**UNITED STATES**

 

**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, DC 20549**

 

**FORM 10-QSB**

 
| **ý** | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.** |
|------------|------------------------------------------------------------------------------------------------|

 

**For the Quarterly Period Ended March 31, 2004**

 

**or**

 
| **o** | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934.** |
|-------|-------------------------------------------------------------------------------------------------|

 

**For the Transition PeriodFrom     To     **

 

**Commission File Number: 001-31925**

 

**VASO ACTIVE PHARMACEUTICALS, INC.**

(Exact name of small business issuer as specified in its charter)

 
| **Delaware**                                                    |   | **02-0670926**                    |
|-----------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction  of incorporation or organization) |   | (IRS Employer Identification No.) |
|                                                            |   |                              |
| **99 Rosewood Drive, Suite 260Danvers, MA**                     |   | **01923**                         |
| (Address of principal executive offices)                        |   | (Zip code)                        |
|                                                            |   |                              |
| Issuer’s telephone number: **(978)  750-1991**             |

 

Check whetherthe issuer (1) filed all reports required to be filed by Section 13 or 15(d) ofthe Exchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes o No ý

 

State the number of shares outstanding ofeach of the issuer’s classes of common equity, as of the latest practicabledate:

 
| Common stock, Class A, $0.0001 par value |   | 5,828,604 shares outstanding on July 19, 2004 |
|------------------------------------------|--------|-----------------------------------------------|
| Common stock, Class B, $0.0001 par value |   | 4,500,000 shares outstanding on July 19, 2004 |

 

 

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**VASO ACTIVEPHARMACEUTICALS, INC.**

 

**INDEX TO FORM 10-QSB**

 
| **PART I.**                                                                                               | **FINANCIAL INFORMATION** |   |
|-----------------------------------------------------------------------------------------------------------|---------------------------|--------|
|                                                                                                      |                      |
| ITEM 1 –  Condensed Financial Statements (unaudited):                                                |                      |
|                                                                                                      |                      |
| Condensed Balance Sheets as of March 31, 2004 and December 31, 2003  (audited)                            |                      |
| Condensed Statements of Operations for the  Three-Month Periods Ended March 31, 2004 and 2003             |                      |
| Condensed Statements of Cash Flows for the  Three-Month Periods Ended March 31, 2004 and 2003             |                      |
| Notes to the Condensed Financial Statements                                                               |                      |
|                                                                                                      |                      |
| ITEM 2 – Management’s Discussion and Analysis of Financial Condition  and Results of Operations |                      |
|                                                                                                      |                      |
| ITEM 3 –   Controls and Procedures                                                              |                      |
|                                                                                                      |                      |
| **PART II**                                                                                               | **OTHER  INFORMATION**    |   |
|                                                                                                      |                      |
| ITEM  1 – Legal Proceedings                                                                          |                      |
| ITEM 2 – Changes in Securities                                                                       |                      |
| ITEM 6 – Exhibits and Reports on Form 8-K                                                            |                      |
|                                                                                                      |                      |
| Signatures                                                                                                |                      |

 

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**VASO ACTIVE PHARMACEUTICALS, INC.**

**CONDENSEDBALANCE SHEETS**

 
|                                                                                                                                                   |   | **March 31,  2004** |       | **December  31  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|--------|
|                                                                                                                                                   |   | **(unaudited)**     |       |                   |   |
| **ASSETS**                                                                                                                                             |   |                |       |                   |   |
| **Current assets:**                                                                                                                                    |   |                |       |                   |   |
| Cash and cash equivalents (Note 1)                                                                                                                     |   | $                   | 12,364,531 |                   | $      | 6,109,775 |   |
| Accounts receivable                                                                                                                                    |   | 2,240               |       | 1,357                  |   |
| Inventory                                                                                                                                              |   | 81,830              |       | 60,826                 |   |
| Prepaid expenses                                                                                                                                       |   | 133,644             |       | 145,684                |   |
|                                                                                                                                                   |   |                |       |                   |   |
| **Total current assets**                                                                                                                               |   | 12,582,245          |       | 6,317,642              |   |
|                                                                                                                                                   |   |                |       |                   |   |
| Property and equipment - net                                                                                                                           |   | 4,961               |       | —                 |   |
|                                                                                                                                                   |   |                |       |                   |   |
|                                                                                                                                                   |   | $                   | 12,587,206 |                   | $      | 6,317,642 |   |
|                                                                                                                                                   |   |                |       |                   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                          |   |                |       |                   |   |
| **Current liabilities:**                                                                                                                               |   |                |       |                   |   |
| Accounts payable                                                                                                                                       |   | $                   | 239,896    |                   | $      | 125,029 |   |
| Accrued compensation                                                                                                                                   |   | 58,273              |       | 278,438                |   |
| Other accrued expenses                                                                                                                                 |   | 114,280             |       | 197,564                |   |
| Convertible note payable (Note 1)                                                                                                                      |   | 7,500,000           |       | —                 |   |
| Due to parent company                                                                                                                                  |   | 92,209              |       | 89,507                 |   |
|                                                                                                                                                   |   |                |       |                   |   |
| **Total current liabilities**                                                                                                                          |   | 8,004,658           |       | 690,538                |   |
|                                                                                                                                                   |   |                |       |                   |   |
| Commitments and contingencies (Note 1)                                                                                                                 |   | 200,000             |       |                   |   |
|                                                                                                                                                   |   |                |       |                   |   |
|                                                                                                                                                   |   | 8,204,658           |       | 690,538                |   |
| **Stockholders’ equity:**                                                                                                                         |   |                |       |                   |   |
| Preferred stock - $0.0001 par value;  authorized  10,000,000 shares; issued and outstanding, none                                                      |   | —              |       | —                 |   |
| Common stock - $0.0001 par value;  authorized  30,000,000 shares; issued and outstanding, 10,328,604  March 31, 2004; and 10,103,613 December 31, 2003 |   | 1,033               |       | 1,011                  |   |
| Additional paid-in capital                                                                                                                             |   | 8,093,656           |       | 7,305,565              |   |
| Deferred compensation                                                                                                                                  |   | (229,080            | )          | —                 |   |
| Accumulated deficit                                                                                                                                    |   | (3,483,061          | )          | (1,679,472             | )      |
|                                                                                                                                                   |   |                |       |                   |   |
| **Total stockholders’ equity**                                                                                                                    |   | 4,382,548           |       | 5,627,104              |   |
|                                                                                                                                                   |   | $                   | 12,587,206 |                   | $      | 6,317,642 |   |

 

See notes to the unaudited condensed financial statements.

 

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**VASO ACTIVE PHARMACEUTICALS, INC.**

**UNAUDITED CONDENSED STATEMENTS OF OPERATIONS**

 
|                                                              |   | **Three-Month  Period Ended March 31,** |       |
|-------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                              |   | **2004**                                |       | **2003** |   |
|                                                              |   |                                    |       |   |   |
| Net revenues                                                      |   | $                                       | 7,147      |   | $ | 29,864 |   |
| Cost of revenues                                                  |   | 5,775                                   |       | 14,858 |   |
|                                                              |   |                                    |       |   |   |
| **Gross profit**                                                  |   | 1,372                                   |       | 15,006 |   |
|                                                              |   |                                    |       |   |   |
| Costs and expenses:                                               |   |                                    |       |   |   |
| Marketing, advertising and promotion                              |   | 66,254                                  |       | 16,386 |   |
| Management fee                                                    |   | 8,160                                   |       | 30,561 |   |
| Selling, general and administrative                               |   | 1,529,833                               |       | 86,944 |   |
| Research and development                                          |   | 95,167                                  |       | — |   |
| Stock based compensation (Note 4)                                 |   | 109,033                                 |       | — |   |
|                                                              |   |                                    |       |   |   |
| Loss from operations                                              |   | (1,807,075                              | )          | (118,885 | ) |
|                                                              |   |                                    |       |   |   |
| Other income (expense), net                                       |   | 3,486                                   |       | (3,082 | ) |
|                                                              |   |                                    |       |   |   |
| **Net loss**                                                      |   | $                                       | (1,803,589 | ) | $ | (121,967 | ) |
|                                                              |   |                                    |       |   |   |
| Net loss per share - basic and diluted  (Note 2)                  |   | $                                       | (0.18      | ) | $ | — |   |
|                                                              |   |                                    |       |   |   |
| Weighted average shares outstanding - basic  and diluted (Note 2) |   | 10,200,536                              |       | — |   |

 

See notes to the unaudited condensed financial statements.

 

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**VASO ACTIVE PHARMACEUTICALS, INC.**

**UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS**

 
|                                                                         |   | **Three-Month  Period Ended March 31,** |       |
|------------------------------------------------------------------------------|--------|-----------------------------------------|------------|
|                                                                         |   | **2004**                                |       | **2003** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                    |   |                                    |       |   |   |
| Net loss                                                                     |   | $                                       | (1,803,589 | ) | $ | (121,967 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                    |       |   |   |
| Depreciation and amortization                                                |   | 261                                     |       | — |   |
| Stock-based compensation (Note 4)                                            |   | 109,033                                 |       | — |   |
| Commitments and contingencies (Note 1)                                       |   | 200,000                                 |       | — |   |
| Increase (decrease) in cash from change in:                                  |   |                                    |       |   |   |
| Accounts receivable                                                          |   | (883                                    | )          | 26,971 |   |
| Inventory                                                                    |   | (21,004                                 | )          | (11,856 | ) |
| Prepaid expenses and other assets                                            |   | 12,040                                  |       | (114,262 | ) |
| Accounts payable                                                             |   | 114,867                                 |       | (220,211 | ) |
| Accrued compensation                                                         |   | (220,165                                | )          | (604 | ) |
| Other accrued expenses                                                       |   | (83,284                                 | )          | 3,082 |   |
| Net cash used in operating activities                                        |   | (1,692,724                              | )          | (438,847 | ) |
|                                                                         |   |                                    |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                    |   |                                    |       |   |   |
| Purchase of property and equipment                                           |   | (5,222                                  | )          | — |   |
| Net cash used in investing activities                                        |   | (5,222                                  | )          | — |   |
|                                                                         |   |                                    |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                    |   |                                    |       |   |   |
| Issuance of Class A common stock                                             |   | 450,000                                 |       | — |   |
| Issuance of convertible promissory notes                                     |   | —                                  |       | 290,000 |   |
| Issuance of convertible notes (Note 1)                                       |   | 7,500,000                               |       | — |   |
| Due to/from parent company                                                   |   | 2,702                                   |       | 438,847 |   |
| Net cash provided by financing activities                                    |   | 7,952,702                               |       | 728,847 |   |
|                                                                         |   |                                    |       |   |   |
| **NET INCREASE IN CASH AND CASH EQUIVALENTS**                                |   | 6,254,756                               |       | 290,000 |   |
|                                                                         |   |                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS, Beginning of  period**                          |   | 6,109,775                               |       | — |   |
|                                                                         |   |                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS, End of period**                                 |   | $                                       | 12,364,531 |   | $ | 290,000 |   |
|                                                                         |   |                                    |       |   |   |
| **SUPPLEMENTAL DISCLOSURES:**                                                |   |                                    |       |   |   |
| Interest paid                                                                |   | $                                       | —     |   | $ | — |   |

 

See notes to the unaudited condensed financial statements.

 

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**VASO ACTIVEPHARMACEUTICALS, INC.**

 

**NOTES TO UNAUDITED CONDENSEDFINANCIAL STATEMENTS**

** **

**1.****              NATUREOF BUSINESS AND BASIS OF PRESENTATION**

 

***The Company***

 

VasoActive Pharmaceuticals, Inc. (the “Company”) is an early-stage company established for thepurpose of commercializing, marketing and selling over-the-counter, or OTC,pharmaceutical products that incorporate the vaso active lipid encapsulated(“VALE”) technology or proprietary PENtoCORE technology.  The patents covering the VALE technology areheld by BioChemics, Inc. (“BioChemics”), a privately-owned biopharmaceuticalcompany. While the Company considers the PENtoCORE technology proprietary, itis not covered by patents.  In February2003, BioChemics granted the Company an exclusive, irrevocable, worldwidelicense to use and practice the VALE patents and PENtoCORE technology in orderto commercialize, market and sell OTC pharmaceutical products.  At March 31, 2004, BioChemics owned approximately 44% of the Company’s combinedclasses of issued and outstanding common stock and 70% of the voting power ofthe Company’s combined classes of common stock.

 

The Company began itsoperations in January 2001, as a division of BioChemics, abiopharmaceutical company engaged in the development of transdermal and topicaldrug delivery systems. In January 2003, the Company incorporated inDelaware and became an independent subsidiary of BioChemics, focused on thefurther commercialization of its existing OTC products and the development ofnew OTC product candidates.

 

BioChemics providesthe Company with certain management and administrative services includingaccounting, corporate services, data processing, telephone, office space andother corporate services and infrastructure. The financial statements of theCompany include expense allocations on bases that the Company and BioChemicsconsider to be reasonable reflections of the utilization of services providedfor the benefit of and received by the Company. In addition, for the three-monthperiod ended March 31, 2003, the Company’s marketing, advertising and promotionexpenses include expenses related to the commercialization, marketing anddistribution of BioChemics’ athlete’s foot preparation product, then calleddeFEET, the revenues of which are realized by the Company through an assignmentof BioChemics’ ownership interests in such revenues.

 

The Company has alimited operating history and has incurred net losses since its inception. TheCompany’s principal risks are the possibility of a material adverse effect fromthe actions and risks summarized under the “Recent Events” and “Risk Factors”sections of this Quarterly Report on Form 10-QSB.

 

Theaccompanying unaudited financial statements have been prepared on the samebasis as the annual financial statements included in the Company’s AnnualReport on Form 10-KSB/A filed with the SEC for the period ended December 31,2003. In the opinion of management, all significant adjustments, which arenormal, recurring in nature and necessary for a fair presentation of thefinancial position, cash flows and results of the operations of the Company,have been consistently recorded. The operating results for the interim periodspresented are not necessarily indicative of expected performance for the entireyear.

 

Certainamounts from the prior year have been reclassified to conform to the currentyear presentation.

 

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The unaudited informationshould be read in conjunction with the audited financial statements of theCompany and the notes thereto for the year ended December 31, 2003 included inthe Company’s Annual Report on Form 10-KSB/A filed with the SEC for thatperiod.

 

***Initial Public Offering***

 

OnDecember 15, 2003, the Company completed an initial public offering of1,667,500 shares of Class A common stock (5,002,500 shares on a post-splitbasis – please see “Stock Split” below) at a price of $5.00 per share ($1.67 ona post-split basis) raising approximately $6.4 million, net of issuancecosts.

 

***Stock Split***

 

OnFebruary 20, 2004, the Company announced a three-for-one stock split onall classes of common equity in the form of a 200% stock dividend paid onMarch 5, 2004 to stockholders of record on February 23, 2004.  Except where otherwise noted, all share andper share information contained in this Quarterly Report on Form 10-QSB havebeen adjusted to reflect the results of this dividend.

 

***Recent Events***

 

***Trading Suspensionand SEC Settlement.***  On April 1, 2004, the United States Securities and ExchangeCommission (the “SEC”) temporarily suspended trading of the Company’ssecurities.  The suspension, by itsterms, terminated on April 15, 2004.  Inthe SEC announcement of the trading suspension, the SEC stated that ittemporarily suspended trading in the securities of the Company because ofquestions regarding the accuracy of assertions by the Company, and by others,in press releases, the Company’s annual report, its registration statement andpublic statements to investors concerning, among other things: “(1) the FDAapproval of certain key products; and (2) the regulatory consequences of thefuture application of [its] primary product.”

 

On April 5,2004, representatives of the Company, together with newly retained specialsecurities counsel and newly retained United States Food and DrugAdministration, or FDA, counsel, met with the staff of the SEC (the “Staff”)for the purpose of discussing the concerns that led to the suspension oftrading in the Company’s securities. During that meeting, the Company stated its intention to review itspublic disclosure, press releases and other public statements and to takewhatever remedial action might be appropriate. The Company also represented to the Staff that it would (i) diligentlyseek to clarify the status of its products under current FDA regulations, (ii)issue disclosure regarding the FDA regulation of its activities and productsand the results of its dialogue with the FDA, and (iii) endeavor to resolve ona timely basis any concerns communicated by the Staff. The Staff stated that ithad been authorized by the SEC to seek injunctive relief against the Company,articulated the concerns that gave rise to the suspension of trading, andinformally requested that the Company provide certain information to the Staff.The Company agreed to cooperate with the Staff, committed to review itsdisclosure promptly and committed to take any remedial action that might berequired.

 

The Companyhas agreed to a settlement with the Staff pursuant to which the Company will bepermanently enjoined from violating certain of the anti-fraud provisions of theSecurities Act and the Exchange Act. The settlement must first be approved by the SEC itself and then by acourt.  In addition, the Company’sPresident and Chief Executive Officer has made an offer to settle a proposedaction by the SEC against him that would similarly enjoin him and prevent himfrom serving as an officer or director of any public company, including theCompany, for a period of five years.

 

Due to the ongoingnature of these matters, the Company is unable to definitively assess theirimpact, nor is it aware if the FDA is contemplating any action against it.  However, the Company has

 

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committed not to market or sell its products until all outstandingmatters have been addressed to the satisfaction of the SEC and until theCompany is reasonably sure that the marketing and sale of its products isconsistent with the FDA’s requirements and policies.  This commitment may have a material adverse impact on theCompany. When appropriate, the Company will make additional publicannouncements and will file public reports with the SEC regarding the status ofits products under applicable FDA regulations.

