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 1934


For the quarterly period ended June 30, 2004





OR





|_|    TRANSITION REPORT UNDER SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from _______ to _______





Commission File Number 0-16686





VIOQUEST PHARMACEUTICALS, INC.


(Exact name of issuer as specified in its charter)








Minnesota
58-1486040(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)7 Deer Park Drive, Suite E, Monmouth Junction, NJ
08852(Address of Principal Executive Offices)
(Zip Code)(732) 274-0399(Issuers telephone number)





Chiral Quest, Inc.


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





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





As of August 13, 2004 there were 17,827,924 shares of the issuers common stock, $.01 par value, outstanding.





Traditional Small Business Disclosure Format (check one): Yes |_|  No |X|











Index





PagePART
            I
        FINANCIAL
            INFORMATIONItem
            1.
        Condensed
            Consolidated Financial Statements
        1Item
            2.
        Managements
            Discussion and Analysis or Plan of Operations
        10Item
            3.
        Controls
            and Procedures
        14PART
            II
        OTHER
            INFORMATIONItem
            1.
        Legal
            proceedings
        15Item
            5.
        Other
            Information
        15Item
            6.
        Exhibits
            and Reports on Form 8-K
        15Signatures
        16








Forward-Looking Statements





This Quarterly Report on Form 10-QSB contains statements that are not historical, but are forward-looking in nature, including statements regarding the expectations, beliefs, intentions or strategies regarding the future. In particular, the Managements Discussion and Analysis or Plan of Operation section in Part I, Item 2 of this quarterly report includes 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 1 in Part I of our Annual Report on Form 10-KSB for the year ended December 31, 2003.














VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE SHEETS


AS OF JUNE 30, 2004 (UNAUDITED) AND DECEMBER 31, 2003




**June 30, 2004(Unaudited)**
****
****
****
******December 31,2003**ASSETSCURRENT ASSETSCash and cash equivalents

$
5,258,622



$
659,117Accounts receivable, net of allowance for doubtful accounts of$8,900 at June 30, 2004 and $11,490 at December 31, 2003


169,005




51,705Inventory


78,808




76,892Prepaid expenses


39,850




50,052Total Current Assets


5,546,285




837,766PROPERTY AND EQUIPMENT, NET


353,347




254,649SECURITY DEPOSITS


26,000




31,000DEFERRED FINANCING COSTS







50,000INTELLECTUAL PROPERTY RIGHTS, NET


488,159




412,442TOTAL ASSETS

$
6,413,791



$
1,585,857LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIESAccounts payable

$
454,062



$
273,414Accrued expenses


198,930




226,200Due to related party







1,201Deferred revenue, current portion


101,253




220,592Total Current Liabilities


754,245




721,407LONG-TERM LIABILITIESDeferred revenue, long-term portion


14,710




39,116TOTAL LIABILITIES


768,955




760,523COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS' EQUITYCommon stock, $.01 par value, 50,000,000 shares authorized, 17,827,924 shares issued and outstanding at June 30, 2004 and13,001,018 shares issued and outstanding at December 31, 2003


178,279




130,010Additional paid-in capital


11,508,715




4,865,353Deferred expenses


(608,137
)



(758,824
)Accumulated deficit


(5,434,021
)



(3,411,205
)Total Stockholders' Equity


5,644,836




825,334TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$
6,413,791



$
1,585,857





See accompanying notes to condensed consolidated financial statements.





1








VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003


(UNAUDITED)





For the Three Months Ended June 30, 2004

For the Three Months Ended June 30, 2003

For the Six Months Ended June 30, 2004

For the Six Months Ended June 30, 2003REVENUE

$
357,200

$
59,382

$
735,123

$
131,441COST OF GOODS SOLD


(294,188
)

(7,528
)

(377,249
)

(25,387
)GROSS PROFIT


63,012


51,854


357,874


106,054OPERATING EXPENSESManagement and consulting fees


124,660


71,335


237,892


126,009Research and development


205,946


110,242


458,050


206,475Selling, general and administrative


388,330


259,882


804,072


423,366Compensation


574,293


146,595


803,878


217,720Depreciation and amortization


62,608


32,716


92,605


42,640Total Operating Expenses


1,355,837


620,770


2,396,497


1,016,210LOSS FROM OPERATIONS


(1,292,825
)

