UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


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


For
      the quarterly period ended
                          March 31, 2009





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




For the
transition period from
____________________________________to____________________________________




Commission
File Number:  000-52018_____________________________________________________________________





VirtualScopics,
Inc.


(Exact
name of registrant as specified in its charter)





Delaware
              04-3007151(State
      or other jurisdiction of incorporation or organization)
              (I.R.S.
      Employer Identification No.)500 Linden Oaks, Rochester, New
      York
              14625(Address
      of principal executive offices)
              (Zip
      Code)





(585)249-6231


(Registrant’s
telephone number, including area code)








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





Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.





xYes ̈ No





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   ̈Yes    ̈No





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer  ̈
                  Accelerated
      filer  ̈Non-accelerated filer  ̈  (Do not check if a smaller reporting company)
                  Smaller reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes  ̈ No x


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





As of
April 30, 2009, there were 23,723,342 shares of the registrant’s common stock,
$0.001 par value, outstanding.








TABLE OF
CONTENTS





Page
      NumbersPART
      I
                  FINANCIAL
      INFORMATIONITEM
      1: Financial StatementsCondensed
      Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December
      31, 2008
                  
                  1Unaudited
      Condensed Consolidated Statements of Operations for the three monthsended
      March 31, 2009 and 2008
                  
                  2Unaudited
      Condensed Consolidated Statements of Cash Flows for the three monthsended
      March 31, 2009 and 2008
                  
                  3Notes
      to Unaudited Condensed Consolidated Financial Statements
                  
                  4-11ITEM
      2: Management's Discussion and Analysis of Financial Condition and
      Results of
      Operations
                  
                  12-17ITEM
      4T: Controls and Procedures
                  
                  18PART
      II
                  OTHER
      INFORMATIONITEM
      1: Legal Proceedings
                  
                  18ITEM
      2: Unregistered Sales of Equity Securities and Use of
    Proceeds
                  
                  18-19ITEM
      3: Defaults Upon Senior Securities
                  
                  19ITEM
      4: Submission of Matters to a Vote of Security Holders
                  
                  19ITEM
      5: Other Information
                  
                  19ITEM
      6: Exhibits
                  
                  19





PART
1:  FINANCIAL INFORMATION





ITEM
1.  Financial Statements





VirtualScopics,
Inc. and Subsidiary


Condensed
Consolidated Balance Sheets





March 31,
                    
                    
                    December 31,2009
                    
                    
                    2008(Unaudited)AssetsCurrent
      assetsCash
                    
                    $
                    3,137,405
                    
                    
                    $
                    3,143,904Accounts
      receivable
                    
                    
                    1,189,828
                    
                    
                    
                    1,021,110Prepaid
      expenses and other current assets
                    
                    
                    306,792
                    
                    
                    
                    263,297Total
      current assets
                    
                    
                    4,634,025
                    
                    
                    
                    4,428,311Patents,
      net
                    
                    
                    1,898,431
                    
                    
                    
                    1,920,446Property
      and equipment, net
                    
                    
                    368,079
                    
                    
                    
                    355,479Other
      assets
                    
                    
                    125,905
                    
                    
                    
                    156,788Total
      assets
                    
                    $
                    7,026,440
                    
                    
                    $
                    6,861,024Liabilities
      and Stockholders' EquityCurrent
      liabilitiesAccounts
      payable and accrued expenses
                    
                    $
                    691,412
                    
                    
                    $
                    659,009Accrued
      payroll
                    
                    
                    310,104
                    
                    
                    
                    554,425Unearned
      revenue
                    
                    
                    740,557
                    
                    
                    
                    291,594Derivative
      liability
                    
                    
                    820,317
                    
                    
                    
                    -Total
      current liabilities
                    
                    
                    2,562,390
                    
                    
                    
                    1,505,028Commitments
      and Contingencies
                    
                    
                    -
                    
                    
                    
                    -Stockholders'
      EquityConvertible
      preferred stock, $0.001 par value; 15,000,000 shares authorized; 8,400
      shares designated Series A; issued and outstanding, 3,816 shares at March
      31, 2009 and 3,976 shares at December 31, 2008; liquidation preference
      $1,000 per share
                    
                    
                    4
                    
                    
                    
                    46,000
      shares designated Series B; issued and outstanding, 4,226 shares at March
      31, 2009 and at December 31, 2008; liquidation preference $1,000 per
      share
                    
                    
                    4
                    
                    
                    
                    4Common
      stock, $0.001 par value; 85,000,000 shares authorized; issued and
      outstanding, 23,723,342 shares at March 31, 2009 and 23,502,352 shares at
      December 31, 2008
                    
                    
                    23,724
                    
                    
                    
                    23,503Additional
      paid-in capital
                    
                    
                    13,694,405
                    
                    
                    
                    16,546,550Accumulated
      deficit
                    
                    
                    (9,254,087
                    )
                    
                    
                    (11,214,065
                    )Total
      stockholders' equity
                    
                    
                    4,464,050
                    
                    
                    
                    5,355,996Total
      liabilities and stockholders' equity
                    
                    $
                    7,026,440
                    
                    
                    $
                    6,861,024





See notes
to condensed consolidated financial statements.


1


VirtualScopics,
Inc. and Subsidiary


Condensed
Consolidated Statements of Operations


(unaudited)





For the Three Months Ended March 31,2009
                
                
                2008Revenues
                
                $
                2,134,370
                
                
                $
                1,634,103Cost
      of services
                
                
                1,014,584
                
                
                
                1,029,984Gross
      profit
                
                
                1,119,786
                
                
                
                604,119Operating
      expensesResearch
      and development
                
                
                235,555
                
                
                
                251,829Sales
      and marketing
                
                
                282,454
                
                
                
                288,874General
      and administrative
                
                
                844,679
                
                
                
                897,504Depreciation
      and amortization
                
                
                117,510
                
                
                
                117,567Total
      operating expenses
                
                
                1,480,198
                
                
                
                1,555,774Operating
      loss
                
                
                (360,412
                )
                
                
                (951,655
                )Other
      income (expense)Interest
      income
                
                
                3,193
                
                
                
                28,725Other
      expense
                
                
                (1,485
                )
                
                
                (1,583
                )Loss
      on derivative financial instrument
                
                
                (397,409
                )
                
                
                -Total
      other income
                
                
                (395,701
                )
                
                
                27,142Net
      loss
                
                
                (756,113
                )
                
                
                (924,513
                )Series
      B preferred stock cash dividend
                
                
                84,520
                
                
                
                85,240Net
      loss attributable to common stockholders
                
                $
                (840,633
                )
                
                $
                (1,009,753
                )Basic
      and diluted net loss per common share
                
                $
                (0.04
                )
                
                $
                (0.04
                )Weighted
      average number of common shares outstanding basic and
    diluted
                
                
                23,533,785
                
                
                
                23,246,067





See notes
to condensed consolidated financial statements.


