**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-Q**

 

| **(Mark  One)**                                                                                                                                                                                                            | ** ** | ** **                                                                                              |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                                                                                                 | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                                                                                                                                                                                                 | ** ** | ** **                                                                                              |
| **FOR  THE QUARTERLY PERIOD ENDED JUNE 29, 2005**                                                                                                                                                                          |
| ** **                                                                                                                                                                                                                 | ** ** | ** **                                                                                              |
| **OR**                                                                                                                                                                                                                     |
| ** **                                                                                                                                                                                                                 | ** ** | ** **                                                                                              |
| **o**                                                                                                                                                                                                                      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                 | ** ** | ** **                                                                                              |
| **FOR  THE TRANSITION PERIOD  FROM               TO               ** |

 

**CommissionFile Number 0-24320**

 

**TAPESTRYPHARMACEUTICALS, INC.**

(Exact name of Registrantas specified in its charter)

 
| **Delaware**                                                     | ** ** | **84-1187753**                         |
|------------------------------------------------------------------|------------|----------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S.  Employer  Identification No.) |

 

**4840Pearl East Circle, Suite 300WBoulder, Colorado 80301**(Address of principal executive office, including zip code)

 

**(303) 516-8500**

(Registrant’s telephonenumber, including area code)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

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

 

As of July 28, 2005, the registrant had 34,238,995 shares of commonstock, $0.0075 par value, outstanding.

 

 

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**TapestryPharmaceuticals, Inc. and Subsidiaries**

**Table ofContents**

 
| **Part I**  | **Financial Information** |                                                                                        |
|------------------|---------------------------|---------------------------------------------------------------------------------------------|
| ** **       | ** **                |                                                                                        |
|             | Item 1                    | Financial Statements                                                                        |   |
|             |                      |                                                                                        |   |
|             | Item  2                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|             |                      |                                                                                        |   |
|             | Item  3                   | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
|             |                      |                                                                                        |   |
|             | Item 4                    | Controls and  Procedures                                                                    |   |
|             |                      |                                                                                        |   |
| **Part II** | **Other Information**     |                                                                                        |
| ** **       | ** **                |                                                                                        |
|             | Item 1                    | Legal Proceedings                                                                           |   |
|             |                      |                                                                                        |   |
|             | Item  2                   | Unregistered  Sales of Equity Securities and Use of Proceeds                                |   |
|             |                      |                                                                                        |   |
|             | Item 3                    | Defaults 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**

**FINANCIAL INFORMATION**

** **

**Item 1.****  FinancialStatements**

 

**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Balance Sheets**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                          | ** ** | **June 29,  2005** | ** ** | **December 29,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **(Unaudited)**    | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                          | ** ** | ** **         | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                     |       |               |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                          |       | $                  | 668        |                        | $          | 1,713 |   |
| Short-term  investments                                                                                                                                                             |       | 20,452             |       | 29,378                      |       |
| Prepaid expense  and other current assets                                                                                                                                           |       | 655                |       | 538                         |       |
| Assets held for  sale                                                                                                                                                               |       | —             |       | 112                         |       |
| Total current  assets                                                                                                                                                               |       | 21,775             |       | 31,741                      |       |
|                                                                                                                                                                                |       |               |       |                        |       |
| Property, plant  and equipment, net                                                                                                                                                 |       | 656                |       | 676                         |       |
| Long-term  investments                                                                                                                                                              |       | —             |       | 4,631                       |       |
| Investment in ChromaDex, Inc.                                                                                                                                                  |       | 1,414              |       | 1,414                       |       |
| Other assets                                                                                                                                                                        |       | 720                |       | 831                         |       |
| Total assets                                                                                                                                                                        |       | $                  | 24,565     |                        | $          | 39,293 |   |
|                                                                                                                                                                                |       |               |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                       | ** ** | ** **         | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                                               |       |               |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                                                                           |       | $                  | 850        |                        | $          | 3,119 |   |
| Accrued payroll  and payroll taxes                                                                                                                                                  |       | 1,101              |       | 2,017                       |       |
| Notes payable – current  portion, net                                                                                                                                          |       | 448                |       | 3,132                       |       |
| Total current  liabilities                                                                                                                                                          |       | 2,399              |       | 8,268                       |       |
|                                                                                                                                                                                |       |               |       |                        |       |
| Notes payable –  long term, net                                                                                                                                                |       | 2,914              |       | 3,245                       |       |
|                                                                                                                                                                                |       |               |       |                        |       |
| Commitments and  contingencies                                                                                                                                                      |       |               |       |                        |       |
|                                                                                                                                                                                |       |               |       |                        |       |
| Stockholders’  equity:                                                                                                                                                         |       |               |       |                        |       |
| Preferred stock,  $.001 par value; 2,000,000 shares authorized; none issued                                                                                                         |       | —             |       | —                      |       |
| Common stock,  $.0075 par value; 100,000,000 shares authorized; 34,238,995 and 33,435,401  shares issued and outstanding at June 29, 2005 and December 29, 2004,  respectively |       | 257                |       | 251                         |       |
| Additional  paid-in capital                                                                                                                                                         |       | 117,823            |       | 117,354                     |       |
| Accumulated  deficit                                                                                                                                                                |       | (98,702            | )          | (89,724                     | )          |
| Accumulated  other comprehensive loss                                                                                                                                               |       | (126               | )          | (101                        | )          |
| Total  stockholders’ equity                                                                                                                                                    |       | 19,252             |       | 27,780                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                    |       | $                  | 24,565     |                        | $          | 39,293 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