(568,916
)

(2,038,623
)

(910,156
)INTEREST INCOME, NET


11,100


4,730


15,807


7,680NET LOSS

$
(1,281,725
)
$
(564,186
)
$
(2,022,816
)
$
(902,476
)NET LOSS PER COMMON SHARE  BASIC AND DILUTED

$
(.07
)
$
(.04
)
$
(.12
)
$
(.08
)WEIGHTED AVERAGE SHARES OUTSTANDING  BASIC AND DILUTED


17,827,924


13,001,018


16,342,722


11,937,998





See accompanying notes to condensed consolidated financial statements.





2








VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY


FOR THE SIX MONTHS ENDED JUNE 30, 2004


(UNAUDITED)




**Additional**







TotalCommon Stock

Paid-In

Deferred

Accumulated

Stockholders**Shares**

Amount

Capital

Expenses

Deficit

EquityBalance, January 1, 2004


13,001,018

$
130,010

$
4,865,353

$
(758,824
)
$
(3,411,205
)
$
825,334Private placement of common stocknet of expenses of $57,841


4,826,906


48,269


6,643,362








6,691,631Amortization of deferred expenses











150,687





150,687Net loss














(2,022,816
)

(2,022,816
)Balance, June 30, 2004


17,827,924

$
178,279

$
11,508,715

$
(608,137
)
$
(5,434,021
)
$
5,644,836





See accompanying notes to condensed consolidated financial statements.





3








VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003


(UNAUDITED)




For the SixMonths EndedJune 30, 2004



For the SixMonths EndedJune 30, 2003CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(2,022,816
)


$
(902,476
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


92,605




42,640Amortization of deferred expenses


150,687




76,734Changes in operating assets and liabilities:Increase in accounts receivable


(117,300
)



(47,874
)Increase in inventory


(1,916
)



(10,090
)Decrease (Increase) in prepaid expenses


10,202




(7,985
)Decrease (Increase) in security deposits


5,000




(20,000
)Increase in accounts payable


180,648




98,774(Decrease) Increase in accrued expenses and due to related party


(46,362
)



83,454Decrease in deferred revenue


(143,745
)



(66,984
)Net Cash Used In Operating Activities


(1,892,997
)



(753,807
)CASH FLOWS FROM INVESTING ACTIVITIES:Payments for purchased equipment


(156,850
)



(139,297
)Payments for intellectual property rights


(92,279
)



(30,160
)Net Cash Used In Investing Activities


(249,129
)



(169,457
)CASH FLOWS FROM FINANCING ACTIVITIES:Payment of note payable







(336,625
)Cash received in merger and recapitalization







3,017,243Private placement of common stock


6,741,631




Net Cash Provided By Financing Activities


6,741,631




2,680,618NET INCREASE IN CASH AND CASH EQUIVALENTS


4,599,505




1,757,354CASH AND CASH EQUIVALENTS  BEGINNING OF PERIOD


659,117




33,520CASH AND CASH EQUIVALENTS  END OF PERIOD

$
5,258,622



$
1,790,874Supplemental Schedule of Non-Cash Investing and Financing Activities:Reclassification of Deferred Financing Costs to Additional Paid-In Capital

$
50,000



$
Accrual for Intellectual Property Rights

$
17,891



$






See accompanying notes to condensed consolidated financial statements.





4




VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


JUNE 30, 2004





NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND LIQUIDITY








(A) Basis of Presentation





The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, the financial statements do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete annual financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for a fair presentation. Interim operating results are not necessarily indicative of results that may be expected for the year ending December 31, 2004 or for any subsequent period. These unaudited condensed consolidated financial statements should be read in conjunction
with the Annual Report on Form 10-KSB of Chiral Quest Inc. and its subsidiary (the Company or Chiral Quest) as of and for the year ended December 31, 2003.