 

***Nasdaq Stock MarketMatters.*** By letter dated April 2, 2004, the Nasdaq Listing Investigationsdepartment of The Nasdaq Stock Market, Inc. (“Nasdaq”) notified the Companythat it had commenced an inquiry to ensure the Company’s ongoing compliancewith Nasdaq’s inclusion requirements and requested certain information from theCompany.  The letter further disclosedthat after review of the information provided by the Company, Nasdaq could takeany action that might be appropriate under its Marketplace Rules including removalof the Company’s securities from Nasdaq. In view of the substantial administrative and cash burdens being borneby the Company at that time and the substantial legal costs anticipated withrespect to the SEC and FDA matters, the Company determined that it was in thebest interest of its shareholders to voluntarily cause its shares to be removedfrom Nasdaq and focus its attention and resources on addressing the SEC and FDAconcerns.  The Company’s securities werevoluntarily delisted, effective the opening of the markets on Thursday, April8, 2004.  At an appropriate time, theCompany will seek to cause its securities to be quoted on an exchange, Nasdaqor other automated quotation system.  Noestimate can be given as to the date when the Company’s securities will resumetrading on a national exchange or automated securities quotation system, ifever.

 

***Litigation.***  In April, May, and June 2004, the Companyand certain of its officers were sued in several purported securities classaction lawsuits filed in the United States District Court for the District ofMassachusetts.  The complaints, whichseek equitable and monetary relief, an unspecified amount of damages, withinterest, attorneys fees and costs, allegedly were filed on behalf ofpurchasers of the Company’s Class A common stock during the period December 11,2003 to March 31, 2004 and allege that during that period, the defendantsviolated the federal securities laws by allegedly failing to make accurate andcomplete disclosures concerning the Company, its financial condition, itsbusiness operations and future prospects, the clinical trial and endorsement ofthe Company’s Termin8 anti-fungal product (previously known as “deFEET”) andthe institutional demand for the Company’s securities.  These complaints are captioned asfollows:  Dennis E. Smith v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10708 (RCL) (D.Mass.); Richard Shapiro v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ. No. 04-10720 (RCL) (D. Mass.); Christopher Pepin v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10763 (RCL) (D.Mass.); Modhi Gude, *et al.* v. Vaso Active Pharmaceuticals,Inc., *etal.*, Civ. No. 04-10789 (RCL) (D. Mass.); Kim Benedetto, *et al.*v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10808 (RCL) (D.Mass.); Dean Dummer v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10819 (RCL) (D.Mass.); Edward Tovrea v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ . No. 04-10851 (RCL); Kourosh Alipor v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10877 (RCL); Paul E. Bostrom v.VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10948 (RCL); Ira A. Turret Sep-Ira Dated01/24/02 v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No.04-10980 (RCL); Richard Pagona v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11100 (RCL); James Karanfilian v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-11101 (RCL); and Charles Robinson v. VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11221 (RCL). The Court has consolidated the above-referenced cases, other than the Tovreaand Karanfilian complaints, under the caption In Re Vaso ActivePharmaceuticals Securities Litigation, Civ. No. 04-10708 (RCL).  Although the Company intends tovigorously defend against these cases, the litigation process is inherentlyuncertain and there can be no guarantee as to the ultimate outcome of thesematters.  There is also no guaranteethat these will be the only lawsuits brought against the Company with respectto these matters.

 

The Company has also been named as a nominaldefendant in two shareholder derivative actions filed, the first filed in theUnited States District Court for the District of Massachusetts in April 2004against its directors and certain of its officers and against BioChemics, Inc.entitled Joseph Rosenkrantz v. BioChemics, Inc., *et al*., Civ. No.04-10792 (RCL) (D. Mass.) and the secondfiled in June 2004, also against

 

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theCompany’s directors and certain of its officers and against BioChemics, Inc.entitled William Pomeroy v. BioChemics Inc., *et a**l.*,  Civ. No. 04-11399 (RCL) (D. Mass.). Thecomplaints allege, among other things, that the alleged conduct challenged inthe securities cases pending against the Company in Massachusetts (describedabove) constitutes a breach of the defendants’ fiduciary duties to theCompany.  The complaints seek equitableand monetary relief, an unspecified amount of damages, and attorneys and otherfees, costs and expenses, ostensibly on behalf of the Company.

 

Because of theuncertainty of estimating the potential financial statement impact of any ofthese actions with any reasonable degree of accuracy, at this time the Companyhas not reserved for any potential liability or costs that may arise as aresult of this litigation except for the $200,000 insurance deductible that itreserved as of March 31, 2004.  Whilethe cases are in very preliminary stages and the outcomes are not predictable, ifa substantial amount is payable by the Company and is not reimbursed throughits director and officer liability insurance policy, this will have a materialadverse effect on the Company’s financial position and liquidity.  There can be no assurance that the Company’sinsurer will admit liability to reimburse the Company with respect to any ofthe claims asserted in any of the litigation against the Company or itsofficers or directors or that coverage limits will be sufficient.

 

***Unwinding of March16, 2004 Private Investment in Public Equity***.  On March 16, 2004, the Company entered intoa private placement transaction in the amount of $7,500,000 with aninstitutional investor.  The investmentwas in the form of an 18 month 2% Convertible Note, or Note, convertible intoshares of the Company’s Class A common stock at a conversion rate of $9 pershare, at the option of the investor. In addition, the Company issued to the investor warrants to purchase166,667 shares of Class A common stock at an exercise price of $8.75 per share.

 

Given that theinitiation and continuation of the April 1, 2004 trading suspension by the SECconstituted a breach under the Note, the Company and the investor agreed,pursuant to the terms of a settlement agreement entered into on April 8, 2004,that the Company would immediately repay the investor the sum of $7,500,000 incash without penalty, interest, redemption premium or any other premium orpenalty, plus an expense reimbursement in connection with the settlementagreement in the amount of $15,000 in cash. In consideration of this repayment, the investor surrendered the Noteand warrants and the parties mutually terminated all other agreements enteredinto in connection with the transaction.

 

In connectionwith this transaction, the Company paid approximately $600,000 in fees tovarious third parties.  These fees werenot refunded when the Company repaid the investor.  These fees were recorded as an expense in the three-month periodended March 31, 2004.

 

**2.****              NETLOSS PER SHARE**

 

Basic net lossper share is computed by dividing net loss by the weighted average number ofcommon shares outstanding for the period. Diluted net loss per share reflects, in addition to the weighted averagenumber of common shares, the potential dilution if stock options and warrantsoutstanding were exercised and/or converted into common stock, unless theeffect of such equivalent shares was antidilutive.

 

For the three-month period ended March 31, 2004, the effectof stock options and other potentially dilutive shares were excluded from thecalculation of diluted net loss per common share as their inclusion would havebeen antidilutive.

 

There were no shares issued or outstanding for thethree-month period ended March 31, 2003, accordingly a net loss per sharecalculation was not presented.  However,on a pro forma basis, net loss per share (basic and diluted) would have been$0.02 per share. This pro forma loss per share was calculated as if (i) the4,500,000 shares of Class B common stock that was issued to BioChemics in June2003 had been issued to BioChemics on January 1, 2003, and (ii) the 10%convertible promissory notes that were issued in

 

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April 2003and converted into 601,113 shares of Class A common stock in December 2003 hadbeen converted into 601, 113 shares of Class A common stock on January 1, 2003.

 

**3.     REVENUE RECOGNITION**

 

The Company recognizes revenue from product sales in accordance withgenerally accepted accounting principles in the United States, including theguidance in Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,”which supercedes SAB No. 101, “Revenue Recognition in Financial Statements,”and Statement of Financial Accounting Standards (“SFAS”) No. 48, “RevenueRecognition When Right of Return Exists.”

 

Revenue from product sales is recognized when there is persuasiveevidence of an arrangement, delivery has occurred, the price is fixed anddeterminable, and collectibility is reasonably assured. However, because theCompany’s products are sold with limited rights of return, revenue isrecognized when the price to the buyer is fixed, the buyer is obligated to paythe Company and the obligation to pay is not contingent on resale of theproduct, the buyer has economic substance apart from the Company, the Companyhas no obligation to bring about the sale of the product and the amount ofreturns can be reasonably estimated.

 

The Company records allowances for product returns, rebates anddiscounts, and reports revenue net of such allowances. The Company must makejudgments and estimates in preparing the allowances that could requireadjustments in the future. For instance, customers have the right to return anyproduct that is held past the labeled expiration date. The Company bases itsestimates on historic patterns of returns and on the expiration dates ofproduct currently being shipped, or as a result of an actual event that maygive rise to a significant return amount such as the discontinuance of aproduct.

 

The Companydoes not recognize revenue unless collectibility is reasonably assured. TheCompany maintains allowances for doubtful accounts for estimated lossesresulting from the inability of its customers to make required payments. If thefinancial condition of our customers were to deteriorate and result in animpairment of their ability to make payments, additional allowances may berequired.

 

**4.****              STOCK-BASEDCOMPENSATION**

 

The Company accounts forstock-based employee compensation arrangements using the intrinsic value methodin accordance with Accounting Principles Board Opinion (“APB”) No. 25,“Accounting for Stock Issued to Employees,” and complies with the disclosureprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Under the intrinsic value method,compensation associated with stock awards to employees is determined as theexcess, if any, of the current fair value of the underlying common stock on thedate compensation is measured over the price an employee must pay to exercisethe award. The Company accounts for stock options and awards to non-employeesusing the fair value method.

 

The Company has an employeestock incentive plan and a non-employee director compensation plan, which aredescribed more fully in Note 6 to the Company’s Annual Report on Form10-KSB/A for the period ended December 31, 2003.

 

The following tableillustrates the effect on net loss and net loss per share if the Company hadapplied the fair value recognition provisions of SFAS No. 123, as amended,to options granted under the stock option plans and rights to acquire stockgranted under the Company’s stock option plans. For purposes of this *pro-forma*disclosure, the value of the options is estimated using a Black-Scholes optionpricing model and amortized ratably to expense over the options’ vesting periods.Because the estimated value is determined as of the date of grant, the actualvalue ultimately realized by the employee may be significantly different.

 

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|                                                                          |   | **Three-Month  Period  Ended March 31, 2004** |       |
|-------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                          |   |                                          |       |
| Net loss, as reported                                                         |   | $                                             | (1,803,589 | ) |
| Add back: stock-based compensation included  in the determination of net loss |   | 109,033                                       |       |
| Less: stock-based compensation had all  options been recorded at fair value   |   | (510,914                                      | )          |
| Adjusted net loss                                                             |   | $                                             | (2,205,470 | ) |
|                                                                          |   |                                          |       |
| Weighted average shares outstanding, basic  and diluted                       |   | 10,200,536                                    |       |
| Net loss per share, basic and diluted, as  reported                           |   | $                                             | (0.18      | ) |
| Adjusted net loss per share, basic and  diluted                               |   | $                                             | (0.22      | ) |

 

The Black-Scholes option pricing model requires the Company to inputhighly subjective assumptions. The key assumptions used to apply this pricingmodel were as follows: 3.3% risk-free interest rate; a 4.0 year expected lifeof options grants; and 98% expected volatility of the Company’s underlyingcommon stock. The estimated weighted average fair value of option grants madeduring the three months ended March 31, 2004 was $4.39 per option. The Companydid not issue any stock options during the three months ended March 31, 2003.

 

**ITEM 2.****                  MANAGEMENT****’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations should be read together with our unaudited condensed financialstatements and related notes included elsewhere in this Quarterly Report onForm 10-QSB. This Quarterly Report on Form 10-QSB, including thefollowing discussion, contains trend analysis and other forward-lookingstatements within the safe harbor provisions of the Private Securities LitigationReform Act of 1995. Any statements in this Quarterly Report on Form 10-QSBthat are not statements of historical facts are forward-looking statements.These forward-looking statements are based on a number of assumptions andinvolve risks and uncertainties. Actual results may differ materially fromthose set forth in such forward-looking statements as a result of factors setforth elsewhere in this Quarterly Report on Form 10-QSB, including under“Risk Factors.”

 

**Overview**

 

*** Formation***

 

We began our operations in January 2001 as a division ofBioChemics, a biopharmaceutical company engaged in the development oftransdermal and topical drug delivery systems. In January 2003, weincorporated in Delaware and became an independent subsidiary of BioChemics,focused on the further commercialization of our existing OTC products and thedevelopment, through BioChemics and other potential collaboration partners, ofnew OTC product candidates. We continue to rely on BioChemics to provide uswith administrative support services, manufacturing and product developmentservices and VALE and PENtoCORE technology licenses.

 

On December 15, 2003, we completed an initial public offering of1,667,500 shares of our Class A common stock (5,002,500 on a post-splitbasis) at a price of $5.00 per share ($1.67 on a post-split basis), raisingapproximately $6.4 million, net of issuance costs. Effective March 5,2004, we completed a 200% stock dividend to holders of record of both ourClass A and B common stock on February 23, 2004. Except where noted,all share and per share information contained in this Quarterly Report onForm 10-QSB have been adjusted to reflect the effects of this dividend.

 

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* **Technology***

 

Transdermal drug delivery isgenerally considered to be any process of delivering drugs through the skin andinto the bloodstream without the use of an invasive instrument such as aneedle.  Transdermal drug deliveryoffers potential advantages over other commonly accepted modes of drug deliveryfor the treatment of certain diseases and medical conditions.  We believe that these potential advantagesinclude:

 

•                  **Reduction ofRoute-of-Administration Related Side Effects**.  Because they areabsorbed through the stomach, some orally administered medicines can causesignificant gastrointestinal side effects, sometimes leading to discontinuationof the medication. There also may be side effects associated with the deliveryof some drugs through the nasal lining, the lungs, and the skin using traditionalmethods.  The goal of the VALEtransdermal delivery system is to provide effective therapy while minimizingside effects.

 

•                  **ImprovedDrug Performance**.  Transdermal formulations may have thepotential to improve the effectiveness of a drug by avoiding the stomach andthe first-pass metabolism associated with oral delivery of drugs. Transdermaldrug delivery also may have the potential to create a higher bioavailabilityindex for drugs, allowing for the desired concentration of the drug molecule toreach the bloodstream from a smaller dose of drug applied to the patient.

 

There are many differenttechnologies used to deliver drugs transdermally. The most common technologiesemployed are: (i) patches that adhere to the skin, holding a drug in placewhile it is administered over time; (ii) liposome, or artificiallyprepared cell-like structures, which are applied topically and absorbed; or(iii) an outside energy source producing electricity, otherwise known asiontophoresis, or sound, otherwise known as sonophoresis, to help move the drugthrough the various skin layers. We believe all three of these technologieshave certain drawbacks that may limit their utility.

 

Our productsutilize formulation technologies that we believe can be applied to asignificant array of currently off-patent drugs for commercialization in theOTC marketplace. The VALE technology is a transdermal formulation that webelieve may have the potential to introduce drugs through the skin and into thebloodstream in an efficient and effective manner.  The PENtoCORE technology is a topical formulation that we believeallows for the formation of OTC products with certain “use advantages” overcompetitors. “Use advantages” include characteristics such as odor, residue,and feel.

 

The goal behindthe development of the VALE technology system is to create an activetransdermal drug system that efficiently and effectively delivers drugs throughthe skin and into the blood supply without the need of a patch.  In order to accomplish this, a deliverysystem must be able to overcome three skin barriers:

 

•                                          theskin’s outer layer, or epidermis;

 

•                                          thesecond layer, the dermis, which is composed of connective tissue, glands andhair; and

 

•                                          thewalls of individual capillaries, tiny, thin-walled blood vessels that transportblood to the larger veins and arteries of the body.

 

The VALE system isintended to be a patchless, lipid-based delivery system which uses an activeprocess to deliver drugs through the skin and into the bloodstream.  It is being developed around the uniqueconcept of incorporating chemical vasodilators into the drug delivery vehicle.These chemical compounds are intended to act on the network of blood vesselslocated near the surface of the skin to elicit the physiologic response of dilatingor relaxing the blood vessels in the immediate area.  This, in turn, is designed to have the effect of increasing theblood flow to the area.  The theorybehind the VALE system is that as blood flow

 

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increases and the blood vesselsdilate, the active drug molecules incorporated into the delivery system aretransported actively and efficiently into the bloodstream.

 

We believe thatthe VALE technology has the potential to eliminate the need for a patch and toallow for the effective delivery of many active ingredients that may nototherwise be effectively delivered using existing drug delivery technologies.

 

The PENtoCOREtechnology is a topical formulation, as opposed to the VALE transdermal technology.  Although the PENtoCORE technology does notachieve its effect by delivering the drug through the skin and into thebloodstream, we believe that this technology may enable the formulation oftopical products that are pleasant to use because they do not have the odor,greasy feel or residue often associated with other topically-applied drugproducts.  In addition, it may bepossible to use the PENtoCORE technology with certain active ingredients todevelop topical formulations that facilitate a longer-lasting effect.

