rambazole product candidates, which are based on a novel class of molecules known as retinoic acid metabolism blocking agents. Since 2004, the FDA has become increasingly concerned about the safety profile of a class of drugs known as synthetic retinoids. Although Liarozole and oral Rambazole are not synthetic retinoids, they block the intracellular metabolism of natural retinoic acid in cells, resulting in an increased accumulation of the body’s own retinoic acid. Since this accumulation is designed to provide the same therapeutic benefits of synthetic retinoid therapy, the FDA may impose a more difficult, time consuming and expensive regulatory path in order to commence and complete the clinical testing of these product candidates as compared to others in our pipeline at the same stage of development. The FDA has placed our Liarozole and oral Rambazole product candidates on clinical hold. Due to the expected costs and time required to address the FDA’s request for significant additional safety data and other requirements for Liarozole, we have placed the further U.S. development of this product candidate on hold. Since, the active ingredient of our topical

Rambazole product candidate is the same as oral Rambazole, we may experience a longer and more expensive regulatory process for this product candidate.

If we fail to obtain regulatory approval in foreign jurisdictions, we would not be able to market our products abroad, and the growth of our revenues, if any, would be limited.

We intend to have our products marketed outside the United States. In order to market our products in the European Union and many other foreign jurisdictions, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and jurisdictions and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or by the FDA. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions. For example, although our Xolegel product has received marketing approval from the FDA, we may not be able to obtain regulatory approval for Xolegel in Europe if the European regulatory authorities require data that could only be obtained by conducting an additional clinical trial, which we currently do not plan to do. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could materially adversely affect our business, financial condition and results of operations.

Risks Related to Commercialization

If our products and product candidates for which we receive regulatory approval do not achieve broad market acceptance, the revenues that we generate from their sales will be limited.

The commercial success of our products and our product candidates for which we obtain marketing approval from the FDA or other regulatory authorities will depend upon the acceptance of these products by physicians, patients and healthcare payors. Safety, efficacy, convenience and cost-effectiveness, particularly as compared to competitive products, are the primary factors that affect market acceptance. Even if a product displays a favorable efficacy and safety profile in clinical trials, market acceptance of the product will not be known until after it is launched. In the United States, we only have three FDA approved products: Xolegel, Vusion and Solagé. Our efforts to educate the medical community and third-party healthcare payors on the benefits of Xolegel, Vusion and Solagé, or any of our future products may require significant resources and may never be successful.

If our products fail to achieve and maintain market acceptance, including coverage by private and public health care insurers, or if new products or technologies are introduced by others that are more favorably received than our products, or if we are otherwise unable to market and sell our products successfully, our business, financial condition, results of operations and future growth will suffer.

If third-party payors do not reimburse patients for our products those products might not be used or purchased, and our revenues and profits will not grow.

Our revenues and profits depend, in part, upon the availability of coverage and reimbursement from third-party healthcare and state and federal government payors. Third-party payors include state and federal programs such as Medicare and Medicaid, managed care organizations, private insurance plans and health maintenance organizations. Reimbursement by a third-party payer may depend upon a number of factors, including determination if the product is:

	•		competitively priced;

	•		safe, effective and medically necessary;

	•		appropriate for the specific patient;

	•		cost-effective; and

	•		approved for the intended use.

Since reimbursement approval for a product is required from third-party and government payors, seeking this approval, particularly when seeking approval for a preferred form of reimbursement over other competitive products, is a time-consuming and costly process.

Managed care organizations and other third-party payors negotiate the pricing of medical services and products to control their costs. Managed care organizations and pharmacy benefit managers typically develop formularies to reduce their cost for medications. Formularies can be based on the prices and therapeutic benefits of the available products. Due to their lower costs, generics are often favored on formularies and the active ingredients in each of our marketed products are generically available, although not in the same formuulations as our products. Consumers and third-party payors may not view our marketed products as cost-effective, and consumers may not be able to get reimbursement or reimbursement may be so low that we cannot market our products on a competitive basis. If a product is excluded from a formulary, its usage may be sharply reduced in the managed care organization patient population. If our products, particularly our Vusion and Xolegel products, are not included within an adequate number of formularies or adequate reimbursement levels are not provided, or if those policies increasingly favor generic products, our market share and gross margins could be negatively affected, as could our overall business and financial condition.

We have limited sales and marketing experience, and, as a result, may be unable to compete successfully with our competitors in commercializing our product candidates.

We currently have a sales force comprised of our own sales representatives and regional managers, supplemented by additional sales representatives who work for us under contract with a contract sales organization. This combined sales force has limited experience in marketing our products. We cannot control, other than by contract, the performance of our contract sales organization. We may encounter difficulty in recruiting and training our sales force to be able to market our products in the dermatological market, which could have a material adverse effect on our financial condition and business strategy.

