** **

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**Form 10-Q**

** **

**(MarkOne)**
| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) Of   THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|----------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                               |
| ** ** | ** ** | **For  the quarterly period ended March 31, 2008**                                                  |

** **

**or**

 
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF   THE SECURITIES EXCHANGE ACT OF 1934**                                                              |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                             |
| ** ** | ** ** | **For  the Transition Period from           to             ** |

** **

**Commissionfile number 0-13634**

** **

**MACROCHEM CORPORATION**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                    | ** ** | **04-2744744**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or Other Jurisdiction

of Incorporation or Organization) |       | (I.R.S. Employer

Identification No.) |

 

**80 BroadStreet, 22nd Floor, New York, New York 10004**

(Address ofprincipal executive offices, Zip Code)

 

**212-514-8094**

(Registrant’stelephone number, including area code)

 

Indicate bycheck mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the Registrantwas required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.
| Yes | x | No | o |
|-----|---|----|---|

 

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

 

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

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).
| Yes | o | No | x |
|-----|---|----|---|

 

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

 
| **Class**                    | ** ** | **Outstanding at April 21, 2008:** |
|------------------------------|------------|-----------------------------------------|
| Common Stock, $.01 par value |       | 45,798,412                              |

 

 

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##### INDEX TO FORM 10-Q

 
|          |   | ** **                                                                                               | ** ** | **Page Number** |
|---------------|--------|----------------------------------------------------------------------------------------------------------|------------|----------------------|
| PART I   |   | FINANCIAL  INFORMATION                                                                                   |       |                 |
|          |   |                                                                                                     |       |                 |
| Item 1        |   | Financial Statements                                                                                     |       |                 |
|          |   |                                                                                                     |       |                 |
|          |   | Condensed  Balance Sheets March 31, 2008  (Unaudited) and December 31, 2007                    |       | 3                    |
|          |   |                                                                                                     |       |                 |
|          |   | Condensed Statements of  Operations for the Three  Months Ended March 31, 2008 and 2007 (Unaudited) |       | 4                    |
|          |   |                                                                                                     |       |                 |
|          |   | Condensed Statements of Cash  Flows for the Three Months  Ended March 31, 2008 and 2007 (Unaudited) |       | 5-6                  |
|          |   |                                                                                                     |       |                 |
|          |   | Notes  to Unaudited Condensed Financial Statements                                                       |       | 7-16                 |
|          |   |                                                                                                     |       |                 |
| Item 2        |   | Management’s  Discussion and Analysis of Financial  Condition and Results of Operations             |       | 17-26                |
|          |   |                                                                                                     |       |                 |
| Item 3        |   | Quantitative  and Qualitative Disclosures about Market Risk                                              |       | 26                   |
|          |   |                                                                                                     |       |                 |
| Item 4        |   | Controls and  Procedures                                                                                 |       | 26                   |
|          |   |                                                                                                     |       |                 |
| PART II  |   | OTHER INFORMATION                                                                                        |       |                 |
|          |   |                                                                                                     |       |                 |
| Item 1A       |   | Risk Factors                                                                                             |       | 27                   |
|          |   |                                                                                                     |       |                 |
| Item 6        |   | Exhibits                                                                                                 |       | 28                   |
|          |   |                                                                                                     |       |                 |
| SIGNATURES    |   |                                                                                                     |       | 29                   |
|          |   |                                                                                                     |       |                 |
| EXHIBIT INDEX |   |                                                                                                     |       | 30                   |

 

2

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**Item 1. Financial Statements**

 

MACROCHEM CORPORATION

CONDENSEDBALANCE SHEETS

 
| ** **                                                                                                                                                             | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                                                                                                                                                                   |       | **(Unaudited)**              |       | **(Note 1)**                    |       |
|                                                                                                                                                                   |       | ** **                   |       | ** **                      |       |
| **ASSETS**                                                                                                                                                             |       |                         |       |                            |       |
| Current assets:                                                                                                                                                        |       |                         |       |                            |       |
| Cash and cash equivalents                                                                                                                                              |       | $                            | 859,472    |                            | $          | 2,423,519 |   |
| Short-term investments                                                                                                                                                 |       | 759,247                      |       | 759,247                         |       |
| Prepaid expenses and other current assets                                                                                                                              |       | 416,073                      |       | 131,047                         |       |
| Total current assets                                                                                                                                                   |       | 2,034,792                    |       | 3,313,813                       |       |
|                                                                                                                                                                   |       |                         |       |                            |       |
| Property and equipment, net                                                                                                                                            |       | 12,385                       |       | 22,042                          |       |
| Other assets                                                                                                                                                           |       | 35,000                       |       | 0                               |       |
| Patents, net                                                                                                                                                           |       | 506,185                      |       | 517,600                         |       |
|                                                                                                                                                                   |       |                         |       |                            |       |
| Total assets                                                                                                                                                           |       | $                            | 2,588,362  |                            | $          | 3,853,455 |   |
|                                                                                                                                                                   |       |                         |       |                            |       |
| **LIABILITIES**                                                                                                                                                        |       |                         |       |                            |       |
| Current liabilities:                                                                                                                                                   |       |                         |       |                            |       |
| Accounts payable                                                                                                                                                       |       | $                            | 141,558    |                            | $          | 94,439 |   |
| Accrued expenses and other liabilities                                                                                                                                 |       | 222,790                      |       | 310,195                         |       |
| Total current liabilities                                                                                                                                              |       | 364,348                      |       | 404,634                         |       |
|                                                                                                                                                                   |       |                         |       |                            |       |
| Warrants liability (Note 4)                                                                                                                                            |       | 1,494,549                    |       | 4,076,488                       |       |
| Total liabilities                                                                                                                                                      |       | 1,858,897                    |       | 4,481,122                       |       |
|                                                                                                                                                                   |       |                         |       |                            |       |
| Commitments and contingencies (Note 3)                                                                                                                                 |       |                         |       |                            |       |
|                                                                                                                                                                   |       |                         |       |                            |       |
| **STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                |       |                         |       |                            |       |
| Preferred stock, $.01 par value, 6,000,000  shares authorized; liquidation value of $0                                                                                 |       | —                       |       | —                          |       |
| Common stock, $.01 par value, 100,000,000  shares authorized; 22,900,026 and 22,500,026 shares issued at March 31,  2008 and December 31, 2007, respectively |       | 229,000                      |       | 225,000                         |       |
| Additional paid-in capital                                                                                                                                             |       | 90,283,514                   |       | 90,054,421                      |       |
| Accumulated deficit                                                                                                                                                    |       | (89,723,939                  | )          | (90,847,978                     | )          |
| Less treasury stock, at cost, 529 shares at  March 31, 2008 and December 31, 2007                                                                            |       | (59,110                      | )          | (59,110                         | )          |
| Total stockholders’ equity (deficit)                                                                                                                              |       | 729,465                      |       | (627,667                        | )          |
|                                                                                                                                                                   |       |                         |       |                            |       |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                             |       | $                            | 2,588,362  |                            | $          | 3,853,455 |   |

 

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

 

