VirtualScopics 10Q 2009 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2009_______________________________________

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

For the transition period from _____________________________to______________________________________

Commission File Number: 000-52018______________________________________________________________

VirtualScopics, Inc.

(Exact name of registrant as specified in its charter)

Delaware	04-3007151
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

500 Linden Oaks, Rochester, New York	14625
(Address of principal executive offices)	(Zip Code)

(585)249-6231

(Registrant’s telephone number, including area code)

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

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

x Yes ¨ No

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

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

Large accelerated filer ¨	Accelerated filer ¨

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

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

Yes ¨ No x

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

As of July 31, 2009, there were 23,758,632 shares of the registrant’s common stock, $0.001 par value, outstanding.

TABLE OF CONTENTS

		Page Numbers
PART I	FINANCIAL INFORMATION

	ITEM 1: Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2009 (unaudited) and December 31, 2008	1
	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 and 2008	2
	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2008	3
	Notes to Unaudited Condensed Consolidated Financial Statements	4-12
	ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations	13-20
	ITEM 4T: Controls and Procedures	20

PART II	OTHER INFORMATION

	ITEM 1: Legal Proceedings	21
	ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds	21
	ITEM 3: Defaults Upon Senior Securities	21
	ITEM 4: Submission of Matters to a Vote of Security Holders	21
	ITEM 5: Other Information	22
	ITEM 6: Exhibits	22

PART 1: FINANCIAL INFORMATION

ITEM 1. Financial Statements

VirtualScopics, Inc. and Subsidiary

Condensed Consolidated Balance Sheets

	June 30,			December 31,
	2009			2008
	(Unaudited)
Assets

Current assets
Cash	$	3,157,927		$	3,143,904
Accounts receivable		1,395,565			1,021,110
Prepaid expenses and other current assets		355,104			263,297
Total current assets		4,908,596			4,428,311

Patents, net		1,877,522			1,920,446
Property and equipment, net		428,960			355,479
Other assets		95,023			156,788
Total assets	$	7,310,101		$	6,861,024

Liabilities and Stockholders' Equity

Current liabilities
Accounts payable and accrued expenses	$	984,035		$	659,009
Accrued payroll		452,081			554,425
Unearned revenue		609,493			291,594
Derivative liability		1,026,231			-
Total current liabilities		3,071,840			1,505,028

Commitments and Contingencies		-			-

Stockholders' Equity
Convertible preferred stock, $0.001 par value; 15,000,000 shares authorized;
8,400 shares designated Series A; issued and outstanding, 3,773 shares at June 30, 2009 and 3,976 shares at December 31, 2008; liquidation preference $1,000 per share		4			4
6,000 shares designated Series B; issued and outstanding, 4,226 shares at June 30, 2009 and at December 31, 2008; liquidation preference $1,000 per share		4			4
Common stock, $0.001 par value; 85,000,000 shares authorized;
issued and outstanding, 23,758,632 shares at June 30, 2009 and 23,502,352 shares at December 31, 2008		23,759			23,503
Additional paid-in capital		13,881,704			16,546,550
Accumulated deficit		(9,667,210	)		(11,214,065	)
Total stockholders' equity		4,238,261			5,355,996
Total liabilities and stockholders' equity	$	7,310,101		$	6,861,024

See notes to condensed consolidated financial statements.

VirtualScopics, Inc. and Subsidiary

Condensed Consolidated Statements of Operations

(unaudited)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2009			2008			2009			2008

Revenues	$	2,541,316		$	1,733,299		$	4,675,685		$	3,367,402
Cost of services		1,147,980			1,021,536			2,162,564			2,051,520
Gross profit		1,393,336			711,763			2,513,121			1,315,882

Operating expenses
Research and development		258,180			212,825			493,735			464,654
Sales and marketing		357,222			384,237			639,676			673,111
General and administrative		859,512			864,663			1,704,191			1,762,167
Depreciation and amortization		119,126			116,765			236,636			234,332
Total operating expenses		1,594,040			1,578,490			3,074,238			3,134,264