(B) Liquidity





Since the Companys inception, it has generated sales revenue but no net profits. Management believes that the Companys research and development (R&D) and manufacturing capacity will need to grow in order for the Company to be able to obtain significant licensing and manufacturing agreements with large fine chemical and pharmaceutical companies. Management believes that the Companys manufacturing capacity will continue to be enhanced with its new office and laboratory space located in Monmouth Junction, New Jersey that was leased in June 2003.





Since inception, the Company has incurred an accumulated deficit of $5,434,021 through June 30, 2004. For the three and six months ended June 30, 2004 the Company had net losses of $1,281,725 and $2,022,816, respectively. Management expects the Companys operating losses to increase significantly over the next several years, primarily due to the expansion of its R&D programs, the hiring of additional chemists, and the expansion of its manufacturing capabilities. There can be no assurance that the Company will ever be able to operate profitably.





As of June 30, 2004, the Company had working capital of $4,792,040 and cash and cash equivalents of $5,258,622. If the Company is unable to significantly increase its revenues, it will most likely require additional financing, perhaps as early as the second quarter of 2005 in order to continue operations. The most likely sources of financing include private placements of the Companys equity or debt securities or bridge loans to the Company from third party lenders.





The Companys net cash used in operating activities for the six months ended June 30, 2004 was $1,892,997. The Companys net cash used in operating activities primarily consisted of a net loss of $2,022,816, an increase in accounts receivable of $117,300 and decreases in accrued expenses and deferred revenue of $46,362 and $143,745, respectively, offset by an increase in accounts payable of $180,648.





The Companys net cash used in investing activities for the six months ended June 30, 2004 totaled $249,129, which consisted of purchases of equipment for $156,850 related to the laboratory expansion completed in April 2004, along with patent applications expenditures of $92,279.





The Companys net cash provided by financing activities for the six months ended June 30, 2004 was $6,741,631. Financing activities consisted of the cash received in the private placement of the Companys common stock on February 25, 2004.





5




VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


JUNE 30, 2004





Management anticipates that the Companys capital resources will be adequate to fund its operations through June 30, 2005. However, changes may occur that would consume available capital resources before that time. The Companys 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, the establishment and funding of the Chiral Quest, Jiashan, China facility, and the development and regulatory approval progress of its customers product candidates into which the Companys technology will be
incorporated.





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





The Companys ability to achieve profitability depends upon, among other things, its ability to discover and develop products (specifically new ligands which are the Companys core proprietary technology consisting of molecular compounds that create a chiral center), and to develop its products on a commercial scale through a cost effective and efficient process. To the extent that the Company is unable to produce, directly or indirectly, ligands in quantities required for commercial use, it will not realize any significant revenues from its technology. Moreover, there can be no assurance that it will ever achieve significant revenues or profitable operations from the sale of any of its products or technologies.





(C) Stock-Based Compensation





The Company accounts for its employee and director stock option plans using the intrinsic value method 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. For pro forma disclosure purposes, the Company values option issuances using the Black-Scholes option pricing model, for the three and six months ended June 30, 2004 and 2003. If the Company had elected to recognize compensation cost for all outstanding options granted by the Company to employees by applying the fair value recognition provisions of SFAS No.
123 Accounting for Stock Based Compensation,to employee stock options, net loss and loss per share would have been increased to the pro forma amounts indicated below:








For the Three Months Ended June 30, 2004

For the Three Months Ended June 30, 2003

For the Six Months Ended June 30, 2004

For the Six Months Ended June 30, 2003Net loss as reported

$
(1,281,725
)
$
(564,186
)
$
(2,022,816
)
$
(902,476
)Total stock-based employee compensation expenses using the fair value based method for all awards, net of related tax effects


(8,542
)

(15,789
)

(48,205
)

(131,614
)Net loss, pro forma

$
(1,290,267
)
$
(579,975
)
$
(2,071,021
)
$
(1,034,090
)Basic and diluted net loss per common share:As reported

$
(.07
)
$
(.04
)
$
(.12
)
$
(.08
)Pro forma

$
(.07
)
$
(.04
)
$
(.13
)
$
(.09
)Black-Scholes option pricing assumptionsRisk-free interest rate


3%-4.5
%

2.3%-4
%

3.6%-4.5
%

2.3%-4
%Volatility


64%-77
%

64%-128
%

39%-127
%

64%-128
%Lives in years


10


3-10


10


3-10Dividend yield


0
%

0
%

0
%

0
%






6




VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


JUNE 30, 2004





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 consolidated financial statements as deferred expenses in the stockholders equity section using the fair value method and then amortized to expense over the applicable service periods.