3

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# ** **

# **MACROCHEM CORPORATION**

# **CONDENSED STATEMENTS OF OPERATIONS**

For the three months ended March 31, 2008 and 2007

(Unaudited)

 
| ** **                                                                | ** ** | **For the Three Months Ended   March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2008**                                                                 | ** ** | **2007** | ** ** |
|                                                                      |       |                                                                     |       |   |   |
| **OPERATING EXPENSES:**                                                   |       |                                                                     |       |   |   |
| Research and development                                                  |       | $                                                                        | 511,971    |   | $ | 298,448 |   |
| Marketing, general and administrative                                     |       | 971,563                                                                  |       | 1,004,312 |   |
| **TOTAL OPERATING EXPENSES**                                              |       | 1,483,534                                                                |       | 1,302,760 |   |
|                                                                      |       |                                                                     |       |   |   |
| **LOSS FROM OPERATIONS**                                                  |       | (1,483,534                                                               | )          | (1,302,760 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **OTHER INCOME AND EXPENSE:**                                             |       |                                                                     |       |   |   |
| Interest income                                                           |       | 19,168                                                                   |       | 34,530 |   |
| Gain (loss) on change in value of warrant  liability (Note  4)            |       | 2,581,939                                                                |       | (275,863 | ) |
| Gain on sale of equipment                                                 |       | 6,466                                                                    |       | 16,000 |   |
| **TOTAL OTHER INCOME AND EXPENSE**                                        |       | 2,607,573                                                                |       | (225,333 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **NET INCOME (LOSS)**                                                     |       | 1,124,039                                                                |       | (1,528,093 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **DIVIDEND ON SERIES C CUMULATIVE PREFERRED  STOCK**                      |       | —                                                                   |       | (192,699 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **NET  INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS**                |       | $                                                                        | 1,124,039  |   | $ | (1,720,792 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **BASIC AND DILUTED NET INCOME (LOSS) PER  SHARE**                        |       | $                                                                        | 0.05       |   | $ | (0.62 | ) |
|                                                                      |       |                                                                     |       |   |   |
| **SHARES USED TO COMPUTE BASIC AND DILUTED  NET INCOME (LOSS) PER SHARE** |       | 22,606,693                                                               |       | 2,752,931 |   |

 

Theaccompanying notes are an integral part of these unaudited condensed financialstatements

 

4

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MACROCHEM CORPORATION

CONDENSEDSTATEMENTS OF CASH FLOWS

For the three months ended March 31,2008 and 2007

(Unaudited)

 
| ** **                                                                            | ** ** | **2008**   | ** ** | **2007**  | ** ** |
|---------------------------------------------------------------------------------------|------------|------------|------------|-----------|------------|
|                                                                                  |       |       |       |      |       |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                              |       |       |       |      |       |
| Net income (loss)                                                                     |       | $          | 1,124,039  |      | $          | (1,528,093 | ) |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities: |       |       |       |      |       |
| Depreciation and amortization                                                         |       | 21,072     |       | 17,735    |       |
| Stock-based compensation                                                              |       | 113,093    |       | 156,442   |       |
| Stock issued for services                                                             |       | 20,000     |       | —    |       |
| (Gain)/loss on change in value of warrant  liability                                  |       | (2,581,939 | )          | 275,863   |       |
| Changes in operating assets and  liabilities:                                         |       |       |       |      |       |
| Prepaid expenses and other current assets                                             |       | (185,026   | )          | 9,131     |       |
| Accounts payable and accrued expenses                                                 |       | (40,286    | )          | 122,210   |       |
| Other assets                                                                          |       | (35,000    | )          | —    |       |
| Net cash used in operating activities                                                 |       | (1,564,047 | )          | (946,712  | )          |
|                                                                                  |       |       |       |      |       |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                             |       |       |       |      |       |
| Sales of short-term investments                                                       |       | 0          |       | 1,000,000 |       |
| Net cash provided by investing activities                                             |       | 0          |       | 1,000,000 |       |
|                                                                                  |       |       |       |      |       |
| Net change in cash and cash equivalents                                               |       | (1,564,047 | )          | 53,288    |       |
| Cash and cash equivalents at beginning of  period                                     |       | 2,423,519  |       | 738,264   |       |
|                                                                                  |       |       |       |      |       |
| Cash and cash equivalents at end of period                                            |       | $          | 859,472    |      | $          | 791,551 |   |

 

The accompanying notes are an integral partof these unaudited condensed financial statements.

 

5

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SUPPLEMENTAL DISCLOSURES OF CASH FLOWINFORMATION:

 

The Company did not pay any cash for interest expense or income taxesduring the three-month periods ended March 31, 2008 and 2007.

 

The accompanying notes are an integral partof these unaudited condensed financial statements.

 

SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCINGACTIVITIES:

 

The Company issued common stock with a fair value of $120,000 on thedate of issuance to a consultant during the three-month period ended March 31,2008.

 

6

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###### **MACROCHEMCORPORATION**

**NOTESTO UNAUDITED CONDENSED FINANCIAL STATEMENTS**

 

**(1)****                                 Basisof Presentation and Operations**

 

The unaudited condensed financial statementsincluded herein have been prepared by MacroChem Corporation (“MacroChem” or the“Company”) without audit, pursuant to the rules and regulations of theSecurities and Exchange Commission. Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to such rules and regulations. Inthe opinion of management, the accompanying unaudited condensed financialstatements include all adjustments (consisting only of normal recurringadjustments) necessary to present fairly the financial position, results ofoperations and cash flows of the Company at the dates and for the periodsindicated. The results disclosed in the Statement of Operations for the three monthsended March 31, 2008 are not necessarily indicative of the results to beexpected for the full year. The unaudited condensed financial statementsincluded herein should be read in conjunction with the audited financialstatements and the notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007.  The condensed balance sheet as of December 31,2007 has been derived from the audited financial statements included in theCompany’s Form 10-K for that year.

 

The Company has been engaged primarily inresearch and development since its inception in 1981 and has derived limitedrevenues from the commercial sale of its products, licensing of certaintechnology and feasibility studies. The Company has had no revenues relating tothe sale of any products currently under development. The Company has incurredlosses from operations every year since its inception and the Companyanticipates that losses will continue for the foreseeable future. At March 31,2008, the Company’s accumulated deficit was $89,723,939. At March 31,2008, the Company believes that its existing cash, cash equivalents andshort-term investments will be sufficient to fund current operations under theCompany’s current plan into the fourth quarter of 2008.  The Company’s continuation as a going concerndepends on its ability to obtain additional financing, to consummate astrategic transaction or to make alternative arrangements to fund itsoperations.  There can be no assurance thatthe Company will be able to obtain additional financing, to consummate astrategic transaction, or to make alternative arrangements to fund itsoperations. The Company’s cash requirements may vary materially from those nowplanned because of changes in the focus and direction of its research anddevelopment programs, identification of additional product candidates andtechnologies, competitive and technical advances, patent developments or otherdevelopments related to the status of fund raising.

 

** (2)****                              Stock-BasedCompensation**

 

*Stock Incentive Plans*

 

The Company has granted options to purchase the Company’s common stockto employees and directors under various stock incentive plans. Under theplans, employees 

 

7

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and non-employee directors are eligible to receive awards of variousforms of equity-based incentive compensation, including stock options,restricted stock, and performance awards, among others. The plans areadministered by the Board of Directors or the Compensation Committee of theBoard of Directors, which determine the terms of the awards granted. Stockoptions are generally granted with an exercise price equal to the market valueof a share of common stock on the date of grant, have a term of ten years orless, and vest over terms of two to three years from the date of grant.

 

*Stock Option Plans*

 

The Company has two stock option plans, the 1994 Equity Incentive Plan(the “1994 Plan”) and the 2001 Incentive Plan (the “2001 Plan”).

 

Under the terms of the 1994 Plan, the Company may no longer award anyoptions. All options previously granted under the 1994 Plan may be exercised atany time up to ten years from the date of award.

 

Under the terms of the 2001 Plan, the Company may grant options topurchase up to a maximum of 2,373,809 shares of common stock to certainemployees, directors and consultants. The options may be awarded as incentivestock options (employees only) and non-incentive stock options (certainemployees, directors and consultants).

 

The 2001 Plan and the 1994 Plan state that the exercise price ofoptions shall not be less than fair market value at the date of grant. As of March 31,2008, there were outstanding options under all plans to purchase 2,546,488shares of common stock with 609,045 shares remaining available for futuregrants under the 2001 Plan.

 

*Stock-Based Compensation*

 

Effective January 1, 2006, the Company adopted FAS No. 123(R),“Accounting for Stock-Based Compensation,” (“FAS 123(R)”) using the modifiedprospective method, which results in the provisions of FAS 123(R) beingapplied to the financial statements on a going-forward basis. FAS 123(R) requirescompanies to recognize stock-based compensation awards granted to its employeesas compensation expense on a fair value method. Under the fair valuerecognition provisions of FAS 123(R), stock-based compensation cost is measuredat the grant date based on the fair value of the award and is recognized asexpense over the service period, which generally represents the vesting period.The grant date fair value of stock options is calculated using theBlack-Scholes option-pricing model and the grant date fair value of restrictedstock is based on fair value on the date of grant.  The expense recognized over the serviceperiod is required to include an estimate of the awards that will be forfeited.