Operating loss		(200,704	)		(866,727	)		(561,117	)		(1,818,382	)

Other income (expense)
Interest income		87			17,002			3,280			45,727
Other expense		(6,592	)		(1,385	)		(8,076	)		(2,968	)
Loss on derivative financial instrument		(205,914	)		-			(603,323	)		-
Total other income (expense)		(212,419	)		15,617			(608,119	)		42,759

Net loss		(413,123	)		(851,110	)		(1,169,236	)		(1,775,623	)

Series B preferred stock dividend		84,520			84,520			169,040			169,760
Net loss attributable to common stockholders	$	(497,643	)	$	(935,630	)	$	(1,338,276	)	$	(1,945,383	)

Basic and diluted net loss per common share	$	(0.02	)	$	(0.04	)	$	(0.06	)	$	(0.08	)

Weighted average number of common shares outstanding – basic and diluted		23,738,855			23,358,625			23,636,886			23,302,346

See notes to condensed consolidated financial statements.

VirtualScopics, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows

(unaudited)

	For the Six Months Ended June 30,
	2009			2008

Cash flows from operating activities
Net loss	$	(1,169,236	)	$	(1,775,623	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		236,636			234,332
Loss on disposal of asset		2,904			-
Stock-based compensation expense		554,348			687,291
Issuance of equity instruments for rent		105,570			170,000
Accrual for future issuance of equity instruments for services		-			102,000
Fair value adjustment of derivative liability		603,323			-
Changes in operating assets and liabilities
Accounts receivable		(374,455	)		(270,063	)
Prepaid expenses and other assets		(91,807	)		24,274
Accounts payable and accrued expenses		308,557			(37,573	)
Accrued payroll		(102,344	)		163,096
Unearned revenue		317,899			(66,336	)
Total adjustments		1,560,631			1,007,021
Net cash provided by (used in) operating activities		391,395			(768,602	)

Cash flows from investing activities
Purchase of equipment		(185,287	)		(21,773	)
Acquisition of patents		(23,045	)		(56,479	)
Net cash used in investing activities		(208,332	)		(78,252	)

Cash flows from financing activities
Restricted cash		-			298,723
Proceeds from the exercise of warrants		-			876
Cash dividends on series B preferred stock		(169,040	)		(169,760	)
Net cash (used in) provided by financing activities		(169,040	)		129,839

Net increase (decrease) in cash and cash equivalents		14,023			(717,015	)

Cash and cash equivalents
Beginning of period		3,143,904			3,955,835
End of period	$	3,157,927		$	3,238,820

Supplemental disclosure of cash flow information
Non-cash financing activity:
Issuance of common stock for partial payment of rent in equity	$	105,570		$	170,000

See notes to condensed consolidated financial statements.

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

NOTE 1 - Organization and Basis of Presentation

Nature of Business

The Company’s headquarters are located in Rochester, New York. The Company’s business evolved from research first carried out at the University of Rochester, a related party. As a result of this research, the Company has created a suite of image analysis software tools and applications which are used in detecting and measuring specific anatomical structures and metabolic activity using medical images. The Company’s developed proprietary software provides measurement capabilities designed to improve clinical research and development.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Company have been condensed in certain respects and should, therefore, be read in conjunction with the audited consolidated financial statements and notes related thereto contained in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2008. In the opinion of the management, these financial statements contain all adjustments necessary for a fair presentation for the interim period, all of which were normal recurring adjustments. The results of operations for the six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year ending December 31, 2009.

In February 2008, the Company received a written notice from the Nasdaq Stock Market indicating that its common stock was not in compliance with minimum bid price required for continued listing on the Nasdaq Capital Market. The Company was granted additional time by Nasdaq to regain compliance with the continued listing requirements. As of May 19, 2009, the Company regained compliance.

NOTE 2 - Summary of Certain Significant Accounting Policies

Principles of Consolidation

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

Revenue Recognition

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

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

Occasionally, the Company provides software development services to its customers, which may require significant development, modification, and customization. Software development revenue is billed on a fixed price basis and recognized upon delivery of the software and acceptance by the customer on a completed contract basis in accordance with the American Institute of Certified Public

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The Company does not sell software licenses, upgrades or enhancements, or post-contract customer services.

