**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

----

 

**FORM 10-Q**

 

**(Mark One)**

 

**ý****          ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended April 30,2004**

 

**o****          ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition periodfrom                                 to                                 **

 

**Commission File Number  1-8366**

 

**POLYDEXPHARMACEUTICALS LIMITED**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **Commonwealth of the Bahamas**                                                       |   | **None**                              |
|---------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)                       |   | (I.R.S. Employer  Identification No.) |
|                                                                                  |   |                                  |
| **421 Comstock Road, Toronto, Ontario,  Canada**                                 |   | **M1L 2H5**                      |
| (Address of Principal Executive Offices)                                              |   | (Zip Code)                            |
|                                                                                  |   |                                  |
| Registrant’s Telephone Number, Including Area Code  **(416) 755-2231** |

 

 

Former Name, Former Address and Former FiscalYear, if Changed Since Last Report

 

Indicate by check whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.     Yes  ý          No  o

 

Indicate by check whether the registrant is an accelerated filer (asdefined in Exchange Act Rule 12b-2).     Yes  o          No  ý

 

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

 

| Common Shares, $.0167 Par Value |   | 3,052,296 shares                    |
|---------------------------------|--------|-------------------------------------|
| (Title of Class)                |   | (Outstanding at June 11, 2004) |

 

 

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**POLYDEXPHARMACEUTICALS LIMITED**

 

**TABLEOF CONTENTS**

 
| **PART I**  |   | **FINANCIAL INFORMATION**                                                                                       |   |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------|--------|
|        |   |                                                                                                            |   |
| Item 1      |   | CONSOLIDATED  FINANCIAL STATEMENTS (UNAUDITED)                                                                  |   |
|        |   |                                                                                                            |   |
|        |   | Consolidated  Balance Sheets April 30, 2004 and January 31, 2004                                      |   |
|        |   |                                                                                                            |   |
|        |   | Consolidated Statements of Operations and  Comprehensive Income Three months ended April 30, 2004 and 2003 |   |
|        |   |                                                                                                            |   |
|        |   | Consolidated Statements of Shareholders’ Equity Three months ended  April 30, 2004 and 2003           |   |
|        |   |                                                                                                            |   |
|        |   | Consolidated  Statements of Cash Flows Three months ended April 30, 2004 and 2003                          |   |
|        |   |                                                                                                            |   |
|        |   | Notes to Consolidated Financial Statements (Unaudited)                                                          |   |
|        |   |                                                                                                            |   |
| Item 2      |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                     |   |
|        |   |                                                                                                            |   |
| Item 3      |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                     |   |
|        |   |                                                                                                            |   |
| Item 4      |   | CONTROLS  AND PROCEDURES                                                                                        |   |
|        |   |                                                                                                            |   |
|        |   |                                                                                                            |   |
| **PART II** |   | **OTHER INFORMATION**                                                                                           |   |
|        |   |                                                                                                            |   |
| Item 1      |   | LEGAL PROCEEDINGS                                                                                               |   |
|        |   |                                                                                                            |   |
| Item 6      |   | EXHIBITS AND REPORTS ON FORM 8-K                                                                                |   |
|        |   |                                                                                                            |   |
|        |   | Signatures  and Certifications                                                                                  |   |

 

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**PART I**

**FINANCIALINFORMATION**

 

**Item 1****.  Consolidated Financial Statements(unaudited).**

 

**POLYDEX PHARMACEUTICALS LIMITED**

 

Consolidated Balance Sheets(Unaudited)

(Expressed in United States dollars)

 
|                                      |   | **April 30  2004** |       | **January 31  2004** |   |
|-------------------------------------------|--------|-------------------------|------------|---------------------------|--------|
|                                      |   |                    |       |                      |   |
| **Assets**                                |   |                    |       |                      |   |
|                                      |   |                    |       |                      |   |
| Current assets:                           |   |                    |       |                      |   |
| Cash and cash equivalents (note 3)        |   | $                       | 4,395,656  |                      | $      | 59,455 |   |
| Trade accounts receivable                 |   | 941,720                 |       | 503,864                   |   |
| Inventories:                              |   |                    |       |                      |   |
| Finished goods                            |   | 1,018,368               |       | 943,373                   |   |
| Work in process                           |   | 57,131                  |       | 107,008                   |   |
| Raw materials                             |   | 138,618                 |       | 176,058                   |   |
|                                      |   |                    |       |                      |   |
| Inventories                               |   | 1,214,117               |       | 1,226,439                 |   |
| Prepaid expenses and other current assets |   | 42,350                  |       | 42,730                    |   |
| Deferred tax assets                       |   | —                  |       | 267,500                   |   |
| Assets subject to sale agreement          |   | —                  |       | 4,285,666                 |   |
|                                      |   |                    |       |                      |   |
|                                      |   | 6,593,843               |       | 6,385,654                 |   |
|                                      |   |                    |       |                      |   |
| Property, plant and equipment, at cost    |   |                    |       |                      |   |
| Land and buildings                        |   | 1,346,180               |       | 1,391,141                 |   |
| Machinery and equipment                   |   | 6,800,572               |       | 6,982,088                 |   |
|                                      |   | 8,146,752               |       | 8,373,229                 |   |
| Less accumulated depreciation             |   | (5,078,081              | )          | (5,124,887                | )      |
| Property, plant and equipment, net        |   | 3,068,671               |       | 3,248,342                 |   |
| Patents and intangible assets, net        |   | 74,984                  |       | 85,511                    |   |
| Due from shareholder                      |   | 768,530                 |       | 791,006                   |   |
|                                      |   |                    |       |                      |   |
|                                      |   | $                       | 10,506,028 |                      | $      | 10,510,513 |   |

 

1

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|                                                         |   | **April 30  2004** |       | **January 31  2004** |   |
|--------------------------------------------------------------|--------|-------------------------|------------|---------------------------|--------|
|                                                         |   |                    |       |                      |   |
| **Liabilities and Shareholders’  Equity**               |   |                    |       |                      |   |
|                                                         |   |                    |       |                      |   |
| Current liabilities:                                         |   |                    |       |                      |   |
| Bank indebtedness                                            |   | $                       | 36,478     |                      | $      | 165,609 |   |
| Accounts payable                                             |   | 486,841                 |       | 515,092                   |   |
| Accrued liabilities                                          |   | 130,838                 |       | 163,463                   |   |
| Payroll and related taxes payable                            |   | 177,370                 |       | 173,583                   |   |
| Customer deposits                                            |   | 95,734                  |       | 100,925                   |   |
| Income taxes payable                                         |   | 254,493                 |       | 923                       |   |
| Liabilities subject to sale agreement                        |   | —                  |       | 880,564                   |   |
| Current portion of long-term debt                            |   | 64,786                  |       | 281,015                   |   |
| Current portion of capital lease  obligations                |   | 151,312                 |       | 161,253                   |   |
|                                                         |   |                    |       |                      |   |
|                                                         |   | 1,397,852               |       | 2,442,427                 |   |
|                                                         |   |                    |       |                      |   |
| Long-term debt                                               |   | 28,759                  |       | 45,517                    |   |
| Capital lease obligations                                    |   | 242,019                 |       | 284,950                   |   |
| Due to shareholder                                           |   | 684,482                 |       | 683,234                   |   |
| Deferred income taxes                                        |   | 198,963                 |       | 147,054                   |   |
|                                                         |   |                    |       |                      |   |
|                                                         |   | 1,154,223               |       | 1,160,755                 |   |
|                                                         |   |                    |       |                      |   |
| Total liabilities                                            |   | 2,552,075               |       | 3,603,182                 |   |
|                                                         |   |                    |       |                      |   |
| Shareholders’ equity:                                   |   |                    |       |                      |   |
| Capital stock                                                |   |                    |       |                      |   |
| Authorized:                                                  |   |                    |       |                      |   |
| 100,000 Class A preferred shares of $0.10  each              |   |                    |       |                      |   |
| 899,400 Class B preferred shares of $0.0167  each            |   |                    |       |                      |   |
| 10,000,000 common shares of $0.0167 each                     |   |                    |       |                      |   |
| Issued and outstanding:                                      |   |                    |       |                      |   |
| 899,400 Class B preferred shares                             |   | 15,010                  |       | 15,010                    |   |
| 3,027,796 common shares (January 31,  2004 - 3,027,796) |   | 50,434                  |       | 50,434                    |   |
| Contributed surplus                                          |   | 23,236,498              |       | 23,236,498                |   |
| Deficit                                                      |   | (15,023,600             | )          | (16,284,268               | )      |
| Accumulated other comprehensive loss                         |   | (324,389                | )          | (110,343                  | )      |
|                                                         |   |                    |       |                      |   |
|                                                         |   | 7,953,953               |       | 6,907,331                 |   |
|                                                         |   |                    |       |                      |   |
|                                                         |   | $                       | 10,506,028 |                      | $      | 10,510,513 |   |

 

2

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**POLYDEX PHARMACEUTICALS LIMITED**

 

ConsolidatedStatements of Operations and Comprehensive Income (Unaudited)