 

All stock-based awards to non-employees are accounted for at their fairmarket value in accordance with FAS 123(R) and Emerging Issues Task Force No. 96-18,“Accounting for Equity Instruments That Are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling, Goods or Services.” Under thismethod, the equity-based instrument was valued at either the fair value of theconsideration received or the equity instrument issued on the date of grant.The resulting compensation cost was recognized and charged to operations overthe service period, which was usually the vesting period.

 

8

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For purposes of recording stock-basedcompensation expense as required by FAS 123(R), the fair values of eachstock option granted under the Company’s stock option plan for the three monthsended March 31, 2007 were estimated as of the date of grant using theBlack-Scholes option-pricing model.

 

The fair values of all stock option grantsissued were determined using the following assumptions:

 

| ** **                              | ** ** | **Three Months Ended  March 31, 2007** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                              | ** ** | ** **                                                 | ** ** |
| Risk-free interest rate                 |       | 4.49                                                       | %          |
| Expected life of option grants          |       | 6 years                                                    |       |
| Expected volatility of underlying stock |       | 113                                                        | %          |
| Expected dividend yield                 |       | 0                                                          | %          |

 

The dividend yield assumption is based on theCompany’s history and expectation of future dividend payouts. The Companyestimated the stock price volatility using the historical volatility in themarket price of its common stock for the expected term of the options. Therisk-free interest rate assumption is based upon the U.S. Treasury yield curvein effect at the time of grant for periods corresponding with the expected lifeof the option.

 

As share-based compensation expense isrecognized based on awards ultimately expected to vest, it must be reduced forestimated forfeitures. FAS 123(R) requires forfeitures to be estimated atthe time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimates. Forfeiture rates are calculated basedon actual historical forfeitures.

 

The expected life of employee stock optionsrepresents the weighted-average period the stock options are estimated toremain outstanding. The expected life of employee stock options is, in part, afunction of the options’ remaining contractual life and the extent to which theoption is in-the-money (i.e., the average stock price during the period isabove the strike price of the stock option).

 

9

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*Stock OptionActivity*

 

Stock option activity for the three months ended March 31, 2008was as follows:

 
| ** **                             | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price  Per Share** | ** ** | **Weighted-Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------|------------|
| **Outstanding December 31, 2007** | ** ** | **3,020,249**              | ** ** | **$**                                                          | **3.90**   | ** **                                         | **8.97**   | ** **                      | **$**      | **—** | ** ** |
|                                   |       |                       |       |                                                           |       |                                               |       |                            |       |
| Granted                                |       | —                     |       | $                                                              | —     |                                               | —     |                            | $          | — |   |
| Exercised                              |       | —                     |       | $                                                              | —     |                                               | —     |                            | $          | — |   |
| Canceled or expired                    |       | (483,761                   | )          | $                                                              | —     |                                               | —     |                            | $          | — |   |
| **Outstanding, March 31, 2008**   |       | 2,536,488                  |       | $                                                              | 4.20       |                                               | 8.71       |                            | $          | — |   |
| Exercisable, March 31, 2008       |       | 1,207,940                  |       | $                                                              | 8.11       |                                               |       |                            | $          |  — |   |
|                                        |            |                            |            |                                                                |            |                                                    |            |                                 |            |  |  |  |

 

*Restricted Stock Activity*

 

On March 7, 2008, the Company issued400,000 shares of common stock to a consultant to the Company for services tobe performed in the first three quarters of 2008.  The common shares vested immediately and werenot subject to forfeiture.  The commonshares had a fair value of $120,000 on the grant date of which $100,000 isincluded in prepaid expenses as of March 31, 2008.

 

**(3)****                                 Commitmentsand Contingencies**

 

Lease Commitments - In accordance with certainoperating lease contracts, in the event that leases are terminated early,approximately $97,850 would be owed as early termination payments.

 

10

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**(4)**                                 **Stockholders’ Equity**

 

*Authorized Capital Stock*

 

Authorized capital stock consists of100,000,000 shares of $.01 par value common stock of which 22,900,026 sharesare issued (22,899,497 are outstanding) and 23,278,733 are reserved forissuance upon exercise of common stock options and warrants at March 31,2008.  Authorized preferred stock totals6,000,000 shares, of which 500,000 shares have been designated Series APreferred Stock, 600,000 shares have been designated Series B PreferredStock and 1,500 shares have been designated Series C CumulativeConvertible Preferred Stock. On March 31, 2008, there were no shares of Series A,B or C Cumulative Preferred Stock outstanding.

 

*Stock Sales*

 

On October 10, 2007, the Company enteredinto a Securities Purchase Agreement, pursuant to which the Company issued in aprivate placement 5,891,667 shares of its common stock and five-year warrantsto purchase 1,767,500 shares of the Company’s common stock at an exercise priceof $0.60 per share, for aggregate gross proceeds of $3,535,000. In connectionwith the private placement, all of the 752.25 then outstanding shares of theCompany’s Series C Cumulative Convertible Preferred Stock were convertedinto a total of 12,571,850 shares of common stock. In addition, outstandingwarrants to purchase 8,648,102 shares of common stock previously issued withthe Series C Preferred have been reset to purchase 17,885,848 shares ofcommon stock at an exercise price of $0.60 per share, pursuant to anti-dilutionprovisions of those warrants.

 

In connection with the private placement, theCompany entered into a Director Designation Agreement dated as of October 1,2007 with SCO Capital Partners, LLC (“SCO”), a current stockholder and apurchaser in the private placement, pursuant to which, for so long as SCO holds20% of the Company’s outstanding common stock, SCO has the right to designatetwo individuals to serve on the Company’s Board of Directors. SCO previouslyheld the right to designate two individuals to serve on the Company’s Board ofDirectors for so long as it held 20% of the Company’s outstanding Series CPreferred.

 

*Warrants*

 

On October 10, 2007, in connection with the conversion of its Series CPreferred Stock to shares of common stock, warrants to purchase 8,648,102 sharesof common stock previously issued with the Series C Preferred Stock havebeen reset to purchase 17,885,847 shares with an exercise price of $.60 pershare pursuant to anti-dilution provisions in the warrants. On February 13,2006, the Company closed a private placement in which institutional investorsreceived six-year warrants to purchase 11,510,018 shares of the Company’scommon stock at an exercise price of $0.60 per share (“Investor Warrants”). Asof March 31, 2008, none of the $0.60 Investor Warrants had been exercised.The placement agent in the transaction received a warrant to purchaseapproximately 959,166 shares of common stock at a purchase price of $0.60 for aperiod of six years (“Placement Agent Warrants”). As of March 31, 2008,none of these $0.60 Placement Agent Warrants had been exercised. On December 23,2005, the Company closed a private placement in which institutional investorsreceived warrants to purchase 4,999,997 shares 

 

11

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of common stock at an exercise price of $0.60 per share for a period ofsix years (“Investor Warrants”). As of March 31, 2008, 37,500 of these$0.60 Investor Warrants had been exercised. The placement agent in thistransaction received a warrant to purchase approximately 416,666 shares ofcommon stock at a purchase price of $0.60 for a period of six years (“PlacementAgent Warrants”).  As of March 31,2008, none of the $0.60 Placement Agent Warrants had been exercised. Inaccordance with EITF 00-19, “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”),the Investor Warrants and the Placement Agent Warrants are included as aliability and valued at fair market value until the Company meets the criteriaunder EITF 00-19 for permanent equity. Changes in the fair value of suchwarrants are recorded as a charge or credit to operations each reportingperiod. The Company valued the Investor Warrants and the Placement AgentWarrants at $1,494,549 on March 31, 2008 using the Black-Scholes modelwith the following assumptions: a risk-free interest rate of 1.62%, volatilityof 113%, expected life of 1 year and a dividend yield of 0%.

 

On October 10, 2007, the Company closed a private placement inwhich institutional investors received warrants to purchase 1,767,500 shares ofcommon stock for a period of five years. The exercise price of the warrants is$0.60 per share. The placement agent also received warrants to purchase 589,166shares of common stock for a period of five years. The exercise price of thesewarrants is $0.60. At March 31, 2008, none of these warrants had beenexercised.