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

Research and Development

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

Fair Value of Financial Instruments

The Company’s financial instruments are cash, accounts receivable and accounts payable. The recorded values of cash, accounts receivable and accounts payable approximate their fair values based on their short-term nature.

Subsequent Events

Management has evaluated subsequent events or transactions occurring through August 12, 2009, the date the financial statements were issued.

Derivative Financial Instruments

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

Recently Issued and Adopted Accounting Pronouncements

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

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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

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

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

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

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

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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

In April 2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments in interim as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in all interim financial statements. This standard is effective for periods ending after June 15, 2009. The adoption of this standard did not have any impact on the Company’s financial position and results of operations.

In May 2009, the FASB issued SFAS 165, Subsequent Events (“SFAS 165”), which provides guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. SFAS 165 distinguishes events requiring recognition in the financial statements and those that may require disclosure in the financial statements. Furthermore, SFAS 165 requires disclosure of the date through which subsequent events were evaluated. SFAS 165 is effective for interim and annual periods after June 15, 2009. The adoption of SFAS 165 is did not have any impact on the condensed consolidated financial statements.

In July 2009, the FASB issued Statement of Financial Accounting Standards No. 168, “The FASB Accounting Codification and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS. 168"). Statement No. 168 supersedes Statement No. 162 issued in May 2008. Statement No. 168 will become the source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the effective date of this Statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative. This Statement is effective for our quarterly reporting period ending September 30, 2009. The adoption of Statement No. 168 is not expected to have any impact the Company’s consolidated financial position or results of operations.

NOTE 3 - Stock-Based Compensation

The Company uses the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment,” using the modified prospective method. Consequently, for the six months ended June 30, 2009 and 2008, the Company’s condensed consolidated statements of operations reflect stock-based compensation expense for stock options granted under its long-term stock incentive plans amounting to $554,348 and $687,291, respectively.

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

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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

of the options, and at that time an estimated forfeiture rate is used to reduce the expense recorded. The Company’s estimate of pre-vesting forfeitures is primarily based on the Company’s historical experience and is adjusted to reflect actual forfeitures as the options vest. The following assumptions were used to estimate the fair value of options granted for the six months ended June 30, 2009 and 2008 using the Black-Scholes option-pricing model:

	June 30,
	2009			2008
Risk free interest rate		2.96	%		3.85	%
Expected term (years)		10.0			9.7
Expected volatility		85.73			89.7	%
Expected dividend yield		-			-

A summary of the option activity for the six months ended June 30, 2009 is as follows:

	Number of Shares			Weighted Average Exercise Price			Weighted- Average Remaining Contractual Term
Options outstanding at January 1, 2009		4,676,868			1.64
Granted		743,058			0.73
Cancelled		(6,000	)		(1.20	)
Exercised		-			-
Options outstanding at June 30, 2009		5,413,926			1.42			6.54
Options exercisable at June 30, 2009		3,374,849			1.99			5.69

The weighted-average grant-date fair value of options granted during the six months ended June 30, 2009 and 2008 was $545,525 and $1,031,981, respectively. There have been no options exercised during the six months ended June 30, 2009.

NOTE 4 - Stockholders’ Equity

During the first two quarters ended June 30, 2009, 202.5 shares of the Company’s series A convertible preferred stock were converted into 168,148 shares of the Company’s common stock and no shares of series B convertible preferred stock were converted.