(D) Loss Per Share





Basic net loss per share is calculated by dividing net loss by the weighted-average number of shares outstanding for each period presented. Diluted net loss per share is the same as basic net loss per share, since potentially dilutive securities from the assumed exercise of stock options and stock warrants would have had an antidilutive effect because the Company incurred a net loss during each period presented. The amount of potentially dilutive securities excluded from the calculation was 2,083,877 at June 30, 2004. There were 2,506,047 potentially dilutive securities at June 30, 2003.








NOTE 2 INVENTORY








The principal components of inventory are as follows:




June 30, 2004(Unaudited)



December 31,2003Raw material compounds

$
34,987



$
25,796Work in process


39,497




42,251Finished goods


4,324




8,845Total Inventory

$
78,808



$
76,892








NOTE 3 STOCKHOLDERS EQUITY








On February 25, 2004, the Company completed the sale of its securities in a private placement to accredited investors for gross proceeds of approximately $7.2 million. Investors in the private placement purchased an aggregate of approximately 4.8 million shares of the Companys common stock at a price per share of $1.50. Additionally, investors received one 5-year warrant to purchase one share of common stock at $1.65 per share for every two common shares purchased in the offering (a total of 2.4 million warrants). ThinkEquity Partners LLC, Paramount BioCapital, Inc. and Casimir Capital L.P. acted as the placement agents for this offering and received fees of approximately $500,000 of which Paramount BioCapital, Inc., a related party, received $300,000. Net proceeds to the Company, after deducting placement agent fees and other expenses relating to the private placement, were
approximately $6.7 million.





The table below illustrates the number of stock options issued to: employees, scientific advisory board members, board of directors and consultants which were issued for services provided:





For the Six Months Ended June 30, 2004Balance, January 1, 2004


2,841,857Granted


205,000Exercised


0Expired


(250
)Terminated


(962,730
)Balance, June 30, 2004


2,083,877


7




VIOQUEST PHARMACEUTICALS, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


JUNE 30, 2004





NOTE 4 COMMITMENTS AND CONTINGENCIES





In April 2004, the Company appointed Ronald Brandt to be its President and Chief Executive Officer on an interim basis. In June 2004, the Company appointed Mr. Brandt to serve as President and Chief Executive Officer of its chiral ligand operating subsidiary. In connection with that appointment, Mr. Brandt entered into a new employment agreement with such subsidiary, which superseded his October 2003 employment agreement with the Company. Mr. Brandts new employment agreement provides for a term expiring in October 2006 and maintains his annual base salary of $200,000. Mr. Brandt is also entitled to receive bonuses based on the Companys gross revenues, as follows:








(i) A one time payment of $50,000 upon the completion of the first two consecutive fiscal quarters in which the Company has gross revenue in excess of $1,000,000;





(ii) A one time payment of $75,000 upon the completion of the first two consecutive fiscal quarters in which the Company has gross revenue in excess of $2,500,000;





(iii) For each fiscal quarter in which the Company has gross revenue in excess of $2,500,000 following the first two consecutive fiscal quarters described in (ii) above, the Company will remit to the Executive a payment of $10,000.





(iv) A one time payment of $100,000 upon the completion of the first two consecutive fiscal quarters in which the Company has gross revenue in excess of $5,000,000; and





(v) For each fiscal quarter in which the Company has gross revenue in excess of $5,000,000 following the first two consecutive fiscal quarters described in (iv) above, the Company will remit to the Executive a payment of $10,000 (in addition to the $100,000 payment in (iv) above).





Mr. Brandt is also entitled to a $100,000 bonus upon such time as the Company sells the operating subsidiary for gross proceeds of at least $40 million.





