**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-QSB**

 
| **ý** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                 |
|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                   |
| ** ** | **For the quarterly period ended March 31,  2006**                                                                                                                                                                           |
|       |                                                                                                                                                                                                                         |
| ** ** | **OR**                                                                                                                                                                                                                       |
|       |                                                                                                                                                                                                                         |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                |
|       |                                                                                                                                                                                                                         |
| ** ** | **For the transition period from                   to               ** |
|       |                                                                                                                                                                                                                         |
| ** ** | **Commission file number: 000-50344**                                                                                                                                                                                        |

 

**LPATH, INC.**

(Name of small business issuer in its charter)

 

| **Nevada**                                                   | ** ** | **16-1630142**                       |
|--------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of                         |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)                               |       |                                 |
|                                                         |       |                                 |
| **6335 Ferris Square, Suite A, San Diego, CA 92121**         |
| (Address of principal executive offices, including zip code) |

 

**(858) 678-0800**

(Issuer’s telephone number)

 

Checkwhether the issuer (1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  ý No  o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes  o No  ý

 

Thenumber of shares of issuer’s outstanding common stock as of May 11, 2006 was24,611, 393.

 

Transitional Small Business Disclosure Format(check one):   Yes o    No ý

 

 

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** **

**LPATH, INC.**

**FORM 10-QSB**

 

**TABLE OF CONTENTS**

 
| **PART I**  | **FINANCIAL INFORMATION**                                                                                        |   |
|------------------|------------------------------------------------------------------------------------------------------------------|--------|
|             |                                                                                                             |   |
| ITEM  1:         | Financial  Statements:                                                                                           |   |
|             |                                                                                                             |   |
|             | Condensed  Consolidated Balance Sheets as of March 31, 2006 (unaudited) and  December 31, 2005              |   |
|             |                                                                                                             |   |
|             | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2006 and 2005 (unaudited) |   |
|             |                                                                                                             |   |
|             | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  2006 and 2005 (unaudited) |   |
|             |                                                                                                             |   |
|             | Notes  to Condensed Consolidated Financial Statements                                                            |   |
|             |                                                                                                             |   |
| ITEM 2:          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                      |   |
|             |                                                                                                             |   |
| ITEM 3:          | Controls and  Procedures                                                                                         |   |
|             |                                                                                                             |   |
| **PART II** | **OTHER INFORMATION**                                                                                            |   |
|             |                                                                                                             |   |
| ITEM 1:          | Legal Proceedings                                                                                                |   |
|             |                                                                                                             |   |
| ITEM 2:          | Unregistered  Sales of Equity Securities and Use of Proceeds                                                     |   |
|             |                                                                                                             |   |
| ITEM 3:          | Default  upon Senior Securities                                                                                  |   |
|             |                                                                                                             |   |
| ITEM 4:          | Submission  of Matters to a Vote of Security Holders                                                             |   |
|             |                                                                                                             |   |
| ITEM 5:          | Other Information                                                                                                |   |
|             |                                                                                                             |   |
| ITEM 6:          | Exhibits                                                                                                         |   |
|             |                                                                                                             |   |
| **SIGNATURES**   |                                                                                                             |   |

 

2

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**PART I. FINANCIALINFORMATION**

 

**Item 1.****    Financial Statements**

 

**LPATH, INC.**

**CondensedConsolidated Balance Sheets**

 
| ** **                                                                                                                                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                            | ** ** | **(Unaudited)**    | ** ** | **Note**              | ** ** |
| **ASSETS**                                                                                                                                                                            | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current Assets:                                                                                                                                                                       |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                             |       | $                  | 5,204,607  |                  | $          | 5,190,273 |   |
| Grant revenue receivable                                                                                                                                                              |       | 77,460             |       | 186,728               |       |
| Prepaid expenses and other current assets                                                                                                                                             |       | 223,361            |       | 127,076               |       |
| Total current assets                                                                                                                                                                  |       | 5,505,428          |       | 5,504,077             |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Equipment, net                                                                                                                                                                        |       | 146,863            |       | 118,385               |       |
| Patents, net                                                                                                                                                                          |       | 244,540            |       | 220,953               |       |
| Deposits and other assets                                                                                                                                                             |       | 94,085             |       | 101,486               |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Total assets                                                                                                                                                                          |       | $                  | 5,990,916  |                  | $          | 5,944,901 |   |
|                                                                                                                                                                                  |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                         | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current Liabilities:                                                                                                                                                                  |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                      |       | $                  | 374,430    |                  | $          | 347,597 |   |
| Accrued expenses                                                                                                                                                                      |       | 294,627            |       | 247,037               |       |
| Total current liabilities                                                                                                                                                             |       | 669,057            |       | 594,634               |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Stockholders’ Equity:                                                                                                                                                            |       |               |       |                  |       |
| Common stock - $.001 par value; 60,000,000  shares authorized; 24,611,393 shares and 23,524,921 shares issued and  outstanding at March 31, 2006 and December 31, 2005, respectively. |       | 24,611             |       | 23,524                |       |
| Additional paid-in capital                                                                                                                                                            |       | 14,089,845         |       | 12,798,057            |       |
| Accumulated deficit                                                                                                                                                                   |       | (8,792,597         | )          | (7,471,314            | )          |
| Total stockholders’ equity                                                                                                                                                       |       | 5,321,859          |       | 5,350,267             |       |
| Total liabilities and stockholders’ equity                                                                                                                                       |       | $                  | 5,990,916  |                  | $          | 5,944,901 |   |

 

Note: The balance sheet atDecember 31, 2005 has been derived from the audited consolidated financialstatements at that date.

