UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2003

[ ] 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 0-13634

MACROCHEM CORPORATION
(Exact name of registrant as specified in its charter)

Delaware 04-2744744
- --------------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

110 Hartwell Avenue
Lexington, Massachusetts 02421-3134
----------------------------------------
(Address of principal executive offices)
(781) 862-4003
(Telephone number)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of Class Name of Each Exchange on Which Registered
- -------------- -----------------------------------------
Common Stock, $.01 par value The Nasdaq SmallCap Market
Series B Preferred Stock Purchase The Nasdaq SmallCap Market
Rights, $.01 par value

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.
Yes X No
-------- --------

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes No X
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The aggregate market value of the shares of Common Stock held by
non-affiliates, based upon the closing price for such stock on June 30, 2003 was
approximately $32,203,453. As of March 5, 2004, 33,143,742 shares of Common
Stock, $.01 par value, were outstanding.

Portions of the following documents are incorporated into the Parts of this
Report on Form 10-K indicated below:

(1) The Registrant's definitive Proxy Statement for the 2004 Annual Meeting
to be filed pursuant to Regulation 14A on or before May 26, 2004 (Part III).

PART I

ITEM 1. BUSINESS.

THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. MACROCHEM'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE
SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED OR REFERRED
TO IN THE SECTION ENTITLED "RISK FACTORS". READERS ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE
DATE HEREOF. WE UNDERTAKE NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE
COMPANY OR PERSONS ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR
ENTIRETY BY THESE CAUTIONARY STATEMENTS. READERS ARE ALSO URGED TO CAREFULLY
REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY THE COMPANY, IN THIS
DOCUMENT, AS WELL AS THE COMPANY'S PERIODIC REPORTS ON FORMS 10-K, 10-Q AND 8-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ("SEC").

MacroChem's Internet address is www.macrochem.com, and the Company
maintains a website at that address. MacroChem makes available, on or through
its Internet website, without charge, its annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports as soon as reasonably practicable after filing them electronically with
the Securities and Exchange Commission.

The business of MacroChem Corporation ("MacroChem" or the "Company") is
further described in Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operation", which should be read in
conjunction with the accompanying financial statements and related footnotes.

MacroChem develops pharmaceutical products for commercialization by
employing SEPA(R) (Soft Enhancement of Percutaneous Absorption), our patented
topical drug delivery technology. SEPA(R) compounds, when properly combined with
drugs, provide pharmaceutical formulations, such as creams, gels, lacquers and
solutions, etc., that enhance the transdermal delivery of drugs into the skin or
into the bloodstream. We believe that SEPA(R) compounds enhance the diffusion of
drugs into and through the skin by making the outer layer of the skin more
permeable to the drug molecule. Transdermal delivery provides an alternative to
other methods of drug administration, such as injection, oral dosage forms and
inhalation, and may allow selected drugs to be administered more effectively, at
lower doses, with fewer adverse events and with improved patient compliance.
MacroChem is also evaluating potential applications of MacroDerm(TM), our
patented low molecular weight polymers that modulate dermal penetration.

Our SEPA(R)-enhanced pharmaceutical product candidates are all currently in
development stages and are neither approved by the U.S. Food and Drug
Administration, or FDA, nor available for commercial sale. We are developing
specific SEPA(R) formulations for use with non-proprietary and proprietary drugs
manufactured by pharmaceutical companies, and we generally plan to commercialize
these products through the formation of partnerships, strategic alliances and
license agreements with those companies. If we are unable to form any strategic

alliances, our business may be materially adversely affected. In order to
attract strategic partners, we are conducting clinical testing of
SEPA(R)-enhanced pharmaceuticals. Because of the substantial costs involved in
bringing a new pharmaceutical product or a new formulation of an old drug to
market, we may be required to rely on pharmaceutical companies to conduct all or
part of the clinical trials necessary to gain regulatory approval to manufacture
and to market any resulting product. We cannot control the resources and
attention that such pharmaceutical companies may devote to a product and this
can result in delays in clinical testing, regulatory filings and
commercialization efforts. As of the date of this Annual Report on Form 10-K, we
have not generated any meaningful revenues from operations and, as of December
31, 2003, we had an accumulated deficit of approximately $68,550,000. Please see
our financial statements referred to in Item 8 of this Annual Report on Form
10-K for a more detailed description of our financial history.

We were organized and commenced operations as a Massachusetts corporation
in 1981 and we were reincorporated as a Delaware corporation on May 26, 1992.
Our principal executive offices are located at 110 Hartwell Avenue, Lexington,
Massachusetts 02421-3134 and our phone number is (781) 862-4003.

RESEARCH AND DEVELOPMENT

We conduct our research and development activities through our own staff
and facilities, and also through collaborative arrangements with universities,
contract research organizations and independent consultants. As of March 5,
2004, the Company had 16 full-time employees, 9 of whom are devoted to research
and development and regulatory affairs. Research and developmental expenditures
were approximately $2,938,000, $3,998,400 and $9,791,400 during the years ended
December 31, 2003, 2002 and 2001, respectively. We also rely upon third parties
to conduct clinical studies, obtain FDA and other regulatory approvals and
manufacture and market a finished product.

We conduct stability studies, test our unique formulations and design
manufacturing processes for our SEPA(R) compounds and MacroDerm(TM) polymer
technologies at our facility and other facilities. We have cGMP (current Good
Manufacturing Practices) facilities for the manufacture of dosage forms for
clinical evaluations.

PRODUCTS AND TECHNOLOGIES

BACKGROUND

To be effective, drugs must reach an intended site in the body, at an
effective concentration, and for an appropriate length of time. Traditional
methods of drug administration, such as oral ingestion, intramuscular and
intravenous injections and inhalation, are effective for a wide variety of
drugs. However, depending upon the given drug, each method may have
disadvantages. For example, following oral administration, a drug must pass
through the gastrointestinal system to be absorbed and may be metabolized or
broken down in the stomach, intestines or liver, resulting in a lower amount of
unaltered drug at the target site for its action. As a result, higher dosages of
the drug must be administered orally to produce the desired effect, which may
cause irritation of the gastrointestinal tract and systemic toxicity.

In addition, the rate at which an orally administered drug is absorbed may
vary depending on several factors, including the drug's chemical properties, the
length of time the drug remains in the gastrointestinal tract and the patient's
meal patterns. The pharmaceutical industry has investigated a variety of
alternative approaches for dealing with drug adverse events and loss of efficacy
following oral dosing, including enteric coating of tablets, formulating with
various waxes and cellulosic materials, microencapsulation and compressing
tablets in various layers. However, the desired effects of these approaches are
not always reproducible from patient to patient or effective in bypassing
metabolism.

TOPICAL DRUG DELIVERY

Topical drug delivery is the process of delivering drugs into the skin
(dermal delivery) so that they can be effective in the treatment of
dermatological or localized conditions and diseases, or through the skin
(transdermal delivery) and into the bloodstream for the treatment of systemic
diseases.

The skin is made up of three layers: the outer layer or stratum corneum;
the middle layer or viable epidermis; and the inner layer or dermis. The stratum
corneum, which serves as the skin's primary barrier to the external environment,
consists of closely packed dead cells and fatty (lipid) material. The epidermis
is composed of several layers of active cells and the dermis consists, in part,
of tissue containing hair follicles, nerve endings and blood capillaries. Within
the stratum corneum, lipid layers bind the dead cells together to form a
protective barrier. Research conducted by MacroChem shows that SEPA(R) compounds
affect drug delivery by acting, in part, upon the stratum corneum to disrupt the
alignment of the lipid molecules within the lipid layers. This disruption
increases the porosity of the lipid-cell layers, allowing drugs to diffuse
through the stratum corneum and through the more porous epidermis to the dermis,
where they enter the blood stream through the capillaries. The rate and amount
of drug absorbed can be controlled by varying the formulation used.

MACROCHEM'S DRUG DELIVERY SYSTEMS AND OTHER PROPOSED PRODUCTS

SEPA(R) COMPOUNDS

The delivery of a drug through the skin depends on the drug's physical and
chemical characteristics (molecular size and shape, the drug's solubility in
lipids and water, its melting point and whether it is lipophilic or
hydrophilic).

Since some drugs move through the skin too rapidly, the transdermal system
must retard the rate of drug absorption to ensure optimal efficacy with minimum
toxicity. Since other drugs move through the skin with difficulty, the
transdermal system must be formulated to increase a drug's rate of absorption
through the skin. Common methods of transdermal delivery use common chemicals
such as ethanol or fatty compounds to enhance penetration.

Although certain delivery methods using chemicals have proven to be
somewhat effective with specific drugs, such as drugs used for the treatment of
motion sickness or hormone deficiencies, they have caused adverse events, such
as skin irritation and sensitivity at the site of application. Some drugs,
because of their physical characteristics or the amount of drug necessary to
achieve the desired therapeutic effect, have not been successfully delivered
transdermally to date.

MacroChem has developed SEPA(R) compounds that are designed to enhance the
transport, penetration and controlled delivery of drugs through the skin.
SEPA(R) compounds are generally colorless, clear liquids that are intended to
promote drug delivery by aiding drug molecules to penetrate the skin, diffuse
into or through the skin layers and become absorbed into the bloodstream.

We have our own facility for the in vitro testing of drug formulations
containing SEPA(R), and therefore are less dependent on outside laboratories for
this type of testing. We have been conducting in vitro studies to evaluate the
transdermal enhancing effect of SEPA(R) in combination with a variety of drugs
with differing physical and chemical characteristics, representing a broad
spectrum of potential drug products. Although our research and development
efforts with SEPA(R) are at an advanced stage, we must still conduct substantial
additional studies to demonstrate the efficacy and safety of any SEPA(R)-drug
formulation. We have found that specific drugs administered transdermally with
SEPA(R) demonstrate increased transdermal absorption. Some of the drug
formulations tested by us with SEPA(R) contain compounds generally recognized as
unlikely or difficult candidates for transdermal delivery because of their
physical and chemical properties and molecular size. As these drug formulations
are further developed, we plan to conduct additional studies to investigate the
efficacy and safety of some of these formulations.

We have conducted early clinical studies with several drug formulations
containing SEPA(R) where SEPA(R) has been demonstrated to enhance transdermal
penetration of the specific drug within in vitro testing. Clinical studies have
included Phase I trials in which safety and tolerance of a topical application
of the drug formulation were assessed and Phase II trials in which efficacy of
the specific drug was evaluated in an appropriate clinical condition.

We have designed and sponsored clinical trials of Topiglan(R), our topical
formulation of alprostadil and SEPA(R) for use in the treatment of erectile
dysfunction. The Company has completed a Phase II/III in-home trial of a first
generation Topiglan(R) gel formulation. The Company has also completed
pre-clinical and Phase I studies, and as of the date of this Annual Report on
Form 10-K is conducting a clinical pharmacology study, of a new Topiglan(R)
cream formulation.

We have also designed and sponsored in vitro and clinical studies of
Opterone(TM), our topical formulation of SEPA(R) and testosterone for use in
treating male hypogonadism. These studies were conducted with a first generation
gel formulation of Opterone(TM). As of the date of this Annual Report on Form
10-K, the Company is conducting a dose proportionality clinical study of a new
Opterone(TM) cream formulation.

We have also conducted a pre-clinical study of EcoNail(TM), our lacquer
formulation of SEPA(R) in combination with selected active antifungal agents to
treat fungal infections of the nail. The study demonstrated substantially
increased nail penetration by an antifungal drug when combined with SEPA(R). As
of the date of filing of this Annual Report on Form 10-K, the Company is
conducting a Phase I study of EcoNail(TM) in patients with onychomycosis (fungal
infection of the nail).

The Company has also conducted pre-clinical laboratory studies with SEPA(R)
formulations of nonsteroidal anti-inflammatory drugs for topical application in
pain management.

We believe that SEPA(R) compounds can be used with a broad variety of new
and existing drugs to enhance their commercial value. The therapeutic
effectiveness and improved convenience of a transdermal SEPA(R) product may
substantially expand the existing market for a drug. In addition, a formulation
containing a SEPA(R) compound may prove to be a superior alternative to the
existing methods of administering certain drugs.

MACRODERM(TM) DRUG DELIVERY SYSTEM

We have developed a series of low molecular weight polymers, termed
MacroDerm(TM), for use in cosmetics and in the superficial dermal delivery of
pharmaceuticals. Potential applications include their use with sunscreens,
moisturizers, and insect repellents. We have synthesized, and are testing and
evaluating, MacroDerm(TM) prototypes and we are seeking strategic partners to
manufacture and market specific MacroDerm(TM) products.

COMPETITION

We compete with numerous firms, many of which are large, multi-national
organizations with worldwide distribution. We believe that our major competitors
in the drug delivery sector of the health care industry include NexMed, Inc.,
Bentley Pharmaceuticals, Inc., ALZA Corporation, Elan Corporation, plc., and
Vivus. Potential competitors in the therapeutic areas our product candidates
seek to address include Eli Lilly, GlaxoSmithKline, Bayer Pharmaceuticals,
Pfizer, Novartis, Johnson & Johnson, Dermik Laboratories, Solvay, Auxilium and
Watson Pharmaceuticals, Inc. Compared with MacroChem, most of these firms have
substantially greater capital resources, research and development and technical
staffs, facilities and experience in obtaining regulatory approvals, as well as
in manufacturing, marketing and distribution of products. Recent trends in this
area are toward further market consolidation of large drug companies into a
smaller number of very large entities, further concentrating financial,
technical and market strength and increasing competitive pressure in the
industry. Academic institutions, hospitals, governmental agencies and other
public and private research organizations are also conducting research and
seeking patent protection and may develop competing products or technologies of
their own through joint ventures or other arrangements. In addition, recently
developed technologies, or technologies that may be developed in the future, may
or could be the basis for competitive products. We cannot guarantee that our
competitors will not succeed in developing technologies and products that are
more effective or less costly to use than any that we are currently developing.

Alprostadil, a synthetic prostaglandin E1 (PGE1), and Viagra(R), Cialis(R)
and Levitra(R) are the only drugs approved for marketing in the United States
for erectile dysfunction. PGE1 is available in two dosage forms. Caverject(R),
marketed by Pfizer (formerly Pharmacia-Upjohn), is administered by needle
injection directly into the penis. The second product, developed by Vivus, is a
pellet form of the drug administered through a tube inserted into the urethra.

In contrast to the invasive forms now available, MacroChem believes that a
topical formulation applied directly to the penis will be the preferred dosage
form for treatment of this disorder. Viagra(R), an oral product of Pfizer, was
approved by the FDA in 1998, Levitra(R), an oral product of Bayer
Pharmaceuticals, was approved by the FDA in 2003 and Cialis(R), an oral product
of Eli Lilly, was approved by the FDA in 2003. Many other drug companies have
ongoing internal programs to develop orally administered medications for
treating male erectile dysfunction. In addition, NexMed, Inc. has announced
completion of U.S. Phase III clinical trials of its cream formulation of
alprostadil for treating the disease.

With respect to Opterone(TM), Solvay and Auxilium each offer a topically
administered testosterone gel, and Watson Pharmaceuticals, Inc. offers a
testosterone patch, for treating male testosterone deficiency. A number of
smaller firms are also developing topical testosterone products.

With respect to EcoNail(TM), Johnson & Johnson and Novartis each offer an
orally administered antifungal therapy and Dermik Laboratories offers a topical
nail lacquer therapy for treating fungal infections of the nail. A number of
other firms are also developing topical and oral therapies for these infections.

We expect any products approved for sale to compete primarily on the basis
of efficacy, safety, patient compliance, reliability, price and patent position.
Generally, the first pharmaceutical product to reach the market in a therapeutic
or preventive area often has a significant advantage compared with later
entrants to the market. Our competitive position will also depend on our ability
to attract and retain qualified scientific and other personnel, develop
effective proprietary products, implement production and marketing plans, obtain
patent protection and secure adequate capital resources.

EMPLOYEES

As of March 5, 2004, the Company had 16 full time employees, 9 of whom are
devoted to research and development and regulatory affairs. None of our
employees are covered by a collective bargaining agreement, and we consider
relations with our employees to be good.

GOVERNMENT REGULATION

The production and marketing of our drug delivery systems and
pharmaceutical products are subject to regulation for safety, efficacy and
quality by numerous federal, state and local agencies and comparable agencies in
foreign countries.

