UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

OR

For the transition period from                     to

Commission File Number 000-50680

BARRIER THERAPEUTICS, INC.

(609) 945-1200

Not Applicable

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 an accelerated filer (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.

BARRIER THERAPEUTICS, INC.

INDEX

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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 increasing trend of operating losses and the reasons for those losses;
	•	our spending on the clinical development of our later stage and earlier stage product candidates;
	•	our plans regarding the development or regulatory path for any of our product candidates;
	•	the timing of the initiation or completion of any clinical trials;
	•	the timing of filing for regulatory approvals with governmental agencies;
	•	the timing of the commercial launch of any of our product candidates, if approved;
	•	the commercialization of any of our product candidates, if approved; 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. We do not intend to update publicly any forward-looking statement, whether as a result of new information, future events or otherwise. 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, in addition to those set forth in Part I, Item 2 under the heading “Risk Factors,” our ability to:

	•	obtain substantial additional funds;
	•	obtain and maintain all necessary patents or licenses;
	•	demonstrate the safety and efficacy of product candidates at each stage of development;
	•	meet applicable regulatory standards and file for or receive required regulatory approvals;
	•	meet obligations and required milestones under our license and other agreements;
	•	produce drug candidates in commercial quantities at reasonable costs and compete successfully against other products and companies; and
	•	market our products, if approved, and generate revenues.

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PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

BARRIER THERAPEUTICS, INC.

CONSOLIDATED BALANCE SHEETS

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

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BARRIER THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(Dollars in thousands, except per share data)

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

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BARRIER THERAPEUTICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Dollars in thousands)

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

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BARRIER THERAPEUTICS, INC.

1. Summary of Significant Accounting Policies

          Organization, Description of Business

     Barrier Therapeutics, Inc. (the “Company”) was incorporated in Delaware on September 17, 2001 but commenced active operations in May 2002. The Company was formed to develop and market products that address medical needs in the treatment of dermatological diseases and disorders initially based on intellectual property in-licensed from Janssen Pharmaceutica Products, L.P., Johnson & Johnson Consumer Companies, Inc. and Ortho-McNeil Pharmaceutical, Inc., each a Johnson & Johnson company. The Company’s activities since inception have consisted principally of licensing products, raising capital, performing research and development, hiring personnel and establishing facilities. With the acquisition of Solagé® in February 2005, the Company has commenced its planned principal operations of selling dermatology products, and therefore is no longer in the development stage. The Company has offices in Princeton, New Jersey 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 and follow-on public offering in February 2005. The Company believes that its existing resources should be sufficient to meet its capital and liquidity requirements through the end of 2006. 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 achieve 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 month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. The Consolidated Balance Sheet as of December 31, 2004 has been derived from the audited consolidated financial statements as of that date. For further information, refer to the consolidated financial statements and notes thereto included in our Form 10-K as filed with the Securities and Exchange Commission (“SEC”).

          Consolidation

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

          Use of Estimates

          The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

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BARRIER THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
March 31, 2005 and 2004
(dollars in thousands, except per share data)

          Inventories

          Inventory consists primarily of finished goods. Inventory is stated at the lower of cost (determined on a first-in first-out method) or market.

          Product Rights

          In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” or SFAS 144, purchased intangibles and other long-lived assets, other than goodwill, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. No impairment charges for long-lived intangible assets have been recorded for the three months ended March 31, 2005.

          Revenue Recognition

          Revenues from product sales are recognized net of allowances for chargebacks, rebates, and other discounts when collectibility is reasonably assured and the amount is fixed and determinable.

          Contract revenues include fees and other payments associated with collaborations with third parties and licensing agreements. Revenues from licensing agreements are recognized based on the performance requirements of the agreement. Non-refundable up-front fees, where the Company has an ongoing involvement or performance obligation, are generally recorded as deferred revenue in the balance sheet and amortized into contract revenues in the statement of operations over the terms of the performance obligation. Royalties from licensees are based on third-party sales of licensed products and will be recorded in accordance with contract terms when third-party results are reliably measurable and collectibility is reasonably assured.

          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.

          Stock-Based Compensation

          The Company uses the intrinsic-value method of accounting for stock-based awards granted to employees, as allowed under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, or APB 25, and related interpretations. Accordingly, the Company does not recognize any compensation in the financial statements in connection with stock options granted to employees when those options have exercise prices equal to or greater than fair market value of our common stock on the date of grant. The Company also does not record any compensation expense in connection with the Employee Stock Purchase Plan as long as the purchase price is not less than 85% of the fair market value at the beginning or end of each offering period, whichever is lower.