 

See accompanying notes tocondensed consolidated financial statements

 

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**LPATH, INC.**

###### **Condensed Consolidated Statementsof Operations**

**(Unaudited)**

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                    | ** ** | **March 31,**               | ** ** |
| ** **                                                                    | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                                          |       |                             |       |   |   |
| Grant revenue                                                                 |       | $                                | 129,475    |   | $ | 137,959 |   |
|                                                                          |       |                             |       |   |   |
| Expenses:                                                                     |       |                             |       |   |   |
| Research and development expenses                                             |       | 953,458                          |       | 162,801 |   |
| General and administrative expenses                                           |       | 550,541                          |       | 76,384 |   |
|                                                                          |       |                             |       |   |   |
| Total expenses                                                                |       | 1,503,999                        |       | 239,185 |   |
|                                                                          |       |                             |       |   |   |
| Loss from operations                                                          |       | (1,374,524                       | )          | (101,226 | ) |
|                                                                          |       |                             |       |   |   |
| Other income (expense):                                                       |       |                             |       |   |   |
| Interest income                                                               |       | 53,241                           |       | 375 |   |
| Interest expense                                                              |       | —                           |       | (27,174 | ) |
| Total other income (expense)                                                  |       | 53,241                           |       | (26,799 | ) |
|                                                                          |       |                             |       |   |   |
| Net loss                                                                      |       | (1,321,283                       | )          | (128,025 | ) |
|                                                                          |       |                             |       |   |   |
| Redeemable preferred stock accretion                                          |       | —                           |       | (3,250 | ) |
|                                                                          |       |                             |       |   |   |
| Net loss attributable to common  shareholders                                 |       | $                                | (1,321,283 | ) | $ | (131,275 | ) |
|                                                                          |       |                             |       |   |   |
| Basic and diluted net loss per share                                          |       | $                                | (0.06      | ) | $ | (0.07 | ) |
|                                                                          |       |                             |       |   |   |
| Weighted average number of common shares outstanding  used in the calculation |       | 23,973,161                       |       | 1,780,000 |   |

 

See accompanying notes to condensedconsolidated financial statements

 

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** **

**LPATH, INC.**

**CondensedConsolidated Statements of Cash Flows**

###### **(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Cash flows from operating  activities:                        |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (1,321,283 | ) | $ | (128,025 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                             |       |   |   |
| Stock-based compensation expense                                             |       | 369,190                                          |       | 11,168 |   |
| Depreciation and amortization                                                |       | 8,965                                            |       | 16,430 |   |
| Non-cash interest expense                                                    |       | —                                           |       | 27,172 |   |
| Deferred rent expense                                                        |       | 11,618                                           |       | — |   |
| Changes in operating assets and  liabilities:                                |       |                                             |       |   |   |
| Grant revenue receivable                                                     |       | 109,268                                          |       | (9,118 | ) |
| Prepaid expenses                                                             |       | (96,285                                          | )          | (18,113 | ) |
| Accounts payable and accrued expenses                                        |       | 44,668                                           |       | 45,386 |   |
| Net cash used in operating activities                                        |       | (873,859                                         | )          | (55,100 | ) |
|                                                                         |       |                                             |       |   |   |
| Cash flows from investing activities:                                        |       |                                             |       |   |   |
| Equipment expenditures                                                       |       | (35,492                                          | )          | (13,873 | ) |
| Patent expenditures                                                          |       | —                                           |       | (13,040 | ) |
| Net cash used in investing activities                                        |       | (35,492                                          | )          | (26,913 | ) |
|                                                                         |       |                                             |       |   |   |
| Cash flows from financing activities:                                        |       |                                             |       |   |   |
| Proceeds from sale of common stock and  warrants                             |       | 923,685                                          |       | — |   |
| Proceeds from issuance of convertible notes  payable                         |       | —                                           |       | 335,000 |   |
| Net cash provided by financing activities                                    |       | 923,685                                          |       | 335,000 |   |
|                                                                         |       |                                             |       |   |   |
| Net increase in cash                                                         |       | 14,334                                           |       | 252,987 |   |
|                                                                         |       |                                             |       |   |   |
| Cash at beginning of period                                                  |       | 5,190,273                                        |       | 36,183 |   |
| Cash at end of period                                                        |       | $                                                | 5,204,607  |   | $ | 289,170 |   |
|                                                                         |       |                                             |       |   |   |
| **Supplemental Schedule of Non-cash Investing  and Financing Activities:**   |       |                                             |       |   |   |
| Common stock warrants issued with  convertible debt                          |       | $                                                | —     |   | $ | 77,943 |   |

 

See accompanying notes to condensedconsolidated financial statements

 

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** **

**LPATH, INC.**

**Notesto Condensed Consolidated Financial Statements**

**March 31, 2006**

 

**Note 1 – ORGANIZATION AND BASIS OF PRESENTATION**

 

Organization

 

Lpath,Inc. (“Lpath,” “We,” or “Company”) is an emerging drug discovery companyfocused on using its proprietary Immune Y2 process to generate antibodiesagainst bioactive signaling lipids and to develop drugs to both diagnose andtreat important human diseases. Lpath has active programs in cancer, heartdisease, and age-related macular degeneration.