If we fail to comply with the laws governing the marketing and sale of our products regulatory agencies may take action against us, which could significantly harm our business.

As a pharmaceutical company, we are subject to a large body of legal and regulatory requirements. In particular, there are many federal, state and local laws that we need to comply with now that we are engaged in the marketing, promoting, distribution and sale of pharmaceutical products. The FDA extensively regulates, among other things, promotions and advertising of prescription drugs. In addition, the marketing and sale of prescription drugs that are covered under Medicaid and Medicare, must comply with the Federal fraud and abuse laws, which are enforced by the Office of the Inspector General of the Division, or OIG, of the Department of Health and Human Services. These laws make it illegal for anyone to give or receive anything of value in exchange for a referral for a product or service that is paid for, in whole or in part, by any federal health program. The federal government can pursue fines and penalties under the Federal False Claims Act which makes it illegal to file, or induce or assist another person in filing, a fraudulent claim for payment to any governmental agency.

Since, as part of our commercialization efforts, we provide physicians with samples we must comply with the Prescription Drug Marketing Act, or PDMA, which governs the distribution of prescription drug samples to healthcare practitioners. Among other things, the PDMA prohibits the sale, purchase or trade of prescription drug samples. It also sets out record keeping and other requirements for distributing samples to licensed healthcare providers.

In addition, we must comply with the body of laws comprised of the Medicaid Rebate Program, the Veterans’ Health Care Act of 1992 and the Deficit Reduction Act of 2005. This body of law governs product pricing for government reimbursement and sets forth detailed formulas for how we must calculate the pricing of our products so as to ensure that the federally funded programs will get the best price.

Moreover, many states have enacted laws dealing with fraud and abuse, false claims, the distribution of prescription drug samples and the calculation of best price. These laws typically mirror the federal laws but in some cases, the state laws are more stringent than the federal laws and often differ from state to state, making compliance more difficult. We expect more states to enact similar laws, thus increasing the number and complexity of requirements with which we would need to comply.

Compliance with this body of laws is complicated, time consuming and expensive. We are a relatively small company that only recently began selling pharmaceutical products. As such, we have very limited experience in developing and managing, and training our employees regarding, a comprehensive healthcare compliance program. We cannot assure you that we are or will be in compliance with all potentially applicable laws and regulations. Even minor, inadvertent irregularities can potentially give rise to claims that the law has been violated. Failure to comply with all potentially applicable laws and regulations could lead to penalties such as the imposition of significant fines, debarment from participating in drug development and marketing and the exclusion from government-funded healthcare programs. The imposition of one or more of these penalties could adversely affect our revenues and our ability to conduct our business as planned.

In addition, the Federal False Claims Act, which allows any person to bring suit alleging the false or fraudulent submission of claims for payment under federal programs and other violations of the statute and to share in any amounts paid by the entity to the government in fines or settlement. Such suits, known as qui tam actions, have increased significantly in recent years and have increased the risk that companies like us may have to defend a false claim action. We could also become subject to similar false claims litigation under state statutes. If we are unsuccessful in defending any such action, such action may have a material adverse effect on our business, financial condition and results of operations.

We rely on third parties to perform many necessary commercial services for our products, including services related to the distribution, storage, and transportation of our products.

We rely on the Specialty Pharmaceutical Services unit of Cardinal Health PTS, LLC, to perform a variety of functions related to the sale and distribution of our products in the United States. These services include distribution, logistics management, inventory storage and transportation, invoicing and collections. We rely on McKesson Logistics Solutions for similar functions related to the import, quality testing, sale and distribution of our products in Canada. If these third party service providers fail to comply with applicable laws and regulations, fail to meet expected deadlines or otherwise do not carry out their contractual duties, our ability to deliver products to meet commercial demand would be significantly impaired.

We depend on three wholesalers for the vast majority of our product revenues in the United States, and the loss of any of these wholesalers would decrease our revenues.

The prescription drug wholesaling industry in the United States is highly concentrated, with a vast majority of all sales made by three major full-line companies. Those companies are Cardinal Health, McKesson Corporation and AmerisourceBergen. We expect that a vast majority of our product revenues will be from these three companies. Although we have entered into agreements with each of these companies concerning the terms of their purchase of products from us, none of them is under an obligation to continue to purchase our products. The loss of any of these wholesalers, a material reduction in their purchases, the cancellation of product orders or unexpected returns of unsold products, or the failure to pay an outstanding invoice, from any one of these wholesalers could decrease our revenues and impede our future growth prospects.