 

***Manufacturing andDevelopment Agreement***

 

In February 2003, we entered into a manufacturing and developmentagreement with BioChemics with respect to the ongoing manufacturing anddevelopment of our products and product candidates. Under this agreement,BioChemics will research, develop and manufacture products for us pursuant tospecific purchase orders submitted by us from time to time. BioChemics willcharge us a development and manufacturing fee at a rate of cost plus 10%. Thedevelopment and manufacturing agreement permits BioChemics to use third partycontractors to manufacture the products that BioChemics provides to us.Currently, BioChemics uses a privately owned third party company as its solecontract manufacturer. We do not currently, nor do we intend to, engage in themanufacturing of, nor conduct any research and development with respect to, anyof our products or product candidates. However, in the event that BioChemics is unwilling or unable to meet ourmanufacturing needs in accordance with the terms of its manufacturing anddevelopment agreement with us, we have the right to retain outside thirdparties to manufacture our products. Pursuant to this agreement, during the three-month period ended March31, 2004 we incurred research and development costs of approximately $95,200related to the formulation of an analgesic utilizing the active ingredientibuprofen.  Pre-clinical studiesutilizing animals were conducted and billed as part of this research.

 

***Administrative andManagerial Support***

 

Since BioChemics provides us with administrative and managerialsupport, our results of operations include allocations of certain BioChemicsexpenses, such as centralized accounting, data processing, utilities, officespace rental, supplies, telephone and other BioChemics corporate services andinfrastructure. These expenses have been charged back to us as a managementfee. We recorded approximately $8,200 and $30,600 in these related-party feesin the three-month periods ended March 31, 2004 and 2003 respectively. Inaddition, during the three-month period ended March 31, 2003, BioChemicsprovided financing to us in the amount of $222,983 to fund our operating lossesincurred during that three-month period as well as fund the up front costs of aprivate placement closed in April 2003, see discussion under “Liquidity andCapital Resources”.  This was reimbursedto BioChemics as a portion of the amount paid to BioChemics upon the closing ofour initial public offering in December 2003. The expense allocations have beendetermined on the basis that we and BioChemics consider to be reasonablereflections of the utilization of services provided for the benefit received byus.

 

Effectiveof September 1, 2003, we entered into an administrative services agreementwith BioChemics. Under this agreement, BioChemics provides to us, at ourrequest, administrative support services including secretarial support,accounting and tax services, data processing services, utilities, designatedoffice space, designated warehouse and storage space, office supplies,telephone and computer services and equipment and such other office andcorporate support services as we may reasonably require from time to time.BioChemics will charge us an administrative services fee at a rate of cost plus10%. This agreement is in effect for an initial term of 5 years and will beautomatically renewable on each anniversary date for an additional period of 12months unless sooner terminated (i) for a material breach by us, not curedwithin three months, and upon written notice (ii) upon 30 dayswritten notice by us, (iii) upon 45 days written notice by eitherparty if BioChemics ceases to own beneficially shares of our capital stock towhich are attached at least 49% of the votes that may be cast to elect ourDirectors, or (iv) upon written notice by either party in the event thatwe shall have disposed of all or substantially all of our assets.

 

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***GovernmentRegulation***

 

***General***The development, testing, manufacture, labeling, marketing, and promotion ofOTC drugs are subject to extensive regulation by the FDA under the FFDCA, andby the Federal Trade Commission, or FTC, under the Federal Trade CommissionAct, or FTC Act.

 

The degree ofregulation under the FFDCA is dependent, in part, upon whether the OTC drug, asformulated, labeled, and promoted, is considered by qualified experts, based onpublicly available scientific data and information, to be generally recognizedas safe and effective, or GRASE, for its recommended conditions of use.  If an OTC drug as formulated, labeled, andpromoted is not considered GRASE for its recommended conditions of use or, ifso considered, if it has not been used to a material extent or for materialtime, the drug is regulated under the FFDCA as a “new drug” which requirespre-market approval in the form of a NDA, before it can be commerciallymarketed.

 

To determinewhich OTC drugs are GRASE, the FDA has undertaken a rulemaking initiative inwhich it seeks to define by regulation which OTC drugs can be considered to beGRASE and thus can be marketed without first obtaining an approved NDA.  This rulemaking initiative, referred to asthe “OTC Review Program,” was initiated on May 11, 1972, and is ongoing.  The OTC Review Program sets forth in theform of an OTC Drug Monograph for specific categories of OTC drugs (e.g.,Topical Anti-Fungal OTC drugs) the conditions under which recognized OTC activeingredients can be considered GRASE and not misbranded.  These conditions include the strength of theactive ingredient, acceptable dosage forms, the use of safe and suitableinactive ingredients, and the recommended conditions of use, includingindications, warnings, precautions, and directions for use.

 

If the activeingredient used in an OTC drug is not covered by the OTC Review Program, oreven if it is covered, if the conditions of use (e.g., strength, dosage form,indications) deviate from that eligible for GRASE status under the OTC ReviewProgram, the product is considered by the FDA to be a “new drug” subject to theNDA pre-market approval requirements. For a full discussion of these requirements see the discussion below in“NDA Review Process”.

 

Pending theissuance of a final and effective OTC Drug Monograph for the category of OTCdrug involved (e.g., External Analgesic), the FDA has adopted an enforcementpolicy of not proceeding against the continued marketing of OTC drugs subjectto the OTC Review Program.  This enforcementdiscretion does not, however, apply if: (a) the FDA considers the drug productinvolved as falling outside of the scope of the OTC Review Program in that theactive ingredient or conditions of use deviate from those eligible for GRASEstatus under the OTC Review Program; (b) the product presents a health hazard;or (c) the active ingredient at the dosage level involved was not available OTCprior to December 4, 1975.  The FDA’swillingness to defer enforcement action generally terminates upon the effectivedate of the final OTC Drug Monograph covering the applicable drug product.

 

Otherrequirements or limitations for OTC drugs imposed under the FFDCA include: (a)a requirement that the drug be manufactured in conformity with cGMPs; (b) arequirement that the labeling for the product contain adequate directions foruse and warnings; (c) a requirement that the manufacturer of the drug productregister with the FDA; (d) a requirement that all drugs manufactured forcommercial distribution be listed with the FDA; and (e) a prohibition against makingany false or misleading misrepresentations in any particular in any labelingfor the product.  As noted above,   OTC products marketed in accordance withOTC Drug Monographs do not require FDA premarket approval prior tomarketing.  If an OTC product deviatesfrom an OTC Drug Monograph requirement in active ingredient(s), intended use,method of administration, dosage form, or labeling, among other things, thenthe manufacturer or distributor must obtain pre-market approval in the form ofan NDA before commercial marketing.

 

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The failure toadhere to the requirements of the Federal Fund, Drug and Cosmetic Act, orFFDCA, can result in: (a) seizure of violative products; (b) injunctionsagainst continued violations of the FFDCA, including active FDA supervision ininstituting appropriate corrective action and prohibition against continuedmarketing of the violative products pending an affirmative determination by theFDA and the courts that the violations have been adequately rectified; (c)civil penalties in the form of liquidated damages and/or recovery of profitsfrom illegal activities; and (d) the imposition of criminal sanctions andpenalties against responsible persons.

 

The FTC, underthe FTC Act, regulates print and broadcast media advertisements for OTCdrugs.  The FTC Act requires thatadvertisements be neither false nor misleading and that claims for productspurportedly based on scientific data be supported by adequate and wellcontrolled studies and that a reasonable basis exists in support of all otherclaims.  Claims consistent with theterms of an OTC Drug Monograph are usually accepted by the FTC as having beenadequately substantiated.  The penaltiesfor the failure of an advertised claim to have adequate substantiation, or forclaims that are false and misleading, include: (a) the FTC initiatingadministrative action for consumer redress; (b) FTC seeking a court injunctionto prevent further false and misleading advertising; (c) the imposition by acourt of liquidated damages and equitable relief to recover profits and provideconsumer redress from illegal activity; and (d) the placing of the company inreceivership to assure that the assets of the company are not dissipatedpending resolution of FTC claims.

 

***The NDA ReviewProcess*** The FDA has taken the position thatinsofar as our products or product candidates use a transdermal technology, theproducts fall outside that eligible for GRASE status under the OTC ReviewProgram and thus the Company must obtain NDA approval of the products beforethey can be commercially marketed. Under the FDA’s procedures it is generally less burdensome to obtain NDAapproval of a drug product which contains active ingredient(s): (a) consideredGRASE in a final OTC Drug Monograph, or (b) contained in a drug producteligible for ANDA approval, but which differs in certain conditions of use(e.g., dosage form) from that covered by a final OTC Drug Monograph or eligiblefor ANDA approval.  However, once aproduct becomes subject to the NDA requirements, the general provisions ofwhich are set forth below, there can be no assurance that a company cangenerate the additional data and information necessary to support NDA approvalof the proposed variant product or that approval can be obtained withoutsubstantial expenditures and delays.

 

The stepsordinarily required before a new drug that is subject to NDA approval may bemarketed in the United States include preclinical laboratory tests, animaltests and formulation studies, the submission to the FDA of an investigationalnew drug application, or IND, which must become effective before clinicaltesting may commence, and adequate and well-controlled clinical trials on humansubjects to establish the safety and effectiveness of the drug for eachindication for which FDA approval is sought. Satisfaction of FDA pre-market approval requirements typically takesseveral years and the actual time required may vary substantially based uponthe type, complexity and novelty of the product or the disease or condition forwhich the new drug is indicated. Government regulation may delay or prevent marketing of potentialproducts for a considerable period of time and impose costly procedures upon amanufacturer’s activities.  Success inearly-stage clinical trials does not assure success in later stage clinicaltrials.  Data obtained from clinicalactivities is not always conclusive and may be susceptible to varyinginterpretations that could delay, limit, or prevent regulatory approval.  Even if a product receives regulatoryapproval, later discovery of previously unknown problems with a product mayresult in restrictions on the product or even complete withdrawal of theproduct from the market.

 

Preclinicaltests include laboratory evaluation of product chemistry and formulation, aswell as animal trials to assess the potential safety and efficacy of theproduct.  The conduct of the preclinicaltests and formulation of compounds for testing must comply with Federalregulations and requirements.  Theresults of preclinical testing are submitted to the FDA as part of an IND.

 

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A 30-daywaiting period after the filing of each IND is required prior to thecommencement of clinical testing in humans. If the FDA has not commented on or questioned the IND within this 30-dayperiod, clinical trials may begin.  Ifthe FDA has comments or questions, the questions must be answered to thesatisfaction of the FDA before initial clinical testing can begin.  In addition, the FDA may, at any time,impose a clinical hold on ongoing clinical trials.  If the FDA imposes a clinical hold, clinical trials cannotcommence or recommence without FDA authorization and then only under termsauthorized by the FDA.  In someinstances, the IND process can result in substantial delay and expense.

 

Clinicaltrials typically involve the administration of the investigational new drug tovolunteers or patients under the supervision of a qualified investigator.  Clinical trials must be conducted incompliance with Federal regulations and requirements, under protocols detailingthe objectives of the trial, the parameters to be used in monitoring safety andthe effectiveness criteria to be evaluated. Each protocol involving testing on U.S. subjects must be submitted tothe FDA as part of the IND.  The studyprotocol and informed consent information for patients in clinical trials mustalso be approved by the institutional review board at each institution wherethe trials will be conducted.

 

Clinicaltrials to support NDAs for marketing approval are typically conducted in threesequential phases, but the phases may overlap. In Phase I, the initial introduction of the drug into healthy humansubjects or patients, the drug is tested to assess metabolism, pharmacokineticsand pharmacological actions and safety, including side effects associated withincreasing doses.  Phase II usuallyinvolves trials in limited patient populations, to determine dosage toleranceand optimum dosage, identify possible adverse effects and safety risks, andprovide preliminary support for the efficacy of the drug in the indicationbeing studied.

 

If a compounddemonstrates evidence of effectiveness and an acceptable safety profile inPhase II evaluations, Phase III trials are undertaken to further evaluateclinical efficacy and to further test for safety within an expanded patientpopulation, typically at geographically dispersed clinical trial sites it ispossible that Phase I, Phase II, or Phase III testing of product candidates maynot be completed successfully within any specified time period, if at all.

 

Aftersuccessful completion of the required clinical testing, generally an NDA isprepared and submitted to the FDA.  FDAapproval of the NDA is required before marketing of the product may begin inthe United States.  The NDA must includethe results of extensive clinical and other testing and a compilation of datarelating to the product’s pharmacology, chemistry, manufacture, andcontrols.  The cost of preparing andsubmitting an NDA is substantial.  UnderFederal law, the submission of NDAs are additionally subject to substantialapplications user fees, currently exceeding $500,000, and the manufacturerand/or sponsor under an approved NDA are also subject to annual product andestablishment user fees, currently exceeding $30,000 per product and $200,000per establishment.  These fees aretypically increased annually.

 

The FDA has 60days from its receipt of an NDA to determine whether the application will beaccepted for filing based on the agency’s threshold determination that the NDAis sufficiently complete to permit substantive review.  Once the submission is accepted for filing,the FDA begins an in-depth review of the NDA. Under Federal law, the FDA has agreed to certain performance goals inthe review of NDAs.  Most applicationsfor non-priority drug products are reviewed within ten months.  The review process is often significantlyextended by FDA requests for additional information or clarification ofinformation already provided in the submission.  The FDA may also refer applications for novel drug products ordrug products which present difficult questions of safety or efficacy to anadvisory committee, typically a panel that includes clinicians and otherexperts, for review, evaluation, and a recommendation as to whether theapplication should be approved.  The FDAis not bound by the recommendation of an advisory committee.

 

If FDAevaluations of the NDA and the manufacturing facilities and procedures, whichtypically involves an FDA on-site inspection, are favorable, the FDA may issuean approval letter, or, in some cases,

 

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an approvable letter followedby an approval letter.  An approvableletter generally contains a statement of specific conditions that must be metin order to secure final approval of the NDA. If and when those conditions have been met to the FDA’s satisfaction theFDA will typically issue an approval letter. An approval letter authorizes commercial marketing of the drug withspecific prescribing information for specific indications.  If the FDA’s evaluation of the NDAsubmission or manufacturing facilities is not favorable, the FDA may refuse toapprove the NDA or issue a not approvable letter.  The not approvable letter outlines the deficiencies in thesubmission and often requires additional testing or information in order forthe FDA to reconsider the application. Even with submission of this additional information, the FDA ultimatelymay decide that the application does not satisfy the regulatory criteria forapproval.  With limited exceptions, FDAmay withhold approval of an NDA regardless of prior advice it may have providedor commitments it may have made to the sponsor.  As a condition of NDA approval, the FDA may require post-approvaltesting and surveillance to monitor the drug’s safety or efficacy and mayimpose other conditions, including labeling restrictions.  Such labeling restrictions can materiallyimpact the potential market and profitability of the drug.  Once granted, product approvals can still bewithdrawn if compliance with regulatory standards is not maintained or problemsare identified following initial marketing.

 

Once the NDAis approved, a product will be subject to certain post-approval requirements,including requirements for adverse event reporting and submission of periodicreports.  Persons responsible formanufacture or distribution are subject to FDA inspections to assess compliancewith applicable statutory and regulatory requirements.

 

Additionally,the FDA also strictly regulates the promotional claims that may be made aboutdrug products.  The FDA requiressubstantiation of any claims of superiority of one product over another including,in many cases, requirements that such claims be proven by adequate and wellcontrolled head-to-head clinical trials. The FTC Substantiation Standards are very similar for the advertising ofOTC products.  To the extent that marketacceptance of the Company’s products may depend on their superiority overexisting therapies, any restriction on the Company’s ability to advertise orotherwise promote claims of superiority, or requirements to conduct additionalexpensive clinical trials to provide proof of such claims, could negativelyaffect the sales of the Company’s products and/or the Company’s costs.

 

***Treatment of theCompany’s Products and Product Candidates*** Webelieve that the active ingredients dosage forms and strengths of our Athlete’sRelief, Osteon and Termin8 products are covered by the OTC Review Program andtherefore these products  as currentlyformulated and labeled are potentially eligible for marketing under the OTCReview Program.  Accordingly, we intendto reintroduce them to the United States market once we are reasonably surethat the marketing of these products is consistent with the FDA’s requirementsand policies.  We anticipate that ourmarketing and sales of these products under revised labeling will resume by theend of 2004, although there is no guarantee of this.  With regard to product candidates that use the VALE transdermaltechnology or otherwise require new drug approval, we will not engage in thedevelopment of those products until we have secured a partnership with a largermarketing partner specifically for those products.  Further, it is expected that the actual development work will bedone by BioChemics which will be required to follow the more extensiveregulations imposed by the FDA, including the NDA requirements, and otherregulatory authorities in the United States and other countries regardingresearch and development, pre-clinical studies and clinical trials andultimately manufacturing of drug products subject to “new drug” status.

 

All of our OTC products and product candidates, whether subject to theOTC Review Program or NDA requirements, are required to be labeled, promoted,and manufactured to avoid the misbranding and adulteration provisions of theFFDCA, including the prohibition against false and misleading representationsand manufacturing in violation of cGMPs.

 

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***Strategy***

 

Our generalstrategy is to commercialize, market and sell transdermal and topical OTC drugsthat we believe can be delivered in an efficient, user-friendly, and reliablemanner by utilizing both the VALE and PENtoCORE technologies.

 

The development and test marketing of our three primary products hasbeen completed.  Each of these productsuses PENtoCORE topical formulations.  Weintend to market each of our three current products under the OTC ReviewProgram. These products are:

 

•                                       Athlete’sRelief — an OTC external analgesic designed to provide temporary relief fromthe muscle and joint pain associated with athletic activity; and

 

•                                       Osteon— an OTC external analgesic designed to provide temporary relief from themuscular-skeletal pain associated with arthritis; and

 

•                                       Termin8— an OTC antifungal lotion designed to effectively treat athlete’s foot(formerly branded under the name deFEET®).

