##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-QSB

x
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2003ORo
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from  to


Commission file number 0-16686

Chiral Quest, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Minnesota
(State or other jurisdiction of
incorporation or organization)
    
    58-1486040
(I.R.S. Employer Identification No.)


1981 Pine Hall Drive, State College, Pennsylvania 16801
(Address of principal executive offices)

(814) 234-5054
(Issuers telephone number)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

As of November 14, 2003, there were 13,001,018 shares of the issuers common
stock, $.01 par value, outstanding.





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TABLE OF CONTENTS



|                                                                  |               |  |  |  |  |  |  | 
|----------------------------------------------------------------- | ------------- |  |  |  |  |  |  | 
|PART I FINANCIAL INFORMATION                                     
|Item 1. Condensed Consolidated Financial Statements              
|Item 2. Managements Discussion and Analysis or Plan of Operation
|                                                                  | Risk Factors 
|Item 3. Controls and Procedures                                  
|PART II OTHER INFORMATION                                        
|Item 1. Legal Proceedings                                        
|Item 6. Exhibits and Reports on Form 8-K                         
|                                                                  | Signatures   
|                                                                  | Exhibit Index
|EX-31.1 Certification of CEO and CFO                             
|EX-32.1 Certification Pursuant to Section 906                    



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##### Table of Contents



Index

PagePART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Financial Statements
    
    3Item 2.
    
    Managements Discussion and Analysis
or Plan of Operation
    
    20Risk Factors
    
    27Item 3.
    
    Controls and Procedures
    
    34PART II
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    35Item 6.
    
    Exhibits and Reports on Form 8-K
    
    35Signatures
    
    36Exhibit Index
    
    37


Forward-Looking Statements

The statements contained in this Quarterly Report on Form 10-QSB that are
not historical are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, including statements regarding the
expectations, beliefs, intentions or strategies regarding the future. We
intend that all forward-looking statements be subject to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. In
particular, the Managements Discussion and Analysis or Plan of Operation
section in Part I, Item 2 of this quarterly report include forward-looking
statements that reflect our current views with respect to future events and
financial performance. We use words such as we expect, anticipate,
believe, and intend and similar expressions to identify forward-looking
statements. A number of important factors could, individually or in the
aggregate, cause actual results to differ materially from those expressed or
implied in any forward-looking statements. Such factors include, but are not
limited to the risks identified under the section entitled Risk Factors
following Item 2 in Part I of this Report.

2



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PART I  FINANCIAL INFORMATION







Item 1. Financial Statements

CHIRAL QUEST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

September 30,2003
    
    
    December 31,(Unaudited)
    
    
    2002ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    918,998
    
    
    $
    33,520Accounts receivable, net of allowance for doubtful accounts of $50,000 at September 30,
2003 and December 31, 2002
    
    
    101,374
    
    
    
    12,456Inventory
    
    
    82,481
    
    
    
    28,422Prepaid expenses
    
    
    61,637
    
    
    
    Total Current Assets
    
    
    1,164,490
    
    
    
    74,398PROPERTY, PLANT AND EQUIPMENT, NET
    
    
    236,341
    
    
    
    67,011SECURITY DEPOSITS
    
    
    21,000
    
    
    
    INTELLECTUAL PROPERTY RIGHTS, NET
    
    
    375,451
    
    
    
    318,320TOTAL ASSETS
    
    $
    1,797,282
    
    
    $
    459,729LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY)CURRENT LIABILITIESAccounts payable
    
    $
    79,449
    
    
    $
    111,832Accrued expenses and other
    
    
    79,984
    
    
    
    105,377Due to related party
    
    
    8,664
    
    
    
    Notes payable
    
    
    
    
    
    
    336,625Deferred revenue, current portion
    
    
    227,800
    
    
    
    133,967Total Current Liabilities
    
    
    395,897
    
    
    
    687,801LONG-TERM LIABILITIESDeferred revenue, long-term portion
    
    
    72,608
    
    
    
    173,083Total Long-Term Liabilities
    
    
    72,608
    
    
    
    173,083TOTAL LIABILITIES
    
    
    468,505
    
    
    
    860,884COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY (DEFICIENCY)Common stock, $.01 par value, 50,000,000 authorized, 13,001,018 and 8,652,298 issued and
outstanding at September 30, 2003 and December 31, 2002, respectively
    
    
    130,010
    
    
    
    86,523Additional paid-in capital
    
    
    4,924,993
    
    
    
    1,261,527Deferred consulting expense
    
    
    (882,386
    )
    
    
    (356,400
    )Accumulated deficit
    
    
    (2,843,840
    )
    
    
    (1,392,805
    )Total Stockholders Equity (Deficiency)
    
    
    1,328,777
    
    
    
    (401,155
    )TOTAL LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY)
    
    $
    1,797,282
    
    
    $
    459,729


See accompanying notes to condensed
consolidated financial statements.

3



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CHIRAL QUEST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)

For the Three
    
    
    For the Three
    
    
    For the Nine
    
    
    For the NineMonths Ended
    
    
    Months Ended
    
    
    Months Ended
    
    
    Months EndedSeptember 30,
    
    
    September 30,
    
    
    September 30,
    
    
    September 30,2003
    
    
    2002
    
    
    2003
    
    
    2002REVENUE
    
    $
    83,068
    
    
    $
    48,089
    
    
    $
    214,509
    
    
    $
    159,573COST OF GOODS SOLD
    
    
    (37,321
    )
    
    
    (1,307
    )
    
    
    (62,708
    )
    
    
    (6,763
    )GROSS MARGIN
    
    
    45,747
    
    
    
    46,782
    
    
    
    151,801
    
    
    
    152,810OPERATING EXPENSESManagement and consulting
    
    
    128,691
    
    
    
    46,675
    
    
    
    254,700
    
    
    
    166,475Research and development
    
    
    76,995
    
    
    
    1,061
    
    
    
    283,470
    
    
    
    47,597Selling, general and administrative
    
    
    230,705
    
    
    
    30,966
    
    
    
    654,071
    
    
    
    67,094Compensation
    
    
    138,205
    
    
    
    32,715
    
    
    
    355,925
    
    
    
    123,346Depreciation and amortization
    
    
    22,032
    
    
    
    7,481
    
    
    
    64,672
    
    
    
    28,548Total Operating Expenses
    
    
    596,628
    
    
    
    118,898
    
    
    
    1,612,838
    
    
    
    433,060LOSS FROM OPERATIONS
    
    
    (550,881
    )
    
    
    (72,116
    )
    
    
    (1,461,037
    )
    
    
    (280,250
    )INTEREST EXPENSE
    
    
    
    
    
    
    (302
    )
    
    
    (2,809
    )
    
    
    (302
    )INTEREST INCOME
    
    
    2,323
    
    
    
    
    
    
    
    12,811
    
    
    
    NET LOSS
    
    $
    (548,558
    )
    
    $
    (72,418
    )
    
    $
    (1,451,035
    )
    
    $
    (280,552
    )NET LOSS PER COMMON SHARE  BASIC
AND DILUTED
    
    $
    (.04
    )
    
    $
    (.01
    )
    
    $
    (.12
    )
    
    $
    (.03
    )WEIGHTED AVERAGE SHARES OUTSTANDING
 BASIC AND DILUTED
    
    
    13,001,018
    
    
    
    8,652,298
    
    
    
    12,324,550
    
    
    
    8,276,114


See accompanying notes to condensed
consolidated financial statements.

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CHIRAL QUEST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY
(DEFICIENCY) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(UNAUDITED)

Additional
    
    
    DeferredCommon Stock
    
    
    Paid-In
    
    
    Consulting
    
    
    Accumulated
    
    
    Total EquityShares
    
    
    Amount
    
    
    Capital
    
    
    Expense
    
    
    Deficit
    
    
    (Deficiency)Balance, December 31, 2002
    
    
    8,652,298
    
    
    $
    86,523
    
    
    $
    1,261,527
    
    
    $
    (356,400
    )
    
    $
    (1,392,805
    )
    
    $
    (401,155
    )Recapitalization of the Company (See Note 1(A))
    
    
    4,348,720
    
    
    
    43,487
    
    
    
    2,964,211
    
    
    
    
    
    
    
    
    
    
    
    3,007,698Options issued for services and rent
    
    
    
    
    
    
    
    
    
    
    699,255
    
    
    
    (689,410
    )
    
    
    
    
    
    
    9,845Amortization of deferred consulting expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    163,424
    
    
    
    
    
    
    
    163,424Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,451,035
    )
    
    
    (1,451,035
    )BALANCE, SEPTEMBER 30, 2003
    
    
    13,001,018
    
    
    $
    130,010
    
    
    $
    4,924,993
    
    
    $
    (882,386
    )
    
    $
    (2,843,840
    )
    
    $
    1,328,777


See accompanying notes to condensed
consolidated financial statements.

5



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CHIRAL QUEST, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)

For the Nine
    
    
    For the NineMonths Ended
    
    
    Months EndedSeptember 30,
    
    
    September 30,2003
    
    
    2002CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (1,451,035
    )
    
    $
    (280,552
    )Adjustments to reconcile net loss to net cash (used in) provided
by operating activities:Depreciation and amortization
    
    
    64,672
    
    
    
    28,548Amortization of deferred consulting expense
    
    
    163,424
    
    
    
    97,200Changes in operating assets and liabilities:
    
    
    
    
    
    
    (7,741
    )(Increase) decrease in accounts receivable
    
    
    (88,918
    )
    
    
    (287
    )(Increase) in inventory
    
    
    (54,059
    )
    
    
    (Increase) in prepaid expenses
    
    
    (51,792
    )
    
    
    (Increase) in security deposit
    
    
    (21,000
    )
    
    
    Increase (decrease) in accounts payable
    
    
    (32,383
    )
    
    
    16,876Increase (decrease) in accrued expenses and due to related party
    
    
    (26,274
    )
    
    
    (98,964
    )(Decrease) increase in deferred revenue
    
    
    (6,642
    )
    
    
    306,465Net Cash (Used In) Provided By Operating Activities
    
    
    (1,504,007
    )
    
    
    61,545CASH FLOWS FROM INVESTING ACTIVITIES:Proceeds from sale of equipment
    
    
    
    
    
    
    8,366Payments for purchased property, plant and equipment
    
    
    (203,888
    )
    
    
    Payments for intellectual property rights
    
    
    (87,245
    )
    
    
    (128,747
    )Net Cash Used In Investing Activities
    
    
    (291,133
    )
    
    
    (120,381
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from notes payable
    
    
    40,000
    
    
    
    156,625Payment of notes payable
    
    
    (376,625
    )
    
    
    Exercise of unit options
    
    
    
    
    
    
    7,500Payment of loans payable
    
    
    
    
    
    
    (50,000
    )Cash received in merger and recapitalization
    
    
    3,017,243
    
    
    
    Net Cash Provided By Financing Activities
    
    
    2,680,618
    
    
    
    114,125NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    885,478
    
    
    
    55,289CASH AND CASH EQUIVALENTS  BEGINNING OF PERIOD
    
    
    33,520
    
    
    
    45,008CASH AND CASH EQUIVALENTS  END OF PERIOD
    
    $
    918,998
    
    
    $
    100,297


SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

During the nine months ended September 30, 2003, the Company issued 8,652,298
shares of common stock related to the merger (See Note 1(A). In connection
with the merger, the Companys accrued expenses, common stock and additional
paid-in capital (APIC) were increased by $9,545, $43,487 and $2,964,211,
respectively. In addition, $9,845 was charged to Prepaid Rent and credited to
APIC for the value of 20,000 options issued to a landlord under a new lease
agreement signed in May 2003 and $689,410 was charged to Deferred Consulting in
the nine months ended September 2003 and credited to APIC for the value of
790,052 options issued to consultants, scientific advisory board members and
directors (See Note 5).

