**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON, D.C.
      20549**





**Form
      10-QSB**





**x
      QUARTERLY REPORT UNDER
      SECTION 13 OR 15(D) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**





For
      the
      quarterly period ended September 30, 2006





**o
      TRANSITION REPORT UNDER
      SECTION 13 OR 15(d) OF THE**


**EXCHANGE
      ACT**





For
      the
      transition period from __________________ to ____________________




**Commission
      file number:** **000-52018**




**VIRTUALSCOPICS,
      INC.**


(Name
      of
      Small Business Issuer in its charter)





**DELAWARE**
            **04-
                3007151**(State
                or other jurisdiction of incorporation or organization)
            (I.R.S.
                Employer Identification No.)**350
                Linden Oaks, Rochester, New York**
            **14625**(Address
                of principal executive offices)
            (Zip
                Code)




**(585)
      249-6231**


( Issuer's
      Telephone Number, Including Area Code )





**SECURITIES
      REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE
      ACT:**


**Common
      Stock, $0.001 par value**  **SECURITIES
      REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE
      ACT:**




**TITLE
      OF EACH CLASS: None.**




(Former
      name, former address and former fiscal year, if changed since last
      report)





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




Indicate
      by a check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Securities Exchange Act of 1934). Yes o No x.





As
      of
      October 31, 2006, there were 22,942,826 shares of the issuer’s common stock,
      $0.001 par value, outstanding.





Transitional
      Small Business disclosure format. Yes o No x








TABLE
      OF
      CONTENTS





PART
                I
            FINANCIAL
                INFORMATION
            Page
                NumbersITEM
                1: Financial Statements (unaudited)Condensed
                Consolidated Balance Sheet as of September 30, 2006
            2Condensed
                Consolidated Statements of Operations for the three and nine months
              ended
                September 30, 2006 and 2005
            3Condensed
                Consolidated Statements of Cash Flows for the nine months
              ended
                September 30, 2006 and 2005
            4Notes
                to Condensed Consolidated Financial Statements
            5-9ITEM
                2: Management's Discussion and Analysis of
              Financial
                Condition and Results of Operations
            10-16ITEM
                3: Controls and Procedures
            16PART
                II
            OTHER
                INFORMATIONITEM
                1: Legal Proceedings
            17ITEM
                2: Unregistered Sales of Equity Securities and Use of Proceeds
            17ITEM
                3: Defaults Upon Senior Securities
            17ITEM
                4: Submission of Matters to a Vote of Security Holders
            17ITEM
                5: Other Information
            17ITEM
                6: Exhibits
            18




i


**PART
      1: FINANCIAL INFORMATION**





**ITEM
      1. Financial Statements (unaudited)**


1


**VirtualScopics,
      Inc. and Subsidiary**


**Condensed
      Consolidated Balance Sheet**


***(unaudited)***





**September
      30, 2006**





**Assets**Current
                assetsCash
                and cash equivalents
            
            $
            3,777,928Accounts
                receivable
            
            
            1,075,970Prepaid
                expenses and other assets
            
            
            233,778Total
                current assets
            
            
            5,087,676Patents,
                net
            
            
            1,896,488Property
                and equipment, net
            
            
            568,150Other
                assets
            
            
            438,886Total
                assets
            
            $
            7,991,200**Liabilities
                and Stockholders' Equity**Current
                liabilitiesNotes
                payable, current portion
            
            $
            72,000Accounts
                payable and accrued expenses
            
            
            428,890Accrued
                payroll
            
            
            499,363Unearned
                revenue
            
            
            106,294Total
                current liabilities
            
            
            1,106,547Notes
                payable, net of current portion
            
            
            27,850Total
                liabilities
            
            
            1,134,397Commitments
                and ContingenciesStockholders'
                EquityPreferred
                stock, $0.001 par value; 15,000,000 shares authorized;8,400
                shares designated Series A; 4,626 issued and outstanding;liquidation
                preference $1,000 per share
            
            
            5Common
                stock, $0.001 par value; 85,000,000 shares authorized;
                22,850,826
            
            
            22,851shares
                issued and outstandingAdditional
                paid-in capital
            
            
            10,577,073Accumulated
                deficit
            
            
            (3,743,126
            )Total
                stockholders' equity
            
            
            6,856,803Total
                liabilities and stockholders' equity
            
            $
            7,991,200




See
      notes
      to condensed consolidated financial statements.


2


**VirtualScopics,
      Inc. and Subsidiary**


**Condensed
      Consolidated Statements of Operations**


***(unaudited)***





For
                the Three Months Ended
              September
                30,
            
            For
                the Nine Months Ended
              September
                30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            1,275,705
            
            $
            986,090
            
            $
            3,561,969
            
            $
            2,676,073Cost
                of services
            
            
            695,095
            
            
            622,798
            
            
            2,022,391
            
            
            1,728,116Gross
                profit
            
            
            580,610
            
            
            363,292
            
            
            1,539,578
            
            
            947,957Operating
                expensesResearch
                and development
            
            
            251,526
            
            
            170,948
            
            
            795,115
            
            
            658,715Sales
                and marketing
            
            
            150,774
            
            
            62,497
            
            
            539,496
            
            
            332,910General
                and administrative(1)
            
            
            1,060,575
            
            
            284,441
            
            
            3,167,509
            
            
            980,269Depreciation
                and amortization
            
            
            121,412
            
            
            97,540
            
            
            344,612
            
            
            294,521Total
                operating expenses
            
            
            1,584,287
            
            
            615,426
            
            
            4,846,732
            
            
            2,266,415Operating
                loss
            
            
            (1,003,677
            )
            