2





VirtualScopics,
Inc. and Subsidiary


Condensed
Consolidated Statements of Cash Flows


(unaudited)





FortheThreeMonthsEndedMarch31,2009
                
                
                2008Cash
      flows from operating activitiesNet
      loss
                
                $
                (756,113
                )
                
                $
                (924,513
                )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                
                
                117,510
                
                
                
                117,567Stock-based
      compensation expense
                
                
                285,332
                
                
                
                403,063Issuance
      of equity instruments for rent
                
                
                105,570
                
                
                
                -Fair
      value adjustment of warrants
                
                
                397,409
                
                
                
                -Changes
      in operating assets and liabilitiesAccounts
      receivable
                
                
                (168,718
                )
                
                
                (28,826
                )Prepaid
      expenses and other assets
                
                
                (43,495
                )
                
                
                (63,041
                )Accounts
      payable and accrued expenses
                
                
                13,096
                
                
                
                112,514Accrued
      payroll
                
                
                (244,321
                )
                
                
                63,185Unearned
      revenue
                
                
                448,963
                
                
                
                (20,767
                )Total
      adjustments
                
                
                911,346
                
                
                
                583,695Net
      cash provided by (used in) operating activities
                
                
                155,233
                
                
                
                (340,818
                )Cash
      flows from investing activitiesPurchase
      of equipment
                
                
                (66,334
                )
                
                
                (15,934
                )Acquisition
      of patents
                
                
                (10,878
                )
                
                
                (24,395
                )Net
      cash used in investing activities
                
                
                (77,212
                )
                
                
                (40,329
                )Cash
      flows from financing activitiesRestricted
      cash
                
                
                -
                
                
                
                133,796Cash
      dividends on series B preferred stock
                
                
                (84,520
                )
                
                
                (85,240
                )Net
      cash (used in) provided by financing activities
                
                
                (84,520
                )
                
                
                48,556Net
      decrease in cash and cash equivalents
                
                
                (6,499
                )
                
                
                (332,591
                )Cash
      and cash equivalentsBeginning
      of period
                
                
                3,143,904
                
                
                
                3,955,835End
      of period
                
                $
                3,137,405
                
                
                $
                3,623,244Supplemental
      disclosure of cash flow informationNon-cash
      financing activity:Issuance
      of common stock for partial payment of rent in equity
                
                $
                105,570
                
                
                $
                -





See notes
to condensed consolidated financial statements.


3


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 1 -
Organization and Basis
of Presentation





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 measuring specific anatomical structures and metabolic
activity using medical images.  The Company’s developed proprietary
software provides measurement 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-K as of and for the
year ended December 31, 2008.  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 three months ended
March 31, 2009 are not necessarily indicative of the results to be expected for
the full year ending December 31, 2009.





In
February 2008, the Company received a written notice from the Nasdaq Stock
Market indicating that its common stock was not in compliance with minimum bid
price required for continued listing on the Nasdaq Capital Market.  In
accordance with section 4310(c)(8) of the Nasdaq Marketplace Rules, the Company
has until November 9, 2009 to regain compliance by maintaining a bid price of
common stock at a close of $1.00 or higher for a minimum of 10 consecutive
business days, or such longer period as Nasdaq may determine to show the ability
to maintain long-term compliance. The Company’s intention is to maintain its
listing on Nasdaq and is currently assessing its options to regain compliance.
As of May 14, 2009, the closing price of the Company’s common stock, as listed
on Nasdaq, was $1.15.





NOTE 2 -
Summary of Certain
Significant Accounting Policies





Principles of
Consolidation


All
significant intercompany balances and transactions have been eliminated in
consolidation.





Revenue
Recognition


The
Company applies the revenue recognition principles set forth under the
Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue
Recognition,” with respect to its revenues from image analysis, consulting and
project/data management services, and recognizes revenue when it is realized or
realizable and earned.  The Company considers revenue realized or
realizable and earned when an agreement exists, services and products are
provided to the customer, prices are fixed or determinable, and collectability
is reasonably assured.  Revenues are reduced for estimated discounts
and other allowances, if any.





The
Company provides advanced medical image analysis on a per analysis basis, and
recognizes revenue when the image analysis is completed and delivered to the
customer.  Revenue related to project, data and site management
services is recognized as the services are rendered and in accordance with the
terms of the contract.  Consulting revenue is recognized once the
services are rendered and typically charged as an hourly rate.





Occasionally,
the Company provides software development services to its customers, which may
require significant development, modification, and
customization.  Software development revenue is billed on a fixed
price basis and recognized upon delivery of the software and acceptance by the
customer on a completed contract basis in accordance with the American Institute
of Certified Public Accountants Statement of Position 81-1, “Accounting for
Performance of Construction-Type and Certain Production-Type
Contracts.”  The Company does not sell software licenses, upgrades or
enhancements, or post-contract customer services.


4


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 2 -
Summary of Certain
Significant Accounting Policies, continued





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





Research and
Development


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





Derivative Financial
Instruments


The
Company does not use derivative instruments to hedge exposures to cash flow,
market or foreign currency risks.  The Company evaluates all of its
financial instruments to determine if such instruments are derivatives or
contain features that qualify as embedded derivatives.  For derivative
financial instruments that are accounted for as liabilities, the derivative
instrument is initially recorded at its fair value and is then re-valued at each
reporting date, with changes in the fair value reported in the condensed
consolidated statements of operations.  For stock-based derivative
financial instruments, the Company uses the Black-Scholes option valuation model
to value the derivative instruments at inception and on subsequent valuation
dates.  The classification of derivative instruments, including
whether such instruments should be recorded as liabilities or as equity, is
evaluated at the end of each reporting period.  Derivative instrument
liabilities are classified in the balance sheet as current or non-current based
on whether or not net-cash settlement of the derivative instrument could be
required within 12 months of the balance sheet date.