See accompanying notes to condensed
consolidated financial statements.

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



|NOTE 1 |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS
|------ |  | -------------------------------------------------------------------



| |  | (A) Nature of Operations
| |  | ------------------------



| |  | On February 18, 2003, Chiral Quest, LLC merged (the Merger) with and into
CQ Acquisition, Inc., a wholly owned subsidiary of Surg II, Inc. (Surg), a
reporting public corporation with no current operations. Each membership
interest of Chiral Quest, LLC issued and outstanding on February 18, 2003
(Effective Date) was automatically converted into 0.752374 shares of Surg
common stock. There were 4,348,720 shares of Surg common stock issued and
outstanding and options to purchase an additional 682,875 shares immediately
prior to the Effective Date. At the Effective Date, Chiral Quest, LLC had
11,500,000 member equity units outstanding. Accordingly, as a result of the
Merger, Surg issued 8,652,298 shares of its common stock to the former
members of Chiral Quest, LLC. In addition, immediately prior to the
Effective Date, there were non-vested contingent options and warrants
outstanding to purchase an aggregate of up to 1,210,000 of Chiral Quest
LLCs member equity units, which following the Merger represented the right
to purchase an aggregate of up to 910,374 shares of Surg common stock at
$1.49 per share. In connection with the Merger, Surg changed its name to
Chiral Quest, Inc. (together with its subsidiaries, the Company or Chiral
Quest).
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Generally accepted accounting principles in the United States of America
require the company whose equity holders retain a majority interest in a
business combination be treated as the acquiror for accounting purposes.
Since, following the Merger, the former members of Chiral Quest, LLC held
approximately two-thirds of the outstanding common stock of the Company, the
Merger was accounted for as a reverse acquisition with Chiral Quest, LLC as
the accounting acquiror (legal acquiree) and Surg as the accounting acquiree
(legal acquiror). Accordingly, when we discuss financial and other
information of the Company or Chiral Quest relating to periods prior to
the Merger, we are referring to Chiral Quest, LLCs financial and other
information, unless the context indicates otherwise.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Chiral Quest provides chiral products and services to the pharmaceutical and
fine chemical industries. Chiral Quest develops chemical catalysts used in
the synthesis of desired isomers of chiral molecules using asymmetrical
catalysis technology (the Technology) owned by the Pennsylvania State
University Research Foundation (PSRF), the technology transfer unit of The
Pennsylvania State University (Penn State). Chiral Quest has a worldwide,
exclusive license from PSRF for the inventions covered by the license. The
original license agreement was entered into on November 8, 2000 (See Note
4).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (B) Basis of Presentation
| |  | -------------------------



| |  | The accompanying condensed consolidated financial statements include the
accounts of Chiral Quest and its subsidiaries (together the Company).
These statements have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the instructions to Form 10-QSB and do not include all the
information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements.
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the
results for the interim periods have been included. Operating results for
the three and nine months ended September 30, 2003 are not necessarily
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | indicative of the results that may be expected for the year ending December
31, 2003. The accompanying condensed consolidated financial statements and
the information included under the heading Managements Discussion and
Analysis or Plan of Operation should be read in conjunction with the
Companys consolidated financial statements and related notes included in
the Companys Current Report on Form 8-K/A filed with the Securities and
Exchange Commission (SEC) on May 5, 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (C) Basis of Consolidation
| |  | --------------------------



| |  | The accompanying September 30, 2003 condensed consolidated financial
statements, after giving effect to the recapitalization, include the
consolidated balance sheets of the Company and its wholly owned subsidiaries
CQ Acquisition, Inc. and Chiral Quest, Ltd. (see Note 6), at historical cost
and the consolidated statements of operations of the accounting acquiror for
the three and nine months ended September 30, 2003 and that of the acquiree
for the period since the Merger. All significant intercompany transactions
and balances have been eliminated in consolidation.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The statements of operations presented for the three and nine months ended
September 30, 2002 and the statements of cash flows for the nine months
ended September 30, 2002 are that of the accounting acquiror. Certain prior
year balances have been reclassified to conform to the current year
presentation.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Statement of Changes in Stockholders Equity (Deficiency) for the nine
months ended September 30, 2003 and these Notes to the Condensed
Consolidated Financial Statements are based on common share equivalents
after the Merger.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (D) Cash and Cash Equivalents
| |  | -----------------------------



| |  | The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
| |  | -----------------------------------------------------------------------------------------------------------------------------



| |  | (E) Inventory
| |  | -------------



| |  | Inventory consists of raw materials, work in process and finished goods
which are stated at the lower of cost or market. Raw materials consist of
chemical compounds. Work in process consists of material, direct labor and
manufacturing overhead allocations. Finished goods, referred to as
proprietary ligands, consist of material, direct labor and manufacturing
overhead allocations. The completed ligands are sold to third parties (See
Note 2).
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (F) Property and Equipment
| |  | --------------------------



| |  | Property and equipment is recorded at cost and depreciated over the
estimated useful lives of the assets, principally using the straight-line
method. For tax purposes, accelerated methods are used. The estimated
useful lives used for depreciation and amortization were three, five and
seven years for leasehold improvements, laboratory/computer equipment and
office equipment, respectively (See Note 3).
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | (G) Intangibles
| |  | ---------------



| |  | Under Statement No. 142, Goodwill and Other Intangible Assets (SFAS 142),
subsequent to June 30, 2002, goodwill should not be amortized. Effective
January 1, 2002, intangibles existing as of June 30, 2001 having a finite
life will be amortized and those with indefinite lives will no longer be
amortized, but rather, evaluated for impairment on an annual basis using a
fair value based test. Intangibles of the Company as of September 30, 2003
and December 31, 2002 consisted of rights to PSRFs intellectual property,
which are classified as Intellectual Property Rights in the accompanying
balance sheets. As of September 30, 2003 and December 31, 2002,
Intellectual Property Rights are $375,451, net of accumulated amortization
of $44,031, and $318,320 net of accumulated amortization of $13,918,
respectively. See Note 4 for more discussion on the Companys Rights to
Intellectual Property.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (H) Revenue Recognition
| |  | -----------------------



| |  | Revenues are comprised principally of two main components: (1) the
licensing of PSRFs Technology, and (2) the sale of proprietary ligands.
Revenues as they relate to the licensing of the Companys rights to PSRFs
intellectual property are recognized upon a signed agreement with the
customer or remittance of an invoice and allocated over the applicable
periods. The Company assumes the financial risks related to these revenues
by financing the research and development of PSRFs technology as well as
the defense of PSRFs patents. Deferred revenue in the accompanying balance
sheets represents amounts prepaid by customers to the Company for services.
These deferred amounts will be amortized into revenue over the applicable
periods. Revenues as they relate to the sale of manufactured proprietary
ligands are recognized in full upon the shipping and invoicing of the
ligands to the customer.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (I) Income Taxes
| |  | ----------------



| |  | From inception in October 2000 through September 30, 2002, the Company
elected to be treated as a partnership for federal and state income tax
purposes. As such, the Company did not pay income taxes, as any income or
loss through September 30, 2002 was included in the tax returns of the
individual equity holders. Accordingly, no provision was made for income
taxes in the accompanying financial statements through September 30, 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As of October 1, 2002, the Company elected to be treated as a Subchapter C
corporation for income tax purposes and has adopted SFAS No. 109 Accounting
for Income Taxes. Under Statement 109, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under Statement 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A deferred tax asset as of September 30, 2003, consisting primarily of the
tax effect of net operating loss carryforwards of approximately $1,700,000
has been fully offset by a valuation allowance because it is managements
belief that realization of such amount is not considered more likely than
not.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9



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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | (J) Stock-Based Compensation
| |  | ----------------------------



| |  | The Company accounts for its employee and director stock option plans in
accordance with APB Opinion No. 25, Accounting For Stock Issued To
Employees, and related interpretations. The Company measures compensation
expense for employee and director stock options as the aggregate difference
between the market value of its common stock and exercise prices of the
options on the date that both the number of shares the grantee is entitled
to receive and the exercise prices are known. Compensation expense
associated with restricted stock grants is equal to the market value of the
shares on the date of grant and is recorded pro rata over the required
holding period. If the Company had elected to recognize compensation cost
for all outstanding options granted by the Company by applying the fair
value recognition provisions of SFAS No. 148 to stock-based employee
compensation, net loss and loss per share would have been reduced to the pro
forma amounts indicated below:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For the Three
    
    
    For the NineMonths Ended
    
    
    Months EndedSeptember 30,
    
    
    September 30,2003
    
    
    2003Net lossAs reported
    
    $
    (548,558
    )
    
    $
    (1,451,035
    )Total stock-based employee compensation
expense using the fair value based method
for all awards, net of related tax effects
    
    
    (12,691
    )
    
    
    (144,305
    )Pro forma
    
    $
    (561,249
    )
    
    $
    (1,595,340
    )Basic and diluted net loss per common shareAs reported
    
    $
    (.04
    )
    