 

We license the Osteon and PENtoCORE trademarks under our amendedlicense agreement with BioChemics.  Inaddition, we have applied for U.S. trademark protection for the mark “Termin8.”

 

In addition to and separate from our Athlete’s Relief, Osteon andTermin8 products, we have identified and are currently developing, incollaboration with BioChemics, six additional OTC product candidates that willutilize either the VALE transdermal or PENtoCORE topical technology. Each ofthese product candidates are in various stages of development and are not yetavailable for sale.  These productcandidates are as follows:

 

•                                       Ananalgesic utilizing ibuprofen;

 

•                                       Toenailfungus treatment;

 

•                                       Acnetreatment;

 

•                                       Firstaid treatments;

 

•                                       Handand body lotions; and

 

•                                       Psoriasistreatment.

 

In instanceswhere the active ingredient (e.g., ibuprofen), dosage form (e.g., VALEtransdermal technology), strength, route of administration, directions for useor indication (e.g., toenail fungus) of the product candidate is not covered bythe OTC Review Program or where the inactive ingredients used in the productcandidate are not recognized as safe and suitable for their intended OTC use,the product candidate cannot be marketed without obtaining pre-market approval inthe form of an approved new drug application, or NDA or an abbreviated new drugapplication, or ANDA. Conversely, where the active ingredient, dosage form,strength, route of administration, directions for use, and indication of theproduct candidate are covered by the OTC Review Program and the inactiveingredients used in the product candidate are safe and suitable for theirintended OTC use, the product candidate could be marketed without obtaining NDAor ANDA clearance, provided it conforms to the applicable OTC Monograph and isnot otherwise adulterated or misbranded.

 

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**Recent Events**

** **

***SEC and FDARegulatory Matters***.  On April 1, 2004, the SEC temporarily suspended trading of theCompany’s securities.  The suspension,by its terms, terminated at 11:59 p.m. on April 15, 2004.  In the SEC announcement of the tradingsuspension, the SEC stated that it temporarily suspended trading in thesecurities of the Company because of questions regarding the accuracy ofassertions by the Company, and by others, in press releases, the Company’sannual report, its registration statement and public statements to investorsconcerning, among other things: “(1) the FDA approval of certain key products;and (2) the regulatory consequences of the future application of [its] primaryproduct.”

 

On April 5,2004, representatives of the Company, together with newly retained specialsecurities counsel and newly retained FDA counsel, met with the staff of theSEC, or Staff, for the purpose of discussing the concerns that led to thesuspension of trading in the Company’s securities.  During that meeting, the Company stated its intention to reviewits public disclosure, press releases and other public statements and to takewhatever remedial action might be appropriate. It also represented to the Staff that it would (i) diligently seek toclarify the status of its products under current FDA regulations, (ii) issuedisclosure regarding the FDA regulation of its activities and products and theresults of its dialogue with the FDA, and (iii) endeavor to resolve on a timelybasis any concerns communicated by the Staff. The Staff stated that it had beenauthorized by the SEC to seek injunctive relief against the Company,articulated the concerns that gave rise to the suspension of trading, andinformally requested that the Company provide certain information to the Staff.The Company agreed to cooperate with the Staff, committed to review itsdisclosure promptly and committed to take any remedial action that might berequired.

 

The Companyhas agreed to a settlement with the Staff pursuant to which the Company will bepermanently enjoined from violating certain of the anti-fraud provisions of theSecurities Act and the Exchange Act. The settlement must first be approved by the SEC itself and then by acourt.  In addition, John J. Masiz, theCompany’s President and Chief Executive Officer, has agreed with the Staff to aproposed action by the SEC against him that would prevent him from serving asan officer or director of any public company, including the Company, for aperiod of five years.  If Mr. Masiz isbarred from serving as an officer and director of the Company for thisfive-year period, he will be permitted and intends to continue to be an activeemployee of the Company.  Please see“Changes in Management” below for additional information on Mr. Masiz’sresignation as well as “Risk Factors” – “If we fail to attract, train andretain additional highly qualified senior executives and technical andmanagerial personnel in the near future, our business will suffer.”

 

The Company isnot aware that the FDA is contemplating any action against the Company.  The Company, through counsel, has engaged inand will continue to maintain a dialogue with the FDA to address anyconcerns.  The Company has submitted newlabels for its previously marketed products to the FDA and has requested FDAcomments on any concerns or issues pertaining to these revised labels.  As of the date of this report, the FDA hasnot provided any comment to the Company based on the agency’s review of thelabels submitted to the FDA.  There is,however, no regulatory requirement that FDA review or provide comment on suchmaterials.  The Company is reasonablysure that these labels are consistent with all FDA regulations and policies.

 

Due to theongoing nature of these matters, the Company is unable to definitively assesstheir impact.  However, the Company hascommitted not to market or sell its products until all outstanding matters havebeen addressed to the satisfaction of the SEC and until the Company isreasonably sure that the marketing and sale of its products is consistent withthe FDA’s requirements and policies. This commitment may have a material adverse impact on the Company.  The Company anticipates that the marketingand sale of Athlete’s Relief, Osteon and Termin8äwill resume by the end of 2004, although there is no guarantee of this.  When appropriate, the Company will makeadditional public announcements and will file public reports with the SECregarding the status of its products under applicable FDA regulations.

 

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* **Nasdaq StockMarket Matters.******* By letter dated April 2, 2004, the Nasdaq Listing Investigationsdepartment of The Nasdaq Stock Market, Inc., or Nasdaq, notified the Companythat it had commenced an inquiry to ensure the Company’s ongoing compliancewith Nasdaq’s inclusion requirements and requested certain information from theCompany.  The letter further disclosedthat after review of the information provided by the Company, Nasdaq could takeany action that might be appropriate under its Marketplace Rules includingremoval of the Company’s securities from Nasdaq.  In view of the substantial administrative and cash burdens beingborne by the Company at that time and the substantial legal costs anticipatedwith respect to the SEC and FDA matters, the Company determined that it was inthe best interest of shareholders to voluntarily cause its shares to be removedfrom Nasdaq and focus its attention and resources on addressing the SEC and FDAconcerns.  The Company’s securities werevoluntarily delisted, effective the opening of the markets on Thursday, April8, 2004.  At an appropriate time, theCompany will seek to cause its securities to be quoted on a national exchange,Nasdaq or other automated quotation system. There can be no assurance that theCompany will be successful or that an organized market for the Company’ssecurities will develop.  If the Companyis unable to list its securities on a national exchange or on an automatedsecurities quotation system in the future, it could have a material adverseimpact on our ability to raise future capital (See “Liquidity and CapitalResources”).

 

***Litigation.***  In April, May, and June 2004, the Companyand certain of its officers were sued in several purported securities classaction lawsuits filed in the United States District Court for the District ofMassachusetts.  The complaints, whichseek equitable and monetary relief, an unspecified amount of damages, withinterest, attorneys fees and costs, allegedly were filed on behalf ofpurchasers of the Company’s Class A common stock during the period December 11,2003 to March 31, 2004 and allege that during that period, the defendantsviolated the federal securities laws by allegedly failing to make accurate andcomplete disclosures concerning the Company, its financial condition, itsbusiness operations and future prospects, the clinical trial and endorsement ofthe Company’s Termin8 anti-fungal product (previously known as “deFEET”) andthe institutional demand for the Company’s securities.  These complaints are captioned asfollows:  Dennis E. Smith v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10708 (RCL) (D.Mass.); Richard Shapiro v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ. No. 04-10720 (RCL) (D. Mass.); Christopher Pepin v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10763 (RCL) (D.Mass.); Modhi Gude, *et al.* v. Vaso Active Pharmaceuticals,Inc., *etal.*, Civ. No. 04-10789 (RCL) (D. Mass.); Kim Benedetto, *et al.*v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10808 (RCL) (D.Mass.); Dean Dummer v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10819 (RCL) (D.Mass.); Edward Tovrea v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ . No. 04-10851 (RCL); Kourosh Alipor v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10877 (RCL); Paul E. Bostrom v.VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10948 (RCL); Ira A. Turret Sep-Ira Dated01/24/02 v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No.04-10980 (RCL); Richard Pagona v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11100 (RCL); James Karanfilian v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-11101 (RCL); and Charles Robinson v. VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11221 (RCL). The Court has consolidated the above-referenced cases, other than the Tovreaand Karanfilian complaints, under the caption In Re Vaso ActivePharmaceuticals Securities Litigation, Civ. No. 04-10708 (RCL).  Although the Company intends tovigorously defend against these cases, the litigation process is inherentlyuncertain and there can be no guarantee as to the ultimate outcome of thesematters.  There is also no guaranteethat these will be the only lawsuits brought against the Company with respectto these matters.

 

The Company has also been namedas a nominal defendant in two shareholder derivative actions filed, the firstfiled in the United States District Court for the District of Massachusetts inApril 2004 against its directors and certain of its officers and againstBioChemics, Inc. entitled Joseph Rosenkrantz v. BioChemics,Inc., *etal*., Civ. No. 04-10792 (RCL) (D. Mass.) and the second filed in June 2004, also against

 

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theCompany’s directors and certain of its officers and against BioChemics, Inc.entitled William Pomeroy v. BioChemics Inc., *et a**l.*,  Civ. No. 04-11399 (RCL) (D. Mass.). Thecomplaints allege, among other things, that the alleged conduct challenged inthe securities cases pending against the Company in Massachusetts (describedabove) constitutes a breach of the defendants’ fiduciary duties to the Company.  The complaints seek equitable and monetaryrelief, an unspecified amount of damages, and attorneys and other fees, costsand expenses, ostensibly on behalf of the Company.

 

An unfavorableoutcome in one or more of these related cases could have a material adverseeffect on the Company’s financial position, liquidity and results ofoperations.  In addition to the costs of defending these cases, the Company mayprovide indemnification for expenses and losses that may be incurred by itsdirectors and officers as parties to one or more of these cases.  Although the Company will seek coverageunder its director and officer liability insurance policy, there can be noassurance that the Company can obtain reimbursement of all of its out-of-pocketdefense costs and any amounts paid in settlement or pursuant to judgments inthe event of unfavorable outcomes in one or more of these cases.

 

Accordingly,the costs of defending these cases and providing indemnification to ourdirectors and officers may be substantial. However, because of the uncertainty of estimating the potentialfinancial statement impact of any of these actions with any reasonable degreeof accuracy, at this time the Company has not reserved for any potentialliability or costs that may arise as a result of this litigation except for the$200,000 insurance deductible that we reserved as of March 31, 2004.  While the cases are in very preliminarystages and the outcomes are not predictable, if a substantial amount is payableby the Company and is not reimbursed through its director and officer liabilitypolicy, this will have a material adverse effect on the Company’s financialposition and liquidity.  There can be noassurance that the Company’s insurer will admit liability to reimburse theCompany with respect to any of the claims asserted in any of the litigationagainst the Company or its officers or directors or that coverage limits willbe sufficient.

 

***Unwinding of March16, 2004 Private Investment in Public Equity***.  On March 16, 2004, the Company entered intoa private placement transaction in the amount of $7,500,000 with aninstitutional investor.  The investmentwas in the form of an 18 month 2% Convertible Note, or Note, convertible intoshares of the Company’s Class A common stock at a conversion rate of $9 pershare. In addition, the Company issued to the investor warrants to purchase166,667 shares of Class A common stock at an exercise price of $8.75 per share.

 

Given that theinitiation and continuation of the April 1, 2004 trading suspension by the SECconstituted a breach under the Note, the Company and the investor agreed,pursuant to the terms of a settlement agreement entered into on April 8, 2004,that the Company would immediately repay the investor the sum of $7,500,000 incash without penalty, interest, redemption premium or any other premium orpenalty, plus an expense reimbursement in connection with the settlementagreement in the amount of $15,000 in cash.  In consideration of this repayment, the investor surrendered the Noteand warrants and the parties mutually terminated all other agreements enteredinto in connection with the transaction.

 

In connectionwith this transaction, we paid approximately $600,000 in fees to various thirdparties.  These fees were not refundedwhen we repaid the investor.  These feeswere recorded as an expense in the three-month period ended March 31, 2004.

 

***Changes inManagement.*** John J. Masiz, the Company’s President and Chief Executive Officer, hasagreed with the Staff to settle a proposed action by the SEC against him thatwould prevent him from serving as an officer or director of any public company,including the Company, for a period of five years.  If Mr. Masiz is barred from serving as an officer and director ofthe Company for this five-year period, he will be permitted and intends tocontinue to be an active employee of the Company.  If the offer to settle is accepted by the SEC itself and an orderis entered by the court, Mr. Masiz would resign as the President and ChiefExecutive Officer of the Company, as well as the Chairman of the Board ofDirectors of the Company.  The Companyis in the process of

 

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conducting a search for a newChief Executive Officer to replace Mr. Masiz when he resigns. There is noassurance that we will be able to attract or retain a suitable Chief ExecutiveOfficer now or in the future, and this could have a material adverse effect onour business, financial condition and results of operations.  Please see “Risk Factors” – “If we fail toattract, train and retain additional highly qualified senior executives andtechnical and managerial personnel in the near future, our business willsuffer”.

 

Effective June 18, 2004, Kevin J. Seifert resigned as the ChiefOperating Officer of the Company and as a director of the Company. The Companyis not currently conducting a search for a new Chief Operating Officer.  We anticipate that our new Chief ExecutiveOfficer will assume Mr. Seifert’s former responsibilities.

 

**Critical AccountingPolicies**

 

* **Revenue Recognition*** We recognizerevenue from product sales in accordance with generally accepted accountingprinciples in the United States, including the guidance in Staff AccountingBulletin, or SAB, No. 104 “Revenue Recognition”, which supercedes SAB, No. 101“Revenue Recognition in Financial Statements,” and Statement of FinancialAccounting Standards, or SFAS, No. 48, “Revenue Recognition When Right ofReturn Exists.”

 

Revenue from product sales is recognized when there is persuasiveevidence of an arrangement, delivery has occurred, the price is fixed anddeterminable, and collectibility is reasonably assured. However, because ourproducts are sold with limited rights of return, revenue is recognized when theprice to the buyer is fixed, the buyer is obligated to pay us and theobligation to pay is not contingent on resale of the product, the buyer haseconomic substance apart from the us, we have no obligation to bring about thesale of the product and the amount of returns can be reasonably estimated.

 

We record allowances for product returns, rebates and discounts, andreport revenue net of such allowances. We must make judgments and estimates inpreparing the allowances that could require adjustments in the future. Forinstance, our customers have the right to return any product that is held pastthe labeled expiration date. We base our estimates on historic patterns ofreturns and on the expiration dates of product currently being shipped, or as aresult of an actual event that may give rise to a significant return amountsuch as the discontinuance of a product.

 

We do not recognize revenue unless collectibility is reasonablyassured. We maintain allowances for doubtful accounts for estimated lossesresulting from the inability of our customers to make required payments. If thefinancial condition of our customers were to deteriorate and result in animpairment of their ability to make payments, additional allowances may berequired.

 

***Expense Allocations/Management Fees***BioChemics provides us with certain administrative, marketing and managementservices, as well as our facilities and general corporate infrastructure. Ourstatement of operations includes allocations of these costs that BioChemics andwe considered to be reasonable.

 

***Deferred Income Taxes***Prior to 2003, we were a division of BioChemics and were not subject to federalor state income tax reporting requirements. Effective 2003, we began preparingour income taxes on a stand-alone basis. We account for income taxes and deferredtax assets and liabilities in accordance with SFAS No. 109, “Accountingfor Income Taxes.” Because we project future operating losses in the near term,we have provided a full valuation allowance against the deferred tax assetscreated by these losses.

 

***Stock-based Compensation***As part of our compensation programs offered to our employees, we grant stockoptions. We grant stock options to employees based on the fair value of theClass A common stock at the grant date. As allowed under SFASNo. 123, “Accounting for Stock-Based Compensation,” and

 

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SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure,” we have adopted thedisclosure-only requirements of these accounting standards. Accordingly, we donot recognize stock-based compensation expense for stock options granted toemployees at their fair value. See Note 4 to our unaudited condensed financialstatements for the impact on earnings had we fully adopted SFAS 123 and 148.

 

***Off-Balance Sheet Arrangements***We do not have off-balance sheet arrangements, financings or otherrelationships with unconsolidated entities known as “special purpose entities.”

 

***Cost of Sales***Our costs of sales primarily consist of manufacturing costs charged by outsidecontractors including BioChemics which, pursuant to our manufacturing anddevelopment agreement charges us the cost of such manufacturing and developmentplus 10%.  We expect to continue to use outsidecontract manufacturers for the production of our products. As a result, all ofour inventory balances are in the form of finished goods and direct laborinitiatives are minimal.

 

***Marketing, Advertising and Promotion Expenses***Our marketing, advertising and promotion expenses include such costs of print,Internet and, costs associated with our attendance and presentation at industrytradeshows and other marketing and sales programs.

 

***Research and Development*****Expenses** Ourresearch and development consist primarily of costs charged by BioChemicswhich, pursuant to our manufacturing and developmentagreement charges us the cost of such manufacturingand development plus 10%.

