UNITED STATES    
SECURITIES AND EXCHANGE COMMISSION    
Washington, DC  20549    
    
    
FORM 10-Q    
    
    
    
[ X ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    
            SECURITIES EXCHANGE ACT OF 1934    
    
For the quarterly period ended     SEPTEMBER 30, 1996    
    
Commission File Number          0-22314    
    
               PENEDERM INCORPORATED    
(Exact name of registrant as specified in its charter)    
    
         CALIFORNIA                    77-0146116           
(State of other jurisdiction of       I.R.S. Employer    
incorporation or organization)      Identification Number    
    
320 LAKESIDE DRIVE, FOSTER CITY,  CALIFORNIA       94404            
 (Address of principal executive offices)        (Zip Code)    
    
            (415) 358-0100                   
(Registrant's telephone number, including area code)     
    
    
Indicate by check 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 month (or for such shorter period    
that the registrant was required to file such reports), and (2) has been    
subject to such filing requirements for the past 90 days.    
    
           YES    X        NO             
    
Indicate number of shares outstanding of each of the issuer's classes of    
common stock, at the latest practicable date:    
    
    Class     Outstanding as of:     SEPTEMBER 30, 1996       
    
    Common Stock                 7,289,628   
    
    
<PAGE>    
Part I:  Financial Information    
    
    
PENEDERM INCORPORATED    
Condensed Consolidated Balance Sheets    
September 30, 1996 and December 31, 1995 (in thousands)    
                                   September 30,       December 31,   
                                       1996               1995    
                                   -----------         ----------   
ASSETS                             (unaudited)    
Current Assets:    
  Cash and cash equivalents        $   1,147           $   8,695    
  Short-term marketable securities     4,753               4,796    
  Accounts receivable                    336                 862    
  Inventory                            1,049                 301    
  Prepaid expenses and other     
   current assets                        447                 467    
                                   -----------         ----------    
    Total current assets               7,732              15,121    
   
  Marketable Securities                1,857               1,520    
  Property & equipment, at cost,   
   less accumulated depreciation   
   and amortization                      282                 282    
  Intangible and other assets          1,078               1,045    
                                  ------------        -----------    
    Total assets                  $   10,949          $   17,968    
                                  ===========         ===========    
LIABILITIES    
Current liabilities:    
  Accounts payable                $      145          $      791    
  Accrued and other liabilities          594               1,166    
                                  ------------        -----------    
    Total current liabilities            739               1,957    
   
  Long-term obligations                   48                  77    
                                  ------------        -----------    
    Total liabilities                    787               2,034    
   
SHAREHOLDERS' EQUITY    
Common stock, no par value            46,829              46,684    
Accumulated deficit                  (36,667)            (30,750)    
                                  ------------        -----------    
    Total shareholders' equity        10,162              15,934    
                                  ------------        -----------    
    Total liabilities and     
     shareholders' equity         $   10,949          $   17,968    
                                  ===========         ===========    
    
See accompanying notes to condensed consolidated financial statements.    
    
<PAGE>    
PENEDERM INCORPORATED    
Condensed Consolidated Statements of Operations     
(in thousands, except per share data)    
(unaudited)    
    
                        Three Months Ended           Nine Months Ended    
                           September 30,               September 30,    
                        1996          1995          1996           1995    
                       ------        ------        ------         ------   
REVENUES    
  Product sales     $     52      $    452       $  1,745      $  2,806    
  License and contract  
   research revenues      10           350            217           950    
                    ---------     ---------      ---------     ---------   
    Total revenues        62           802          1,962         3,756    
                    ---------     ---------      ---------     ---------   
COSTS AND EXPENSES    
  Cost of sales           16           356          1,131         1,700    
  Research and     
   development         1,019         1,604          4,140         3,951    
  Selling, general and    
   administration        745           748          3,053         2,884    
                    ---------     ---------      ---------     ---------   
    Total costs and     
     expenses          1,780         2,708          8,324         8,535    
                    ---------     ---------      ---------     ---------   
Loss from operations  (1,718)       (1,906)        (6,362)       (4,779)   
  
Interest income, net     115           220            445           730    
                     --------      --------       --------      --------   
Net loss             $(1,603)      $(1,686)       $(5,917)      $(4,049)   
                     ========      ========       ========      ========   
Net loss per share   $( 0.22)      $( 0.23)       $( 0.81)      $( 0.57)   
                     ========      ========       ========      ========   
Number of shares used    
 in computing net    
 loss per share        7,288         7,175          7,266         7,157    
                     ========      ========       ========      ========   
    
See accompanying notes to condensed consolidated financial statements.    
    