    $
    (.12
    )Pro forma
    
    $
    (.04
    )
    
    $
    (.13
    )




| |  | For the three and nine months ended September 30, 2002, there is no pro
forma expense for any stock options issued.
| |  | -------------------------------------------------------------------------------------------------------------------



| |  | In addition, options are issued to non-employees such as consultants,
scientific advisory board members and directors. Any options issued to
non-employees are recorded in the financial statements in Deferred
Consulting in the Equity section using the fair value method and then
amortized to consulting expense over the applicable vesting periods. See
Note 5 for more discussion on the Companys stock-based compensation.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (K) Use of Estimates
| |  | --------------------



| |  | The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results could
differ from those estimates.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | (L) Impairment of Long-Lived Assets
| |  | -----------------------------------



| |  | The Company evaluates the recoverability of its long-lived assets, where
indicators of impairment are present, by reviewing current and projected
profitability or undiscounted cash flows of such assets. Intangible assets
that are subject to amortization are reviewed for potential impairment
whenever events or circumstances indicate that carrying amounts may not be
recoverable. Intangible assets not subject to amortization are tested for
impairment at least annually. For the nine months ended September 30, 2003
and 2002, the Company determined that an impairment to its long-lived assets
was not required. Accordingly, no impairment loss was recorded for the nine
months ended September 30, 2003 and 2002.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (M) Research and Development Expense
| |  | ------------------------------------



| |  | Research and development (R&D) costs are expensed as incurred. These
expenses include the cost of the Companys proprietary R&D efforts, as well
as costs incurred in connection with the Companys third-party collaboration
efforts. For the three months ended September 30, 2003 and 2002, $76,995
and $1,061, respectively, had been charged to R&D expense. For the nine
months ended September 30, 2003 and 2002, $283,470 and $47,597,
respectively, had been charged to R&D expense.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (N) Loss Per Share
| |  | ------------------



| |  | Basic and diluted net loss per common share for all periods presented is
computed based on the weighted average common shares outstanding during the
year as defined by Statement of Financial Accounting Standards No. 128,
Earnings Per Share. The assumed exercise of common stock equivalents was
not utilized since the effect would be anti-dilutive.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | (O) Recent Accounting Pronouncements
| |  | ------------------------------------



| |  | In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. SFAS No. 145 rescinds the provisions of SFAS No. 4,
which requires companies to classify certain gains and losses from debt
extinguishments as extraordinary items, eliminates the provisions of SFAS
No. 44 regarding transition to the Motor Carrier Act of 1980 and amends the
provisions of SFAS No. 13 to require that certain lease modifications be
treated as sale leaseback transactions. The provisions of SFAS No. 145
related to classification of debt extinguishments are effective for fiscal
years beginning after May 15, 2002, with earlier application encouraged.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In July 2002, FASB issued SFAS No. 146, Accounting for Restructuring
Costs. SFAS No. 146 applies to costs associated with an exit activity
(including restructuring) or with a disposal of long-lived assets. Those
activities can include eliminating or reducing product lines, terminating
employees and contracts and relocating plant facilities or personnel. Under
SFAS No. 146, the Company will record a liability for a cost associated with
an exit or disposal activity when that liability is incurred and can be
measured at fair value. SFAS No. 146 will require the Company to disclose
information about its exit and disposal activities, the related costs, and
changes in those costs in the notes to the interim and annual financial
statements that include the period in which an exit activity is initiated
and in any subsequent period until the activity is completed. SFAS No. 146
is effective prospectively for exit or disposal activities initiated after
December 31, 2002, with earlier adoption encouraged. Under SFAS No. 146, a
company cannot
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | restate its previously issued financial statements and the new statement
grandfathers the accounting for liabilities that a company had previously
recorded under Emerging Issues Task Force Issue 94-3.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure  an amendment of FASB Statement No.
123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock Based
Compensation to provide alternative methods for accounting for a change by
registrants to the fair value method of accounting for stock-based
compensation. Additionally, SFAS No. 148 amends the disclosure requirements
of SFAS No. 123 to require disclosure in the significant accounting policy
footnote of both annual and interim financial statements of the method of
accounting for stock based-compensation and the related pro-forma
disclosures when the intrinsic value method continues to be used. The
statement is effective for fiscal years beginning after December 15, 2002,
and disclosures are effective for the first fiscal quarter beginning after
December 15, 2002.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In January 2003, The FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research
Bulletin (ARB) No. 51, Consolidated Financial Statements.
Interpretation No. 46 addresses consolidation by business enterprises of
variable interest entities, which have one or both of the following
characteristics: (i) the equity investment at risk is not sufficient to
permit the entity to finance its activities without additional subordinated
support from other parties, which is provided through other interest that
will absorb some or all of the expected losses of the entity; (ii) the
equity investors lack one or more of the following essential characteristics
of a controlling financial interest: the direct or indirect ability to make
decisions about the entities activities through voting rights or similar
rights; or the obligation to absorb the expected losses of the entity if
they occur, which makes it possible for the entity to finance its
activities; the right to receive the expected residual returns of the entity
if they occur, which is the compensation for the risk of absorbing the
expected losses.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Interpretation No. 46 also requires expanded disclosures by the primary
beneficiary (as defined) of a variable interest entity and by an enterprise
that holds a significant variable interest in a variable interest entity but
is not the primary beneficiary. Interpretation No. 46 applies immediately
to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after
that date. It applies in the first fiscal year or interim period beginning
after June 15, 2003, to variable interest entities in which an enterprise
holds a variable interest that it acquired before February 1, 2003.
Interpretation No. 46 may be applied prospectively with a cumulative-effect
adjustment as of the date on which it is first applied or by restating
previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. The changes in SFAS No. 149 improve financial reporting by
requiring that contracts with comparable characteristics be accounted for
similarly. This statement is effective for contracts entered into or
modified after June 30, 2003 and all of its provisions should be applied
prospectively.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No.
150 changes the accounting for certain
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | financial instruments with characteristics of both liabilities and equity
that, under previous pronouncements, issuers could account for as equity.
The new accounting guidance contained in SFAS No. 150 requires that those
instruments be classified as liabilities in the balance sheet.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | SFAS No. 150 affects the issuers accounting for three types of freestanding
financial instruments. One type is mandatorily redeemable shares, which the
issuing company is obligated to buy back in exchange for cash or other
assets. A second type includes put options and forward purchase contracts,
which involves instruments that do or may require the issuer to buy back
some of its shares in exchange for cash or other assets. The third type of
instruments that are liabilities under this Statement is obligations that
can be settled with shares, the monetary value of which is fixed, tied
solely or predominantly to a variable such as a market index, or varies
inversely with the value of the issuers shares. SFAS No. 150 does not
apply to features embedded in a financial instrument that is not a
derivative in its entirety.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Most of the provisions of SFAS No. 150 are consistent with the existing
definition of liabilities in FASB Concepts Statement No. 6, Elements of
Financial Statements. The remaining provisions of this Statement are
consistent with the FASBs proposal to revise that definition to encompass
certain obligations that a reporting entity can or must settle by issuing
its own shares. This Statement shall be effective for financial instruments
entered into or modified after May 31, 2003 and otherwise shall be effective
at the beginning of the first interim period beginning after June 15, 2003,
except for mandatorily redeemable financial instruments of a non-public
entity, as to which the effective date is for fiscal periods beginning after
December 15, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In June 2003, the FASB issued an Exposure Draft for proposed SFAS entitled
Qualifying Special Purpose Entities (QSPE) and Isolation of transferred
Assets, an amendment of SFAS No. 140 (The Exposure Draft). The Exposure
Draft is a proposal that is subject to change and as such, is not yet
authoritative. If the proposal is enacted in its current form, it will
amend and clarify SFAS 140. The Exposure Draft would prohibit an entity
from being a QSPE if it enters into an agreement that obliged a transferor
of financial assets, its affiliates, or its agents to deliver additional
cash or other assets to fulfill the special-purposes entitys obligation to
beneficial interest holders.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Management does not expect the impact from these statements pronouncements
to have a material impact on the Companys consolidated financial position
or results of operations.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 2 |  | INVENTORY
|------ |  | ---------



| |  | The principal components of inventory are as follows:
| |  | -----------------------------------------------------

September 30,2003
    
    
    December 31,(Unaudited)
    
    
    2002Raw material compounds
    
    $
    24,036
    
    
    $
    28,422Work in process
    
    
    49,600
    
    
    
    Finished goods
    
    
    8,845
    
    
    
    Total Inventory
    
    $
    82,481
    
    
    $
    28,422


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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



|NOTE 3 |  | PROPERTY, PLANT AND EQUIPMENT, NET
|------ |  | ----------------------------------



| |  | The major classes of equipment and the related estimated useful lives are as
follows:
| |  | -------------------------------------------------------------------------------------

September 30,2003
    
    
    December 31,(Unaudited)
    
    
    2002
    
    
    LifeLaboratory equipment
    
    $
    252,518
    
    
    $
    112,044Accumulated depreciation
    
    
    (74,362
    )
    
    
    (47,020
    )
    
    5 YearsLaboratory equipment, net
    
    
    178,156
    
    
    
    65,024Office equipment
    
    $
    2,291
    
    
    $
    2,291Accumulated depreciation
    
    
    (550
    )
    
    
    (304
    )
    
    7 YearsOffice equipment, net
    
    
    1,741
    
    
    
    1,987Computer equipment
    
    $
    19,118
    
    
    $
    Accumulated depreciation
    
    
    (1,434
    )
    
    
    
    
    
    5 YearsComputer equipment, net
    
    
    17,684
    
    
    
    Leasehold improvements
    
    $
    44,296
    
    
    $
    Accumulated amortization
    
    
    (5,536
    )
    
    
    
    
    
    3 YearsLeasehold improvements, net
    
    
    38,760
    
    
    