In the event Mr. Brandts employment is terminated by the Company upon a change of control (as defined in the employment agreement), or for a reason other than disability or cause (as those terms are defined in the employment agreement), the Company has agreed to pay Mr. Brandt his base salary for 6 months, plus accrued bonuses, provided, that the Companys obligation to continue paying his base salary for a 6-month period will be reduced by the amount Mr. Brandt earns from other employment during that period.





In
  connection with his employment agreement, Mr. Brandt also received options to
  purchase an aggregate of 400,000 shares of Company common stock at $1.01 per
  share (the fair market value at the date of grant). Of such options, the right
  to purchase 100,000 shares vests in three equal annual installments beginning
  June 2004. The right to purchase the remaining 300,000 shares vests as follows:
  (1) 100,000 shares vest at such time as the closing bid price for the Companys
  common stock exceeds $3.00 per share for 10 consecutive trading days during
  the term of the employment agreement; (2) 100,000 shares vest at such time as
  the closing bid price for the Companys common stock exceeds $5.00 per
  share for 10 consecutive trading days during the term of the employment agreement;
  and 100,000 shares vest at such time as the closing bid price for the Companys
  common stock exceeds $7.00 per share for 10 consecutive trading days during
  the term of the employment agreement. Mr. Brandt further received an option
  to purchase 2.5% of the subsidiarys common stock at a price of $.01 per
  share, which will vest in 3 annual installments commencing June 2005.





NOTE 5 SUBSEQUENT EVENTS





On August 12, 2004, the Company announced that it changed its name to VioQuest Pharmaceuticals, Inc. and created a new wholly owned subsidiary, VioQuest Drug Development, Inc. which will concentrate on acquiring, developing and commercializing human therapeutics.





The Company also announced that it will assign substantially all of its operating and technology assets relating to its proprietary chemical catalysis platform to a second wholly owned subsidiary which will be re-named Chiral Quest, Inc., and will continue to aggressively pursue its current business plan to commercialize its technology.





8










NOTE 6 CONTINGENCIES





On
  August 6, 2004, the Company received a letter from a competitor notifying the
  Company of the competitors belief that one of the Company's proprietary
  ligands was infringing on a European patent held by such competitor. The Company
  believes that the competitors claims are without merit. Although the Company does not believe the competitor’s
    claims have any merit, even if the Company were prevented from selling or
    otherwise marketing the ligand, such prohibition would not have a material adverse effect on the Company’s
    financial condition or results of operations.








9











**Item 2.**MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.

Overview

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), the technology development arm of the Pennsylvania State University (Penn State). Our license from PSRF covers certain inventions discovered by our Chief Technology Officer (CTO) prior to November 8, 2002.





Since inception we have incurred an accumulated deficit of $5,434,021 through June 30, 2004. 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 which are the Companys core proprietary technology consisting of molecular compounds that create a chiral center), 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.





Since our inception, we have generated sales revenue but no 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 continue to be enhanced with the expansion of our new office and laboratory space located in Monmouth Junction, New Jersey that was leased in June 2003.





On February 18, 2003, we acquired Surg II, Inc., a Minnesota corporation (Surg), in a reverse merger transaction (the Merger). Pursuant to the terms of the Merger, Chiral Quest, LLC merged with and into a wholly-owned subsidiary of Surg. In exchange for all of the outstanding membership interests of Chiral Quest, LLC, Surg issued to the former member of Chiral Quest, LLC a number of shares of Surgs common stock that resulted in the members of Chiral Quest, LLC owning two-thirds of Surgs outstanding shares following the Merger. In connection with the Merger, Surg changed its name to Chiral Quest, Inc., a Minnesota corporation, and adopted the business plan of Chiral Quest, LLC. 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. In August 2004, we changed the Companys name to VioQuest Pharmaceuticals, Inc.





Results of Operations  For the Three Months Ended June 30, 2004 vs. 2003





Our revenues for the three months ended June 30, 2004 were $357,200 as compared to $59,382 for the three months ended June 30, 2003. For the three months ended June 30, 2004, approximately 8% of total revenue was derived from the amortization of option fee income pertaining to the licensing of our intellectual property and 92% 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 June 30, 2003, approximately 56% of total revenue was derived from the amortization of option fee income and 46% 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.