We may acquire additional products, product candidate, technology and businesses in the future and any difficulties from integrating such acquisitions could damage our ability to attain profitability.

We have acquired our entire current product pipeline by licensing intellectual property from third parties, and we may acquire additional products or product candidates or technologies that complement or augment our existing product development pipeline. However, because we acquired substantially all of our existing product candidates in the same transaction, we have limited experience integrating products or product candidates into our existing operations. Integrating any newly acquired product or product candidate could be expensive and time-consuming. We may not be able to integrate any acquired product or product candidate successfully. Moreover, we may need to raise additional funds through public or private debt or equity financing to make these acquisitions, which may result in dilution for stockholders and the incurrence of indebtedness.

We plan to consider, as appropriate, acquisitions of businesses, which may subject us to a number of risks that may affect our stock price, operating results and financial condition. If we were to acquire a business in the future, we would need to consolidate and integrate its operations with our business. Integration efforts often take a significant amount of time, place a significant strain on our managerial, operational and financial resources, and

could prove to be more difficult and expensive than we predicted. If we fail to realize the expected benefits from acquisitions we may consummate in the future, our business, results of operations and financial condition could be adversely affected.

If our post-marketing studies for one or more of our marketed products produce undesirable results, the FDA may require us to make changes to the applicable product’s label which could adversely affect our ability to market that product.

In connection with its approval of our Xolegel and Vusion products, the FDA has required us to conduct additional post marketing studies. For Xolegel, we must perform a pre-clinical dermal carcinogenicity study in mice to determine the carcinogenic potential of repeated treatment courses of Xolegel over a prolonged period of time. For Vusion, we must conduct two Phase 4 clinical studies: a percutaneous absorption study to determine the amount, if any, of miconazole nitrate which is absorbed into the bloodstream through the skin and its potential effect on liver function; and a microbial resistance study to evaluate the extent, if any, to which the Candida yeast may develop resistance to repeated treatment courses with Vusion. If any of these studies, or any Phase 4 clinical study that we may elect to conduct, produces undesirable results, the FDA could require us to make changes to the approved label for Xolegel or Vusion, as applicable, which would adversely affect our ability to market that product and potentially adversely affect our revenues for that product.

Foreign governments tend to impose strict price controls, which may adversely affect our revenues.

In some foreign countries, particularly the countries of the European Union and Canada, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take six to twelve months or longer after the receipt of regulatory marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our product candidate to other available therapies. If reimbursement of our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels our business could be materially harmed. The risk of being unable to obtain pricing at a satisfactory level is greater for products for which the active ingredient is generically available such as our Vusion and Xolegel products and our Hyphanox product candidate.

For example, although our Vusion product candidate, which we market under the name “Zimycan” in Belgium, has received marketing approval from several countries in Europe, our distributor has not launched that product in any of those countries. This product might not be launched in any country in which we are not able to obtain pricing approval at a satisfactory level.

Risks Related to Our Dependence on Third Parties for Manufacturing, Research and Development and Marketing and Distribution Activities

Because we have no manufacturing capabilities, we contract with third-party contract manufacturers whose performance may be substandard or not in compliance with regulatory requirements, which could increase the risk that we will not have adequate supplies of our product candidates and harm our ability to commercialize our product candidates.

We do not have any manufacturing experience or facilities. We rely on third-party contract manufacturers to produce the products that we commercialize and use in our clinical trials. If we are unable to retain our current, or engage additional, contract manufacturers, we will not be able to conduct our clinical trials or sell any products for which we receive regulatory approval. The risks associated with our reliance on contract manufacturers include the following:

	•		Contract manufacturers may encounter difficulties in achieving volume production, quality control and quality assurance and also may experience shortages in qualified personnel. As a result, our contract manufacturers might not be able to meet our clinical development schedules or adequately manufacture our products in commercial quantities when required.

	•		Changing manufacturers may be difficult because the number of potential manufacturers for some of our

product candidates may be limited and, in one case, there is only a single source of supply. Specifically, the intermediate for our product candidate Hyphanox is manufactured using a process that is proprietary to our contract manufacturer. We do not have a license to the technology used by our contract manufacturer to make the intermediate needed for the Hyphanox tablets. If this manufacturer cannot provide adequate supplies of the intermediate for Hyphanox, we cannot sublicense this technology to a third party to act as our supplier. As a result, it may be difficult or impossible for us to find a qualified replacement manufacturer quickly or on terms acceptable to us, the FDA and corresponding foreign regulatory agencies, or at all.