 

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***Outlook for the remainder of 2004***

* *

On December 10, 2003, our Registration Statement on Form SB-2(registration no. 333-106785) for the sale of 1,667,500 shares of ourClass A common stock (5,002,500 on a post-split basis) which included217,500 shares of Class A common stock (652,500 on a post-split basis) tocover underwriter over-allotments, at a price of $5.00 per share ($1.67 on apost-split basis), became effective. We completed this initial public offeringon December 15, 2003. All of the shares sold in this offering were fromour authorized pool of Class A common stock. Kashner Davidson SecuritiesCorp. functioned as the representative of the underwriters for this publicoffering. Net of offering costs of approximately $1.9 million, we receivedapproximately $6.4 million in proceeds, which we estimated would be allocatedas follows:

 

•                                          Approximately$1.1 million to fund our continued development, commercialization and saleof our products and product candidates;

 

•                                          Approximately$1.9 million to implement our strategic marketing and commercializationplan, which approximately $1.2 million was to be allocated to fund ourradio advertising campaign.  This radiocampaign was originally to be initiated in connection with the retail rolloutof our products, which we anticipated would occur in 2004.  As a result of the cessation of themarketing and sale of our products following the initiation of the SEC tradingsuspension on April 1, 2004, we do not expect that the retail rollout of ourproducts, which was designed as the second stage of our rollout strategy, willcommence until at least 2005. Consequently, we do not anticipate using any of the initial publicoffering proceeds to fund advertising, direct mail programs or otherpromotional activities related to this retail roll-out strategy before thattime and there can be no assurance that any of the initial public offeringproceeds will be used for this purpose. We have allocated approximately $372,000 in 2004 for marketing costsassociated with the first stage of our rollout strategy.

 

•                                          $200,000 torecruit and hire individuals for key senior management positions;

 

•                                          $350,000 tocover the cost of providing sales incentives, product samples and discounts;

 

•                                          To repay,without interest, BioChemics approximately $99,000 for management fees chargedback to us since we became a stand-alone entity upon our incorporation forcentralized accounting, data processing, utilities, office space rental,supplies, telephone and other BioChemics corporate services and infrastructurecosts, and approximately $347,000 for other operational charges paid byBioChemics to third parties on our behalf through September 30, 2003;these amounts increased to approximately $122,000 and $518,200 respectively,which reflect the modifications necessary for these additional type costsincurred from October 1, 2003 through December 31, 2003; and

 

•                                          Approximately$1.68 million to provide working capital for general and corporatepurposes.  We increased this to$2.2 million from the registration disclosure to reflect the net impact ofthe exercise of the over allotment option. In addition, we anticipate using the funds initially allocated for theimplementation of our strategic marketing and commercialization plan, includingthe approximately $1.2 million that was allocated to fund our anticipatedradio advertising campaign, less the approximately $372,000 budgeted formarketing costs associated with the first stage of our rollout strategy, asworking capital for general and corporate purposes.

 

We anticipate,based on our current plans and assumptions relating to our operations, that ourcurrent working capital together with our expected cash flows from resumedmarketing of our products and related operations should be sufficient tosatisfy our cash requirements for at least the balance of 2004. We have no currentplans, agreements or commitments with respect to any acquisitions.

 

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The SEC’s temporary suspension in the trading of our securities hasaffected our marketing.  In light of thediscussion under “Recent Events”, immediately upon the initiation of thissuspension we voluntarily suspended the marketing and sale of Athlete’s Relief,Osteon and Termin8 until we are reasonably sure that the marketing of theseproducts is consistent with the FDA’s requirements and policies.  We anticipate that our marketing and sale ofthese products under revised labeling will resume by the end of 2004, althoughthere is no guarantee of this. Accordingly, we are no longer able to providemeaningful guidance on what our 2004 or 2005 revenues will be.  Therefore, our projections of March 26, 2004should not be relied on for any purpose.

 

If and when we resume marketing, we anticipate executing our marketingand sales strategy in two phases. We believe this two-phase approach is themost efficient and cost effective manner to quickly bring our products to themarket place.

 

In the first phase of our rollout strategy, we believe the mostefficient and economical means of obtaining market penetration is throughstrategic alliances. Accordingly, this is where we have placed our immediatefocus.  Typically under these alliances,our prospective partners will control and assume all the costs of marketing anddistribution. We will assume all the costs of manufacturing. This modeleliminates many prohibitive costs such as mass-media advertising and thedevelopment of large sales and distribution channels. We will attempt toleverage the already established market visibility, presence and experience ofour prospective partners as well as their distribution networks. We believethat these factors and our decision to outsource all our product manufacturingallows us to operate with minimal direct labor and other business costs.

 

In January 2004, we executed our first strategic alliance withOrtho Distribution Inc., or ODI, a wholly owned subsidiary ofOrthoRehab, Inc. of Tempe, Arizona. OrthoRehab has an extensivedistribution network, across the United States and in approximately 50 othercountries.  We and ODI expect to launchproduct through ODI’s distribution network by the end of 2004.   However, there can be no assurance thatthis alliance will continue, or if continued, that it will be successful

 

In March 2004, in furtherance of the first phase of our rolloutstrategy, we entered into an exclusive, direct to consumer media based,strategic alliance with M2G Media of Irvine, California, a marketing and distributioncompany that utilizes direct to consumer media and television as its primaryforms of marketing medium. M2G Media will market privately labeled versions ofour current products specifically targeting the over the counter topical andanalgesic arthritis and pain relief markets. We expect M2G Media to commenceinfomercial filming by the end of 2004 and we and M2G Media expect to launchproduct through its channels of distribution in the first quarter of 2005.  However, there can be no assurance that thisalliance will continue, or if continued, that it will be successful.

 

In addition to our focus on the strategic alliance model as the firststage of our rollout strategy, we also intend to pursue opportunities to launchour products into retail market chains, but not before 2005.  We believe that because retail sales effortstypically require large economic outlays and long sales cycles, they produceless of an immediate impact on operations than strategic alliances.  Therefore, we have categorized this as partof the second phase of our rollout strategy. In January 2004, we appointedCommotion LLC of Golden, Colorado, a strategic product marketing company, toassist us in establishing direct brand recognition and strategic retail rolloutfor our products.  Our plan is focusedon the systematic rollout of our current products into major retail and drugstore chains, select independent pharmacies and nontraditional channels,including multilevel marketing, direct marketing, web-sites andcatalogues.  However, a result of thecessation of the marketing and sale of our products following the initiation ofthe SEC trading suspension on April 1, 2004, and changes in the timing for theretail rollout of our products, we do not anticipate using any of our initial publicoffering proceeds to fund our advertising, direct mail programs and relatedpromotional activities before 2005. There can be no assurance that any of the initial public offeringproceeds will be used for this purpose.

 

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At various times, we and BioChemics have marketed Osteon, Athlete’sRelief and deFEET on a “test basis” to experiment with consumer packaging andproduct performance receptivity, packaging size, label design along with othercriteria.  We consider this informationimportant to deciding on an eventual roll out strategy for the products.  We call these programs “test marketing”because neither the Company nor its parent, BioChemics, were sufficientlycapitalized to engage in advertising campaigns.  In some cases, we terminated test marketing programs and in othercases, the retailer terminated test marketing programs.  In connection with the test marketingprogram with Walgreens to sell deFEET in mid-2003, we could not provide sufficientfunding for an advertising program that would be acceptable to Walgreens. Ourefforts were complicated by our need to change the product name from deFEET toTermin8 as we needed more flexibility than was afforded to us under ourApril 20, 2002 settlement and license agreement with DeFeet International,an independent company that owns the deFEET registered trademark.  Because of our inability to undertake anacceptable advertising campaign, we and Walgreens terminated this testmarketing program.

 

Although we believe that our products, supported by sufficientadvertising, will earn retailers acceptance, there can be no assurance thatthis will happen, or if it does, that it will continue.

 

We believe that the systematic and multi-phased launch for each of ourthree current products as described above will allow us to maintain controlover the required costs associated with these launches and will maximize thereturn on investment for the advertising and marketing expenditures.

 

The success of our marketing and sales activities will be dependent,among other things, on our ability to retain and attract qualified marketingand sales personnel, enter into qualified strategic partnerships, place ourproducts into the market and on the consumer perception of our products.

 

***Three-Month PeriodsEnded March 31, 2004 and 2003***

 

***Net Revenues***Net revenues decreased approximately 76% to $7,147 for the three-month periodended March 31, 2004 from $29,864 for the three-month period ended March 31,2003. This decrease was a direct result of our decision to re-brand ourathlete’s foot product deFEET to Termin8. In response to this decision, inSeptember 2003, Walgreen’s returned most of the deFEET product that it hadin its possession.  We did not launchthe re-branded product, Termin8 in the three-month period ended March 31,2004.  Sales of deFEET to Walgreen’sdecreased to less than 1% of net revenues for the three-month period endedMarch 31, 2004 from approximately 88% in the three-month period ended March 31,2003.

 

***Cost of Sales*** Weoutsource all manufacturing costs. As a result, cost of sales is limited tothose costs incurred and billed by outside contract manufacturers and certainproduction costs regarding batch testing and analysis.  Cost of sales decreased approximately 61% to$5,775 for the three-month period ended March 31, 2004 from $14,858 for thethree-month period ended March 31, 2003. This decrease is a net decrease duemainly to decreased manufacturing costs relative to the decrease in netrevenue, but also increased by batch testing and production costs in the amountof  $4,497.  The Company does not capitalize these costs as inventory becauseit is not possible to determine the number of units these costs areattributable too, accordingly, cost of sales comparisons over a low volume ofsales as is the case in this situation causes this relationship to bemeaningless.

 

***Gross Profit***Gross profit as a percentage of net revenues decreased to approximately 19% forthe three- month period ended March 31, 2004 from approximately 50% during thethree-month period ended March 31, 2003. The decrease was due to charges in the amount of $4,497 for batchtesting for future production runs, which were expensed in the three-month periodended March 31, 2004 as discussed under the Cost of Sales analysis above.   We do not believe this comparison ismeaningful due to the low volume in sales.

 

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***Marketing,Advertising and Promotion Expenses*** Marketing,advertising and promotion expenses increased approximately 304% to $66,254 forthe three-month period ended March 31, 2004 from $16,386 for the three-monthperiod ended March 31, 2003.  Thisincrease was primarily due to increased advertising, marketing and thepromotion of our products including payments made to Commotion Inc. during thethree- month period ended March 31, 2004.

 

***Management Fee***Management fee decreased approximately 73% to $8,160 for the three-month periodended March 31, 2004 from $30,561 for the three-month period ended March 31,2003.  Presently, the Company paysdirectly certain expenses allocated as part of Management Fees in previousperiods. This has caused a decrease to this expense amount when comparing thethree-month period ended March 31, 2004 to the three-month period ended March31, 2003.

 

***Selling, General andAdministrative*** Selling, general and administrativeexpenses increased by $1,441,889 to $1,529,833 for the three-month period endedMarch 31, 2004 from $86,944 in the three-month period ended March 31,2003.  Approximately $100,000 of thisincrease was attributable to increased expenses we incurred in the areas oflegal and professional services necessary for a public company.  Approximately $530,000 of this increase wasattributable to increased personnel and other general and administrativeexpenses we incurred as we expanded our operations.  In addition, approximately $600,000 of this increase wasattributable to a one-time charge we incurred in connection with our March 16,2004 private placement transaction. Finally, we recorded a $200,000 charge during the three-month periodended March 31, 2004, which represents our deductible under our directors andofficers insurance policy in connection with the litigation we are currentlysubject to, see “Recent Events.”

 

***Research andDevelopment*** Research and development expenses forthe three-month period ended March 31, 2004 increased to $95,167 from $0 in thethree-month period ended March 31, 2003. Beginning in January 2004, we engaged Biochemics to provide servicespursuant to a February 2003 manufacturing and development agreement. Theseservices related to the formulation of an analgesic utilizing the activeingredient ibuprofen.  Pre-clinicalstudies utilizing animals were conducted and billed as part of this research.

 

***Stock BasedCompensation*** We are required to record stock-basedcompensation when we grant options to purchase our common stock tonon-employees in accordance with SFAS 123. The value of these options iscalculated using the Black-Scholes option-pricing model. Stock basedcompensation for the three-month period ended March 31, 2004 was $109,033.  During the three-month period ended March31, 2004 the Company granted 165,000 options to non-employees pursuant to itsStock Incentive Plan. In addition, 225,000 options were granted to aconsultant, which were separately registered by the Company by filing a FormS-8 with the SEC in February 2004. There were no stock options granted during the three-month period endedMarch 31, 2003.

 

***Liquidity and Capital Resources***

 

Historically, while we were a division of BioChemics, cash was managedon a centralized basis. Cash receipts associated with our business weretransferred to BioChemics directly upon receipt and in turn BioChemics hasprovided funds to cover our disbursements. Accordingly, BioChemics made cashcontributions to our capital in the three-month period ended March 31, 2003 tocover our deficits incurred during that period and to fund the initial costs ofa private placement, discussed below which closed in May 2003.  BioChemics provided us with approximately$223,000 during the three-month period ended March 31, 2003 which we laterreimbursed to BioChemics using a portion of the net proceeds from our December2003 initial public offering.

 

In accordance with our plan to obtain independent financing as astand-alone entity, we initiated a private placement of our 10% convertiblesubordinated pay-in-kind promissory notes in the aggregate principal amount of$500,000. The proceeds from the sale of these notes were used to fund certainexpenses

 

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related to ourinitial public offering, as well as for general administrative and operatingexpenses, which is discussed further below. In December 2003, werepurchased $35,000 principal amount of these notes at cost, without interest,from an unrelated third party investor. The private placement closed in May 2003 and as of March 31, 2003,$290,000 of the $500,000 had been collected.

 

On December 15, 2003, we completed an initial public offering of1,667,500 shares of our Class A common stock (5,002,500 on a post-splitbasis) at a price of $5.00 per share ($1.67 on a post-split basis), raisingapproximately $6.4 million, net of issuance costs. At March 31, 2004, wehad approximately $4.9 million remaining from these proceeds for ourworking capital needs. Concurrently with the completion of our initial publicoffering, we converted our 10% convertible subordinated pay-in-kind promissorynotes into an aggregate of 200,371 shares of Class A common stock (601,113shares on a post-split basis).

 

In the three-month period ended March 31, 2004, we received anaggregate of $450,000 from the exercise of warrants in February 2004 and March2004 by the founder of Commotion LLC, a marketing company that we closed amarketing agreement with on January 1, 2004. These warrants were issued onJanuary 16, 2004 (please see “Outlook for the remainder of 2004” for moreinformation on our agreement with Commotion, LLC).

 

On March 16, 2004 we entered into a private placement transactionwith an institutional investor in the amount of $7.5 million. Theinvestment was in the form of an 18 month 2% Convertible Note convertibleinto shares of Class A common stock at a conversion rate of $9 per share,at the option of the investor. Both principal and interest were payable in cashor in shares of Class A common stock at our option. In addition, we issuedto the investor warrants to purchase 166,667 shares of our Class A commonstock at an exercise price of $8.75 per share. Given that the initiation and continuation of the April 1, 2004 tradingsuspension by the SEC constituted a breach under the Note, the Company and theinvestor agreed, pursuant to the terms of a settlement agreement entered intoon April 8, 2004, that the Company would immediately repay the investor the sumof $7,500,000 in cash without penalty, interest, redemption premium or anyother premium or penalty, plus an expense reimbursement in connection with the settlementagreement in the amount of $15,000 in cash.  In consideration of this repayment, the investor surrendered the Noteand warrants and the parties mutually terminated all other agreements enteredinto in connection with the transaction.

 

In connection with this transaction, we paid approximately $600,000 infees to various third parties.  Thesefees were not refunded when we repaid the investor.   These fees were recorded as an expense in the three-month periodended March 31, 2004.

 

We do not expect our marketing efforts with M2G Media and OrthoDistribution, Inc. to provide us with significant revenues or cash flow in2004.

 

In addition, our financial condition has been affected by theadministrative costs and legal fees associated with both the SEC and FDAregulatory matters, as well as the preliminary aspects of our pendinglitigation.  Please see “LegalProceedings” and “Recent Events” for more information on the underlying claimsin the lawsuits against us and the SEC’s trading suspension.  We expect to use our working capital, inpart, to defray those costs for the foreseeable future.  Nevertheless, we believe we have sufficientcash to execute our business plan through the end of the 2004 fiscal year.  However, if there are adverse developments inthe lawsuits against us, or resolution of our regulatory matters with the SECand the FDA take longer than we expect, our capital resources could beadversely affected.

 

***Off-Balance SheetArangements***

 

We have no off balance sheet financing or financing that is notdisclosed in our unaudited condensed financial statements included in thisQuarterly Report.

 

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***Quantitative andQualitative Disclosures Regarding Market Risk***

 

*Interest Rate Sensitivity*

 

As of March 31, 2004, we had cash and cash equivalents of$12,364,531 ($7.5 million of this balance was paid on April 8, 2004 as a resultof the settlement reached in connection with the March 16, 2004 unwinding ofthe private investment in public entity transaction; see – “Recent Events”)that consisted of highly liquid money market instruments with maturities lessthan 90 days. Because of the short maturities of these instruments, asudden change in market interest rates would not have a material impact on the fairvalue of the portfolio. Accordingly we do not expect our operating results orcash flows to be affected to any significant degree by the effect of a suddenchange in market interest rates on our portfolio.

 

*Equity Security Price Risk*

 

We do not own any equity investments. Therefore, we do not currentlyhave any direct equity price risk.

 

*Market/Price Risk*

 

We are exposed to market risk in the normal course of businessoperations. We face competition and must offer our products and services atprices the market will bear.  If andwhen we resume marketing our products, we believe we will be well positionedwith our products such that price risk will not affect our operating results toany significant degree. However, should the prices of our products be less thananticipated, this may adversely affect our future profitability andcompetitiveness.