    Total
    
    $
    236,341
    
    
    $
    67,011




| |  | Depreciation and amortization expense for property, plant and equipment for
the three months ended September 30, 2003 and 2002 was $14,749 and $4,879,
respectively. Depreciation and amortization expense for property, plant and
equipment for the nine months ended September 30, 2003 and 2002 was $34,558
and $17,149 respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 4 |  | RIGHTS TO INTELLECTUAL PROPERTY
|------ |  | -------------------------------



| |  | The Companys exclusive right to certain PSRF patents, in the aggregate, are
of material importance for the Companys survival. These PSRF patents
result from inventions by the Companys Chief Technology Officer (CTO),
who is also an employee at Pennsylvania State University. The PSRF patents
cover chemical formulations, processes for or intermediates useful in the
manufacture of products and the uses of products. Protection for PSRFs
individual products extends for varying periods in accordance with the date
of grant and the legal life of patents in the various countries. The
protection afforded, which may also vary from country to country, depends
upon the type of patent and its scope of coverage. The Company is
financially responsible for all aspects of these PSRF inventions, including
legal and R&D expenses associated with the chemical developments. As of
November 8, 2002, PSRF is not obligated to license future inventions by the
CTO to the Company.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During the three months ended September 30, 2003 and 2002, the Company
capitalized $57,085 and $101,169, respectively, in legal fees, U.S. Patent
office handling fees and other expenses incurred in the defense of the
patents. During the nine months ended September 30, 2003 and 2002, the
Company
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | capitalized $87,245 and $128,747, respectively. Expenses incurred for
research and development of the patents were expensed.
| |  | ----------------------------------------------------------------------------------------------------------------------------



| |  | The Intellectual Property Rights are being amortized over the lives of the
underlying patents, which generally are twenty years. Amortization expense
recorded for the three months ended September 30, 2003 and 2002 was $7,283
and $2,602, respectively. Amortization expense recorded for the nine months
ended September 30, 2003 and 2002 was $30,114 and $11,399, respectively.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 5 |  | STOCKHOLDERS EQUITY
|------ |  | --------------------



| |  | The Company accounts for equity based compensation in accordance with
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation. The standard requires the Company to adopt the
fair value method with respect to equity-based compensation of consultants
and other non-employees.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In connection with two 5-year consulting agreements entered into by the
Company in 2000, the Company issued 4,062,820 shares of common stock. As a
result of these agreements, the Company recorded current charges to
operations of $32,400 and $97,200 for the three and nine months ended
September 30, 2003 and 2002, respectively. The Company also recorded a
deferred consulting expense, which is recognized as an offset to equity, of
$259,200 and $356,400 as of September 30, 2003 and December 31, 2002,
respectively, as a result of these agreements. The deferred consulting
expense is being amortized over the lives of the agreements.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Company did not adopt the fair value method, in accordance with SFAS 123
(as amended by SFAS 148), with respect to employee stock options. The
Company accounts for employee stock options under the intrinsic value
method in accordance with Accounting Principles Board (APB) No. 25,
Accounting for Stock Issued to Employees. In December 2000, the Company
granted an employee 1,128,562 options for services rendered to the Company.
During January 2001, this employee purchased 564,281 shares of common stock
subject to the option at an exercise price of $.0133 per share for total
proceeds of $7,500. During June 2002, the employee purchased the remaining
564,281 shares subject to the option at an exercise price of $.0133 for
total proceeds of $7,500. The option issuance did not result in charges to
operations for the three and nine months ended September 30, 2003 and 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During 2002, the Company granted options to purchase 865,230 shares of its
common stock to its CEO as required by his employment agreement with the
Company. The options vest equally over a three-year period commencing with
the date of the Merger (See Note 1), are exercisable at $1.49 per share and
are for services to be rendered to the Company over the vesting period. The
option issuance did not result in charges to operations for the three and
nine months ended September 30, 2003 and 2002.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During July 2002, two of the Companys former shareholders (the Sellers)
sold all of their interest in the Company to another individual. The total
number of shares sold was 4,589,481, giving the individual a then 53%
ownership in the Company. The individual has paid the purchase price for
his shares to the Sellers in six quarterly installments. Subsequent to the
purchase of the shares from the Sellers, the individual sold a substantial
portion of his shares to certain other individuals.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In connection with the Merger (see Note 1), the Company issued 550,000
options, with an exercise price of $1.25, to an independent consultant for
services related to the Merger. The value of the options were
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | treated as Merger transaction costs and charged directly to equity in the
accompanying financial statements.
| |  | ------------------------------------------------------------------------------------------------------------



| |  | During April 2003, the Company issued options to purchase an aggregate of
167,500 shares of common stock at an exercise price of $1.50 to three
employees. The total value of the option issuance of $157,650 was valued
using the Black-Scholes pricing model with the following assumptions: a
risk-free interest rate ranging from 3.98% to 4.0%, volatility ranging from
67.24% to 67.38%, lives of ten years and an annual rate of quarterly
dividend of 0%. Since the Company uses the intrinsic value method for
employee option issuances, none of the expense is recorded in the financial
statements as of September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | During May 2003, the Company issued options to purchase an aggregate of
20,000 shares of common stock to the landlord of new office space that the
Company is leasing in New Jersey. The option issuance resulted in a charge
to Prepaid Rent of $9,845 and it will be amortized to rent expense over the
applicable vesting periods beginning in July 2003. The option issuance
resulted in a charge of $82 to operations for the three and nine months
ended September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In June 2003, the Company issued options to purchase an aggregate of 30,000
shares of common stock at an exercise price of $1.50 to two employees. The
total value of the option issuance of $12,690 was valued using the
Black-Scholes pricing model with the following assumptions: a risk-free
interest rate of 2.35%, volatility of 74.03%, estimated lives of five years
and an annual rate of quarterly dividend of 0%. Since the Company uses the
intrinsic value method for employee option issuances, none of the expense is
recorded in the financial statements for the three and nine months ended
September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In June 2003, the Company issued options to purchase an aggregate of 740,052
shares of common stock at exercise prices ranging between $1.49 and $1.50
per share to two consultants (including 650,052 options issued to the CTO)
and two members of the Companys Scientific Advisory Board. The total value
of the option issuances of $622,970 was valued using the Black-Scholes
pricing model with the following assumptions: a risk-free interest rate
ranging from 2.32% to 2.49%, volatility ranging from 86.63% to 87.94%, lives
of five years and an annual rate of quarterly dividend of 0%. The option
issuances were charged to Deferred Consulting expense in the Equity section
of the balance sheet and are being amortized to consulting expense over the
applicable vesting periods. For the three and nine months ended September
30, 2003 total charges to operations for these option issuances was $40,448
and $52,382, respectively.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In July 2003, the Company issued options to a member of the board of
directors to purchase 50,000 shares of common stock at an exercise price of
$1.70 per share. These options will vest over a three-year period. The
total value of the option issuance of $66,440 was valued using the
Black-Scholes pricing model with the following assumptions: a risk-free
interest rate of 3.42%, volatility of 105.54%, estimated lives of five years
and an annual quarterly dividend of 0%. For the three and nine months ended
September 30, 2003, total charges to operations for these option issuances
were $13,842.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 6 |  | AGREEMENTS
|------ |  | ----------



| |  | Pursuant to a January 2002 agreement between the Company and a
pharmaceutical product development customer, the Company granted the
customer a worldwide, non-exclusive, royalty free license to certain of the
Companys Intellectual Property Rights for research purposes only in
connection with certain of
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

16



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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | the customers compounds. The customer paid the Company a nonrefundable
license fee of $400,000 in 2002. The fee is being amortized to revenue
through September 2005. For the three months ended September 30, 2003 and
2002, the Company has recognized income of $28,560 and $28,169,
respectively, in relation to this agreement. For the nine months ended
September 30, 2003 and 2002, the Company has recognized income of $85,681
and $84,507, respectively, in relation to this agreement.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In August 2002, the Company entered into a one-year scientific research
agreement with another pharmaceutical product development customer to assist
in the completion of a feasibility screening program and report. In
consideration for the experimental activity, the customer paid a fee of
$30,000. The fee is being amortized to revenue through August 2003. For the
three months ended September 30, 2003 and 2002, the Company recognized
income of $4,932 and $2,712, respectively. For the nine months ended
September 30, 2003 and 2002, the Company has recognized income of $14,795
and $2,712, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In May 2003, the Company entered into a four-year consulting agreement with
the CTO at an annual rate of $120,000 per year. In addition, the CTO
received an option to purchase 650,052 shares of common stock at $1.49 per
share as mentioned in Note 5.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In May 2003, the Company entered into an option agreement with the Science
and Technology Bureau of Jiashan County, China (Jiashan), whereby the
Company has an option to acquire a laboratory facility in an industrial park
near Shanghai. Jiashan is currently building 4,000 square meters of
laboratory space built to the Companys specifications. The Company will
not pay rent for the initial 3 years of the lease, following which the
Company, at its sole option, may rent the space for annual rent of no more
than $60,000. In addition, the Company will have the option to purchase the
lab on commercially reasonable terms. Should the Company wish to occupy the
laboratory after its completion (estimated to be in the fourth quarter of
2003 or first quarter of 2004), it will begin to pay a maintenance fee of
$4,500 per month. For purposes of entering the lease, the Company has
established a wholly owned subsidiary in Hong Kong, Chiral Quest Ltd., which
in turn will be the sole shareholder of a subsidiary in the Peoples
Republic of China (the China Sub). The Company will provide at least
$65,000 of capital to the China Sub by the end of the year. In addition,
the Company was also granted the option to purchase approximately 13 acres
of land adjacent to the industrial park where the lab will be established.
As of September 30, 2003, the Company has not yet funded the China Sub.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In September 2003, a sales agreement with a customer was executed for
$242,500. The payment arrangement as agreed upon with the customer,
specifies one-third is due upon the acceptance of the purchase order,
one-third is due one month from the date of the purchase order, and
one-third is due upon the completion of the order. As of September 30,
2003, the Company has not delivered any goods under this sales agreement. A
receivable for the one-third up front payment of this agreement has been
recorded in the Companys receivable balance and deferred revenue balance as
of September 30, 2003.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Pursuant to an October 2002 agreement with Penn State, the Company funded
the services of four post-doctorate fellows who, under the supervision of
the CTO, conducted research and provided research quantities of chiral
ligands to the Company. That agreement expired on October 15, 2003 and an
extension is currently being negotiated.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17