	•		Each of our marketed products could be produced by multiple manufacturers. However, if we need to change manufacturers, the FDA and corresponding foreign regulatory agencies must approve these manufacturers in advance. This would involve testing and pre-approval inspections to ensure compliance with FDA and foreign regulations and standards.

	•		Our contract manufacturers are subject to ongoing periodic, unannounced inspection by the FDA and corresponding state and foreign agencies or their designees to ensure strict compliance with current Good Manufacturing Practices, or cGMPs, and other governmental regulations and corresponding foreign standards. Other than through contract, we do not have control over compliance by our contract manufacturers with these regulations and standards. Our present or future contract manufacturers may not be able to comply with cGMPs and other FDA requirements or similar regulatory requirements outside the United States. Failure of our contract manufacturers or our employees to comply with applicable regulations could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of our product candidates, delays, suspension or withdrawal of approvals, seizures or recalls of product candidates, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business.

	•		Our contract manufacturers may breach our manufacturing agreements because of factors beyond our control or may terminate or fail to renew a manufacturing agreement based on their own business priorities at a time that is costly or inconvenient for us.

We may compete with other drug developers for access to manufacturing facilities for our products and product candidates. If we are not able to obtain adequate supplies of our products we may not be able to distribute our products as planned which could adversely affect our revenues. If we are not able to obtain adequate supplies of our product candidates, it will be more difficult for us to develop our product candidates. Dependence upon third parties for the manufacture of our product candidates may reduce our profit margins, if any, and may limit our ability to develop and deliver products on a timely and competitive basis.

We rely on a single source supplier for the manufacture of each of our marketed products and the active ingredients contained in those products and the loss of these suppliers could disrupt our business.

Although each of our marketed products and the active ingredients in those products can be produced by multiple manufacturers, we predominately rely on a single source of supply for those products and active ingredients. If any of these manufacturers, or any manufacturer of any other ingredient or component contained in our marketed products or their packaging, were to become unable or unwilling to continue to provide us with these products or ingredients, we may need to obtain an alternate supplier. The process of changing or adding a manufacturer includes qualification activities and may require approval from the FDA and corresponding foreign regulatory agencies, and can be time consuming and expensive. If we are not able to manage this process efficiently or if an unforeseen event occurs, we could face supply disruptions that would result in significant costs and delays, undermine goodwill established with physicians and patients, damage the commercial prospects for our products and adversely affect our operating results.

If third parties on whom we rely do not perform as contractually required or expected, we may not be able to obtain regulatory approval for or commercialize our products and product candidates.

We depend on independent clinical investigators and contract research organizations to conduct our clinical trials. Contract research organizations also assist us in the collection and analysis of trial data. The investigators,

contract research organizations, and other contractors are not our employees, and we cannot control, other than by contract, the amount of resources, including time, that they devote to our product candidates. However, we are responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan and protocols for the trial that have been approved by regulatory agencies and for ensuring that we report product-related adverse events in accordance with applicable regulations. Furthermore, the FDA and European regulatory authorities require us to comply with standards, commonly referred to as good clinical practice, for conducting, recording and reporting clinical trials to assure that data and reported results are credible and accurate and that the rights, integrity and confidentiality of trial participants are protected.

In connection with our reliance on our independent clinical investigators and contract research organizations, our clinical trials may be extended, delayed, suspended, terminated, or deemed unacceptable including as a result of:

	•		the failure of these investigators and research organizations to comply with good clinical practice or to meet their contractual duties;

	•		the failure of our independent investigators to devote sufficient resources to the development of our product candidates or to perform their responsibilities at a sufficiently high level;

	•		our need to replace these third parties for any reason, including for performance reasons or if these third parties go out of business; or

	•		the existence of problems in the quality or accuracy of the data they obtain due to the failure to adhere to clinical protocols or regulatory requirements or for other reasons.

Extensions, delays, suspensions or terminations of our clinical trials as a result of the performance of our independent clinical investigators and contract research organizations will delay, and make more costly, regulatory approval for any product candidates that we may develop.

In addition, although we have used a number of contract research organizations to conduct our clinical trials, there are many other qualified contract research organizations available. Any change in a contract research organization during an ongoing clinical trial could seriously delay that trial and potentially compromise the results of the trial.

We are dependent upon distribution arrangements and marketing alliances to commercialize our product candidates outside the United States and Canada. These distribution arrangements and marketing alliances place the marketing and sale of our product candidates in these regions outside our control.