            (252,134
            )
            
            (3,307,154
            )
            
            (1,318,458
            )Other
                income (expense)Interest
                income
            
            
            54,760
            
            
            4,088
            
            
            135,876
            
            
            18,102Interest
                and other expense
            
            
            (1,710
            )
            
            (3,261
            )
            
            (12,090
            )
            
            (15,630
            )Total
                other income (expense)
            
            
            53,050
            
            
            827
            
            
            123,786
            
            
            2,472Net
                loss
            
            $
            (950,627
            )
            $
            (251,307
            )
            $
            (3,183,368
            )
            $
            (1,315,986
            )Basic
                and diluted net loss per common share
            
            $
            (0.04
            )
            $
            (0.01
            )
            $
            (0.14
            )
            $
            (0.06
            )Weighted
                average number of common shares outstanding
            
            
            22,449,433
            
            
            21,889,075
            
            
            22,079,452
            
            
            21,889,075





(1)  Includes
      stock option compensation expense of $502,061 and $1,491,678 for the three
      and
      nine months ended September 30, 2006, respectively




See
      notes to condensed consolidated financial
      statements.




3


**VirtualScopics,
        Inc. and Subsidiary**
 **Condensed
        Consolidated Statements of Cash Flows**
 ***(unaudited)***





For
                the Nine Months Ended September 30,2006
            
            2005**Cash
                flows from operating activities**Net
                loss
            
            $
            (3,183,368
            )
            $
            (1,315,986
            )Adjustments
                to reconcile net lossto
                net cash used in operating activities:Depreciation
                and amortization
            
            
            344,612
            
            
            294,521Stock
                option compensation expense
            
            
            1,491,678
            
            
            -Issuance
                of equity instruments to non-employees for services
            
            
            989
            
            
            9,792Changes
                in operating assets and liabilitiesAccounts
                receivable
            
            
            (578,197
            )
            
            (151,301
            )Prepaid
                expenses and other assets
            
            
            152,205
            
            
            -Accounts
                payable and accrued expenses
            
            
            (48,786
            )
            
            249,507Accrued
                payroll
            
            
            190,224
            
            
            37,400Unearned
                revenue
            
            
            (460,974
            )
            
            (1,626,715
            )Total
                adjustments
            
            
            1,091,751
            
            
            (1,186,796
            )Net
                cash used in operating activities
            
            
            (2,091,617
            )
            
            (2,502,782
            )**Cash
                flows from investing activities**Purchase
                of equipment
            
            
            (370,310
            )
            
            (70,422
            )Acquisition
                of patents
            
            
            (111,177
            )
            
            (73,415
            )Net
                cash used in investing activities
            
            
            (481,487
            )
            
            (143,837
            )**Cash
                flows from financing activities**Principal
                payments of notes payable - related parties
            
            
            (56,578
            )
            
            (10,281
            )Net
                decrease in cash and cash equivalents
            
            
            (2,629,682
            )
            
            (2,656,900
            )**Cash
                and cash equivalents**Beginning
                of period
            
            
            6,407,610
            
            
            3,538,446End
                of period
            
            $
            3,777,928
            
            $
            881,546**Supplemental
                disclosure of cash flow information**Cash
                paid during the periods for:Interest
            
            $
            5,940
            
            $
            10,661





See
      notes
      to condensed consolidated financial statements.


4


**VirtualScopics,
      Inc. and Subsidiary**


**Notes
      to Condensed Consolidated Financial Statements**


***(unaudited)***


NOTE
      1 - Organization
      and Basis of Presentation





Organization


On
      November 4, 2005, VirtualScopics, LLC (“VS”), a New York limited liability
      company, entered into a merger agreement with ConsultAmerica, Inc. (“CA”), a
      Delaware corporation. CA issued 17,326,571 of its unregistered shares of common
      stock for 100% of the outstanding membership units of VS. As a result of the
      exchange, the members of VS became the controlling stockholders of CA. CA did
      not have any meaningful operations prior to the merger. The transaction was
      treated as a recapitalization of VS, and accounted for on a historical cost
      basis for all periods presented. Moreover, the financial statements set forth
      in
      this report for all periods, prior to the recapitalization, are the financial
      statements of VS and the common stock of VS has been retroactively restated
      to
      give the effect to the exchange for CA common stock. Immediately following
      the
      merger, CA changed its name to VirtualScopics, Inc. (the “Company” or “New VS”)
      and its fiscal year end from August 31 to December 31. The Company also changed
      its trading symbol from “CSAA.OB” to “VSCP.OB.” On May 31, 2006, the Company
      began trading on NASDAQ Capital Markets under the symbol “VSCP.”





Nature
      of Business


The
      Company’s headquarters are located in Rochester, New York. The Company’s
      business evolved from research first carried out at the University of Rochester,
      a related party. As a result of this research, the Company has created a suite
      of image analysis software tools and applications which are used in detecting
      and analyzing specific structures in medical images. The Company’s developed
      software provides measurement and visualization capabilities designed to improve
      clinical research and development.





Basis
      of Presentation


The
      accompanying unaudited condensed consolidated financial statements of Company
      have been condensed in certain respects and should, therefore, be read in
      conjunction with the audited consolidated financial statements and notes related
      thereto contained in the Company’s Annual Report on Form 10-KSB as of and for
      the year ended December 31, 2005. In the opinion of the management, these
      financial statements contain all adjustments necessary for a fair presentation
      for the interim period, all of which were normal recurring adjustments. The
      results of operations for the nine months ended September 30, 2006 are not
      necessarily indicative of the results to be expected for the full year ending
      December 31, 2006.