10








Cost of goods sold for three months ended June 30, 2004 was $294,188 as compared to $7,528 during the three months ended June 30, 2003. The increase in cost of goods sold is attributable to the materials used in production for projects completed and shipped along with the allocation of direct labor and overhead expenses to finished goods.





Management and consulting expenses for the three months ended June 30, 2004 were $124,660 as compared to $71,335 during the three months ended June 30, 2003. The overall change for the three months ended June 30, 2004 vs. June 30, 2003 was primarily caused by an increase in consulting expense. Consulting expense increased due to the new consulting agreement we entered into with our CTO at a rate of $10,000 per month effective May 15, 2003, along with the Company utilizing the consulting services of a previous employee during the second quarter 2004. In addition, consulting expense increased due to the amortization of the fair value of stock options issued to consultants and scientific advisory board members, during the second, third, and fourth quarters of 2003.





Our R&D expenses for the three months ended June 30, 2004 were $205,946 as compared to $110,242 during the three months ended June 30, 2003. 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, which has been extended to October 14, 2004, provides for the Company to fund services of four post-doctorate fellows whom under the supervision of the CTO, conduct research and provide research quantities of chiral ligands to the Company. The future obligation payable by the Company through October 14, 2004 as of the end of the agreement is approximately $73,000. This amount consists principally of four post-doctorate salaries, fringe benefits, materials and supplies for the stated period. In addition, during the second quarter of 2003, we opened an additional
laboratory facility in New Jersey, and have completed an expansion to the facility in April 2004, that enabled us to produce both research and commercial quantities of our ligands. In connection with the new facility and its expansion, numerous lab supplies and chemicals were purchased. Accordingly, we incurred increased expenses in the second quarter due to the opening and expansion of the New Jersey facility, along with the increased costs of using the facility and chemists at Penn State.





Selling, general and administrative (SG&A) expenses for the three months ended June 30, 2004 were $388,330 as compared to $259,882 during the three months ended June 30, 2003. This increase in SG&A expenses was due in part to establishing contract reserves, increased usage of temporary contractors, higher legal and accounting fees, increased rent expense for the New Jersey facility as a result of the facilitys expansion, additional spending on advertising and promotion expenses, increased travel expenses for new business development opportunities and higher administrative expenses associated with having more employees such as insurance and employer payroll taxes.





Compensation expense was $574,293 for the three months ended June 30, 2004 as compared to $146,595 for the three months ended June 30, 2003. This increase was caused primarily by the resignation of the CEO effective April 16 2004, which resulted in a charge of $375,000 in severance costs. In addition, compensation expense increased due to the hiring of a vice president of business development, a controller, and several chemists to work at the new laboratory facility in New Jersey. 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 June 30, 2004 were $62,608 as compared to $32,716 during the three months ended June 30, 2003. This increase was primarily related to fixed asset purchases for office equipment, computer equipment, laboratory equipment and leasehold improvements for the newly leased facility and expansion in New Jersey.





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Interest income for the three months ended June 30, 2004 was $11,100 as compared to $4,730 for the three months ended June 30, 2003. The increase in interest income is attributed to having higher cash reserves as a result of the funds received from the private placement of the Companys common stock in February 2004.





Our net loss for the three months ended June 30, 2004 was $1,281,725 as compared to $564,186 for the three months ended June 30, 2003. The increased net loss for the three months ended June 30, 2004 as compared to June 30, 2003 was primarily due to the severance costs associated with the resignation of the Companys CEO in April 2004, higher R&D expenses incurred with funding Penn States research services provided to the Company, increased operational expenditures comprised of higher total rent expense due to the newly leased, and expanded New Jersey facility in June 2003 and April 2004 respectively, higher legal and accounting expenses, higher payroll expenses associated with having more employees along with increased usage of temporary contractors, along with the establishment of contract reserves. We expect losses to continue and increase in the next year as we
attempt to expand our laboratory space.