 

**Risk Factors**

 

**Weare an early stage company with a brief history of losses and may never achieveor sustain profitability.**

 

We do not have any continuing revenues and we have never beenprofitable and we may not achieve profitability in the foreseeable future, ifat all. Our ability to generate profits in the future will depend on a numberof factors, including:

 

•              start-up costsrelating to the commercialization, sale and marketing of our products;

 

•              market acceptance ofour products and product candidates;

 

•              costs of acquiringand developing new product candidates;

 

•              ability to bring ourproducts to market;

 

•              general andadministrative costs relating to our operations;

 

•              increases in ourresearch and development costs;

 

•              charges related topurchases of technology or other assets;

 

•              ability to raiseadditional capital; and

 

•              the favorableresolution of our current litigation (see “Legal Proceedings”).

 

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At March 31, 2004, we had an accumulated deficit of approximately$3.5 million.  We expect to incuradditional operating losses as we expand our marketing and sales efforts.  If we are unable to generate sufficientrevenue from our operations to pay expenses or we are unable to obtainadditional financing on commercially reasonable terms, our business, financialcondition and results of operations may be materially and adversely affected.

 

**Weare an early stage company that has a limited operating history.**

 

We are an early stage company focused on commercializing, marketing andselling over-the-counter, or OTC, pharmaceutical products. We began ouroperations as a division of BioChemics, Inc. in January 2001. We haveonly operated as an entity independent of BioChemics since January 2003.Our operating history is therefore limited. Our Termin8, Athlete’s Relief andOsteon products are in the early stages of commercialization. Our productcandidates are only in the early stages of development. With the exception ofthe introduction of deFEET to the marketplace by BioChemics while we were stilla division of BioChemics, we have not yet commercialized, marketed or sold anyproducts or recognized significant revenue from product sales. You shouldevaluate the likelihood of financial and operational success in light of theuncertainties and complexities present in an early-stage company, many of whichare beyond our control, including:

 

•              our potentialinability to market, distribute, and sell our products; and

 

•              the significantinvestment of capital and other resources necessary to achieve ourcommercialization, marketing and sales objectives.

 

Our operations have been limited to organizing and staffing ourcompany, acquiring our license, developing and testing our revenue distributionmodels and test marketing our products. These operations provide a limitedbasis for you to assess our ability to commercialize our products and productcandidates and the advisability of investing in us.

 

**Our failure to comply with extensive governmental regulationmay significantly affect our operating results.**

 

The worldwide marketing of our products and our product candidates aresubject to extensive requirements by foreign, national, state and localgovernments. These regulations potentially impact many aspects of our and ourpartner’s operations, including testing, research and development,manufacturing, pre-market labeling, storage, quality control, adverse eventreporting, record keeping, advertising and promotion.  Failure to comply with applicable regulatory requirements could,among other things, result in:

 

• fines;

 

• changesto advertising;

 

• failureto obtain necessary marketing approvals;

 

•revocation or suspension of regulatory approvals of products;

 

• productseizures or recall;

 

• delay,interruption or suspension of product manufacturing, distribution, marketingand sale; or

 

• civil orcriminal sanctions.

 

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The discovery of previously unknown problemswith our initial and future products may result in the interruption ofmarketing, including withdrawal from the market.  In addition, the FDA may revisit and change its prior determinationswith regard to the safety or efficacy of our products. If the FDA’s positionchanges, we may be required to change our labeling or cease to market or havemanufactured market the product or products at issue.  Even prior to any formal regulatory action, we could voluntarilydecide to cease the distribution and sale or recall any of our future productsif concerns about their safety or efficacy develop.

 

In their regulation of all our promotionalmaterials, the FDA and the FTC may take issue with some advertising orpromotional practices as being false, misleading or deceptive. The FDA or theFTC may impose a wide array of sanctions on companies for such advertisingpractices, which could result in any of the following:

 

• incurringsubstantial expenses, including fines, penalties, legal fees and costs tocomply with FDA or FTC requirements;

 

• changingthe methods of marketing and selling products;

 

• takingmandated corrective action, which may include placing advertisements or sendingletters to physicians and marketing partners rescinding previous advertisementsor promotions; or

 

•disrupting the distribution of products and causing the loss of sales untilcompliance with the FDA’s or FTC’s position is obtained.

 

If we become subject to any of the above requirements, it could be damagingto our reputation, and our business condition could be adversely affected.

 

**Wecannot market our products unless they have been listed with the FDA, arecovered by the FDA’s OTC Review Program, and are marketed in conformity withthe applicable OTC Drug Monograph or unless they have attained NDA or ANDAapproval.**

 

If our topical Athlete’s Relief, Osteon and Termin8 products areformulated and promoted in accordance with the OTC Drug Monographs pursuant tothe FDA’s OTC Review Program, FDA pre-market approval is not required prior tomarketing.  If these or any of ourproduct candidates deviate from an OTC Drug Monograph requirement in activeingredients, intended use, method of administration, dosage form, or labeling,among other things, then we or our marketing partners must obtain a NDApre-market approval from the FDA before beginning commercial marketing. The FDAhas taken the position that insofar as our product candidates may use the VALEtransdermal technology, they fall outside of those eligible for GRASE statusunder the OTC Review Program and thus we must obtain, or our marketing partnersmust obtain, NDA approval of these product candidates before they can becommercially marketed.

 

Under FDA’s procedures it is generally less burdensome to obtain NDAapproval of a drug product which contains the same active ingredient(s) asthose:  (a) considered GRASE in a finalOTC Drug Monograph, or (b) contained in a drug product eligible for ANDA,approval, but which differs in certain conditions of use (e.g., dosage form)from that covered by a final OTC Drug Monograph or eligible for ANDAapproval.  However, once a productbecomes subject to the NDA requirements there can be no assurance that acompany can generate the additional data and information necessary to supportNDA approval of the proposed variant product or that approval can be obtainedwithout substantial expenditures and delays.

 

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**Clinical trials may fail to demonstrate the safety andefficacy of our product candidates and could prevent or significantly delayregulatory approval.**

 

Prior to receiving approval to commercialize anyof our product candidates, we must demonstrate with substantial evidence fromwell-controlled clinical trials, and to the satisfaction of the FDA and otherregulatory authorities in the United States and abroad, that the productcandidate is both safe and effective. If these trials or future clinical trials are unsuccessful, our businessand reputation would be harmed and our stock price would be adversely affected.

 

All of our product candidates are prone to therisks of failure. The results of early-stage clinical trials of our productcandidates will not necessarily predict the results of later-stage clinicaltrials. Product candidates in later-stage clinical trials may fail to showdesired safety and efficacy traits despite having progressed through initialclinical testing. Even if we believe the data collected from clinical trials ofour product candidates are promising, these data may not be sufficient tosupport approval by the FDA or any other U.S. or foreign regulatory approval.Preclinical and clinical data can be interpreted in different ways.Accordingly, FDA officials could interpret such data in different ways than wedo, which could delay, limit or prevent regulatory approval. The FDA, otherregulatory authorities, or we may suspend or terminate clinical trials at anytime. Any failure or significant delay in completing clinical trials for ourproduct candidates, or in receiving regulatory approval for the sale of anyproducts resulting from our product candidates, may severely harm our businessand reputation.

 

Because of these risks, the research and development efforts of ourcollaborative partners may not result in any commercially viable products. If asignificant portion of these development efforts is not successfully completed,required regulatory approvals are not obtained by our partners, or any approvedproducts are not commercially successful, we are not likely to generatesignificant revenues or become profitable.

 

**There is no organized market for our stock; our stock pricehas been volatile and could experience substantial****declines**.

 

The market price ofour common stock has experienced, and may continue to experience, significantvolatility. During 2003 and the first quarter of 2004, the per share closingprice of our common stock ranged from $1.73 to $14.11.  As a result of the temporary suspension oftrading in our securities on April 1, 2004, our press release dated April 7,2004 advising investors not to trade in our securities until further disclosurewas made by us, and our voluntary delisting of our securities from The NasdaqStock Market on April 8, 2004, there is not currently an organized market inour securities, and there can be no assurance that such a market willdevelop.  On July 19, 2004 the averagebid for a share of our Class A Common Stock as quoted by the OTC Pink Sheetswas $.60. The value of our Class A Common Stock may decline regardless of ouroperating performance or prospects. Factors affecting our market price include:

 

•the success or failure of our product development efforts, especially thoserelated to obtaining regulatory approvals;

 

•technological innovations developed by us or our competitors;

 

•variations in our operating results and the extent to which we achieve our keybusiness targets;

 

•differences between our reported results and those expected by investors andsecurities analysts; and

 

•market reaction to any acquisitions or joint ventures announced by us or ourcompetitors.

 

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In addition, in recent years, the stock marketin general, and the market for pharmaceutical companies in particular, haveexperienced significant price and volume fluctuations. This volatility hasaffected the market prices of securities issued by many companies, often forreasons unrelated to their operating performance, and it may adversely affectthe price of our common stock. In the past, securities class action litigationhas often been instituted following periods of volatility in the market priceof a company’s securities.  A number ofsecurities class action have been filed against the Company.  See “Legal Proceedings” for moreinformation.

 

**We are defendants in a number of class action lawsuits thatmay adversely affect our business.**

 

As discussed ingreater detail under “Legal Proceedings”, we and certain of our officers arethe defendants in a number of class action lawsuits filed on behalf ofpurchasers of the Company’s Class A common stock during the period December 11,2003 to March 31, 2004 which allege that thedefendants violated the federal securities laws by allegedly failing to makeaccurate and complete disclosures concerning the Company, its businessoperations and future prospects, the clinical trial and endorsement of theCompany’s Termin8 anti-fungal product (previously known as “deFEET”) and theinstitutional demand for the Company’s securities. The complaints seekequitable and monetary relief, an unspecified amount of damages, with interest,attorneys fees and costs.

 

BioChemics,our directors and certain of our officers are also party to two shareholderderivative actions alleging a breach of the defendants’ fiduciary duties to theCompany.  The complaints seek equitable and monetary relief, an unspecified amountof damages, and attorneys and other fees, costs and expenses, ostensibly onbehalf of the Company.

 

Regardless of whetherwe win or lose, these securities class action lawsuits, and others which may befiled, could result in:

 

•      a material adverse financial statementimpact;

•      substantial costs for defending thesesuits; and

•      a diversion of management’s attention andresources.

 

If there are adverse developmentsin the lawsuits against us, or resolution of our regulatory matters with theSEC and the FDA takes longer than we expect, our capital resources could beadversely affected.

 

**Provisions in our bylaws provide for indemnification ofofficers and directors, which could require us to direct funds away from ourbusiness operations.**

 

Our bylaws provide forthe indemnification of our officers and directors.  We may be required to advance costs incurred by an officer ordirector and to pay judgments, fines and expenses incurred by an officer ordirector, including reasonable attorneys’ fees, as a result of actions orproceedings in which our officers and directors are involved by reason of beingor having been an officer or director of the Company.  Funds paid in satisfaction of judgments, fines and expenses maybe funds we need for the operation of our business, commercialization of ourcurrent products and the development of our product candidates, therebyaffecting our ability to attain profitability.

 

**We have depended on a small number ofcustomers for the majority of our gross revenue. As of the date of this report,we are not generating any revenue.  Wemay not be able to generate future revenue.**

 

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At various times, we and BioChemics have marketed Osteon, Athlete’sRelief and deFEET on a “test basis” to experiment with consumer packaging andproduct performance receptivity, packaging size, label design along with othercriteria.  We consider this informationimportant to deciding on an eventual roll out strategy for the products.  We call these programs “test marketing”because neither the Company nor its parent, BioChemics, were sufficientlycapitalized to engage in advertising campaigns.  In some cases, we terminated test marketing programs and in othercases, the retailer terminated test marketing programs.  In connection with the test marketingprogram with Walgreens to sell deFEET in mid-2003, we could not providesufficient funding for an advertising program that would be acceptable toWalgreen’s. Our efforts were complicated by our need to change the product namefrom deFEET to Termin8.  Because of ourinability to undertake an acceptable advertising campaign, we and Walgreen’sterminated this test marketing program. Although management believes that our products, supported by sufficientadvertising, will earn retailers acceptance, there can be no assurance thatthis will happen, or if it does, that it will continue.

 

We have, as discussed previously, established two strategic marketingand distribution alliances. If these two strategic alliances are not successfuland if other strategic alliances or retail distribution agreements are notestablished, this could result in a material adverse impact on our revenues.

 

**We have suspended the sale and marketing of our products.**

 

After the initiation of the trading suspension, we ceased marketing andselling Athlete’s Relief, Osteon and Termin8. Marketing and sale of these products has not yet resumed.  We anticipate that our marketing and salesof these products will resume by the end of 2004, although there is noguarantee of this.  We expect that oursales and marketing efforts will resume if and when all outstanding issuesbetween the SEC, FDA and the Company have been addressed.

 

Failure to resolve the concerns of the SEC or the FDA will have amaterial adverse effect on our ability to market and sell our products or raisecapital.

 

**Wedepend on BioChemics and third parties to develop and manufacture our productsand product candidates and our commercialization of our products could bestopped, delayed or made less profitable if BioChemics or those third partiesfail to provide us with sufficient quantities at acceptable prices.**

 

We do not possess product development capability. As a result, wedepend on collaborations with third parties, such as BioChemics, fordevelopment of our product candidates. During the three-month period endedMarch 31, 2004, we incurred research and development costs of approximately$95,200 related to the formulation of an analgesic utilizing the activeingredient ibuprofen.  Pre-clinicalstudies utilizing animals were conducted as a part of these charges.  These services were incurred pursuant to aFebruary 2003 manufacturing and development agreement with BioChemics (seeManufacturing and Development agreement filed on September 9, 2003 as anexhibit to Amendment 1 of our Registration Statement). In addition, we have nomanufacturing capability. As a result, we will depend on BioChemics, which inturn will rely upon third parties to manufacture our products. Although ourstrategy is based on leveraging BioChemics’ ability to develop and manufactureour products for commercialization in the OTC marketplace, we will be dependenton BioChemics’ collaborations with drug development and manufacturingcollaborators. If we and BioChemics are not able to maintain existingcollaborative arrangements or establish new arrangements on commerciallyacceptable terms, we would be required to undertake product manufacturing anddevelopment activities at our own expense. This would increase our capitalrequirements or require us to limit the scope of our development activities.Moreover, we have limited or no experience in conducting full scale bioequivalencestudies, preparing, and submitting regulatory applications, and manufacturingand marketing drug products. There can be no assurance that we will besuccessful in performing these activities and any failure to perform suchactivities could have a material adverse effect on our business, financialcondition and results of our operations.

 

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If any of our developmental collaborators, especially BioChemics,breach or terminate their agreements with us or otherwise fail to conduct theircollaborative activities in a timely manner, the preclinical and/or clinicaldevelopment and/or commercialization of our product candidates will be delayed,and we would be required to devote additional resources to product developmentand commercialization or terminate certain development programs. Also, theserelationships generally may be terminated at the discretion of ourcollaborators, in some cases with only limited notice to us. The termination ofcollaborative arrangements could have a material adverse effect on ourbusiness, financial condition and results of operations. There also can be noassurance that disputes will not arise with respect to the ownership of rightsto any technology developed with third parties. These and other possibledisagreements with collaborators could lead to delays in the development orcommercialization of our product candidates or could result in litigation orarbitration, which could be time consuming and expensive and could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

Additionally, the failure of any of our contract manufacturers tomanufacture our products in conformity with cGMPs could result in interruptionor halt of the availability of our products, pending demonstration to the FDAor a court of compliance with cGMPs. Any such interruption could have a material adverse impact upon ourfinancial position and results of operations.

 

**Ifwe or BioChemics fail to adequately protect or enforce our intellectualproperty rights, we may be unable to operate effectively.**

 

BioChemics owns proprietary technology developed in connection with itsfour U.S. patents.  These are: PatentNo. 5,460,821, issued on October 24, 1995 and expiring June 23, 2013; PatentNo. 5,645,854, issued on July 8, 1997 and expiring June 23, 2013; Patent No.5,853,751, issued on December 29, 1998 and expiring June 23, 2013; and PatentNo.6,635,274, issued on October 21, 2003 and expiring October 27, 2020. BioChemics has licensed thesepatents to us. In addition, foreign patents have been issued to BioChemics in17 foreign countries and are pending in seven others. The PENtoCORE technologyis not covered by patents but is considered proprietary. BioChemics also ownsfifteen registered trademarks, including Osteon and PENtoCORE. We have appliedfor U.S. Trademark protection for the mark “Termin8”.  Our license agreement, as amended, with BioChemics permits us tocommercialize, market and sell our products and product candidates using thesepatents, proprietary formulations and the Osteon and PENtoCORE trademarks. Oursuccess and ability to compete are substantially dependent on these patents,proprietary formulations and trademarks. Although both we and BioChemics believethat the patents and associated trademarks and licenses are valid, there can beno assurance that they will not be challenged and subsequently invalidatedand/or canceled. The invalidation or cancellation of any one or all of thepatents or trademarks would significantly damage our commercial prospects.Further, BioChemics may find it necessary to legally challenge partiesinfringing its patents or trademarks or licensed trademarks to enforce itsrights thereto. There can be no assurance that any of the patents wouldultimately be held valid or that efforts to defend any of the patents, tradesecrets, know-how or other intellectual property rights would be successful.