We have entered into distribution arrangements and marketing alliances relating to the commercialization of some of our product candidates. Dependence on these arrangements and alliances subjects us to a number of risks, including:

	•		we may not be able to control the amount and timing of resources that our distributors may devote to the commercialization of our product candidates;

	•		our distributors may experience financial difficulties;

	•		our distributors may determine not to launch our product candidates in countries where the distributor determines that commercialization of a particular product candidate is not feasible or is economically unreasonable due to government pricing controls or other market conditions existing in a particular country;

	•		business combinations or significant changes in a distributor’s business strategy may also adversely affect a distributor’s willingness or ability to complete its obligations under any arrangement; and

	•		these arrangements are often terminated or allowed to expire, which could interrupt the marketing and sales of a product and decrease our revenue.

We may not be successful in entering into additional distribution arrangements and marketing alliances with third parties for our earlier stage products. Our failure to enter into these arrangements on favorable terms could delay or impair our ability to commercialize our product candidates outside the United States and Canada and could increase our costs of commercialization. In addition, we may be at a competitive disadvantage in negotiating these agreements with third parties because under our license agreements, Johnson & Johnson, through any of its affiliates, has a right of first negotiation for the commercialization of our product candidates that are based on the licensed intellectual property. Because this first right of negotiation may only be triggered after Phase 2 clinical trials and could extend for up to 180 days, it may hinder our ability to enter into distribution agreements and marketing alliances. It may also delay our receipt of any milestone payments or reimbursement of development costs.

Risks Related to Intellectual Property

There are limitations on our patent rights relating to our products and product candidates that may affect our ability to exclude third parties from competing against us.

The patent rights that we own or have licensed relating to our products and product candidates are limited in ways that may affect our ability to exclude third parties from competing against us. In particular:

	•		We do not hold composition of matter patents covering the active pharmaceutical ingredients of Xolegel, Vusion, Solagé, or our Hyphanox product candidates. Composition of matter patents on active pharmaceutical ingredients are the strongest form of intellectual property protection for pharmaceutical products as they apply without regard to any method of use or other type of limitation. The active ingredients for Solagé, Vusion, Xolegel and Hyphanox are off patent. As a result, competitors who obtain the requisite regulatory approval can offer products with the same active ingredients as our products so long as the competitors do not infringe any method of use or formulation patents that we may hold.

	•		We do not hold composition of matter patents covering the formulations of some of our later stage product candidates. Composition of matter patents on formulations can provide protection for pharmaceutical products to the extent that the specifically covered formulations are important. For our product candidates for which we do not hold composition of matter patents covering the formulation, competitors who obtain the requisite regulatory approval can offer products with the same formulations as our products so long as the competitors do not infringe any active pharmaceutical ingredient or method of use patents that we may hold. The United States patent covering the formulation of miconazole nitrate and zinc oxide in Vusion expires in 2007. The United States patent covering the composition of Solagé expires in 2013.

	•		For some of our product candidates, the principal patent protection that covers, or that we expect will cover, our product candidate is a method of use patent. This type of patent only protects the product when used or sold for the specified method. However, this type of patent does not limit a competitor from making and marketing a product that is identical to our product for an indication that is outside of the patented method. Moreover, physicians may prescribe such a competitive identical product for off-label indications that are covered by the applicable patents. Although such off-label prescriptions may infringe or contribute to the infringement of method of use patents, the practice is common and such infringement is difficult to prevent or prosecute.

	•		Our patent licenses from Janssen Pharmaceutica Products, L.P., Johnson & Johnson Consumer Companies, Inc. and Ortho-McNeil Pharmaceutical, Inc. are limited to the field of dermatology. As a result, with some exceptions, Johnson & Johnson, its affiliates or its licensees could manufacture and market products similar to our products outside of this field. This also could result in off-label use of these competitive products for dermatological indications.

These limitations on our patent rights may result in competitors taking product sales away from us, which would reduce our revenues and harm our business.

If we fail to comply with our obligations in the agreements under which we license development or commercialization rights to products or technology from third parties, we could lose license rights that are important to our business.

All of our current product candidates in clinical development are based on intellectual property that we have licensed from Janssen Pharmaceutica Products, L.P., Johnson & Johnson Consumer Companies, Inc. and Ortho-McNeil Pharmaceutical, Inc. We depend, and will continue to depend, on these license agreements. The terms of these licenses are set out in two license agreements. These license agreements may be terminated on a product-by-product basis, if, by dates specified in the license agreements, we are not conducting active clinical development of the particular product or if we do not obtain regulatory approval for that product. Either of the license agreements may also be terminated if we breach that license agreement and do not cure the breach within 90 days or in the event of our bankruptcy or liquidation.

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

Various aspects of our Johnson & Johnson license agreements may adversely affect our business.