Results of Operations  For the Six Months Ended June 30, 2004 vs. 2003





Our revenues for the six months ended June 30, 2004 were $735,123 as compared to $131,441 for the six months ended June 30, 2003. For the six months ended June 30, 2004, approximately 8% of total revenue was derived from the amortization of option fee income pertaining to the licensing of our intellectual property and 92% of total revenue was derived from sales of our ligands, feasibility screening and customized process development services sold to third parties. For the six months ended June 30, 2003, approximately 51% of total revenue was derived from the amortization of option fee income and 49% 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 six months ended June 30, 2004 was $377,249 as compared to $25,387 during the six months ended June 30, 2003. The increase in cost of goods sold is attributable to the materials used in production for projects completed and shipped along with the allocation of direct labor and overhead expenses to finished goods.





Management and consulting expenses for the six months ended June 30, 2004 were $237,892 as compared to $126,009 during the six months ended June 30, 2003. The overall change for the six months ended June 30, 2004 vs. June 30, 2003 was primarily caused by an increase in consulting expense. Consulting expense increased due to the new consulting agreement we entered into with our CTO at a rate of $10,000 per month effective May 15, 2003, along with the Company utilizing the consulting services of a previous employee during the second quarter 2004. In addition, consulting expense increased due to the amortization of the fair value of stock options issued to consultants and scientific advisory board members, during the second, third and fourth quarters of 2003. The increased management and consulting expenses have been offset by a decrease in management expenses, charged by Paramount
BioCapital LLC, for administrative services which are no longer required by the Company.





Our R&D expenses for the six months ended June 30, 2004 were $458,050 as compared to $206,475 during the six months ended June 30, 2003. 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, which has been extended to October 14, 2004, provides for the Company to fund services of four post-doctorate fellows who, under the supervision of the CTO, conduct research and provide research quantities of chiral ligands to the Company. The future obligation payable by the Company through October 14, 2004 as of the end of the agreement is approximately $73,000. This amount consists principally of four post-doctorate salaries, fringe benefits, materials and supplies for the stated period. In addition, during the second quarter of 2003, we opened an additional laboratory
facility in New Jersey, and have completed an expansion to the facility in April 2004, that enabled us to produce both research and commercial quantities of our ligands. In connection with the new facility and its expansion, numerous lab supplies and chemicals were purchased. Accordingly, we incurred increased expenses for the six months ended June 30, 2004, due to the opening and expansion of the New Jersey facility, along with the increased costs of using the facility and chemists at Penn State.





Selling, general and administrative (SG&A) expenses for the six months ended June 30, 2004 were $804,072 as compared to $423,366 during the six months ended June 30, 2003. This increase in SG&A expenses was due in part to establishing contract reserves, increased usage of temporary contractors, higher legal and accounting fees, increased rent expense for the New Jersey facility as a result of the facilitys expansion, additional spending on advertising and promotion expenses, increased travel expenses for new business development opportunities and higher administrative expenses associated with having more employees such as insurance and employer payroll taxes.





Compensation expense was $803,878 for the six months ended June 30, 2004 as compared to $217,720 for the six months ended June 30, 2003. This increase was caused primarily by the resignation of the CEO effective April 16 2004, which resulted in charge of $375,000 in severance costs. In addition, compensation expense increased due to the hiring of a vice president of business development, a controller, and several chemists to work at the new laboratory facility in New Jersey.


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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 six months ended June 30, 2004 were $92,605 as compared to $42,640 during the six months ended June 30, 2003. This increase was primarily related to fixed asset purchases for office equipment, computer equipment, laboratory equipment and leasehold improvements for the newly leased facility and expansion in New Jersey. Additionally, the Company recognized a one time charge to the amortization of patents for approximately $13,000. This adjustment to patent amortization was based upon properly accounting for the amortization of a patents legal life of 17 years from the prior amortization of 20 years.





Interest income for the six months ended June 30, 2004 was $15,807 as compared to $7,680 for the six months ended June 30, 2003. The increase in interest income is attributed to having higher cash reserves as a result of the funds received from the private placement of the Companys common stock in February 2004.