<PAGE>    
PENEDERM INCORPORATED    
Condensed Consolidated Statements of Cash Flows    
(in thousands)    
(unaudited)    
                                           Nine Months Ended    
                                              September 30,    
                                         1996              1995    
                                       -------           -------    
CASH FLOWS FROM OPERATING ACTIVITIES:    
 Net loss                            $( 5,917)         $( 4,049)    
 Adjustments to reconcile net loss    
  to net cash used in operating    
  activities:    
   Loss on disposal of fixed assets      --                 127    
   Depreciation and amortization          191               184    
   Decrease (increase) in accounts  
    receivable                            526           (   161)   
   Decrease (increase) in inventory   (   748)              375    
   Decrease in prepaid expenses and    
    other current assets                   20               122   
   Decrease in other assets                 2              --      
   Decrease in accounts payable,    
    accrued liabilities and deferred   
    rent                              ( 1,220)          (   917)    
                                     ---------          --------    
     Net cash used in operating     
      activities                      ( 7,146)          ( 4,319)    
                                     ---------          --------    
CASH FLOWS FROM INVESTING ACTIVITIES:    
 Maturity of held-to-maturity     
  securities                             --               2,000    
 Purchase of available-for-sale     
  securities                          ( 6,905)          ( 5,983)    
 Maturity of available-for-sale    
  securities                            5,850             6,865    
 Sales of available-for-sale securities   761              --    
 Acquisition of technology            (   125)          ( 1,098)    
 Acquisition of fixed assets          (   101)          (   142)    
                                     ---------         ---------    
     Net cash from (used in)     
      investing activities            (   520)            1,642    
                                     ---------         ---------    
CASH FLOWS FROM FINANCING ACTIVITIES:    
 Proceeds from issuance of common stock   145               148    
 Repayment of long-term debt, net     (    27)           (   16)   
                                      --------          --------    
     Net cash provided by financing     
      activities                          118               132    
                                      --------          --------    
Net decrease in cash and cash     
 equivalents                          ( 7,548)          ( 2,545)    
Cash and cash equivalents at     
 beginning of period                    8,695             6,728    
                                      --------          --------    
Cash and cash equivalents at end     
 of period                            $ 1,147           $ 4,183    
                                      ========          ========    
    
See accompanying notes to condensed consolidated financial statements.    
    
<PAGE>    
PENEDERM INCORPORATED  
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  
(unaudited)  
  
  
Interim Unaudited Financial Information:  
  
The accompanying interim unaudited condensed consolidated financial  
statements of the Company for the three and nine month periods ended  
September 30, 1996 and 1995,  have been prepared in accordance with  
generally accepted accounting principles for interim financial  
statements and include all adjustments (consisting of normal and  
recurring adjustments) that the Company considers necessary for a fair   
presentation of the operating results and cash flows for these   
periods. The results of operations for the interim periods are not   
necessarily indicative of the results to be expected for an entire   
year.  These financial statements should be read in conjunction with   
the financial statements and notes included as part of the Company's   
Form 10-K for the year ended December 31, 1995.  
  
<PAGE>  
  
  
Item 2.  Management's Discussion and Analysis of Financial Condition   
         and Results of Operations  
  
Recent Events  
  
In October 1996, the FDA granted final approval to the Company   
to market MENTAX (trademark), the Company's 1% butenafine HCl cream.  
MENTAX, a prescription topical antifungal, is approved for   
use against interdigital tinea pedis, or athlete's foot.  
  
Overview  
  
Penederm is developing and commercializing topically   
administered prescription dermatology products that use the   
Company's proprietary delivery technology or novel drug   
compounds to achieve enhanced safety or efficacy profiles.    
The Company currently has NDAs pending before the FDA for   
treatment of tinea corporis (ringworm) and tinea cruris (groin   
fungus) with MENTAX and for AVITA (trademark) gel and AVITA cream   
topical retinoic acid acne treatments, and has several other   
pharmaceutical products for psoriasis, nail fungus, and   
antifungal line extensions in Phase II human clinical trials.   
The Company also sells its patented TopiCare Delivery   
Compounds (registered trademark) for use in cosmetics and personal
care products.The Company has several agreements with various
pharmaceutical companies, as follows:  
  
    COMPANY               PRODUCT AREA                   TERRITORY    
-----------------       -----------------            ------------------    
Schering-Plough    Prescription & over-the-counter     U.S. and Canada    
HealthCare         (OTC) Nail and Skin Antifungals    
Products, Inc.    
(Schering-Plough)   
    
UCB Group of       Prescription Nail Antifungal      Europe, Africa and    
Belgium (UCB)                                           Middle East    
    
Warner Wellcome Consumer    OTC Dry Skin              U.S. and Canada    
Health Products (Warner)    
    
SmithKline Beecham      OTC Consumer Products              Europe    
(SmithKline)    
    
  
The Company has been unprofitable since inception and expects   
to incur significant additional operating losses in the near   
future. For the period from inception through September 30,   
1996, the Company incurred a cumulative net loss of    
$36,667,000.  Penederm's sources of working capital have been   
equity financings, product sales to Warner, sales of over-the-  
counter products, product license fees and contract research   
revenues, sales of TopiCare Delivery Compounds and interest   
earned on investments.  
  