Recently Issued and Adopted
Accounting Pronouncements


In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standard No. 157, “Fair Value Measurements,”
(“SFAS 157”) which is effective for fiscal years beginning after November 15,
2007 and for interim periods within those years. This statement defines fair
value, establishes a framework for measuring fair value and expands the related
disclosure requirements. This statement applies under other accounting
pronouncements that require or permit fair value measurements.  The
statement indicates, among other matters, that a fair value measurement assumes
that the transaction to sell an asset or transfer a liability occurs in the
principal market for the asset or liability or, in the absence of a principal
market, the most advantageous market for the asset or liability.  FAS
157 defines fair value based upon an exit price model.  Relative to
FAS 157, the FASB issued FASB Staff Positions (“FSP”) 157-1, FSP 157-2, and
proposed FSP 157-c.  FSP 157-1 amends FAS 157 to exclude SFAS No. 13,
“Accounting for Leases,” (“FAS 13”), and its related interpretive accounting
pronouncements that address leasing transactions, while FSP 157-2 delays the
effective date of FAS 157 for all nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis.  FSP 157-c clarifies the
principles in FAS 157 on the fair value measurement of
liabilities.  The Company adopted FAS 157 as of January 1, 2008. Refer
to Note 5 for additional discussion on fair value measurements.





In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," (“FAS
141(R)”) which replaces SFAS No. 141, “Business Combinations.”  FAS
141(R) establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration and certain acquired contingencies. FAS 141 ( R ) also
requires that acquisition-related transaction expenses and restructuring costs
be expensed as incurred rather than capitalized as a component of the business
combination.   FAS 141(R)   became   effective   on  
January 1, 2009.


5


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 2 -
Summary of Certain
Significant Accounting Policies, continued




In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51," (“FAS 160”). FAS
160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). FAS 160
also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Under FAS 160,
noncontrolling interests are reported as a separate component of consolidated
stockholders’ equity. In addition, net income allocable to noncontrolling
interests and net income attributable to stockholders of the Company
are reported separately in the consolidated statements of  operations. FAS 160
became effective beginning January 1, 2009. FAS 160 would have an impact on
the presentation and disclosure of the non-controlling interests of any non
wholly-owned businesses acquired by the Company in the future.




In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities,” (“FAS 161”).  The new standard amends SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“FAS
133”) and enhances disclosures about how and why a company uses derivatives; how
derivative instruments are accounted for under FAS 133 (and the interpretations
of that standard); and how derivatives affect a company’s financial position,
financial performance and cash flows.  FAS 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008.  The Company has adopted this standard as of
January 1, 2009.  Additional disclosures have been included in the
Company’s condensed consolidated financial statements in accordance with FAS
161.





In
April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3,
“Determination of the Useful Life of Intangible Assets,” (“FSP 142-3”). FSP
142-3 amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized
intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,”
(“FAS 142”) .  The objective of FSP 142-3 is to improve the
consistency between the useful life of a recognized intangible asset under FAS
142 and the period of expected cash flows used to measure the fair value of the
asset under FAS 141(R) and other United States GAAP principles .  FSP
142-3 is effective prospectively for intangible assets acquired or received
after January 1, 2009.  The Company does not expect FSP 142-3 to have
a material impact on its accounting for future acquisitions or renewals of
intangible assets.





Effective
January 1, 2009, the Company adopted the provisions of Emerging Issues Task
Force (‘‘EITF’’) EITF 07-05, Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entity’s Own Stock, (‘‘EITF
07-05’’). EITF 07-05 applies to any freestanding financial instruments or
embedded features that have the characteristics of a derivative, as defined by
SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, and to any freestanding
financial instruments that are potentially settled in an entity’s own common
stock. The adoption of EITF 07-05 had a material impact on our consolidated
financial position, results of operations and cash flows as the Company has
financial instruments with characteristics which meet the definition of a
derivative instrument in accordance with the provisions of this
pronouncement.  Refer to Note 5 for additional disclosure regarding the
adoption of EITF 07-05.





In April
2009, the FASB issued FSP SFAS 157-4, “Determining Whether a Market Is Not
Active and a Transaction Is Not Distressed,” (“FSP FAS 157-4”) which provides
guidelines for making fair value measurements more consistent with the
principles presented in SFAS 157.  FSP FAS 157-4 provides additional
authoritative guidance in determining whether a market is active or inactive and
whether a transaction is distressed, is applicable to all assets and liabilities
(i.e. financial and nonfinancial) and will require enhanced
disclosures.  This standard is effective for periods ending after June
15, 2009.  The Company is evaluating the impact that this standard
will have on the Company’s financial position and results of
operations.


6


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 2 -
Summary of Certain
Significant Accounting Policies, continued





In April
2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about
Fair Value of Financial Instruments,” (“FSP FAS 107-1 and APB
28-1”).  FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures
about Fair Value of Financial Instruments,” to require disclosures about fair
value of financial instruments in interim as well as in annual financial
statements.  FSP FAS 107-1 and APB 28-1 amends APB Opinion No. 28,
“Interim Financial Reporting,” to require those disclosures in all interim
financial statements. This standard is effective for periods ending after June
15, 2009.  The Company is evaluating the impact that this standard
will have on the Company’s financial position and results of
operations.





NOTE 3 -
Stock-Based
Compensation





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 months ended March 31, 2009 and 2008, the Company’s condensed
consolidated statements of operations reflect stock-based compensation expense
for stock options granted under its long-term stock incentive plans amounting to
$285,332 and $403,063, respectively.





Stock
options issued under the Company’s long-term incentive plans are granted with an
exercise price equal to no less than the market price of the Company’s stock at
the date of grant and expire up to ten years from the date of
grant.  These options generally vest over a three- or four-year
period.