 

Lpath Therapeutics Inc. (“LTI”),the predecessor company to Lpath, was founded in 1998. On November 30, 2005,LTI merged with a publicly traded corporation, Neighborhood Connections, Inc. (“NCI”),to form Lpath (“the Merger”). Although NCI (which changed its name to Lpath,Inc. in connection with the Merger) acquired LTI as a result of the Merger, theformer shareholders of LTI held a majority of the voting interest in thecombined enterprise immediately after the Merger. Additionally, the Mergerresulted in LTI’s management and Board of Directors assuming operationalcontrol of Lpath, Inc. Accordingly, the Merger has been treated as are-capitalization of LTI and the financial information presented here andelsewhere in this Annual Report reflects the historical activity of LTI, unlessotherwise indicated. NCI conducted limited operations prior to the merger in aline of business wholly unrelated to biopharmaceutical operations, and theresults of NCI’s operations are not reflected in the financial information ofLpath.

 

Basisof Presentation

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States, and with the rules and regulations of the Securities and ExchangeCommission related to a quarterly report on Form 10-QSB. Accordingly, they donot include all of the information and disclosures required by accountingprinciples generally accepted in the United States for complete financialstatements. The interim financial statements include all adjustments that, inthe opinion of management, are necessary for a fair presentation of thefinancial condition and results of operations for the periods presented. Exceptas otherwise disclosed, all such adjustments are of a normal recurring nature.

 

Resultsfor the interim periods are not necessarily indicative of the results for theentire year. For more complete financial information, these financialstatements, and notes thereto, should be read in conjunction with the auditedfinancial statements for the year ended December 31, 2005 included in Lpath’sAnnual Report on Form 10-KSB filed with the Securities and Exchange Commission.

 

Theconsolidated financial statements include the accounts of Lpath, Inc. andits wholly-owned subsidiary, Lpath Therapeutics Inc. All significantintercompany balances and transactions have been eliminated in consolidation.

 

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** **

**Note 2 – SIGNIFICANT ACCOUNTING POLICIES**

 

RevenueRecognition – Grant Revenue

 

Lpath’ssole source of revenue to date has been research grants received from theNational Institutes of Health. Lpath recognizes grant revenue as the relatedresearch expenses are incurred, up to contractual limits.

 

Researchand Development

 

Researchand development costs, other than patent expenses, are charged to expense whenincurred.

 

CashEquivalents 

 

Cashequivalents consist of highly liquid investments with maturities of threemonths or less from the original purchase date. Lpath classifies its securitiesas “held-to maturity” in accordance with SFAS 115, *Accountingfor Certain Investments in Debt and Equity Securities*. Lpath carriesthese investments at amortized cost since the company has the positive intentand ability to hold them to maturity.

 

FairValue of Financial Instruments

 

Lpathhas determined the estimated fair value of its financial instruments. Theamounts reported for cash equivalents, accounts receivable, accounts payable,and accrued expenses approximate the fair value because of their shortmaturities.

 

Concentration of Credit Risk

 

Financialinstruments that potentially subject the company to a significant concentrationof credit risk consist of cash equivalents. The company places its cashequivalents with high credit-quality financial institutions, and invests itsexcess cash in money market instruments, certificates of deposit, andcommercial paper with initial maturities no longer than 90 days.

 

Equipment

 

Equipmentis recorded at cost. Depreciation is computed using the straight-line methodover the estimated useful asset lives, which range from three to five years.Repairs and maintenance are charged to expense as incurred.

 

Patents

 

Legaland filing costs directly associated with obtaining patents are capitalized. Uponissuance of a patent, amortization is computed using the straight-line methodover the estimated remaining useful life of the patent.

 

Long-LivedAssets

 

Thecompany accounts for the impairment and disposition of long-lived assets inaccordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets.*In accordance with SFAS No. 144, long-livedassets are reviewed for impairment when events or changes in circumstancesindicate that their carrying value may not be recoverable. Based on its review,management does not believe that any impairment of long-lived assets exists asof March 31, 2006.

 

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** **

Deferred Rent

 

Rentexpense is recorded on a straight-line basis over the term of the lease. Thedifference between rent expense and amounts paid under the lease agreements isrecorded as deferred rent in the accompanying consolidated balance sheets.

 

Stock-BasedCompensation

 

Priorto January 1, 2006, Lpath followed SFAS No. 123, *Accountingfor Stock-Based Compensation*.  On January 1, 2006, thecompany adopted SFAS No. 123R, *Share-Based Payment*,using the modified prospective method, which results in the provisions of SFAS123R being applied to the consolidated financial statements on a going-forwardbasis. Prior periods have not been restated. SFAS 123R requires companies torecognize stock-based compensation awards granted to its employees ascompensation expense on a fair value method. Under the fair value recognitionprovisions of SFAS 123R, stock-based compensation cost is measured at the grantdate based on the fair value of the award and is recognized as expense over theservice period, which generally represents the vesting period. The grant datefair value of stock options is calculated using the Black-Scholesoption-pricing model. This method is substantially the same method that thecompany was using under SFAS 123 except that under SFAS 123R the expenserecognized over the service period is required to include an estimate of theawards that will be forfeited. Previously, the company recorded the effects offorfeitures as they occurred.  Management presently estimates that theeffect of forfeitures on the financial statements will be insignificant. Accordingly, the adoption of SFAS No. 123R had no material effect on prior orcurrent periods.

 

Thecompany accounts for stock-based compensation issued to non-employees underSFAS No. 123R, *Share-Based Payment*, and EmergingIssues Task Force (“EITF”) Issue 96-18, *Accountingfor Equity Investments that are Issued to Other than Employees for Acquiring,or in Conjunction with Selling, Goods or Services.*As such, thevalue of such options is periodically remeasured and income or expense isrecognized during their vesting terms.

 

Net Operating Losses and Tax CreditCarryforwards

 

AtDecember 31, 2005, Lpath had federal and state net operating losscarryforwards of approximately $7,300,000 each. Under present law, the federalnet operating loss carryforwards may be available to offset taxable incomethrough 2025 and California net operating loss carryforwards may be availableto offset taxable income through 2015, if not utilized.