Under our principal license agreements, neither Johnson & Johnson nor any of its affiliates is restricted from developing or acquiring products that may address similar indications as our products or otherwise compete with our products. We have the sole right to commercialize any product candidate based on intellectual property licensed to us under these agreements that we elect to commercialize ourselves or with the assistance of a contract sales organization. In other circumstances, however, Johnson & Johnson and any of its affiliates has a right of first negotiation for the commercialization of our product candidates based on such intellectual property. The rights of first negotiation for the commercialization of our product candidates can be exercised on a territory-by-territory basis. This negotiation may extend for up to 180 days, which may delay our commercialization efforts or hinder our ability to enter into distribution agreements.

The license agreements also permit each of Janssen Pharmaceutica Products, L.P., Johnson & Johnson Consumer Companies, Inc. and Ortho-McNeil Pharmaceutical, Inc., to abandon its maintenance of any patents or the prosecution of any patent applications included in the licensed intellectual property for any reason. If any of these companies abandon these activities, we have the option to undertake their maintenance and prosecution if we decide to prevent their abandonment. To date, we have assumed the maintenance and prosecution for all of the patents and patent applications relating to our Xolegel and Vusion product candidates. If we are required to undertake these activities for any additional product candidates, our operating costs will increase.

In addition, our license agreements limit our use of our product candidates to the specific field of dermatology as defined in the license agreements. As so defined, dermatology consists of applications for the treatment or prevention of diseases of human skin, hair, nails and oral and genital mucosa, but excludes treatments for skin cancer. We have not been granted the right to sell Oxatomide in Japan, Italy, Mexico and much of Central America or to sell Ketanserin in Mexico, Central America and the Caribbean. Our right to sell the following products in the following countries is semi-exclusive with the Johnson & Johnson companies:

	•		Vusion in Argentina, Australia, Belgium, Denmark, Germany, Indonesia, Luxembourg, Mexico, New Zealand, Peru and Venezuela; and

	•		Ketanserin in South America.

This field of use and geographic restrictions limit our ability to market our products worldwide and, therefore, limit the potential market size for our products.

If we are unable to obtain and maintain patent protection for our intellectual property, our competitors could develop and market products similar or identical to ours, which may reduce demand for our product candidates.

Our success will depend in part on our ability to obtain and maintain patent protection for our proprietary

technologies and product candidates and our ability to prevent third parties from infringing our proprietary rights. The patent situation in the field of biotechnology and pharmaceuticals generally is highly uncertain and involves complex legal and scientific questions. We may not be able to obtain additional issued patents relating to our technology or products. Even if issued, patents may be challenged, narrowed, invalidated, or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of term of patent protection we may have for our products. Changes in either patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection. We also may not have the resources to aggressively protect and enforce existing patent protection, and our competitors may infringe our patents or successfully avoid them through design innovation. To prevent infringement or unauthorized use, we may need to file infringement lawsuits, which are expensive and time-consuming.

Because of the substantial length of time and expense associated with bringing new products through the development and regulatory approval processes in order to reach the marketplace, the pharmaceutical industry places considerable importance on patent protection for new technologies, products and processes. Accordingly, we expect to seek patent protection for our new proprietary technologies and some of our product candidates. The risk exists, however, that new patents may be unobtainable and that the breadth of the claims in a patent, if obtained, may not provide adequate protection for our proprietary technologies or product candidates.

Although we own or otherwise have rights to a number of patents, these patents may not effectively exclude competitors. The issuance of a patent is not conclusive as to its validity or enforceability and third parties may challenge the validity or enforceability of our patents. Because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, or in some cases not at all, and because publications of discoveries in the scientific literature often lag behind actual discoveries, we cannot be certain that we were the first to make the inventions claimed in our issued United States patents or pending patent applications, or that we were the first to file for protection of the inventions set forth in the foreign patents or patent applications. It is possible that a competitor may successfully challenge our patents or that challenges will result in the elimination or narrowing of patent claims and, therefore, reduce our patent protection.

We may need to initiate lawsuits to protect or enforce our patents and other intellectual property rights, which could result in the forfeiture of these rights.

Any issued patents that cover our proprietary technologies may not provide us with substantial protection or be commercially beneficial to us. The issuance of a patent may be challenged with respect to its validity or its enforceability. In particular, if a competitor were to file a paragraph IV certification under the United States Drug Price Competition and Patent Term Restoration Act of 1984, known as the Hatch-Waxman Act, in connection with that competitor’s submission to the FDA of an abbreviated new drug application, or ANDA, for approval of a generic version of any of our products for which we believed we held a valid patent, then we would have 45 days in which to initiate a patent infringement lawsuit against such competitor. In any infringement proceeding, a court may decide that a patent of ours is not valid or is unenforceable, may narrow our patent claims or may refuse to stop the other party from using the technology at issue on the grounds that our patents do not cover its technology. If a court so found that one of our patents was invalid or not infringed in an infringement suit under paragraph IV of the Hatch-Waxman Act, then the FDA would be permitted to approve the competitor’s ANDA resulting in a competitive generic product.