The fair
value of stock options granted was determined on the grant date using
assumptions for risk free interest rate, the expected term, expected volatility,
and expected dividend yield.  The risk free interest rate is based on
U.S. Treasury zero-coupon yield curve over the expected term of the
option.  The expected term assumption is primarily based on the
Company’s historical data related to exercise and post-vesting cancellation
information, which is expected to be similar to future results.  Since
the Company has limited historical volatility information, it bases its expected
volatility on the historical volatility of similar entities whose share prices
are publicly available.  In making its determination as to similarity,
the Company considered the industry, stage of life cycle, size, and financial
leverage of such other entities.  The Company’s model includes a zero
dividend yield assumption, as the Company has not historically paid nor does it
anticipate paying dividends on its common stock.  The Company’s model
does not include a discount for post-vesting restrictions, as the Company has
not issued awards with such restrictions.  The periodic expense is
then determined based on the valuation


of the
options, and at that time an estimated forfeiture rate is used to reduce the
expense recorded.  The Company’s estimate of pre-vesting forfeitures
is primarily based on the Company’s historical experience and is adjusted to
reflect actual forfeitures as the options vest.  The following
assumptions were used to estimate the fair value of options granted for the
three months ended March 31, 2009 and 2008 using the Black-Scholes
option-pricing model:





March 31,2009
                  
                  
                  2008Risk
      free interest rate
                  
                  
                  2.80
                  %
                  
                  
                  3.86
                  %Expected
      term (years)
                  
                  
                  10.0
                  
                  
                  
                  9.7Expected
      volatility
                  
                  
                  86.7
                  %
                  
                  
                  89.6
                  %Expected
      dividend yield
                  
                  
                  -
                  
                  
                  
                  -


7


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 3 -
Stock-Based
Compensation, continued





A summary
of the option activity for the three months ended March 31, 2009 is as
follows:





Number
                    of Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    Price
                  
                  
                  Weighted-
                    Average
                    Remaining
                    Contractual TermOptions
      outstanding at January 1, 2009
                  
                  
                  4,676,868
                  
                  
                  
                  1.64Granted
                  
                  
                  608,750
                  
                  
                  
                  .90Cancelled
                  
                  
                  (6,000
                  )
                  
                  
                  (1.20
                  )Exercised
                  
                  
                  -
                  
                  
                  
                  -Options
      outstanding at March 31, 2009
                  
                  
                  5,279,618
                  
                  
                  
                  1.45
                  
                  
                  
                  6.70Options
      exercisable at March 31, 2009
                  
                  
                  3,220,850
                  
                  
                  
                  1.92
                  
                  
                  
                  5.84





The
weighted-average grant-date fair value of options granted during the three
months ended March 31, 2009 and 2008 was $545,525 and $955,391,
respectively.  There have been no options exercised during the three
months ended March 31, 2009.





NOTE 4 -
Stockholders’
Equity





During
the quarter ended March 31, 2009, approximately 160 shares of the Company’s
series A convertible preferred stock were converted into 132,858 shares of the
Company’s common stock and no shares of the Company’s series B convertible
preferred stock were converted into shares of the Company’s common
stock.





On March
23, 2009, the Company issued a total of 88,132 shares of common stock to 500
Linden Oaks Associates LLC, as partial payment for the lease of the Company's
corporate headquarters, pursuant to the terms of its lease dated May 14, 2007.
The shares were issued at $1.20 per share for a total consideration of $105,570.
The shares were issued in transactions not involving a public offering and
exempt from registration pursuant to Section 4(2) of the Securities Act of 1933,
or Securities Act. The purchaser is an accredited investor under the Securities
Act, was knowledgeable about the Company's operations and financial condition
and had access to such information. The sales did not involve any form of
general solicitation. The shares were purchased for investment purposes only and
contain restrictions on transfer with certificates containing a legend setting
forth such restrictions.


NOTE 5
- Derivative
Liability





In June
2008, the FASB finalized Emerging Issues Task Force (“EITF”) 07-05, “Determining
Whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own
Stock.”  Under EITF 07-05, instruments which do not have fixed
settlement provisions are deemed to be derivative instruments. The warrants
issued with the Company’s series A and series B preferred stock, and to the
placement agent in the series B financing, do not have fixed settlement
provisions because their exercise prices may be lowered if the Company issues
securities at lower prices in the future.  The Company was required to
include the reset provisions in order to protect the warrant holders from the
potential dilution associated with future financings.  In accordance
with EITF 07-05, the warrants were recognized as a derivative instrument and
have been re-characterized as derivative liabilities. SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities” (“FAS 133”) requires that the
fair value of these liabilities be re-measured at the end of every reporting
period with the change in value reported in the statement of
operations.


8


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 5
- Derivative
Liability, continued





The
derivative liabilities were valued using the Black-Scholes option valuation
model and the following assumptions on the following dates:





March 31,
                    2009
                  
                  
                  January 1,
                    2009
                  
                  
                  November 5,
                    2005Series
      A warrants:Risk-free
      interest rate
                  
                  
                  2.68
                  %
                  
                  
                  2.24
                  %
                  
                  
                  4.66
                  %Expected
      volatility
                  
                  
                  88.0
                  %
                  
                  
                  72.9
                  %
                  
                  
                  59.6
                  %Expected
      life (in years)
                  
                  
                  .67
                  
                  
                  
                  .92
                  
                  
                  
                  4Expected
      dividend yield
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Number
      of warrants
                  
                  
                  1,400,000
                  
                  
                  
                  1,400,000
                  
                  
                  
                  1,400,000Fair
      value
                  
                  $
                  67,760
                  
                  
                  $
                  14,840
                  
                  
                  $
                  1,299,900





March 31,
                    2009
                  
                  
                  January 1,
                    2009
                  
                  
                  September 7,
                    2007Series
      B warrants:Risk-free
      interest rate
                  
                  
                  2.68
                  %
                  
                  
                  2.24
                  %
                  
                  
                  4.37
                  %Expected
      volatility
                  
                  
                  58.5
                  %
                  
                  
                  57.8
                  %
                  
                  
                  70.0
                  %Expected
      life (in years)
                  
                  
                  5.42
                  
                  
                  
                  5.67
                  
                  
                  
                  7Expected
      dividend yield
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Number
      of warrants
                  
                  
                  2,234,764
                  
                  
                  
                  2,234,764
                  
                  
                  
                  2,234,764Fair
      value
                  
                  $
                  752,557
                  
                  
                  $
                  408,068
                  
                  
                  $
                  1,839,099





The
risk-free interest rate was based on rates established by the Federal
Reserve.  The Company’s expected volatility was based on the
historical volatility of similar entities whose share prices are publicly
available.  The expected life of the warrants was determined by the
expiration date of the warrants.  The expected dividend yield was
based upon the fact that the Company has not historically paid dividends, and
does not expect to pay dividends in the future.