          Although SFAS 123 allows the Company to continue to follow the APB 25 guidelines, pro forma disclosure of net income (loss) and basic and diluted income (loss) per share as if the fair value based method had been applied to all awards is required. Because the estimated value is determined as of the date of grant, the actual value ultimately realized by the employee may be significantly different.

          Had compensation cost for the Company’s outstanding employee stock options been determined based on the fair value at the grant dates for those options consistent with SFAS 123, the Company’s net loss and basic and diluted net loss per share, would have been changed to the following pro forma amounts:

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BARRIER THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
March 31, 2005 and 2004
(dollars in thousands, except per share data)

          SFAS 123 pro forma information regarding net loss is required by SFAS 123, and has 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 was estimated using the Black-Scholes pricing model with the following assumptions:

          The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. Stock option grants are expensed over their respective vesting periods.

          The Company accounts for options issued to nonemployees under SFAS 123 and EITF Issue 96-18, Accounting for Equity Investments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services (“EITF 96-18”). As such, the value of such options is periodically remeasured and income or expense is recognized during their vesting terms.

          Deferred Stock Compensation

     In connection with the granting of employee stock options and restricted stock awards prior to the Company’s initial public offering, the Company recorded deferred compensation of approximately $3.7 million, representing the difference between the fair value of common stock on the date such options were granted, determined in accordance with GAAP, and the exercise price. These amounts were recorded as a reduction of stockholders’ equity and are 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. During the three months ended March 31, 2005, the Company recorded amortization of deferred stock compensation of $290.

          Recently Issued Accounting Pronouncements

     On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004) Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes Accounting Principal Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and amends FASB No. 95, Statement of Cash Flows. Generally, the approach to accounting in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R)

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BARRIER THERAPEUTICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
March 31, 2005 and 2004
(dollars in thousands, except per share data)

requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. On April 15, 2005, the Securities and Exchange Commission adopted a new rule that extended the compliance date to January 1, 2006.

     Currently the Company accounts for these payments under the intrinsic value provisions of APB No. 25. Statement 123(R) must be adopted no later than January 1, 2006. The Statement offers several alternatives for implementation. At this time, the Company’s management has not made a decision as to the alternative it may select. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed by Statement 123(R) will be applied to valuing stock-based awards granted after the effective date and the impact the recognition of additional non-cash compensation expense related to such awards will have on its financial statements.

2. Comprehensive Loss

The components of comprehensive loss for the three month periods ended March 31, 2005 and 2004 are as follows:

          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.

3. Sale of Common Stock

          On February 15, 2005, the Company completed a follow-on offering of 2,000,000 shares of common stock at $19.50 per share, which resulted in net proceeds to the Company of $36,098. In connection with the stock sale, the Company paid $2,340 in underwriting discounts and commissions to underwriters, and reclassified $562 of offering expenses to Additional Paid-in Capital.

4. Acquisition of Product Rights

          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 Solagé®’s pharmaceutical composition and methods of use until at least 2013.

          The Company acquired the intellectual property and finished goods inventory for $3,061 and will make future payments totaling up to an additional $2,000, if certain sales targets are met. During the three month period ended March 31, 2005, the Company recorded a liability and a corresponding increase to the intangible asset product rights of $100 for future amounts payable to Moreland based on product sales during the period. The total initial purchase price was allocated $3,000 to product rights and $61 to inventory. Product rights are being amortized on a straight line basis over the life of the underlying patent, which expires in 2013.

          Amortization expense of $56 has been recorded for the three months ended March 31, 2005. Amortization expense for the remainder of 2005 will be $255 and will be $340 for each of the next five years.

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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 discovery, development and commercialization of pharmaceutical products in the field of dermatology. Our goal is to develop a portfolio of innovative products that address major medical needs in the treatment of dermatological diseases and disorders. We currently market Solagé® in the U.S. for the treatment of solar lentigines, a common condition also known as age spots or liver spots, and for the broader indication including related hyperpigmented lesions in Canada. Our product pipeline includes eight product candidates in various stages of clinical development. Our four most advanced product candidates are the following:

	•	Zimycan: an ointment for the treatment of infants with diaper dermatitis complicated by candidiasis, an inflammatory disease characterized by diaper rash complicated with an infection by a yeast called Candida.
	•	Sebazole: a gel for the treatment of seborrheic dermatitis, a type of eczema characterized by inflammation and scaling of the skin, principally of the scalp, face and chest.
	•	Hyphanox: an oral therapeutic for the treatment of fungal infections, including vaginal candidiasis, commonly known as vaginal yeast infection, and onychomycosis, commonly known as nail fungus.
	•	Liarozole: an oral therapeutic for the treatment of the group of conditions known as congenital ichthyosis, a rare genetic disease characterized by dryness and scaling of the skin.