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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



|NOTE 7 |  | BUSINESS AND CREDIT CONCENTRATIONS
|------ |  | ----------------------------------



| |  | The Company had two customers who accounted for approximately 48% and 35%,
respectively, of net revenue for the nine months ended September 30, 2003.
The Company had two customers who accounted for approximately 53% and 14%,
respectively, of net revenue for the nine months ended September 30, 2002.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Company had a customer who accounted for approximately 80% of net
customer accounts receivable as of September 30, 2003.
| |  | ----------------------------------------------------------------------------------------------------------------------------



|NOTE 8 |  | COMMITMENTS AND CONTINGENCIES
|------ |  | -----------------------------



| |  | In May 2003, the Company signed an agreement to lease laboratory and office
space located in Monmouth Junction, New Jersey. The lease commenced
effective June 1, 2003 and is for a three-year term with a total base rent
of $354,240 to be paid in monthly installments that increase after each
year. Due to the escalation clause in the lease, the Company is
straight-lining the expense of the lease over the term of the lease and has
recorded deferred rent of $1,640 as of September 30, 2003. The Company also
issued the landlord options to purchase 20,000 shares of common stock, as
described in Note 5. The future minimum lease payments under this lease are
as follows: $28,290 for the remainder of 2003, $116,030 for 2004, $120,950
for 2005, and $51,250 for 2006.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Total rent expense (which includes base rent, utilities, and operating
escalations) for the Company for the three months and nine months ended
September 2003 was $27,357 and $48,279, respectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In July 2002, the Company received a cease and desist letter from a
competitor apprising the Company of the existence of a U.S. Patent. In
October 2002, the Company and such competitor entered into a mutual
confidentiality agreement in which each party agreed to exchange technology
information in order to more fully evaluate whether either is infringing
upon the rights of the other.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Also, in October 2002, the Company received an additional patent
notification letter from another competitor apprising them of the existence
of another U.S. Patent.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | As of September 30, 2003, to the Companys knowledge, no legal proceedings
have been initiated with respect to either of the matters discussed in such
letters.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



|NOTE 9 |  | RELATED PARTY TRANSACTIONS
|------ |  | --------------------------



| |  | The original purchaser of the 53% ownership discussed in Note 5 above is
also the managing member of Paramount Capital Investments, LLC (Paramount)
which has been performing certain administrative functions for the Company
since July 12, 2002, and financed the Company through loans for working
capital evidenced by a series of promissory notes (the Notes) aggregating
$376,625. The Notes bore interest at 5% and were repaid including interest
in full on February 28, 2003, and subsequently cancelled.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Additionally, since September 1, 2002, the Company has been paying $4,000
per month to Paramount for administrative services. For the three and nine
months ended September 30, 2003 this resulted in charges to operations of
$12,000 and $36,000, respectively. As of September 30, 2003, the Company
owed
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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CHIRAL QUEST, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2003
(UNAUDITED)



| |  | $8,664 to Paramount for administrative and miscellaneous expenses.
| |  | ------------------------------------------------------------------



|NOTE 10 |  | SUBSEQUENT EVENTS
|------- |  | -----------------



| |  | In October 2003, options to purchase an aggregate of 190,000 shares of
common stock at an exercise price of $1.67 per share were issued to two
employees. These options will vest in annual installments over a three-year
period.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In October 2003, a consultant for the Company received options to purchase
4,300 shares of common stock at an exercise price of $1.96 per share. These
options will fully vest on February 14, 2004.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In October 2003, six non-employee members of the board of directors each
received options to purchase 12,900 shares of common stock at an exercise
price of $1.96. These options vest in annual installments over a three-year
period.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In October 2003, the employment agreement with the CEO was amended to
provide bonus payments aggregating up to $323,646, primarily based upon the
Companys achieving certain stock price milestones.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Item 2. Managements Discussion and Analysis or Plan of Operation.

Overview

Until January 22, 2002, we were engaged in the design, development, manufacture
and sale of medical and surgical wound drainage products. On January 22, 2002,
we sold substantially all of our operating assets, leaving us with no sources
of revenue.

On February 18, 2003, we completed a reverse acquisition of privately-held
Chiral Quest, LLC. In accordance with this transaction we issued approximately
two-thirds of our outstanding common stock (after giving effect to the
transaction) to the former members of Chiral Quest, LLC, a Pennsylvania limited
liability company. Following the acquisition, we adopted the business plan of
Chiral Quest, LLC as our business plan and changed our name to Chiral Quest,
Inc. Accordingly, when we refer to our business or financial information
relating to periods prior to the merger, we are referring to the business and
financial information of Chiral Quest, LLC, unless the context indicates
otherwise.

Since our inception in October 2000, we have focused our efforts and resources
on the development of asymmetric catalysis technology, our primary intellectual
property to which we hold an exclusive worldwide license from the Pennsylvania
State Research Foundation (PSRF). Our license from PSRF covers certain
inventions discovered by our Chief Technology Officer (CTO) prior to November
8, 2002.

Since inception we have incurred a cumulative deficit of $2,843,840 through
September 30, 2003. We expect our operating losses to increase significantly
over the next several years, primarily due to expansion of our research and
development programs, the hiring of additional chemists, and the expansion of
our manufacturing capabilities.

Our ability to achieve profitability depends upon, among other things, our
ability to discover and develop products (specifically new ligands), and to
develop our products on a commercial scale through a cost effective and
efficient process. To the extent that we are unable to produce, directly or
indirectly, ligands in quantities required for commercial use, we will not
realize any significant revenues from our technology. Moreover, there can be
no assurance that we will ever achieve significant revenues or profitable
operations from the sale of any of our products or technologies. Risks
associated with our business are more thoroughly addressed in the section
entitled Risk Factors.

Since our inception, we have generated sales revenue but not yet generated any
net profits. Our management believes that our research and development (R&D)
and manufacturing capacity will need to grow in order for us to be able to
obtain significant licensing and manufacturing agreements with large fine
chemical and pharmaceutical companies. We believe that our manufacturing
capacity will be significantly enhanced with our new office and laboratory
space that was leased in June 2003.

Results of Operations  Three Months Ended September 30, 2003 vs. 2002

Our revenues for the three months ended September 30, 2003 were $83,068 as
compared to $48,089 during the three months ended September 30, 2002. For the
three months ended September 30, 2003, approximately 40% of total revenue was
derived from the amortization of option fee income pertaining to the licensing
of our intellectual property and 60% of total revenue was derived from sales of
our ligands, feasibility screening and customized process development services
sold to third parties. For the three months ended September 30, 2002,
approximately 80% of total revenue was derived from the amortization of option
fee income and 20% of total revenue was comprised of sales or our ligands. It
is

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anticipated that sales of our ligands, molecular building blocks and customized
chiral services will continue to comprise a greater percentage of our revenues
in the future as we expand our manufacturing capabilities.

Cost of goods sold for the three months ended September 30, 2003 was $37,321 as
compared to $1,307 during the three months ended September 30, 2002. The
increase of cost of goods sold for the three months ended September 30, 2003
vs. 2002 is attributable to the job costing of projects and services through
direct labor and manufacturing overhead allocations as cost components as they
relate to work in process and finished goods.

Management and consulting expenses for the three months ended September 30,
2003 were $128,691 as compared to $46,675 during the three months ended
September 30, 2002. The overall change for the three months ended September 30,
2003 vs. 2002 was primarily caused by an increase in consulting fee expense.
Consulting expenses increased due to the new consultant agreement entered with
our CTO at a rate of $10,000 per month effective May 15, 2003. In addition,
consulting expense increased from the amortization of stock options issued to
consultants, scientific advisory board members, and directors during the second
and third quarters of 2003.

Our R&D expenses for the three months ended September 30, 2003 were $76,995 as
compared to $1,061 during the three months ended September 30, 2002. This
increase was primarily caused by increased utilization of the Penn State
research resources in connection with the development of new ligands. The
agreement with Penn State is currently be renegotiated. There is no guarantee
that we will be able to enter into such new agreement or find an alternative
source for its ligands on commercially reasonable terms. In addition, during
the second quarter we opened additional laboratory facilities that enabled the
Company to produce both research and commercial quantities of our ligands. In
connection with the new facilities, numerous lab supplies and chemicals were
purchased. We may also outsource certain manufacturing requirements.
Accordingly, the Company expects R&D and manufacturing costs to continue to
increase significantly in the fourth quarter due to the new facilities and the
possible increased cost of using facilities and chemists at Penn State and the
new facility in Monmouth Junction, NJ.

Selling, general and administrative (SG&A) expenses for the three months
ended September 30, 2003 was $230,705 as compared to $30,966 during the three
months ended September 30, 2002. This increase in SG&A expenses was due to
higher legal and accounting fees associated with our obligations as a public
company subject to the reporting requirements of the Securities Exchange Act of
1934, as amended (the Exchange Act). SG&A expenses also increased due to
rent expense for the New Jersey facility, additional spending on advertising
and promotion expenses, increased travel expenses for new business development
opportunities, and higher expenses associated with having
more employees such as insurance and employer payroll taxes.

Compensation expense was $138,205 for the three months ended September 30, 2003
compared to $32,715 for the three months ended September 30, 2002. This
increase was caused primarily by the new CEO (hired in November 2002) receiving
an annual base salary of $205,000 effective at the date of our merger with Surg
II, Inc., as provided in his employment agreement. In addition, compensation
expense increased due to the hiring of several chemists to work at the new
laboratory facility that was leased in the second quarter of 2003.
Compensation expense as it relates to direct labor for ongoing and completed
projects, has been capitalized as part of inventory work in process and
finished goods as these cost components relate directly to cost of goods sold.

Depreciation and amortization expenses for the three months ended September 30,
2003 were $22,032 as compared to $7,481 during the three months ended September
30, 2002. This increase was primarily

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related to fixed asset purchases for computer and laboratory equipment
purchased for the newly leased facility in Monmouth Junction, NJ.

Interest expense for the three months ended September 30, 2003 was $0 as
compared to $302 during the three months ended September 30, 2002. The
decrease was caused by the promissory notes issued between July 2002 through
February 2003 owed to an affiliate, which were fully paid and discharged in
February 2003.

Interest income for the three months ended September 30, 2003 was $2,323 as
compared to $0 during the three months ended September 30, 2002. The increase
in interest income was caused by significantly higher cash reserves obtained
after the merger.

Our net loss for the three months ended September 30, 2003 was $548,558
compared to $72,418 for the three months ended September 30, 2002. The
increased losses for the three months ended September 30, 2003 compared to 2002
were primarily due to higher R&D expenses incurred with Penn State, increased
legal and accounting expenses in connection reporting as a public company, and
higher payroll expenses associated with having more employees. We expect
losses to continue and increase in the next year as the Company attempts to
expand its laboratory space, purchase more chemicals and raw material
compounds, and hire additional employees.