EITF
07-05 was implemented in the first quarter of 2009 and is reported as a
cumulative effect of a change in accounting principle.  As a result,
the cumulative effect on the accounting for the warrants was as
follows:





Derivative
                    Instrument
                  
                  Decrease in
                    Additional Paid-
                    In-Capital
                  
                  
                  Decrease in
                    Accumulated
                    Deficit
                  
                  
                  Increase in
                    Derivative
                    LiabilityWarrants
                  
                  $
                  3,138,999
                  
                  
                  $
                  2,716,091
                  
                  
                  $
                  422,908





The
warrants were originally recorded at their relative fair value as an increase in
additional paid-in-capital.  Changes in accumulated deficit include
$2,716,091 in gains resulting from the decrease in the fair value of the
derivative liabilities through December 31, 2008.  The derivative
liability amount reflects the fair value of each derivative instrument as of the
January 1, 2009 date of implementation.


9


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 5
- Derivative
Liability, continued





Fair
Value Measurement





Valuation
Hierarchy





FAS 157
establishes a valuation hierarchy for disclosure of the inputs to valuation used
to measure fair value. This hierarchy prioritizes the inputs into three broad
levels as follows.  Level 1 inputs are quoted prices (unadjusted) in
active markets for identical assets or liabilities.  Level 2 inputs
are quoted prices for similar assets and liabilities in active markets or inputs
that are observable for the asset or liability, either directly or indirectly
through market corroboration, for substantially the full term of the financial
instrument.  Level 3 inputs are unobservable inputs based on the
Company’s own assumptions used to measure assets and liabilities at fair
value.  A financial asset or liability’s classification within the
hierarchy is determined based on the lowest level input that is significant to
the fair value measurement.





The
following table provides the assets and liabilities carried at fair value
measured on a recurring basis as of March 31, 2009:





Fair Value Measurements at March 31, 2009Total Carrying
                    Value at
                    March 31, 2009
                  
                  
                  Quoted prices
                    in active
                    markets
                    (Level 1)
                  
                  
                  Significant
                    other
                    observable
                    inputs
                    (Level 2)
                  
                  
                  Significant
                    unobservable
                    inputs (Level 3)Derivative
      liabilities
                  
                  $
                  820,317
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  820,317





The
carrying amounts of cash, accounts receivable, accounts payable, and accrued
liabilities approximate their fair value due to their short
maturities.  The derivative liabilities are measured at fair value
using quoted market prices and estimated volatility factors, and are classified
within Level 2 of the valuation hierarchy. There were no changes in the
valuation techniques during the three months ended March 31, 2009.





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.  Diluted loss attributable to common shares adjusts basic 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, the exercise of stock options and warrants are excluded from
the calculation of net loss per share as their effect would be
antidilutive.


10


VirtualScopics,
Inc. and Subsidiary


Notes
to Condensed Consolidated Financial Statements


(unaudited)





NOTE 6 -
Net Loss Per Share,
continued





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
as of March 31:





2009
                      
                      
                      2008Series
      A convertible preferred stock
                      
                      
                      3,168,240
                      
                      
                      
                      3,301,098Series
      B convertible preferred stock
                      
                      
                      3,509,092
                      
                      
                      
                      3,509,092Series
      A warrants to purchase common stock
                      
                      
                      1,629,402
                      
                      
                      
                      1,629,402Series
      B warrants to purchase common stock
                      
                      
                      2,234,764
                      
                      
                      
                      2,234,764Other
      warrants to purchase common stock
                      
                      
                      444,888
                      
                      
                      
                      532,490Options
      to purchase common stock
                      
                      
                      5,421,308
                      
                      
                      
                      4,872,866Total
                      
                      
                      16,407,694
                      
                      
                      
                      16,079,712





NOTE 7 -
Income
Taxes





Effective
January 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109” (“FIN No. 48”).  FIN No. 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with FASB Statement 109, “Accounting for
Income Taxes,” and prescribes a recognition threshold and measurement process
for financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return.





Upon
adoption, the Company has concluded that there were no significant uncertain tax
positions requiring recognition in its financial statements.  As of
March 31, 2009, all of the Company’s deferred tax assets were fully reserved by
a valuation allowance equal to 100% of the net deferred tax
assets.  The Company has never been profitable and has not paid any
income taxes.





The
Company has significant net operating loss and business credit carryovers which
are subject to a valuation allowance due to the uncertain nature of the
realization of the losses.  The Internal Revenue Code imposes certain
limitations on the utilization of net operating loss carryovers and other tax
attributes after a change in control.  The Company does not believe to
have encountered ownership changes which could significantly limit the possible
utilization of such carryovers.  However, the Company has not
performed a detailed analysis to determine the effect of any such ownership
changes on its ability to use these net operating loss and credit
carryforwards.  It is not anticipated that limitations, if any, would
have a material impact on the condensed consolidated balance sheet as a result
of offsetting changes in the deferred tax valuation allowance.





The
Company will recognize interest and penalties accrued related to unrecognized
tax benefits as components of its income tax provision.  The Company
did not have any interest and penalties accrued upon the adoption of FIN No. 48
and as of March 31, 2009, the Company does not have any interest and penalties
accrued related to unrecognized tax benefits.





NOTE 8 -
Concentration of
Credit Risk





The
Company’s top two customers accounted for approximately 27% and 10% of its total
revenue for the three months ended March 31, 2009. For the three months ended
March 31, 2008, its then top three customers accounted for 15%, 13% and 11% of
its total revenue.


11


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





The
following discussion should be read in conjunction with VirtualScopics’
condensed consolidated balance sheets as of March 31, 2009 and December 31, 2008
and the related condensed consolidated statements of operations and cash flows
for the quarters ended March 31, 2009 and 2008, included elsewhere in this
report. This discussion contains forward-looking statements, the accuracy of
which involves risks and uncertainties. Our actual results could differ
materially from those anticipated in the forward-looking statements for many
reasons including, but not limited to, those discussed under the heading
“Forward Looking Statements” below and elsewhere in this report. We disclaim any
obligation to update information contained in any forward-looking
statements.





Overview





We are a
provider of imaging solutions to accelerate drug and medical device development.
Our technology helps to curtail trials that are not likely to be beneficial and
to avoid mistaken termination of compounds that are likely to prove efficacious,
as well as allow our customers to expedite compounds that are demonstrating
response. This is done through:





·
            improved
      precision in the measurement of existing imaging-based biomarkers
      resulting in shorter observation periods, with beneficial cost savings
      within a clinical trial;





·
            new
      imaging biomarkers, which are better correlated with disease states, again
      reducing trial length and therefore costs;
and





·
            reduced
      processing time for image data analysis through
  automation.