     We were incorporated in September 2001 and commenced active operations in May 2002. We generated initial product revenues from sales of Solagé® during the first quarter of 2005. 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 offering in the first quarter of 2005. Through December 31, 2004, we were a development stage enterprise. We have incurred significant losses since our inception in 2001, as we have devoted substantially all of our efforts to research and development activities, including clinical trials. As of March 31, 2005, we had an accumulated deficit of $118.4 million, which has resulted primarily from our acquisition of the rights to our product candidates, our research and development activities and preferred stock accretion. We expect our operating losses to continue to increase as we do not expect to generate significant revenues in the near future. We expect to continue to increase our research and development costs, our costs of commercial operations are expected to increase, and we will continue to incur the costs of being a public company.

     We expect to continue to spend significant amounts, including clinical trial costs, on the development of our product candidates. We plan to seek marketing approvals for our products in various countries throughout the world, particularly in the United States, Canada and Europe. We expect our costs to increase as we continue to develop and ultimately commercialize our product candidates and acquired products, such as Solagé® . While we will be focusing on the clinical development of our later stage product candidates in the near term, we expect to increase our spending on earlier stage clinical candidates as well. We also plan to identify and develop, either internally or through collaborative agreements, additional product candidates that address major needs in dermatology through acquisitions or licenses of marketed dermatological products or rights to potential new products and product candidates that would fit within our growth strategy. Accordingly, we will need to generate significant revenues to achieve, and then maintain, profitability.

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     The successful development of our product candidates is highly uncertain. We cannot reasonably estimate or know the nature, timing and estimated expenses of the efforts necessary to complete the development of, or the period in which material net cash inflows are expected to commence from, any of our product candidates due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

	•	the scope, rate of progress and expense of our clinical trials and other research and development activities;
	•	future clinical trial results;
	•	the expense of clinical trials for additional indications;
	•	the expense and timing of regulatory approvals;
	•	the expense of establishing clinical and commercial supplies of our product candidates and any products that we may develop;
	•	the effect of competing technological and market developments; and
	•	the expense of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.

     Our research and development expenses consist primarily of costs incurred for the conduct of our clinical trials, manufacturing development costs related to our clinical product candidates, personnel and related costs in support of our research and product development activities and outside professional fees related to product development and regulatory matters.

     Sales and marketing costs include the expenses related to the initial sales of Solagé®, and those incurred to prepare for the launch of our first product, Zimycan, subject to obtaining requisite marketing approvals. In addition, if we were to acquire or in-license other products, we would then incur sales and marketing costs related to such products. These costs could also include expenses related to a sales organization for those regions in which we decide to market our products ourselves and costs for marketing efforts to support third parties with whom we may collaborate in the future in regions where we do not market directly.

     Our general and administrative expenses consist primarily of salaries and related expenses and costs of general corporate activities, including legal and accounting fees, insurance and consulting costs.

     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, if approved, 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 our research and development efforts;
	•	the timing and extent of our adding new employees and infrastructure;
	•	the timing of any contract, license fee or royalty payments that we may receive or be required to make; and
	•	the timing and outcome of our applications for regulatory approvals.
	•	the timing and extent of recognition of product and other revenue.
	•	the timing and extent of product revenues, offset by marketing and selling expenses.

Recent Developments

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     On February 15, 2005, we completed a follow-on offering of 2,000,000 shares of our common stock which resulted in net proceeds to the Company of approximately $36.1 million, after payment of underwriters’ discounts, commissions and other expenses.

     In February 2005, we acquired the United States and Canadian rights to Solagé® (mequinol 2%, tretinoin 0.01%) Topical Solution. Under the terms of the acquisition, Barrier made an initial cash payment of $3.1 million and will make future payments totaling up to an additional $2.0 million, if certain sales targets are met. We were assigned all U.S. and Canadian marketing authorizations, patents, and trademarks for the product. The patent rights include U.S. and Canadian patents covering Solagé® ‘s pharmaceutical composition and methods of use until at least 2013.

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 unaudited 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.

Revenue Recognition

     Revenues from product sales are recognized net of allowances for chargebacks, rebates, and other discounts when collectibility is reasonably assured and the amount is fixed and determinable.