NOTE
      2 - Summary
      of Certain Significant Accounting Policies





Principles
      of Consolidation


The
      accompanying unaudited condensed consolidated financial statements include
      the
      accounts of New VS and its wholly-owned subsidiary, VS. All significant
      intercompany balances and transactions have been eliminated in
      consolidation.





Concentration
      of Credit Risk


The
      Company derived 37% and 77% of its revenue from its largest customer for the
      nine months ended September 30, 2006 and 2005, respectively.





Revenue
      Recognition


The
      Company provides advanced medical image analysis which is charged to its
      customers on a per image basis in addition to various consulting and
      project/data management services. Revenue is recognized after the services
      are
      rendered or when the image analysis is delivered.




Reimbursements
      received for out-of-pocket expenses incurred are reported as revenue in the
      accompanying consolidated financial statements in accordance with Emerging
      Issues Task Force (EITF) Issue No. 01-14, “Income Statement Characterization of
      Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred.”




5
 
 **VirtualScopics,
          Inc. and Subsidiary**
 **Notes
          to Condensed Consolidated Financial Statements**
 ***(unaudited)***


The
      Company also offers software development to its customers. Software development
      revenue includes software integration, customization and development fees.
      Software development revenue is billed on a fixed price basis.





Research
      and Development


Research
      and development expense relates to the development of new products and processes
      including significant improvements to existing products. These costs are
      expensed as incurred.





NOTE
      3 - Notes
      Payable





Notes
      payable to related parties as of September 30, 2006 amounted to
      $99,850.





During
      2002, the Company entered into note agreements with two of the Company’s
      founders, along with three additional employees, for total cash proceeds of
      $360,000. The notes are payable in quarterly installments of principal and
      interest. The notes bear interest at the rate of 5.75% per annum and are due
      on
      March 31, 2008.





Interest
      expense amounted to $5,940 and $10,661 for the nine months ended September
      30,
      2006 and 2005, respectively.





NOTE
      4 - Employee
      Stock Options





On
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based
      Payment,” using the modified prospective method. Consequently, for the three and
      nine months ended September 30, 2006, the Company’s results of operations
      reflected compensation expense for new stock options granted under its stock
      incentive plans during the three and nine months ended September 30, 2006 and
      compensation expense related to the unamortized portion of stock options granted
      prior to January 1, 2006. The amount included in the general and administrative
      expenses in the condensed consolidated statements of operation related to
      stock-based compensation was $502,061 and $1,491,678 for the three and nine
      months ended September 30, 2006, respectively.





Stock
      options issued under the Company’s long-term incentive plans are granted with an
      exercise price equal to the market price of the Company’s stock at the date of
      grant and expire ten years from the date of grant. These options generally
      vest
      over a three- or four-year period.





Prior
      to
      January 1, 2006, the Company accounted for its stock-based employee compensation
      arrangements in accordance with the provisions and related interpretations
      of
      Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
      Employees.” Had compensation cost for stock-based compensation been determined
      consistent with SFAS No. 123R, the net loss and net loss per share for the
      three
      and nine months ended September 30, 2005 would have been adjusted to the
      following pro forma amounts:


6


**VirtualScopics,
      Inc. and Subsidiary**


**Notes
      to Condensed Consolidated Financial Statements**


***(unaudited)***




Three
                Months
              Ended
                September 30, 2005
            
            Nine
                Months
              Ended
                September 30,
              2005Net
                loss, as reported
            
            $
            (251,307
            )
            $
            (1,315,986
            )Deduct:
                Total stock-based employee compensation
              expense
                determined under the fair value method
            
            
            (368,533
            )
            
            (818,173
            )Net
                loss, pro forma
            
            $
            (619,840
            )
            $
            (2,134,159
            )Basic
                and diluted net loss per common share:As
                reported
            
            $
            (0.01
            )
            $
            (0.06
            )Pro
                forma
            
            $
            (0.03
            )
            $
            (0.10
            )





The
      fair
      value of each option granted is estimated on the date of grant using the
      Black-Scholes option-pricing method. The Company uses historical data to
      estimate the expected price volatility, the expected option life and the
      expected forfeiture rate. The risk-free rate is based on the U.S. Treasury
      yield
      curve in effect at the time of grant for the estimated life of the option.
      The
      Company has not made any dividend payments nor does it have plans to pay
      dividends in the foreseeable future. The following assumptions were used to
      estimate the fair value of options granted for the three and nine months ended
      September 30, 2006 and 2005 using the Black-Scholes option-pricing
      model:





September
                30,2006
            
            2005Risk
                free interest rate
            
            
            4.88
            %
            
            4.15
            %Expected
                term (years)
            
            
            8.9
            
            
            8.6Expected
                volatility
            
            
            84.2
            %
            
            80.6
            %Expected
                dividend yield
            
            
            -
            
            
            -





A
      summary
      of the option activity for the nine months ended September 30, 2006 is as
      follows:





Number
              of
                Shares
            
            Weighted
                Average
              Exercise
                Price
            
            Weighted-Average
                Remaining Contractual Term
            
            Aggregate
                Intrinsic ValueOptions
                outstanding at January 1, 2006
            
            
            2,892,166
            
            $
            1.89Granted
            
            
            600,250
            
            $
            4.01Options
                outstanding at September 30, 2006
            
            
            3,492,416
            
            $
            2.25
            
            
            7.88
            
            $
            2,221,520Options
                exercisable at September 30, 2006
            
            
            1,674,532
            
            $
            1.52
            
            
            6.73
            
            $
            2,291,642





The
      weighted-average grant-date fair value of options granted during the nine months
      ended September 30, 2006 and 2005 was $2,407,003 and $2,233,158, respectively.
      There have been no options exercised as of September 30, 2006.