In the United States, the Federal Food, Drug and Cosmetics Act, the Public
Health Service Act, the Controlled Substances Act and other federal statutes and
regulations govern or influence the testing, manufacture, safety, labeling,
storage, record keeping, approval, advertising and promotion of our proposed
products and technologies.

Non-compliance with applicable requirements can result in fines and other
judicially imposed sanctions including recalls and criminal prosecutions based
on violation of statutory requirements by products, promotional practices,
clinical practices or manufacturing practices. In addition, administrative

remedies can involve voluntary recalls or cessation of sale of products,
administrative detention, public notice, voluntary changes in labeling,
manufacturing or promotional practices, as well as refusal of the government to
approve New Drug Applications (NDAs). The FDA also has the authority to withdraw
approval of drugs in accordance with statutory procedures.

The FDA approval procedure involves completion of certain pre-clinical and
manufacturing/stability studies and the submission of the results of these
studies to the FDA in an Investigational New Drug (IND) application in support
of performing clinical trials. IND allowance is then followed by performance of
human clinical trials, and additional pre-clinical and manufacturing quality
control studies, supporting safety, efficacy and manufacturing quality control.
The safety, chemistry, manufacturing and stability and clinical studies
developed under the IND are compiled into an NDA or Abbreviated New Drug
Application (ANDA) and submitted to the FDA for approval to market.

Preclinical studies involve laboratory evaluation of product
characteristics and animal studies to assess the efficacy and safety of the
product. Human clinical trials are typically conducted in three sequential
phases, but the phases may overlap. Phase I trials typically consist of testing
of the product in a small number of normal volunteers primarily for safety. In
Phase II, in addition to safety, the efficacy of the product is typically
evaluated in a small patient population. Phase III trials typically involve
multicenter testing for safety and clinical efficacy in an expanded population
of patients at geographically dispersed test sites. A clinical plan, or
"protocol," accompanied by the identification of the institutions participating
in the trials, must be submitted to the FDA prior to commencement of each
clinical trial. The FDA may order the temporary or permanent discontinuation of
a clinical trial at any time if adverse events that endanger patients in the
trials are observed. In addition, the FDA may request Phase IV clinical trials,
to be performed after marketing approval, to resolve any lingering questions.

A 30-day waiting period after the filing of each IND application is
required by the FDA prior to the commencement of clinical testing in human
subjects. If the FDA does not comment on or question the IND application within
30 days, initial clinical studies may begin. However, any FDA comments or
questions must be answered to the satisfaction of the FDA before initial
clinical testing can begin. In some instances, this process could result in
substantial delay and expense.

The results of the preclinical and clinical studies on new drugs are
submitted to the FDA in the form of NDAs for approval to commence commercial
sales. Following extensive review, the FDA may grant marketing approval, require
additional testing or information, or deny the application. All products must
continue to comply with all FDA requirements and the conditions in an approved
application, including product specifications, manufacturing process and
labeling requirements. Failure to comply, or the occurrence of unanticipated
adverse events during commercial marketing, could lead to the need for labeling
changes, product recall, seizure, injunctions against distribution or other
FDA-initiated action, which could delay further marketing until the products are
brought into compliance.

In certain cases, an Abbreviated New Drug Application, or ANDA, may be
filed in lieu of filing an NDA. An ANDA relies on bioequivalency tests that

compare the applicant's drug with an already approved reference drug, rather
than on clinical trials. An ANDA may be available to us for a new formulation of
a drug, which has already been approved by the FDA in other topical dosage
forms.

The NDA itself is a complicated and detailed document and must include the
results of extensive animal, clinical and other testing, the cost of which is
substantial. Although the FDA is required to review applications within 180 days
of filing, in the process of reviewing applications the FDA frequently requests
that additional information be submitted and restarts the 180-day regulatory
review period when the requested additional information is submitted. The effect
of such requests and subsequent submissions can significantly extend the time
for the NDA review process. Until an NDA is actually approved, no assurance can
be given that the information requested and submitted will be considered
adequate by the FDA to justify approval.

In addition, packaging and labeling of most of our proposed products are
subject to FDA regulation. We must get FDA approval for all labeling and
packaging prior to marketing of a regulated product.

Whether or not FDA approval has been obtained, approval of a product by a
comparable regulatory authority must be obtained in most foreign countries
before marketing of the product in that country. The approval procedure varies
from country to country and may involve additional testing, and the time
required may differ from that required for FDA approval. Although some
procedures for unified filings exist for certain European countries, in general
each country has its own procedure and requirements, many of which are time
consuming and expensive. Thus, substantial delays in obtaining required
approvals from foreign regulatory authorities can result after the relevant
applications are filed. After such approvals are obtained, further delays may be
encountered before the products become commercially available.

We cannot guarantee that any required FDA or other governmental approval
will be granted or, if granted, will not be withdrawn. Governmental regulation
may prevent or substantially delay the marketing of our proposed products, cause
us to undertake costly procedures and furnish a competitive advantage to the
more substantially capitalized companies with which we plan to compete. In
addition, we cannot predict the extent of potentially adverse government
regulations that may arise from future administrative action or legislation.

PATENTS, TRADEMARKS AND LICENSE RIGHTS

During 2003, the Company filed two new U.S. patent applications and three
foreign patent applications became patent grants. The Company also sold one
patent and one associated pending patent application.

The two new U.S. patent applications both relate to topical administration
compositions, one for a new class of enhancer compounds, the other for a new
carrier system. We anticipate that corresponding foreign applications will be
filed in 2004.

The three granted foreign patents involve the Company's Topiglan(R)
formulations and are Canadian Patent No. 2,296,373 granted on August 12, 2003;
Russian Federation Patent No. 2,198,660 granted on February 20, 2003; and
Singapore Patent No. 70,478 granted on May 20, 2003.

In 2003, the Company sold its US Patent 6,459,124, which relates to an
antifungal topical composition but which does not use the Company's SEPA(R)
platform technology. The sale included a pending application based on this
patent.

In addition to the patent activity, one trademark application for the mark
MacroDerm(TM) was filed in March, 2003 and has been allowed.

We believe that patent protection of our technologies, processes and
products is important to our future operations. The success of our proposed
products may depend, in part, upon our ability to obtain patent protection.

Although we intend to file additional patent applications, as management
believes appropriate for any new products or technological developments, we
cannot guarantee that any additional patents will be issued or, if issued, will
be of commercial benefit to us. In addition, to anticipate the breadth or degree
of protection that any such patents may afford is impossible. To the extent that
we rely on unpatented proprietary technology, we cannot guarantee that others
will not independently develop or obtain substantially equivalent or superior
technology or otherwise gain access to our trade secrets, that any obligation of
confidentiality will be honored or that we will be able to effectively protect
our rights to proprietary technology. Further, we cannot guarantee that any
products developed by us will not infringe patents held by third parties or
that, in such case, licenses from such third parties will be available on
commercially acceptable terms, if at all.

In connection with our prior research and development efforts, we own
several patents and possess certain license rights in connection with other
technologies, which we are not currently pursuing. We intend to enforce our
patent position and intellectual property rights vigorously. The cost of
enforcing our patent rights in lawsuits, if necessary, may be significant and
could interfere with our operations.

RISK FACTORS

INVESTING IN OUR COMMON STOCK IS RISKY. IN ADDITION TO THE OTHER INFORMATION IN
THIS ANNUAL REPORT ON FORM 10-K, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED
CAREFULLY IN EVALUATING US AND OUR BUSINESS. IF ANY OF THE FOLLOWING RISKS WERE
TO OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS WOULD
LIKELY SUFFER. IN THAT EVENT, THE TRADING PRICE OF OUR COMMON STOCK COULD
DECLINE.

RISKS RELATED TO OUR BUSINESS
-----------------------------

WE HAVE A HISTORY OF OPERATING LOSSES AND RELY ON EXTERNAL FINANCING TO MAINTAIN
OUR OPERATIONS. IF WE ARE UNABLE TO OBTAIN SUCH EXTERNAL FINANCING, OUR BUSINESS
WOULD BE NEGATIVELY AFFECTED.

Since 1981, we have been engaged primarily in research and development and
have derived limited revenues from feasibility studies, the commercial sale of

our products and the licensing of certain technology. We have not generated any
revenues from the sale of any products currently under development. We have
incurred net losses every year since we began doing business and we anticipate
that losses will continue for the foreseeable future. As of December 31, 2003,
we had an accumulated deficit of approximately $68,550,000. For the fiscal year
ended December 31, 2003, we had a net loss of $5,661,694. For the fiscal year
ended December 31, 2002, we had a net loss of $7,514,514, and for the fiscal
year ended December 31, 2001, we had a net loss of $12,333,243. Our ability to
continue operations after our current capital resources are exhausted depends on
our ability to secure additional financing and to become profitable, which we
cannot guarantee. However, we believe that our financial resources are
sufficient to meet planned operating activities for at least the next 12 months.

We have been pursuing the commercialization of our SEPA(R) technology
through discussions with potential licensees, but there can be no guarantee that
we will enter into any licenses or that we will receive any license fees. Until
marketing approvals are obtained and/or license agreements are entered into, if
ever, we expect to generate only limited licensing revenue and no royalties from
sales of products using SEPA(R). In addition, we intend to continue to make the
substantial expenditures required to support our research and development
programs, including preclinical studies and clinical trials. As a result, we
expect to incur operating losses for the foreseeable future.

OUR PRODUCTS ARE IN AN EARLY STAGE OF DEVELOPMENT AND ARE SUBJECT TO THE RISK OF
FAILURE INHERENT IN THE DEVELOPMENT OF INNOVATIVE TECHNOLOGIES. EVEN IF THE
PRODUCTS ARE PROVEN EFFECTIVE, THEY MAY BE UNECONOMICAL TO MARKET.

Various pharmaceutical companies have developed systems to enhance the
transdermal delivery of specific drugs, but relatively limited research has been
conducted about using transdermal delivery systems for a wider range of
pharmaceutical products. Although we have demonstrated in preclinical and
clinical studies that SEPA(R) transdermal compounds may have applicability when
paired with a broad range of drugs, transdermal delivery systems are currently
marketed for only a limited number of products. In addition, some transdermal
delivery systems used to date have demonstrated adverse side effects for users,
including skin irritation and delivery difficulties.

Most of our proposed products are in the early development stage and will
require significant further research, development, testing and regulatory
clearances. Our proposed products are subject to the risks of failure inherent
in the development of products based on innovative technologies. These risks
include the possibilities that any or all of the proposed products may be found
to be ineffective or toxic, or otherwise may fail to receive necessary
regulatory clearances. In addition, even if our proposed products are effective,
they may be uneconomical to market or third parties may market superior or
equivalent products. Due to the extended testing and regulatory review process
required before we obtain marketing clearance for any of our proposed products,
we do not expect to realize royalty revenues from the sale of any drugs in the
foreseeable future.

OUR PRODUCTS ARE SUBJECT TO SIGNIFICANT FDA SUPERVISION AND MAY NOT SUCCESSFULLY
COMPLETE THE EXTENSIVE REGULATORY APPROVAL PROCESS REQUIRED PRIOR TO THE
MARKETING OF ANY PHARMACEUTICAL PRODUCT.

Our activities are regulated by a number of government authorities in the
United States and other countries, including the FDA. The FDA regulates
pharmaceutical products, including their manufacture and labeling. Before
obtaining regulatory approval for the commercial sale of any of the
pharmaceutical products we have under development, we must demonstrate that the
product is safe and efficacious for use in each proposed indication through,
among other things, preclinical studies and clinical trials. Data obtained from
testing is subject to varying interpretations which can delay, limit or prevent
FDA approval. In addition, the results of preclinical studies and early clinical
trials may not accurately predict results that will be obtained in large-scale
testing. A number of other companies in the pharmaceutical industry have
suffered significant setbacks in advanced clinical trials, even after they
achieved promising results in earlier trials. Because of the uncertainties
inherent in the clinical testing process, we cannot guarantee that clinical
trials will prove that our products are safe and efficacious or that any of our
products will ultimately be marketable.

On October 11, 2002, the FDA advised us that further clinical trials of our
drugs containing our absorption enhancer SEPA(R) had been placed on clinical
hold pending review of questions surrounding a 26-week transgenic-mouse (Tg.AC)
carcinogenicity study of SEPA(R) we performed in 1999. On April 10, 2003, the
FDA lifted this clinical hold. In releasing the hold, the FDA requested
additional information on that 1999 study, which we have provided. The clinical
hold release does not impose any SEPA(R) dosage or regimen constraints on
subsequent trials.

To date, neither the FDA nor any of its international equivalents has
approved any of our technologies or products for marketing. If we are unable to
demonstrate the safety and efficacy of our products, we may be adversely
affected. Additional risks associated with the regulatory approval process
include:

o Changes in existing regulatory requirements could prevent or affect our
regulatory compliance. Federal and state laws, regulations and policies
may be changed with possible retroactive effect, and how these rules
actually operate can depend heavily on administrative policies and
interpretations over which we have no control or inadequate experience
to assess their full impact upon our business.

o Obtaining FDA clearances is time-consuming and expensive and we cannot
guarantee that such clearances will be granted or, if granted, will not
be withdrawn.

o The FDA review process may prevent the marketing of our products or may
involve delays that significantly and negatively affect our products. We
may encounter similar delays in foreign countries.

o Regulatory clearances may place significant limitations on the uses for
which any approved products may be marketed.

o Any marketed product and its manufacturer are subject to periodic
review. Any discovery of previously unrecognized problems with a product
or manufacturer could result in suspension or limitation of approvals.

IF WE ARE UNABLE TO ESTABLISH, MAINTAIN AND RELY ON ANY SUCCESSFUL LICENSING OR
OTHER COLLABORATIVE ARRANGEMENTS WITH THIRD PARTIES, WE MAY NOT BE ABLE TO
SUCCESSFULLY DEVELOP AND MARKET OUR PRODUCTS.

To the extent we rely on licensees and joint venture arrangements to fund
most of the costs relating to product development and clinical trials, licensees
and joint venturers may have the legal right to terminate funding for a product
at any time for any reason without significant penalty. We cannot control the
resources and attention that a licensee or a joint venturer may devote to a
product and this can result in delays in clinical testing, regulatory filings
and commercialization efforts. There is no certainty that we will be able to
enter into collaborative arrangements on economically feasible or mutually
beneficial terms, or that any collaborative arrangements will be successful.

OUR PRIOR DEVELOPMENT EFFORTS HAVE NOT GENERATED SUSTAINED REVENUES OR ANY
PROFITS AND, UNLESS OUR PRODUCTS OBTAIN REGULATORY APPROVAL AND MARKET
ACCEPTANCE, WE MAY NEVER BE PROFITABLE.

Since 1981, we have engaged in research and development activities with
respect to a variety of technologies and products, including polymers for
medical and industrial use, dental adhesives, osteoporotic drugs and transdermal
drug delivery products. None of our products or technologies has ever generated
sustained revenues and we have never been profitable. We have expended
substantial resources in researching and developing technology relating to our
products as well as in connection with the research and development of
transdermal delivery systems. Unless our products obtain regulatory approval and
market acceptance, we may never be profitable.

WE WILL NEED TO MAKE SIGNIFICANT PRODUCT DEVELOPMENT EFFORTS AND RECEIVE
ADDITIONAL FINANCING TO MARKET OR LICENSE ANY PRODUCTS.

Before we or any of our potential licensees may market any products based
upon our technology, significant additional development efforts and substantial
testing will be necessary. In most cases, we will require substantial additional
financing to fund clinical studies on our proposed products. We may not,
however, be able to secure such financing on favorable terms or at all.

IF WE ARE NOT ABLE TO RETAIN OUR KEY PERSONNEL AND/OR RECRUIT ADDITIONAL KEY
PERSONNEL IN THE FUTURE, THEN OUR BUSINESS MAY SUFFER.

The success of our business depends on our ability to attract, retain and
motivate qualified senior management personnel and qualified scientific
personnel. We consider Robert J. DeLuccia, our President and Chief Executive
Officer, and Thomas C. K. Chan, Ph.D., our Chief Technology Officer, to be key
employees, and we have employment agreements with each of them. We do not
maintain key person life insurance on any of our employees. The competition for
such experienced personnel is intense and can be expected to increase. Like
others in our industry, we may face and in the past have faced from time to time
difficulties in attracting and retaining certain employees with the requisite
experience and qualifications. If we fail to retain or attract such personnel,
it could have a significant negative effect on our ability to develop our
technologies.