 

**Ifwe infringe on the intellectual property rights of others, our business andprofitability may be adversely affected.**

 

Our commercial success will also depend, in part, on us and BioChemicsnot infringing on the patents or proprietary rights of others. There can be noassurance that the technologies and products used or developed by BioChemicsand marketed and sold by Vaso Active will not infringe such rights. If suchinfringement occurs and neither we nor BioChemics is able to obtain a licensefrom the relevant third party, we will not be able to continue the development,manufacture, use, or sale of any such infringing technology or product. Therecan be no assurance that necessary licenses to third-party technology will beavailable at all, or on commercially reasonable terms. In some cases,litigation or other proceedings may be necessary to defend against or assertclaims of infringement or to determine the scope and validity of theproprietary

 

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rights ofthird parties. Any potential litigation could result in substantial costs to, anddiversion of, our resources and could have a material and adverse impact on us.An adverse outcome in any such litigation or proceeding could subject us and/orBioChemics to significant liabilities, require us to cease using the subjecttechnology or require us and/or BioChemics to license the subject technologyfrom the third party, all of which could have a material adverse effect on ourbusiness.

 

**Weoperate in a competitive environment and there can be no assurances thatcompeting technologies would not harm our business development.**

 

We are engaged in a rapidly evolving field. Competition from numerouspharmaceutical companies including Pfizer, Bristol-Myers Squibb,Schering-Plough, and biotechnology companies including, Alza, Cygnus and Elan,as well as research and academic institutions, is intense and expected toincrease. The market for transdermal and topical drug delivery systems is largeand growing rapidly and is likely to attract new entrants. Numerousbiotechnology and biopharmaceutical companies have focused on developing newdrug delivery systems and most, if not all of these companies, have greaterfinancial and other resources and development capabilities than we do. Theyalso have greater collective experience in undertaking pre-clinical and theclinical testing of products; obtaining regulatory approvals; and manufacturingand marketing OTC and prescription pharmaceutical products. Accordingly,certain of our competitors may succeed in obtaining approval for products morerapidly than us. In addition to competing with universities and other researchinstitutions in the development of products, technologies and processes, we maycompete with other companies in acquiring rights to products or technologiesfrom universities. There can be no assurance that our products, existing or tobe developed, will be more effective or achieve greater market acceptance thancompetitive products, or that our competitors will not succeed in developingproducts and technologies that are more effective than those being developed byus or that would render our products and technologies less competitive orobsolete.

 

**Technologicaladvancement by our competitors could result in the obsolescence of some or allof our products and may harm business development.**

 

The areas in which we are commercializing, distributing, and/or sellingproducts involve rapidly developing technology. There can be no assurance thatwe will be able to establish ourselves in such fields, or, if established, thatwe will be able to maintain our position. There can be no assurance that thedevelopment by others of new or improved products will not make our productsand product candidates, if any, superfluous or our products and productcandidates obsolete.

 

**Shouldproduct liability claims be brought successfully against us exceeding theproduct liability coverage we currently have in place there can be noassurances that such events would not materially impact our performance andviability.**

 

The sale of our products may expose us to potential liability resultingfrom the sale and use of such products. Liability might result from claims madedirectly by consumers or by pharmaceutical companies or by others selling suchitems. We currently maintain $5 million of product liability insurance.There can be no assurance that we will be able to renew our current insurance,renew it at a rate comparable to what we now pay, or that the coverage will beadequate to protect us against liability. If we were held liable for a claim orclaims exceeding the limits of our current or future insurance coverage, or ifcoverage was discontinued for any reason, it could have a materially adverseeffect on our business and our financial condition.

 

**Our limited sales and marketing experiencemay adversely impact our ability to successfully commercialize and sell ourproducts.**

 

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We have limited sales and marketing experience, particularly withrespect to marketing and selling products in commercial quantities. If we areunable to expand our sales and marketing capabilities we may not be able toeffectively commercialize our products and product candidates.

 

**Ifwe are unable to effectively promote our brand and establish a leading positionin the marketplace, our business may fail.**

 

Our brand names are new and unproven. If we are unable to effectivelypromote our brands and establish a prominent position in the marketplace, ouroperations will suffer.  We believe thatthe importance of brand recognition will increase over time.  In order to gain brand recognition, we mayincrease our marketing and advertising budgets to create and maintain brandloyalty.  We do not know whether theseefforts will lead to greater recognition.

 

**We depend onBioChemics to provide us with certain support and services. The loss of suchsupport and services would have a material adverse effect on our business.**

 

We were originally formed as a division of BioChemics and the viabilityand financial strength of BioChemics is critical to our success. Throughout ourdevelopment, we have relied on services and financing provided to us byBioChemics. When we became an independent operating entity, we entered into alicense agreement and, prior to the consummation of our initial publicoffering, we entered into a manufacturing and development agreement, withBioChemics. We presently maintain our executive offices on premises that weshare with BioChemics. We do not have a lease agreement with BioChemics. Webelieve that we can obtain suitable alternative space without any materialdisruption of our business and that such space will be available to us in thefuture on commercially reasonable terms. Since BioChemics provides us withadministrative and managerial support, our results of operations include allocationsof certain BioChemics expenses, such as centralized accounting, dataprocessing, utilities, office space rental, supplies, telephone and otherBioChemics corporate services and infrastructure costs. These expenses havebeen charged back to us as a management fee. We recorded approximately $8,200and $30,600 in these related-party fees in the three-month periods ended March31, 2004 and 2003 respectively. In addition, during the three-month periodended March 31, 2003, BioChemics provided financing to us in the amount of$222,983 to fund our operating losses incurred during that three-month periodas well as fund the up front costs of a private placement closed in May 2003,see discussion at “Liquidity and Capital Resources.  This was reimbursed as a portion of the amount paid to BioChemicsupon the closing of our initial public offering in December 2003. The expenseallocations have been determined on the basis that we and BioChemics considerto be reasonable reflections of the utilization of services provided for thebenefit received by us.  The loss of theservices provided by BioChemics or the loss of the license of the VALE patentsor the PENtoCORE technology under the license agreement would have a material adverseeffect on our business, financial condition and results of operations.

 

In thisregard, investors should be aware that BioChemics has never been profitable andmost likely will not achieve profitability in the near future, if ever.Although BioChemics was founded in 1989, and incorporated in 1991, it is stilla development stage company. It has generated significant losses throughDecember 31, 2003, has limited revenue, and is likely to sustain operatinglosses in the foreseeable future. BioChemics’ operations are subject to all ofthe risks inherent in the establishment of a business enterprise. ThroughDecember 31, 2003, BioChemics had an unaudited, consolidated accumulateddeficit of approximately $12.8 million, which includes the operations of VasoActive. In addition, as of December 31, 2003, BioChemics was in default underdebt obligations in the approximate amount of $8.0 million, which includesaccrued interest, that it has issued to private investors, of whichapproximately $5.3 million, inclusive of accrued interest,****is held by Mr. Masiz,members of his family and other related parties.  Although BioChemics is attempting to restructure or refinancethese obligations, there can be no assurance that it will be able to do so onacceptable terms.  If BioChemics is notsuccessful in maintaining its financial viability, our business, financialcondition and results of operations may be materially and adversely affected.BioChemics anticipates that it will continue to incur net losses and beunprofitable for the foreseeable future.

 

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There can be no assurance thatBioChemics will ever operate at a profit even if its or our products arecommercialized.

 

In addition,it is expected that BioChemics will encounter significant marketing difficultiesand will also face significant regulatory hurdles. The likelihood of success ofBioChemics must be considered in light of the problems, expenses, difficulties,complications and delays frequently encountered in connection with anynon-profitable business enterprise, including but not limited to theidentification and development of new products, difficulties with corporatepartners, vendors, and a very competitive environment. Additionally, BioChemicsitself requires additional capital and/or revenues to continue its operationsand there is no guarantee that it will be able to fund its own operations orthose of the Company.

 

**Ifwe fail to attract, train and retain additional highly qualified seniorexecutives and technical and managerial personnel in the near future, ourbusiness will suffer.**

 

John J. Masiz,the Company’s President and Chief Executive Officer, has agreed with the Staffto settle a proposed action by the SEC against him that would prevent him fromserving as an officer or director of any public company, including the Company,for a period of five years.  If Mr.Masiz is barred from serving as an officer and director of the Company for thisfive-year period, he will be permitted and intends to continue to be an activeemployee of the Company.  If the offerto settle is accepted by the SEC itself, Mr. Masiz would resign as thePresident and Chief Executive Officer of the Company, as well as the Chairmanof the Board of Directors of the Company. The Company is in the process of conducting a search for a new ChiefExecutive Officer to replace Mr. Masiz when he resigns. There is no assurancethat we will be able to attract or retain a suitable Chief Executive Officernow or in the future, and this could have a material adverse effect on our business,financial condition and results of operations. There is, however, a high demandfor highly trained executives and managerial personnel in our industry.  We do not know whether we will be able toattract or retain a suitable Chief Executive Officer either now or in thefuture and this could have a material adverse effect on our business, financialcondition and results of operations.

 

Effective June18, 2004, Kevin J. Seifert resigned as the Chief Operating Officer of theCompany and as a director of the Company. The Company is not currentlyconducting a search for a new Chief Operating Officer.  We anticipate that our new Chief ExecutiveOfficer will assume Mr. Seifert’s former responsibilities.

 

Furthermore, several of our other senior officers are devoting lessthan all their time to the Company.  Forexample, our chief scientific officer, Dr. Stephen Carter, will devoteapproximately 30% of his business time to our affairs. For us to pursue ourproduct development, marketing and commercialization plans, we will need tohire personnel with experience in clinical testing, government regulation,manufacturing, marketing and finance. We may not be able to attract and retainpersonnel on acceptable terms given the intense competition for such personnel amonghigh technology enterprises, including biotechnology, pharmaceutical andhealthcare companies, universities and non-profit research institutions. If welose any of these persons, or are unable to attract and retain qualifiedpersonnel, our business, financial condition and results of operations may bematerially and adversely affected.

 

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**Mr.Masiz is also the principal stockholder of BioChemics which is our principalstockholder and he will have substantial control over our affairs, possibly tothe detriment of other holders of our Class A common stock.**

 

Our principal stockholder, BioChemics, owns 4,500,000 shares of ourClass B common stock, which at March 31, 2004 representedapproximately 70% of the combined voting power of our common stock.Mr. Masiz, as President, Chief Executive Officer and Chairman ofBioChemics and, as the principal stockholder in BioChemics, will be able tocontrol the outcome of stockholder votes, including votes concerning theelection of our directors, the adoption or amendment to provisions in ourcertificate of incorporation or by-laws, the approval of mergers and/oracquisitions, decisions affecting our capital structure and other significantcorporate transactions. This concentration of ownership may delay, deter orprevent transactions that would result in a change of control, which in turncould reduce the value of our common stock.

 

**Inthe event of a conflict of interest between BioChemics and us, our stockholderscould be negatively affected.**

 

There are likely to be situations where our best interests and those ofBioChemics will be in conflict.  Forexample, we are a party to a license agreement, a manufacturing and developmentagreement and an administrative services agreement with BioChemics, each ofwhich is critical to our business operations. To the extent that decisions are made by Mr. Masiz that could enhancethe value of BioChemics versus the value to us, our stockholders interestscould be negatively affected. Investors should be aware of these potentialconflicts.

 

**ITEM 3****.****                 CONTROLSAND PROCEDURES**

 

In connection with the preparation and filing of this Quarterly Reporton Form 10-QSB, our management, including our chief executive officer and chieffinancial officer, carried out an evaluation of the effectiveness of our“disclosure controls and procedures” (as defined under Rules l3a-l5(e) and15d-l5(e) promulgated under the Exchange Act) as those controls existed as ofMarch 31, 2004.  Based on thisevaluation, our principal executive and principal financial officers haveconcluded that our disclosure controls and procedures were not effective toensure that material information is recorded, processed, summarized andreported properly by our management on a timely basis in order to comply withour disclosure obligations.

 

Based on ourevaluation, we concluded that our disclosure controls and procedures were noteffective because we lacked the specialized managerial resources to enable usto determine whether the regulatory requirements applicable to our products andproduct candidates were fully disclosed.

 

As a result ofthese findings, we determined to take the following steps to improve ourdisclosure controls and procedures:

 

•      hire counsel expert in FDAregulation;

•      hire special counsel expertin SEC regulation; and

•      hire a chief executiveofficer with experience in FDA regulation and SEC reporting obligations.

 

We have hired outsidecounsel expert in FDA regulation and outside counsel expert in SEC regulation.  We believe the involvement of these counselin our reporting process, including the preparation of this 10-QSB, is asignificant improvement to our disclosure controls and procedures.

 

We anticipatecompleting our search for a chief executive officer with appropriate experienceby the end of the third quarter 2004. We believe with the completion of thatstep we will be able conclude that our disclosure controls and procedures areeffective to ensure that material information is recorded, processed, summarizedand reported by our management on a timely basis in order to comply with ourdisclosure obligations under the Exchange Act.

 

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**PARTII** – OTHER INFORMATION

 

**ITEM1. LEGAL PROCEEDINGS**

 

**Recent Events**

 

***Trading Suspensionand SEC Settlement***.  On April 1, 2004, the SEC temporarily suspended trading of theCompany’s securities.  The suspension,by its terms, terminated at 11:59 p.m. on April 15, 2004.  In the SEC announcement of the tradingsuspension, the SEC stated that it temporarily suspended trading in thesecurities of the Company because of questions regarding the accuracy ofassertions by the Company, and by others, in press releases, the Company’sannual report, its registration statement and public statements to investorsconcerning, among other things: “(1) the FDA approval of certain key products;and (2) the regulatory consequences of the future application of [its] primaryproduct.”

 

On April 5, 2004, representatives of the Company, together with newlyretained special securities counsel and newly retained FDA counsel, met withthe staff of the SEC, or Staff, for the purpose of discussing the concerns thatled to the suspension of trading in the Company’s securities.  During that meeting, the Company stated itsintention to review its public disclosure, press releases and other publicstatements and to take whatever remedial action might be appropriate.  It also represented to the Staff that itwould (i) diligently seek to clarify the status of its products under currentFDA regulations, (ii) issue disclosure regarding the FDA regulation of itsactivities and products and the results of its dialogue with the FDA, and (iii)endeavor to resolve on a timely basis any concerns communicated by the Staff. TheStaff stated that it had been authorized by the SEC to seek injunctive reliefagainst the Company, articulated the concerns that gave rise to the suspensionof trading, and informally requested that the Company provide certaininformation to the Staff. The Company agreed to cooperate with the Staff,committed to review its disclosure promptly and committed to take any remedialaction that might be required.

 

The Company has agreed to a settlement with the Staff pursuant to whichthe Company will be permanently enjoined from violating certain of theanti-fraud provisions of the Securities Act and the Exchange Act.  The settlement must first be approved by theSEC itself and then by a court.  Inaddition, John J. Masiz, the Company’s President and Chief Executive Officer,has agreed with the Staff to a proposed action by the SEC against him thatwould similarly enjoin him and prevent him from serving as an officer ordirector of any public company, including the Company, for a period of fiveyears.  If Mr. Masiz is barred fromserving as an officer and director of the Company for this five-year period, hewill be permitted and intends to continue to be an active employee of theCompany.  Please see “Changes in Management”below for additional information on Mr. Masiz’s resignation as well as “RiskFactors” – “If we fail to attract, train and retain additional highly qualifiedsenior executives and technical and managerial personnel in the near future,our business will suffer.”

 

The Company is not aware that the FDA is contemplating any actionagainst the Company.  The Company,through counsel, has engaged in and will continue to maintain a dialogue withthe FDA to address any concerns.  TheCompany has submitted new labels for its previously marketed products to theFDA and has requested FDA comments on any concerns or issues pertaining tothese revised labels.  As of the date ofthis report, the FDA has not provided any comment to the Company based on theagency’s review of the labels submitted to the FDA.  There is, however, no regulatory requirement that FDA review orprovide comment on such materials.  TheCompany is reasonably sure that these labels are consistent with all FDAregulations and policies.

 

Due to the ongoing nature of these matters, the Company is unable todefinitively assess their impact. However, the Company has committed not to market or sell its productsuntil all outstanding matters have been addressed to the satisfaction of theSEC and until the Company is reasonably sure that the

 

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marketing and sale of itsproducts is consistent with the FDA’s requirements and policies.  This commitment may have a material adverseimpact on the Company.  The Company anticipatesthat the marketing and sale of Athlete’s Relief, Osteon and Termin8äwill resume by the end of 2004, although there is no guarantee of this.  When appropriate, the Company will makeadditional public announcements and will file public reports with the SECregarding the status of its products under applicable FDA regulations.

* *

***Nasdaq Stock MarketMatters.*** By letter dated April 2, 2004, the Nasdaq Listing Investigationsdepartment of The Nasdaq Stock Market, Inc., or Nasdaq, notified the Companythat it had commenced an inquiry to ensure the Company’s ongoing compliancewith Nasdaq’s inclusion requirements and requested certain information from theCompany.  The letter further disclosedthat after review of the information provided by the Company, Nasdaq could takeany action that might be appropriate under its Marketplace Rules includingremoval of the Company’s securities from Nasdaq.  In view of the substantial administrative and cash burdens beingborne by the Company at that time and the substantial legal costs anticipatedwith respect to the SEC and FDA matters, the Company determined that it was inthe best interest of shareholders to voluntarily cause its shares to be removedfrom Nasdaq and focus its attention and resources on addressing the SEC and FDAconcerns.  The Company’s securities werevoluntarily delisted, effective the opening of the markets on Thursday, April8, 2004.  At an appropriate time, theCompany will seek to cause its securities to be quoted on a national exchange,Nasdaq or other automated quotation system. There can be no assurance that theCompany will be successful or that an organized market for the Company’ssecurities will develop.  If the Companyis unable to list its securities on a national exchange or on an automatedsecurities quotation system in the future, it could have a material adverseimpact on our ability to raise future capital (See “Liquidity and CapitalResources”).