(Expressed in United States dollars)

 
|                                                                 |   | **Three  Months Ended  April 30  2004** |      | **Three  Months Ended  April 30  2003** |   |
|----------------------------------------------------------------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|
|                                                                 |   |                                         |      |                                         |   |
| Sales                                                                |   | $                                            | 2,521,794 |                                         | $      | 3,296,518 |   |
| Cost of goods sold                                                   |   | 1,646,629                                    |      | 2,518,230                                    |   |
|                                                                 |   |                                         |      |                                         |   |
|                                                                 |   | 875,165                                      |      | 778,288                                      |   |
|                                                                 |   |                                         |      |                                         |   |
| Expenses:                                                            |   |                                         |      |                                         |   |
| General and administrative                                           |   | 432,196                                      |      | 424,978                                      |   |
| Depreciation                                                         |   | 117,494                                      |      | 142,357                                      |   |
| Interest expense                                                     |   | 30,691                                       |      | 35,372                                       |   |
| Selling and promotion                                                |   | 25,167                                       |      | 44,213                                       |   |
| Foreign exchange loss                                                |   | 15,360                                       |      | 192,177                                      |   |
| Research and development                                             |   | 13,424                                       |      | 9,439                                        |   |
| Amortization                                                         |   | 10,527                                       |      | 5,546                                        |   |
|                                                                 |   |                                         |      |                                         |   |
|                                                                 |   | 644,859                                      |      | 854,082                                      |   |
|                                                                 |   |                                         |      |                                         |   |
| Income (loss) before the following                                   |   | 230,306                                      |      | (75,794                                      | )      |
|                                                                 |   |                                         |      |                                         |   |
| Other income (expense):                                              |   |                                         |      |                                         |   |
| Gain on sale of assets (note 5)                                      |   | 1,859,471                                    |      | —                                       |   |
| Other income (expense), net                                          |   | (15,072                                      | )         | (138,994                                     | )      |
|                                                                 |   |                                         |      |                                         |   |
|                                                                 |   | 1,844,399                                    |      | (138,994                                     | )      |
|                                                                 |   |                                         |      |                                         |   |
| Income (loss) before income taxes                                    |   | 2,074,705                                    |      | (214,788                                     | )      |
|                                                                 |   |                                         |      |                                         |   |
| Provision for income taxes                                           |   | 814,037                                      |      | 74,782                                       |   |
|                                                                 |   |                                         |      |                                         |   |
| Net income (loss) for the period                                     |   | 1,260,668                                    |      | (289,570                                     | )      |
|                                                                 |   |                                         |      |                                         |   |
| Currency translation adjustment                                      |   | (214,046                                     | )         | 443,373                                      |   |
|                                                                 |   |                                         |      |                                         |   |
| Comprehensive income for the period                                  |   | $                                            | 1,046,622 |                                         | $      | 153,803 |   |
|                                                                 |   |                                         |      |                                         |   |
| Per share information:                                               |   |                                         |      |                                         |   |
| Earnings (loss) per common share:                                    |   |                                         |      |                                         |   |
| Basic                                                                |   | $                                            | 0.42      |                                         | $      | (0.10 | ) |
| Diluted                                                              |   | $                                            | 0.39      |                                         | $      | (0.10 | ) |
|                                                                 |   |                                         |      |                                         |   |
| Weighted average number of common shares  outstanding for the period |   | 3,027,796                                    |      | 3,027,796                                    |   |

 

3

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**POLYDEX PHARMACEUTICALS LIMITED**

 

ConsolidatedStatements of Shareholders’ Equity(Unaudited)

(Expressedin United States dollars)

 
|                                            |   | **Three  Months Ended  April 30  2004** |        | **Three  Months Ended  April 30  2003** |   |
|-------------------------------------------------|--------|----------------------------------------------|-------------|----------------------------------------------|--------|
|                                            |   |                                         |        |                                         |   |
| Preferred Shares:                               |   |                                         |        |                                         |   |
| Balance, beginning and end of period            |   | $                                            | 15,010      |                                         | $      | 15,010 |   |
|                                            |   |                                         |        |                                         |   |
| Common Shares:                                  |   |                                         |        |                                         |   |
| Balance, beginning and end of period            |   | $                                            | 50,434      |                                         | $      | 50,434 |   |
|                                            |   |                                         |        |                                         |   |
| Contributed Surplus:                            |   |                                         |        |                                         |   |
| Balance, beginning and end of period            |   | $                                            | 23,236,498  |                                         | $      | 23,224,128 |   |
|                                            |   |                                         |        |                                         |   |
| Deficit:                                        |   |                                         |        |                                         |   |
| Balance, beginning of period                    |   | $                                            | (16,284,268 | )                                            | $      | (16,278,269 | ) |
| Net income (loss) for the period                |   | 1,260,668                                    |        | (289,570                                     | )      |
|                                            |   |                                         |        |                                         |   |
| Balance, end of period                          |   | $                                            | (15,023,600 | )                                            | $      | (16,567,839 | ) |
|                                            |   |                                         |        |                                         |   |
| Accumulated Other Comprehensive Loss:           |   |                                         |        |                                         |   |
| Balance, beginning of period                    |   | $                                            | (110,343    | )                                            | $      | (986,776 | ) |
| Currency translation adjustment for the  period |   | (214,046                                     | )           | 443,373                                      |   |
|                                            |   |                                         |        |                                         |   |
| Balance, end of period                          |   | $                                            | (324,389    | )                                            | $      | (543,403 | ) |

 

4

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**POLYDEXPHARMACEUTICALS LIMITED**

 

Consolidated Statements of CashFlows (Unaudited)

(Expressed in United States dollars)

 
|                                                                   |   | **Three  Months Ended  April 30  2004** |      | **Three  Months Ended  April 30  2003** |   |
|------------------------------------------------------------------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|
|                                                                   |   |                                         |      |                                         |   |
| Cash provided by (used in):                                            |   |                                         |      |                                         |   |
|                                                                   |   |                                         |      |                                         |   |
| Operating activities:                                                  |   |                                         |      |                                         |   |
| Net income (loss) for the period                                       |   | $                                            | 1,260,668 |                                         | $      | (289,570 | ) |
| Add (deduct) items not affecting cash:                                 |   |                                         |      |                                         |   |
| Depreciation and amortization                                          |   | 128,021                                      |      | 147,903                                      |   |
| Imputed interest on long-term debt                                     |   | 9,936                                        |      | 6,598                                        |   |
| Deferred income taxes                                                  |   | 558,955                                      |      | 46,010                                       |   |
| Gain on sale of veterinary products  business                          |   | (1,859,471                                   | )         | —                                       |   |
| Net change in non-cash working capital  balances related to operations |   | (278,322                                     | )         | 18,022                                       |   |
|                                                                   |   |                                         |      |                                         |   |
|                                                                   |   | (180,213                                     | )         | (71,037                                      | )      |
|                                                                   |   |                                         |      |                                         |   |
| Investing activities:                                                  |   |                                         |      |                                         |   |
| Additions to property, plant and equipment  and patents                |   | (41,075                                      | )         | (60,998                                      | )      |
| Decrease in due from shareholder                                       |   | 22,476                                       |      | 14,310                                       |   |
| Proceeds from sale of veterinary products  business                    |   | 4,599,218                                    |      | —                                       |   |
|                                                                   |   |                                         |      |                                         |   |
|                                                                   |   | 4,580,619                                    |      | (46,688                                      | )      |
|                                                                   |   |                                         |      |                                         |   |
| Financing activities:                                                  |   |                                         |      |                                         |   |
| Repayment of long-term debt                                            |   | (242,923                                     | )         | (5,039                                       | )      |
| Repayment of capital lease obligations                                 |   | (39,330                                      | )         | (28,068                                      | )      |
| Increase (decrease) in due to shareholder                              |   | 1,248                                        |      | (122                                         | )      |
| Increase (decrease) in bank indebtedness                               |   | (129,131                                     | )         | 126,868                                      |   |
|                                                                   |   |                                         |      |                                         |   |
|                                                                   |   | (410,136                                     | )         | 93,639                                       |   |
|                                                                   |   |                                         |      |                                         |   |
| Effect of exchange rate changes on cash                                |   | 33,858                                       |      | 163,482                                      |   |
|                                                                   |   |                                         |      |                                         |   |
| Increase (decrease) in cash position                                   |   | 4,024,128                                    |      | 139,396                                      |   |
|                                                                   |   |                                         |      |                                         |   |
| Cash and cash equivalents, beginning of  period                        |   | 371,528                                      |      | 280,748                                      |   |
|                                                                   |   |                                         |      |                                         |   |
| Cash and cash equivalents, end of period                               |   | $                                            | 4,395,656 |                                         | $      | 420,144 |   |

 

5

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**1.****             Basis ofPresentation:**

 

Theinformation contained in the interim consolidated financial statements iscondensed from that which would appear in annual consolidated financialstatements.  The interim consolidatedfinancial statements included herein should be read in conjunction with theaudited financial statements, and notes thereto, and other financialinformation contained in the 2004 Annual Report on Form 10-K for the fiscalyear ended January 31, 2004 as filed by Polydex Pharmaceuticals Limited(the “Company”) with the Securities and Exchange Commission.  The unaudited interim consolidated financialstatements as of April 30, 2004 and 2003 include all normal recurringadjustments which management considers necessary for a fair presentation.  The results of operations for the interimperiods are not necessarily indicative of the results that may be expected forthe entire fiscal year.  The interimconsolidated financial statements include the accounts and transactions of theCompany and its majority owned subsidiaries in which the Company has equal toor more than a 50% ownership interest and exercises control.

 

**2.**     Significant AccountingPolicies:

 

**Basisof consolidation**

 

The consolidated financial statements include the accounts of theCompany and its subsidiaries.  Allinter-company accounts and transactions have been eliminated on consolidation.

 

**Useof estimates**

 

The preparation of financial statements in conformity with UnitedStates generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from these estimates.

 

**Cashand cash equivalents**

 

**Cash and cash equivalents include cash and short-termdeposits with maturities of less than three months at the date of purchase.**

 

**Inventories**

 

Inventories of raw materials are stated at the lower of cost and netrealizable value, cost being determined on a first-in, first-out basis.  Work-in-process and finished goods arevalued at the lower of cost and net realizable value, and include the cost ofraw materials, direct labour and overhead expenses.

 

**Property,plant and equipment and patents and intangible assets**

** **

Property, plant and equipment are recorded at cost less accumulateddepreciation.  Depreciation is providedon a straight-line basis over the estimated useful lives of the assets asfollows:

 
| Buildings               |   | 15 years      |   |
|-------------------------|--------|---------------|--------|
| Machinery and equipment |   | 3 to 10 years |   |

 

Patents and intangible assets are recorded at cost and are amortized ona straight-line basis over their estimated useful lives of ten years.  Intangible assets consist of intellectualproperty, government licenses and government license applications.

 

6

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Useful life is the period over which the asset is expected tocontribute to the Company’s future cash flows. The Company reviews the recoverability of its long-lived assets whenevents or changes in circumstances occur that indicate that the carrying valueof the asset may not be recoverable. The assessment of possible impairment is based on the Company’s ability torecover the carrying value of the asset from the expected future pre-tax cashflows of the related operations.  Ifthese cash flows are less than the carrying value of such asset, an impairmentloss is recognized for the difference between estimated fair value and carryingvalue.

 

Costs related to plant refurbishments and equipment upgrades thatrepresent improvements to existing facilities are capitalized.  Costs related to repair and maintenance ofbuildings and equipment are expensed. The Company has no major planned maintenance activity.

 

**Revenuerecognition**

 

All revenue is from sales of bulk and finished dosage manufacturedproducts and is recognized when title and risk of ownership of products pass tothe customer.  Title and risk ofownership pass to the customer pursuant to the applicable sales contract,either upon shipment of product or upon receipt by the customer.