7


**VirtualScopics,
      Inc. and Subsidiary**


**Notes
      to Condensed Consolidated Financial Statements**


***(unaudited)***


A
      summary
      of the status of the nonvested shares as of September 30, 2006 and changes
      during the nine month period ended September 30, 2006, is presented
      below:





Nonvested
                Shares
            
            Shares
            
            Weighted-Average
                Grant-Date Fair ValueNonvested
                at January 1, 2006
            
            
            1,699,757
            
            
            2.35Granted
            
            
            600,250
            
            
            4.01Vested
            
            
            (482,123
            )
            
            1.52Nonvested
                at September 30, 2006
            
            
            1,817,884
            
            
            3.12





As
      of
      September 30, 2006, there was $4,159,913 of total unrecognized compensation
      cost
      related to nonvested share-based compensation arrangements. This cost is
      expected to be recognized over a weighted-average period of 8.9 years. The
      total
      fair value of shares vested during the nine month period ended September 30,
      2006 amounted to $732,827.





NOTE
      5 - Stockholders’
      Equity





During
      the nine months ended September 30, 2006, 2,374 shares of the Company’s Series A
      convertible preferred stock have been converted into 949,600 shares of the
      Company’s common stock. Additionally, there was a cashless exercise of 50,000 of
      the Company’s warrants in August 2006 resulting in the issuance of 12,151 shares
      of common stock. Subsequent to September 30, 2006, 230 shares of the Company’s
      Series A convertible preferred stock were converted into 92,000 shares of the
      Company’s common stock.





NOTE
      6 - Net
      Loss Per Share





Basic
      net
      loss per share is computed by dividing the net loss applicable to common shares
      by the weighted average number of common shares outstanding during the period.
      The weighted average number of shares has been given retroactive effect to
      the
      recapitalization. Diluted net loss attributable to common shares adjusts basic
      net loss per share for the effects of convertible securities, warrants, stock
      options, and other potentially dilutive financial instruments, only in the
      periods in which such effect is dilutive. The shares issuable upon the
      conversion of preferred stock and the exercise of stock options and warrants
      are
      excluded from the calculation of net loss per share as their effect would be
      antidilutive.





Securities
      that could potentially dilute earnings per share in the future that were not
      included in the computation of diluted loss per share consist of the
      following:





September
                30,2006
            
            2005Series
                A convertible preferred stock
            
            
            1,850,400
            
            
            -Warrants
                to purchase common stock
            
            
            2,162,490
            
            
            532,490Options
                to purchase common stock
            
            
            3,633,912
            
            
            2,261,185Total
            
            
            7,646,802
            
            
            2,793,675






8


**VirtualScopics,
        Inc. and Subsidiary**
 **Notes
        to Condensed Consolidated Financial Statements**
 ***(unaudited)***
  NOTE
      7 - Severance
      Payment Demand





In
      the
      summer of 2005, the former President and Chief Executive Officer of VS, Dr.
      Stuart Shapiro, made a demand for severance payments under an employment
      agreement with VS alleged by him to be due in connection with his termination
      in
      the approximate amount of $230,000 and certain options.  On May 3, 2006,
      Dr. Shapiro filed a demand for arbitration with the American Arbitration
      Association seeking $325,000, plus the value of his option to purchase
      approximately 174,570 shares of common stock at $2.25 per unit. 
VirtualScopics filed a response on May 24, 2006, denying the allegations and
      asserting several defenses. The hearing is scheduled for February 5 through
      8 of
      2007. VS believes the demand is without merit and intends to vigorously defend
      against the demand.  As of September 30, 2006, the Company did not accrue
      any liability related to the demand.




9


**ITEM
      2: Management's Discussion and Analysis of Financial Condition and Result of
      Operations**





**Overview**





We
      are a
      provider of image-based biomarker solutions to the pharmaceutical, biotechnology
      and medical device industries. We focus on applying our imaging technology
      in
      two areas:





·
            improving
                the efficiency and effectiveness of the pharmaceutical and medical
                device
                research and development processes;
                and





·
            providing
                unique products to improve treatment planning and diagnosis of patients
                in
                a clinical setting.





We
      were
      originally formed in 1988 under the name ConsultAmerica, Inc. On November 4,
      2005, we acquired all of the outstanding membership units of VirtualScopics,
      LLC
      (“VS”), in exchange for 17,326,571 shares of our common stock, and changed our
      name to VirtualScopics, Inc. The newly issued shares constituted approximately
      70% of our outstanding shares of common stock and shares of common stock
      initially issuable upon the conversion of our outstanding series A convertible
      preferred stock. Prior to the exchange transaction, we provided strategic
      business planning to small companies. As a result of the exchange transaction,
      we have succeeded to the business of VS and plan to continue this business.





VS
      was
      formed in July 2000 after being spun out of the University of Rochester. In
      June
      2002, VS purchased the underlying technology and patents created by the founders
      of VS from the University of Rochester. VS owns all rights to the patents
      underlying its technology. Since its inception, VS’s principal activities
      consisted of:





·
            research
                and development;





·
            hiring
                technical, sales and other personnel;





·
            sales
                and operations;





·
            business
                development of customer and strategic relationships; and





·
            raising
                capital.