In
addition, our technology helps reduce aggregate clinical development costs
through:





·
            improved
      precision for existing biomarkers, thus requiring smaller patient
      populations and lower administrative costs;
and





·
            new
      biomarkers that serve as better correlates, leading to better early
      screening and elimination of weak drug candidates in pre-clinical
      trials.





In July
2000, VirtualScopics was formed after being spun out of the University of
Rochester and in June 2002, VirtualScopics purchased the underlying technology
and patents created by VirtualScopics’ founders from the University of
Rochester. VirtualScopics owns all rights to the patents underlying its
technology.





Since
VirtualScopics’ inception, VirtualScopics’ principal activities have consisted
of:





·
            research
      and development;





·
            hiring
      technical, sales and other
personnel;





·
            providing
      imaging services and consultancy to pharmaceutical and medical device
      companies;





·
            business
      development of customer and strategic relationships;
  and





·
            raising
      capital.





Revenues
over the past eight years have been derived primarily from image processing
services in connection with pharmaceutical drug trials.  For these
services, we have been concentrating in the areas of oncology and
osteoarthritis.  We have also derived a portion of revenue from
consulting services and pharmaceutical drug trials in the neurology and
cardiovascular therapeutic areas.  We expect that the concentration of
our revenue will continue in these services and in these areas throughout
2009.  Revenues are recognized as the images that we process are
quantified and delivered to our customers.


12





The
number of customers that we perform services for has increasingly grown over the
past several years.  We have submitted proposals and bids for a number
of other contracts and have received verbal indication that certain projects
have been awarded to us. However, there can be no assurance that we will secure
contracts from these efforts or that any such contracts or any of our 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 effect whether we will realize the full benefits under
the contract, and the time over which we will realize that
revenue.  Customers may not continue our services due to performance
reasons with their compounds in development.  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
or awarded.  Recognition of revenue under the contract may also be
affected by the timing of patient recruitment and image site identification and
training.





Results
of Operations





Results
of Operations for Quarter Ended March 31, 2009 Compared to Quarter Ended March
31, 2008





Revenues





We had
revenues of $2,134,000 for the quarter ended March 31, 2009 compared to
$1,634,000 for the comparable period in 2008.  This $500,000, or 31%,
increase in revenues was directly related to the increase in the demand for our
services within the pharmaceutical industry. During the quarter, we performed
work for 26 customers, representing 83 different projects, in connection with
our pharmaceutical drug trials in the fields of oncology, osteoarthritis and
various other projects.  This compares to 26 customers and 57 projects
during the same period in 2008. As of March 31, 2009, our project balance
(amount remaining to be earned under active projects and awards) exceeded
$31,000,000. This represents over a 120% increase over the project balance as of
March 31, 2008. The majority of the demand is seen within our oncology service
line, however, we have recently seen increased interest in our musculoskeletal
applications. During the first quarter of 2009, 63% of our business was in
oncology services, 19% in musculoskeletal, the remaining 18% was work performed
for the Department of Defense and in other therapeutic areas. This compares to
44%, 35% and 21%, respectively, in 2008. During the first three months of 2009,
55% of the revenues were derived from Phase II and III studies compared to 28%
during the comparable period in 2008. Our margins in the later stage studies
(Phase II and III) tend to be higher due to the efficiencies gained with the
larger volume of analysis and site coordination.





Gross
Profit





We had a
gross profit of $1,120,000 for the first quarter of 2009 compared to $604,000
for the comparable period in 2008.  Our gross profit margin was 52%
during the period ended March 31, 2009 compared to 37% in the first three months
of 2008.   The percentage of our business in Phase II and III
trials has doubled over the past twelve months which is reflected in our gross
margin. Phase II and III studies are inherently more efficient for us to
process. Also impacting the improved margin is the increase in overall volume of
business during the quarter. We have made significant improvements in order for
us to effectively scale the business without requiring a significant amount of
additional resources. These improvements and the higher revenue volume allow us
to be more effective in the processing of our services, thereby typically
resulting in higher margins.





13




Research
and Development


Research
and development costs decreased in the quarter ended March 31, 2009 by $16,000,
or 6%, to $236,000, when compared to the quarter ended March 31,
2008.  The slight decrease was due to one less employee within our
research group in 2009 compared to 2008. Our research and development efforts
center around refining our processes through the use of our software platform in
order to gain efficiencies which we believe will better allow us to standardize
our processes as we scale the business. As of March 31, 2009, there were 9
employees in our research and development group, which includes the algorithm
development and software development groups.





Sales
and Marketing





Sales and
marketing costs decreased slightly in the quarter ended March 31, 2009 by
$7,000, or 2%, to $282,000, when compared to the quarter ended March 31,
2008.  The decrease was a result of the costs incurred rebranding our
marketing materials in the first and second quarter of 2008. The resulting
marketing materials now display a consistent and representative reflection of
the services we provide and the value it generates for our customers. The
decrease in the outside marketing costs during the first quarter of 2009 were
offset by higher costs associated with the attendance at various trade shows and
company sponsored seminars in 2009. As of March 31, 2009, we had four
individuals in our sales department.





General
and Administrative





General
and administrative expenses for the quarter ended March 31, 2009 were $845,000,
a decrease of $53,000 or 6%, when compared to the quarter ended March 31,
2008.  The decrease was mainly due to the valuation changes within our
stock compensation expense related to the exercise prices and vesting periods of
outstanding options granted to employees.





Depreciation
and Amortization





Depreciation
and amortization charges remained constant at $118,000 for the quarter ended
March 31, 2009 when compared to the quarter ended March 31,
2008.  This was a result of depreciation charges related to recent
capital purchases being offset by a reduction in depreciation charges for assets
that have been fully depreciated during the past quarter. We anticipate higher
IT costs in 2009 as we seek efficiencies through acquired software applications
and computers necessary to support the existing employees and the planned
increase in our headcount.





Interest
Income (Expense)





Interest
income for the quarter ended March 31, 2009 was $3,000, representing interest
derived on the Company’s operating and savings accounts, compared to interest
income of $29,000 in the quarter ended March 31, 2008.  The decrease
in interest income was a reflection of lower average rates of return on our
savings accounts in the first quarter of 2009 compared to first quarter of 2008.
Our policy is to place our cash in low risk investments in order to insulate our
cash from any adverse market conditions.  Additionally, we recognized
a marked to market adjustment of $397,409 related to the loss in fair value of
certain derivative financial instruments as a result of the implementation of
EITF 07-05 during the first quarter of 2009 (see Note 5).  Under the
guidelines of EITF 07-05, there was no adjustment required for the first quarter
of 2008.