Results of Operations  Nine Months Ended September 30, 2003 vs. 2002

Our revenues for the nine months ended September 30, 2003 were $214,509 as
compared to $159,573 during the nine months ended September 30, 2002. For the
nine months ended September 30, 2003, approximately 47% of total revenue was
derived from the amortization of option fee income pertaining to the licensing
of our intellectual property and 53% of total revenue was derived from sales of
our ligands, feasibility screening and customized process development services
sold to third parties. For the nine months ended September 30, 2002,
approximately 77% of total revenue was derived from the amortization of option
fee income and 23% of total revenue was comprised of sales or our ligands. It
is anticipated that sales of our ligands, molecular building blocks and
customized chiral services will continue to comprise a greater percentage of
our revenues in the future as we expand our manufacturing capabilities.

Cost of goods sold for the nine months ended September 30, 2003 was $62,708 as
compared to $6,763 during the nine months ended September 30, 2002. The
increase of cost of goods sold for the nine months ended September 30, 2003 vs.
2002 is attributable to the job costing of projects and services through direct
labor and manufacturing overhead allocations as cost components as they relate
to work in process and finished goods.

Management and consulting expenses for the nine months ended September 30, 2003
were $254,700 as compared to $166,475 during the nine months ended September
30, 2002. The overall change for the nine months ended September 30, 2003 vs.
2002 was caused by a reduction in management fee expense and an increase in
consulting fee expense. Management fee expense decreased during 2002 from
$11,000 per month to $4,000 per month. Consulting fees for the nine months
ended September 30, 2003 increased due to a new consultant agreement with our
CTO at an annual rate of $120,000 effective May 15, 2003 and the amortization
of stock options issued to consultants in the second and third quarters of
2003.

Our R&D expenses for the nine months ended September 30, 2003 were $283,470 as
compared to $47,597 during the nine months ended September 30, 2002. This
increase was primarily caused by

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increased utilization of the Penn State research resources in connection with
the development of new ligands. R&D expense also was higher because of the new
laboratory facilities that were leased in the second quarter of 2003, along
with increased purchases of lab chemicals and supplies used for research.

SG&A expenses for the nine months ended September 30, 2003 was $654,071 as
compared to $67,094 during the nine months ended September 30, 2002. This
increase in SG&A expenses was due to higher legal and accounting fees
associated with our obligation as a public company subject to the reporting
requirements of Exchange Act. SG&A expenses also increased due to rent expense
for the New Jersey facility, additional spending on advertising and promotion
expenses, increased travel expenses for new business development
opportunities, and higher expenses associated with having more employees
such as insurance and employer payroll taxes.

Compensation expense was $355,925 for the nine months ended September 30, 2003
compared to $123,346 for the nine months ended September 30, 2002. This
increase was caused primarily by the new CEO (hired in November 2002) receiving
an annual base salary of $205,000 effective at the date of our merger with Surg
II, Inc., as provided in his employment agreement. In addition, compensation
expense increased due to the hiring of several chemists to work at the new
laboratory facility that was leased in the second quarter of 2003.

Depreciation and amortization expenses for the nine months ended September 30,
2003 were $64,672 as compared to $28,548 during the nine months ended September
30, 2002. This increase was primarily related to fixed asset purchases for
laboratory equipment, computer equipment, and leasehold improvements for the
newly leased facility in Monmouth Junction, New Jersey.

Interest expense for the nine months ended September 30, 2003 was $2,809 as
compared to $302 during the nine months ended September 30, 2002. This
increase was caused by the promissory notes issued between July 2002 through
February 2003 owed to an affiliate, which were fully paid and discharged in
February 2003.

Interest income for the nine months ended September 30, 2003 was $12,811, as
compared to $0 during the nine months ended September 30, 2002. The increase
in interest income was caused by significantly higher cash reserves obtained
after the merger.

Our net loss for the nine months ended September 30, 2003 was $1,451,035
compared to $280,552 for the nine months ended September 30, 2002. The
increased losses for the nine months ended September 30, 2003 compared to 2002
were primarily due to higher R&D, expenses in connection with the merger and
becoming a public company, and higher payroll costs. We expect losses to
continue and increase in the next year as the Company attempts to expand its
laboratory space, purchase more chemicals and raw material compounds and hire
additional employees.

Liquidity and Capital Resources

As of September 30, 2003, we had working capital of $768,593 and cash and cash
equivalents of $918,998. We anticipate that our current working capital will
be sufficient to fund operations for approximately 4-6 months excluding
revenues. If we are unable to significantly increase our revenues, we will most
likely require additional financing in order to continue operations. The most
likely source of financing includes private placements of our equity or debt
securities or bridge loans to the company from third party lenders.

Our working capital requirements will depend upon numerous factors, including
without limitation the

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progress of our R&D programs, the resources we devote to developing
manufacturing and marketing capabilities, technological advances, the status of
competitors, and our ability to establish sales arrangements with new
customers. Working capital will also be affected by new leases for office and
laboratory space that were entered into during the second quarter of 2003, and
the hiring of additional employees.

Critical Accounting Policies

Review of Impairment of Intellectual Property Rights

The Company evaluates the recoverability of its long-lived assets, where
indicators of impairment are present, by reviewing current and projected
profitability or undiscounted cash flows of such assets. Intangible assets
that are subject to amortization are reviewed for potential impairment whenever
events or circumstances indicate that carrying amounts may not be recoverable.
Intangible assets not subject to amortization are tested for impairment at
least annually. For the nine months ended September 30, 2003 and 2002, the
Company determined that an impairment to its long-lived assets was not
required. Accordingly, no impairment loss was recorded for the nine months
ended September 30, 2003 and 2002.

Revenue Recognition

Revenues are comprised principally of two main components: (1) the licensing
of PSRFs Technology, and (2) the sale of proprietary ligands. Revenues as
they relate to the licensing of the Companys rights to PSRFs intellectual
property are recognized upon a signed agreement with the customer or remittance
of an invoice and allocated over the applicable periods. The Company assumes
the financial risks related to these revenues by financing the research and
development of PSRFs technology as well as the defense of PSRFs patents.
Deferred revenue in the accompanying balance sheets represents amounts prepaid
by customers to the Company for services to be preformed and products to be
delivered at a subsequent date. These deferred and unearned amounts will be
amortized into revenue over the applicable periods. Revenues as they relate to
the sale of manufactured proprietary ligands are recognized in full upon the
shipping and invoicing of the ligands to the customer.

Recently Issued Accounting Standards

In April 2002, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. SFAS No. 145 rescinds the provisions of SFAS No. 4,
which requires companies to classify certain gains and losses from debt
extinguishments as extraordinary items, eliminates the provisions of SFAS No.
44 regarding transition to the Motor Carrier Act of 1980 and amends the
provisions of SFAS No. 13 to require that certain lease modifications be
treated as sale leaseback transactions. The provisions of SFAS No. 145 related
to classification of debt extinguishments are effective for fiscal years
beginning after May 15, 2002, with earlier application encouraged.

In July 2002, the FASB issued SFAS No. 146, Accounting for Restructuring
Costs. SFAS No. 146 applies to costs associated with an exit activity
(including restructuring) or with a disposal of long-lived assets. Those
activities can include eliminating or reducing product lines, terminating
employees and contracts and relocating plant facilities or personnel. Under
SFAS No. 146, the Company will record a liability for a cost associated with an
exit or disposal activity when that liability is incurred and can be measured
at fair value. SFAS No. 146 will require the Company to disclose information
about its exit and disposal activities, the related costs, and changes in those
costs in the notes to the interim and annual

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financial statements that include the period in which an exit activity is
initiated and in any subsequent period until the activity is completed. SFAS
No. 146 is effective prospectively for exit or disposal activities initiated
after December 31, 2002, with earlier adoption encouraged. Under SFAS No. 146,
a company cannot restate its previously issued financial statements and the
new statement grandfathers the accounting for liabilities that a company had
previously recorded under Emerging Issues Task Force Issue 94-3.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure  an amendment of FASB Statement No.
123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock Based
Compensation and provides alternative methods for accounting for a change by
registrants to the fair value method of accounting for stock-based
compensation. Additionally, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require disclosure in the significant accounting policy
footnote of both annual and interim financial statements of the method of
accounting for stock based-compensation and the related pro-forma disclosures
when the intrinsic value method continues to be used. The statement is
effective for fiscal years beginning after December 15, 2002, and disclosures
are effective for the first fiscal quarter beginning after December 15, 2002.

In January 2003, The FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of Accounting Research Bulletin
(ARB) No. 51, Consolidated Financial Statements. Interpretation No. 46
addresses consolidation by business enterprises of variable interest entities,
which have one or both of the following characteristics: (i) the equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated support from other parties, which is
provided through other interest that will absorb some or all of the expected
losses of the entity; (ii) the equity investors lack one or more of the
following essential characteristics of a controlling financial interest: the
direct or indirect ability to make decisions about the entities activities
through voting rights or similar rights; or the obligation to absorb the
expected losses of the entity if they occur, which makes it possible for the
entity to finance its activities; the right to receive the expected residual
returns of the entity if they occur, which is the compensation for the risk of
absorbing the expected losses.

Interpretation No. 46 also requires expanded disclosures by the primary
beneficiary (as defined) of a variable interest entity and by an enterprise
that holds a significant variable interest in a variable interest entity but is
not the primary beneficiary. Interpretation No. 46 applies immediately to
variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date.
It applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. Interpretation No. 46 may
be applied prospectively with a cumulative-effect adjustment as of the date on
which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. The
changes in SFAS No. 149 improve financial reporting by requiring that contracts
with comparable characteristics be accounted for similarly. This statement is
effective for contracts entered into or modified after June 30, 2003 and all of
its provisions should be applied prospectively.

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In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150
changes the accounting for certain financial instruments with characteristics
of both liabilities and equity that, under previous pronouncements, issuers
could account for as equity. The new accounting guidance contained in SFAS No.
150 requires that those instruments be classified as liabilities in the balance
sheet.

SFAS No. 150 affects the issuers accounting for three types of freestanding
financial instruments. One type is mandatorily redeemable shares, which the
issuing company is obligated to buy back in exchange for cash or other assets.
A second type includes put options and forward purchase contracts, which
involves instruments that do or may require the issuer to buy back some of its
shares in exchange for cash or other assets. The third type of instruments
that are liabilities under this Statement is obligations that can be settled
with shares, the monetary value of which is fixed, tied solely or predominantly
to a variable such as a market index, or varies inversely with the value of the
issuers shares. SFAS No. 150 does not apply to features embedded in a
financial instrument that is not a derivative in its entirety.