During
      the first five years, we have expanded our customer base. In 2001, we performed
      our services for one customer. Currently, we have 20 active customers, as of
      the
      date of this report. Revenue over this time has been derived primarily from
      image processing services in connection with pharmaceutical drug trials and
      contract research studies. For these services, we have been concentrating in
      the
      areas of oncology and osteoarthritis. We have also derived a portion of revenue
      from software development and consulting services, as well as research studies
      in the neurology and sexual dysfunction areas. We expect that the concentration
      of our revenue will continue in these services and in therapeutic areas
      throughout 2006. Revenues are recognized as the images that we process are
      quantified and delivered to our customers.





We
      have
      found that our customers value the ability to better understand the efficacy
      profile of their compounds. To date, nearly all of our customers have expressed
      interest in expanding their service agreements with us. We have also submitted
      proposals and bids for a number of other contracts. However, there can be no
      assurance that we will secure contracts from these efforts or that any such
      contracts or any of its existing contracts will not be cancelled on 30 days’
advance notice by a customer.





Additionally,
      once we enter into a new contract for participation in a drug trial, there
      are
      several factors that can affect whether we will realize the full benefits under
      the contract, and the time over which we will realize revenue. Customers may
      not
      continue our services due to the performance of their compound. Furthermore,
      the
      contracts may contemplate performance over multiple years. Therefore, revenue
      may not be realized in the fiscal year in which the contract is signed.
      Recognition of revenue under the contract may also be affected by timing,
      reduction in patient recruitment or image site identification and training.





10




***Results
      of Operations***





***Results
      of Operations for the Three Months Ended September 30, 2006 Compared to the
      Three Months Ended September 30, 2005***





*Revenues*





Our
      revenues for the three months ended September 30, 2006 were $1,276,000, an
      increase of $290,000 or 29% over the comparable quarter of 2005. This increase
      in sales was a direct reflection of the increase in our customer base. We
      performed services for a total of 48 projects in the third quarter of 2006,
      as
      compared to 22 in the third quarter of 2005. In 2006, 26% of the revenues for
      the third quarter were generated from Pfizer, as compared to 73% in the same
      period of 2005. We anticipate
      that our revenues from Pfizer will continue to grow; however, we expect the
      relative percentage of the Pfizer business to decline throughout 2006 as we
      continue to broaden our customer base .
      During
      the third quarter of 2006, we derived 59% of our revenues from musculoskeletal
      projects, 26% from oncology projects, and 15% from consulting and other smaller
      projects. The majority of the pharmaceutical trial projects for which we have
      performed work to date are in pre-clinical, Phase I or Phase II studies. We
      expect that a majority of our work on pharmaceutical trial projects will
      continue to be focused in these areas through 2007.





*Gross
      Profit*





We
      had a
      gross profit of $581,000 for the three months ended September 30, 2006 compared
      to $363,000 for the comparable period in 2005. Our gross profit margin also
      increased from 37% in the third quarter 2005 to 46% in the third quarter 2006.
      This improvement in gross margin is largely attributed to the increase in sales,
      operational process improvements, and the product mix of the services that
      were
      delivered on during the quarter.





*Research
      and Development*





Total
      research and development expenditures were $252,000 in the third quarter of
      2006
      compared to $171,000 for the comparable period in 2005, an increase of 47%.
      The
      increase in research and development costs for the period was due to the
      additional algorithm and software development staff hired in 2006. Costs
      included in research and development compose mostly of salaries for our
      technical, scientific and software development staff. All costs associated
      with
      the development of a new product or enhancement of an existing product or
      software platform are expensed as incurred.





*Sales
      and Marketing*





Sales
      and
      marketing costs for the three months ended September 30, 2006 were $151,000,
      an
      increase of $88,000 or 141% over the third quarter of 2005. The increase is
      attributable to the broadening of our efforts in sales and marketing, including
      new marketing brochures, greater exposure at targeted trade shows and the hiring
      of a new business development person at the end of 2005. All costs associated
      with our selling efforts, including trade shows, seminars, customer
      presentations and proposal related travel are included in sales and marketing
      expenses.





*General
      and Administrative*





General
      and administrative expenses for the three months ended September 30, 2006 costs
      were $559,000 (excluding the costs of Statement of Financial Accounting
      Standards (“SFAS”) No. 123R as discussed below), an increase of $274,000 or 96%,
      over the third quarter of 2005. The increase is mainly due to the additional
      costs of being a public company which was a result of the exchange transaction
      between ConsultAmerica, Inc. and VirtualScopics, LLC on November 4, 2005. These
      additional costs include legal fees, filing fees, as well as audit and
      tax-related services. The increase was also a result of the hiring of
      administrative functions, including IT, human resources and finance in order
      to
      support the Company’s growth. We expect that our general and administrative
      costs will be higher throughout 2006 as a result of being a publicly traded
      company.





11




*Stock
      Option Compensation Expense*





On
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      SFAS No. 123R, “Share-Based Payment,” using the modified prospective method.
      Consequently, for the three months ended September 30, 2006, the Company’s
      results of operations reflected compensation expense for new stock options
      granted and vested under its stock incentive plans during the three months
      ended
      September 30, 2006 and the unvested portion of previous stock option grants
      which vested during the three months ended September 30, 2006. The amount
      recognized in the financial statements related to stock-based compensation
      was
      $502,000 for the three months ended September 30, 2006. SFAS No. 123R does
      not
      require retroactive adjustments; therefore, there was no comparable amount
      in
      the September 30, 2005 statement of operations. Prior to January 1, 2006, the
      effects of stock options are disclosed in the notes to the unaudited condensed
      consolidated financial statements.