 

***Litigation.*** In April, May, and June 2004, the Company andcertain of its officers were sued in several purported securities class actionlawsuits filed in the United States District Court for the District ofMassachusetts.  The complaints, whichseek equitable and monetary relief, an unspecified amount of damages, withinterest, attorneys fees and costs, allegedly were filed on behalf ofpurchasers of the Company’s Class A common stock during the period December 11,2003 to March 31, 2004 and allege that during that period, the defendantsviolated the federal securities laws by allegedly failing to make accurate andcomplete disclosures concerning the Company, its financial condition, itsbusiness operations and future prospects, the clinical trial and endorsement ofthe Company’s Termin8 anti-fungal product (previously known as “deFEET”) andthe institutional demand for the Company’s securities.  These complaints are captioned asfollows:  Dennis E. Smith v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10708 (RCL) (D.Mass.); Richard Shapiro v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ. No. 04-10720 (RCL) (D. Mass.); Christopher Pepin v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10763 (RCL) (D.Mass.); Modhi Gude, *et al.* v. Vaso Active Pharmaceuticals,Inc., *etal.*, Civ. No. 04-10789 (RCL) (D. Mass.); Kim Benedetto, *et al.*v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10808 (RCL) (D.Mass.); Dean Dummer v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10819 (RCL) (D.Mass.); Edward Tovrea v. Vaso Active Pharmaceuticals, Inc., *et al.*,Civ . No. 04-10851 (RCL); Kourosh Alipor v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-10877 (RCL); Paul E. Bostrom v.VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-10948 (RCL); Ira A. Turret Sep-Ira Dated01/24/02 v. Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No.04-10980 (RCL); Richard Pagona v.Vaso Active Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11100 (RCL); James Karanfilian v. Vaso ActivePharmaceuticals, Inc., *et al.*, Civ. No. 04-11101 (RCL); and Charles Robinson v. VasoActive Pharmaceuticals, Inc., *et al.*, Civ. No. 04-11221 (RCL). The Court has consolidated the above-referenced cases, other than the Tovreaand Karanfilian complaints, under the caption In Re Vaso ActivePharmaceuticals Securities Litigation, Civ. No. 04-10708 (RCL).  Although the Company intends to vigorouslydefend against these cases, the litigation process is inherently uncertain andthere can be no guarantee as to the ultimate outcome of these matters.  There is also no guarantee that these willbe the only lawsuits brought against the Company with respect to these matters.

 

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The Company has also been named as a nominal defendantin two shareholder derivative actions filed, the first filed in April 2004against its directors and certain of its officers and against BioChemics, Inc.entitled Joseph Rosenkrantz v. BioChemics, Inc., *et al.*., Civ. No.04-10792 (RCL) (D. Mass.)  and the second filed in June 2004, alsoagainst the Company’s directors and certain of its officers and againstBioChemics, Inc. entitled William Pomeroy v. BioChemics Inc., *et a**l*,  Civ. No. 04-11399 (RCL) (D. Mass.).

The complaints allege, among other things, that thealleged conduct challenged in the securities cases pending against the Companyin Massachusetts (described above) constitutes a breach of the defendants’fiduciary duties to the Company.  Thecomplaints seek equitable and monetary relief, an unspecified amount ofdamages, and attorneys and other fees, costs and expenses, ostensibly on behalfof the Company.

 

An unfavorable outcome in one or more of these related cases could havea material adverse effect on the Company’s financial position, liquidity andresults of operations.  In addition to the costs of defending thesecases, the Company may provide indemnification for expenses and losses that maybe incurred by its directors and officers as parties to one or more of thesecases.  Although the Company will seekcoverage under its director and officer liability insurance policy, there canbe no assurance that the Company can obtain reimbursement of all of itsout-of-pocket defense costs and any amounts paid in settlement or pursuant tojudgments in the event of unfavorable outcomes in one or more of these cases.

 

Accordingly, the costs of defending these cases and providingindemnification to our directors and officers may be substantial.  However, because of the uncertainty ofestimating the potential financial statement impact of any of these actionswith any reasonable degree of accuracy, at this time the Company has notreserved for any potential liability or costs that may arise as a result ofthis litigation except for the $200,000 insurance deductible that we reservedas of March 31, 2004.  While the casesare in very preliminary stages and the outcomes are not predictable, if asubstantial amount is payable by the Company and is not reimbursed through itsdirector and officer liability policy, this will have a material adverse effecton the Company’s financial position and liquidity.  There can be no assurance that the Company’s insurer will admitliability to reimburse the Company with respect to any of the claims assertedin any of the litigation against the Company or its officers or directors orthat coverage limits will be sufficient.

 

**ITEM 2. CHANGES IN SECURITIES**

 

*Warrant Issued*

 

OnJanuary 1, 2004, we entered into a marketing agreement with Commotion andits founder, whereby Commotion and its founder agreed to provide certainservices to our Company in connection with marketing, promotion and branddevelopment of our products. Pursuant to the terms of this agreement and inconsideration for the services rendered thereunder, we agreed to pay monthlyservices fees and media commissions and to issue the aggregate of 225,000(75,000 pre-split), five-year warrants (collectively, the “Warrants”) to itsfounder. The Warrants were issued as of January 16, 2004 in the followingthree tranches, each exercisable immediately upon issuance:

 

(i)Warrants to purchase up to75,000 (25,000 pre-split) shares of Class A common stock of the Company atan exercise price of $1.83 ($5.50 pre-split) per share;

 

(ii)Warrantsto purchase up to 75,000 (25,000 pre-split) shares of Class A common stockof the Company at an exercise price of $2.00 ($6.00 pre-split) per share; and

 

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(iii)Warrantsto purchase up to 75,000 (25,000 pre-split) shares of Class A common stockof the Company at an exercise price of $2.17 ($6.50 pre-split) per share.

 

A registration statement on Form S-8 wasfiled on February 13, 2004 that registered the underlying Class A commonshares of our Company issuable upon exercise of the Warrants. In February andMarch 2004, we received $450,000 upon the exercise of the above warrants intoClass A Common Stock.

 

*Stock Split*

 

Effective March 5, 2004, we effected a 3 for 1 stock split throughthe issuance of a 200% stock dividend to holders of record of both ourClass A and B common stock as of February 23, 2004.

 

*Private Placement*

 

On March 16, 2004 we entered into a private placement transactionwith an institutional investor in the amount of $7.5 million. Theinvestment was in the form of an 18 month 2% Convertible Note convertibleinto shares of Class A common stock at a conversion rate of $9 per share.  In addition, we issued to the investorwarrants to purchase 166,667 shares of our Class A common stock at anexercise price of $8.75 per share.  OnApril 8, 2004, we entered into a settlement agreement and release with the investorpursuant to which we repaid the investor the sum of $7.5 million withoutpenalty, interest, redemption premium or any other premium or penalty, plus anexpense reimbursement in the amount of $15,000.  In consideration of this repayment, the investor surrendered theNote and warrants and terminated all other agreements entered into inconnection with the private placement transaction.  In connection with this transaction, we paid approximately$600,000 in fees to various third parties. These fees were not refunded when we repaid the investor.  See “Recent Events”–”Unwinding of March 16,2004 Private Investment In Public Equity” for further information.  These fees were recorded as an expenseduring the three-month period ended March 31, 2004.

 

*Use of Proceeds from Initial Public Offering*

 

On December 10, 2003, our Registration Statement on Form SB-2(registration no. 333-106785) for the sale of 1,667,500 shares of ourClass A common stock (5,002,500 on a post-split basis) which included217,500 shares of Class A common stock (652,500 on a post-split basis) tocover underwriter over-allotments, at a price of $5.00 per share ($1.67 on apost-split basis), became effective. We completed this initial public offeringon December 15, 2003. All of the shares sold in this offering were fromour authorized pool of Class A common stock. Kashner Davidson SecuritiesCorp. functioned as the representative of the underwriters for this publicoffering. Net of offering costs of approximately $1.9 million, we receivedapproximately $6.4 million in proceeds, which we estimated would beallocated as follows:

 

•              Approximately $1.1 million to fundour continued development, commercialization and sale of our products andproduct candidates;

 

•              Approximately $1.9 million toimplement our strategic marketing and commercialization plan, whichapproximately $1.2 million was to be allocated to fund our radioadvertising campaign.  This radiocampaign was originally to be initiated in connection with the retail rolloutof our products, which we anticipated would occur in 2004.  As a result of the cessation of themarketing and sale of our products following the initiation of the SEC tradingsuspension on April 1, 2004, we do not expect that the retail rollout of ourproducts, which was designed as the second stage of our rollout strategy, willcommence until at least 2005. Consequently, we do not anticipate using any of the initial publicoffering proceeds to fund advertising, direct mail programs or otherpromotional activities related to this retail

 

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roll-out strategy before that time and therecan be no assurance that any of the initial public offering proceeds will beused for this purpose.  We haveallocated approximately $372,000 in 2004 for marketing costs associated with thefirst stage of our rollout strategy.

 

•              $200,000 to recruit and hire individualsfor key senior management positions;

 

•              $350,000 to cover the cost of providingsales incentives, product samples and discounts;

 

•              To repay, without interest, BioChemics approximately$99,000 for management fees charged back to us since we became a stand-aloneentity upon our incorporation for centralized accounting, data processing,utilities, office space rental, supplies, telephone and other BioChemicscorporate services and infrastructure costs, and approximately $347,000 forother operational charges paid by BioChemics to third parties on our behalfthrough September 30, 2003; these amounts increased to approximately$122,000 and $518,200 respectively, which reflect the modifications necessaryfor these additional type costs incurred from October 1, 2003 throughDecember 31, 2003; and

 

•              Approximately $1.68 million toprovide working capital for general and corporate purposes.  We increased this to $2.2 million fromthe registration disclosure to reflect the net impact of the exercise of theover allotment option.  In addition, weanticipate using the funds initially allocated for the implementation of ourstrategic marketing and commercialization plan, including the approximately$1.2 million that was allocated to fund our anticipated radio advertisingcampaign, less the approximately $372,000 budgeted for marketing costsassociated with the first stage of our rollout strategy, as working capital forgeneral and corporate purposes.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITIES HOLDERS**

 

OnFebruary 19, 2004 we submitted a written consent to BioChemics as the holder ofour Class B common stock requesting approval of an amendment to our Amended andRestated Certificate of Incorporation. Because of its ownership of Class B Common Stock, BioChemics holds 70%of the vote. BioChemics approved the amendment by written consent on the sameday.  Because this was accomplished bywritten consent under Delaware corporate law, there were no votes against theamendment.

 

Theamendment increased our authorized capital to 40 million shares by increasingour authorized Class A Common Stock to 20 million shares and our authorizedClass b Common Stock to 10 million shares, while keeping our authorizedpreferred stock at 10 million shares.

 

Thepurpose of the amendment was to increase our authorized capital to allow forthe stock dividend paid on March 5, 2004.

 

**ITEM 6****(a).  EXHIBITS AND REPORTS ON FORM 8-K**

 
| **Exhibit  Number** |   | **Description  of Exhibit**                                                                                                                                                                                             |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |   | Amended  and Restated Articles of Incorporation, as amended on February 19, 2004(4)                                                                                                                                     |
| 4.1                 |   | Form  of Warrant Agreement with Greg Gorman, dated January 16, 2004, for the  purchase of up to 25,000 shares of the Class A Common Stock of Vaso Active  Pharmaceuticals, Inc. for the aggregate amount of $137,500(1) |
| 4.2                 |   | Form  of Warrant Agreement with Greg Gorman, dated January 16, 2004, for the  purchase of up to 25,000 shares of the Class A Common Stock of Vaso Active  Pharmaceuticals, Inc. for the aggregate amount of $150,000(1) |

 

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| 4.3  |   | Form  of Warrant Agreement with Greg Gorman, dated January 16, 2004, for the  purchase of up to 25,000 shares of the Class A Common Stock of Vaso Active  Pharmaceuticals, Inc. for the aggregate amount of $162,500(1) |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.4  |   | Securities  Purchase Agreement, dated as of March 16, 2004, between Vaso Active  Pharmaceuticals, Inc. and The Riverview Group, LLC(2)                                                                                  |
| 4.5  |   | Warrant  to Purchase Class A Common Stock issued to the Riverview Group LLC on March  16, 2004(2)                                                                                                                       |
| 4.6  |   | Registration  Rights Agreement, dated as March 16, 2004, between Vaso Active  Pharmaceuticals, Inc. and The Riverview Group, LLC(2)                                                                                     |
| 4.7  |   | Convertible  Note issued to The Riverview Group LLC on March 16, 2004(2)                                                                                                                                                |
| 10.1 |   | Form  of Marketing and Distribution Agreement, dated as of January 9, 2004 between  Vaso Active Pharmaceuticals, Inc. and Ortho Distribution, Inc. (4)                                                                  |
| 10.2 |   | Form  of Marketing Agreement, dated January 16, 2004, by and between Vaso Active  Pharmaceuticals, Inc., Commotion, LLC and Greg Gorman(1)                                                                              |
| 10.3 |   | Form of Marketing Agreement, dated as of March 9,  2004, by and between Vaso Active Pharmaceuticals, Inc. and M2G Media, Inc.  (4)                                                                                      |
| 10.4 |   | Settlement Agreement and Release between Vaso  Active Pharmaceuticals, Inc. and The Riverview Group LLC, dated April 8, 2004  (3)                                                                                       |
| 31.1 |   | Certification  of John J. Masiz, Chief Executive Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002(4)                                                                                                 |
| 31.2 |   | Certification  of Joseph Frattaroli, Chief Financial Officer, pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002(4)                                                                                             |
| 32.1 |   | Certification  of John J. Masiz, Chief Executive Officer, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002(4)                                                                                                 |
| 32.2 |   | Certification  of Joseph Frattaroli, Chief Financial Officer, pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002(4)                                                                                             |

 

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(1)           Previously filed as an exhibit to our registration statement on FormS-8 filed February 13, 2004.

 

(2)           Previously filed as an exhibit to our current report on Form 8-K filedMarch 17, 2004.

 

(3)           Previously filed as an exhibit to our current report on Form 8-K filedApril 9, 2004.

 

(4)           Filed herewith.

 

**ITEM 6 (b).  Reportson Form 8-K**

 

The Company filed Form8-K on January 12, 2004, containing a press release announcing that it hadentered into a non-exclusive marketing and distribution agreement with OrthoDistribution, Inc. of Andover, Massachusetts, a wholly owned subsidiary ofTempe, Arizona-based OrthoRehab, Inc., a multi-national provider of orthopedictherapies and medical devices.

 

The Company filed Form 8-K on February 19,2004, containing a press release that the Board of Directors declared a 3 for 1stock split effective in the form of a 200 percent stock dividend payableon or about March 5, 2004 to holders of record of both Class A andClass B common stock as of February 23, 2004.

 

The Company filed Form8-K on February 23, 2004 containing a press release in response to an item inthe February 23, 2004 issue of Barron’s.

 

The Company filed Form8-K on February 26, 2004 containing a press release announcing that on February19, 2004, the number of directors on the Board of Directors of the Company (the“Board”) had

 

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beenincreased to eight and that Kevin J. Seifert, the Chief Operating Officer of theCompany, had been appointed to the Board.

 

The Company filed Form 8-K on March 8, 2004 containing a press release that The Wall Street Transcript published an in-depth interview with John J. Masiz, President and Chief Executive Officer of the Company, in which Mr. Masiz spoke at length about the Company.

 

The Company filed Form 8-K on March 9, 2004 containing a press release in response to an article written by Matthew Goldstein that appeared online in TheStreet.com on March 9, 2004.

 

The Company filed Form 8-K on March 10, 2004 containing a press release announcing that it had entered into an exclusive, global strategic alliance with M2G Media of Irvine, California.

 

The Company filed Form8-K on March 16, 2004 indicating that the Company had completed a privateplacement transaction pursuant to which the Company issued (i) an 18 month 2%convertible note in the aggregate principal amount of $7,500,000 convertibleinto shares of the Company’s Class A common stock at a conversion price of$9.00 and (ii) warrants to purchase 166,667 shares of Class A common stock atan exercise price of $8.75 per share.

 

The Company filed Form8-K on March 26, 2004 containing a press release regarding its intent tobroadcast its full year 2003 results and outlook for 2004 via a conference calland audio web cast conducted by Mr. John J. Masiz, President, Chairman andChief Executive Officer.

 

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**SIGNATURES**

 

In accordance with Section 13 and 15(d) of the Exchange Act, theregistrant caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| Dated:  July 20, 2004 | **Vaso Active Pharmaceuticals, Inc.** |
|----------------------------|--------------------------------------------|
|                       |                                       |
|                       | By:                                        | /s/ John Masiz |   |
|                       |                                       | John Masiz  President, Chief Executive  Officer and Chairman of  the Board |
|                       |                                       |
|                       |                                       |
|                       | By:                                        | /s/ Joseph Frattaroli |   |
|                       |                                       | Joseph Frattaroli  Chief Financial Officer |

 

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