If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology may be adversely affected.

In addition to patent protection, we rely upon trade secrets relating to unpatented know-how and technological innovations to develop and maintain our competitive position, which we seek to protect, in part, by confidentiality agreements with our employees, consultants and other third parties. We also have confidentiality and invention or patent assignment agreements with our employees and our consultants. If our employees, consultants or other third parties breach these agreements, we may not have adequate remedies for any of these breaches. In addition, our trade secrets may otherwise become known to or be independently developed by our competitors.

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

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

Third parties may assert patent or other intellectual property infringement claims against us, or our collaborators, with respect to technologies used in potential product candidates. Any claims that might be brought against us relating to infringement of patents may cause us to incur significant expenses and, if successfully asserted against us, may cause us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. In addition, any patent claims brought against our collaborators could affect their ability to carry out their obligations to us.

Furthermore, as a result of a patent infringement suit brought against us, or our collaborators, the development,

manufacture or potential sale of product candidates claimed to infringe a third party’s intellectual property may have to be stopped or be delayed. Ultimately, we may be unable to commercialize some of our product candidates or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business.

Risk Related to Our Industry

Federal legislation will likely increase the pressure to reduce the price of pharmaceutical products paid for by Medicare, which will adversely affect our revenues.

The Medicare Prescription Drug Improvement and Modernization Act of 2003 reformed the way Medicare covers and reimburses for pharmaceutical products. The law expands Medicare coverage for drug purchases by the elderly and introduced a new reimbursement methodology based on average sales prices for drugs. In addition, the law provides authority for limiting the number of drugs that will be covered in any therapeutic class. As a result of the expansion of federal coverage of drug products, we expect that there will be additional pressure to contain and reduce costs. These cost initiatives and other provisions of this law could decrease the coverage and price that we receive for our products and could seriously harm our business.

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

We are dependent on the members of our senior 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. 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 our products and development of product candidates. If we are unable to attract and retain qualified and talented senior management personnel, our business may suffer.

In addition, competition for qualified scientific, technical, and business personnel is intense in the pharmaceutical industry. If we are unable to hire and retain qualified personnel, our business will suffer.

We face potential product liability exposure, and, if successful claims are brought against us, we may incur substantial liability for a product and may have to limit its commercialization.

The use of our product candidates in clinical trials and the sale of products may expose us to the risk of product liability claims. Product liability claims might be brought against us by consumers, health care providers, pharmaceutical companies or others selling our products. If we cannot successfully defend ourselves against these claims, we may incur substantial losses or expenses, be required to limit the commercialization of our product candidates and face adverse publicity. We have product liability insurance coverage with a $10 million annual aggregate coverage limit, and our insurance coverage may not reimburse us or may not be sufficient to reimburse us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. On occasion, large judgments have been awarded in class action lawsuits based on drugs that had unanticipated side effects. A successful product liability claim or series of claims brought against us could cause our stock price to fall and, if judgments exceed our insurance coverage, could decrease our cash.

If our competitors develop and market products faster than we do or if the products of our competitors are considered more desirable than ours, revenues for any of our products and product candidates that are approved for marketing will not develop or grow.

The pharmaceutical industry, and the dermatology segment in particular, is highly competitive and includes a number of established, large and mid-sized pharmaceutical companies, as well as smaller emerging companies, whose activities are directly focused on our target markets and areas of expertise. We face and will continue to face competition in the discovery, in-licensing, development and commercialization of our product candidates, which could severely impact our ability to generate revenue or achieve significant market acceptance of our product candidates. Furthermore, new developments, including the development of other drug technologies and methods of

preventing the incidence of disease, occur in the pharmaceutical industry at a rapid pace. These developments may render our product candidates or technologies obsolete or noncompetitive.

Compared to us, many of our competitors and potential competitors have substantially greater:

	•		capital resources;

	•		research and development resources, including personnel and technology;

	•		regulatory experience;

	•		preclinical study and clinical trial experience; and

	•		manufacturing, distribution and sales and marketing experience.

As a result of these factors, our competitors may obtain regulatory approval of their products more rapidly than us. Our competitors may obtain patent protection or other intellectual property rights that limit our ability to develop or commercialize our product candidates or technologies. Our competitors may also develop drugs that are more effective, useful and less costly than ours and may also be more successful than us in manufacturing and marketing their products.