Net
Loss





Net loss
for the quarter ended March 31, 2009 was $756,000 compared to a net loss of
$925,000 for the quarter ended March 31, 2008.  The significant
improvement in our net loss over the prior period was primarily related to the
increase in our revenues, growth in our gross profit along with reductions in
our operating expenses offset by a non-cash marked to market adjustment to
reflect the changes in the fair value of certain outstanding warrants during the
first quarter of 2009 as compared to 2008.


14





Liquidity
and Capital Resources





Our
working capital as of March 31, 2009 was approximately $2,072,000 as compared to
$2,923,000 as of December 31, 2008.  The decrease in working capital
was the result of the recognition of recent accounting pronouncements that
require the company to reflect the changes in fair value of certain outstanding
warrants.





Net cash
provided by operating activities totaled $155,000 in the quarter ended March 31,
2009 compared to net cash used of $341,000 in the comparable 2008
quarter.  The $496,000 decrease in cash usage was primarily the result
of the higher revenues, improved gross profit and lower operating costs during
the first quarter of 2009 compared to the same period in 2008.





We
invested $77,000 in the purchase of equipment and the acquisition of patents in
the first quarter of 2009, compared to $40,000 for the investment of these items
in the first quarter of 2008.  This increase was attributable to
further investments in 2009 in our IT infrastructure and costs associated with
our intellectual property. We anticipate higher IT related costs in 2009 as we
support the growing demand from our customers and to gain efficiencies through
the use of purchased software applications.





Cash used
for financing activities in the quarter ended March 31, 2009 was $85,000,
compared to cash provided by financing activities of $49,000 in the quarter
ended March 31, 2008  This change represents the release of restricted
cash for investor relations and dividend payments offset by monthly dividend
payments for the convertible series B preferred stock in 2008. No similar
restriction exists in 2009.





We
currently expect that existing cash and cash equivalents will be sufficient to
fund operations for 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.





In
February 2008, the Company received a written notice from the Nasdaq Stock
Market indicating that its common stock was not in compliance with the minimum
bid price required for continued listing on the Nasdaq Capital
Market.  In accordance with section 4310(c)(8) of the Nasdaq
Marketplace Rules, the Company has until November 9, 2009 to regain compliance
by maintaining a bid price of common stock at a close of $1.00 or higher for a
minimum of 10 consecutive business days, or such longer period as Nasdaq may
determine to show the ability to maintain long-term compliance. The Company’s
intention is to maintain its listing on Nasdaq and is currently assessing its
options to regain compliance. As of May 14, 2009, the closing price of the
Company’s common stock, as listed on Nasdaq, was $1.15.





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 on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital resources or capital
expenditures that is material to investors.





Recently
Issued and Adopted Accounting Pronouncements





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standard No. 157, “Fair Value Measurements,”
(“SFAS 157”) which is effective for fiscal years beginning after November 15,
2007 and for interim periods within those years. This statement defines fair
value, establishes a framework for measuring fair value and expands the related
disclosure requirements. This statement applies under other accounting
pronouncements that require or permit fair value measurements.  The
statement indicates, among other matters, that a fair value measurement assumes
that the transaction to sell an asset or transfer a liability occurs in the
principal market for the asset or liability or, in the absence of a principal
market, the most advantageous market for the asset or liability.  FAS
157 defines fair value based upon an exit price model.  Relative to
FAS 157, the FASB issued FASB Staff Positions (“FSP”) 157-1, FSP 157-2, and
proposed FSP 157-c.  FSP 157-1 amends FAS 157 to exclude SFAS No. 13,
“Accounting for Leases,” (“FAS 13”), and its related interpretive accounting
pronouncements that address leasing transactions, while FSP 157-2 delays the
effective date of FAS 157 for all nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis.  FSP 157-c clarifies the
principles in FAS 157 on the fair value measurement of
liabilities.  The Company adopted FAS 157 as of January 1, 2008. Refer
to Note 5 for additional discussion on fair value measurements.


15


In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," (“FAS
141(R)”) which replaces SFAS No. 141, “Business Combinations.”  FAS
141(R) establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration and certain acquired contingencies. FAS 141 ( R ) also
requires that acquisition-related transaction expenses and restructuring costs
be expensed as incurred rather than capitalized as a component of the business
combination.   FAS 141 ( R )   became   effective   on
  January 1, 2009.





In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51," (“FAS 160”). FAS
160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). FAS 160
also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Under FAS 160,
noncontrolling interests are reported as a separate component of consolidated
stockholders’ equity . In addition, net income allocable to noncontrolling
interests and net income attributable to stockholders of the Company
are  reported separately in the   consolidated statements of
 operations. FAS
160 became effective beginning January 1, 2009.  FAS 160 would
have an impact on the presentation and disclosure of the non-controlling
interests of any non wholly-owned businesses acquired by the Company in the
future.




In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities,” (“FAS 161”).  The new standard amends SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“FAS
133”) and enhances disclosures about how and why a company uses derivatives; how
derivative instruments are accounted for under FAS 133 (and the interpretations
of that standard); and how derivatives affect a company’s financial position,
financial performance and cash flows.  FAS 161 is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008.  The Company has adopted this standard as of
January 1, 2009.  Additional disclosures have been included in the
Company’s condensed consolidated financial statements in accordance with FAS
161.





In
April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “
Determination of the Useful Life of Intangible Assets ,” (“FSP 142-3”). FSP
142-3 amends the factors that should be considered in developing renewal or
extension assumptions used to determine the useful life of a recognized
intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets,”
(“FAS 142”) .  The objective of FSP 142-3 is to improve the
consistency between the useful life of a recognized intangible asset under FAS
142 and the period of expected cash flows used to measure the fair value of the
asset under FAS 141 ( R ) and other United States GAAP principles
..  FSP 142-3 is effective prospectively for intangible assets acquired
or received after January 1, 2009.  The Company does not expect FSP
142-3 to have a material impact on its accounting for future acquisitions or
renewals of intangible assets.





Effective
January 1, 2009, the Company adopted the provisions of Emerging Issues Task
Force (‘‘EITF’’) EITF 07-05, Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entity’s Own Stock, (‘‘EITF
07-05’’). EITF 07-05 applies to any freestanding financial instruments or
embedded features that have the characteristics of a derivative, as defined by
SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, and to any freestanding
financial instruments that are potentially settled in an entity’s own common
stock. The adoption of EITF 07-05 had a material impact on our consolidated
financial position, results of operations and cash flows as the Company has
financial instruments with characteristics which meet the definition of a
derivative instrument in accordance with the provisions of this
pronouncement.  Refer to Note 5 for additional disclosure regarding the
adoption of EITF 07-05.