Our net loss for the six months ended June 30, 2004 was $2,022,816 as compared to $902,476 for the six months ended June 30, 2003. The increased net loss for the six months ended June 30, 2004 as compared to June 30, 2003 was primarily due to the severance costs associated with the resignation of the Companys CEO, higher R&D expenses incurred with funding Penn States research services provided to the Company, increased operational expenditures comprised of higher total rent expense due to the newly leased, and expanded New Jersey facility in June 2003 and April 2004 respectively, higher legal and accounting expenses, higher payroll expenses associated with having more employees along with increased usage of temporary contractors, along with the establishment of contract reserves. We expect losses to continue and increase in the next year as we attempt to expand our
laboratory space.





Liquidity and Capital Resources





As of June 30, 2004, we had working capital of $4,792,040 and cash and cash equivalents of $5,258,622. If we are unable to significantly increase our revenues, we may require additional financing as early as the second quarter of 2005 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.





The Companys net cash used in operating activities for the six months ended June 30, 2004 was $1,892,997. The Companys net cash used in operating activities primarily consisted of a net loss of $2,022,816, an increase in accounts receivable of $117,300 and decreases in accrued expenses and deferred revenue of $46,362 and $143,745, respectively, offset by an increase in accounts payable of $180,648.





The Companys net cash used in investing activities for the six months ended June 30, 2004 totaled $249,129, which consisted of purchases of property and equipment primarily used in the New Jersey facility, along with patent application expenditures.





The Companys net cash provided by financing activities for the six months ended June 30, 2004 was $6,741,631, which was the result of funding provided through the private placement of the Companys common stock.





Management believes that the capital resulting from the private placement will provide sufficient resources to fund our continued operational expansion and corporate development through approximately the second quarter of 2005. Our long term liquidity is contingent upon achieving increased sales and/or obtaining additional financing.





Our working capital requirements will depend upon numerous factors, including, without limitation, the 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 the expansion of office and laboratory space lease agreements that were entered into during the second quarter of 2003 and first quarter of 2004, along with the hiring of additional employees, in addition to the establishment and funding of the China subsidiary.





We have formed two China subsidiaries through which we intend to open a laboratory facility in the Peoples Republic of China. We have provided $66,000 of capital to the China subsidiary during the second quarter of 2004. Our management believes that by opening a facility in China to produce non-proprietary chemical building blocks and related compounds, we will be able to significantly decrease our manufacturing costs and expenses, enabling us to cost-effectively produce our ligands and end products and make our products substantially more competitive and even more attractive to current and potential customers. We expect operations to commence on a limited basis by the end of fiscal 2004.





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Item 3. Controls and Procedures





As of June 30, 2004, we carried out an evaluation, under the supervision and with the participation of our chief executive and interim 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 Interim 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. During the fiscal three months ended June 30, 2004, there was no change in the Companys internal control over financial reporting that materially affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting.





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PART II  OTHER INFORMATION





Item 1. Legal proceedings.





The
  Company is not a party to any material litigation or other proceeding and is
  not aware of any threatened litigation that would have a material adverse effect
  on its business.





Item 5. Other Information.





On August 12, 2004, the Company announced that it had formed a new wholly owned subsidiary, VioQuest Drug Development, Inc., which will concentrate on acquiring, developing and commercializing human therapeutics. The Companys press release dated August 12, 2004 is attached hereto as Exhibit 99.1 and incorporated herein by reference.





Item 6. Exhibits and Reports on Form 8-K





(a)      Exhibits





Exhibit No.
Description10.1
Employment Agreement dated June 17, 2004 between CQ Acquisition, Inc. and Ronald Brandt.31.1
Certification of Chief Executive Officer31.2
Certification of Interim Chief Financial Officer32.1
Certifications of Chief Executive and Interim Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
Press release dated August 12, 2004.





(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.





VIOQUEST PHARMACEUTICALS, INC.Date: August 16, 2004
By:
/s/ Ronald BrandtRonald Brandt
Chief Executive OfficerDate: August 16, 2004
By:
/s/ Brian LenzBrian Lenz
Interim Chief Financial Officer








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EXHIBIT INDEX








Exhibit No.
Description10.1
Employment Agreement dated June 17, 2004 between CQ Acquisition, Inc. and Ronald Brandt.31.1
Certification of Chief Executive Officer31.2
Certification of Interim Chief Financial Officer32.1
Certifications of Chief Executive and Interim Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
Press release dated August 12, 2004.





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