 

On April 19, 2005, the Company closed a private placement in whichinstitutional investors and certain executive officers and directors of theCompany received warrants to purchase 32,520 shares of common stock for aperiod of five years. The exercise price of the warrants is $14.70 per sharefor the institutional investors and $21.84 for the participating executive officersand directors. As of March 31, 2008, 6,012 of the $14.70 warrants issuedto the institutional investors had been exercised and none of the $21.84warrants issued to participating executive officers and directors had beenexercised. The placement agent in this transaction received a warrant topurchase 1,190 shares of common stock at a purchase price of $14.70 for aperiod of five years. As of March 31, 2008, none of the $14.70 warrantsissued to the placement agent had been exercised.

 

During 2004, the Company conducted a private placement in whichprimarily institutional investors received warrants to purchase an aggregate of25,723 shares of common stock at a purchase price of $87.78 per share for aperiod of five years. As of March 31, 2008, none of the $87.78 warrantshad been exercised.

 

**(5)****                                ****Basic and Diluted (Loss) IncomePer Share-**

 

The Company presents “basic” earnings(loss) per share and, if applicable, “diluted” earnings per share pursuantto the provisions of Statement of Financial Accounting Standards No. 128, “Earningsper Share”. Basic earnings (loss) per share is calculated by dividing netincome or loss by the weighted average number of common shares outstandingduring each period. The calculation of diluted earnings per share is similar tothat of basic earnings per share, except that the denominator is increased toinclude the number of additional common shares that would have been outstandingif all potentially dilutive common shares, such as those issuable upon theexercise of outstanding stock options and warrants were issued during the 

 

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period and the treasury stockmethod had been applied to the proceeds from the exercise of the options andwarrants and net income or loss was adjusted for changes in warrantliabilities.

 

As of March 31, 2007, there were options and warrants outstandingfor the purchase of shares of common stock. However, diluted per share amounts presented in the accompanyingcondensed statements of operations for the three months ended March 31,2007 are the same as basic per share amounts because the assumed effects of theexercise of the Company’s options and warrants that were outstanding during allor part of the period would have been anti-dilutive due to the Company being ina net loss position.

 

The table below presents the computation of basic and diluted earningsper common share for the three months ended March 31, 2008:

 

**Basic earnings per share computation**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31, 2008**     | ** ** |
| Numerator:                                        |       |                             |       |
| Net income                                        |       | $                                | 1,124,039  |   |
| Denominator:                                      |       |                             |       |
| Basic weighted average common shares  outstanding |       | 22,606,693                       |       |
| Basic net income per share                        |       | $                                | 0.05       |   |

 

**Diluted earnings per share computation**

 
| ** **                                                                                                                                             | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                             | ** ** | **March 31, 2008**     | ** ** |
| Numerator:                                                                                                                                             |       |                             |       |
| Net income as reported                                                                                                                                 |       | $                                | 1,124,039  |   |
|                                                                                                                                                   |       |                             |       |
| Deduct: Gain on change in value of  warrants liability attributable to warrants issued assumed to have been  exercised at the beginning of period |       | (2,581,939                       | )          |
| Net loss, as adjusted                                                                                                                                  |       | $                                | (1,457,900 | ) |
| Denominator:                                                                                                                                           |       |                             |       |
| Basic weighted average common shares  outstanding                                                                                                      |       | 22,606,693                       |       |
| Incremental shares from assumed conversion:                                                                                                            |       |                             |       |
|                                                                                                                                                   |       |                             |       |
| Exercise of warrants                                                                                                                                   |       | 17,848,897                       |       |
| Diluted weighted average common shares                                                                                                                 |       | 40,455,590                       |       |
| Diluted net loss per share                                                                                                                             |       | $                                | (0.04      | ) |

 

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The following shares of common stock issuable upon the exercise ofstock options, and warrants were excluded from the computation of dilutedincome(loss) per common share because they were anti-dilutive for those periods

 
| ** **                         | ** ** | **Three months ended March 31** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Anti-dilutive warrants and options |       | 3,805,577                                           |       | 18,131,979 |   |

 

**(6)****                                 RecentAccounting Pronouncements**

 

In September 2006, the FASB issued FAS No. 157, “Fair ValueMeasurements” (“FAS 157”). FAS 157 establishes a common definition of fairvalue to be used whenever GAAP requires (or permits) assets or liabilities tobe measured at fair value, and does not expand the use of fair value in any newcircumstances. It also requires expanded disclosure about the extent to whichcompanies measure assets and liabilities at fair value, the information used tomeasure fair value, and the effect of fair value measurements on earnings. On February 12,2008, FASB issued proposed FASB Staff Position No. FAS No. 157-2, “EffectiveDate of FASB Statement No. 157” which defers the effective date for allnonfinancial assets and nonfinancial liabilities, except those that arerecognized or disclosed at fair value in the financial statements on arecurring basis (that is, at least annually) to fiscal years beginning after November 15,2008.  The Company adopted FAS 157 forall financial assets and liabilities required to be measured at fair value on arecurring basis, prospectively from January 1, 2008. The application ofFAS 157 did not have a significant impact on the Company’s financial position,results of operations or cash flows.

 

In February 2007, the FASB issued FAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities – including anamendment of FASB 115” (“FAS 159”) which allows an entity to choose to measurecertain financial instruments and liabilities at fair value. Subsequentmeasurements for the financial instruments and liabilities an entity elects tofair value will be recognized in earnings and this election is irrevocable. FAS159 also establishes additional disclosure requirements. FAS 159 is effectivefor the Company beginning January 1, 2008. The Company has not elected toapply the fair value option to any of its financial instruments.

 

In December 2007, the FASB issued FAS No.141 (revised 2007), “BusinessCombinations” (“FAS 141R”). FAS 141R establishes principles and requirementsfor how an acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any non controllinginterest in the acquiree and the goodwill acquired. FAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. FAS 141R is effective beginning January 1,2009. The Company is currently evaluating the potential impact of the adoptionof FAS 141R on its financial position, results of operations or cash flows.

 

In December 2007, the FASB issued SFAS No.160, “Non ControllingInterests in Consolidated Financial Statements-an amendment of AccountingResearch Bulletin 

 

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No.51” (“FAS 160”). FAS 160 establishes accounting and reportingstandards for ownership interests in subsidiaries held by the parties otherthan parent, the amount of the consolidated net income attributable to theparent and to the non controlling interest, changes in parent’s ownershipinterest, and the valuation of retained non controlling equity investments whena subsidiary is deconsolidated.  FAS 160also establishes disclosure requirements that clearly identify and distinguishbetween the interests of the parent and interests of the non controllingowners. FAS 160 is effective for the Company beginning January 1, 2009.The Company is currently evaluating the potential impact of the adoption of FAS160 on its financial position, results of operations or cash flows.

 

In March 2008, the FASB issued SFAS No. 161 “Disclosuresabout Derivative Instruments and Hedging Activities-an amendment of FASBStatement No. 133” (“FAS 161”). FAS 161 enhances disclosures about theCompany’s derivative and hedging activities and thereby improves thetransparency of financial reporting. FAS 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008. The Company is currently evaluating the potential impact of the adoptionof FAS 161 on its financial position, results of operations or cash flows.

 

**(7)****                                 SubsequentEvents**

 

On April 18, 2008, the Company acquired Virium PharmaceuticalsInc. (“Virium”), a privately held biotechnology company focused primarily ononcology based technology, pursuant to the terms of an Agreement and Plan ofMerger (the “Merger Agreement”) dated as of April 18, 2008 (the “EffectiveTime”) by and among the Company, VRM Acquisition, LLC, a Delaware limitedliability company and a direct wholly-owned subsidiary of the Company (“VRMAcquisition”), Virium and Virium Holdings, Inc., a non-public Delawarecorporation (“Holdings”) and the parent of Virium.  On the Effective Date,VRM Acquisition merged with and into Virium with Virium continuing as thesurviving company and a wholly-owned subsidiary of the Company (the “Merger”). Pursuant to the Merger Agreement, each share of Virium common stockoutstanding at the Effective Time was converted into the right to receive0.89387756 shares of the Company’s common stock (the “Merger Consideration”)resulting in an aggregate of 22,899,206 shares of MacroChem common stock beingissued in the Merger. The fair value of the shares issued on the closingdate to the stockholders of Virium was $6,869,618.