 

Product sold in bulk quantities is tested, prior to release forshipment, to ensure that it meets customer specifications, and in many cases,customers receive samples for their own testing.  Approval is obtained from the customer prior to shipping.  Further purchases by a customer of a bulkproduct with the same specifications do not require approvals.  Returns of bulk product are rare andgenerally are not accepted.

 

No testing and approval is required for finished dosage product becauseof its nature.  Returns of finisheddosage product are rare and generally are not accepted.

 

**Shippingand handling costs**

 

Shipping and handling costs incurred by the Company for shipment ofproducts to customers are classified as cost of goods sold.

 

**Researchand development**

 

Research and development costs are expensed as incurred and are statednet of investment tax credits earned.

 

**Foreigncurrency translation**

 

The functional currency of the Company’s Canadian operations has beendetermined to be the Canadian dollar. All asset and liability accounts of the Company have been translatedinto United States dollars using the current exchange rates at the consolidatedbalance sheet dates.  Revenue andexpense items are translated using the average exchange rates for theyear.  The resulting gains and losseshave been reported separately as other comprehensive loss within shareholders’equity.

 

**Stock options**

 

The Company has elected to follow Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation” [“SFAS123”].  Under SFAS 123, compensationexpense is recognized on the date of grant, based on the fair value of the optionsgranted.

 

7

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**Earnings(loss) per common share**

** **

Basic earnings (loss) per common share are computed using the weightedaverage number of shares outstanding of 3,027,796 at April 30, 2004 (2003- 3,027,796).  Diluted earnings (loss)per common share are computed using the weighted average number of sharesoutstanding adjusted for the incremental shares, using the treasury stockmethod, attributed to outstanding options to purchase common stock.  Incremental shares of 187,251 and nil atApril 30, 2004 and April 30, 2003, respectively, were used in thecalculation of diluted earnings (loss) per common share.  Options to purchase 3,885 and 431,550 commonshares at April 30, 2004 and April 30, 2003, respectively, were notincluded in the computation of diluted earnings (loss) per common share becausetheir effect was anti-dilutive.

 

**3.**     Cash and Cash Equivalents:

** **

**Cashand cash equivalents consist of the following:**

** **
|             |   | **April 30  2004** |      | **January 31  2004** |   |
|------------------|--------|-------------------------|-----------|---------------------------|--------|
|             |   |                    |      |                      |   |
| Cash             |   | $                       | 160,016   |                      | $      | 59,455 |   |
| Commercial paper |   | 4,232,640               |      | —                    |   |
|             |   | $                       | 4,395,656 |                      | $      | 59,455 |   |

** **

**Thecommercial paper bears interest at rates of approximately 2% and expiry datesextending up to two months.**

** **

**4.**     Stock-based Employee Compensation:

** **

The Company maintains an incentive share option plan for managementpersonnel for options to purchase up to 1,000,000 common shares.  The Company also issues options to certainconsultants for services provided to the Company.

 

All options granted have terms ranging from two to five years and vestimmediately.  At January 31, 2004,the Company had 427,935 options outstanding at exercise prices ranging from$2.50 to $7.72 and a weighted average exercise price of $3.92.  The options, which are immediatelyexercisable and expire on dates between May 31, 2004 and January 31, 2009,entitle the holder of an option to acquire one common share of the Company.

 

The Company uses the fair value method in accordance with SFAS 123 toaccount for awards of stock-based employee compensation.  No stock-based employee compensation expensewas recorded during the period from February 1, 2004 to April 30,2004, because there were no options granted during this period.  Similarly, no stock-based employeecompensation expense was recorded during the period from February 1, 2003to April 30, 2003, because there were no options granted during thisperiod.

 

**5.**     The Vet Labs – Sparhawk JointVenture:

** **

In 1992, Veterinary Laboratories, Inc. (“Vet Labs”) and SparhawkLaboratories, Inc. (“Sparhawk”) entered into the Vet Labs – Sparhawk JointVenture (the “Joint Venture”) for the manufacture and sale of veterinarypharmaceutical products.  Vet Labs andSparhawk each own 50% of the Joint Venture.

 

On January 13, 2004, the Company entered into an Asset PurchaseAgreement with Sparhawk.  Pursuant tothis Asset Purchase Agreement, the Company agreed to sell the finished productveterinary pharmaceutical business, including substantially all of the assetsof Vet Labs, to

 

8

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Sparhawk for $5,500,000 in cash. Effective March 4, 2004, thissale was completed.  Simultaneously, onMarch 4, 2004, Chemdex, Inc. ("Chemdex"), a wholly-ownedsubsidiary of the Company, advanced $350,000 to Sparhawk in exchange for apromissory note bearing interest at 13% per annum and a warrant to purchase 4%of the equity of Sparhawk for no additional consideration.  The promissory note is due in full onMarch 4, 2009.  Interest is payableannually, but can be deferred and added to the principal balance of thepromissory note each year at Sparhawk’s discretion.  The warrant expires at the earlier of payment in full of thepromissory note or 10 years from date of issue.  The warrant becomes exercisable the day after the fifthanniversary from the date of issue. Pursuant to a definitive supply agreement [the “Supply Agreement”]entered into on March 4, 2004, Chemdex agreed to supply ferric hydroxideand hydrogenated dextran solution to Sparhawk on an exclusive basis in theUnited States for 10 years.  Chemdexalso granted to Sparhawk an exclusive license to use the drug master file tomanufacture 10% bulk Iron Dextran for veterinary use, and the use of certainequipment during the 10-year period of the Supply Agreement.  Pursuant to definitive agreements, theCompany made customary representations, warranties and indemnities and agreedto a full release of all claims against Sparhawk arising from the Joint Venturelitigation.  Similarily, Sparhawk agreedto a full release of all claims against the Company arising from the JointVenture litigation.

 

The sale resulted in a gain of $2,209,471, of which $1,859,471 wasrecognized in the consolidated statement of operations and $350,000 wasdeferred.  The deferred gain of $350,000relates to the promissory note receivable from Sparhawk as Sparhawk is thinlycapitalized and highly leveraged.  TheCompany will monitor the financial position of Sparhawk and will recognize thisdeferred gain at such time as Sparhawk’s cash flows from operations aresufficient to fund debt service on a full accrual basis.

 

**6.****    ****Segmented Information:**

 

Alloperations are carried out through Dextran Products Limited (“Dextran”) inCanada and through Chemdex in the United States.  The operations of Chemdex represent the veterinary productsbusiness.  Each of Dextran and Chemdexoperates as a strategic business unit offering different products.  Each subsidiary comprises a reportablesegment as follows:

 
| Dextran  - |   | manufactures  and sells bulk quantities of Dextran and several of its derivatives to large  pharmaceutical companies throughout the world.                                                                                                                                                               |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Chemdex  - |   | manufactures  and sells veterinary pharmaceutical products and specialty chemicals to the  United States.  The primary customers  are distributors and private labelors, who in turn sell to the end user of  these products.  The majority of this  business was sold in March 2004 (note 5). |

 
|                                                  |   | **Three  Months Ended  April 30  2004** |      | **Three  Months Ended  April 30  2003** |   |
|-------------------------------------------------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|
|                                                  |   |                                         |      |                                         |   |
| **Sales:**                                            |   |                                         |      |                                         |   |
| Dextran                                               |   | $                                            | 1,529,824 |                                         | $      | 1,298,941 |   |
| Less:   intercompany sales elimination           |   | 99,931                                       |      | 82,921                                       |   |
|                                                  |   |                                         |      |                                         |   |
|                                                  |   | 1,429,893                                    |      | 1,216,020                                    |   |
| Chemdex                                               |   | 1,091,901                                    |      | 2,080,498                                    |   |
|                                                  |   |                                         |      |                                         |   |
| Total consolidated sales                              |   | $                                            | 2,521,794 |                                         | $      | 3,296,518 |   |
|                                                  |   |                                         |      |                                         |   |
| **Income (loss)  before provision for income taxes:** |   |                                         |      |                                         |   |
| Dextran                                               |   | $                                            | 269,279   |                                         | $      | 33,341 |   |
| Chemdex                                               |   | 1,980,391                                    |      | (138,068                                     | )      |
|                                                  |   |                                         |      |                                         |   |
| Total pre-tax income (loss) from segments             |   | 2,249,670                                    |      | (104,727                                     | )      |
| Less:   Unallocated corporate expenses           |   | 174,965                                      |      | 110,061                                      |   |
|                                                  |   |                                         |      |                                         |   |
| Total consolidated pre-tax income (loss)              |   | $                                            | 2,074,705 |                                         | $      | (214,788 | ) |
|                                                  |   |                                         |      |                                         |   |
| **Total Revenue by  significant customer:**           |   |                                         |      |                                         |   |
| Customer A                                            |   | $                                            | 268,186   |                                         | $      | 287,239 |   |
| Customer B                                            |   | 246,684                                      |      | 339,631                                      |   |
| Customer C                                            |   | 246,296                                      |      | 450,457                                      |   |
|                                                  |   |                                         |      |                                         |   |
| **Sales Revenue by  product group:**                  |   |                                         |      |                                         |   |
| Bulk Dextran and derivatives                          |   | $                                            | 1,429,893 |                                         | $      | 1,216,020 |   |
| Sterile injectible veterinary products                |   | 663,629                                      |      | 1,047,075                                    |   |
| Oral and topical veterinary products                  |   | 428,272                                      |      | 1,033,423                                    |   |
|                                                  |   |                                         |      |                                         |   |
| Total consolidated sales                              |   | $                                            | 2,521,794 |                                         | $      | 3,296,518 |   |

 
|                       |   | **April 30, 2004** |   | **January 31, 2004** | ** ** |
|----------------------------|--------|-------------------------|--------|---------------------------|------------|
|                       |   |                    |   |                      |       |
| **Assets:**                |   |                    |   |                      |       |
| Dextran                    |   | 9,496,861               |   | 5,045,899                 |       |
| Chemdex                    |   | 228,637                 |   | 4,281,084                 |       |
|                       |   |                    |   |                      |       |
| Total assets from segments |   | 9,725,498               |   | 9,326,983                 |       |
| Corporate assets           |   | 780,530                 |   | 1,183,530                 |       |
|                       |   |                    |   |                      |       |
| Total consolidated assets  |   | 10,506,028              |   | 10,510,513                |       |

 

 

9

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** **

**7.****    ****Recent Accounting Pronouncements:**

 

In December 2003, the FASB issued FASBInterpretation [“FIN”] No. 46R, “Consolidation of Variable Interest Entities aninterpretation of ARB No. 51” [the “Interpretation”], which is a revision ofFIN No. 46 originally issued in January 2003.  The Interpretation introduces a new consolidation model - thevariable interests model - which determines control [and consolidation] basedon potential variability in gains and losses of the entity being evaluated forconsolidation. It also requires application in financial statements of publicentities for periods ended after December 15, 2003 to special purposeentities, and in financial statements for periods ending after March 15,2004 to other types of variable interest entities.  The Company does not have any interests in special purposeentities, and will account for any variable interest entities in accordancewith the Interpretation. The adoption of this Interpretation had no impact onthe Company’s consolidated financial statements.