*Depreciation
      and Amortization*





Depreciation
      and amortization charges increased in the three months ended September 30,
      2006
      by $24,000 or 24%, to $121,000, when compared to the same period in 2005. This
      increase is attributed mostly to the rise in depreciation charges for the period
      resulting from the purchase of new hardware and software to support the
      Company’s delivery of services to its customers. We intend to continue to invest
      in our IT infrastructure in order to meet the demands of our
      customers.





*Interest
      Income (Expense)*





Interest
      income for the three months ended September 30, 2006 was $55,000 and composed
      of
      interest derived on the Company’s operating and savings accounts, compared to
      interest income of $4,000 in the same period in 2005. The increase in interest
      income was a reflection of the higher cash balances on hand during the fiscal
      year 2006 as well as higher average rates of return on our savings accounts
      in
      2006 compared to 2005. Interest expense for the quarters ended September 30,
      2006 and 2005 was $2,000 and $3,000, respectively, representing interest due
      to
      loans from certain stockholders of the Company.





*Net
      Loss*





Our
      net
      loss for the three months ended September 30, 2006 was $951,000 compared to
      a
      net loss of $251,000 for the same period in 2005. The increase in our net loss
      over the prior period was primarily related to the effects of implementing
      SFAS
      No. 123R in 2006 as well as greater general administrative costs associated
      with
      being a public company, as discussed above.





***Results
      of Operations for the Nine Months Ended September 30, 2006 Compared to the
      Nine
      Months Ended September 30, 2005***





*Revenues*





Our
      revenues for the nine months ended September 30, 2006 were $3,562,000, an
      increase of $886,000 or 33% over the first nine months of 2005. This increase
      in
      sales was a direct reflection of the increase in our customer base and number
      of
      contracts. We performed services for a total of 62 projects in the first nine
      months of 2006, as compared to 36 in the first nine months of 2005. In 2006,
      37%
      of the revenues for the first three quarters were generated from Pfizer, as
      compared to 77% in the same period of 2005. We anticipate
      that our revenues from Pfizer will continue to grow; however, we expect the
      relative percentage of the Pfizer business to decline in 2006 as we continue
      to
      broaden our customer base .
      During
      the first three quarters of 2006, we derived 52% of our revenues from
      musculoskeletal projects, 25% from oncology projects, and 23% from consulting
      and other smaller projects. The majority of the pharmaceutical trial projects
      for which we have performed work to date are in pre-clinical, Phase I or Phase
      II studies. We expect that a majority of our work on pharmaceutical trial
      projects will continue to be focused in these areas through 2007.





12




*Gross
      Profit*





We
      had a
      gross profit of $1,540,000 for the nine months ended September 30, 2006 compared
      to $948,000 for the comparable period in 2005. Our gross profit margin also
      increased from 35% in the first three quarters of 2005 to 43% in the first
      three
      quarters of 2006. This improvement in gross margin is largely attributed to
      the
      increase in sales, operational process improvements, and the product mix of
      the
      services that were delivered on during the period.





*Research
      and Development*





Total
      research and development expenditures were $795,000 in the first three quarters
      of 2006 compared to $659,000 for the comparable period in 2005, an increase
      of
      21%. The increase was attributable to the additional algorithm and software
      development staff hired in 2006. These costs were composed mostly of salaries
      for our technical, scientific and software development staff. All costs
      associated with the development of a new product or enhancement of an existing
      product or software platform are expensed as incurred.





*Sales
      and Marketing*





Sales
      and
      marketing costs for the nine months ended September 30, 2006 increased to
      $539,000, an increase of $207,000 or 62% over the first three quarters of 2005.
      The increase is attributable to the broadening of our efforts in sales and
      marketing, including new marketing brochures, greater exposure at targeted
      trade
      shows and the hiring of a new business development person at the end of 2005.
      All costs associated with our selling efforts, including trade shows, seminars,
      customer presentations and proposal related travel are included in sales and
      marketing.





*General
      and Administrative*





General
      and administrative expenses for the nine months ended September 30, 2006 were
      $1,676,000 (excluding the impact of SFAS No. 123R, as discussed below), an
      increase of $696,000 or 71%, over the first nine months of 2005. The increase
      is
      mainly due to the additional costs of being a public company which was a result
      of the exchange transaction between ConsultAmerica and VirtualScopics, LLC
      on
      November 4, 2005, as well as the fees associated with our NASDAQ listing. These
      additional costs included legal fees, filing fees, as well as audit and
      tax-related services. The increase was also a result of the hiring of
      administrative functions, including IT, human resources and finance in order
      to
      support the Company’s growth. We expect that our general and administrative
      costs will increase throughout 2006 as a result of being a publicly traded
      company.





*Stock
      Option Compensation Expense*





On
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      SFAS No. 123R, “Share-Based Payment,” using the modified prospective method.
      Consequently, for the nine months ended September 30, 2006, the Company’s
      results of operations reflected compensation expense for new stock options
      granted and vested under its stock incentive plans during the first three
      quarters of fiscal year 2006 and the unvested portion of previous stock option
      grants which vested during the first nine months of fiscal year 2006. The amount
      recognized in the financial statements related to stock-based compensation
      was
      $1,492,000 for the nine months ended September 30, 2006. SFAS No. 123R does
      not
      require retroactive adjustments; therefore, there was no comparable amount
      in
      the September 30, 2005 statement of operations. Prior to January 1, 2006, the
      effects of stock options are disclosed in the notes to the unaudited condensed
      consolidated financial statements.