3

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**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Statements of Operations**

**(Inthousands, except per share data)**

**(Unaudited)**

 
| ** **                                                     | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **June 29,  2005** | ** ** | **June 30,  2004**   | ** ** | **June 29,  2005** | ** ** | **June 30,  2004** | ** ** |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Operating  expenses:                                           |       |               |       |                 |       |   |   |   |   |
| Research and  development                                      |       | $                  | 2,785      |                 | $          | 3,164 |   | $ | 5,575 |   | $ | 4,916 |   |
| General and administrative                                     |       | 1,469              |       | 2,022                |       | 3,066 |   | 4,167 |   |
| Operating loss                                                 |       | 4,254              |       | 5,186                |       | 8,641 |   | 9,083 |   |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Other income  (expense):                                       |       |               |       |                 |       |   |   |   |   |
| Interest and  other income                                     |       | 211                |       | 143                  |       | 382 |   | 296 |   |
| Interest and  other expense                                    |       | (244               | )          | (238                 | )          | (411 | ) | (473 | ) |
| Net loss from  continuing operations                           |       | (4,287             | )          | (5,281               | )          | (8,670 | ) | (9,260 | ) |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Discontinued  operations:                                      |       |               |       |                 |       |   |   |   |   |
| Loss from  discontinued operations                             |       | (127               | )          | (1,106               | )          | (308 | ) | (2,102 | ) |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Net loss                                                       |       | $                  | (4,414     | )                    | $          | (6,387 | ) | $ | (8,978 | ) | $ | (11,362 | ) |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Basic and  diluted loss per share from continuing operations   |       | $                  | (0.13      | )                    | $          | (0.16 | ) | $ | (0.26 | ) | $ | (0.29 | ) |
| Basic and  diluted loss per share from discontinued operations |       | $                  | —     |                 | $          | (0.03 | ) | $ | (0.01 | ) | $ | (0.07 | ) |
| Basic and  diluted loss per share                              |       | $                  | (0.13      | )                    | $          | (0.19 | ) | $ | (0.27 | ) | $ | (0.35 | ) |
|                                                           |       |               |       |                 |       |   |   |   |   |
| Basic and  diluted weighted average shares outstanding         |       | 34,124             |       | 33,234               |       | 33,790 |   | 32,151 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