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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

NOTE 5 - - Derivative Liability

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

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

	June 30, 2009			January 1, 2009			November 5, 2005
Series A warrants:
Risk-free interest rate		.19	%		2.24	%		4.66	%
Expected volatility		69.4	%		72.9	%		59.6	%
Expected life (in years)		.42			.92			4
Expected dividend yield		-			-			-

Number of warrants		1,400,000			1,400,000			1,400,000

Fair value	$	23,380		$	14,840		$	1,299,900

	June 30, 2009			January 1, 2009			September 7, 2007
Series B warrants:
Risk-free interest rate		2.54	%		2.24	%		4.37	%
Expected volatility		59.5	%		57.8	%		70.0	%
Expected life (in years)		5.16			5.67			7
Expected dividend yield		-			-			-

Number of warrants		2,234,764			2,234,764			2,234,764

Fair value	$	1,002,851		$	408,068		$	1,839,099

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

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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

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

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

The fair value of these warrant liabilities was $1,026,231 at June 30, 2009. The $603,323 change in fair value is reported in our condensed consolidated statement of operations as a loss on derivative financial instruments. The fair value of these liabilities will be re-measured at the end of every reporting period and the change in fair value will be reported in our consolidated statement of operations as a gain or loss on derivative financial instruments.

Fair Value Measurement

Valuation Hierarchy

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

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of June 30, 2009:

			Fair Value Measurements at June 30, 2009
	Total Carrying Value at June 30, 2009		Quoted prices in active markets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Derivative liabilities	$	1,026,231	$	-	$	-	$	1,026,231

The carrying amounts of cash, accounts receivable, accounts payable, and accrued liabilities approximate their fair value due to their short maturities. The derivative liabilities are measured at fair value using quoted market prices and estimated volatility factors, and are classified within Level 3 of the valuation hierarchy. There were no changes in the valuation techniques during the six months ended June 30, 2009.

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

NOTE 6 - Net Loss Per Share

Basic net loss per share is computed by dividing the net loss applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted loss attributable to common shares adjusts basic loss per share for the effects of convertible securities, warrants, stock options and other potentially dilutive financial instruments, only in the periods in which such effect is dilutive. The shares issuable upon the conversion of preferred stock, the exercise of stock options and warrants are excluded from the calculation of net loss per share as their effect would be antidilutive.

Securities that could potentially dilute earnings per share in the future that were not included in the computation of diluted loss per share consist of the following as of June 30:

	2009		2008
Series A convertible preferred stock		3,132,950		3,301,098
Series B convertible preferred stock Series A warrants to purchase common stock		3,509,092 1,629,402		3,509,092 1,629,402
Series B warrants to purchase common stock		2,234,764		2,234,764
Other warrants to purchase common stock		444,888		444,888
Options to purchase common stock		5,555,616		4,972,366

Total		16,506,712		16,091,610

NOTE 7 - Income Taxes

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

Upon adoption, the Company has concluded that there were no significant uncertain tax positions requiring recognition in its financial statements. As of June 30, 2009, all of the Company’s deferred tax assets were fully reserved by a valuation allowance equal to 100% of the net deferred tax assets. The Company has never been profitable and has not paid any income taxes.

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

The Company will recognize interest and penalties accrued related to unrecognized tax benefits as components of its income tax provision. The Company did not have any interest and penalties accrued upon the adoption of FIN No. 48 and as of June 30, 2009, the Company does not have any interest and penalties accrued related to unrecognized tax benefits.

VirtualScopics, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

NOTE 8 - Concentration of Credit Risk

The Company’s top customer accounted for approximately 30% of its total revenue and 27% of its accounts receivable for the six months ended June 30, 2009. For the six months ended June 30, 2008, its then top three customers accounted for 15%, 13% and 12% of its total revenue.

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

The following discussion should be read in conjunction with VirtualScopics’ condensed consolidated balance sheets as of June 30, 2009 and December 31, 2008 and the related condensed consolidated statements of operations and cash flows for the quarters ended June 30, 2009 and 2008, included elsewhere in this report. This discussion contains forward-looking statements, the accuracy of which involves risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons including, but not limited to, those discussed under the heading “Forward Looking Statements” below and elsewhere in this report. We disclaim any obligation to update information contained in any forward-looking statements.

Overview

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

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

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

reduced processing time for image data analysis through automation.

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

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

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

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

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

research and development;

hiring technical, sales and other personnel;

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

business development of customer and strategic relationships; and

raising capital.