Most of the provisions of SFAS No. 150 are consistent with the existing
definition of liabilities in FASB Concepts Statement No. 6, Elements of
Financial Statements. The remaining provisions of this Statement are
consistent with the FASBs proposal to revise that definition to encompass
certain obligations that a reporting entity can or must settle by issuing its
own shares. This Statement shall be effective for financial instruments
entered into or modified after May 31, 2003 and otherwise shall be effective at
the beginning of the first interim period beginning after June 15, 2003, except
for mandatorily redeemable financial instruments of a non-public entity, as to
which the effective date is for fiscal periods beginning after December 15,
2003.

In June 2003, the FASB issued an Exposure Draft for proposed SFAS entitled
"Qualifying Special Purpose Entities (QSPE) and Isolation of transferred
Assets, an amendment of SFAS No. 140 (The Exposure Draft). The Exposure
Draft is a proposal that is subject to change and as such, is not yet
authoritative. If the proposal is enacted in its current form, it will amend
and clarify SFAS 140. The Exposure Draft would prohibit an entity from being a
QSPE if it enters into an agreement that obliged a transferor of financial
assets, its affiliates, or its agents to deliver additional cash or other
assets to fulfill the special-purposes entitys obligation to beneficial
interest holders.

We believe that the adoption of these pronouncements will not have a material
impact on our financial position or results of operations.

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RISK FACTORS

Risks Related to Our Company

Our future success is highly dependent on the continued availability of Dr.
Xumu Zhang and other key employees and consultants.

In connection with the continued development of our products and services, we
are substantially dependent upon on the continued service of its existing
research personnel, including in particular, Xumu Zhang, Ph.D. Dr. Zhang, an
associate professor at Penn State, serves as our chief technology officer and
provides essential services to us pursuant to a consulting agreement. Although
we maintain key-man insurance with respect to Dr. Zhang and he has entered into
a non-compete agreement with us, the loss of his services would have a material
adverse affect on our business. In addition to Dr. Zhang, we employ other
research scientists who are also critical to our success. Although these
research scientists have entered into confidentiality agreements, most have not
entered into noncompete agreements with us. The loss of one or more of our
research personnel could prevent or delay the ongoing development of our
products and services, which would materially and adversely affect our
business.

A small group of persons is able to exert significant control over our company.

Our current officers and directors beneficially own or control
approximately 32% of our common stock. Individually and in the aggregate,
these persons will have significant influence over the management of our
business, the election of directors and all matters requiring shareholder
approval. In particular, this concentration of ownership may have the effect of
facilitating, delaying, deferring or preventing a potential acquisition of our
company and may adversely affect the market price of our common stock.
Additionally, four members of our Board of Directors and the treasurer of our
company are employees of Paramount Capital, Inc., or one of its affiliates. Dr.
Lindsay A. Rosenwald is the chairman and sole owner of Paramount Capital, Inc.
and such affiliates. Dr. Rosenwald beneficially owns 4.9% of our outstanding
common stock, and several trusts for the benefit of Dr. Rosenwald and his
family beneficially own 14.7% of our outstanding common stock. Although Dr.
Rosenwald does not have the legal authority to exercise voting power or
investment discretion over the shares held by those trusts, he nevertheless may
have the ability to exert significant influence over the Company.

The illiquidity of our common stock could make it difficult for you to sell
shares of our common stock.

Trading of our common stock is conducted on the National Association of
Securities Dealers Over-the-Counter Bulletin Board, or OTC Bulletin Board.
This has an adverse effect on the liquidity of our common stock, not only in
terms of the number of shares that can be bought and sold at a given price, but
also through delays in the timing of transactions and reduction in security
analysts and the medias coverage of us. This may result in lower prices for
our common stock than might otherwise be obtained and could also result in a
larger spread between the bid and asked prices for our common stock.

In addition, our common stock is a penny stock. Broker-dealers who sell penny
stocks must provide purchasers of these stocks with a standardized risk
disclosure document prepared by the SEC. This document provides information
about penny stocks and the nature and level of risks involved in investing in
the penny stock market. A broker must also give a purchaser, orally or in
writing, bid and offer quotations and information regarding broker and
salesperson compensation, make a written determination that the penny stock is
a suitable investment for the purchaser, and obtain the purchasers written
agreement to the purchase. The penny stock rules may make it difficult for you
to sell your shares of our stock. Because of the rules, there is less trading
in penny stocks. Also, many brokers choose not to

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participate in penny stock transactions. Accordingly, you may not always be
able to resell shares of our common stock publicly at times and prices that you
feel are appropriate.

We have no meaningful operating history on which to evaluate our business or
prospects.

We commenced operations in October 2000 and, therefore, have only a limited
operating history on which you can base an evaluation of our business and
prospects. Accordingly, our business prospects must be considered in light of
the risks, uncertainties, expenses and difficulties frequently encountered by
companies in their early stages of development, particularly companies in new
and rapidly evolving markets, such as the fine chemical, pharmaceutical and
biotechnology markets.

Our management anticipates incurring losses for the foreseeable future.

For the nine months ending September 30, 2003, we had a net loss of $1,451,035
and since our inception in October 2000 through September 30, 2003, we have
incurred an aggregate net loss of $2,843,840. As of September 30, 2003, we had
total assets of $1,797,282, of which $918,998 was cash or cash equivalents. We
expect operating losses to continue for the foreseeable future and there can be
no assurance that we will ever be able to operate profitably.

We will require additional financing in order to complete the development of
our products and services and otherwise develop our business operations. Such
financing may not be available on acceptable terms, if at all.

We anticipate that our current capital will be adequate to fund our operations
at least for the next 4 to 6 months. However, changes may occur that would
consume available capital resources before that time. Our combined capital
requirements will depend on numerous factors, including competing technological
and market developments; changes in our existing collaborative relationships;
the cost of filing, prosecuting, defending and enforcing patent claims and
other intellectual property rights and the outcome of any potentially related
litigation or other dispute; the purchase of additional capital equipment;
acquisition of technologies; and the development and regulatory approval
progress of our customers product candidates into which our technology will be
incorporated.

Additional capital that may be needed by us in the future may not be available
on reasonable terms, or at all. If adequate financing is not available, we may
be required to terminate or significantly curtail our operations, or enter into
arrangements with collaborative partners or others that may require us to
relinquish rights to certain of our technologies, or potential markets that we
would not otherwise relinquish.

Our operating results will fluctuate, making it difficult to predict our
results of operations in any future period.

As we develop our business, we expect our revenues and operating results to
vary significantly from quarter-to-quarter. As a result, quarter-to-quarter
comparisons of our revenues and operating results may not be meaningful. In
addition, due to the fact that we have little or no significant operating
history with our new technology, we cannot predict our future revenues or
results of operations accurately. Our current and future expense levels are
based largely on our planned expenditures and estimates of future revenues.
Accordingly, we may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall, and any significant shortfall
in revenues relative to our planned expenditures could have an immediate
adverse effect on our business and results of operations.

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We may be unable to develop successful customer relationships.

We intend to establish relationships with various types of customers and
partners, such as pharmaceutical and fine chemical manufacturers. Each of these
relationships will involve negotiation of terms and fees. We cannot be certain
that we will be able to negotiate profitable relationships or that we can
successfully fulfill our obligations under development agreements that will
allow us to continue these relationships.

Our license agreement with Penn State Foundation may be terminated if we do not
achieve certain milestones.

Our business is based on technically complex products and services. We do not
directly own this technology, but rather we have the exclusive, worldwide right
to use it pursuant to a license agreement with the Penn State Foundation.
Currently, our commercial success depends entirely on this licensed technology.
Pursuant to the license agreement, we are required to use our best efforts to
achieve gross revenue (as defined in the license agreement) of at least
$250,000 in 2004, at least $350,000 in 2005 and at least $500,000 in 2006. In
the event we fail to achieve these milestones, or otherwise materially breach
the license agreement, the Penn State Foundation may have the right, but not
the obligation, to terminate the license. Unless we subsequently develop our
own technology independent of the Penn State Foundation, termination of this
license would preclude us from implementing our business plan.

We may rely heavily on third parties to formulate and manufacture our products.

We currently lack the resources to formulate or manufacture the overwhelming
majority of our own products on a commercial scale.If any of our customers
require our ligands in commercial quantities in the near term, we may have to
rely one or more third-party contractors to manufacture the ligands to satisfy
the needs of such customers. Reliance on one or more third-party manufacturers
exposes us to certain risks, including the following:



| |  |  | We may be unable to replace manufacturers on commercially
reasonable terms or at all because the number of potential
manufacturers is limited, and the United States Food and Drug
Administration (FDA), or such similar regulatory authorities, may
have to approve any replacement contractor;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Third-party manufacturers might be unable to formulate and
manufacture our ligands in the volume and of the quality required to
meet customers clinical and commercial needs;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our existing and future contract manufacturers may not
perform as agreed or may not remain in the contract manufacturing
business for the time required to supply our customers to complete
their clinical trials or to successfully produce, store and
distribute our products;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Drug manufacturers are subject to ongoing periodic
unannounced inspections by the FDA and corresponding state agencies
to ensure strict compliance with good manufacturing practice and
other government regulations and corresponding foreign standards,
which we would be unable to control; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | If any third-party manufacturer makes improvements in the
manufacturing process for our products, we may not own, or may have
to share, the intellectual property rights to the innovation.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Each of these risks could delay the clinical trials conducted by our customers,
approvals required by

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regulatory authorities, and the commercialization of some of our customers
product candidates. These risks could also result in higher costs to the
customer or could deprive us of potential product revenues.

We will need to create and grow our scientific, sales and support operations.

We will need to create and substantially grow our direct and indirect sales
operations, both domestically and internationally, in order to create and
increase market awareness and sales of our products and services. The sale of
our products and services will require the engagement of sophisticated and
highly knowledgeable sales personnel. Similarly, the anticipated complexity of
our products and services and the difficulty of customizing them will require
us to hire research and development personnel and customer service and support
personnel, highly trained in chiral chemistry and chemical engineering.
Competition among our company and others to retain qualified sales personnel,
chemists and chemical engineers is intense due to the limited number of
available qualified candidates for such positions. Many of our competitors are
in a financial position to offer potential employees greater compensation and
benefits than those which may be offered by us. Failure to recruit and retain
such persons will have a material adverse effect on our business operations.