 

 

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**Item 2****.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*The Company’s fiscal year ends on January 31stof each year.  In this report, fiscalyear 2005 refers to the Company’s fiscal year ended January 31, 2005.  The following discussion should be read inconjunction with the April 30, 2004 interim consolidated financialstatements and notes thereto included elsewhere in this report.  Operating results for the first quarterended April 30, 2004 are not necessarily indicative of the results thatmay be expected for the fiscal year ended January 31, 2005.  For further information, refer to theconsolidated financial statements and footnotes thereto included in theCompany’s annual report on Form 10-K for the fiscal year ended January 31,2004.*  *The Company’s financial statements are prepared inaccordance with United States generally accepted accounting principles.  All amounts are in United States dollars,unless otherwise denoted.*

 

**Overview**

 

The Company is engaged inthe research, development, manufacture and marketing of biotechnology-basedproducts for the human pharmaceutical market, and also manufactures bulkpharmaceutical intermediates for the worldwide veterinary pharmaceuticalindustry.  The Company conducts itsbusiness operations through its subsidiaries, which operate as strategicbusiness units:  Dextran Products andChemdex.

 

***Dextran Products Business***

 

The manufacture and saleof bulk quantities of Dextran and derivative products for sale to largepharmaceutical companies throughout the world is conducted through a Canadiansubsidiary, Dextran Products.

 

*Management Objectives for Fiscal Year 2005*. In fiscal year 2005 management intends to focus on the core businessesof Dextran Products that have historically been the backbone of theCompany.  Opportunities to implementdistribution chains for existing Dextran products in untapped markets, such asIndia, China and Russia are being explored by management.  Expanding current market opportunities andthe potential for new market penetration has led management to make plantrefurbishment and the expansion of production capacity a priority for fiscalyear 2005 with respect to Dextran Products operations.

 

Research and developmentof the Company’s human pharmaceutical products is coordinated at the DextranProducts facility.  Ushercell, the Company’s leading human pharmaceuticalcompound, is a high molecular weight Cellulose Sulphate envisioned for topicalvaginal use primarily in the prevention of transmission of AIDS and othersexually transmitted diseases, as well as unplanned pregnancies.  Multipleclinical trials have been completed, and additional trials have commenced orare being actively planned, to evaluate various aspects of the use of CelluloseSulphate as a contraceptive gel with antiviral capabilities.  The Companyalso intends to significantly explore the use of Ushercell as a treatment forBacterial Vaginosis (BV), the most common vaginal disorder amongreproductive-age women.  If effective, BV

 

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treatment may present an opportunity for commercial viability ofUshercell in advance of the completion of the much lengthier required testingfor its use as an antiviral contraceptive gel.

 

***Chemdex, Vet Labs and the Joint Venture Business***

 

DuringFebruary 2004, the Company also engaged in the finished product veterinarypharmaceutical business through its United States subsidiary Chemdex, which, inturn, conducted its operations through its subsidiary, Vet Labs.  OnDecember 1, 1992, Vet Labs and Sparhawk Laboratories Inc. entered into aJoint Venture for the purpose of manufacturing and selling veterinarypharmaceutical products.

 

On January 13, 2004,the Company, Chemdex and Vet Labs entered into an Asset Purchase Agreement withSparhawk pursuant to which the Company agreed to sell its finished productveterinary pharmaceutical business, including substantially all of the assetsof Vet Labs and its ownership interest in the Joint Venture, to Sparhawk for$5,500,000 in cash.  The sale was completed on March 4, 2004. Simultaneously with the closing, Chemdex advanced $350,000 to Sparhawk inexchange for an unsecured subordinated promissory note bearing interest at 13%per annum and a warrant to purchase 4% of the equity of Sparhawk.  Thepromissory note is payable in full on March 4, 2009.  Interest ispayable annually, but can be deferred and added to the principal balance of thepromissory note each year at Sparhawk’s discretion.  The warrant becomesexercisable on March 5, 2009 and expires at the earlier of payment in fullof the promissory note or March 4, 2014.  Chemdex also entered into asupply agreement with Sparhawk to supply ferric hydroxide and hydrogenateddextran solution to Sparhawk on an exclusive basis in the United States for 10years.  In connection with the sale, the litigation involving the JointVenture, *SparhawkLaboratories, Inc. v. Veterinary Laboratories, Inc., et al*, Case No.02CV07426, County of Johnson, State of Kansas, was settled, and a Motion ofApproval of Settlement and Stipulation of Dismissal with Prejudice was filedwith the Court on March 4, 2004.

 

**Resultsof Operations**

 

***Three months ended April 30, 2004 compared to threemonths ended April 30, 2003:***

 

|                      |   | **2004** |      | **2003** |   |
|---------------------------|--------|----------|-----------|----------|--------|
| Net income (loss)         |   | $        | 1,271,626 |     | $      | (289,570 | ) |
|                      |   |     |      |     |   |
| Earnings (loss) per share |   | 0.42     |      | (0.10    | )      |
|                           |        |          |           |          |        |  |  |

 

The increase in netincome for the first quarter of fiscal year 2005 ended April 30, 2004, ascompared to the first quarter of fiscal year 2004 is attributable to theincrease in gross profit and the gain on sale of the Vet Labs assets.  Inaddition, there was a large decline in the foreign exchange loss in the firstquarter of fiscal year 2005 as compared to the first quarter of fiscal year2004.  In the first quarter of fiscalyear 2004, there was a substantial rise in the value of the Canadian dollarrelative to the United States dollar. Dextran Products had a very large exposure to the United States dollarduring fiscal year

 

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2004, which resulted in this foreign exchange loss.  Dextran Products’ exposure to the U.S.dollar has decreased significantly in fiscal year 2005 due to the repayment ofintercompany receivables by Chemdex.

 

| **Income (loss) before income taxes** |   | **2004**  |      | **2003** |     | **Variance** |   |
|---------------------------------------|--------|-----------|-----------|----------|----------|--------------|--------|
|                                  |   |      |      |     |     |         |   |
| Consolidated                          |   | $         | 2,089,395 |     | (214,788 | )            | 1,073  | % |
| Dextran Products                      |   | 283,969   |      | 33,341   |     | 752          | %      |
| Chemdex                               |   | 1,980,391 |      | (138,068 | )        | 1,534        | %      |
|                                       |        |           |           |          |          |              |        |  |

 

The increase in operatingresults in the first quarter of fiscal year 2005 is primarily attributable tothe gain on sale of the Vet Labs assets reported at Chemdex.

 

*Dextran Products*.  The increase in operating results is due to alarge foreign exchange loss in the first quarter of fiscal year 2004 at DextranProducts, which was not repeated in fiscal year 2005.  This foreign exchange loss was due to the decline in the UnitedStates dollar relative to the Canadian dollar.  In fiscal year 2004,Dextran Products had a significant net asset exposure to the United Statesdollar because the majority of its accounts receivable balance and intercompanyreceivables are denominated in United States dollars, while the majority of itsliabilities and expenses are in Canadian dollars.  Therefore, if the valueof the Canadian dollar increases in relation to the United States dollar,margins decrease.  This exposure to the United States dollar decreasedsignificantly in the first quarter of fiscal year 2005 due to the repayment ofintercompany receivables by Chemdex.

 

*Chemdex*.  In addition to the gain on sale of the VetLabs assets, Chemdex incurred significant legal and receiver costs in the firstquarter of fiscal year 2004 due to the winding-up of the Joint Venture andresulting litigation with its joint venture partner.  On March 4,2004, the Company sold its finished product veterinary pharmaceutical businessto Sparhawk.  The sale included substantially all of the assets of Vet Labsand its ownership interest in the Joint Venture, and settled all outstandinglitigation among the parties.  The Company did not incur legal or receivercosts in connection with Vet Labs or the Joint Venture following the date ofsale.

 

| **Sales**                   |   | **2004**  |      | **2003**  |   | **Variance** |   |
|-----------------------------|--------|-----------|-----------|-----------|--------|--------------|--------|
|                        |   |      |      |      |   |         |   |
| Consolidated                |   | $         | 2,521,794 |      | $      | 3,296,518    |   | (24 | )% |
| Dextran Products            |   | 1,429,893 |      | 1,216,020 |   | 18           | %      |
| Percentage of Company sales |   | 57        | %         | 37        | %      |         |   |
| Chemdex                     |   | $         | 1,091,901 |      | $      | 2,080,498    |   | (48 | )% |
| Percentage of Company sales |   | 43        | %         | 63        | %      |         |   |

 

The majority of the firstquarter sales decrease in fiscal year 2005 was attributable to the sale of thefinished goods veterinary pharmaceutical business from the Chemdex operatingsegment.

 

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*Dextran Products*.  Sales of Dextran and related productsincreased in the first quarter of fiscal year 2005 due primarily to increasedcustomer demand.

 

*Chemdex*.  The sale of the Joint Venture operations onMarch 4, 2004 results in a cessation of all finished veterinary productsales.  Chemdex sales in the UnitedStated will be limited for the foreseeable future to sales of ferric hydroxideand hydrogenated dextran solution to Sparhawk, therefore Chemdex sales in fiscalyear 2005 will be significantly less than in fiscal year 2004.