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

The number of customers that we perform services for has increasingly grown over the past several years, and we continue to submit proposals and bids for new contracts. However, there can be no assurance that we will secure contracts from these efforts or that any such contracts or any of our existing contracts will not be cancelled by a customer.

Additionally, once we enter into a new contract for participation in a drug trial, there are several factors that can effect whether we will realize the full benefits under the contract, and the time over which we will realize that revenue. Customers may not continue our services due to performance reasons with their compounds in development. Furthermore, the contracts may contemplate performance over multiple years. Therefore, revenue may not be realized in the fiscal year in which the contract is signed or awarded. Recognition of revenue under the contract may also be affected by the timing of patient recruitment and image site identification and training.

Results of Operations

Results of Operations for Quarter Ended June 30, 2009 Compared to Quarter Ended June 30, 2008

Revenues

We had revenues of $2,541,000 for the quarter ended June 30, 2009 compared to $1,733,000 for the comparable period in 2008. This $808,000, or 47%, increase in revenues was directly related to the expansion of our penetration within the pharmaceutical and medical device industries. During the current quarter, we performed work on 82 different projects, in connection with our pharmaceutical drug trials in the fields of oncology, osteoarthritis and various other projects. This compares to 64 projects during the same period in 2008. The majority of the demand is seen within our oncology service line, however, we have recently seen increased interest in our musculoskeletal applications. During the second quarter of 2009, 70% of our business was in oncology services, 21% in musculoskeletal, the remaining 9% was work performed for the Department of Defense and in other therapeutic areas. This compares to 55%, 27% and 18%, respectively, in 2008. During the second three months of 2009, 59% of the revenues were derived from Phase II and III studies compared to 44% during the comparable period in 2008. Our margins in the later stage studies (Phase II and III) tend to be higher due to the efficiencies gained with the larger volume of analysis and site coordination.

Gross Profit

We had a gross profit of $1,393,000 for the second quarter of 2009 compared to $712,000 for the comparable period in 2008, an increase of 681,000, or 96%. Our gross profit margin was 55% during the period ended June 30, 2009 compared to 41% in the first six months of 2008. The percentage of our business in Phase II and III trials has grown over the past twelve months which is reflected in our gross margin. Phase II and III studies are inherently more efficient for us to process. Also impacting the improved margin is the increase in overall volume of business during the quarter. We have made significant improvements in order for us to effectively scale the business without requiring a significant amount of additional resources. These improvements and the higher revenue volume allow us to be more effective in the processing of our services, thereby typically resulting in higher margins. We have begun hiring within our operations to support the growing demand for our services and therefore, anticipate margins to be slightly lower for the remainder of 2009.

Research and Development

Research and development costs increased in the quarter ended June 30, 2009 by $45,000, or 21%, to $258,000, when compared to the quarter ended June 30, 2008. The increase was a result of relocation costs for one of our scientific staff. Our research and development efforts center around refining our processes through the use of our software platform in order to gain efficiencies which we believe will better allow us to standardize our processes as we scale the business. Additionally, we continue to invest in the commercialization of new imaging techniques across many modalities and therapeutic areas to best serve our customers. As of June 30, 2009, there were 9 employees in our research and development group, which includes the algorithm development and software development groups.

Sales and Marketing

Sales and marketing costs decreased in the quarter ended June 30, 2009 by $27,000, or 7%, to $357,000, when compared to the quarter ended June 30, 2008. The decrease was a result of the costs incurred rebranding our marketing materials in the first and second quarter of 2008. The resulting marketing materials now display a consistent and representative reflection of the services we provide and the value it generates for our customers. The decrease in the outside marketing costs during the second quarter of 2009 were offset by higher costs associated with the attendance at various trade shows and company sponsored seminars in 2009.

General and Administrative

General and administrative expenses for the quarter ended June 30, 2009 were $859,000, a decrease of $5,000 or 1%, when compared to the quarter ended June 30, 2008. The slight decrease was mainly due to the valuation changes within our stock compensation expense. In May 2009, the stockholders approved a stock option exchange program whereby certain option holders are eligible to receive 1 option at the closing market price on the date of the exchange for 2 of their current options. Based on the amount of option holders electing to participate, the non-cash stock compensation expense may increase at the time of the exchange. The specific timing of the exchange is not yet determined however, it is estimated to occur prior to year end.