 

On April 22, 2008, James M. Pachence was appointed Chief ExecutiveOfficer of the Company, pursuant to an Employment Agreement of even datetherewith.  Prior to his appointment asChief Executive Officer, Dr. Pachence was appointed a Director of theCompany at the Effective Time of the merger on April 18, 2008.  Dr. Pachence previously served asPresident & Chief Executive Officer of Virium.  Dr. Pachence will continue to serve asChief Executive Officer until his successor is chosen or he is removed fromsuch office by a majority vote of the Board of Directors in accordance with theCompany’s by-laws.

 

On April 22, 2008, David P. Luci was appointed President and ChiefBusiness Officer of the Company.  Mr. Luci, has served as GeneralCounsel, Vice President Corporate 

 

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Development and Corporate Secretary since joining the Company on December 6,2007, Chief Financial Officer since March 19, 2008 and Director ofMacroChem since April 18, 2008.  Upon his appointment as Presidentand Chief Business Officer, Mr. Luci assumed the responsibilities of ChiefOperating Officer and will continue to serve as Chief Financial Officer andGeneral Counsel until his successor is chosen or he is removed from any suchoffice by a majority vote of the Board of Directors in accordance with theCompany’s by-laws.

 

On April 22, 2008, Robert J. DeLuccia was appointed to the officeof Chairman of the Company.  Prior to April 2008,Mr. DeLuccia had served as the Company’s President & ChiefExecutive Officer and Vice Chairman of the Board of Directors from June 2003.

 

Virium has a pipeline of oncology products that target a variety ofniche cancer indications.  Virium’s product pipeline included a nextgeneration nucleoside analogue (small molecule) which it had licensed from theSouthern Research Institute in August 2007.  This class of compoundshas demonstrated proven efficacy in certain hematological cancerindications.  Upon completing the merger,management has commenced a process of conducting a strategic evaluation of eachdrug candidate in the Company’s newly constituted product portfolio.

 

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**Item2.****                              Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Note Regarding Forward Looking Statements**

 

Thisreport and the documents incorporated in this report by reference may contain “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended (the “Exchange Act”). These statements may beidentified by the use of forward-looking words or phrases such as “anticipate,”“believe,” “could,” “expect,” “intend,” “look forward,” “may,” “planned,” “potential,”“should,” “will,” and “would.”  Theseforward-looking statements reflect our current expectations and are based uponcurrently available data. The Private Securities Litigation Reform Act of 1995provides a “safe harbor” for such forward-looking statements. In order tocomply with the terms of the safe harbor, we note that a variety of factorscould cause actual results and experience to differ materially from theanticipated results or other expectations expressed in the forward-lookingstatements. These factors include, but are not limited to: our history ofoperating losses, our decision to discontinue research and developmentactivities and our need for additional external financing; our need forsignificant additional product development efforts and additional financing;technological uncertainty relating to transdermal drug delivery systems; theearly stage of development of our proposed products; the lack of success of ourprior development efforts; uncertainties related to clinical trials of ourproposed products; uncertainties relating to government regulation andregulatory approvals; our dependence on third parties for the FDA applicationprocess; uncertainties regarding market acceptance of our product candidates;uncertainties regarding the potential health risks of hormone replacementtherapies; our ability to identify and obtain rights to products ortechnologies in order to build our portfolio of product candidates; our abilityto recruit additional key employees; our limited personnel and our dependenceon continued access to scientific talent; no assurance of our entering intolicense arrangements; our lack of laboratory facilities and scientificpersonnel and uncertainties regarding our reliance on third parties to conductresearch and development activities for our technologies and productcandidates; uncertainties relating to competition, patents and proprietarytechnology; our dependence on third parties to conduct research and developmentactivities; our dependence on third-party suppliers and manufacturers;uncertainties relating to risks of product liability claims, lack of productliability insurance, and expense and difficulty of obtaining adequate insurancecoverage; our majority shareholders, who own a large portion of our votingstock, could control company decisions and could substantially lower the marketprice of our common stock if they were to sell large blocks of our common stockin the future; uncertainty of pharmaceutical pricing and related matters;volatility of our stock price; the effect that our quotation on the OTCBulletin Board will have on the liquidity of our common stock; and dilution ofour shares as a result of our contractual obligation to issue shares in thefuture. Additional information on these and other factors which could affectthe Company’s actual results and experience are included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007 and,in particular, the section entitled “Risk Factors”.

 

These or other events or circumstances could cause our actualperformance or financial results in future periods to differ materially fromthose expressed in the forward-looking statements. We undertake no obligation tomake any revisions to the forward-looking statements contained in this reportor the documents incorporated by reference in this report, or to update 

 

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the forward-looking statementsto reflect events or circumstances occurring after the date of this report.

 

**General**

 

We are a specialty pharmaceutical company that develops and seeks tocommercialize pharmaceutical products. As of March 31, 2008, our portfolioof proprietary product candidates are based on our drug delivery technologies:SEPA, MacroDerm and DermaPass. Our SEPA topical drug delivery technology (SEPAis an acronym for “Soft Enhancement of Percutaneous Absorption,” where “soft”refers to the reversibility of the skin effect, and “percutaneous” means “throughthe skin”) enhances the efficiency and rate of diffusion of drugs into andthrough the skin. Our patented MacroDerm drug delivery technology encompasses afamily of low to moderate molecular weight polymers that impede dermal drug orchemical penetration. We have also filed a patent application for our DermaPassfamily of transdermal absorption enhancers that have a different drug deliveryprofile than SEPA, which we believe could be used with a wider range of activepharmaceutical ingredients. Our product candidates include two clinical stageinvestigational new drugs: EcoNail, for the treatment of fungal infections ofthe nails and pexiganan, for the treatment of mild diabetic foot infection(DFI). We believe that products incorporating our drug delivery technologiesmay allow selected drugs to be administered more effectively and with improvedpatient compliance compared to alternative methods of drug administration, suchas ingestion and injection.

 

Since inception, we have been engaged primarily in research anddevelopment. We have not generated any meaningful revenues from operations andwe have sustained significant operating losses. We anticipate that we willcontinue to incur significant losses for the foreseeable future. We cannot guaranteethat we will be successful in commercializing our products, or that we willever become profitable. As of March 31, 2008, we had an accumulateddeficit of $89,723,939. Our product candidates are in discovery ordevelopmental stages and must undergo a rigorous regulatory approval process,which includes costly and extensive pre-clinical and clinical testing, todemonstrate safety and efficacy before we can market any resulting product. Todate, neither the FDA nor any of its international equivalents has approved anyof our product candidates for marketing.

 

Our results of operations can vary significantly from year-to-year andquarter-to-quarter, and depend, among other factors, on:

 

·                  the progress ofclinical trials we conduct;

 

·                  the degree ofour research, marketing and administrative efforts;

 

·                  our ability toraise additional capital;

 

·                  the signing oflicenses and product development agreements;

 

·                  the timing ofrevenues recognized pursuant to license agreements; and

 

·                  the achievementof milestones by licensees.

 

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We expect to continue spending funds on developing and seekingregulatory approval of our lead product candidates, EcoNail and pexiganan.Ultimately, if we receive regulatory approval for either product, significantexpenses will be incurred in connection with its commercialization. Inaddition, we also plan to identify and develop, internally, throughin-licensing, or through other collaborative arrangements, additional productcandidates and technologies that fit within our growth strategy. If we identifypotential product candidates, we will incur additional costs in connection withtesting and seeking regulatory approval of those product candidates.