 

| **Gross profit**    |   | **2004** |    | **2003** |   | **Variance** |   |
|---------------------|--------|----------|---------|----------|--------|--------------|--------|
|                |   |     |    |     |   |         |   |
| Consolidated        |   | $        | 875,165 |     | $      | 778,288      |   | 12 | % |
| Percentage of sales |   | 35       | %       | 24       | %      |         |   |
| Dextran Products    |   | $        | 580,005 |     | $      | 486,081      |   | 19 | % |
| Percentage of sales |   | 40       | %       | 40       | %      |         |   |
| Chemdex             |   | $        | 264,098 |     | $      | 281,154      |   | (6 | )% |
| Percentage of sales |   | 24       | %       | 14       | %      |         |   |

 

The first quarter fiscalyear 2005 increase in gross profit resulted from increases at the DextranProducts operating segment.  The increase in gross profit percentage isprimarily due to an increase in gross profit percentage from the Chemdexoperating segment as a result of the cessation of low-margin veterinary productsales subsequent to the sale of the Joint Venture operations.  Since the sale of the Joint Ventureoperations in March, 2004, sales by Dextran Products comprise the majority ofthe consolidated sales of the Company. The Company realizes significantly higher gross margins on DextranProducts’ sales than sales of products from the Joint Venture operations.

 

*Dextran Products*.  Dextran Products’ first quarter fiscal year2005 gross profit increase was due to increased sales volume.  Gross margins were consistent with thoseearned during the first quarter of fiscal year 2004.

 

*Chemdex*.  Due to the sale of the finished goodsveterinary pharmaceutical business, the first quarter of fiscal year 2005included only one month of Joint Venture operations, resulting in a loss ofsales and decrease in gross profit from the first quarter of fiscal year2004.  In February 2004, the JointVenture did achieve higher gross profit percentages than in the first quarterof fiscal year 2004 due to the introduction of higher gross margin productsduring fiscal year 2004.

 

|                                                         |   | **2004** |    | **2003** |   | **Variance** |   |
|--------------------------------------------------------------|--------|----------|---------|----------|--------|--------------|--------|
|                                                         |   |     |    |     |   |         |   |
| **Selling, promotion,  general and administrative expenses** |   | $        | 457,363 |     | $      | 469,191      |   | (3 | )% |
|                                                              |        |          |         |          |        |              |        |  |  |

 

The first quarter fiscalyear 2005 decrease in selling, promotion, general and administrative expensesis primarily due to the sale of the Joint Venture operations on March 4,2004.  The majority of the selling, general and administrative expensesfor the

 

14

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Chemdex operating segment have been eliminated because of the sale ofthese operations.  This decline inselling, promotion, general and administrative expenses was partially offset bytwo factors.  The cost of the Company’sdirector and officer liability insurance increased by 144% as compared to thefirst quarter of fiscal year 2004, due to general market conditions.  Thispremium increase took effect in the third quarter of fiscal year 2004.  The Company has never made a claim under anydirector and officer liability policy.  Also, the selling, promotion,general and administrative expenses incurred at Dextran Products were incurredin Canadian dollars, resulting in increased expenses upon translation to UnitedStates dollars due to the significant rise in the Canadian dollar since thefirst quarter of fiscal year 2004.

 

|                                      |   | **2004** |   | **2003** |   | **Variance** |   |
|-------------------------------------------|--------|----------|--------|----------|--------|--------------|--------|
|                                      |   |     |   |     |   |         |   |
| **Research and development expenditures** |   | $        | 13,424 |     | $      | 9,439        |   | 42 | % |
|                                           |        |          |        |          |        |              |        |  |  |

 

Due to continued directfunding of research and development expenses by third party public and/orprivate sector groups, the Company’s research and development expense continuedat low levels in the first quarter of fiscal year 2005.

 

Funding for the Company’sprimary development products is provided directly by third party public and/orprivate sector groups to the entities carrying out such research.  TheCompany does not take possession or control over these funds.  The Companybenefits from the results of research projects through the ownership of patentsand/or licenses with respect to the products involved.  The Company has nocommitments to repay the funding or to purchase the results of the research.

 

The current stage of thecellulose sulphate project is such that a lesser portion of development isbeing performed in-house by the Company, and significant funding from researchand development partners for the current phase of the project is expected tocontinue at necessary levels for the foreseeable future.  The Company’sresearch and development expenditures are expected to increase during theremainder of fiscal year 2005 due to additional product development activitiesthe Company expects to perform and fund outside of its partnership relationships.

 

|                                       |   | **2004** |    | **2003** |   | **Variance** |   |
|--------------------------------------------|--------|----------|---------|----------|--------|--------------|--------|
|                                       |   |     |    |     |   |         |   |
| **Depreciation and  amortization expense** |   | $        | 128,021 |     | $      | 147,903      |   | (13 | )% |
|                                            |        |          |         |          |        |              |        |  |  |

 

The decrease indepreciation and amortization expense in the first quarter of fiscal year 2005is primarily attributable to the sale of substantially all of the assets of VetLabs on March 4, 2004.

 

|                 |   | **2004** |   | **2003** |   | **Variance** |   |
|----------------------|--------|----------|--------|----------|--------|--------------|--------|
|                 |   |     |   |     |   |         |   |
| **Interest expense** |   | $        | 30,691 |     | $      | 35,372       |   | (13 | )% |
|                      |        |          |        |          |        |              |        |  |  |

 

15

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The decrease in interestexpense in the first quarter of fiscal year 2005 is primarily attributable to adecrease in long-term debt, as well as the associated decrease in imputedinterest due to the continuing repayment of non-interest bearing long-termdebt.

 

|                       |   | **2004** |   | **2003** |   | **Variance** |   |
|----------------------------|--------|----------|--------|----------|--------|--------------|--------|
|                       |   |     |   |     |   |         |   |
| **Foreign exchange  loss** |   | $        | 15,360 |     | $      | 192,177      |   | (92 | )% |
|                            |        |          |        |          |        |              |        |  |  |

 

The decrease in foreignexchange loss at Dextran Products in the first quarter of fiscal year 2005 wasdue to the significant decline in Dextran Products’ net exposure to the UnitedStates dollar.  Dextran Productscontinues to have a net exposure to the United States dollar because themajority of its accounts receivable balance is denominated in United Statesdollars.  In the first quarter of fiscalyear 2004, Dextran Products also had large intercompany receivables denominatedin United States dollars.  There was asignificant foreign exchange loss in the first quarter of fiscal year 2004because the value of the Canadian dollar increased relative to the UnitedStates dollar.  A large portion of theseintercompany receivables were repaid in March 2004 when the Joint Ventureoperations were sold.  Management does not expect that the Company willincur significant foreign exchange losses in fiscal year 2005.

 

|                       |   | **2004** |    | **2003** |   | **Variance** |   |
|----------------------------|--------|----------|---------|----------|--------|--------------|--------|
|                       |   |     |    |     |   |         |   |
| **Other income (expense)** |   | $        | (15,072 | )        | $      | (138,994     | )      | (89 | )% |
|                            |        |          |         |          |        |              |        |  |  |

 

In the first quarter ofboth fiscal years 2005 and 2004, the other expenses relate primarily to legaland receiver costs associated with the winding-up of the Joint Venture, and theresulting litigation.  This litigation was settled with the closing of thesale of the Joint Venture on March 4, 2004.  Management does not expect to incur similar costs in theremainder of fiscal year 2005.

 

| **Provision for income taxes** |   | **2004** |    | **2003** |   | **Variance** |   |
|--------------------------------|--------|----------|---------|----------|--------|--------------|--------|
|                           |   |     |    |     |   |         |   |
| Consolidated                   |   | $        | 814,037 |     | $      | 74,782       |   | 989 | % |
| Dextran Products               |   | 92,537   |    | 74,782   |   | 24           | %      |
| Chemdex                        |   | 721,500  |    | —   |   | —       |   |
|                                |        |          |         |          |        |              |        |  |  |

 

The increase in taxprovision at Dextran Products for the first quarter of fiscal year 2005 is aresult of the increase in profitability as described above.  The Canadianoperations continue to have significant research and development tax pools tooffset current taxes payable.

 

The significant increasein tax provision at Chemdex for the first quarter of fiscal year 2005 is aresult of the gain recognized on the sale of the Vet Labs assets and the JointVenture operations on March 4, 2004. Chemdex has significant tax loss carry forwards to offset a largeportion of the current taxes payable.

 

16

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**Liquidityand Capital Resources**

 

As of April 30,2004, the Company had cash of $4,395,656, compared to cash of $371,528,including amounts classified as assets subject to sale agreement of $312,073,at January 31, 2004.  In the first quarter of fiscal year 2005 theCompany used cash of $180,213 in its operating activities, compared to $71,037for the first quarter of fiscal year 2004.  Although there was a largeincrease in the net income in the first quarter of fiscal year 2005, thisincrease resulted from the sale of the Vet Labs assets and its interest in theJoint Venture, which is a non-operating item. Depreciation and amortization continues to be a large non-cash expenseof the Company.

 

The Company maintained$5,195,991 of working capital and a current ratio of 4.7 to 1 as ofApril 30, 2004, compared to $2,058,161 and 1.8 to 1 as of January 31,2004.

 

Management expects theprimary source of its future capital needs to be a combination of Companyearnings, cash reserves and borrowings.  The Company, at present, does nothave any material commitments for capital expenditures, although Managementintends to continue the plant refurbishment process at Dextran Products inToronto.

 

The Company believes thatbased upon the current levels of revenues and spending, its existing workingcapital resources will be sufficient to support continuing operations for theforeseeable future.

 

At April 30, 2004,the Company had accounts receivable of $941,720 and inventory of $1,214,117,compared to $503,864 and $1,226,439 at January 31, 2004.  Theincrease in accounts receivable at Dextran Products during the first quarter offiscal year 2005 is due to increased sales towards the end of the quarter.

 

At April 30, 2004,the Company had accounts payable, of $486,841 compared to $515,092 atJanuary 31, 2004.  The decrease in accounts payable was due to timingof supplier payments.

 

During the first quarterof fiscal year 2005, capital expenditures totaled $41,075, as compared to$60,998 in the first quarter of fiscal year 2004.  All of the capitalexpenditures were for production equipment at the Dextran Products plant inToronto in both of these periods.  Management intends to continue itsplant refurbishment and expansion plan in fiscal year 2005, and expects capitalexpenditures to increase in that period.

 

The change in accumulatedother comprehensive loss of the Company is entirely attributable to thecurrency translation adjustment of Dextran Products.  Dextran Products’functional currency is the Canadian dollar.  This currency translationadjustment arises from the translation of Dextran Products’ financialstatements to U.S. dollars.

 

Dextran Products has aCdn. $1,250,000 (U.S. $912,000) line of credit, of which Cdn. $50,000 (U.S.$36,000) was utilized at April 30, 2004.  At January 31, 2004,Cdn. $150,000 (U.S. $113,000) of this line of credit was utilized.  Thisline of credit bears interest at the

 

17

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Canadian banks’ prime lending rate plus 0.75% (April 30, 2004 –4.5%; January 31, 2004 – 5%).  This indebtedness is collateralized bya general security agreement over the Company’s assets and a collateralmortgage of Cdn. $500,000 on the Dextran Products building in Toronto.