Depreciation and Amortization

Depreciation and amortization charges remained constant at $119,000 for the quarter ended June 30, 2009 when compared to the quarter ended June 30, 2008. This was a result of depreciation charges related to recent capital purchases being offset by a reduction in depreciation charges for assets that have been fully depreciated during the past quarter. We anticipate higher IT costs in 2009 as we seek efficiencies through acquired software applications and computers necessary to support the existing employees and the planned increase in our headcount.

Other Income (Expense)

Interest income for the quarter ended June 30, 2009 was nominal due to the low interest rates received from our primary banking institution. We continue to assess the level of risk and related rates within our current banking arrangement as well as opportunities with other institutions in order to leverage our cash balances while minimizing our risk. Additionally, we recognized a marked to market adjustment of $206,000 related to the loss in fair value of certain derivative financial instruments as a result of the implementation of EITF 07-05 during the first quarter of 2009 (see Financial Statement Note 5). Under the guidelines of EITF 07-05, and because implementation was required beginning in 2009, there was no adjustment required in 2008.

Net Loss

Net loss for the quarter ended June 30, 2009 was $413,000 compared to a net loss of $851,000 for the quarter ended June 30, 2008. The significant improvement in our net loss over the prior period was primarily related to the increase in our revenues, growth in our gross profit along with reductions in our operating expenses offset by a non-cash marked to market adjustment to reflect the changes in the fair value of certain outstanding warrants during the second quarter of 2009 as compared to 2008.

Results of Operations for the Six Months Ended June 30, 2009 Compared to the Six Months Ended June 30, 2008

Revenues

Our revenues for the six months ended June 30, 2009 were $4,676,000, an increase of $1,309,000 or 39% over the first half of 2008. The increase in sales is a reflection of the broadening of our customer base, the broader penetration of our services in the industry and the shift to later stage clinical trials which are inherently larger contracts. We performed services for a total of 92 projects in the first half of 2009, as compared to 70 in the first half of 2008. We are experiencing increased demand for our services in Phase II/III trials, and as a result, we expect that a majority of our revenues from pharmaceutical trial projects will be derived from Phase II and III studies throughout the rest of 2009.

Gross Profit

We had a gross profit of $2,513,000 for the six months ended June 30, 2009 compared to $1,316,000 for the comparable period in 2008. Our gross profit improved $1,197,000 or 91% for the first two quarters combined in 2009 compared to the first two quarters combined in 2008. The improvement is the result of operating efficiencies, greater sales volume and the inherent efficiency obtained in performing work in later stage clinical trials. During the first half of 2009, 57% of our revenues were generated from Phase II/III trials as compared to 36% during the same period a year ago.

Research and Development

Total research and development expenditures were $494,000 in the first half of 2009 compared to $465,000 for the comparable period in 2008, an increase of 6%. The slight increase was due to relocation costs incurred in 2009 related to one of our scientific staff. Our research and development efforts center around refining our processes through the use of our software platform in order to gain efficiencies which we believe will better allow us to standardize our processes as we scale the business. Additionally, we continue to invest in the commercialization of new imaging techniques across many modalities and therapeutic areas to best serve our customers. As of June 30, 2009, there were 9 employees in our research and development group, which includes the algorithm development and software development groups.

Sales and Marketing

Sales and marketing costs for the six months ended June 30, 2009 decreased to $640,000, a decrease of $33,000 or 5% over the first half of 2008. The decrease was a result of a new marketing strategy to better align our marketing materials with our value proposition and service offering in the industry in 2008. We incurred the majority of our rebranding expenses in the first and second quarters of 2008. Offsetting the decrease in 2009 we have incurred higher costs associated with presenting and attending industry sponsored conferences and conducting seminars on emerging topics within imaging for new and existing customers.