WE DEPEND ON PATENTS TO PROTECT OUR TECHNOLOGIES AND IF WE ARE UNABLE TO SECURE
ADEQUATE PATENT PROTECTION, OUR ABILITY TO COMPETE WITH OTHER PHARMACEUTICAL
COMPANIES MAY BE NEGATIVELY AFFECTED.

Although we intend to file additional patent applications, the patent
application process is lengthy and expensive, and there is no guarantee that a
patent will be issued or, if issued, that it will be of commercial benefit to
us. In addition, it is impossible to anticipate the breadth or degree of
protection that any such patents may afford. To the extent that we rely on
unpatented proprietary technology, we cannot guarantee that others will not
independently develop or obtain substantially equivalent or superior technology
or otherwise gain access to our trade secrets, that any obligation of
confidentiality will be honored, or that we will be able to effectively protect
our rights to proprietary technology. Further, products we develop could
infringe patents held by third parties. In such cases, licenses from the third
parties may not be available on commercially acceptable terms, if at all. We do
not maintain separate insurance to cover intellectual property infringement.

We are not currently involved in any litigation, settlement negotiations,
or other legal action regarding patent issues and are not aware of any patent
litigation threatened against us. We intend to enforce our patent position and
intellectual property rights vigorously. The cost of enforcing our patent rights
in lawsuits, if necessary, may be significant and could interfere with our
operations.

WE LACK MARKETING RESOURCES AND AS A RESULT ARE DEPENDENT ON THIRD PARTIES TO
MARKET AND DISTRIBUTE OUR PRODUCTS.

We intend to market and distribute our proposed products through other
companies. We cannot guarantee that we will be able to enter into agreements
with other companies on acceptable terms, if at all. We may have to cede control
over some or all aspects of the marketing and sales of our products as a
condition to entering into such arrangements. We currently have no sales force
or marketing organization. If we decide to directly market and sell any of our
products, we will, among other things, have to develop such capabilities,
including the ability to attract and retain qualified and experienced marketing
and sales personnel. Competition for qualified and experienced marketing and
sales personnel is strong, and thus we cannot guarantee that we will be able to
attract and retain such personnel or that any efforts undertaken by such
personnel will be successful.

WE DO NOT HAVE ANY MANUFACTURING FACILITIES AND ARE HEAVILY DEPENDENT ON THIRD
PARTIES TO MANUFACTURE OUR PRODUCTS.

We do not have facilities capable of manufacturing any of our proposed
products in commercial quantities and we do not have plans to obtain such
facilities. Accordingly, we will depend to a significant extent on licensees or
corporate partners for such manufacturing and for compliance with regulatory
requirements for good manufacturing practices. The failure by any third-party

manufacturer to perform its obligations in a timely fashion and in accordance
with the applicable regulations may delay clinical trials, the commercialization
of products, and the ability to supply product for sale. If we decide to
establish a commercial manufacturing facility, we would need to hire and retain
significant additional personnel, comply with extensive government regulations,
and obtain significant amounts of additional capital, which may not be available
on acceptable terms, or at all.

WE FACE THE RISK OF PRODUCT LIABILITY CLAIMS AND WE MAY NOT HAVE SUFFICIENT
PRODUCT LIABILITY INSURANCE TO COVER SUCH CLAIMS. IT MAY BE EXPENSIVE AND
DIFFICULT TO OBTAIN ADEQUATE INSURANCE COVERAGE.

The design, development, manufacture and sale of our products involve risk
of liability claims and associated adverse publicity. We currently have products
liability insurance coverage with an aggregate policy limit of approximately
$10,000,000 for claims related to our products that may arise from previously
conducted clinical trials and an aggregate policy limit of approximately
$7,650,000 for claims related to our products that may arise from ongoing
clinical trials. In the event that our products receive regulatory approval and
become commercialized, we would need to acquire additional coverage. Such
insurance is expensive, may be difficult to obtain and may not be available on
acceptable terms, if at all. If we obtain such coverage, we have no guarantee
that the coverage limits of such insurance policies will be adequate. A
successful claim against us if we are uninsured, or which is in excess of our
insurance coverage, could have a material adverse effect upon us and our
financial condition.

WE RELY ON A THIRD PARTY SUPPLIER FOR A NON-ACTIVE INGREDIENT IN SOME OF OUR
PRODUCTS AND, IN THE EVENT THE SUPPLIER IS UNABLE TO SUPPLY US WITH ADEQUATE
PRODUCT, OUR BUSINESS MAY BE NEGATIVELY AFFECTED IF WE ARE NOT ABLE TO TIMELY
OBTAIN A SUBSTITUTE PRODUCT.

We depend on a third party supplier, Seppic Inc., for a non-active
ingredient that is important to the formulation and production of some of our
topical products. While we believe similar products are available from other
suppliers, if Seppic Inc. were unable or unwilling to supply its product in
sufficient quantities at a reasonable price, our results could suffer, as we may
encounter costs and delays in identifying and measuring the efficacy of
replacement third party products.

RISKS RELATED TO OUR INDUSTRY
-----------------------------

OUR INDUSTRY IS HIGHLY COMPETITIVE AND MANY OF OUR COMPETITORS HAVE
SIGNIFICANTLY MORE RESOURCES THAN WE HAVE.

smaller number of very large entities, further concentrating financial,
technical and market strength and increasing competitive pressure in the
industry. Academic institutions, hospitals, governmental agencies and other
public and private research organizations are also conducting research and
seeking patent protection and may develop competing products or technologies of
their own through joint ventures or other arrangements. In addition, recently
developed technologies, or technologies that may be developed in the future, may
or could be the basis for competitive products which may be more effective or
less costly to use than any products that we are currently developing.

We expect any products approved for sale to compete primarily on the basis
of product efficacy, safety, patient compliance, reliability, price and patent
position. Generally, the first pharmaceutical product to reach the market in a
therapeutic or preventive area often has a significant advantage compared with
later entrants to the market. Our competitive position will also depend on our
ability to attract and retain qualified scientific and other personnel, develop
effective proprietary products, implement production and marketing plans, obtain
patent protection and secure adequate capital resources.

GOVERNMENT OR PRIVATE INITIATIVES TO REDUCE HEALTH CARE COSTS COULD HAVE A
MATERIAL ADVERSE EFFECT ON PHARMACEUTICAL PRICING AND ON OUR OPERATIONS.

The future revenues and profitability of, and availability of capital for,
biomedical and pharmaceutical companies such as us may be affected by the
continuing efforts of governmental and third-party payers to contain or reduce
the costs of health care through various means. For example, in certain foreign
markets pricing or profitability of prescription pharmaceuticals is subject to
government control and to reform in the health care system. In the United
States, there have been, and we expect there will continue to be, a number of
federal and state proposals to impose similar government control. While we
cannot predict whether any such legislative or regulatory proposals will be
adopted, the announcement or adoption of such proposals could have a material
adverse effect on our prospects. If we or one of our partners succeeds in
bringing to market one or more of our products, there can be no assurance that
these products will be cost effective and that reimbursement to the consumer
will be available or will be sufficient to allow us or our partners to sell such
products on a profitable basis.

RISKS RELATED TO THE SECURITIES MARKET
--------------------------------------

OUR STOCK PRICE HAS BEEN, AND WILL LIKELY CONTINUE TO BE, HIGHLY VOLATILE, WHICH
MAY NEGATIVELY AFFECT OUR ABILITY TO OBTAIN ADDITIONAL FINANCING IN THE FUTURE.

The market price of our stock has been and is likely to continue to be
highly volatile due to the risks and uncertainties described in this section of
the Annual Report on Form 10-K, as well as other factors, including:

o the results of our clinical trials for our SEPA(R)-enhanced
pharmaceuticals;

o our ability to license or develop other compounds for clinical
development;

o conditions and publicity regarding the pharmaceutical industry generally
as well as the specific therapeutic areas our product candidates seek to
address;

o price and volume fluctuations in the stock market at large which do not
relate to our operating performance; and

o comments by securities analysts, or our failure to meet market
expectations.

Over the two-year period ending December 31, 2003, the closing price of our
common stock as reported on The Nasdaq National Market and The Nasdaq SmallCap
Market ranged from a high of $4.32 to a low of $0.26. As a result of this
volatility, an investment in our stock is subject to substantial risk.
Furthermore, the volatility of our stock price could negatively impact our
ability to raise capital in the future.

Finally, the stock market has from time to time experienced extreme price
and volume fluctuations that are unrelated to the operating performance of
particular companies. In the past, companies that have experienced volatility
have sometimes been the subject of securities class action litigation. If
litigation were instituted on this basis, it could result in substantial costs
and a diversion of management's attention and resources.

ON NOVEMBER 24, 2003, THE LISTING OF OUR COMMON STOCK WAS TRANSFERRED FROM THE
NASDAQ NATIONAL MARKET TO THE NASDAQ SMALLCAP MARKET, WHICH MAY AFFECT OUR
ABILITY TO RAISE ADDITIONAL FUNDS IN THE FUTURE.

On March 31, 2003, we received a notification from Nasdaq indicating that,
as of December 31, 2002, our stockholders' equity did not comply with the
minimum $10,000,000 stockholders' equity requirement for continued inclusion on
The Nasdaq National Market. Following subsequent communications with the Nasdaq
Listing Qualifications Panel, we received a conditional extension of our
inclusion on The Nasdaq National Market. On November 19, 2003, however, we
received notification from the Nasdaq Listing Qualifications Panel that, as a
result of our continued non-compliance with the stockholders' equity requirement
for The Nasdaq National Market, the listing of our common stock would be
transferred to The Nasdaq SmallCap Market, which has a minimum stockholders'
equity requirement of $2,500,000, effective as of November 24, 2003. The
November 24, 2003 transfer of the listing of our common stock to The Nasdaq
SmallCap Market could affect our ability to raise additional funds in the
future.

WE ARE CONTRACTUALLY OBLIGATED TO ISSUE SHARES IN THE FUTURE, DILUTING A
SHAREHOLDER'S INTEREST IN US.

As of December 31, 2003, there are outstanding and exercisable warrants to
purchase approximately 1,796,276 shares of our common stock, at a weighted
average exercise price of $3.03 per share. As of December 31, 2003, there are
also outstanding and exercisable options to purchase approximately 4,154,295
shares of our common stock, at a weighted average exercise price of $3.73 per
share. Moreover, we expect to issue additional options to purchase shares of our
common stock to compensate employees, consultants and directors and may issue
additional shares to raise capital, acquire other companies or technologies, to
pay for services, or for other corporate purposes. Any such issuances will have
the effect of further diluting the interest of our existing shareholders.

ITEM 2. PROPERTIES.

We occupy 17,277 square feet of office and laboratory space under a lease
expiring February 28, 2005. This space is located on one floor of a three story
building in Lexington, Massachusetts. We believe that this facility is adequate
to meet our current requirements and we are evaluating our future facility
requirements as we approach the expiry of our current lease.

ITEM 3. LEGAL PROCEEDINGS.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There were no matters submitted to a vote of stockholders during the three
months ended December 31, 2003, through the solicitation of proxies or
otherwise.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.

MARKET PRICE OF SECURITIES AND RELATED MATTERS

Our Common Stock is traded on the Nasdaq SmallCap Market under the symbol
"MCHM." Prior to November 24, 2003, our common stock was traded on the Nasdaq
National Market under the symbol "MCHM." The following chart shows the high and
low closing prices for the Common Stock for the periods indicated as obtained
from Nasdaq:

COMMON STOCK
MCHM
YEAR ENDED HIGH LOW
DECEMBER 31, 2003
First Quarter $0.70 $0.46
Second Quarter 1.38 0.45
Third Quarter 1.17 0.84
Fourth Quarter 1.18 0.75

DECEMBER 31, 2002
First Quarter $4.32 $3.02
Second Quarter 3.15 1.60
Third Quarter 1.70 0.91
Fourth Quarter 0.94 0.26

These prices are between dealers and do not reflect retail markups,
markdowns or commissions and may not necessarily represent actual transactions.
As of March 10, 2004, there were 14,011 holders of record of our Common Stock.

We have never paid cash dividends on our Common Stock and our Board of
Directors does not contemplate declaring any dividends in the foreseeable
future. We intend to retain any earnings to finance research, development, and
expansion of our business.

Information concerning securities authorized for issuance under equity
compensation plans appears in Part III, Item 12, "Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters."

ITEM 6. SELECTED FINANCIAL DATA.

------------------------------------------------------------------------------------
Years Ended December 31,
------------------------------------------------------------------------------------
2003 2002 2001 2000 1999

STATEMENTS OF OPERATIONS DATA:

Sale of Patent $ 1,000,000 $ --- $ --- $ --- $ ---
Research Contracts 10,031 42,925 829,385 629,647 464,332
Total Revenues $ 1,010,031 $ 42,925 $ 829,385 $ 629,647 $ 464,332
Research and development
expenses 2,938,026 3,998,388 9,791,438 5,280,641 5,423,138
Net loss (5,661,694) (7,514,514) (12,333,243) (9,745,357) (6,787,069)
Basic and diluted net
loss per share $ (0.19) $ (0.27) $ (0.46) $ (0.43) $ (0.30)
Shares used to compute
basic and diluted net
loss per share 29,594,120 27,928,562 26,607,363 22,854,646 22,311,890

BALANCE SHEET DATA:

Working capital $ 6,345,396 $ 8,704,944 $ 15,739,712 $ 15,969,137 $ 14,776,372
Current assets 7,325,361 9,119,723 17,099,675 17,063,070 15,437,685
Total assets 8,249,648 10,132,007 18,257,543 17,981,957 16,313,732
Current liabilities 979,965 414,779 1,359,963 1,093,933 661,313
Total liabilities 1,013,328 462,488 1,408,838 1,131,197 1,161,313
Stockholders' equity $ 7,236,320 $ 9,669,519 $ 16,848,705 $ 16,850,760 $ 15,152,419

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

The following discussion of the financial condition and results of
operations for the Company should be read in conjunction with the accompanying
financial statements and related footnotes.

GENERAL

MacroChem's primary business is the development of specialty pharmaceutical
products for commercialization by employing SEPA(R) (Soft Enhancement of
Percutaneous Absorption), its patented drug delivery technology. SEPA(R)
compounds, when properly combined with drugs, provide pharmaceutical
formulations (creams, gels, lacquers, solutions, etc.) that enhance the
transdermal delivery of drugs into the skin or into the bloodstream. The Company
is currently developing investigational new drugs for the treatment of erectile
dysfunction (Topiglan(R)), testosterone deficiency (Opterone(TM)) and fungal
infections of the toenails (EcoNail(TM)). Our technologies are currently in
developmental stages and must undergo a rigorous regulatory approval process,
which includes extensive preclinical and clinical testing, to demonstrate safety
and efficacy before any resulting product can be marketed. To date, neither the
FDA nor any of its international equivalents has approved any of our
technologies for marketing. The Company currently derives no significant revenue

from product sales, royalties or license fees. The Company is developing
specific SEPA(R) formulations for use with proprietary and non-proprietary drugs
manufactured by other pharmaceutical companies, and seeks to commercialize these
products through the formation of partnerships, strategic alliances and
licensing arrangements with those companies. If the Company is unable to form
any strategic alliances, partnerships or licensing arrangements, its business
may be materially adversely affected. In addition, if strategic relationships
are formed, the Company may not be able to control the resources and attention
that its partners devote to the products.

The Company's results of operations can vary significantly from year to
year and quarter to quarter, and depend, among other factors, on the signing of
new licenses and product development agreements, the timing of revenues
recognized pursuant to license agreements, the achievement of milestones by
licensees, the progress of clinical trials conducted by licensees and the
Company, and the degree of our research, marketing and administrative efforts.
The timing of the Company's revenues may not match the timing of the Company's
associated product development expenses. To date, research and development
expenses have generally exceeded revenues in any particular period and/or fiscal
year.