 

Lpathalso has federal and California research and development tax creditcarryforwards, each totaling approximately $214,000 as of December 31,2005, available to offset future taxes. The federal credits begin expiring in2019, and the state credits do not expire.

 

Underthe provisions of Section 382 of the Internal Revenue Code, substantialchanges in Lpath’s ownership may limit the amount of net operating losscarryforwards and tax credit carryforwards that can be utilized annually in thefuture to offset taxable income. A valuation allowance has

 

8

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** **

beenestablished to reserve the potential benefits of these carryforwards in Lpath’sfinancial statements to reflect the uncertainty of future taxable incomerequired to utilize available tax loss carryforwards and other deferred taxassets. If it is determined that a change in Lpath’s ownership occurred inprior years, or if a change in ownership occurs in the future, Lpath’s abilityto use its net operating loss carryforwards in any fiscal year may besignificantly limited.

 

### **NetLoss Per Share**

### ** **

Inaccordance with SFAS No. 128, *Earnings PerShare,* and SEC Staff Accounting Bulletin (“SAB”) No. 98, basic netloss per common share is computed by dividing net loss for the period by theweighted average number of common shares outstanding during the period. UnderSFAS No. 128, diluted net loss per share is computed by dividing the net lossfor the period by the weighted average number of common and common equivalentshares, such as stock options, warrants, and convertible securities, outstandingduring the period. As Lpath incurred net losses in the periods endedMarch 31, 2006 and 2005, we did not include common equivalent shares inthe computation of diluted net loss per share because the effect would beanti-dilutive.

 

Estimates

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. By their nature, estimates are subject to aninherent degree of uncertainty and, as such, actual results may differ fromthose estimates.

 

RecentAccounting Pronouncements

 

# **There havebeen no recent accounting pronouncements that will have a significant impact onLpath’s financial position or results of operations.**

#  

**Note 3 — GOING CONCERN**

 

Theaccompanying condensed consolidated financial statements have been prepared ona going concern basis, which contemplates the realization of assets and thesatisfaction of liabilities in the normal course of business. Lpath hasincurred net losses since its inception and has an accumulated deficit as ofMarch 31, 2006 of $8,793,000 (including the losses of LTI, its predecessorcorporation). The company does not expect to generate meaningful revenues fromits drug development programs in the foreseeable future. These factors, amongothers, raise substantial doubt about the company’s ability to continue as agoing concern. Lpath’s independent registered public accountants, Levitz, Zacks& Ciceric, indicated in their audit report on the 2005 consolidatedfinancial statements that there is substantial doubt about the company’sability to continue as a going concern. The accompanying financial statementsdo not include any adjustments that might result from the outcome of thisuncertainty.

 

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** **

During2006 the company expects to continue to incur cash losses from operations. Whilethe company had cash and cash equivalents totaling $5,204,607 as of March 31,2006, the cost of its ongoing drug discovery and development efforts, basedupon its currently planned activities for 2006 and 2007, are expected toconsume more than $5,000,000 in 2006 and early 2007. Additional capital will berequired to continue to fund the company’s research and development projects in2007 and beyond. The Company plans to obtain the funds necessary to meet itsanticipated cash requirements by taking actions such as:

 

1.     Pursuing additional funding from bothexisting and new investors.

 

2.     Exploring revenue generating opportunitiesfrom strategic alliances, licensing, co-development, and similar collaborations.

 

3.     Seeking additional research grants from theNational Institutes of Health or other sources.

 

# **Note4 – PRIVATE PLACEMENTS OF COMMON STOCK AND WARRANTS**

#  

Duringthe three month period ended March 31, 2006, the company received grossproceeds of $1,032,140 from the sale of 543,236 units. The price was $1.90 perunit. Each unit included two shares of common stock and a warrant to purchaseone additional share of common stock at an exercise price of $1.50 per share. Thewarrants expire on September 30, 2010. As a result of this private placement, 1,086,472shares of common stock and 543,236 warrants were issued.

 

Stockissuance costs related to these private placements were paid in cash andwarrants. Cash expenses for these placements totaled $108,455 and were nettedagainst the gross proceeds of the private placement. Of the total cashexpenses, $54,845 was paid to placement agents and $53,610 was paid for legalcounsel and filing fees. In addition, warrants to purchase 69,294 shares wereissued to placement agents. These warrants carry an exercise price of $0.95 pershare. Of the 69,294 warrants issued to placement agents, 22,988 expire on July31, 2008, 23,400 expire on September 29, 2008, and 22,906 expire on September30, 2010.

 

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** **

**Item 2.****    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*This discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our financial statements andnotes thereto included in this quarterly report on Form 10-QSB (the “QuarterlyReport”) and the audited financial statements and notes thereto included in ourannual report on Form 10-KSB for the year ended December 31, 2005(the “2005 Annual Report”), as filed with the Securities and ExchangeCommission (the “SEC”). In addition to historical information, this discussionand analysis contains forward-looking statements that involve risks, uncertainties,and assumptions. Our actual results may differ materially from thoseanticipated in these forward-looking statements as a result of certain factors,including but not limited to those identified in the 2005 Annual Report in thesection entitled “Market Risks.”*

 

**Overview**

 

Lpath Therapeutics, Inc. (“LTI”),the predecessor company to Lpath, was founded in 1998. On November 30, 2005,LTI merged with a publicly traded corporation, Neighborhood Connections, Inc. (“NCI”),to form Lpath (“the Merger”). Although NCI (which changed its name toLpath, Inc. in connection with the Merger) acquired LTI as a result of theMerger, the former shareholders of LTI held a majority of the voting interestin the combined enterprise immediately after the Merger. Additionally, theMerger resulted in LTI’s management and Board of Directors assuming operationalcontrol of Lpath, Inc. Accordingly, the Merger has been treated as are-capitalization of LTI and the financial information presented here andelsewhere in this Annual Report reflects the historical activity of LTI, unlessotherwise indicated. NCI conducted limited operations prior to the merger in aline of business wholly unrelated to biopharmaceutical operations, and theresults of NCI’s operations are not reflected in the financial information ofLpath.