General and Administrative

General and administrative expenses for the six months ended June 30, 2009 were $1,704,000, a decrease of $58,000 or 3%, over the first half of 2008. The decrease is mainly due to a reduction in stock compensation expense for vested stock options related to the timing and vesting schedule of stock option grants.

Depreciation and Amortization

Depreciation and amortization charges remained consistent in the six months ended June 30, 2009 and 2008.

Other Income (Expense)

Interest income for the six months ended June 30, 2009 was $3,000 and composed of interest derived on the Company’s operating and savings accounts, compared to interest income of $46,000 in the same period in 2008. The decrease in interest income was a reflection of the lower average rates of return on our savings accounts in 2009 compared to 2008. Additionally, we recognized a marked to market adjustment of $603,000 related to the loss in fair value of certain derivative financial instruments as a result of the implementation of EITF 07-05 in 2009 (see Financial Statement Note 5). Under the guidelines of EITF 07-05, and because implementation was required beginning in 2009, there was no adjustment required in 2008.

Net Loss

Our net loss for the six months ended June 30, 2009 was $1,169,000 compared to a net loss of $1,776,000 for the same period in 2008. The improvement in our net loss over the prior period was primarily related to higher revenues and gross profit, as outlined above, offset by the marked to market adjustment for the fair value of certain outstanding warrants.

Liquidity and Capital Resources

Our working capital as of June 30, 2009 was approximately $1,837,000 compared to $2,923,000 as of December 31, 2008. The decrease in working capital was a result of the recording of a derivative warrant liability related to the marked to market adjustment of certain warrants in accordance with EITF 07-05 which became effective during 2009 and therefore, no similar adjustment was required in 2008.

Net cash provided by operating activities totaled $391,000 in the six months ended June 30, 2009 compared to net cash used of $769,000 in the comparable 2008 period. This significant improvement in the amount of cash provided by operating activities is a direct result of increases in revenues and gross profit without increases in spending in research and development and general and administrative expenses. Also impacting operating cash flow was the timing of receivables and payment of accounts payable and payroll.

We invested $208,000 in the purchase of equipment and the acquisition of patents in the first half of 2009, compared to $78,000 for the investment in these items in the first half of 2008. The increase represents investments in our IT infrastructure to support the growing demand for our services.

Cash used in our financing activities in the six months ended June 30, 2009 was $169,000, compared to $130,000 provided by financing activities in the six months ended June 30, 2008 representing the release of restricted cash for investor relations and dividend payments offset by monthly dividend payments for the convertible series B preferred stock.

We currently expect that existing cash and cash equivalents will be sufficient to fund operations for the next 12 months. If in the next 12 months our plans or assumptions change or prove to be inaccurate, we may be required to seek additional capital through public or private debt or equity financings. If we need to raise additional funds, we may not be able to do so on terms favorable to us, or at all. If we cannot raise sufficient funds on acceptable terms, we may have to curtail our level of expenditures and our rate of expansion.

Off Balance Sheet Arrangements

We have no off-balance sheet arrangements, other than the consulting agreements and operating leases that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital resources or capital expenditures that is material to investors.

Recently Issued and Adopted Accounting Pronouncements

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

In April 2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments in interim as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in all interim financial statements. This standard is effective for periods ending after June 15, 2009. The adoption of this standard did not have an impact on the Company’s financial position and results of operations.

Forward Looking Statements

Certain statements made in this discussion are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate may occur in the future, including the following risk factors:

adverse economic conditions;

inability to raise sufficient additional capital to operate our business;

unexpected costs, lower than expected sales and revenues, and operating defects;

adverse results of any legal proceedings;

the volatility of our operating results and financial condition;

inability to attract or retain qualified senior management personnel, including sales and marketing, and scientific personnel; and

other specific risks that may be referred to in this report.