<PAGE>  
  
Item 2.  Management's Discussion and Analysis of Financial Condition and   
Results of Operations, continued  
  
Results of Operations  
  
Three Months Ended September 30, 1996 and 1995  
  
Total revenues for the three months ended September 30, 1996 of   
$62,000 decreased from $802,000 in the same period of 1995, due   
primarily to lower quantities of Lubriderm products shipped to   
Warner as compared to 1995 launch quantities, a decline in Penederm   
cream and lotion sales as a result of reduced promotional spending   
against the brand, and reduced license revenues.  The Company   
reduced promotional spending on Penederm cream and lotion in order   
to direct more resources to prescription product human clinical   
trials.  Based on current product demand forecasts from Warner, the   
Company anticipates sales to Warner will continue to be less than   
previous levels for the remainder of 1996.  
  
The Company's cost of sales decreased to $16,000 in the three months   
ended September 30, 1996 from $356,000 in the same period of 1995   
due to the decrease in revenues.  Gross margins declined in the   
third quarter of 1996 compared to the same period of 1995 due to   
lower sales levels and change in the mix of product revenues.  
  
The Company's research and development expenses decreased 36% to   
$1,019,000 in the three months ended September 30, 1996 from   
$1,604,000 in the same period of 1995 primarily due to completion of   
clinical trials for the three month period.  
  
Sales, marketing, general and administrative expenses decreased   
slightly to $745,000 in the three months ended September 30, 1996   
from $748,000 in the same period of 1995, due primarily to increased   
legal costs related to enforcement of patent rights, and the costs   
of pre-launch preparations for MENTAX offset by continued reductions   
in OTC promotions and reduced personnel costs.  
  
Interest income for the three months ended September 30 decreased   
48% to $115,000 in 1996 from $220,000 for the same period in 1995.   
This decrease is primarily the result of lower cash balances   
available for investment in the three months ended September 30,   
1996.  
  
<PAGE>  
  
Item 2.  Management's Discussion and Analysis of Financial Condition   
and Results of Operations, continued   
  
Nine Months Ended September 30, 1996 and 1995  
  
Total revenues for the nine months ended September 30, 1996 of   
$1,962,000 decreased 48% from $3,756,000 in the same period of 1995,   
due primarily to lower quantities of Lubriderm products shipped to   
Warner as compared to 1995 launch quantities, a decline in Penederm   
cream and lotion sales as a result of reduced promotional spending   
against the brand, and reduced licensing revenues.  
  
The Company's cost of sales decreased to $1,131,000 in the nine   
months ended September 30, 1996 from $1,700,000 in the same period   
of 1995 due to the decrease in revenues.  Gross margins declined in   
1996 compared to the same period of 1995 due to lower sales levels   
and change in the mix of product revenues.  
  
The Company's research and development expenses increased 5% to   
$4,140,000 in the nine months ended September 30, 1996 from   
$3,951,000 in the same period of 1995 primarily due to the cost of   
human clinical trials to establish additional marketing claims for   
both AVITA (acne treatment) and MENTAX (skin antifungal).  These   
studies encompassed 1,600 patients over 26 sites across the U.S. and   
Canada.  
  
Sales, marketing, general and administrative expenses increased 6%   
to $3,053,000 in the nine months ended September 30, 1996 from   
$2,884,000 in the same period of 1995 due primarily to increased   
legal costs related to enforcement of patent rights and the costs of 
pre-launch preparations for MENTAX, the Company's topical antifungal   
product, partially offset by reduced personnel costs.  
  
Interest income for the nine months ended September 30 decreased 39%   
to $445,000 in 1996 from $730,000 for the same period in 1995. This   
decrease is primarily the result of lower cash balances available   
for investment in the nine months ended September 30, 1996.  
  
The Company expects that future operating results may be subject to   
quarterly variations that may impact cash flow from operations.    
Operating results for the three and nine month period ended   
September 30, 1996 are not necessarily indicative of future   
operating results.  
  
<PAGE>  
  
Item 2.  Management's Discussion and Analysis of Financial Condition   
and Results of Operations, continued   
  
Liquidity and Capital Resources  
  
In November 1993, the Company completed its initial public offering   
of Common Stock, raising approximately $23,000,000 net of expenses.   
Prior to the initial public offering, the Company financed   
operations primarily through private placements of its equity   
securities, interest income earned on investment of cash, initial   
sales of products and product license fees. At September 30, 1996,   
the Company had cash, cash equivalents and investments totaling   
$7,757,000.  
  