 

Chemdex entered into along-term debt obligation relating to the redemption of the 10% minorityinterest in Chemdex in fiscal year 2004. The redemption amount was $146,500, which is to be paid in 25 equalmonthly installments of $5,860.  TheCompany has timely made 8 payments through April 30, 2004.  Since this installment contract isnon-interest bearing, it has been discounted using a discount rate of 9%.  The present value of this installmentcontract is $93,545 which has been recorded as long-term debt.

 

The significant decreasein long-term debt from January 31, 2004 is due to continuing payments bythe Company, and the full repayment of the share value guarantee.  Alllong-term debt is due in the next two years.

 

The Company did not enterinto any new capital lease obligations during the first quarter of fiscal year2005.  Capital lease obligations are due over the next three years.

 

No changes in accountingprinciples or their application have been implemented in the reporting periodthat would have a material effect on reported income.

 

Changes in the relativevalues of the Canadian dollar and the United States dollar occur from time totime and may, in certain instances, materially affect the Company’s results ofoperations.

 

The Company does notbelieve that the impact of inflation and changing prices has had a materialeffect on its operations or financial results at any time in the last threeyears.

 

**RelatedParty Transactions**

 

In August 1997, theCompany loaned Thomas C. Usher, its Vice-Chairman, Director of Research andDevelopment, a member of its Board of Directors and the beneficial owner ofgreater than 5% of the outstanding common shares of the Company, $691,500 at aninterest rate equal to the prime rate of Toronto Dominion Bank plus 1.50% (the“Loan”).  The Loan was used to partially fund a $1,000,000 payment to theState of Florida in order to allow Thomas C. Usher to regain possession of430,000 Common Shares of the Company then held by the State as collateralsecurity relating to the liquidation of insurance companies formerly owned byThomas C. Usher.  Repayment of the Loan is accomplished by monthlypayments and through offsets by the Company against royalty payments due ThomasC. Usher pursuant to intellectual property license agreements and bonuspayments, if any, granted Thomas C. Usher as an employee of the Company. The amount outstanding under the Loan as of April 30, 2004 was $400,524,as compared to $417,467 at January 31, 2004, including accruedinterest.  The Company has taken a cumulative provision of $248,210 againstaccrued interest on this loan at April 30, 2004, compared to a cumulativeprovision of $242,677 at January 31, 2004.

 

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In August 1999,Thomas C. Usher personally assumed all of the assets and liabilities of NovadexCorp., including the balance of receivables (the “Receivables”) due to theCompany from Novadex Corp.  The Receivables have no specific repaymentterms.  The total outstanding amount of the Receivables as ofApril 30, 2004 and January 31, 2004 was $366,216.  Thomas C.Usher also owes $250,000 to a subsidiary of the Company, Novadex InternationalLimited, as of April 30, 2004, pursuant to a non-interest bearing loanwith no specific repayment terms.  The outstanding amount of this loan hasnot changed from January 31, 2004.

 

Thomas C. Usher haspledged 328,051 common shares of the Company as security for these amountsowing to the Company.  These common shares have a market value of$2,401,300 at April 30, 2004, based on the closing price of the Company’scommon shares on the Nasdaq SmallCap market on that date.

 

The Company also has anoutstanding loan payable to Ruth Usher, a member of the Board of Directorsuntil her retirement on October 31, 2003, the beneficial owner of greaterthan 5% of the outstanding common shares of the Company, and the spouse ofThomas C. Usher.  The amount due from the Company pursuant to this loanincreased to $684,482 at April 30, 2004 from $683,234 at January 31,2004 due to interest charges less monthly payments by the Company.

 

**Off-BalanceSheet Arrangements**

 

The Company has no off-balance sheet arrangements.

 

**TabularDisclosure of Contractual Obligations**

 

As of April 30,2004, future minimum cash payments due under contractual obligations,including, among others, the Dextran Products line of credit, the loan payableto Ruth Usher, the long-term debt obligation in connection with the Chemdexredemption, and capital lease agreements, are as follows:

 
|                            |   | **Payment  due by period** |      |                  |   |
|---------------------------------|--------|----------------------------|-----------|-----------------------|--------|
| **Contractual Obligations**     |   | **Total**                  |      | **Less than  1 year** |   | **1-3  years** |   | **3-5  years** |   | **More than  5 years** |   |
|                            |   |                       |      |                  |   |   |   |   |   |   |   |
| Long-term debt obligations (1)  |   | $                          | 784,102   |                  | $      | 82,320 |   | $ | 53,300 |   | $ | 24,000 |   | $ | 624,482 |   |
| Capital lease obligations (2)   |   | 430,728                    |      | 179,245               |   | 251,483 |   | — |   | — |   |
| Operating lease obligations (3) |   | 8,489                      |      | 4,720                 |   | 3,769 |   | — |   | — |   |
| Purchase obligations            |   | —                     |      | —                |   | — |   | — |   | — |   |
| Revolving loans (4)             |   | 36,478                     |      | 36,478                |   | — |   | — |   | — |   |
| Total                           |   | $                          | 1,259,797 |                  | $      | 302,763 |   | $ | 308,552 |   | $ | 24,000 |   | $ | 624,482 |   |

 

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(1)           Consists of:

 

(a)           Note payable in monthly payments of $5,860 maturingSeptember 19, 2005; and

 

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(b)           Amounts due to shareholder which bear interest at theCanadian banks’ prime lending rate plus 1.5%, with required minimum monthlypayments, including interest, of $1,000.

 

(2).          Consists of capital lease obligationsfor:

 

(a)           Production equipment of Cdn. $38,734 (US $29,203)repayable in monthly installments, bearing interest at 6.65% and maturingDecember 2004;

 

(b)           Production equipment of Cdn. $103,170 (US $77,783) repayablein monthly installments, bearing interest at 7.59% and maturingNovember 2006; and

 

(c)           Production equipment of Cdn. $449,937 (US $339,217)repayable in monthly installments, bearing interest at 9% and maturingNovember 2006.

 

(3).          Consists of operating lease obligationsfor:

 

(a)           Production equipment requiring monthly payments ofCdn. $732 (US $552) terminating June 2004;

 

(b)           Office equipment requiring semi-annual payments ofCdn. $2,180 (US $1,644) terminating November 2005; and

 

(c)           Office equipment requiring quarterly payments of Cdn.$161 (US $121) terminating June 2006.

 

(4).          Consists of Canadian operating line of credit bearinginterest at the Canadian banks’ prime lending rate plus 0.75%, repayable upondemand.

 

**RiskFactors**

 

The risks, uncertaintiesand other factors described below could materially and adversely affect theCompany’s business, financial condition, operating results and prospects.

 

***The Company’s product development efforts may be reduced ordiscontinued due to difficulties or delays in clinical trials.***

 

To achieve sustainedprofitability, the Company must, alone or with corporate partners andcollaborators, successfully research, develop and commercialize identifiedtechnologies or product candidates.  Current developmental productcandidates are in various stages of clinical and pre-clinical development andwill require significant further funding, research, development, preclinicaland/or clinical testing, regulatory approval and commercialization testing, andare subject to the risks of failure inherent in the development of productsbased on innovative or novel technologies.  These products are alsorigorously regulated by the U.S. federal government, particularly the FDA, andby comparable agencies in state and local jurisdictions

 

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and in foreign countries.  Specifically, each of the followingresults is possible with respect to any one of the Company’s developmentalproduct candidates:

 

•      that the Company will not be able tomaintain its current research and development schedules;

 

•      that the Company will not be able toenter into human clinical trials because of scientific, governmental orfinancial reasons, or that it will encounter problems in clinical trials thatwill cause a delay or suspension of the development of the product candidate;

 

•      that the developmental product will befound to be ineffective or unsafe;

 

•      that government regulations will delay orprevent the product’s marketing for a considerable period of time and imposecostly procedures upon the Company’s activities;

 

•      that the FDA or other regulatory agencieswill not approve the product or the process by which the product ismanufactured, or will not do so on a timely basis; and/or

 

•      that the FDA’s policies may change andadditional government regulations and policies may be instituted, which couldprevent or delay regulatory approval of the product.

 

If any of the risks setforth above occurs, the Company may not be able to successfully develop its identifieddevelopmental product candidates.

 

***The Company’s developmental product commercializationefforts may not be successful.***

 

It is possible that, forreasons including, but not limited to those set forth below, the Company may beunable to commercialize or receive royalties from the sale of any givendevelopmental product, even if it is shown to be effective, if:

 

•      the product is uneconomical or if themarket for the product does not develop or diminishes;

 

•      the Company is not able to enter intoarrangements or collaborations to commercialize and/or market the product;

 

•      the product is not eligible forthird-party reimbursement from government or private insurers;

 

•      others hold proprietary rights thatpreclude the Company from commercializing the product;

 

•      others have brought to market similar orsuperior products;

 

•      others have superior resources to marketsimilar products or technologies;

 

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•      government regulation imposes limitationson the indicated uses of the product, or later discovery of previously unknownproblems with the product results in added restrictions on the product orresults in the product being withdrawn from the market; and/or

 

•      the product has undesirable or unintendedside effects that prevent or limit its commercial use.

 

***The Company depends on partnerships with third parties forthe development and commercialization of its products.***

 

The Company’s strategyfor development and commercialization of its products is to rely on licensingagreements with third party partners.  As a result, the ability of theCompany to commercialize future products is dependent upon the success of thirdparties in performing clinical trials, obtaining regulatory approvals,manufacturing and successfully marketing its products.  There can be noassurance that such third party collaborations will be successful.  Shouldany of the Company’s current research and development partnerships bediscontinued, it may not be able to find others to develop and commercializeits current product candidates.

 

***The Company does not currently have agreements with thirdparties to market its developmental products.***

 

The commercialization ofany of the Company’s developmental products that receive FDA approval will dependupon the Company’s ability to enter into agreements with companies that havesales and marketing capabilities.  The Company currently intends to sellits products in the United States and internationally in collaboration with oneor more marketing partners.  The Company may not be able to enter into anysuch collaboration to market its developmental products in a timely manner oron commercially reasonable terms, if at all.