Our future success is dependent on the management of our potential growth.

Our future success depends upon our ability to grow our business. Such growth,
if it occurs, will require us to establish management and operating systems,
hire additional support technical and sales personnel, and establish and
maintain our own independent office, research and production facilities.
Failure to manage that growth efficiently could have a material adverse affect
on our business.

We currently have no capabilities and no experience in manufacturing our
products on a commercial scale.

We do not currently have the experience or ability to directly manufacture or
market most chemical or pharmaceutical products in commercial quantities that
may be developed under our collaborative arrangements. Even though, with the
opening of our Princeton, New Jersey facility, we have the capacity to develop
certain of our products on a commercial scale, we most likely will not be able
to produce all of our ligands on a commercial scale at the Princeton facility.
In addition, we have not yet developed a cost effective and efficient
commercial manufacturing process for some of our ligands, and may never be able
to do so. To the extent we are unable to produce, directly or indirectly, our
ligands in quantities required for commercial use, we will not realize any
benefits from our technology. Further, in the event we decide to establish a
manufacturing facility in the future, we may require substantial additional
funds, and will be required to hire and train a significant number of
additional personnel, and, in certain circumstances, may need to comply with
the extensive FDA good manufacturing practice regulations applicable to such
a facility.

Risks Relating to Our Industry

We face intense competition.

We compete directly with the in-house research departments of fine chemical,
pharmaceutical and biotechnology companies, as well as contract research
companies, and research and academic institutions. Many of our competitors
have greater financial and other resources than us. As new companies enter the
market and as more advanced technologies become available, we expect to face
increased competition. In the future, any one of our competitors may develop
technological advances that render obsolete the products or services that we
provide or may provide in the future. While we plan

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to develop new and better technologies, which will give us competitive
advantages, our competitors plan to do the same. We may not be able to develop
the technologies we need to successfully compete in the future, and our
competitors may be able to develop such technologies before we do.
Consequently, we may not be able to successfully compete in the future.

The fine chemical, pharmaceutical and biotechnology industries involve rapidly
changing technologies.

Rapid technological change and uncertainty due to new and emerging technologies
characterize the drug and fine chemical development industries. We may not be
able to develop, integrate and market, on a timely basis, the new and enhanced
products and services necessary to keep pace with competitors. Failure to
anticipate or to respond to changing technologies, or significant delays in
product development or introduction, could cause our customers to delay or
decide against purchases of our products or services.

Since many of or customers and potential customers are pharmaceutical and
biotechnology companies, we are and will be subject to risks, uncertainties and
trends that affect companies in these industries.

For the foreseeable future, we will derive a substantial portion of our revenue
from pharmaceutical and biotechnology companies. As a result, we will be
subject to risks and uncertainties that affect the pharmaceutical and
biotechnology industries and possible reduction and delays in research and
development expenditures by companies in these industries. Our future revenues
may also be adversely affected by mergers and consolidation in the
pharmaceutical and biotechnology industries, which will reduce the number of
potential customers.

In particular, pharmaceutical and biotechnology companies face significant
regulation by governmental entities in the United States and other countries.
The nature and the extent to which such regulation may apply to our customers
will vary depending on the nature of any such customers products. Most of the
pharmaceutical products developed by our customers will require regulatory
approval by governmental agencies prior to commercialization. In particular,
human pharmaceutical therapeutic products are subject to rigorous preclinical
and clinical testing and other approval procedures by the FDA and by foreign
regulatory authorities. Various federal and, in some cases, state laws also
govern or influence the manufacturing, safety, labeling, storage, record
keeping and marketing of such pharmaceutical products. The process of
obtaining these approvals and the subsequent compliance with appropriate
federal and foreign statutes and regulations are time consuming, can cause
significant delays in the commercialization of a drug, and often require the
expenditure of substantial resources. To the extent our customers experience
significant delays in obtaining the necessary regulatory approvals to market
their pharmaceutical products, or are unable to obtain such approvals at all,
these customers will not purchase our proprietary ligands and other services
used in the manufacture of the ultimate pharmaceutical product.

We may be held liable for harm caused by drugs that our customers develop and
test.

Often times, our ligands will be used by our customers to produce drugs for
human use. If any of the drugs cause injuries or illness to people, we may be
required to incur substantial costs in defending against claims and may be
required to pay damages arising therefrom. Although we intends to obtain
liability insurance and will use commercially reasonable efforts to obtain
indemnification covenants from our customers for their use of our products,
such protections may not be sufficient to protect us from the cost of such
claims. Damages awarded in a product liability action could be substantial and
could have a

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material adverse effect on our financial condition.

We may be held liable for contamination or other harm caused by hazardous
materials that we use.

Some of our research and development processes involve the use of hazardous
materials and, therefore, we are subject to federal, state and local regulation
governing the use, manufacture, handling, storage and disposal of hazardous
materials. We cannot completely eliminate the risk of contamination or injury
resulting from hazardous materials and we may incur liability as a result of
any contamination or injury. We may also incur expenses relating to compliance
with environmental laws. Such expenses or liability may have a material
adverse effect on our financial condition.

Risks Relating to Our Technology

We may not be able to license technologies that we need to conduct our
business.

In addition to the technologies that we develop, we will rely heavily on
technologies that we license from other companies or institutions. We may not
be able to license technologies that we need in the future or we may be unable
to license such technologies on a commercially reasonable basis. Although our
license agreement with the Penn State Foundation provides that we are entitled
to use any improvements subsequently made to the technologies we currently
license, the Penn State Foundation has no obligation to license any new
technologies discovered by Dr. Zhang and researchers at Penn State. If we are
unable to license the technologies we need in the future, or to license or
otherwise acquire such technologies on commercially reasonable terms, we may
experience increased costs (and, therefore, reduced profits) or be unable to
engage in certain activities that require those technologies. Accordingly,
failure to license the technologies we need in the future or failure to license
or otherwise acquire such technologies on commercially reasonable terms could
have a material adverse effect on the our business operations.

Our success will depend on our ability to protect our proprietary technology.

Our rights to a substantial portion of our technology are as the exclusive
licensee to several United States patents and a number of United States and
foreign pending patent applications held by the Penn State Foundation,
including the ligands that comprise our Chiral ToolKit. These patents and
patent applications are based primarily upon the work of Dr. Zhang, our chief
technology officer, who is also an associate professor at the Pennsylvania
State University. Our success will depend largely on our ability, and the
ability of our licensors and licensees, to obtain patents for their
technologies and products, if any, resulting from the application of such
technologies, defend patents once obtained, and maintain trade secrets.

If we are unable to protect our intellectual property, or incur significant
expense in doing so, our business, operating results and financial condition
may be materially adversely affected. Any steps we take to protect our
intellectual property may be inadequate, time consuming and expensive.

Our success and ability to compete are substantially dependent upon our
internally developed products and services, which we currently protect through
the use of United States and foreign patents. To the extent such products and
services are not patentable, we will rely on trade secret protection. As with
other knowledge-based products, however, our patent positions rest on complex
factual and legal issues that are not entirely resolved and there can be no
assurance that the patents utilized by us will adequately protect our
proprietary products and services. Although we have taken steps to protect our
unpatented trade secrets and know-how, in part through the control of access to
such information and through the use

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of confidentiality agreements with our employees, consultants and certain of
our contractors, customers and potential customers, there can be no assurance
that these agreements will not be breached, that we would have adequate
remedies for any breach, or that our trade secrets will not otherwise become
known or be independently developed or discovered by competitors. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. We anticipate
that policing unauthorized use of our products will be difficult, and we cannot
be certain that the steps we intend to take to prevent misappropriation of our
technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States, will be successful.
Other companies may also independently develop substantially equivalent
information.

Foreign laws may not afford us sufficient protection for our intellectual
property rights and, in certain cases, we may not seek patent protection
outside the United States.

We believe that our success will depend, in part, upon our ability to obtain
international protection for our intellectual property. We have existing
foreign customers and believe we will have access to large markets oversees.
The laws of some foreign countries may not be as comprehensive as those of the
United States and may not be sufficient to protect our proprietary rights
abroad, however. In addition, in certain cases, we may decide not to pursue
patent protection outside the United States, because of cost and
confidentiality concerns. Accordingly, our international competitors could
obtain foreign patent protection for, and market overseas, technology for which
we are seeking United States patent protection, though such competitors patent
protection generally requires such competitors to make their patent filings
prior to information on our relevant inventions becoming sufficiently available
under local law as to block the availability of such competitors patent
protection.

Our technology may infringe on the proprietary rights of others.

We anticipate that other patents that we license or may license in the future
will be increasingly subject to infringement claims due to the rapid
development of chiral chemistry and competitors in our industry. In fact, one
potential competitor, Solvias, AG, based in Basel, Switzerland, notified us in
July 23, 2002, of its claim that one of the patented ligands we license from
the Penn State Foundation infringes on a patent that Solvias licenses from BASF
Group, AG. Some of our other competitors or our potential competitors may have
filed or intend to file patent applications that may make claims that conflict
with the claims of the patents that we license. We cannot be certain that
these competitors or other third parties will not assert infringement claims
against us with respect to our products and technology. Any infringement
claim, including Solvias claim, regardless of its merit, could be
time-consuming and expensive to defend. Such claims may also require us to
enter into royalty or licensing agreements in order to continue using the
disputed technology. In the event we could not afford to defend our company
against an infringement claim or are not able to enter into a license or
royalty agreement on commercially favorable terms, or at all, we may be
required to abandon the technology that is subject to such claims.

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Item 3. Controls and Procedures

As of September 30, 2003, we carried out an evaluation, under the supervision
and with the participation of our chief executive and chief financial officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934, as amended). Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective in alerting them on a timely basis to
material information required to be disclosed in our periodic reports to the
Securities and Exchange Commission. There have been no significant changes in
our internal controls or in other factors which could significantly affect
internal controls subsequent to such evaluation.

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PART II  OTHER INFORMATION




Item 1. Legal Proceedings.

We are not a party to any material legal proceedings.




Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer and Chief Financial Officer.32.1
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


(b) Reports on Form 8-K.

None.

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SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

CHIRAL QUEST, INCDate: November 14, 2003
    
    By:
    
    /s/  Alan D. RothAlan D. Roth
President, Chief Executive Officer
and Chief Financial Officer


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Exhibit Index

Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer and Chief Financial Officer.32.1
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


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