A significant portion of our research and development expenses (including
employee payroll and related benefits, laboratory supplies, travel, dues and
subscriptions, clinical trial costs, temporary help costs, consulting costs and
allocable costs such as occupancy and depreciation) are not tracked by project
as they benefit multiple projects or our drug delivery technologies in general.
For the fiscal year ended December 31, 2003, approximately $1,354,000 was not
specifically tracked and approximately $1,584,000 represents costs associated
with clinical trials for our erectile dysfunction product. For the fiscal year
ended December 31, 2002, approximately $3,902,000 was not specifically tracked
and approximately $96,000 represents costs associated with clinical trials for
our erectile dysfunction product. Each of our research and development programs
are subject to risks and uncertainties, including the requirement to seek
regulatory approval, that are outside of our control. Moreover, the product
candidates identified in these research and development programs, which are
currently in developmental stages, must overcome significant technological,
manufacturing and marketing challenges before they can be successfully
commercialized. As a result of these risks and uncertainties, we are unable to
predict with any certainty the period in which material net cash inflows from
such projects could be expected to commence or the completion date of these
programs.

These risks and uncertainties also prevent us from estimating with any
certainty the specific timing and future costs of our clinical development
programs, although historical trends at similarly situated companies indicate
that expenses tend to increase in later stages of clinical development. Our
failure to obtain requisite governmental approvals timely or at all will delay
or preclude us from licensing or marketing our products or limit the commercial
use of our products, which could adversely affect our business, financial
condition and results of operations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Note 1 of the consolidated financial statements, included elsewhere in this
Form 10-K, includes a summary of the significant accounting policies and methods

used in the preparation of our consolidated financial statements. The following
is a brief discussion of the more significant accounting policies and methods
used by us.

The Company's discussion and analysis of its financial condition and
results of operations are based upon its financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
the Company to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses.

The Company believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
financial statements. As more fully described in the notes to the financial
statements included elsewhere in this Annual Report on Form 10-K, the Company's
business seeks to generate revenues through the development, commercialization
and licensing of drug products based upon the Company's intellectual property.

Research and development funding is generally recognized as revenue at the
time the research and development activities are performed under the terms of
the related agreements, when the counter-party is obligated to pay, and when no
future performance obligation exists. The Company makes estimates of the status
of performance with respect to research and development contracts. In the past,
the Company has found such estimates to be sufficiently accurate for revenue
recognition purposes. Research and development revenue is billed on a cost
reimbursement basis, which includes direct costs incurred in connection with
research activities and an allocation of certain other costs incurred by the
Company.

Costs and expenses incurred in connection with pending patent applications
are deferred. Costs related to successful patent applications are amortized over
the estimated useful lives of the patents using the straight-line method.
Accumulated patent costs and deferred patent application costs related to
patents that are considered to have limited future value are charged to
operations. Estimates used to determine the future value of deferred patent
costs include analysis of potential market size, time and cost to complete
clinical trials, anticipated interest in our products and potential value for
licensing or partnering opportunities. Revenues derived or expected to be
derived from the sale, assignment, transfer, or licensing of patents or other
intellectual property are recognized over various periods based upon the terms
of the relevant agreement.

RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31, 2002

For 2003 and 2002, the Company recognized revenues of approximately
$1,010,000 and $43,000, respectively. The increase in revenues in 2003 is the
result of the Company having obtained a payment of $1,000,000 in connection with
the sale of U.S. Patent No. 6,495,124 B1 covering antifungal nail lacquers
containing a pentadecalactone drug-absorption excipient. This patent represented
a non-strategic asset not related to the Company's core SEPA(R) technology.
Accordingly, we believe the sale of the patent will not materially adversely
affect the Company's future operations, cash flows and financial position.

Research and development costs decreased by approximately $1,060,000 from
approximately $3,998,000 in 2002 to approximately $2,938,000 in 2003, a 27%
decrease. The decrease in research and development costs for 2003 is primarily
attributable to a reduction in staff and the number of clinical trials being
conducted by the Company following the FDA's imposition of a clinical hold on
trials of our drugs containing SEPA(R) in October 2002. On April 10, 2003, the
FDA lifted this clinical hold and the Company resumed clinical trials. Of total
research and development expenses, approximately $494,000 in 2003 and $185,500
in 2002 were paid to independent third party contractors. The Company expects
that research and development expenses will increase by approximately 40% to 65%
for 2004 as compared to 2003, depending in part on the availability of resources
and the progress of clinical trial enrollments.

Marketing, general and administrative expenses for 2003 aggregated
approximately $3,798,000, an increase of approximately $95,000 or 3%, from
2002's total of approximately $3,703,000. Marketing, general and administrative
expenses in 2003 reflect a $160,000 increase in our Directors and Officers
liability insurance premium, which increase was offset in part by savings
attributable to a reduction in administrative staff in November 2002. The
Company expects that marketing, general and administrative expenses will
increase by approximately 7% to 15% for 2004 as compared to 2003.

Total other income decreased by approximately $123,100 or 64%, from
$193,500 in 2002 to $70,400 in 2003. The decrease is attributable primarily to
lower interest income as a result of lower interest rates and a decrease in our
average invested balance.

For the year ended December 31, 2003, our net loss was approximately
$5,661,700 as compared to a loss of approximately $7,514,500 for the previous
year, a 25% decrease due to the above mentioned factors.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001

For 2002 and 2001, the Company recognized revenues of approximately $43,000
and $829,400, respectively. The decrease in revenues is attributed to the
completion of a large research contract in 2001 and a smaller research contract
being completed in 2002.

Research and development costs decreased by approximately $5,793,000 from
approximately $9,791,000 in 2001 to approximately $3,998,000 in 2002, a 59%
decrease. This change for the period was primarily attributable to a reduction
in the number and size of clinical trials conducted in 2002, partially resulting
from the clinical hold imposed by the FDA and referenced elsewhere in this
Annual Report on Form 10-K and in certain of the Company's previous SEC filings.
Of total research and development expenses, approximately $185,500 in 2002 and
$363,500 in 2001 were paid to independent third party contractors.

Marketing, general and administrative expenses for 2002 aggregated
approximately $3,703,000, a decrease of approximately $297,000 or 7%, from
2001's total of approximately $4,000,000. This decrease was primarily the result
of a $193,000 reduction in consulting fees and a $104,000 reduction in costs for
preparation of investor relations materials and securities filings offset by an
increase in insurance of $115,200, an increase in rent of $22,100 and an
increase in other related expenses in 2002.

Total other income decreased by approximately $497,500 or 72%, from
$691,000 in 2001 to $193,500 in 2002. The decrease was attributable primarily to
lower interest income as a result of lower interest rates and a decrease in our
average invested balance.

For the year ended December 31, 2002, our net loss was approximately
$7,514,500 as compared to a loss of approximately $12,333,000 for the previous
year, a 39% decrease due to the above mentioned factors.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the primary source of funding for the Company's operations
has been the private and public sale of its securities, and, to a lesser extent,
the licensing of its proprietary technology and products, research
collaborations, feasibility studies, government grants and the limited sales of
products and test materials. During 2003, the Company received net proceeds of
$99,000 from the exercise of stock options and warrants, and net proceeds of
$2,972,000 as result of the sale of common stock in a private placement
financing transaction. During 2002, there were no exercises of stock options and
warrants and no sale of common stock.

At December 31, 2003, working capital was approximately $6.3 million,
compared to $8.7 million at December 31, 2002. The decrease in the Company's
working capital reflects the use of funds in operations, net of private
placement proceeds, and lower cash balances, cash equivalents and short-term
investments. Until such time as the Company obtains agreements with third-party
licensees or partners to provide funding for the Company's anticipated business
activities, or otherwise generates revenue from the commercialization of its
products, the Company's working capital will be utilized to fund its operating
activities.

Pursuant to a plan approved by the Company's Board of Directors in 1998,
the Company is authorized to repurchase 1,000,000 shares of its common stock to
be held as treasury shares for future use. During 2003, the Company did not
repurchase any shares of Common Stock. At December 31, 2003, 116,302 repurchased
shares remain available for future use and 679,587 shares remain available for
repurchase under the plan.

Capital expenditures and additional patent development costs for the year
ended December 31, 2003 were approximately $98,000. The Company anticipates that
it will not make any significant capital expenditures during the fiscal year
ending December 31, 2004.

On July 10, 2003, the Board of Directors approved retention payments for
certain key employees, including certain executive officers, in order to enhance
retention of those employees. Payments of approximately $80,000 were paid on
January 8, 2004 and payments of up to $155,000 in the aggregate will be paid on
July 1, 2004.

On March 31, 2003, the Company received a notification from Nasdaq
indicating that, as of December 31, 2002, its stockholders' equity did not
comply with the minimum $10,000,000 stockholders' equity requirement for
continued inclusion on The Nasdaq National Market. Following subsequent
communications with the Nasdaq Listing Qualifications Panel, the Company
received a conditional extension of its inclusion on The Nasdaq National Market.
On November 19, 2003, however, the Company received notification from the Nasdaq

Listing Qualifications Panel that, as a result of its continued
non-compliance with the stockholders' equity requirement for The Nasdaq National
Market, the listing of its common stock would be transferred to The Nasdaq
SmallCap Market, which has a minimum stockholders' equity requirement of
$2,500,000, effective as of November 24, 2003. The November 24, 2003 transfer of
the listing of the Company's common stock to The Nasdaq SmallCap Market could
affect its ability to raise additional funds in the future.

As described in the Notes to Financial Statements contained elsewhere in
this Annual Report on Form 10-K (see Note 8, Subsequent Event), on March 9,
2004, the Company sold 5,402,000 shares of its common stock for $7,292,700 in
gross proceeds ($6,782,211 net of issuance costs and before legal and accounting
fees) in a private placement to institutional investors. The investors also
received warrants to purchase an aggregate of 1,080,400 shares of common stock
at a purchase price of $2.09 per share expiring five years from the closing
date. As a result, the Company believes that its existing cash and cash
equivalents will be sufficient to meet its operating expenses and capital
expenditure requirements for at least the next twelve months. The Company's cash
requirements may vary materially from those now planned because of changes in
focus and direction of the Company's research and development programs,
competitive and technical advances, patent developments or other developments.
The Company will require additional financing to continue its long term plans
for clinical trials and new product development. It is not believed that
inflation will have any significant effect on the results of the Company's
operations.

Currently, the Company does not enter into financial instrument
transactions for trading or speculative purposes. The Company does not intend to
establish any special purpose entity and does not have any material off balance
sheet financing transactions.

The following summarizes MacroChem's contractual obligations at December
31, 2003, and the effect that such obligations are expected to have on future
cash flows and liquidity:

Due In
--------------------------------------------------------
Obligations: 1 Year or 5 Years or
Total Amount Less 1-3 Years 3-5 Years More

Lease Commitment (through February 2005) $ 543,700 $ 465,300 $ 78,400 $ 0 $ 0

Employment Agreements (per year) 1,008,600 1,008,600 0 0 0
------------ ------------ ------------ ------------ ------------

Total Contractual Cash Obligations $ 1,552,300 $ 1,473,900 $ 78,400 $ 0 $ 0
============ ============ ============ ============ ============

Excluded from the above contractual obligation summary are clinical trial
contracts which may approximate $1,200,000 in 2004. These contracts range in
duration from six (6) weeks to five (5) months and may be terminated by the
Company at its discretion.

RECENT ACCOUNTING PRONOUNCEMENTS

The FASB issued FASB Interpretation No. 46 (FIN 46) and No. 46, revised
(FIN 46R), Consolidation of Variable Interest Entities in January 2003 and

December 2003, respectively. These statements, which address accounting for
entities commonly known as special-purpose or off-balance-sheet entities,
require consolidation of certain interests or arrangements by virtue of holding
a controlling financial interest in such entities. Certain provisions of FIN 46R
related to interests in special purpose entities were applicable for the period
ended December 31, 2003. The Company must apply FIN 46R to its interests in all
entities subject to the interpretation as of the first interim or annual period
ending after March 15, 2004. The Company has considered the application of FIN
46 and FIN46R to its business relationships and concluded that the adoption of
this new method of accounting for variable interest entities did not and is not
expected to have a material impact on the Company's consolidated results of
operations or financial position.

SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

FIRST SECOND THIRD FOURTH
-------------------------------------------------------------------------

2003 Quarters
Revenues $ 0 $ 1,010,000 $ 0 $ 0
Net Loss $ (1,169,000) $ (547,000) $ (1,609,000) $ (2,337,000)
Net Loss per share $ (0.04) $ (0.02) $ (0.05) $ (0.08)
(basic and diluted)

2002 Quarters
Revenues $ 43,000 $ 0 $ 0 $ 0
Net Loss $ (2,204,000) $ (2,148,000) $ (1,528,000) $ (1,633,000)
Net Loss per share $ (0.08) $ (0.08) $ (0.05) $ (0.06)
(basic and diluted)

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

As of December 31, 2003, the Company is exposed to market risks, which
relate primarily to changes in U.S. interest rates. The Company's cash
equivalents and short-term investments are subject to interest rate risk and
will decline in value if interest rates increase. Due to the short duration of
these financial instruments, generally one year or less, changes to interest
rates would not have a material effect upon the Company's financial position. A
hypothetical 10% change in interest rates would not have a material effect on
our Statement of Operations or Cash Flows for the twelve months ending December
31, 2004 based on December 31, 2003 balances.

THE FOREGOING STATEMENTS IN THIS REPORT INCLUDE FORWARD-LOOKING STATEMENTS
THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE THOSE DISCUSSED OR REFERRED
TO IN ITEM 1, BUSINESS - "RISK FACTORS".

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required under this Item 8 is set forth on pages 26 through
43 of this report.

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Stockholders of MacroChem Corporation:

We have audited the accompanying balance sheets of MacroChem Corporation as of
December 31, 2003 and 2002, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material
respects, the financial position of MacroChem Corporation at December 31, 2003
and 2002, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Boston, Massachusetts

March 26, 2004

MACROCHEM CORPORATION
BALANCE SHEETS

December 31, December 31,
2003 2002
--------------- ---------------
ASSETS

Current assets:
Cash and cash equivalents $ 3,839,772 $ 771,046
Short-term investments 3,169,523 8,118,355
Receivable due from related party - 25,057
Prepaid expenses and other current assets 316,066 205,265
-------------- --------------
Total current assets 7,325,361 9,119,723

Property and equipment, net 227,659 376,109

Other assets:
Patents, net 667,435 606,982
Deposits 29,193 29,193
-------------- --------------
Total other assets 696,628 636,175
-------------- --------------

Total assets $ 8,249,648 $ 10,132,007
============== ==============

LIABILITIES

Current liabilities:
Accounts payable $ 358,097 $ 18,619
Accrued expenses and other liabilities 621,868 396,160
-------------- --------------

Total current liabilities 979,965 414,779

Deferred rent 33,363 47,709
-------------- --------------

Total liabilities 1,013,328 462,488

Commitments and contingencies (Note 5)

STOCKHOLDERS' EQUITY

Preferred stock, authorized and unissued, 6,000,000 shares --- ---
Common stock, $.01 par value, 60,000,000 shares
authorized; 32,944,334 and 28,163,054 shares issued
at December 31, 2003 and 2002, respectively 329,443 281,630
Additional paid-in capital 75,778,945 72,949,352
Unearned compensation (2,451) (382)
Accumulated deficit (68,549,996) (62,888,302)
Less treasury stock, at cost, 116,302 and 185,264 shares at
December 31, 2003 and 2002, respectively (319,621) (672,779)
-------------- --------------
Total stockholders' equity 7,236,320 9,669,519
-------------- --------------

Total liabilities and stockholders' equity $ 8,249,648 $ 10,132,007
============== ==============

See notes to financial statements.

MACROCHEM CORPORATION
STATEMENTS OF OPERATIONS

Years Ended December 31,
----------------------------------------------------
2003 2002 2001
---- ---- ----

REVENUES

Sale of patent $ 1,000,000 $ --- $ ---
Research contracts 10,031 42,925 829,385
------------- -------------- --------------
TOTAL REVENUES 1,010,031 42,925 829,385
============= ============== ==============

OPERATING EXPENSES

Research and development 2,938,026 3,998,388 9,791,438
Marketing, general and administrative 3,798,092 3,702,593 4,000,330
Consulting fees with related parties 6,000 50,000 61,750
------------- -------------- --------------

TOTAL OPERATING EXPENSES 6,742,118 7,750,981 13,853,518
------------- -------------- --------------

LOSS FROM OPERATIONS (5,732,087) (7,708,056) (13,024,133)
------------- -------------- --------------

OTHER INCOME (EXPENSE)

Interest income 70,393 193,542 690,890
------------- -------------- --------------

TOTAL OTHER INCOME 70,393 193,542 690,890
-------------- -------------- --------------
NET LOSS $ (5,661,694) $ (7,514,514) $ (12,333,243)
============== ============== ==============

BASIC AND DILUTED NET LOSS
PER SHARE $ (0.19) $ (0.27) $ (0.46)
============== ============== ==============

SHARES USED TO COMPUTE BASIC
AND DILUTED NET LOSS PER
SHARE 29,594,120 27,928,562 26,607,363
============== ============== ==============

STOCK BASED COMPENSATION INCLUDED IN:

2003 2002 2001
---- ---- ----

Research and development $ 39,128 $ 23,429 $ 216,226
Marketing, general and administrative 69,468 224,436 265,257
-------------- -------------- --------------
$ 108,596 $ 247,865 $ 481,483
============== ============== ==============

See notes to financial statements.