 

***The Company may be unable to commercialize its products ifit is unable to protect its proprietary rights, and may be liable forsignificant costs and damages if it faces a claim of intellectual propertyinfringement by a third party.***

 

The Company’s successdepends in part on its ability to obtain and maintain patents, protect trade secretsand operate without infringing upon the proprietary rights of others.  Inthe absence of patent and trade secret protection, competitors may adverselyaffect the Company’s business by independently developing and marketingsubstantially equivalent or superior products, possibly at lower prices. The Company could also incur substantial costs in litigation and sufferdiversion of attention of technical and management personnel if it is requiredto defend intellectual property infringement suits brought by third parties,with or without merit, or if required to initiate litigation against others toprotect or assert intellectual property rights.  Moreover, any suchlitigation may not be resolved in favor of the Company.

 

The Company has receivedvarious patents covering the uses of its developmental products.  However,the patent position of companies in the pharmaceutical industry generallyinvolves complex legal and factual questions, and recently has been the subjectof much

 

22

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litigation.  Any patents the Company has obtained, or may obtainin the future, may be challenged, invalidated or circumvented.  To date,no consistent policy has been developed by the United States Patent andTrademark Office regarding the breadth of claims allowed in biotechnologypatents.

 

In addition, becausepatent applications in the United States are maintained in secrecy untilpatents issue, and because publication of discoveries in scientific or patentliterature often lags behind actual discoveries, the Company cannot be certainthat it and its licensors are the first creators of inventions covered by anylicensed patent applications or patents or that the Company or such licensorsare the first to file.  The United States Patent and Trademark Office maycommence interference proceedings involving patents or patent applications, inwhich the question of first inventorship is contested.  Accordingly, thepatents owned by or licensed to the Company may not be valid or may not affordthe Company protection against competitors with similar intellectual property.

 

It is also possible thatthe Company’s patents may infringe on patents or other rights owned by others,licenses to which may not be available to the Company.  The Company mayhave to alter its products or processes, pay licensing fees or cease certainactivities altogether because of patent rights of third parties.

 

In addition to theproducts for which the Company has patents or have filed patent applications,the Company relies upon unpatented proprietary technology and may not be ableto meaningfully protect its rights with regard to that unpatented proprietarytechnology.

 

**CriticalAccounting Policies**

 

The Company’sconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States, applied on a consistentbasis.  The critical accounting policies include the use of estimates ofallowance for doubtful accounts, the useful lives of assets and the realizabilityof deferred tax assets.  The Company’s accounting policies with respect tothe Joint Venture and its disposition are also discussed below.

 

Management is required tomake estimates and assumptions, in preparing the consolidated financialstatements, that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenue and expenses duringthe periods.  The actual results could differ from these estimates. Significant estimates made by management include the calculation of reservesfor uncollectible accounts, inventory allowances, useful lives of long-livedassets and the realizability of deferred tax assets.

 

***Revenue Recognition***

 

All revenue is from sales of bulk and finished dosagemanufactured products and is recognized when title and risk of ownership ofproducts pass to the customer.  Title and risk of ownership pass to thecustomer pursuant to the applicable sales contract, either upon shipment ofproduct or upon receipt by the customer.  Since returns are rare andgenerally not accepted, management

 

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has not made provision for returns.  In addition, product sold inbulk quantities is tested, prior to release for shipment, to ensure that itmeets customer specifications, and in many cases, customers receive samples fortheir own testing.  Approval is obtained from the customer prior toshipping.

 

***Allowance for Doubtful Accounts***

 

Accounts receivable isstated net of allowances for doubtful accounts.  Allowances for doubtfulaccounts are determined by each reporting unit on a specific item basis. Management reviews the credit worthiness of individual customers and past paymenthistory to determine the allowance for doubtful accounts.  Since themajority of sales at Dextran Products are export, Dextran Products maintainscredit insurance through a crown corporation for the majority of its customersreceivables.

 

***Long-Lived Assets***

 

Long-lived assets arestated at cost, less accumulated depreciation or amortization computed usingthe straight-line method based on their estimated useful lives ranging fromthree to fifteen years.  Useful life is the period over which the asset isexpected to contribute to the Company’s cash flows.  A significant changein estimated useful lives could have a material impact on the results ofoperations.  The Company reviews the recoverability of its long-livedassets, including buildings, equipment and other intangible assets, when eventsor changes in circumstances occur that indicate that the carrying value of theasset may not be recoverable.  The assessment of possible impairment isbased on the Company’s ability to recover****the carrying value of the asset from theexpected future pre-tax cash flows (undiscounted and****without interest charges) ofthe related operations.  If these cash flows are less than the****carryingvalue of such asset, an impairment loss is recognized for the differencebetween****estimatedfair value and carrying value.  The measurement of impairment requiresmanagement to****make estimates of these cash flows related to long-livedassets as well as other fair value****determinations.

 

***Deferred Tax Assets***

 

The Company has recordeda valuation allowance on deferred tax assets where there is uncertainty as tothe ultimate realization of the future tax deduction.  Dextran Productshas incurred capital losses, which are only deductible against capitalgains.  It is not certain that Dextran Products will realize capital gainsin the future to use these Canadian capital loss deductions.

 

***The Joint Venture***

 

In 1992, Vet Labs andSparhawk entered into the Joint Venture for the manufacture and sale ofveterinary pharmaceutical products.  Vet Labs and Sparhawk each owned 50%of the Joint Venture during its operation. The Joint Venture was governed bythe Agreement for the Operation of Veterinary Laboratories, Inc.’s LenexaFacility and Sparhawk Lab of KC as a Joint Venture, dated December 1, 1992,by and among Sparhawk, Chemdex and Vet Labs (the “Joint Venture Agreement”).

 

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Pursuant to the JointVenture Agreement, the Joint Venture Policy Committee was responsible for theoverall management of the Joint Venture, including the direction and control ofthe persons designated with the daily management responsibilities of the JointVenture, and the general supervision of the management and conduct of theaffairs of the Joint Venture.  The Policy Committee consisted of fivemembers, three of which were selected by Vet Labs and two of which wereselected by Sparhawk.  Decisions of the Policy Committee required a simplemajority vote.

 

Because the Companycontrolled the operating, financing and investing decisions of the JointVenture through Vet Labs’ control of the Policy Committee, it consolidated theJoint Venture’s assets, liabilities, revenue and expenses in the Company’sfinancial statements.  The Company has funded the Joint Venture’scumulative losses since 1992 and, accordingly, has recorded 100% of theselosses in the consolidated financial statements.

 

On January 13, 2004,the Company, Chemdex and Vet Labs entered into an Asset Purchase Agreement withSparhawk.  Pursuant to the Asset Purchase Agreement, the Company agreed tosell substantially all of the assets of Vet Labs, including its interest in theJoint Venture, to Sparhawk for $5,500,000 in cash.  EffectiveMarch 4, 2004, this sale was completed and a gain of $1,859,471 wasrecognized.  Simultaneously with the closing, Chemdex advanced $350,000 toSparhawk in exchange for an unsecured subordinated promissory note bearinginterest at 13% per annum and a warrant to purchase 4% of the equity ofSparhawk.  The promissory note is payable in full on March 4,2009.  Interest is payable annually, but can be deferred and added to theprincipal balance of the****promissory note each year at Sparhawk’sdiscretion.  The warrant becomes exercisable on March 5, 2009 andexpires at the earlier of payment in full of the promissory note orMarch 4, 2014.  Chemdex also entered into a supply agreement withSparhawk to supply ferric hydroxide and hydrogenated dextran solution toSparhawk on an exclusive basis in the United States for 10 years.  Inconnection with the sale, the litigation involving the Joint Venture, *SparhawkLaboratories, Inc. v. Veterinary Laboratories, Inc., et al*, Case No.02CV07426, County of Johnson, State of Kansas, was settled, and a Motion ofApproval of Settlement and Stipulation of Dismissal with Prejudice was filedwith the Court on March 4, 2004.

 

Since Sparhawk is thinlycapitalized and highly leveraged, the Company has deferred $350,000 of the gainrelating to the promissory note receivable from Sparhawk.  The Company will monitor the financialposition of Sparhawk and will recognize this deferred gain at such time asSparhawk’s cash flows from operations are sufficient to fund debt service on afull accrual basis.

 

There will be significantchanges in the Company’s results of operations due to the sale of the Vet Labsassets and its ownership interest in the Joint Venture.  Sales of theJoint Venture accounted for 66% of the Company’s total sales in fiscal year2004.  Income before income taxes from Vet Labs and the Joint Venture amountedto $408,667 in fiscal year 2004.  Management expects that gross profit asa percentage of sales for the Company will increase because the Joint Venture’smargins were generally lower than those of Dextran Products.

 

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**Changesin Accounting Policies**

 

There were no changes inaccounting policies during the first quarter ended April 30, 2004.

 

**RecentAccounting Pronouncements**

 

In December 2003,the FASB issued FASB Interpretation [“FIN”] No. 46R, “Consolidation of VariableInterest Entities an interpretation of ARB No. 51” [the “Interpretation”],which is a revision of FIN No. 46 originally issued in January 2003.  The Interpretation introduces a newconsolidation model - the variable interests model - which determines control[and consolidation] based on potential variability in gains and losses of theentity being evaluated for consolidation. It also requires application infinancial statements of public entities for periods ended afterDecember 15, 2003 to special purpose entities, and in financial statementsfor periods ending after March 15, 2004 to other types of variableinterest entities.  The Company does nothave any interests in special purpose entities, and will account for anyvariable interest entities in accordance with the Interpretation. The adoptionof this Interpretation had no impact on the Company’s consolidated financialstatements.

 

**Forward-lookingStatements**

 

This Quarterly Report onForm 10-Q, including the Management’s Discussion and Analysis of FinancialCondition and Results of Operations, contains various “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended, which represent the Company’s expectations or beliefs concerningfuture events, including, but not limited to statements regarding management’sexpectations of regulatory approval and the commencement of sales.  In addition, statements containingexpressions such as “believes”, “anticipates”, “plans” or “expects” used inthis Quarterly Report on Form 10-Q, the Company’s Annual Report, and theCompany’s periodic reports on Forms 10-K and 10-Q previously filed with theSecurities and Exchange Commission are intended to identify forward-lookingstatements.  The Company cautions thatvarious risks and uncertainties and other factors could cause actual results todiffer materially from those expressed in or implied by the forward-lookingstatements.  These factors include, withoutlimitation, changing market conditions, the progress of clinical trials, andthe results obtained, the establishment of new corporate alliances, the impactof competitive products and pricing, the timely development, FDA approval andmarket acceptance of the Company’s products, and the other risks discussedabove, none of which can be assured.