 

Weare a theranostics company with a focus on bioactive signaling lipids astargets for treating and diagnosing important human diseases. Lpath hasmonoclonal antibody-based programs as well as small-molecule-based programs. Ourmost advanced product candidate, *SphingomabTM*, is a potentially superior competitor to other successfulanti-angiogenic cancer treatments. *Sphingomab*TMis the only monoclonal antibody ever developed against a bioactive lipid, andacts as a molecular sponge to selectively absorb tumorigenic sphingolipids fromblood and tissues that tumors rely upon. Lpath’s unique ability to generatemonoclonal antibodies against lysolipids is based on its Immune Y2TM technology.We intend to continue to extend our research and development efforts to othervaluable monoclonal antibodies against other valuable targets using ourproprietary ImmuneY2TM process. In addition to our antibody-development program,we also have a program to develop small–molecule inhibitors against a keyenzyme in the sphingolipid production pathway.

 

Inthe past twelve months, Lpath has completed the Merger by which its stockbecame publicly traded, raised net proceeds of approximately $7,200,000 throughprivate placements, moved into its own research and development facility, andadded key research, development, and management personnel.

 

Lpathhas incurred significant net losses since its inception. As of March 31,2006, Lpath had an accumulated deficit of approximately $8,800,000. Lpathexpects its operating losses to increase for the next several years as itpursues the clinical development of its product candidates.

 

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# **Revenue**

#  

Lpathhas generated $1,400,000 in revenue to date from research grants awarded by theNational Institutes of Health. Lpath expects to continue to receive smallamounts of revenue from research grants. Lpath does not expect to generate anyrevenue from licensing, milestones, or product sales until it executes apartnership or collaboration arrangement or is able to commercialize its firstproduct.

 

# **Research and Development Expenses**

#  

Lpath’sresearch and development expenses consist primarily of salaries and relatedemployee benefits, costs associated with its drug discovery research, and costsincurred in preparation for clinical development, including regulatory expenses.Lpath’s historical research and development expenses are principally related tothe research and drug discovery efforts in creating its lead product candidate,*Sphingomab TM*.

 

Lpathcharges all research and development expenses to operations as incurred. Lpathexpects its research and development expenses to increase significantly in thefuture as its product candidates continue to move through pre-clinical testingand clinical trials.

 

Atthis time, due to the risks inherent in the drug discovery and clinical trialprocess and given the early stage of our product development programs, Lpath isunable to estimate with any certainty the costs it will incur in the continueddevelopment of its product candidates for potential commercialization. Clinicaldevelopment timelines, the probability of success and development costs varywidely. While Lpath is currently focused on advancing each of its productdevelopment programs, Lpath anticipates that it will make determinations as tothe scientific and clinical success of each product candidate, as well asongoing assessments as to each product candidate’s commercial potential. Inaddition, Lpath cannot forecast with any degree of certainty which productcandidates will be subject to future partnering, when such arrangements will be secured,if at all, and to what degree such arrangements would affect our developmentplans and capital requirements. As a result, Lpath cannot be certain when andto what extent it will receive cash inflows from the commercialization of itsproduct candidates.

 

Lpathexpects its drug development expenses to be approximately $9 million over the 24-monthperiod ending December 31, 2007, which will be used to conduct preclinicaltesting of our two most advanced product candidates. Lpath expects theseexpenditures to increase as it continues the advancement of its productdevelopment programs. To date, Lpath has not yet initiated clinical trials forany of its product candidates. The lengthy process of completing clinicaltrials and seeking regulatory approval for its product candidates will requireLpath to incur substantial, but presently uncertian, expenditures, typicallywell in excess of $50 million. Any failure by Lpath or delay in completingclinical trials, or in obtaining regulatory approvals, would cause Lpath’sresearch and development expenses to increase and, in turn, have a materialadverse effect on Lpath’s results of operations and its ability to continue asa going concern.

 

## ***General and AdministrativeExpenses***

## *** ***

Lpath’sgeneral and administrative expenses principally comprise salaries and benefitsand professional fees related to Lpath’s administrative, finance, humanresources, legal, and internal systems support functions. In addition, generaland administrative expenses include insurance and facilities costs.

 

Lpathanticipates increases in general and administrative expenses as it addspersonnel, becomes subject to the reporting obligations applicable topublicly-held companies, and continues to develop and prepare for thecommercialization of its product candidates.

 

12

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**Resultsof Operations**

 

***Three Months Ended March 31,2006 and March 31, 2005***

 

*Grant Revenue.* Grant revenue for the three month periodended March 31, 2006 declined slightly to $129,000 from $138,000 forthe three month period ended March 31, 2005. This decrease reflects typicalvariations in research activities from one quarter to another.