MACROCHEM CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY

Total
Common Stock Shares Additional Unearned Cost of Stock-
--------------------- Common Paid-In Compen- Accumulated Treasury holders'
Issued Treasury Stock Capital sation Deficit Subtotal Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------

BALANCE, JANUARY 1, 2001 24,730,783 (276,174) $247,308 $60,787,144 $(24,719) $(43,040,545) $17,969,188 $(1,118,428)$16,850,760

Issuances of common
stock-net 1,566,047 - 15,660 9,390,631 - - 9,406,291 - 9,406,291
Exercise of common
stock options 922,580 - 9,226 1,970,590 - - 1,979,816 - 1,979,816
Purchase of treasury
stock 932,644 (2,330) 9,326 371,000 - - 380,326 (8,826) 371,500
Stock based compensation
(1) 6,000 - 60 527,860 (46,437) - 481,483 - 481,483
Stock issued to 401(k)
trust - 25,158 - (27,435) - - (27,435) 119,533 92,098
Net loss - - - - - (12,333,243) (12,333,243) - (12,333,243)
---------- -------- -------- ----------- -------- ------------ ----------- ----------- -----------

BALANCE, DECEMBER 31, 2001 28,158,054 (253,346) 281,580 73,019,790 (71,156) (55,373,788) 17,856,426 (1,007,721) 16,848,705

Stock based compensation
(1) 5,000 - 50 177,041 70,774 - 247,865 - 247,865
Stock issued to 401(k)
trust - 68,082 - (247,479) - - (247,479) 334,942 87,463
Net loss - - - - - (7,514,514) (7,514,514) - (7,514,514)
---------- -------- -------- ----------- -------- ------------ ----------- ----------- -----------

BALANCE, DECEMBER 31, 2002 28,163,054 (185,264) 281,630 72,949,352 (382) (62,888,302) 10,342,298 (672,779) 9,669,519

Stock based compensation
(1) - - - 110,665 (2,069) - 108,596 - 108,596
Exercise of common stock
options 227,600 - 2,276 97,299 - - 99,575 - 99,575
Stock issued to 401(k)
trust - 68,962 - (304,439) - - (304,439) 353,158 48,719
Issuance of common stock,
net 4,553,680 - 45,537 2,926,068 - - 2,971,605 - 2,971,605
Net loss - - - - - (5,661,694) (5,661,694) - (5,661,694)
---------- -------- -------- ----------- -------- ------------ ----------- ----------- -----------

BALANCE, DECEMBER 31, 2003 32,944,334 (116,302) $329,443 $75,778,945 $ (2,451) $(68,549,996) $ 7,555,941 $ (319,621)$ 7,236,320
========== ======== ======== =========== ======== ============ =========== =========== ===========

(1) See following page for details.
See notes to financial statements. (continued)

MACROCHEM CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY

(1) STOCK BASED COMPENSATION
ADDITIONAL
COMMON STOCK PAID-IN UNEARNED
SHARES AMOUNT CAPITAL COMPENSATION TOTAL
- ------------------------------------------------------------------------------------------------------------------------------
2001

Issuance of common stock options to non-employees --- $ --- $ 82,458 $ (68,299) $ 14,159
Amortization and other changes in unearned compensation --- --- 129,200 21,862 151,062
Stock based compensation to employees and directors 6,000 60 316,202 --- 316,262
-------- -------- --------- ------------ ---------
6,000 $ 60 $ 527,860 $ (46,437) $ 481,483
======== ======== ========= ============ =========

2002

Issuance of common stock options to non-employees --- $ --- $ --- $ --- $ ---
Amortization and other changes in unearned compensation --- --- (28,697) 70,774 42,077
Stock based compensation to employees and directors 5,000 50 205,738 --- 205,788
-------- -------- --------- ------------ ---------
5,000 $ 50 $ 177,041 $ 70,774 $ 247,865
======== ======== ========= ============ =========

2003

Issuance of common stock options to non-employees --- $ --- $ 35,108 $ (4,902) $ 30,206
Amortization and other changes in unearned compensation --- --- (11) 2,833 2,822
Stock based compensation to employees and directors --- --- 75,568 --- 75,568
-------- -------- --------- ------------ ---------
--- $ --- $ 110,665 $ (2,069) $ 108,596
======== ======== ========= ============ =========

See notes to financial statements. (concluded)

MACROCHEM CORPORATION
STATEMENTS OF CASH FLOWS

Years Ended December 31,
----------------------------------------------
2003 2002 2001
---- ---- ----

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,661,694) $ (7,514,514) $(12,333,243)
------------ ------------ ------------

Adjustments to reconcile net loss to net cash used
by operating activities:
Depreciation and amortization 185,847 216,921 181,696
Stock-based compensation 108,596 247,865 481,483
401(k) contributions in company common stock 48,719 87,463 92,098
Deferred rent (14,346) (1,166) 11,611
Change in assets and liabilities:
Accounts receivable --- 334,919 (344,331)
Receivable due from related party 25,057 (893) (1,600)
Prepaid expenses and other current assets (110,801) 5,321 70,799
Accounts payable and accrued expenses 565,186 (945,184) 266,030
------------ ------------ ------------

Net cash used by operating activities (4,853,436) (7,569,268) (11,575,457)
------------ ------------ ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of short-term investments 5,000,000 7,900,000 10,000,000
Purchases of short-term investments (51,178) (185,527) (9,654,068)
Expenditures for property and equipment (3,454) (31,991) (307,212)
Additions to patents (94,396) (39,346) (113,465)
------------ ------------ ------------

Net cash provided/(used) by investing activities 4,850,982 7,643,136 (74,745)
------------ ------------ ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from exercise of common stock options 99,575 --- 1,979,816
Net proceeds from issuance of common stock 2,971,605 --- 9,406,291
Proceeds from exercise of warrants --- --- 371,500
Net purchase of treasury stock --- --- ---
------------ ------------ ------------

Net cash provided by financing activities $ 3,071,180 $ --- $ 11,757,607
------------ ------------ ------------

See notes to financial statements. (Continued)

MACROCHEM CORPORATION
STATEMENTS OF CASH FLOWS (Continued)

Years Ended December 31,
------------------------------------------------
2003 2002 2001
---- ---- ----

NET CHANGE IN CASH
AND CASH EQUIVALENTS $3,068,726 $ 73,868 $ 107,405

CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 771,046 697,178 589,773
---------- ----------- ----------

CASH AND CASH EQUIVALENTS,
END OF YEAR $3,839,772 $ 771,046 $ 697,178
========== =========== ==========

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITY:

During 2003 and 2002, the Company received no shares of Company stock relating
to the exercise of warrants on a "cashless" basis.

During 2001, the Company received 2,330 shares of Company stock relating to the
exercise of 882,644 warrants on a "cashless" basis.

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

The Company did not pay any cash for interest expense or income taxes during the
years ended December 31, 2003, 2002 and 2001.

See notes to financial statements. (Concluded)

MACROCHEM CORPORATION
NOTES TO FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

MacroChem Corporation (the "Company") develops transdermal drug delivery
compounds and systems intended to promote the delivery of drugs from the surface
of the skin into the skin or the bloodstream.

The Company has been engaged primarily in research and development since its
inception in 1981 and has derived limited revenues from the commercial sale of
its products, licensing of certain technology and feasibility studies. The
Company has had no revenues relating to the sale of any products currently under
development. The Company has incurred net losses every year since its inception
and the Company anticipates that losses may continue for the foreseeable future.
At December 31, 2003, the Company's accumulated deficit was approximately $68.5
million. The Company's ability to continue operations after its current capital
resources are exhausted depends on its ability to obtain additional financing
and achieve profitable operations, as to which no assurances can be given.
However, the Company believes that its financial resources are sufficient to
meet planned operating activities for at least the next twelve months.

The Company organizes itself as one segment reporting to the chief executive
officer. Products and services consist primarily of research and development
activities in the pharmaceutical industry.

ACCOUNTING ESTIMATES - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. The primary estimates
underlying the Company's financial statements include the carrying value and
useful lives of the Company's patents and property and equipment, the valuation
allowance established for the Company's deferred tax assets, and the underlying
assumptions to apply the pricing model to value stock options under SFAS No.
123. Management bases its estimates on certain assumptions, which it believes
are reasonable in the circumstances, and while actual results could differ from
those estimates, management does not believe that any change in those
assumptions in the near term would have a significant effect on the financial
position or the results of operations.

FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of cash equivalents,
marketable securities, accounts receivable, accounts payable and accrued
expenses approximate their fair value because of their short-term nature.
Short-term investments are carried at aggregate fair value.

CONCENTRATION OF RISK - Cash and cash equivalents and short-term investments at
December 31, 2003 and 2002 are primarily comprised of government agency
securities and certificates of deposit. Revenues for the years ended December
31, 2003 were the result of the sale of a patent and from a research and
development contract and revenues for 2002 were derived from a research and
development contract.

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)

CASH AND CASH EQUIVALENTS - Cash equivalents consist of short-term, highly
liquid investments with a maturity of three months or less when purchased.

SHORT-TERM INVESTMENTS - The Company has classified its short-term investments
as "available-for-sale" and, accordingly, carries such securities at aggregate
fair value. Fair value has been determined based on quoted market prices. The
cost of such securities approximates fair market value. Short-term investments
are a liquid money market mutual fund with a carrying value of $3,169,523 and
$8,118,355 at December 31, 2003 and 2002, respectively.

PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. Depreciation
and amortization are provided on the straight-line method over the estimated
useful lives of the related assets, which range from five to ten years.

PATENTS - The Company has filed applications for United States and foreign
patents covering aspects of its technology. Costs and expenses incurred in
connection with pending patent applications are deferred. Costs related to
successful patent applications are amortized over the estimated useful lives of
the patents, not exceeding 20 years, using the straight-line method. Accumulated
patent costs and deferred patent application costs related to patents that are
considered to have limited future value are charged to expense. Accumulated
amortization aggregated approximately $237,500 and $203,600, respectively, at
December 31, 2003 and 2002. On an on-going basis, the Company evaluates the
recoverability of the net carrying value of various patents by reference to the
patent's expected use in drug and other research activities as measured by
outside interest in the Company's patented technologies and management's
determination of potential future uses of such technologies.

LONG-LIVED ASSETS - The Company reviews its long-lived assets for impairment
when events or changes in circumstances indicate that the carrying amount of a
long-lived asset may not be recoverable. Recoverability of such assets to be
held and used is measured by a comparison of the carrying amount of the asset to
future net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets.

REVENUE RECOGNITION - The Company's business seeks to generate revenues through
the development, commercialization and licensing of drug products based upon the
Company's intellectual property. Revenues derived or expected to be derived from
the sale, assignment, transfer or licensing of patents or other intellectual
property are recognized over various periods based upon the terms of the
relevant agreement. Research contract revenues consist of non-refundable
research and development funding under collaborative agreements with various
corporate and government organizations. Research and development funding is
generally recognized as revenue at the time the research and development
activities are performed under the terms of the related agreements, when the
corporate partner is obligated to pay and when no future performance obligations
exist. Payments received in advance of services provided result in the deferral
of revenue recognition to future periods.

In November 2002, the EITF issued EITF Issue No. 00-21, "Revenue Arrangements
with Multiple Deliverables" ("EITF 00-21"), which provides guidance on the

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)

timing and method of revenue recognition for sales arrangements that include the
delivery of more than one product or service. EITF 00-21 is effective
prospectively for arrangements entered into in fiscal periods beginning after
June 15, 2003. In December 2003, the Securities and Exchange Commission released
Staff Accounting Bulletin no. 104 ("SAB 104"), Revenue Recognition. SAB 104
clarifies existing guidance regarding revenues for contracts which contain
multiple deliverables to make it consistent with EITF No. 00-21. The adoption of
the provisions of EITF 00-21 and SAB 104 had no effect on the Company's results
of operations.

RESEARCH AND DEVELOPMENT - Research and development costs are charged to
operations as incurred. Such costs include proprietary research and development
activities and expenses associated with research and development contracts,
whether performed by the Company or contracted with independent third parties.

STOCK BASED COMPENSATION - The Company applies the intrinsic value method of
accounting for stock options and awards granted to employees. The Company
accounts for stock options and awards to non-employees using the fair value
method.

Under the intrinsic value method, compensation associated with stock awards to
employees is determined as the difference, if any, between the current fair
value of the underlying common stock on the date compensation is measured and
the price an employee must pay to exercise the award. The measurement date for
employee awards is generally the date of grant. Under the fair value method,
compensation associated with stock awards to non-employees is determined based
on the estimated fair value of the award itself, measured using either current
market data or an established option pricing model. The measurement date for
non-employee awards is generally the date performance of services is complete.

Stock or other equity-based compensation for non-employees must be accounted for
under the fair value based method as required by SFAS No. 123 and Emerging
Issues Task Force No. 96-18, "Accounting for Equity Instruments That Are Issued
to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services". Under this method, the equity-based instrument is valued at either
the fair value of the consideration received or of the equity instrument issued
on the date of grant. The resulting compensation cost is recognized and charged
to operations over the service period or the vesting period, whichever is
shorter.

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)

The Company intends to continue to use the intrinsic value method to account for
stock-based compensation to employees and directors. The following table
illustrates the effect on net loss and net loss per share if the Company had
applied the fair value method to stock-based employee and director compensation:

2003 2002 2001
---- ---- ----

Net loss as reported $(5,661,694) $ (7,514,514) $(12,333,243)

Add: Stock-based employee compensation
expense included in reported net loss 75,568 189,920 271,491

Deduct: Total stock employee
compensation measured using
the fair value method (1,449,341) (2,174,596) (3,508,675)
----------- ------------ ------------

Proforma net loss $(7,035,467) $ (9,499,190) $(15,570,427)
=========== ============ ============

Basic and diluted net loss per share - as
reported $ (0.19) $ (0.27) $ (0.46)
=========== =========== ============

Basic and diluted net loss per share -
proforma $ (0.24) $ (0.34) $ (0.59)
=========== =========== ============

The fair value of options on their grant date was measured using the
Black/Scholes option pricing model. Key assumptions used to apply this pricing
model are as follows:

2003 2002 2001
---- ---- ----

Risk-free interest rate 2.62%-3.47% 4.08%-4.53% 4.38%-5.27%
Expected life of option grants 6 years 6 years 6 years
Expected volatility of underlying stock 97% 154% 128%

Expected dividend payment rate, as a percentage of
the stock price on the date of grant --- --- ---

The weighted average fair values of options granted during 2003, 2002 and 2001
were $0.86, $1.20 and $3.42, respectively.

The option pricing model used was designed to value readily tradable stock
options with relatively short lives. The options granted to employees are not
tradable and have contractual lives of up to ten years.

INCOME TAXES - The Company recognizes deferred tax assets and liabilities for
the expected future tax consequences of events that have been included in the

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)

Company's financial statements or tax returns. Deferred tax assets and
liabilities are determined based upon the difference between the financial
reporting basis and the tax basis of existing assets and liabilities using
enacted tax rates expected to be in effect in the year(s) in which the
differences are expected to reverse. A valuation allowance is provided against
deferred tax assets if it is more likely than not that such assets will not be
realized.

NET INCOME (LOSS) PER SHARE - Basic earnings per share is computed using the
weighted average number of common shares outstanding during each year. Diluted
earnings per common share reflect the effect of the Company's outstanding
options and warrants, except where such items would be anti-dilutive. Due to the
net losses reported in 2003, 2002 and 2001, basic and diluted per share amounts
are the same. For the years ended December 31, 2003, 2002 and 2001 potential
common shares are not included in the per share calculations for diluted EPS,
because the effect of their inclusion would be anti-dilutive. Anti-dilutive
potential shares not included in per share calculations for 2003, 2002 and 2001
were approximately 5,451,000, 5,059,000 and 4,791,000 shares, respectively.