13





*Depreciation
      and Amortization*





Depreciation
      and amortization charges increased in the nine months ended September 30, 2006
      by $50,000 or 17%, to $345,000, when compared to the same period in 2005. This
      increase is attributed mostly to the rise in depreciation charges for the period
      resulting from the purchase of new hardware and software to support the
      Company’s delivery of services to its customers. We intend to continue to invest
      in our IT infrastructure in order to meet the demands of our
      customers.





*Interest
      Income (Expense)*





Interest
      income for the nine months ended September 30, 2006 was $136,000 and composed
      of
      interest derived on the Company’s operating and savings accounts, compared to
      interest income of $18,000 in the same period in 2005. The increase in interest
      income was a reflection of the higher cash balances on hand during the fiscal
      year 2006 as well as higher average rates of return on our savings accounts
      in
      2006 compared to 2005. Interest expense for the nine month period ended
      September 30, 2006 and 2005 were $12,000 and $16,000, respectively, representing
      interest due to loans from certain stockholders of the Company.





*Net
      Loss*





Our
      net
      loss for the nine months ended September 30, 2006 was $3,183,000 compared to
      a
      net loss of $1,316,000 for the same period in 2005. The increase in our net
      loss
      over the prior period was primarily related to the effects of implementing
      SFAS
      No. 123R in 2006, as well as higher general and administrative costs associated
      with being a public company.




**Liquidity
      and Capital Resources**





Our
      working capital as of September 30, 2006 was $3,981,000 compared to our working
      capital of $5,899,000 as of December 31, 2005. The decrease was a result of
      increased planned expenditures in research and development, sales and marketing
      as well as hiring within our core lab to meet the increased demand from our
      customers.





On
      November 4, 2005 and in two subsequent closings on November 23, 2005 and
      December 2, 2005, we closed on our private placement for the sale of 7,000
      shares of our newly issued series A convertible preferred stock. We received
      net
      cash proceeds of approximately $5.7 million from the private placement. The
      net
      proceeds from our 2005 private placement have been invested in money market
      funds that invest primarily in short-term, highly-rated investments, including
      U.S. Government securities, commercial paper and certificates of deposit
      guaranteed by banks. Under our current policies, we do not use interest rate
      derivative instruments to manage our exposure to interest rate changes. Because
      of the short-term maturities of our investments, we do not believe that a
      decrease in market rates would have a significant negative impact on the value
      of our investment portfolio. As of October 31, 2006, we had approximately $4.0
      million in cash and cash equivalents.





We
      have
      begun to utilize the net proceeds from the private placement to support the
      expansion of our business to serve larger scale clinical trials, further
      research and development of existing and new targeted therapeutic areas.
      Additionally, we have begun the added investment in our sales and marketing
      efforts through hiring of sales support and broadening our marketing materials
      and participation in medical conferences.





Net
      cash
      used in operating activities totaled $2,092,000 in the first nine months of
      2006
      compared to $2,503,000 for the comparable period in 2005. This decrease in
      usage
      was primarily the result of the timing of collection of receivables as well
      as
      the earning of advance payments from customers.





We
      invested a total of $481,000 in the purchase of equipment and legal costs
      associated with new patent applications in the first three quarters of 2006,
      compared to $144,000 in the same period in 2005. We anticipate further spending
      within our IT infrastructure to support the Company’s operations.





14




Net
      cash
      used in our financing activities for the nine month period ended September
      30,
      2006 was $57,000, compared to $10,000 for the nine month period ended September
      30, 2005. The amounts included in cash used in financing activities represent
      amounts paid on loans from certain stockholders of the Company.





We
      currently expect that existing cash and cash equivalents will be sufficient
      to
      fund operations for at least the next 12 months. If in the next 12 months our
      plans or assumptions change or prove to be inaccurate, we may be required to
      seek additional capital through public or private debt or equity financings.
      If
      we need to raise additional funds, we may not be able to do so on terms
      favorable to us, or at all. If we cannot raise sufficient funds on acceptable
      terms, we may have to curtail our level of expenditures and our rate of
      expansion.





**Off
      Balance Sheet Arrangements**





We
      have
      no off-balance sheet arrangements, other than the consulting agreements and
      operating leases that have or are reasonably likely to have a current or future
      effect that is material to investors on our financial condition, revenues or
      expenses, results of operations, liquidity, capital resources or capital
      expenditures.





**Forward
      Looking Statements**





Certain
      statements made in this discussion are “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995. These
      forward-looking statements include statements that address activities, events
      or
      developments that we expect, believe or anticipate may occur in the future,
      including:





·
            adverse
                economic conditions;





·
            inability
                to raise sufficient additional capital, if necessary, to operate
                our
                business;





·
            unexpected
                costs, lower than expected sales and revenues, and operating defects;





·
            adverse
                results of any legal proceedings;





·
            the
                volatility of our operating results and financial condition;





·
            inability
                to attract or retain qualified senior management personnel, including
                sales and marketing, and scientific personnel; and





·
            other
                specific risks that may be referred to in this report.