16





In April
2009, the FASB issued FSP SFAS 157-4, “Determining Whether a Market Is Not
Active and a Transaction Is Not Distressed,” (“FSP FAS 157-4”) which provides
guidelines for making fair value measurements more consistent with the
principles presented in SFAS 157.  FSP FAS 157-4 provides additional
authoritative guidance in determining whether a market is active or inactive and
whether a transaction is distressed, is applicable to all assets and liabilities
(i.e. financial and nonfinancial) and will require enhanced
disclosures.  This standard is effective for periods ending after June
15, 2009.  The Company is evaluating the impact that this standard
will have on the Company’s financial position and results of
operations.





In April
2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about
Fair Value of Financial Instruments,” (“FSP FAS 107-1 and APB
28-1”).  FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures
about Fair Value of Financial Instruments,” to require disclosures about fair
value of financial instruments in interim as well as in annual financial
statements.  FSP FAS 107-1 and APB 28-1 amends APB Opinion No. 28,
“Interim Financial Reporting,” to require those disclosures in all interim
financial statements. This standard is effective for
periods ending after June 15, 2009.  The Company is evaluating the
impact that this standard will have on the Company’s financial position and
results of operations.





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 the following risk factors:





·
            adverse
      economic conditions;





·
            inability
      to raise sufficient additional capital 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
including, without limitation, statements 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-K for the fiscal year
ended December 31, 2008 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.


17





ITEM
4T.  Controls and Procedures




Evaluation
of Disclosure 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 Securities Exchange Act of 1934, as
amended (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(b) of the Exchange Act. Based on that evaluation, our Chief Executive
Officer and our Chief Financial Officer concluded that our disclosure controls
and procedures were effective as of the end of the period covered by this
report.





Notwithstanding
the foregoing, there can be no assurance that the Company’s disclosure controls
and procedures will detect or uncover all failures of persons within the Company
to disclose material information otherwise required to be set forth in the
Company’s periodic reports. There are inherent limitations to the effectiveness
of any system of disclosure controls and procedures, including the possibility
of human error and the circumvention or overriding of the controls and
procedures. Accordingly, even effective disclosure controls and procedures can
only provide reasonable, not absolute, assurance of achieving their control
objectives.





Changes
in Internal Controls Over Financial Reporting





An
evaluation was performed under the supervision of the Company’s management,
including the CEO and CFO, as required under Exchange Act Rule 13a-15(d) and
15d-15(d) of whether any change in the Company’s internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred
during the fiscal quarter ended March 31, 2009.  Based on that
evaluation, the Company’s management, including the CEO and CFO, concluded that
no change in the Company’s internal controls over financial reporting occurred
during the fiscal quarter ended March 31, 2009 that has materially affected or
is reasonably likely to materially affect, the Company’s internal control over
financial reporting.




PART
II. OTHER INFORMATION





Item
1.  Legal Proceedings





None





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





During
the quarter ended March 31, 2009, approximately 160 shares the Company’s series
A convertible preferred stock were converted into 132,858 shares of the
Company’s common stock. 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 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.


18





On March
23, 2009, the Company issued a total of 88,132 shares of common stock to 500
Linden Oaks Associates LLC, as partial payment for the lease of the Company's
corporate headquarters, pursuant to the terms of its lease dated May 14, 2007.
The shares were issued at $1.20 per share for a total consideration of $105,570.
The shares were issued in transactions not involving a public offering and
exempt from registration pursuant to Section 4(2) of the Securities Act of 1933,
or Securities Act. The purchaser is an accredited investor under the Securities
Act, was knowledgeable about the Company's operations and financial condition
and had access to such information. The sales did not involve any form of
general solicitation. The shares were purchased for investment purposes only and
contain restrictions on transfer with certificates containing a legend setting
forth such restrictions.





Item
3.  Defaults upon Senior Securities





Not
applicable.





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





Not
applicable.





Item
5.  Other Information





None





Item
6.  Exhibits





Exhibit
10.1     Employment Agreement dated February 24, 2009,
by and between Jeffrey Markin and VirtualScopics, Inc. (Incorporated by
reference herein to Exhibit 10.17 to the VirtualScopics, Inc., Annual Report on
Form 10-K filed with the Securities and
Exchange   Commission  on March 19, 2009 (File No.
000-52018))*





Exhibit
10.2     Employment Agreement dated February 24, 2009,
by and between Molly  Henderson and VirtualScopics, Inc. (Incorporated
by reference herein to Exhibit 10.18 to the VirtualScopics, Inc., Annual Report
on Form 10-K filed with the Securities and Exchange Commission  on
March 19, 2009 (File No. 000-52018))*





Exhibit 10.3
     VirtualScopics, Inc. 2009 Bonus
Plan.*





Exhibit
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.





Exhibit
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.





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 of 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 of 2002.





*                 Management
contract or compensatory plan or arrangement.


19


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.





Dated:  May
      15, 2009
              VIRTUALSCOPICS,
      INC./s/  Jeffrey
    MarkinJeffrey
      MarkinPresident
      and Chief Executive Officer/s/  Molly
    HendersonMolly
      HendersonChief
      Business and Financial Officer and Senior
                Vice
      President


20


Exhibit
Index





Exhibit
10.1    Employment Agreement dated February 24, 2009, by and
between Jeffrey Markin and VirtualScopics, Inc.(Incorporated by reference
herein to Exhibit 10.17 to the VirtualScopics, Inc., Annual Report on Form 10-K
filed with the Securities and Exchange Commission  on March 19, 2009
(File No. 000-52018))*





Exhibit
10.2  Employment Agreement dated February 24, 2009, by and between
Molly Henderson  and VirtualScopics, Inc. (Incorporated by reference
herein to Exhibit 10.18 to the VirtualScopics, Inc., Annual Report on Form 10-K
filed with the Securities and Exchange Commission  on March 19, 2009
(File No. 000-52018))*





Exhibit
10.3 VirtualScopics, Inc. 2009 Bonus Plan.*





Exhibit
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





Exhibit  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





Exhibit
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





Exhibit
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





*            
Management contract or compensatory plan or arrangement.


21