 

On October 10, 2007, the Company entered into a SecuritiesPurchase Agreement, pursuant to which the Company issued in a private placement5,891,667 shares of its common stock and five-year warrants to purchase1,767,500 shares of the Company’s common stock at an exercise price of $0.60 pershare, for aggregate proceeds of $3,535,000. In connection with the privateplacement, all of the 752.25 then outstanding shares of the Company’s Series CCumulative Convertible Preferred Stock were converted into a total of12,571,850 shares of common stock. In addition, outstanding warrants topurchase 8,648,102 shares of common stock previously issued with the Series CPreferred have been reset to purchase 17,885,848 shares of common stock at anexercise price of $0.60 per share, pursuant to anti-dilution provisions ofthose warrants.

 

In connection with the private placement, the Company entered into aDirector Designation Agreement dated as of October 1, 2007 with SCOCapital Partners, LLC (“SCO”), a current stockholder and a purchaser in theprivate placement, pursuant to which, for so long as SCO holds 20% of theCompany’s outstanding common stock, SCO has the right to designate twoindividuals to serve on the Company’s board of directors. SCO previously heldthe right to designate two individuals to serve on the Company’s board ofdirectors for so long as it held 20% of the Company’s outstanding Series CPreferred.

 

We believe that our existing cash, cash equivalents and short terminvestments of $1,618,719 as of March 31, 2008 will be sufficient to meetour current operating plan into the fourth quarter of 2008. The Company’scontinuation as a going concern depends on its ability to obtain additionalfinancing, to consummate a strategic transaction or to make alternativearrangements to fund its operations, which cannot be guaranteed. There can beno assurance that the Company will be able to obtain additional financing, toconsummate a strategic transaction, or to make alternative arrangements to fundits operations. The Company’s cash requirements may vary materially from thosenow planned because of changes in the focus and direction of its research anddevelopment programs, identification of additional product candidates andtechnologies, competitive and technical advances, patent developments or otherdevelopments related to the status of fund raising.

 

*Researchand Development Expenses*. Research and developmentexpenses consist of:

 

·                  payments toconsultants, investigators, contract research organizations and manufacturersin connection with ourpre-clinical and clinical trials;

 

·                  costs associatedwith conducting our clinical trials;

 

·                  costs ofdeveloping and obtaining regulatory approvals; and

 

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·                  allocable costs,including occupancy and depreciation.

 

Because a significant portion of our research and development expenses(including laboratory supplies, travel, dues and subscriptions, temporary helpcosts, consulting costs and allocable costs such as occupancy and depreciation)benefit multiple projects or our drug delivery technologies in general, we donot track these expenses by project. For the three months ended March 31,2008, we spent $511,971 on research and development, including $209,431 incosts associated with the clinical trial for EcoNail, $295,410 in costsassociated with the in-licensing of pexiganan acetate from Genaera, and $7,130in costs not specifically tracked to a project. Opterone was not in a clinicaltrial in 2008. For the three months ended March 31, 2007, we spent $298,448on research and development, including $229,514 in costs associated with theclinical trial for EcoNail, and $68,934 in costs not specifically tracked to aproject. Opterone was not in a clinical trial in 2007. For the year ending December 31,2008, we expect to continue spending funds on product development in amounts tobe determined by management and our Board of Directors.

 

Each of our research and development programs is subject to risks anduncertainties, including the requirement to seek regulatory approval, that areoutside of our control. Moreover, the product candidates identified in theseresearch and development programs, which currently are in developmental stages,must overcome significant technological, manufacturing and marketing challengesbefore they can be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from these projects could be expected to commence orthe completion date of these programs. For example, we are seeking a partner toadvance development of our Opterone product candidate. We cannot predictwhether our efforts to find a partner will be successful nor can we predict themanner and timing in which any eventual partner may elect to pursue developmentof Opterone. In addition, these risks and uncertainties also prevent us fromestimating with any certainty the specific timing and future costs of ourclinical development programs, although historical trends at similarly situatedcompanies indicate that research and development expenses tend to increase inlater stages of clinical development. Our failure to obtain requisitegovernmental approvals timely or at all will delay or preclude us fromlicensing or marketing our products or limit the commercial use of ourproducts, which could adversely affect our business, financial condition andresults of operations.

 

*Marketing, General and AdministrativeExpenses*. Marketing, general and administrativeexpenses consist primarily of salaries and other related costs for personnel,marketing and promotion, professional fees and facilities costs. Assuming weare able to raise sufficient capital, we anticipate that marketing, general andadministrative expenses will increase over the next several years as we begin,when appropriate, to license, partner, or market our product candidates if andwhen they receive regulatory approval.

 

**Critical Accounting Policies and Estimates**

 

Our discussion and analysis of our financial condition and results ofoperations are based on our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses. The following is a brief discussion of themore significant accounting 

 

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policies and methods thataffect the judgments and estimates used in the preparation of our financialstatements.

 

*Research and Development*.Research and development costs are expensed as incurred.

 

*Patent Assets*. Wedefer costs and expenses incurred in connection with pending patent applications.We amortize costs related to successful patent applications over the estimateduseful lives of the patents using the straight-line method. We chargeaccumulated patent costs and deferred patent application costs related topatents that are considered to have limited future value to operations.Estimates we use to determine the future value of deferred patent costs includeanalysis of potential market size, time and cost to complete clinical trials,anticipated interest in our products and potential value for licensing orpartnering opportunities.

 

*Deferred Taxes*. Aspart of the process of preparing our financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatments of itemsfor tax and accounting purposes. We have recorded a valuation allowance tofully offset against these otherwise recognizable net deferred tax assets dueto the uncertainty surrounding the timing of the realization of the taxbenefit. In the event that we determine in the future that we will be able torealize all or a portion of the net deferred tax benefit, an adjustment todeferred tax valuation allowance would increase net income in the period inwhich such a determination is made. The utilization of net operating losscarryforwards and credits available to be used in any given year may be limitedin the event of significant changes in ownership interest, as defined.

 

*Warrant Liability.*Basedon certain terms in the warrants that we issued in connection with the sale ofour Series C Cumulative Convertible Preferred Stock, we determined thatthe warrants should be classified as a liability and valued at fair marketvalue each reporting period, with the changes in fair value recorded inearnings, in accordance with EITF 00-19, “Accounting for Derivative FinancialInvestments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  We will continue to evaluate the warrantsunder EITF 00-19 to determine when, if ever, they meet certain criteria underEITF 00-19 for permanent equity.

 

*Stock-Based Compensation.* On January 1, 2006, the Company adoptedStatement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment,” using the modified prospective method, which requires measurement ofcompensation cost for all stock awards at fair value on the date of grant andrecognition of compensation over the requisite service period for awardsexpected to vest. The fair value of stock options is estimated using theBlack-Scholes valuation model, and the fair value of restricted stock units isdetermined based on the number of shares granted and the quoted price of theCompany’s common stock on the date of grant. Such value is recognized asexpense over the requisite service period, net of estimated forfeitures, usingthe straight-line attribution method. The estimate of awards that willultimately vest requires significant judgment, and to the extent actual resultsor updated estimates differ from the Company’s current estimates, such amountswill be recorded as a cumulative adjustment in the period estimates arerevised. The Company considers many factors when estimating expectedforfeitures, including types of awards, employee class and historical employeeattrition rates. Actual results, and future changes in estimates, may differsubstantially from the Company’s current estimates.

 

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**Results of Operations**

 

We had no revenues for the three month period ended March 31,2008. For the year ending December 31, 2008 and the foreseeable future, wedo not expect to have any revenues.

 

For the three month period ended March 31, 2008, research anddevelopment costs increased by $213,523, or 71.5% to $511,971 from $298,448 inthe three month period ended March 31, 2007. The increase is primarilyattributable to the in licensing costs of the pexiganan acetate product of$295,410, offset in part by a decrease in spending on the EcoNail clinicaltrial of $20,083 in the three month period ended March 31, 2008 comparedwith the same period in 2007. There was also a decrease in general research anddevelopment costs of approximately $61,804 for the three months ended March 31,2008.

 

For the three month period ended March 31, 2008, marketing,general and administrative costs decreased by $32,749, or 3.3% to $971,563 from$1,004,312 in the three month period ended March 31, 2007.