     Contract revenues include fees and other payments associated with collaborations with third parties and licensing agreements. Revenues from licensing agreements are recognized based on the performance requirements of the agreement. Non-refundable up-front fees, where the Company has an ongoing involvement or performance obligation, are generally recorded as deferred revenue in the balance sheet and amortized into contract revenues in the statement of operations over the terms of the performance obligation. 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. Royalties from licensees are based on third-party sales of licensed products and will be recorded in accordance with contract terms when third-party results are reliably measurable and collectibility is reasonably assured.

     We use revenue recognition criteria in Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” and Emerging Issues Task Force (“EITF”) Issue 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). Revenue arrangements that include multiple deliverables, are divided into separate units of accounting if the deliverables meet certain criteria, including whether the fair value of the delivered items can be determined and whether there is evidence of fair value of the undelivered items. In addition, the consideration is allocated among the separate units of accounting based on their fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units of accounting.

     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.

Stock-based Compensation

     Stock-based compensation charges represent the difference between the exercise price of options granted to employees and the fair value of our common stock on the date of grant for financial statement purposes in

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accordance with Accounting Principles Board Opinion No. 25 and its related interpretations. We recognize this compensation charge over the vesting periods of the shares purchasable upon exercise of options. Should our assumptions of fair value change, the amount recorded as intrinsic value may increase or decrease in the future.

     We recorded amortization of deferred stock-based compensation of $290,000 during the three months ended March 31, 2005. To date, we have recorded deferred stock-based compensation of $3.7 million and related amortization expense of $2.5 million. We are applying a graded vesting amortization policy for our deferred compensation. This accelerated vesting method provides for vesting of portions of the overall award at interim dates and results in higher compensation expense in earlier years than straight-line amortization. Had we chosen to apply the straight line method of amortization of deferred compensation, our stock compensation charge would have been $60,000 lower for the three months ended March 31, 2005.

     Stock-based compensation charges also include the periodic revaluation of stock options that we have granted to non-employees, in accordance with the provisions of Statement of Financial Accounting Standards No. 123 and Emerging Issues Task Force No. 96-18. Pursuant to this accounting literature, equity instruments, such as options, are required to be recorded at the fair value of the consideration received, or the fair value of the equity instrument issued, whichever may be more readily measured. For grants to our non-employees, the fair value of the equity instrument issued is more readily measured and we assign value to the options using a Black-Scholes methodology. As required, we revalue these options over the period when earned in accordance with their respective terms. Should our input assumptions change, for example, fair value of common stock at the measurement date, the fair value of our non-employee consultant compensation will change.

     We recorded stock-based compensation expense totaling $189,000 for the three months ended March 31, 2005 in connection with the grant of stock options to our non-employees.

Recent Accounting Pronouncements

     On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004) Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes Accounting Principal Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and amends FASB No. 95, Statement of Cash Flows. Generally, the approach to accounting in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. On April 15, 2005, the Securities and Exchange Commission adopted a new rule that extended the compliance date for periods ending after January 1, 2006.

     Currently, the Company accounts for these payments under the intrinsic value provisions of APB No. 25. Statement 123(R) must be adopted no later than January 1, 2006. The Statement offers several alternatives for implementation. At this time, the Company’s management has not made a decision as to the alternative it may select. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed by Statement 123(R) will be applied to valuing stock-based awards granted after the effective date and the impact the recognition of additional non-cash compensation expense related to such awards will have on its financial statements.

Results of Operations

          Three months ended March 31, 2005 compared to three months ended March 31, 2004

          Revenue. We recognized product revenue of $210,000, contract revenue of $220,000 and grant revenue of $223,000 in the three months ended March 31, 2005, compared to only grant revenue of $181,000 in the three months ended March 31, 2004. The product revenue was for U.S. and Canadian sales of Solagé® which was acquired in February 2005. The contract revenue related to our marketing and distribution agreements. Grant revenue related to the performance of qualifying work under a Belgian grant.

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          Cost of Goods Sold. Our cost of goods sold totaled $26,000 for the three months ended March 31, 2005, and related entirely to sales of Solagé® in the U.S. and Canada. Our gross margin on product sales for this period was 87.6%. We expect that our gross margin will fluctuate as we begin to sell additional products, if and when they are approved.

          Research and Development Expenses. Below is a summary of our research and development expenses for the three months ended March 31, 2004 and 2005.

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

	•	Sebazole—third-party direct project expenses relating to the development of Sebazole and our former product candidate, Seboride.
	•	Hyphanox—third-party direct project expenses relating to the development of Hyphanox.
	•	Zimycan—third-party direct project expenses relating to the development of Zimycan.