 

The forward-lookingstatements contained in this quarterly report speak only as to the date of thisreport.  Except as otherwise required byfederal securities laws, the Company undertakes no obligation to publiclyupdate or revise any forward-looking statements or the risk factors describedin this Quarterly Report on Form 10-Q, whether as a result of new information,future events, changed circumstances or any other reason after the date of thisreport.

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with United States generally accepted accounting principles forinterim

 

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financial information and the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financial statements.  In the opinion of management, alladjustments (consisting of normally recurring accruals) considered necessaryfor a fair presentation have been included.

 

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**Item 3**** Quantitativeand Qualitative Disclosures About Market Risk**

 

**ExchangeRate Sensitivity**

 

The Company’s operations consist of manufacturingactivities in the United States and Canada. The Company’s products are sold in North America, Europe and the PacificRim.

 

While the majority of thesales of Dextran Products, the Company’s Canadian operation, are denominated inUnited States dollars, the majority of its expenses are incurred in Canadiandollars.  The majority of the assets andliabilities of Dextran Products are denominated in Canadian dollars prior tothe currency translation adjustment necessary for preparation of the financialstatements of the Company contained in this report.  Therefore, Dextran Products has a net asset exposure to theUnited States dollar.  When the Canadiandollar rises in value relative to the United States dollar, the carrying valueof the assets and liabilities of Dextran Products as stated in United Statesdollars increases.  A rise in theCanadian dollar relative to the United States dollar also results in a decreasein gross margins and net income of Dextran Products.  Dextran Productsalso experiences a foreign exchange loss when the Canadian dollar rises inrelation to the United States dollar due to this net asset exposure.  Similarly, a decline in the Canadian dollarrelative to the United States dollar results in a foreign exchange gain andincreased gross margins and net income at Dextran Products.

 

Management monitors currency fluctuations to ensurethat an acceptable margin level at Dextran Products is maintained.  Management has the ability, to some extent,to adjust sales prices to maintain an acceptable margin level.

 

The following table presents information about theCompany’s financial instruments other than accounts receivable that are sensitiveto changes in foreign currency exchange rates. All financial instruments are held for other than trading purposes.  The table presents principal cash flows andrelated weighted average interest rates by expected maturity dates.

 
|                    |   | **Expected  Maturity Date** |   |        |   | **Fair**    |   |
|-------------------------|--------|-----------------------------|--------|-------------|--------|-------------|--------|
|                    |   | **1/31/05**                 |   | **1/31/06** |   | **1/31/07** |   | **1/31/08** |   | **1/31/09** |   | **Thereafter** |   | **Total** |   | **Value** |   |
|                    |   | **(US$  Equivalent)**       |   |
| **Assets:**             |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Short-term investments: |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| (Fixed rate ($Cdn.)     |   | (89,506                     | )      | 631,096     |   | 646,8732    |   | 663,045 |   | 679,621 |   | 1,664,283 |   | 4,195,412 |   | 4,195,412 |   |
| Average interest rate   |   | 2.50                        | %      | 2.50        | %      | 2.50        | %      | 2.50 | % | 2.50 | % | 2.50 | % | 2.50 | % |   |   |
|                    |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities:**        |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Long-term debt:         |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate ($Cdn.)      |   | 158,434                     |   | 141,530     |   | 138,437     |   | — |   | — |   | — |   | 438,401 |   | 439,484 |   |
| Average interest rate   |   | 8.35                        | %      | 8.73        | %      | 8.75        | %      | — |   | — |   | — |   | 8.61 | % |   |   |

 

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**Interest Rate Sensitivity**

 

The Company has interest earning assets consisting ofinvestment grade or higher short-term commercial paper.  A significant portion of the Company’s debtis at fixed rates.  The variable ratedebt represents the shareholder loan payable, which is approximately offsetwith the shareholder loan receivable.  Both of these financial instruments carry the same interestrate.  As such, the Company has no significant risk exposure to changes ininterest rates.

 

The following table presents information about theCompany’s financial instruments that are sensitive to changes in interestrates.  All financial instruments areheld for other than trading purposes. The table presents principal cash flows and related weighted averageinterest rates by expected maturity dates.

 
|                    |   | **Expected  Maturity Date** |   |        |   | **Fair**    |   |
|-------------------------|--------|-----------------------------|--------|-------------|--------|-------------|--------|
|                    |   | **1/31/05**                 |   | **1/31/06** |   | **1/31/07** |   | **1/31/08** |   | **1/31/09** |   | **Thereafter** |   | **Total** |   | **Value** |   |
|                    |   | **(US$  Equivalent)**       |   |
| **Assets:**             |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Short-term investments: |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate ($Cdn.)      |   | (89,506                     | )      | 631,096     |   | 646,873     |   | 663,045 |   | 679,621 |   | 1,664,283 |   | 4,195,412 |   | 4,195,412 |   |
| Average interest rate   |   | 2.50                        | %      | 2.50        | %      | 2.50        | %      | 2.50 | % | 2.50 | % | 2.50 | % | 2.50 | % |   |   |
|                    |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Notes receivable:       |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Variable rate ($US)     |   | 54,861                      |   | 58,153      |   | 61,642      |   | 65,340 |   | 69,261 |   | 108,209 |   | 417,466 |   | 417,466 |   |
| Average interest rate   |   | 6.00                        | %      | 6.00        | %      | 6.00        | %      | 6.00 | % | 6.00 | % | 6.00 | % | 6.00 | % |   |   |
|                    |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities:**        |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Long-term debt:         |   |                        |   |        |   |        |   |   |   |   |   |   |   |   |   |   |   |
| Fixed rate ($Cdn.)      |   | 158,434                     |   | 141,530     |   | 138,437     |   | — |   | — |   | — |   | 438,401 |   | 439,484 |   |
| Average interest rate   |   | 8.35                        | %      | 8.73        | %      | 8.75        | %      | — |   | — |   | — |   | 8.61 | % |   |   |
| Variable rate           |   | 1,007                       |   | 1,068       |   | 1,132       |   | 1,200 |   | 1,272 |   | 677,535 |   | 683,213 |   | 683,213 |   |
| Average interest rate   |   | 6.00                        | %      | 6.00        | %      | 6.00        | %      | 6.00 | % | 6.00 | % | 6.00 | % | 6.00 | % |   |   |

 

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**Item 4****.  Controls and Procedures.**

 

The Company completed anevaluation as of the end of the period covered by this report under thesupervision and with the participation of management, including its Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of its disclosure controls and procedures pursuant to Rule 13a-14 ofthe Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures are effective in alerting them on a timely basis of materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in its periodic Securities and Exchange Commissionfilings.

 

There have been nochanges in the Company’s internal control over financial reporting identifiedin connection with the evaluation discussed above that occurred in theCompany’s last fiscal quarter that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

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**PART II**

**OTHER INFORMATION**

 

**Item 1.  LegalProceedings.**

 

There are no pendinglegal proceedings to which the Company or any of its subsidiaries is a party,or to which any of their property is subject.

 

The litigation involvingthe Joint Venture, *Sparhawk Laboratories,Inc. v. Veterinary Laboratories, Inc., et al*, Case No. 02CV07426,County of Johnson, State of Kansas, was settled on March 4, 2004, and aMotion of Approval of Settlement and Stipulation of Dismissal with Prejudicewas filed with the Court on that date.

 

**Item6.  Exhibitsand Reports on Form 8-K.**

 

(a)           Exhibits

 

3.1           Memorandum ofAssociation of Polydex Pharmaceuticals Limited, as amended to date (filed asExhibit 3.1 to the Annual Report on Form 10-K filed April 30, 1997, andincorporated herein by reference)

 

3.2           Articles of Associationof Polydex Pharmaceuticals Limited, as amended to date (filed as Exhibit 3.2 tothe Quarterly Report on Form 10-Q filed September 13, 1999, andincorporated herein by reference)

 

10.1         Supply Agreement, datedas of March 1, 2004, by and between Chemdex, Inc. and Sparhawk Laboratories,Inc. (filed as Exhibit 10.10 to the Annual Report on Form 10-K filedApril 30, 2004, and incorporated herein by reference)

 

10.2         Unsecured subordinatedPromissory Note, dated March 4, 2004, made by Sparhawk Laboratories, Inc.in favor of Chemdex, Inc. (filed as Exhibit 10.11 to the Annual Report on Form10-K filed April 30, 2004, and incorporated herein by reference)

 

10.3         Warrant and RepurchaseAgreement, dated March 4, 2004, issued by Sparhawk Laboratories, Inc. toChemdex, Inc. (filed as Exhibit 10.12 to the Annual Report on Form 10-K filedApril 30, 2004, and incorporated herein by reference)

 

31.1         Certification of ChiefExecutive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Actof 1934

 

31.2         Certification of ChiefFinancial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Actof 1934

 

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32.1         Certification of ChiefExecutive Officer pursuant to 19 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         Certification of ChiefFinancial Officer pursuant to 19 U.S.C. Section 1350, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)           Reports on Form 8-K

 

1.             The Company filed aCurrent Report on Form 8-K on March 19, 2004 to report the Company’scompletion of the sale of its Unites States finished product veterinarypharmaceutical business (Items 2 and 7 on Form 8-K).

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| Date:       June 14, 2004 |                            |
|--------------------------------------------------------------|---------------------------------|
|                                                         |                            |
|                                                         | POLYDEX PHARMACEUTICALS LIMITED |
|                                                         | (Registrant)                    |
|                                                         |                            |
|                                                         | By                              | /s/ George G. Usher |   |
|                                                         |                            | George G. Usher, Chairman, President  and Chief Executive Officer |
|                                                         |                            | (Principal Executive Officer) |
|                                                         |                            |
|                                                         |                            |
|                                                         | By                              | /s/ Sharon L. Wardlaw |   |
|                                                         |                            | Sharon L. Wardlaw, Treasurer, Secretary and  Chief Financial and Accounting Officer |
|                                                         |                            | (Principal Financial Officer) |

 

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**Exhibit Index**

 
| 31.1   |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                          |
| 31.2   |   | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934                                                |
|   |   |                                                                                                                                                          |
| 32.1   |   | Certification of Chief Executive Officer  pursuant to 19 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
|   |   |                                                                                                                                                          |
| 32.2   |   | Certification of Chief Financial Officer  pursuant to 19 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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