We believe the primary competition for our products are:

	•		For Xolegel, in the treatment of seborrheic dermatitis, ketoconazole creams from generic manufacturers, Colbex from Galderma S.A. and generic desowen, and Loprox from Medicis Pharmaceutical Corporation and the generic equivalents of each.

	•		For Vusion in the treatment of diaper dermatitis complicated by documented candidiasis, from ointments and creams containing nystatin, Mycolog II from Bristol-Myers Squibb Company, clotrimazole containing creams from Schering Plough and from generic manufacturers and topical miconazole creams.

	•		For Solagé in the treatment of solar lentigines from Triluma from Galderma S.A., Avage from Allergan, Inc., EpiQuin Micro from SkinMedica, Inc. and other prescription hydroquinone formulations as well as over-the-counter hydroquinone products, Retin-A from Neutrogena and other tretinoin containing topical formulations.

If approved, each of our product candidates will compete for a share of the existing market with numerous products that have become standard treatments recommended or prescribed by physicians. For example, we believe the primary competition for our product candidates are:

	•		For Hyphanox, in the treatment of onychomycosis, Sporanox from Janssen and generic manufacturers, Lamisil from Novartis AG and Penlac from Dermik Laboratories.

	•		For oral Rambazole, in the treatment of psoriasis, Soriatane from Hoffman-La Roche and Connetics, biologic agents such as Amevive from Astellas Pharma U.S., Inc. and Raptiva from Genentech, Inc. and methotrexate from generic manufacturers.

	•		For Azoline, in the treatment of acute fungal infections, topical antifungals including Loprox from Medicis, Lotrimin AF from Schering-Plough and generic manufacturers, Lotrimin Ultra from Schering Plough, Lamisil AT from Novartis, and ketoconazole, miconazole and nystatin from generic manufacturers.

Risks Related to Our Common Stock

Our stock price is volatile, and the market price of our common stock may drop below the price you pay.

Market prices for securities of biopharmaceutical and specialty pharmaceutical companies have been particularly

volatile. Some of the factors that may cause the market price of our common stock to fluctuate include:

	•		results of our clinical trials or those of our competitors;

	•		the regulatory status of our product candidates;

	•		failure of any of our products to achieve commercial success;

	•		developments concerning our competitors and their products;

	•		success of competitive products and technologies;

	•		regulatory developments in the United States and foreign countries;

	•		developments or disputes concerning our patents or other proprietary rights;

	•		our ability to manufacture any products to commercial standards;

	•		public concern over our drugs;

	•		litigation involving our company or our general industry or both;

	•		future sales of our common stock;

	•		changes in the structure of health care payment systems, including developments in price control legislation;

	•		departure of key personnel;

	•		period-to-period fluctuations in our financial results or those of companies that are perceived to be similar to us;

	•		changes in estimates of our financial results or recommendations by securities analysts;

	•		investors’ general perception of us; and

	•		general economic, industry and market conditions.

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.

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

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

•

a classified board of directors;

	•		limitations on the removal of directors;

	•		advance notice requirements for stockholder proposals and nominations;

	•		the inability of stockholders to act by written consent or to call special meetings; and

	•		the ability of our board of directors to designate the terms of and issue new series of preferred stock without stockholder approval, which could be used to institute a rights plan, or a poison pill, that would work to dilute the stock ownership of a potential hostile acquirer, effectively preventing acquisitions that have not been approved by our board of directors.

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

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

ITEM 6. EXHIBITS


Exhibit
No.		Description

1.1		Underwriting Agreement dated September 14, 2006 between Barrier Therapeutics, Inc. and Pacific Growth Equities, LLC. (1)

31.1		Certification of principal executive officer required by Rule 13a-14(a).

31.2		Certification of principal financial officer required by Rule 13a-14(a).

31.3		Certification of principal accounting officer required by Rule 13a-14(a).

32.1		Section 1350 Certification of principal executive officer.

32.2		Section 1350 Certification of principal financial officer.

32.3		Section 1350 Certification of principal accounting officer.


(1)		Previously filed as an exhibit to the Form 8-K filed on September 15, 2006.

SIGNATURES

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


	BARRIER THERAPEUTICS, INC. (Registrant)
November 8, 2006	By	/s/ Geert Cauwenbergh
		Geert Cauwenbergh, Ph.D.
		Chief Executive Officer (Principal Executive Officer)



	By	/s/ Anne M. VanLent
		Anne M. VanLent
		Executive Vice President, Chief Financial Officer & Treasurer (Principal Financial Officer)


	By	/s/ Dennis P. Reilly
		Dennis P. Reilly
		Vice President, Finance (Principal Accounting Officer)

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Barrier Therapeutics Inactive 10-Q2006 Q3 Quarterly report

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