All statements, other than statements of historical facts, included in this report including, without limitation, statements regarding our strategy, future operations, financial position, estimated revenue or losses, projected costs, prospects and plans and objectives of management are forward-looking statements. When used in this report, the words “may,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project,” “plan,” “could,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this report. We do not undertake any obligation to update any forward-looking statements or other information contained in this report. Existing stockholders and potential investors should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements in this report are reasonable, we cannot assure our stockholders or potential investors that these plans, intentions or expectations will be achieved. We disclose important factors that could cause our actual results to differ materially from our expectations under the heading entitled “Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2008 filed with the Securities and Exchange Commission (“SEC”) and elsewhere in this report. These risk factors qualify all forward-looking statements attributable to us or persons acting on our behalf.

ITEM 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain a set of disclosure controls and procedures, as defined in Section 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

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

Changes in Internal Controls Over Financial Reporting

An evaluation was performed under the supervision of the Company’s management, including the CEO and CFO, as required under Exchange Act Rule 13a-15(d) and 15d-15(d) of whether any change in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred during the fiscal quarter ended June 30, 2009. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that no change in the Company’s internal controls over financial reporting occurred during the fiscal quarter ended June 30, 2009 that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None

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

During the quarter ended June 30, 2009, approximately 42.5 shares the Company’s series A convertible preferred stock were converted into 35,290 shares of the Company’s common stock. The Company did not receive any cash or other consideration in connection with the conversions. Additionally, no commission or other remuneration was paid by the Company in connection with such conversions. The issuance of common stock upon conversions of the series A convertible preferred stock was made in reliance on the exemption provided in Section 3(a)(9) of the Securities Act of 1933, as amended.

Item 3. Defaults upon Senior Securities

Not applicable.

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

a) The Company held its Annual Meeting of Stockholders on May 28, 2009.

c) The stockholders voted for the election of eight nominees to serve as directors for a one-year term expiring in 2010 and until their successors are elected. The vote was as follows:

Name of Candidate	For	Withheld

Mostafa Analoui	23,039,444	370,792
Dan Kerpelman	22,961,600	448,636
Robert Klimasewski	23,032,785	377,451
Sidney Knafel	21,897,646	1,512,590
Jeffrey Markin	23,028,908	381,328
Norman Mintz	22,937,787	472,449
Charles Phelps	22,942,535	467,701
Terence Walts	23,035,537	374,699

There were no abstentions and no broker non-votes.

The stockholders voted to approve an amendment to our Certificate of Incorporation to effect a reverse stock split of our outstanding common stock in the range of 1:2 to 1:4, to be determined by our Board of Directors at any time between May 28, 2009 and May 28, 2010, without the requirement of further approval by our stockholders. The vote was 22,763,640 for, 626,716 against and there were 19,880 abstentions. There were no broker non-votes.

The stockholders voted to approve our Amended and Restated 2006 Long-Term Incentive Plan (the “Plan”) (i) to increase the number of shares authorized for issuance under the Plan from 2,500,000 to 6,900,000, (ii) to permit conditional awards under the amended Plan and future amendments thereto, and (iii) to increase the limitation on the number of shares available for stock awards with no vesting restrictions from 5% to 20% under the Plan. The vote was 10,140,872 for, 7,404,064 against and there were 13,850 abstentions. There were no broker non-votes.

The stockholders voted to approve a one-time stock option exchange program under which our eligible employees (including our executive officers) and directors would be able to elect to exchange outstanding stock options issued under our equity incentive plans for new lower-priced options. The vote was 11,140,944 for, 6,399,895 against and there were 17,947 abstentions. There were no broker non-votes.

Item 5. Other Information

None

Item 6. Exhibits

Exhibit 31.1 Certification of Chief Executive Officer as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 31.2 Certification of Chief Financial Officer as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act 0f of 2002.

Exhibit 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act 0f of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: August 12, 2009	VIRTUALSCOPICS, INC.

		/s/ Jeffrey Markin
		Jeffrey Markin
		President and Chief Executive Officer

		/s/ Molly Henderson
		Molly Henderson
		Chief Business and Financial Officer and Senior Vice President

Exhibit Index

Exhibit 31.1 Certification of Chief Executive Officer as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2 Certification of Chief Financial Officer as required by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 by the Chief Executive Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 by the Chief Financial Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

VirtualScopics (VSCP) Inactive 10-Q2009 Q2 Quarterly report

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