All
      statements, other than statements of historical facts, included in this report
      regarding our strategy, future operations, financial position, estimated revenue
      or losses, projected costs, prospects and plans and objectives of management
      are
      forward-looking statements. When used in this report, the words “may,”
“believe,” “anticipate,” “intend,” “estimate,” “expect,” “project,” “plan,”
“could,” “would” and similar expressions are intended to identify
      forward-looking statements, although not all forward-looking statements contain
      such identifying words. All forward-looking statements speak only as of the
      date
      of this report. We do not undertake any obligation to update any forward-looking
      statements or other information contained in this report. Existing stockholders
      and potential investors should not place undue reliance on these forward-looking
      statements. Although we believe that our plans, intentions and expectations
      reflected in or suggested by the forward-looking statements in this report
      are
      reasonable, we cannot assure our stockholders or potential investors that these
      plans, intentions or expectations will be achieved. We disclose important
      factors that could cause our actual results to differ materially from our
      expectations under the heading entitled “Risk Factors” in our Annual Report on
      Form 10-KSB for the fiscal year ended December 31, 2005 filed with the
      Securities and Exchange Commission (“SEC”) and elsewhere in this report. These
      risk factors qualify all forward-looking statements attributable to us or
      persons acting on our behalf.




15





**ITEM
      3. Controls and Procedures**




We
      maintain a set of disclosure controls and procedures, as defined in Section
      13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange
      Act”), that are designed to ensure that information required to be disclosed by
      us in the reports filed by us under the Exchange Act is recorded, processed,
      summarized and reported within the time periods specified in the SEC’s rules and
      forms. We carried out an evaluation, under the supervision and with the
      participation of our Chief Executive Officer and our Chief Financial Officer,
      of
      the effectiveness of the design and operation of our disclosure controls and
      procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that
      evaluation, our Chief Executive Officer and our Chief Financial Officer
      concluded that our disclosure controls and procedures are effective as of the
      end of the period covered by this report.




There
      have been no changes in our internal control over financial reporting identified
      in connection with the evaluation discussed above that occurred during our
      last
      fiscal quarter that have materially affected, or are reasonably likely to
      materially affect, our internal control over financial reporting





16





**PART
      II. OTHER INFORMATION**





**Item
      1. Legal Proceedings**





For
      information on legal proceedings, see Note 6 to Condensed Consolidated Financial
      Statements, which is incorporated by reference in response to this Item 1.





**Item
      2. Unregistered Sales of Equity Securities and Use of
      Proceeds**





During
      the three months ended September 30, 2006, the Company issued 949,600 shares
      of
      the Company’s common stock upon conversion of 2,374 shares of the Company’s
      Series A convertible preferred stock by existing holders of those shares
      pursuant to the terms thereof. The Company did not receive any cash or other
      consideration in connection with the conversions. Additionally, no commission
      or
      other remuneration was paid by the Company in connection with such conversions.
      The issuance of the common stock upon conversions of the Series A convertible
      preferred stock was made in reliance on the exemption provided in Section
      3(a)(9) of the Securities Act of 1933, as amended (the “Securities Act”).





In
      August
      2006, there was a cashless exercise of a warrant on 50,000 shares that resulted
      in the issuance of 12,151 shares of common stock. The issuance of the Company's
      common stock under the warrant was effected as a private placement pursuant
      to
      an exemption from registration under Section 4(2) of the Securities Act for
      transactions not involving a public offering. No advertising or general
      solicitation was employed in offering the securities which were acquired by
      an
      accredited investor for investment purposes only.





**Item
      3. Defaults upon Senior Securities**





Not
      applicable.





**Item
      4. Submission of Matters to a Vote of Security Holders**




None.




**Item
      5. Other Information**





In
      September 2006, the Company was issued U.S. Patent No. 7,103,224, “System and
      Method for Identifying Optimized Blood Signal in Medical Images to Eliminate
      Flow Artifacts” by the U.S. Patent and Trademark Office. **** The
      patent directly applies to an area of current drug development research in
      anti-angiogenic and anti-vascular agents. In oncology these drugs are designed
      to cut off a tumor's blood supply, starving it of nutrients and eventually
      killing it. Tests to show a drug is working can be done non-invasively using
      dynamic contrast enhanced MRI (DCE-MRI). The patent covers an innovation in
      DCE-MRI analysis involving the measurement of tracer concentration in arterial
      plasma.





**Item
      6. Exhibits**





Exhibit
      31.1 Certification of Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act
      of 2002.





Exhibit
      31.2 Certification of Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act
      of 2002.





Exhibit
      32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act 0f 2002.





Exhibit
      32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act 0f 2002.





17





**SIGNATURES**





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


VIRTUALSCOPICS,
              INC.Dated:
              November 14, 2006
            
            /s/
              Jeffrey MarkinJeffrey
              MarkinPresident
              and
              Chief Executive Officer


/s/
              Molly HendersonMolly
                Henderson
              Chief
                Financial Officer and Vice President of Finance





18




**Exhibit
      Index**





31.1
            Certification
                of Chief Executive Officer as required by Rule 13a-14 Or 15d-14 of
                the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                Of The
                Sarbanes-Oxley Act of 2002


31.2
            Certification
                of Chief Financial Officer as required by Rule 13a-14 Or 15d-14 of
                the
                Securities Exchange Act of 1934, as adopted pursuant to Section 302
                Of The
                Sarbanes-Oxley Act of 2002


32.1
            Certification
                pursuant to 18 U.S.C. Section 1350 by the Chief Executive Officer,
                as
                adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002


32.2
            Certification
                pursuant to 18 U.S.C. Section 1350 by the Chief Financial Officer,
                as
                adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002





19