 

*Research and Development Expenses.*Research and development expenses increasedfrom $163,000 for the first quarter of 2005 to $953,000 for the first quarterof 2006. This increase reflects the progress of the company and itscapabilities from the first quarter of 2005 to the first quarter of 2006. Outsideservices expense increased by approximately $360,000 primarily due to the workrequired in the humanization phase of monoclonal antibody development. Lpath hascontracted with a biomedical research company to perform this task. The use ofconsultants and other contracted services to augment the capabilities of ourresearch and development team also contributed to the increase in expendituresfor outside services. The amount spent for research supplies and materialsincreased by approximately $70,000 as we increased the level of effort on ourkey drug discovery and development projects. Employee compensation and benefitsexpense increased by approximately $65,000, commensurate with the increase inresearch and development staffing. The move into our new lab and office spaceresulted in an increase of approximately $55,000 in facilities related expenses.The increase also included a $215,000 increase in stock-based compensationexpense related to consultants used to support research and developmentactivities.

 

*General and Administrative Expenses.*General and administrative expenses increasedfrom $76,000 for the three month period ended March 31, 2005 to $551,000 forthe three month period ended March 31, 2006. This increase was due to increasesin employee compensation, and the costs of outside services necessary tosupport a publicly-traded company, including legal, accounting, investorrelations, stock administration services, and liability insurance for directorsand officers. Employee compensation expense increased by approximately $130,000reflecting the fact that certain members of our management team joined thecompany after the first quarter of 2005. Lpath hired its CEO in March 2005, buthe did not become a full-time employee until January 2006. Accounting feesincreased by approximately $70,000 primarily due to the expense associated withLpath’s first annual audit as a public company. Legal fees, investor relations,stock administration, and insurance expenses increased, in aggregate, byapproximately $90,000. Stock-based compensation charges also increased by $143,000,primarily due to stock options granted to our CEO in 2005.

 

*Interest Expense.*Interest expense decreased from $27,000 forthe first quarter of 2005 to zero in the first quarter of 2006. Lpath’sinterest expense in 2005 primarily resulted from borrowings secured by convertiblenotes. At March 31, 2005, the outstanding principal and accrued interest onthese notes totaled $930,000. In conjunction with the November 30, 2005 Merger,all of the convertible notes, together with the accumulated accrued interest,were converted into Lpath, Inc. common stock and warrants. Therefore, as ofDecember 31, 2005 and during the first quarter of 2006 Lpath had no debtsecurities outstanding and incurred no interest expense.

 

**Liquidity and Capital Resources**

 

**Since Lpath’sinception, its operations have been financed through the private placement ofequity and debt securities. Through March 31, 2006 Lpath had received netproceeds of approximately $12,600,000 from the sale of equity securities andfrom the issuance of convertible promissory notes. As of March 31, 2006,Lpath had cash, cash equivalents, and short-term investments totaling $5,204,000.**

** **

**13**

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** **

Duringthe quarter ended March 31, 2006, we used net cash of $874,000 foroperating activities compared to $55,000 in the first quarter of 2005. Theincrease in net cash used in operating activities was primarily driven byincreased expenses related to the pre-clinical development activities for ourlead drug candidate SphingomabTM, increased headcount, and the costs ofconsultants and outside services, as well as increased legal, accounting, andother services associated with being a publicly-traded company.

 

Netcash used in investing activities during the first quarter of 2006 amounted to$35,000 compared to $27,000 in the first quarter of 2005. Of the amount usedfor investing activities in the first quarter of 2006, $35,000 was used topurchase new equipment. In the comparable period of 2005 $14,000 was used topurchase new equipment and $13,000 was spent in patent activities.

 

Netcash provided from financing activities during the three month period endedMarch 31, 2006 totaled approximately $924,000 compared to $335,000 in the firstthree months of 2005. During the first quarter of 2006 Lpath sold common stockand warrants to purchase common stock for $924,000, net of issuance costs. In thefirst quarter of 2005 Lpath borrowed $335,000 under the terms of convertiblepromissory notes. In conjunction with the Merger, all of the outstandingprincipal and accrued interest on the notes were exchanged for Lpath commonstock and warrants.

 

InAugust 2005 we entered into a five-year facilities lease. A portion of thefacility is subleased to a company that is co-owned by Lpath’s two largestshareholders. The sublease was approved by the landlord. The following tabledescribes Lpath’s commitments to settle contractual obligations in cash as ofDecember 31, 2005:

 
| ** **                  | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **Through  December  2006**               | ** ** | **2007  through  2008** | ** ** | **2009  through  2010** | ** ** | **After  2010** | ** ** | **Total** | ** ** |
|                        |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating lease obligations |       | $                                         | 157,432    |   | $ | 344,836 |   | $ | 364,624 |   | $ | -0- |   | $ | 866,892 |   |
|                        |       |                                      |       |   |   |   |   |   |   |   |   |
| Sublease income             |       | 56,840                                    |       | 109,140 |   | 115,160 |   | -0- |   | 281,140 |   |
|                        |       |                                      |       |   |   |   |   |   |   |   |   |
| **Total**                   |       | $                                         | 100,592    |   | $ | 235,696 |   | $ | 249,464 |   | $ | -0- |   | $ | 585,752 |   |

 

Lpath has entered into acollaboration agreement with another biomedical research company to utilizetheir proprietary processes to assist Lpath in preparing its lead drugcandidate for clinical trials. Lpath also plans to enter into agreements withthird parties to perform specialized drug discovery tasks, manufacture ourproduct candidates, conduct our preclinical studies, and provide analyticalservices. Lpath’s payment obligations under these agreements depend upon theprogress of its discovery and development programs. Therefore, Lpath is unableto estimate with certainty the future costs it will incur under theseagreements. In addition, under the terms of the existing collaborationagreement Lpath is obligated to make additional milestone payments upon theoccurrence of certain product-development events and certain royalty payments. Thesemilestone payments and royalty payments under Lpath’s license agreements arenot included in the table above because Lpath cannot, at this time, determinewhen or if the related milestones will be achieved or the events triggering thecommencement of payment obligations will occur.