 

Other income and expense increased by $2,832,906 due to a gain of$2,607,573 in the three month period ended March 31, 2008 compared with aloss of $225,333 in the three month period ended March 31, 2007. Theincrease is primarily attributable to an increase in the gain associated withthe change in value of the warrant liability of $2,581,939 for the three monthperiod ended March 31, 2008. Interest income decreased by $15,362, or44.5% to $19,168 in the three month period ended March 31, 2008 from$34,530 in the three month period ended March 31, 2007. The decrease ininterest expense is due to less cash available for investing purposes duringthe three month period ended March 31, 2007.

 

For the reasons described above, the Company’sfinancial statements reflect net income of $1,124,039 in the three month periodended March 31, 2008 compared with a net loss of $1,528,093 in the threemonth period ended March 31, 2008.

 

**Liquidity and Capital Resources**

 

Since inception, our primary source of funding for our operations hasbeen the private and public sale of our securities, and, to a lesser extent,the licensing of our proprietary technology and products, researchcollaborations, feasibility studies, government grants and the limited sales ofproducts and test materials.

 

At March 31, 2008, working capital was approximately $1.7 million,compared to $2.9 million at December 31, 2007. The decrease in our workingcapital reflects use of funds for operations.

 

On October 10, 2007, the Company entered into a SecuritiesPurchase Agreement, pursuant to which the Company issued in a private placement5,891,667 shares of its common stock and five-year warrants to purchase1,767,500 shares of the Company’s common stock at an exercise price of $0.60per share, for gross proceeds of $3,535,000 ($3,046,245 net of issuance costs).In connection with the private placement, all of the 752.25 then outstandingshares of the Company’s Series C Cumulative Convertible Preferred Stockwere converted into a total of 

 

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12,571,850 shares of commonstock. In addition, outstanding warrants to purchase 8,648,102 shares of commonstock previously issued with the Series C Preferred have been reset topurchase 17,885,848 shares of common stock at an exercise price of $0.60 pershare, pursuant to anti-dilution provisions of those warrants.

 

In connection with the private placement, the Company entered into aDirector Designation Agreement dated as of October 1, 2007 with SCOCapital Partners, LLC (“SCO”), a current stockholder and a purchaser in theprivate placement, pursuant to which, for so long as SCO holds 20% of theCompany’s outstanding common stock, SCO has the right to designate twoindividuals to serve on the Company’s board of directors. SCO previously heldthe right to designate two individuals to serve on the Company’s Board ofDirectors for so long as it held 20% of the Company’s outstanding Series CPreferred.

 

Until such time as we obtain agreements with third-party licensees orpartners to provide funding for our anticipated business activities, orotherwise generate revenue from the commercialization of our products, we willuse our working capital to fund our operating activities.

 

As of March 31, 2008, we had $1,618,719 in cash, cash equivalentsand short-term investments. We believe that our existing cash, cash equivalentsand short-term investments will be sufficient to meet our current operatingplan into the fourth quarter of 2008. The Company’s continuation as a going concern depends on its ability toobtain additional financing, to consummate a strategic transaction or to makealternative arrangements to fund its operations, which cannot be guaranteed.Our cash requirements may vary materially from those now planned because ofchanges in the focus and direction of our research and development programs,competitive and technical advances, patent developments or other developments.To continue to operate, the Company will require significant additionalfunding. The Company is assessing opportunities to raise capital and expects tocontinue financing operations through sales of securities, strategic alliancesand other financing vehicles, if any, that might become available to theCompany on terms that it deems acceptable. The Company cannot assure thatsufficient funds will be available to the Company, if they are available atall, to enable the Company to continue to operate. The financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

We do not enter into financial instrument transactions for trading orspeculative purposes. We do not intend to establish any special purpose entityand do not have any material off balance sheet financing transactions. We donot believe that inflation will have any significant effect on the results ofour operations.

 

**Recent Accounting Pronouncements**

** **

In September 2006, the FASB issued FAS No. 157, “Fair ValueMeasurements” (“FAS 157”). FAS 157 establishes a common definition of fairvalue to be used whenever GAAP requires (or permits) assets or liabilities tobe measured at fair value, and does not expand the use of fair value in any newcircumstances. It also requires expanded disclosure about the extent to whichcompanies measure assets and liabilities at fair value, the information used tomeasure fair value, and the effect of fair value measurements on earnings. On February 12,2008, the FASB issued proposed FASB Staff Position No. FAS No. 157-2,“Effective Date of FASB Statement 

 

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No. 157” which defers theeffective date for all nonfinancial assets and nonfinancial liabilities, exceptthose that are recognized or disclosed at fair value in the financialstatements on a recurring basis (that is, at least annually) to fiscal yearsbeginning after November 15, 2008. The Company adopted FAS 157 for allfinancial assets and liabilities required to be measured at fair value on arecurring basis, prospectively from January 1, 2008. The application ofFAS 157 did not have a significant impact on the Company’s financial position,results of operations or cash flows.

 

In February 2007, the FASB issued FAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities – including anamendment of FASB 115” (“FAS 159”), which allows an entity to choose to measurecertain financial instruments and liabilities at fair value. Subsequentmeasurements for the financial instruments and liabilities an entity elects tofair value will be recognized in earnings and this election is irrevocable. FAS159 also establishes additional disclosure requirements. FAS 159 is effectivefor the Company beginning January 1, 2008. The Company has not elected toapply the fair value option to any of its financial instruments.

 

In December 2007, the FASB issued FAS No.141 (revised 2007), “BusinessCombinations” (“FAS 141R”). FAS 141R establishes principles and requirementsfor how an acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any non controllinginterest in the acquiree and the goodwill acquired. FAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financialeffects of the business combination. FAS 141R is effective beginning January 1,2009. The Company is currently evaluating the potential impact of the adoptionof FAS 141R on its financial position, results of operations or cash flows.

 

In December 2007, the FASB issued SFAS No. 160, “NonControlling Interests in Consolidated Financial Statements-an amendment ofAccounting Research Bulletin No.51” (“FAS 160”). FAS 160 establishes accountingand reporting standards for ownership interests in subsidiaries held by theparties other than parent, the amount of the consolidated net incomeattributable to the parent and to the non controlling interest, changes inparent’s ownership interest, and the valuation of retained non controllingequity investments when a subsidiary is deconsolidated. FAS 160 alsoestablishes disclosure requirements that clearly identify and distinguishbetween the interests of the parent and interests of the non controllingowners. FAS 160 is effective for the Company beginning January 1, 2009.The Company is currently evaluating the potential impact of the adoption of FAS160 on its financial position, results of operations or cash flows.

 

In March 2008, the FASB issued SFAS No.161, “Disclosures aboutDerivative Instruments and Hedging Activities-an amendment of FASB StatementNo.133” (“FAS 161”). FAS161 enhances disclosures about the Company’s derivativeand hedging activities and thereby improves the transparency of financialreporting. FAS 161 is effective for financial statements issued for fiscalyears and interim periods beginning after November 15, 2008. The Companyis currently evaluating the potential impact of the adoption of FAS 161 on itsfinancial position, results of operations or cash flows.

 

**In December 2007, the FASBissued FAS No. 160, “Noncontrolling Interests in Consolidated FinancialStatements-an amendment of Accounting Research Bulletin No. 51”**

 

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** **

**(“FAS 160”). FAS 160 clarifies the classification ina company’s consolidated balance sheet and the accounting for and disclosure oftransactions between the company and holders of noncontrolling interests. FAS160 is effective for the Company January 1, 2009. Early adoption is notpermitted. The Company does not expect the adoption of FAS 160 to have amaterial impact on its financial statements upon adoption.**

** **

**Subsequent Events.**

** **

On April 18, 2008, the Company acquired Virium PharmaceuticalsInc. (“Virium”), a privately held biotechnology company focused primarily ononcology based technology, pursuant to the terms of an Agreement and Plan of Merger(the “Merger Agreement”) dated as of April 18, 2008 (the “Effective Time”)by and among the Company, VRM Acquisition, LLC, a Delaware limited liabilitycompany and a direct wholly-owned subsidiary of the Company (“VRM Acquisition”),Virium and Virium Holdings, Inc., a non-public Delaware corporation (“Holdings”)and the parent of Virium.  On the Effective Date, VRM Acquisition mergedwith and into Virium with Virium continuing as the surviving company and awholly-owned subsidiary of the Company (the “Merger”).  Pursuant to theMerger Agreement, each share of Virium common stock outstanding at theEffective Time was converted into the right to receive 0.89387756 shares of theCompany’s common stock (the “Merger Consideration”) resulting in an aggregateof 22,899,206 shares of MacroChem common stock being issued in theMerger. The fair value of the shares issued on the closing date to thestockholders of Virium was $6,869,618.