NEW ACCOUNTING PRONOUNCEMENTS - The FASB issued FASB Interpretation No. 46 (FIN
46) and No. 46, revised (FIN 46R), Consolidation of Variable Interest Entities
in January 2003 and December 2003, respectively. These statements, which address
accounting for entities commonly known as special-purpose or off-balance-sheet
entities, require consolidation of certain interests or arrangements by virtue
of holding a controlling financial interest in such entities. Certain provisions
of FIN 46R related to interests in special purpose entities were applicable for
the period ended December 31, 2003. The Company must apply FIN 46R to its
interests in all entities subject to the interpretation as of the first interim
or annual period ending after March 15, 2004. The Company has considered the
application of FIN 46 and FIN46R to its business relationships and concluded
that the adoption of this new method of accounting for variable interest
entities did not and is not expected to have a material impact on the Company's
consolidated results of operations or financial position.

RECLASSIFICATION - Certain previously disclosed and prior year amounts have been
reclassified to conform to the 2003 presentation.

2. PROPERTY AND EQUIPMENT

Property and equipment consists of the following as of December 31:

2003 2002
---- ----

Laboratory equipment $1,098,296 $1,105,260
Office equipment 444,365 440,903
Leasehold improvements 250,048 250,048
---------- ----------
Total 1,792,709 1,796,211

Less: accumulated depreciation (1,565,050) (1,420,102)
---------- ----------

Property and equipment, net $ 227,659 $ 376,109
========== ==========

3. ACCRUED EXPENSES

Accrued expenses consists of the following as of December 31:

2003 2002
---- ----

Accrued professional fees $ 59,000 $ 72,750
Accrued clinical trial costs 23,108 80,378
Accrued bonuses 421,188 0
Accrued severance 0 116,400
Accrued other 118,572 126,632
---------- ----------

$ 621,868 $ 396,160
========== ==========

4. STOCKHOLDERS' EQUITY

AUTHORIZED CAPITAL STOCK - Authorized capital stock consists of 60,000,000
shares of $.01 par value common stock of which 32,944,334 shares are issued
(32,828,032 are outstanding) and 5,950,571 are reserved for issuance upon
exercise of common stock options and warrants at December 31, 2003. Authorized
and unissued preferred stock totals 6,000,000 shares, of which 600,000 shares
have been designated Series B Preferred Stock. During 1998, the Company's Board
of Directors authorized the repurchase of up to 1,000,000 shares of common stock
at market price. The Company repurchased no shares in 2001, 2002 and 2003. At
December 31, 2003, 116,302 repurchased shares remain available for future use
and 679,587 shares are available to be repurchased.

WARRANTS - During 2003, the Company conducted a private placement in which
primarily institutional investors received warrants to purchase an aggregate of
910,736 shares of common stock at a purchase price of $1.173 per share for
period of three years. The placement agent in this transaction received a
warrant to purchase 150,000 shares of common stock at a purchase price of $1.173
for a period of three years. As of December 31, 2003, none of the $1.173
warrants had been exercised.

During 2001, institutional investors received warrants to purchase an aggregate
of 313,209 shares of common stock at a purchase price of $8.995 per share
expiring in five years in connection with a private placement. The warrants are
callable by the Company if the closing price of the stock is higher than $17.99
for 15 consecutive trading days at any time before expiration. As a result of
subsequent financing transactions, the exercise price of these warrants has been
adjusted to $6.94 in accordance with the terms of the warrants. As of December
31, 2003, none of these warrants had been exercised.

During 2000, as part of a financing, two institutional investors received
warrants to purchase an aggregate of 363,322 shares of common stock at a
purchase price of $5.90 per share expiring in five years. As a result of
subsequent financing transactions, the exercise price of these warrants has been
adjusted to $4.64 in accordance with the terms of the warrants. Through December
31, 2003, none of these warrants had been exercised. In addition, the investors
received a warrant to purchase additional shares at a purchase price of $.01 per
share exercisable only upon certain conditions relating to the trading price of
the common stock during the period following December 12, 2000. Through December

4. STOCKHOLDERS' EQUITY (CONTINUED)

31, 2003, 880,314 of the $0.01 warrants had been exercised. There are no further
exercises available under the $.01 warrants. The placement agent received a
warrant to purchase 108,999 shares of common stock at a purchase price of $7.43
per share expiring in five years. As a result of subsequent financing
transactions, the exercise price of these warrants has been adjusted to $5.74 in
accordance with the terms of the warrants. Through December 31, 2003, 50,000 of
these warrants had been exercised.

STOCK OPTION PLANS - The Company has four stock option plans, the 1984 Incentive
Stock Option Plan (ISO Plan), the 1984 Non-Qualified Stock Option Plan
(Non-Qualified Plan), the 1994 Equity Incentive Plan (1994 Plan) and the 2001
Incentive Plan (the 2001 Plan). Under the terms of the 1984 ISO and
Non-Qualified Plans, the Company may no longer award any options. All options
previously granted may be exercised at any time up to ten years from the date of
award.

Under the terms of the 1994 Plan, as of February 11, 2004, the Company may no
longer award any options. All options previously granted under the 1994 Plan may
be exercised at any time up to ten years from the date of award.

Under the terms of the 2001 Plan, the Company may grant options to purchase up
to a maximum of 1,200,000 shares of common stock to certain employees, directors
and consultants. The options may be awarded as incentive stock options
(employees only) and non-incentive stock options (certain employees, directors
and consultants).

The 2001 Plan, 1994 Plan and the ISO Plan state that the exercise price of
options shall not be less than fair market value at the date of grant.

The following table presents activity under all stock option plans:

Number Weighted Average
of Options Exercise Price
---------- ----------------

Outstanding January 1, 2001 4,258,625 $4.64
Granted 1,081,200 3.80
Exercised (922,580) 2.15
Canceled (362,100) 4.41
---------

Outstanding December 31, 2001 4,055,145 4.99
Granted 1,018,000 1.19
Exercised --- ---
Canceled (749,198) 6.72
---------

Outstanding December 31, 2002 4,323,947 3.82
Granted 446,600 1.12
Exercised (227,600) 0.44
Canceled (888,652) 2.20
---------

Outstanding December 31, 2003 3,654,295 $4.09
==========

Exercisable at December 31: 2003 2,983,014 $4.53
==========
2002 2,995,321 $4.55
==========
2001 3,051,877 $5.18
==========

4. STOCKHOLDERS' EQUITY (CONTINUED)

The following table sets forth information regarding options outstanding at
December 31, 2003:

Weighted Ave. Weighted Ave.
Range of Number of Number Exercise Price- Weighted Ave. Exercise Price-
Exercise Options Currently Options Remaining Currently
Prices Outstanding Exercisable Outstanding Life Exercisable
---------------------------------------------------------------------------------------------------

$0.63 - $1.11 388,500 365,000 $ 0.68 9.03 $ 0.66
1.15 - 1.82 542,100 53,509 1.35 9.21 1.82
2.215 - 3.02 770,820 766,154 2.83 2.72 2.83
3.155 - 4.875 464,025 417,361 4.22 4.25 4.34
5.00 - 5.875 687,650 647,650 5.64 4.20 5.65
5.938 - 6.875 546,200 478,340 6.35 6.80 6.39
7.00 - 12.688 255,000 255,000 9.72 4.55 9.72
--------- --------- ------- ---- -------
TOTAL 3,654,295 2,983,014 $ 4.09 5.56 $ 4.53
========= ========= ======= ==== =======

All options granted during the three year period ended December 31, 2003 were
granted at the market price of the stock.

At December 31, 2003, the Company has reserved 5,950,561 shares of common stock
for issuance under all stock option plans and for warrants outstanding.

UNEARNED COMPENSATION - The following table sets forth the changes to the
Company's reported unearned compensation for the years ended December 31, 2003,
2002 and 2001 for the non-employee options:

2003 2002 2001
---- ---- ----

Balance, January 1 $ 382 $ 71,156 $ 24,719
Options, warrants and common stock granted to
non-employees valued at fair market value 4,902 --- 68,299
Amortization of unearned compensation (2,822) (70,774) (21,862)
Other changes in unearned compensation (11) --- ---
-------- -------- --------
Balance, December 31 $ 2,451 $ 382 $ 71,156
======== ======== ========

STOCK AND STOCK OPTION ISSUANCES TO NON-EMPLOYEES - During 2003, 2002 and 2001,
the Company issued 47,500, 0 and 30,000 stock grants and options, respectively,
to non-employees and consultants and recorded unearned compensation of $4,902,
$0 and $68,299, respectively.

STOCK AND STOCK OPTION ISSUANCES OUTSIDE THE STOCK OPTION PLANS - During 2003,
an option to purchase 500,000 shares of common stock was granted to Robert J.
DeLuccia, the Company's new Chief Executive Officer, of which 150,000 shares
vest immediately, with the remainder vesting over two years, with an exercise
price of $1.06 per share.

STOCK SALES - In July 2001, the Company sold 1,566,047 shares of common stock to
institutional investors. Net proceeds were $9,406,000. In September 2003, the
Company sold 4,553,680 shares of common stock to primarily institutional
investors. Gross proceeds were $3,246,000 ($3,027,000 net of issuance costs and
before legal and accounting fees).

4. STOCKHOLDERS' EQUITY (CONTINUED)

SHAREHOLDER RIGHTS PLAN - The Company has adopted a shareholder rights plan. The
Company declared a dividend consisting of one Right for each share of common
stock outstanding on September 10, 1999. Stock issued after that date will be
issued with an attached Right.

Each Right entitles the holder, upon the occurrence of certain events, to
purchase 1/100th of a share of Series B Preferred Stock of the Company at an
initial exercise price of $50.00, subject to adjustments for stock dividends,
splits and similar events. The Rights are exercisable only if a person or group
acquires 20% or more of the Company's outstanding common stock, or announces an
intention to commence a tender or exchange offer, the consummation of which
would result in ownership by such person or group of 20% or more of the
Company's outstanding common stock.

The Board of Directors may, at its option after the occurrence of one of the
events described above, exchange all of the then outstanding and exercisable
Rights for shares of common stock at an exchange ratio of one share of common
stock per Right.

The Board of Directors may redeem the Rights at the redemption price of $0.01
per Right at any time prior to the expiration of the rights plan on August 13,
2009. Distribution of the Rights is not a taxable event to shareholders.

The Board of Directors has authorized 600,000 shares of Series B Preferred
Stock.

5. COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENTS - The Company leases office space under an agreement expiring
in 2005. The lease includes payment increases over the term of the agreement.
The total amount of the lease payments is being charged to expense using the
straight-line method over the term of the agreement. The Company has recorded
deferred rent to reflect the excess of rental expense over cash payments since
the inception of the agreement. Future minimum payments under the agreement are
as follows:
2004 $465,259
2005 78,409

Rent expense included in the statement of operations was approximately $451,800,
$438,600 and $425,800 for the years ended December 31, 2003, 2002 and 2001,
respectively.

EMPLOYMENT AND CONSULTING AGREEMENTS - The Company has employment and consulting
agreements with various consultants and certain key employees. The terms of each
key employee agreement provide that the employee is an employee at-will. The
terms of the consulting agreements do not exceed one year. These agreements
provide for annual payments of approximately $1,008,625.

6. INCOME TAXES

No income tax provision or benefit has been provided for federal or state income
tax purposes as the Company has incurred losses in all periods reported and
recoverability of these losses in future tax filings is uncertain. As of
December 31, 2003, the Company has available net operating loss carryforwards of
approximately $59,086,000 for federal income tax purposes, expiring through 2023
and $37,954,000 for state income tax purposes, expiring through 2008. In
addition, the Company has unused investment and research and development tax
credits for federal and state income tax purposes aggregating $1,563,000 and
$802,000, respectively. The use of the federal net operating loss may also be
restricted due to changes in ownership in accordance with definitions as stated
in the Internal Revenue Code.

The net tax effect of differences in the timing of certain revenue and expense
items and the related carrying amounts of assets and liabilities for financial
reporting and tax purposes are not material and, accordingly, are not displayed
in the table below. The components of the Company's deferred tax assets as of
December 31, 2003 and 2002 are as follows:

2003 2002
---- ----

Deferred Tax Assets:
Net operating loss carryforwards $ 22,469,000 $ 21,526,000
Tax credit carryforwards 2,365,000 2,314,000
------------ ------------
24,834,000 23,840,000
Valuation allowance (24,834,000) (23,840,000)
------------ ------------
Deferred tax asset, net $ --- $ ---
============ ============

For the years ended December 31, 2003 and 2002, the valuation allowance was
increased by approximately $994,000 and $2,680,000, respectively, due to the
uncertainty of future realization of currently generated net operating loss and
tax credit carryforwards.

7. EMPLOYEE BENEFIT PLAN

The Company sponsors a qualified 401(k) Retirement Plan (the "Plan") under which
employees are allowed to contribute certain percentages of their pay, up to the
maximum allowed under Section 401(k) of the Internal Revenue Code. Company
contributions to the Plan are at the discretion of the Board of Directors. The
Company contributed 68,962 shares of common stock in 2003, 68,082 shares of
common stock in 2002 and 25,158 shares of common stock in 2001, valued at
$48,719, $87,463 and $92,098, respectively.

8. SUBSEQUENT EVENT

On March 9, 2004, the Company sold 5,402,000 shares of its common stock for
$7,292,700 in gross proceeds ($6,782,211 net of issuance costs and before legal
and accounting fees) in a private placement to institutional investors. The
investors also received warrants to purchase an aggregate of 1,080,400 shares of
common stock at a purchase price of $2.09 per share expiring five years from the
closing date.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

ITEM 9A. CONTROL AND PROCEDURES.

As of the end of the period covered by this report, we carried out a
review, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures (as defined in the SEC
rules promulgated under the Securities Exchange Act of 1934, as amended), which
are designed to ensure that information required to be disclosed in our
Securities and Exchange Commission reports is properly and timely recorded,
processed, summarized and reported. Based upon that review, our Chief Executive
Officer and Chief Financial Officer concluded that these controls and procedures
are operating in an effective manner as of December 31, 2003.

There were no changes in our internal control over financial reporting that
occurred during the quarter ended December 31, 2003 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth the year each Director was first elected and
the age, positions, and offices presently held by each Director with the
Company:
Year
First Became
Name Age a Director Position with Company
- --------------------------------------------------------------------------------

John L. Zabriskie....64 2000 Chairman of the Board of Directors
Robert J. DeLuccia...58 2000 President, Chief Executive Officer and
Vice Chairman of the Board of Directors
Michael A. Davis....62 1997 Director
Paul S. Echenberg....60 2000 Director
Peter G. Martin.....55 1995 Director

The following is a brief summary of the background of each Director of the
Company:

JOHN L. ZABRISKIE, PH.D., has served as a Director of the Company since
2000 and was elected Chairman of the Board of Directors in 2001. Since 2001, he
has been a co-founder and Director of PureTech Ventures, LLC. From 1997 to 2000,
he was Chairman, President and Chief Executive Officer of NEN Life Science
Products, which was sold to Perkin Elmer. In 1994, Dr. Zabriskie became
Chairman, President and Chief Executive Officer of Upjohn; he was responsible
for Upjohn's merger with the Swedish pharmaceutical company Pharmacia, and
became Chief Executive Officer of the merged company. Before his appointment at

Upjohn, he spent nearly 30 years with Merck & Company, rising to Executive Vice
President and President of Merck Manufacturing Division. He is a member of the
Board of Directors of PureTech Ventures, LLC (since 2000) and the following
publicly traded companies: Array Biopharma (since 2001); Biosource International
(since 2002); Cubist Pharmaceuticals, Inc. (since 1998); and Kellogg Company
(since 1995). Dr. Zabriskie received a B.S. in chemistry from Dartmouth College
and a Ph.D. in organic chemistry from the University of Rochester.