Cash expenditures related to operating activities, the acquisition   
of fixed assets and repayment of long-term debt totaled $7,274,000   
in the nine months ended September 30, 1996 and $4,477,000 for the   
same period in fiscal 1995, and were used to finance research,   
development, clinical trials, product sales, promotion and general   
administration activities.  The Company also made milestone payments   
of $125,000 related to the in-licensing of drug compounds in the   
nine months ended September 30, 1996.  The Company expects that   
amounts expended historically are not indicative of future   
expenditures by the Company, which the Company believes will   
increase. The Company expects to continue to incur substantial   
expenditures related to the further research and development of its   
technologies, development of its products, acquisition of additional   
products and rights to drug compounds and sales and marketing.  
  
The Company believes that existing capital resources, and the   
interest income earned thereon, together with anticipated revenues   
(consisting of product sales, license fees and royalties), will   
satisfy the Company's working capital and identified capital   
expenditure requirements through 1997. However, the Company's future   
capital requirements will depend on many factors, including the   
progress of the Company's collaborative and independent research and   
development programs, payments received under collaborative   
agreements with other companies, if any, the results and costs of   
preclinical and clinical testing for the Company's products, the   
costs associated with and the timing of regulatory approvals,   
technological advances, the status of competitive products, and the   
commercial success of Penederm's licensing and marketing efforts.   
There can be no assurance that additional funds, if required, will   
be available to the Company on favorable terms, if at all, to permit   
the Company to continue with its plan for operations.  
  
<PAGE> 

Item 2.  Management's Discussion and Analysis of Financial Condition and 
         Results of Operations, continued  
 
Liquidity and Capital Resources 
 
Uncertainties Related to Forward-Looking Statements 
 
Any statements contained in this 10-Q that relate to future plans, 
events or performance, including the planned product marketing efforts, are  
forward-looking statements that involve risks and uncertainties 
including, but not limited to, product development and market acceptance
risks, product manufacturing risks, risks associated with the
establishment and management of a contract sales force, the impact of 
competitive products  and pricing, the results of financing efforts, 
developments regarding intellectual property rights and litigation, 
risks of product non-approval or delays or post-approval reviews by the
FDA or foreign regulatory authorities, and other risks identified in the 
Company's Securities and Exchange Commission filings.  Actual results, 
events or performance may differ materially.  Readers are cautioned not 
to place undo reliance on these forward-looking statements, which speak 
only as of the date hereof.  The Company undertakes no obligation to 
publicly release the results of any revisions to these forward-looking 
statements that may be made to reflect events or circumstances after the 
date hereof or to reflect the occurrence of unanticipated events. 
 
<PAGE>  
  
PENEDERM INCORPORATED  
  
  
  
  
Part II:  OTHER INFORMATION  
  
Item 1.  Legal Proceedings -  
  
On July 22, 1996, Johnson & Johnson filed a complaint against   
Penederm in the U.S. District Court, Northern District of   
California, alleging that AVITA gel, one of the Company's retinoic   
acid acne formulations, infringes a Johnson & Johnson patent (the   
"J&J Patent"). The J&J Patent expires on January 27, 1998. Based on   
opinion of counsel, Penederm believes that AVITA does not   
infringe the J&J Patent. The Company believes that the litigation   
will not affect the timing of the FDA's review of the NDA for the   
Company's AVITA cream formulations and will not have a material   
adverse effect on the Company's business, financial position and   
results of operations. However, pursuant to FDA regulations,   
although the FDA can issue an approval it cannot make any approval   
for the AVITA gel effective prior to the expiration of the J&J   
Patent if the lawsuit is pending.  There can be no assurance that   
the lawsuit will not delay the timing of the market introduction of   
AVITA gel, will not result in a substantial diversion of management   
attention or will not require substantial expenditures to defend or   
resolve.  
  
Item 6.  Exhibits and Reports on Form 8-K  
            (a) Exhibits  
  
                27  Financial Data Schedule  
  
            (b) Reports on Form 8-K - Not Applicable  
  
<PAGE>  
  
SIGNATURES    
    
    
Pursuant to the requirements of the Securities and Exchange Act of 1934,    
the registrant has duly caused this report to be signed on its behalf by    
the undersigned, thereunto duly authorized.    
    
    
                                         PENEDERM INCORPORATED    
    
    
    
    
    
/S/  Lloyd H. Malchow                   November 14, 1996   
Lloyd H. Malchow, President    
and Chief Executive Officer    
    
    
    
    
    
    
    
/S/  Edgar Luce                         November 14, 1996   
Edgar Luce, Vice President of    
Finance and Administration    
    
<PAGE>