 

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**We expect ourcash requirements to increase significantly in the foreseeable future as wecontinue to: (i) increase our research and development, especially preclinicalactivities, (ii) begin the process of seeking regulatory approvals, and (iii) pursuecommercialization and strategic partnering of our current product candidates. Aswe expand our research and development efforts and pursue additional productopportunities, we anticipate significant cash requirements associated withhiring additional personnel, capital expenditures, and investment in equipmentand facilities. The costs of filing and prosecuting patents to protect ourintellectual property will also increase. The amount and timing of cashrequirements will depend on regulatory and market acceptability of our productcandidates, if any, and the resources we devote to the research, development,regulatory, manufacturing, and commercialization activities required to supportour product candidates.**

** **

**We believe thatour existing cash will be sufficient to meet Lpath’s projected operatingrequirements at least through December 2006.**

** **

**Until we cangenerate significant cash from operations, we expect to continue to fund ouroperations with the proceeds from offerings of our equity securities. Inaddition, we may finance future cash needs through debt financing and strategiccollaboration agreements. However, we may not be successful in obtaining additionalequity or debt financing or entering into collaboration agreements. If we doenter into collaboration agreements, we may not be successful in receivingmilestone or royalty payments under those agreements. In addition, we cannot besure that its existing cash and investment resources will be adequate or thatadditional financing will be available when needed or that, if available,financing will be obtained on terms favorable to us or to our stockholders. Havinginsufficient funds may require us to delay, scale back, or eliminate some orall of our development programs, relinquish some or even all rights to productcandidates at an earlier stage of development, or renegotiate less favorableterms than we would otherwise choose. Failure to obtain adequate financing mayalso adversely affect our ability to operate as a going concern. If we raiseadditional funds from the issuance of equity securities, substantial dilutionto our existing stockholders would likely result. If we raise additional fundsby incurring debt financing, the terms of the debt may involve significant cashpayment obligations as well as covenants and specific financial ratios that mayrestrict our ability to operate our business.**

** **

**Recent Accounting Pronouncements**

 

# **There havebeen no recent accounting pronouncements that will have a significant impact onLpath’s financial condition or results of operations.**

#  

**Item 3.****    CONTROLSAND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

Ourmanagement, including the Chief Executive Officer and the Chief FinancialOfficer, has conducted an evaluation of the effectiveness of our disclosurecontrols and procedures pursuant to Rule 13a-15(e) under the SecuritiesExchange Act of 1934. Based on that evaluation, the Chief Executive Officer andthe Chief Financial Officer concluded that, as of March 31, 2006, ourdisclosure controls and procedures were effective.

 

**Changes in Internal Controls Over Financial Reporting**

 

Therehave been no significant changes in our internal controls over financialreporting during the quarter ended March 31, 2006 that have materiallyaffected, or that are reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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** **

**PART II – OTHER INFORMATON**

 

**Item 1.****    LEGALPROCEEDINGS**

 

Inthe ordinary course of our business, we become involved in various disputesregarding our business. However, we do not believe that the ultimate resolutionof any such dispute will be material to our business, financial condition, orresults of operations.

 

**Item 2.****   ****UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

InJanuary 2006, we sold 669,626 shares of common stock and 334,813 warrants topurchase common stock in a private placement of units at a price of $1.90 perunit. Each unit consisted of two shares of common stock and one warrant topurchase an additional share of common stock at a price of $1.50 per share. Thewarrants expire on September 30, 2010.

 

InMarch 2006, in a separate private placement, we sold 416,846 shares of commonstock and 208,423 warrants to purchase common stock at a price of $1.90 perunit. Each unit consisted of two shares of common stock and one warrant topurchase an additional share of common stock at a price of $1.50 per share. Thewarrants expire on September 30, 2010.

 

Theoffer and sale of our securities summarized above were made pursuant to theexemption provided under Section 4(2) pursuant to Rule 506 of Regulation D, asthe offer and sales were made solely to accredited investors without any general solicitation or advertising to marketthe securities. Proceedsresulting from the January 2006 and March 2006 sales of our securities wereused from general working capital purposes.

 

Nounderwriter or underwriting discount or commission was involved in any of thetransactions set forth in this Item 2.

 

**Item 3.****   ****DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**Item 4.****    SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

**Item 5.****   ****OTHER INFORMATION**

 

None.

 

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** **

**Item 6.****    EXHIBITS**

 

Thefollowing exhibit index shows those exhibits filed with this report and thoseincorporated by reference:

 
| 2.1*   | Agreement  and Plan of Reorganization, by and between Neighborhood Connections, Inc.,  Neighborhood Connections Acquisition Corporation, and Lpath  Therapeutics Inc. dated July 15, 2005.                                                                         |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                              |
| 3.1*   | Amendment  to Articles of Incorporation filed December 1, 2005.                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                              |
| 3.2    | Articles  of Incorporation filed on September 18, 2002 (filed as Exhibit 3.1  to Amendment No. 1 to the Annual Report on Form 10-KSB for the year  ended December 31, 2003 (the “2003 Amended 10-KSB”) and incorporated  herein by reference). |
|   |                                                                                                                                                                                                                                                                              |
| 3.3    | Amendment  to Articles of Incorporation filed on December 27, 2002 (filed as  Exhibit 3.3 to Amendment No. 2 to the Current Report on Form 8-K/A filed on  January 9, 2006 and incorporated herein by reference).                                                            |
|   |                                                                                                                                                                                                                                                                              |
| 3.4    | By-laws  (filed as Exhibit 3.2 to the 2003 Amended 10-KSB and incorporated herein  by reference).                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                              |
| 4.1*   | Form of  Warrant issued to Western States Investment Corporation for lease guaranty.                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                              |
| 4.2*   | Form of  Warrant issued pursuant to the Common Stock and Warrant Purchase Agreement  dated June 30, 2005.                                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                              |
| 4.3*   | Form of  Warrant issued to Johnson & Johnson Development Corporation dated  April 3, 2002.                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                              |
| 4.4*   | Form of  Warrant issued to purchasers of Convertible Secured Promissory Notes as  amended by the Omnibus Amendment to Convertible Secured Promissory Notes and  Warrants dated November 30, 2005.                                                                       |
|   |                                                                                                                                                                                                                                                                              |
| 4.5*   | Form of  Warrant issued pursuant to the Common Stock and Warrant Purchase Agreement  dated November 30, 2005.                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                              |
| 4.6#   | Form of  Warrant issued pursuant to the Common Stock and Warrant Purchase Agreement  dated January 31, 2006.                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                              |
| 4.7    | Form  of Warrant issued pursuant to the Common Stock and Warrant Purchase Agreement  dated March 28, 2006 (filed as Exhibit 4.7 to the registration statement on  Form SB-2 filed on March 30, 2006, SEC File No. 333- 132850, and incorporated herein by  reference).            |
|   |                                                                                                                                                                                                                                                                              |
| 10.1*  | Lease  Agreement dated August 12, 2005 between Lpath Therapeutics Inc. and  Pointe Camino Windell, LLC.                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                              |
| 10.2*  | Research  Agreement dated January 28, 2004 between Medlyte, Inc. and San  Diego State University, together with Amendment No.2.                                                                                                                                         |

 

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| 10.3*   | Assignment  Agreement dated June 9, 2005 between Lpath Therapeutics Inc. and LPL  Technologies, Inc.                                                                                                                                                                                                                      |
|---------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.4    | Research  Collaboration Agreement dated August 2, 2005 between Lpath Therapeutics  Inc. and AERES Biomedical Limited (portions of this exhibit have been omitted  pursuant to a request for confidential treatment) (filed as Exhibit 10.4 to  Amendment No. 2 to the Current Report on Form 8-K/A filed on January 9,  2006). |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.5*   | Consultant  Agreement dated July 1, 2005 between Lpath Therapeutics Inc. and William  Garland.                                                                                                                                                                                                                                 |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.6*   | Consultant  Agreement dated September 1, 2005 between Lpath Therapeutics Inc. and  Roger Sabbadini.                                                                                                                                                                                                                            |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.7*   | 2005  Stock Option/Stock Issuance Plan.                                                                                                                                                                                                                                                                                             |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.8#   | Assignment  and Assumption Agreement dated December 1, 2005 by and between Lpath, Inc.  and Lpath Therapeutics, Inc.                                                                                                                                                                                                                |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.9**  | Form  of Employment Agreement between Lpath, Inc. and Scott R. Pancoast dated as of  January 1, 2006.                                                                                                                                                                                                                               |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.10** | Form  of Employment Agreement between Lpath, Inc. and Gary Atkinson dated as of  February 6, 2006.                                                                                                                                                                                                                                  |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.11** | Form  of Consultant Agreement between Lpath, Inc. and William Garland dated as of  January 1, 2006.                                                                                                                                                                                                                                 |
|    |                                                                                                                                                                                                                                                                                                                                |
| 10.12** | Form  of Consultant Agreement between Lpath, Inc. and Roger Sabbadini dated as of  February 1, 2006.                                                                                                                                                                                                                                |
|    |                                                                                                                                                                                                                                                                                                                                |
| 31.1    | Section  302 Certification by Chief Executive Officer of Lpath, Inc.                                                                                                                                                                                                                                                                |
|    |                                                                                                                                                                                                                                                                                                                                |
| 31.2    | Section  302 Certification by Chief Financial Officer of Lpath, Inc.                                                                                                                                                                                                                                                                |
|    |                                                                                                                                                                                                                                                                                                                                |
| 32      | Section  906 Certification by CEO and CFO of Lpath, Inc.                                                                                                                                                                                                                                                                            |

 

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*Filedas an exhibit to the Current Report on Form 8-K filed with the SEC on December6, 2005 and incorporated herein by reference

 

#Filed asan exhibit to the Annual Report on Form 10-KSB for the year ended December 31,2005 filed with the SEC on March 16, 2006 and incorporated herein by reference

 

**Filedas an exhibit to the Current Report on Form 8-K filed with the SEC on March 29,2006 and incorporated herein by reference

 

18

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##### ***SIGNATURES***

##### *** ***

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the Registrant and inthe capacities and on the dates indicated. 

 

 
|                     | Lpath,  Inc.                         |   |
|--------------------------|--------------------------------------|--------|
|                     |                                 |   |
|                     |                                 |   |
| Date:  May 12, 2006 | /s/  Scott R. Pancoast               |   |   |
|                     | Scott  R. Pancoast              |   |   |
|                     | President  and Chief Executive  |   |
|                     | Officer                              |   |
|                     | (Principal  executive officer)       |   |
|                     |                                 |   |
|                     |                                 |   |
|                     | /s/  Gary J. G. Atkinson             |   |   |
|                     | Gary  J. G. Atkinson,           |   |
|                     | Vice  President and Chief            |   |
|                     | Financial  Officer              |   |
|                     | (Principal  financial and            |   |
|                     | accounting  officer)                 |   |
|                          |                                      |        |  |  |

 

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