ROBERT J. DELUCCIA has served as the Company's President and Chief
Executive Officer and Vice Chairman of the Board since June of 2003 and as a
Director since 2000. Mr. DeLuccia is the former President and Chief Executive
Officer of Immunomedics, Inc., a NASDAQ biopharmaceutical company focused on the
development and commercialization of antibody diagnostic imaging and therapeutic
products for cancer and infectious diseases. Prior to Immunomedics, he was
President of Sterling Winthrop Pharmaceuticals, the U.S. subsidiary of Sanofi
(now Sanofi-Sythelabo). Mr. DeLuccia began his career as a pharmaceutical sales
representative for Pfizer and progressed to Vice President Marketing and Sales
Operations for Pfizer's Roerig Division. He is also a member of the board of
directors of IBEX Technologies, a publicly traded (TSX) pharmaceutical company
specializing in the development of biological markers for diagnosis, monitoring
and treatment of certain diseases. Mr. DeLuccia holds both an M.B.A. and a B.S.
in marketing from Iona College.

MICHAEL A. DAVIS, M.D., SC.D., has served as a Director of the Company
since 1997 and provided medical and pharmaceutical consulting services to the
Company from 1991 to 2003. He currently is Medical Director of E-Z-EM, Inc., a
public company engaged in supplying oral radiographic contrast media, as well as
medical devices, where he also serves as a Director. From 1980 to 2002, Dr.
Davis was Professor of Radiology and Nuclear Medicine and Director of the
Division of Radiologic Research at the University of Massachusetts Medical
School. From 1982 to 1997, Dr. Davis was Adjunct Professor of Surgery at Tufts
University School of Veterinary Medicine. From 1986 to 2002, he was Affiliate
Professor of Biomedical Engineering at Worcester Polytechnic Institute. In
addition, from February to November 1999 he was President and Chief Executive
Officer of Amerimmune Pharmaceuticals, Inc., a public company, and its wholly
owned subsidiary, Amerimmune Inc., which is engaged in developing drugs relating
to the immune system. From February 1999 to March 2003, Dr. Davis served as a
Director of both Amerimmune Pharmaceuticals, Inc. and Amerimmune Inc. Dr. Davis
received a B.S. and M.S. from Worcester Polytechnic Institute, an S.M. and Sc.D.
from the Harvard School of Public Health, an M.B.A. from Northeastern University
and an M.D. from the University of Massachusetts Medical School.

PAUL S. ECHENBERG has served as a Director of the Company since 2000. Since
1997, he has been the President and Chief Executive Officer of Schroders &
Associates Canada, Inc. and a director of Schroder Ventures Limited. These firms
provide merchant banking advisory services to a number of Canadian buy-out
funds. He is a director of the following publicly traded companies: E-Z-EM,
Inc., a supplier of oral radiographic contrast media and medical devices and
Benvest Capital Inc., a merchant bank that he founded. From 1989 through 1997,
Mr. Echenberg was President of Eckvest Equity, Inc., a private merchant bank
providing consulting and personal investment services. From 1970 to 1989, he was
President and Chief Executive Officer of Twinpak, Inc., a manufacturer of
plastic packaging, and from 1982 to 1989 he was Executive Vice President of CB
Pak, Inc., a publicly traded plastic, glass and packaging company. Mr. Echenberg
received a B.Sc. from McGill University and an M.B.A. from Harvard Business
School.

PETER G. MARTIN has served as a Director of the Company since 1995. Since
1990, Mr. Martin has been an independent investment banker and venture
capitalist and currently an advisor to Enzo Biochem. Prior to 1990, he was a
commercial banker. Mr. Martin was initially elected to the Board of Directors as
the designee of David Russell, who privately purchased 1 million shares of the
Company's Common Stock in 1995. Mr. Russell is no longer entitled to designate a
Director of the Company. Mr. Martin received a B.A. and J.D. from Fordham
University and an M.B.A. from Columbia University.

EXECUTIVE OFFICERS

The executive officers of the Company, their ages and their positions with
the Company are as follows:

Name Age Position with Company
- --------------------------------------------------------------------------------

Robert J. DeLuccia..........58 President and Chief Executive Officer
Thomas C.K. Chan............48 Vice President of Research and Development,
Chief Technology Officer
Glenn E. Deegan ............37 Vice President and General Counsel
Bernard R. Patriacca........60 Vice President, Chief Financial Officer and
Treasurer
Melvin A. Snyder............61 Vice President, Market Development

The following is a brief summary of the backgrounds of Dr. Chan, Mr.
Deegan, Mr. Patriacca and Mr. Snyder. The background of the Company's other
executive officer, Mr. DeLuccia, is summarized above.

THOMAS C.K. CHAN, PH.D., has served as the Company's Vice President of
Research and Development and Chief Technology Officer since April 2003. From
September 2001 until April 2003, Dr. Chan served as the Company's Vice President
of Research and Technology. From December 2000 until September 2001, he served
as the Company's Senior Director of Preclinical Studies. From 1997 to 2000, he
served as Senior Director of Pharmacology and Toxicology at EPIX Medical, Inc.
From 1994 to 1997, he served as Director of Therapeutic Development at Creative
BioMolecules, Inc. and from 1992 to 1993, Dr. Chan served as their Manager of
Pharmacology and Toxicology. From 1990 to 1992, he served as Associate Director
at the Purdue Cancer Center. Dr. Chan earned a B.Sc. in
Biochemistry/Microbiology and a doctorate in Pharmacology from the University of
British Columbia. He then completed a fellowship in Hematology/Oncology at the
UCSD Cancer Center in San Diego.

GLENN E. DEEGAN, ESQ., has served as the Company's Vice President, General
Counsel and Secretary since July 2003. From June 2001 until July 2003, Mr.
Deegan served as the Company's Director of Legal Affairs and as General Counsel
and Secretary. Prior to joining MacroChem, he served as Assistant General
Counsel of Summit Technology, Inc. Earlier in his career, Mr. Deegan was engaged
in the private practice of law in Boston at Holland & Knight LLP and at Nutter,
McClennen & Fish, LLP. Mr. Deegan holds a bachelor of science degree from
Providence College and a juris doctor degree from Boston College.

BERNARD R. PATRIACCA, C.P.A., has served as the Company's Vice President,
Chief Financial Officer and Treasurer since April 2001. From 1997 to 2001, he
served as Vice President and Controller of Summit Technology, Inc. From 1994 to
1997, he served as Vice President of Errands Etc., Inc., a privately held
homeowners' personal service company. From 1991 to 1994, Mr. Patriacca held
senior financial management positions at several privately held consumer
services companies. From 1973 to 1991, he was employed in various capacities at
Dunkin Donuts, Inc., including Chief Financial Officer and Director. Mr.
Patriacca received a B.S. and an M.B.A. from Northeastern University.

MELVIN A. SNYDER, has served as the Company's Vice President for Market
Development since October 2000. From June 1999 until October 2000, he served as
a consultant to the Company in the area of business development. From 1998 until
1999, he was Vice President of Marketing and Business Development at
Immunomedics, and, between 1995 and 1998, he served as a consultant to several
pharmaceutical companies including Immunomedics. Between 1975 and 1995, he was
President of ProClinica Inc., a marketing communications and licensing-support
company. Mr. Snyder holds a bachelor's degree from Lehigh University.

Information concerning MacroChem's Audit Committee will appear in
MacroChem's Proxy Statement for the 2004 Annual Meeting of Stockholders, to be
filed pursuant to Regulation 14A on or before May 26, 2004, under the caption
"Corporate Governance at MacroChem -- Committees of the Board of Directors."
Such information is incorporated herein by reference.

MacroChem's Board of Directors has adopted a code of ethics and conduct
that applies to its principal executive officer, principal accounting officer or
controller, or persons performing similar functions. That Code of Ethics and
Conduct has been posted on MacroChem's Internet website at www.macrochem.com.
MacroChem would intend to satisfy the disclosure requirements under Item 10 of
Form 8-K regarding an amendment to, or waiver from, a provision of its Code of
Ethics and Conduct and that relates to a substantive amendment or material
departure from a provision of the Code by posting such information on its
internet website at www.macrochem.com.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who beneficially own more than 10 percent of
the Company's Common Stock to file reports of ownership and changes in ownership
with the Securities and Exchange Commission. Based solely on its review of the
copies of such reports received by it, and written representations from certain
reporting persons that no Forms 5 were required for those persons, the Company
believes that during 2003 all filing requirements applicable to its officers,
directors, and such 10 percent beneficial owners were complied with.

ITEM 11. EXECUTIVE COMPENSATION.

EXECUTIVE OFFICERS' COMPENSATION

The following table sets forth the compensation earned by or paid or
awarded to Dr. Chan, Mr. Deegan, Mr. Palmisano, Mr. Patriacca, and Mr. Snyder
during each of the three fiscal years ended December 31, 2003, and to Mr.
DeLuccia during the fiscal year ended December 31, 2003:

SUMMARY COMPENSATION TABLE

Long Term
Annual Compensation Compensation Awards
- ---------------------------------------------------------------------------------------------------------------------

Restricted Securities All
Other Annual Stock Underlying Other
Name and Principal Salary Bonus Compensation Awards Options Compensation
Position Year $ $ $(1) ($)(2) # $(3)
- ---------------------------------------------------------------------------------------------------------------------

Robert J. DeLuccia (4) 2003 195,000 54,720 6,516 54,720 500,000
President, Chief
Executive Officer

Robert J. Palmisano (5) 2003 167,491 ----- 3,758 ----- ----- 5,483
President, Chief 2002 375,950 ----- 13,032 290,000 5,500
Executive Officer 2001 265,561 122,822 8,952 1,000,000 -----

Bernard R. Patriacca (6) 2003 185,000 29,360 1,032 29,360 48,000 28,000
Vice President, Chief 2002 185,000 ----- 1,032 125,000 5,500
Financial Officer and 2001 113,808 ----- 452 178,200 -----
Treasurer

Thomas C.K. Chan (7) 2003 182,716 30,359 360 30,359 76,000 27,481
Vice President, Research 2002 177,725 ----- 360 120,000 5,332
& Development, Chief 2001 148,917 ----- 158 104,700 4,289
Technology Officer

Glenn E. Deegan (8) 2003 138,763 22,913 360 22,913 55,900 15,481
Vice President,
General Counsel and
Secretary

Melvin A. Snyder (9) 2003 194,250 24,010 1,584 24,010 50,000 27,160
Vice President, Market 2002 194,250 ----- 1,584 125,000 5,160
Development 2001 185,000 ----- 598 184,100 3,870

- ---------------------------------------------------------------------------------------------------------------------
<FN>
(1) Includes amounts paid for taxable group term life insurance. Also includes
for Mr. Palmisano and Mr. DeLuccia a monthly automobile allowance of
$1,000.
(2) Although the restricted stock reflected in this table was earned in 2003,
the awards were made in January 2004. The values in this table are as of
the date of the grant. There are no other restricted stock holdings other
than as reflected in this table.
(3) Represents the dollar value of Company contributions to the Company's
401(k) Retirement Plan, which are made in Company common stock, as well as,
for fiscal year 2003, the following retention payments payable as of
December 31, 2003: Mr. Patriacca - $22,000; Dr. Chan - $22,000; Mr. Deegan
- $10,000; and Mr. Snyder - $22,000.

(4) Mr. DeLuccia's employment commenced on July 1, 2003. Of total salary in
2003, $51,000 related to a consulting contract in connection with his role
as interim CEO. As part of Mr. DeLuccia's 2003 compensation, he received an
award of 60,800 shares of restricted stock on January 7, 2004, all of which
vest 6 months from the date of grant.
(5) Mr. Palmisano's employment commenced on April 9, 2001 and he resigned
effective April 11, 2003.
(6) Mr. Patriacca's employment commenced on April 23, 2001. As part of Mr.
Patriacca's 2003 compensation, he received an award of 32,622 shares of
restricted stock on January 7, 2004, all of which vest 6 months from the
date of grant.
(7) Dr. Chan was appointed Vice President, Research and Technology on September
24, 2001. As part of Dr. Chan's 2003 compensation, he received an award of
33,732 shares of restricted stock on January 7, 2004, all of which vest 6
months from the date of grant.
(8) Mr. Deegan was appointed Vice President, General Counsel and Secretary on
July 10, 2003. As part of Mr. Deegan's 2003 compensation, he received an
award of 25,458 shares of restricted stock on January 7, 2004, all of which
vest 6 months from the date of grant.
(9) As part of Mr. Snyder's 2003 compensation, he received an award of 26,677
shares of restricted stock on January 7, 2004, all of which vest 6 months
from the date of grant.
</FN>

STOCK OPTIONS

The following table provides information concerning the grant of stock
options during 2003 to Mr. DeLuccia, Mr. Patriacca, Mr. Snyder, Dr. Chan, and
Mr. Deegan:

OPTION GRANTS IN LAST FISCAL YEAR

Individual Grants
-----------------

Potential
Realizable
Value
at Assumed
Annual Rates
of Stock Price
Number of % of Total Appreciation for
Securities Options Exercise Option Term
Underlying Granted to or Base ------------------------
Options Employees in Price Expiration 5% 10%
Name Granted (#) Fiscal Year ($/Sh) Date ($) ($)
- -----------------------------------------------------------------------------------------------------------

Robert J. DeLuccia 500,000 (1) 52.8 1.06 6/20/13 333,314 844,684

Thomas C.K. Chan 76,000 (2) 8.0 1.15 7/10/13 54,965 139,293

Glenn E. Deegan 55,900 (3) 5.9 1.15 7/10/13 40,428 102,454

Bernard R. Patriacca 48,000 (4) 5.1 1.15 7/10/13 34,715 87,975

Melvin A. Snyder 50,000 (5) 5.3 1.15 7/10/13 36,161 91,640
- -----------------------------------------------------------------------------------------------------------
<FN>
(1) The options granted to Mr. DeLuccia were granted in June 2003 at an
exercise price of $1.06 per share. The options expire ten years from the
date of grant. One hundred fifty thousand (150,000) options vested
immediately and the remaining options vest over the next two years.
(2) The options granted to Dr. Chan were granted in July 2003 at an exercise
price of $1.15 per share. The options expire ten years from the date of
grant and vest over the next three years.
(3) The options granted to Mr. Deegan were granted in July 2003 at an exercise
price of $1.15 per share. The options expire ten years from the date of
grant and vest over the next three years.
(4) The options granted to Mr. Patriacca were granted in July 2003 at an
exercise price of $1.15 per share. The options expire ten years from the
date of grant and vest over the next three years.
(5) The options granted to Mr. Snyder were granted in July 2003 at an exercise
price of $1.15 per share. The options expire ten years from the date of
grant and vest over the next three years.
</FN>

The following table provides information concerning option exercises during
the fiscal year ended December 31, 2003 and unexercised options held by Mr.
DeLuccia, Mr. Palmisano, Mr. Patriacca, Mr. Snyder, Dr. Chan, and Mr. Deegan, as
of December 31, 2003:

AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
Number of
Securities Value of
Underlying Unexercised
Shares Unexercised In-The-Money
Acquired Value Options at Options at
On Exercise Realized Fiscal Year-End Fiscal Year-End
(#) ($) # $(1)
- --------------------------------------------------------------------------------
Exercisable/ Exercisable/
Name Unexercisable Unexercisable
- --------------------------------------------------------------------------------

Robert J. DeLuccia 0 0 216,668/363,332 NA/NA
Robert J. Palmisano(2) 0 0 0/0 NA/NA
Bernard R. Patriacca 0 0 227,135/124,065 $22,000/NA
Melvin Snyder 0 0 322,434/66,666 22,000/NA
Thomas C.K. Chan 0 0 269,135/31,565 22,000/NA
Glenn E. Deegan 0 0 80,000/95,000 5,500/NA
- --------------------------------------------------------------------------------
<FN>
(1) The value of Mr. DeLuccia's, Mr. Palmisano's, Mr. Patriacca's, Mr.
Snyder's, Dr. Chan's and Mr. Deegan's in-the-money unexercised options at
the end of fiscal year ended December 31, 2003 was determined by
multiplying the number of options held by the difference between the
market price of Common Stock underlying the options on December 31, 2003
($0.85 per share) and the exercise price of the options granted.
(2) All of Mr. Palmisano's outstanding options were cancelled as of October
10, 2003.
</FN>

DIRECTORS' COMPENSATION

Each non-employee Director of the Company receives compensation of $12,000
annually, $1,000 per regular meeting attended for the chairman of each
committee, $1,000 per regular meeting attended, $500 for each special, telephone
or committee meeting attended and reimbursement of travel expenses in connection
with attending meetings of the Board of Directors. During 2003, ten-year stock
options were granted to non-employee Directors as follows: Dr. Davis, Mr.
Martin, Mr. Echenberg and Dr. Zabriskie each received 30,000 options exercisable
at $1.15 per share, vesting over the next three years from grant date of July
10, 2003.