 

**On April 22, 2008, James M.Pachence was appointed Chief Executive Officer of the Company, pursuant to anEmployment Agreement of even date therewith. Prior to his appointment as Chief Executive Officer, Dr. Pachencewas appointed a Director of the Company at the Effective Time of the merger on April 18,2008.  Dr. Pachence previouslyserved as President & Chief Executive Officer of Virium.  Dr. Pachence will continue to serve asChief Executive Officer until his successor is chosen or he is removed fromsuch office by a majority vote of the Board of Directors in accordance with theCompany’s by-laws.**

** **

**On April 22, 2008, David P.Luci was appointed President and Chief Business Officer of the Company.  Mr. Luci,has served as General Counsel, Vice President Corporate Development andCorporate Secretary since joining the Company on December 6, 2007, ChiefFinancial Officer since March 19, 2008 and Director of MacroChem since April 18,2008.  Upon his appointment as President and Chief Business Officer, Mr. Luciassumed the responsibilities of Chief Operating Officer and will continue toserve as Chief Financial Officer and General Counsel until his successor ischosen or he is removed from any such office by a majority vote of the Board ofDirectors in accordance with the Company’s by-laws.**

** **

**On April 22, 2008, Robert J.DeLuccia was appointed to the office of Chairman of the Company.  Prior to April 2008, Mr. DeLucciahad served as the Company’s President & Chief Executive Officer andVice Chairman of the Board of Directors from June 2003.**

** **

Virium has a pipeline of oncology products that target a variety ofniche cancer indications.  Virium’s product pipeline included a nextgeneration nucleoside analogue (small molecule) which it had licensed from theSouthern Research Institute in August 2007.  This class of compoundshas demonstrated proven efficacy in certain hematological cancerindications.  

 

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Upon completing the merger,management has commenced a process of conducting a strategic evaluation of eachdrug candidate in the Company’s newly constituted product portfolio.

 

**Item 3. Quantitative and QualitativeDisclosures about Market Risk**

 

**Cash, Cash Equivalents and Short-TermInvestments**

** **

As of March 31, 2008, we were exposed to market risks, whichrelate primarily to changes in U.S. interest rates. Our cash equivalents andshort-term investments are subject to interest rate risk and will decline invalue if interest rates increase. Due to the short duration of these financialinstruments, generally one year or less, changes in interest rates would nothave a material effect on our financial position. A hypothetical 10% change ininterest rates would not have a material effect on our Statement of Operationsor Cash Flows for the three months ended March 31, 2008.

 

**Item 4. Controls and Procedures**

 

As of the end of the period covered by this report, we carried out areview, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures (as defined in the SEC rules promulgatedunder the Securities Exchange Act of 1934, as amended), which are designed toensure that information required to be disclosed in our Securities and ExchangeCommission reports is properly and timely recorded, processed, summarized andreported. Based upon that review, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures are noteffective in timely alerting them to material information required to beincluded in our periodic filings with the Securities and Exchange Commissionand that there is a lack of segregation of duties at the Company due to thesmall number of employees dealing with general administrative and financialmatters. This constitutes a material weakness in financial reporting. However,management has addressed these issues, in part, by appointing a financialcontroller who will begin employment with the Company in May 2008.  Management will continue to evaluate the segregationof duties specifically and the finance and accounting function generally.

 

There were no changes in our internal control over financial reportingthat occurred during the quarter ended March 31, 2008 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting. Notwithstanding the foregoing, on March 19, 2008, Mr. Patriacca,our then-current CFO, retired and was replaced by David P. Luci as the Company’sChief Financial Officer.  On April 22,2008, Mr. Luci was appointed to the position of President & ChiefBusiness Officer, a post which includes the functions of Chief OperatingOfficer, Chief Financial Officer & General Counsel.

 

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** **

**PART II– OTHER INFORMATION**

** **

**Item 1A.         Risk Factors.**

** **

Except as set forth below, there have been no material changes to therisk factors included in Item 1A of Part I of our annual Report on Form 10-Kfor the year ended December 31, 2007.

 

***Federal regulatory reforms may createadditional burdens that would cause us to incur additional costs and mayadversely affect our ability to commercialize our products.***

 

From time to time, legislationis drafted, introduced and passed in Congress that could significantly changethe statutory provisions governing the approval, manufacturing and marketing ofproducts regulated by the FDA. For example, on September 27, 2007, theFood and Drug Administration Amendments Act of 2007 (the “FDAAA”) was enacted,giving the FDA enhanced post-market authority, including the authority torequire post-market studies and clinical trials, labeling changes based on newsafety information, and compliance with a risk evaluation and mitigationstrategy approved by the FDA. The FDA’s post-market authority takes effect 180days after the enactment of the law. Failure to comply with any requirementsunder the FDAAA may result in significant penalties. The FDAAA also authorizessignificant civil money penalties for the dissemination of false or misleadingdirect-to-consumer advertisements and allows the FDA to require companies tosubmit direct-to-consumer television drug advertisements for FDA review priorto public dissemination. Additionally, the new law expands the clinical trialregistry so that sponsors of all clinical trials, except for Phase I trials,are required to submit certain clinical trial information for inclusion in theclinical trial registry data bank. In addition to the FDAAA, FDA regulationsand guidance are often revised or reinterpreted by the agency in ways that maysignificantly affect our business and our products. It is impossible to predictwhether further legislative changes will be enacted, or FDA regulations,guidance or interpretations will change, and what the impact of such changes,if any, may be.

 

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** **

**Item 6.        Exhibits.**

** **

The followingis a list of exhibits to this Quarterly Report on Form 10-Q:

 
| 10.1   |   | Employment Agreement,  dated April 22, 2008, by and between the registrant and Dr. James  Pachence.                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                  |
| 10.2   |   | Employment Agreement,  dated April 22, 2008, by and between the registrant and David P.  Luci, Esq.                                                                                         |
|   |   |                                                                                                                                                                                                  |
| 31.1   |   | Certification of  Principal Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                        |
|   |   |                                                                                                                                                                                                  |
| 31.2   |   | Certification of  Principal Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                        |
|   |   |                                                                                                                                                                                                  |
| 32.1   |   | Certification of  Principal Executive Officer Pursuant to Section 1350, Chapter 63 of  Title 18, United States Code, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                  |
| 32.2   |   | Certification of  Principal Financial Officer Pursuant to Section 1350, Chapter 63 of  Title 18, United States Code, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, asamended, the Registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 
|              | MacroChem Corporation                                      |
|-------------------|------------------------------------------------------------|
|              | (Registrant)                                               |
|              |                                                       |
| May 14, 2008 |  /s/  James Pachence                        |
|              |  James Pachence    (Principal Executive Officer) |
|              |                                                       |
|              |  /s/  David P. Luci                         |
|              |  David P. Luci  (Principal Financial Officer)    |

 

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**EXHIBITINDEX**

 

The following is a list of exhibits to thisQuarterly Report on Form 10-Q:

 
| 10.1   |   | Employment Agreement, dated April 22, 2008, by and between the  registrant and Dr. James Pachence.                                                                                         |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                 |
| 10.2   |   | Employment Agreement, dated April 22, 2008, by and between the  registrant and David P. Luci, Esq.                                                                                         |
|   |   |                                                                                                                                                                                                 |
| 31.1   |   | Certification of Principal Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                        |
|   |   |                                                                                                                                                                                                 |
| 31.2   |   | Certification of Principal Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                        |
|   |   |                                                                                                                                                                                                 |
| 32.1   |   | Certification of Principal Executive Officer Pursuant to  Section 1350, Chapter 63 of Title 18, United States Code, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                 |
| 32.2   |   | Certification of Principal Financial Officer Pursuant to  Section 1350, Chapter 63 of Title 18, United States Code, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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