During 2003, the Company paid Dr. Davis $9,000 for medical and
pharmaceutical consulting services. Dr. Davis' consulting agreement with the
Company terminated effective as of March 31, 2003. The Company also paid Mr.
DeLuccia $51,000 for consulting services in connection with his role as interim
Chief Executive Officer. Mr. DeLuccia's consulting agreement terminated
effective as of July 1, 2003.

EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS

The Company had entered into an employment agreement of indefinite length
effective as of April 9, 2001 with Robert J. Palmisano, the Company's former
Chief Executive Officer. Mr. Palmisano resigned his employment with the Company
effective as of April 11, 2003. During 2003, Mr. Palmisano received salary
totaling $167,491 pursuant to the employment agreement.

The Company has entered into an employment agreement of indefinite length
effective as of June 19, 2003 with Robert J. DeLuccia. The agreement currently
provides for annual compensation of $288,000 and for the payment of twelve

months' salary in the event he is terminated without cause. The agreement also
provides for a monthly automobile allowance of $1,000. In addition, the
agreement precludes Mr. DeLuccia from competing with the Company during his
employment and for a period of two years thereafter, and from disclosing
confidential information.

The Company has entered into an employment agreement of indefinite length
effective as of September 24, 2001 with Thomas C.K. Chan. The agreement, as
modified by the Severance Agreement between Dr. Chan and the Company dated as of
October 25, 2002, currently provides for annual compensation of $185,000 and for
the payment of twelve months' salary in the event he is terminated without
cause. In addition, the agreement precludes Dr. Chan from competing with the
Company during his employment and for a period of two years thereafter, and from
disclosing confidential information.

The Company has entered into Confidentiality and Noncompetition Agreements
effective as of June 4, 2001 with Glenn E. Deegan. These Agreements preclude Mr.
Deegan from competing with the Company during his employment and for a period of
one year thereafter, and from disclosing confidential information. The Company
has also entered into a Severance Agreement with Mr. Deegan dated as of October
25, 2002, which provides for the payment of nine months' salary in the event he
is terminated without cause.

The Company has entered into an employment agreement of indefinite length
effective as of April 23, 2001 with Bernard Patriacca. The agreement, as
modified by the Severance Agreement between Mr. Patriacca and the Company dated
as of October 25, 2002, currently provides for annual compensation of $185,000
and for the payment of twelve months' salary in the event he is terminated
without cause. In addition, the agreement precludes Mr. Patriacca from competing
with the Company during his employment and for a period of two years thereafter,
and from disclosing confidential information.

The Company has entered into an employment agreement of indefinite length
effective as of October 1, 2000 with Mel Snyder. The agreement currently
provides for annual compensation of $194,250 and for the payment of six months'
salary in the event he is terminated without cause. In addition, the agreement
precludes Mr. Snyder from competing with the Company during his employment and
for a period of two years thereafter, and from disclosing confidential
information.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Company's Compensation Committee consists of Dr. Davis (Chairman) and
Dr. Zabriskie.

ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS.

The following table details the Registrant's equity compensation plans:

EQUITY COMPENSATION PLAN INFORMATION

(a) (b) (c)
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- --------------------------------------------------------------------------------------------------------------------

Equity compensation plans
approved by security
holders 5,450,561 $ 3.96 806,078

Equity compensation plans
not approved by
security holders 500,000 (1) $ 1.06 NONE
--------- -------- -------

Total 5,950,561 $ 3.72 806,078
========= ======== =======
- --------------------------------------------------------------------------------------------------------------------
<FN>
(1) Represents 500,000 stock options granted to Robert J. DeLuccia in June
2003.
</FN>

The following table sets forth, as of March 5, 2004, certain information
concerning ownership of the Company's common stock by (i) each person known by
the Company to be the beneficial owner of more than five percent (5%) of the
Company's common stock, (ii) each of the Company's Directors, (iii) each of the
executive officers named in the Summary Compensation Table under "Executive
Officers' Compensation" above and (iv) all Directors and executive officers as a
group. Except as otherwise indicated, the stockholders listed in the table have
sole voting and investment powers with respect to the shares indicated.

Name and Address Number of Shares
of Beneficial Owner (1) Beneficially Owned Percentage of Class
- --------------------------------------------------------------------------------

Peter G. Martin(2) .................. 118,938 *
Michael A. Davis(2).................. 113,668 *
Robert J. DeLuccia(2)................ 295,468 *
Paul S. Echenberg(2)................. 70,668 *
John L. Zabriskie(2)................. 179,912 *
Robert J. Palmisano(2)(3)............ 15,000 *
Bernard R. Patriacca(2)(3)........... 274,757 *
Melvin A. Snyder(2)(3)............... 300,097 *
Thomas C.K. Chan(2)(3)............... 226,867 *
Glenn E. Deegan (2)(3)............... 116,815 *
All Directors and Officers as a
Group (10 persons) (2)(3)......... 1,712,190 5.16%
- --------------------------------------------------------------------------------
* Less than one percent (1%).
<FN>
(1) The address of Mr. Martin, Dr. Davis, Mr. DeLuccia, Mr. Echenberg, Dr.
Zabriskie, Mr. Palmisano, Mr. Patriacca, Mr. Snyder, Dr. Chan and Mr.
Deegan is c/o the Company, 110 Hartwell Avenue, Lexington, Massachusetts
02421.

(2) Includes the following numbers of shares issuable upon the exercise of
stock options exercisable within 60 days: Mr. Martin-116,668; Dr.
Davis-107,668; Mr. DeLuccia-216,668; Mr. Echenberg-66,668; Dr.
Zabriskie-73,335; Mr. Patriacca-237,135; Mr. Snyder-273,420; Dr.
Chan-193,135; and Mr. Deegan-82,734.
(3) Does not include the following numbers of vested shares in the Company's
401(k) Plan contributed by the Company to match portions of cash
contributions by the following Plan participants: Mr. Palmisano-12,876; Mr.
Patriacca-13,308; Mr. Snyder- 12,995; Dr. Chan-13,661; and Mr.
Deegan-13,355.
</FN>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Not applicable.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

Information concerning principal accountant fees and services will appear in
MacroChem's Proxy Statement for the 2004 Annual Meeting of Stockholders, to be
filed pursuant to Regulation 14A on or before May 26, 2004, under the caption
"Relationship with Independent Auditors." Such information is incorporated
herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)(1) The following Financial Statements as of December 31, 2003 and 2002 and
for the three years in the period ended December 31, 2003 are filed
herewith:

Page
------
Independent Auditors' Report 27
Balance Sheets 28
Statements of Operations 29
Statements of Stockholders' Equity 30-31
Statements of Cash Flows 32-33
Notes to Financial Statements 34-43

(a)(2) The following Financial Statement Schedules are filed herewith:

None.

Schedules not included herein are omitted because they are not applicable
or the required information appears in the Financial Statements or Notes
thereto.

(a)(3) The following exhibits are filed herewith or are incorporated by
reference as may be indicated:

3.1 Certificate of Incorporation as amended, incorporated by reference to
Exhibit 3a to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997 (File No. 0-13634).

3.2 Amended and Restated By-Laws of the Company, incorporated by reference to
Exhibit 5 to the Company's Current Report on Form 8-K dated August 13,
1999 (File No. 0-13634).

4.1 Stock Purchase Warrant, incorporated by reference to Exhibit 4 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1996
(File No. 0-13634).

4.2 Rights Agreement dated as of August 13, 1999 between the Company and
American Stock Transfer & Trust Company, as Rights Agent, including Form
of Certificate of Designation with respect to the Series B Preferred
Stock, par value $.01 per share (attached as Exhibit A to the Rights
Agreement), Form of Rights Certificate (attached as Exhibit B to the
Rights Agreement), and Summary of Rights (attached as Exhibit C to the
Rights Agreement), incorporated by reference to Exhibits 1, 2, 3 and 4,
respectively, to the Company's Current Report on Form 8-K dated August
13, 1999 (File No. 0-13634).

4.3 Common Stock Certificate, incorporated by reference to Exhibit 4c to the
Company's Annual Report on Form 10-K for the year ended December 31, 1999
(File No. 0-13634).

10.1 MacroChem Corporation 2001 Incentive Plan incorporated by reference to
Exhibit 99 to the Company's Form S-8 as filed on August 8, 2001 (File No.
333-67080).

10.2 1994 Equity Incentive Plan as amended November 14, 1997, incorporated by
reference to Exhibit 99.1 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 0-13634). *

10.3 1984 Non-Qualified Stock Option Plan as amended November 15, 1996,
incorporated by reference to Exhibit 10.2 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1996 (File No. 0-13634). *

10.4 1984 Incentive Stock Option Plan as amended November 15, 1996,
incorporated by reference to Exhibit 10.3 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1996 (File No. 0-13634). *

10.5 Form of Employment Agreement between the Company and Mr. Mel Snyder,
incorporated by reference to Exhibit 10f to the Company's Annual Report
on Form 10-K for the year ended December 31, 2000 (File No. 0-13634). *

10.6 Form of Employment Agreement between the Company and Mr. Robert J.
Palmisano, incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 (File
No. 0-13634). *

10.7 MacroChem Corporation Option Certificate between the Company and Robert
J. Palmisano, incorporated by reference to Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 (File
No. 0-13634). *

10.8 Form of Employment Agreement between the Company and Mr. Bernard R.
Patriacca, incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 (File
No. 0-13634). *

10.9 Form of Employment Agreement between the Company and Dr. Thomas C.K.
Chan, incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the Quarter ended September 30, 2001
(File No. 0-13634).*

10.10 Form of Severance Agreement between the Company and Mr. Bernard R.
Patriacca, dated as of October 25, 2002 incorporated by reference to
Exhibit 10h to the Company's Annual Report on Form 10-K for the year
ended December 31, 2002 (File No. 0-13634).*

10.11 Form of Severance Agreement between the Company and Dr. Thomas C.K. Chan,
dated as of October 25, 2002 incorporated by reference to Exhibit 10i to
the Company's Annual Report on Form 10-K for the year ended December 31,
2002 (File No. 0-13634).*

10.12 Form of Noncompetition Agreement between the Company and Glenn E. Deegan,
Esq., dated as of June 5, 2001.*

10.13 Form of Confidentiality Agreement between the Company and Glenn E.
Deegan, Esq., dated as of June 5, 2001.*

10.14 Form of Severance Agreement between the Company and Glenn E. Deegan,
Esq., dated as of October 25, 2002.*

10.15 Form of Employment Agreement between the Company and Robert J. DeLuccia
incorporated by reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2003 (File No.
0-13634).*

10.16 MacroChem Corporation Option Certificate reflecting grant by the Company
to Robert J. DeLuccia incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the period ended September
30, 2003 (File No. 0-13634).*

10.17 Form of Retention Agreement between the Company and Bernard R. Patriacca
incorporated by reference to Exhibit 10.3 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2003 (File No.
0-13634).*

10.18 Form of Retention Agreement between the Company and Melvin A. Snyder
incorporated by reference to Exhibit 10.4 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2003 (File No.
0-13634).*

10.19 Form of Retention Agreement between the Company and Thomas C.K. Chan
incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2003 (File No.
0-13634).*

10.20 Form of Retention Agreement between the Company and Glenn E. Deegan
incorporated by reference to Exhibit 10.6 to the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 2003 (File No.
0-13634).*

10.21 Securities Purchase Agreement among the Company, Bay Harbor Investments,
Inc. and Strong River Investments, Inc., incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K dated October
23, 2000 (File No. 0-13634).

10.22 Form of Closing Warrant dated as of October 23, 2000, incorporated by
reference to Exhibit 10.2 to the Company's Current Report on Form 8-K
dated October 23, 2000 (File No. 0-13634).

10.23 Form of Adjustable Warrant dated as of October 23, 2000, incorporated by
reference to Exhibit 10.3 to the Company's Current Report on Form 8-K
dated October 23, 2000 (File No. 0-13634).

10.24 Form of Registration Rights Agreement by and among the Company, Bay
Harbor Investments, Inc. and Strong River Investments, Inc., incorporated
by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K
dated October 23, 2000 (File No. 0-13634).

10.25 Warrant issued to Leerink Swann & Company dated as of October 23, 2000,
incorporated by reference to Exhibit 10.5 to the Company's Current Report
on Form 8-K dated October 23, 2000 (File No. 0-13634).

10.26 Securities Purchase Agreement among MacroChem Corporation, Pine Ridge
Financial Ltd., DMG Legacy International, Ltd., SDS Merchant Fund, LP,
Par Investment Partners, L.P., Narragansett I, LP, and Narragansett
Offshore Ltd., incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated July 24, 2001 (File No. 0-13634).

10.27 Form of Warrant incorporated by reference to Exhibit 10.2 to the
Company's Current Report on Form 8-K dated July 24, 2001 (File No.
0-13634).

10.28 Form of Registration Rights Agreement by and among MacroChem Corporation,
Pine Ridge Financial Ltd., DMG Legacy International, Ltd., SDS Merchant
Fund, LP, Par Investment Partners, L.P., Narragansett I, LP, and
Narragansett Offshore Ltd., incorporated by reference to Exhibit 10.3 to
the Company's Current Report on Form 8-K dated July 24, 2001 (File No.
0-13634).

10.29 Securities Purchase Agreement, dated as of September 10, 2003, by and
among MacroChem Corporation and the purchasers listed on Schedule A
thereto, incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated September 12, 2003 (File No. 0-13634).

10.30 Form of Warrant dated as of September 10, 2003, incorporated by reference
to Exhibit 10.2 to the Company's Current Report on Form 8-K dated
September 12, 2003 (File No. 0-13634).

10.31 Registration Rights Agreement, dated as of September 10, 2003, by and
among MacroChem Corporation and the investors listed on the signature
page thereto, incorporated by reference to Exhibit 10.3 to the Company's
Current Report on Form 8-K dated September 12, 2003 (File No. 0-13634).

10.32 Securities Purchase Agreement, dated as of March 9, 2004, by and among
MacroChem Corporation and the purchasers listed on Schedule A thereto,
incorporated by reference to Exhibit 10.1 to the Company's Current Report
on Form 8-K dated March 10, 2004 (File No. 0-13634).

10.33 Form of Warrant dated as of March 9, 2004, incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form 8-K dated March 10,
2004 (File No. 0-13634).

10.34 Registration Rights Agreement, dated as of March 9, 2004, by and among
MacroChem Corporation and the investors listed on the signature page
thereto, incorporated by reference to Exhibit 10.3 to the Company's
Current Report on Form 8-K dated March 10, 2004 (File No. 0-13634).

10.35 Lease between GLB Lexington Limited Partnership and the Company dated as
of July 21, 1999, for space located at 110 Hartwell Avenue, Lexington, MA
02421, incorporated by reference to Exhibit 10.11 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (File No.
0-13634).

23.1 Consent of Deloitte & Touche LLP.

31.1 Certification of Principal Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.

31.2 Certification of Principal Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.

32.1 Certification of Principal Executive Officer Pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of Principal Financial Officer Pursuant to Section 1350,
Chapter 63 of Title 18, United States Code, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

(b) A report on Form 8-K was filed on October 14, 2003 and included an
unaudited balance sheet of the Company in response to a request from
Nasdaq regarding the Company's stockholders' equity.

- --------------------------
*Management contract or compensatory plan or arrangement

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

MACROCHEM CORPORATION

Dated: March 26, 2004 By: /s/ Robert J. DeLuccia
-------------- -------------------------------------
Robert J. DeLuccia
President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities indicated on March 26, 2004.

/s/ Robert J. DeLuccia President and
- --------------------------------- Chief Executive Officer
Robert J. DeLuccia

/s/ Bernard R. Patriacca Vice President and
- --------------------------------- Chief Financial Officer
Bernard R. Patriacca

/s/ John L. Zabriskie Chairman, Board of Directors
- ---------------------------------
John L. Zabriskie, Ph.D.

/s/ Peter G. Martin Director
- ---------------------------------
Peter G. Martin

/s/ Michael A. Davis Director
- ---------------------------------
Michael A. Davis, M.D.

/s/ Paul S. Echenberg Director
- ---------------------------------
Paul S. Echenberg