4

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**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Statements of Cash Flows**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **June 29, 2005**    | ** ** | **June 30, 2004** | ** ** |
| Operating  activities:                                                       |       |                 |       |   |   |
| Net loss                                                                     |       | $                    | (8,978     | ) | $ | (11,362 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                 |       |   |   |
| Depreciation and  amortization                                               |       | 132                  |       | 249 |   |
| Amortization of  debt issue cost & debt discount                         |       | 301                  |       | 305 |   |
| Amortization of  investment premium                                          |       | 152                  |       | 75 |   |
| Interest paid  with common stock                                             |       | —               |       | 54 |   |
| Compensation  paid with common stock and options                             |       | 24                   |       | 104 |   |
| Retirement  contributions paid with common stock                             |       | 210                  |       | 396 |   |
| Impairment  charges                                                          |       | 104                  |       | 205 |   |
| Loss on disposal  of assets                                                  |       | 16                   |       | — |   |
| Gain on sale of  investments                                                 |       | (72                  | )          | — |   |
| Changes in  operating assets and liabilities:                                |       |                 |       |   |   |
| Accounts  receivable                                                         |       | —               |       | 1,496 |   |
| Prepaid expense  and other assets                                            |       | 100                  |       | 108 |   |
| Accounts payable  and accrued liabilities                                    |       | (2,269               | )          | (1,373 | ) |
| Accrued payroll  and payroll taxes                                           |       | (916                 | )          | (1,132 | ) |
| Net cash used in  operating activities                                       |       | (11,196              | )          | (10,875 | ) |
|                                                                         |       |                 |       |   |   |
| Investing  activities:                                                       |       |                 |       |   |   |
| Additions to  property and equipment                                         |       | (120                 | )          | (111 | ) |
| Proceeds from  sale of assets held for sale                                  |       | 104                  |       | — |   |
| Purchases of  investments                                                    |       | (19,379              | )          | (66,219 | ) |
| Proceeds from  sale of investments                                           |       | 32,831               |       | 70,853 |   |
| Net cash  provided by investing activities                                   |       | 13,436               |       | 4,523 |   |
|                                                                         |       |                 |       |   |   |
| Financing  activities:                                                       |       |                 |       |   |   |
| Payments of  notes payable                                                   |       | (3,316               | )          | (41 | ) |
| Proceeds from  the sale of common stock, net of issuance cost                |       | —               |       | 4,837 |   |
| Proceeds from  the exercise of common stock options                          |       | 31                   |       | 23 |   |
| Net cash (used  in) provided by financing activities                         |       | (3,285               | )          | 4,819 |   |
| Net decrease in  cash and cash equivalents                                   |       | (1,045               | )          | (1,533 | ) |
| Cash and cash  equivalents at beginning of period                            |       | 1,713                |       | 2,281 |   |
| Cash and cash  equivalents at end of period                                  |       | $                    | 668        |   | $ | 748 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

5

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| ** **                                                        | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                        | ** ** | **June 29, 2005**    | ** ** | **June 30, 2004** | ** ** |
| Supplemental  disclosure of cash flow information:                |       |                 |       |   |   |
|                                                              |       |                 |       |   |   |
| Interest paid                                                     |       | $                    | 136        |   | $ | 6 |   |
|                                                              |       |                 |       |   |   |
| Non-cash  investing and financing activities:                     |       |                 |       |   |   |
| Issuance of  common stock for payment of interest payable         |       | —               |       | 107 |   |
| Issuance of  common stock to prepay retirement plan contributions |       | 210                  |       | 375 |   |
|                                                                   |            |                      |            |  |  |  |  |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

6

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**TapestryPharmaceuticals, Inc.**

**Notes toConsolidated Condensed Financial Statements**

**June29, 2005**

**(Unaudited)**

 

**Note 1.****  Basis ofPresentation**

 

The accompanying financial statements are unaudited.  However, in the opinion of management, thefinancial statements reflect all adjustments, consisting of only normalrecurring adjustments, necessary for fair presentation.  Interim results of operations may not beindicative of results for the full year. These financial statements should be read in conjunction with theCompany’s Annual Report on Form 10-K for the year ended December 29,2004.

 

#### **Note 2.**  Reclassifications

#### ** **

Certain data in theconsolidated condensed financial statements of the prior period have beenreclassified to conform to the current year presentation.

 

# **Note 3.**  StockOptions

# ** **

Tapestry accounts for its stock options to employees and directors inaccordance with Accounting Principles Board Opinion No. 25 (“APB 25”), *Accounting for Stock Issued to Employees*, and relatedinterpretations.  Pursuant to APBNo. 25, compensation expense to employees is recorded only if the fairvalue of the underlying stock exceeds the exercise price on the grantdate.  Stock options granted toconsultants are accounted for under the fair value method, in accordance withStatement of Financial Accounting Standards No. 123 (“SFAS123”), *Accounting for Stock-Based Compensation*.

 

Proforma information regarding net income and earnings per share is required by SFAS 123 and Statement of Financial Accounting StandardsNo. 148, *Accounting for Stock-Based CompensationTransition and Disclosure*, which requires that the information bedetermined as if the Company had accounted for employee stock options grantedsubsequent to December 31, 1994 under the fair value method of thatstatement.  Tapestry estimated the fairvalue for these options at the date of grant using a Black-Scholesoption pricing model with the following weighted-average assumptions for thequarters ended June 29, 2005 and June 30, 2004, respectively: risk-freeinterest rates of 4.27% and 2.51% to 3.17%; no expected dividend; volatility factorsof 1.205 and 1.028, and an estimated expected life range of three to sixyears.  For the six months ended June 29,2005 and June 30, 2004, respectively, Tapestry estimated the fair market valueof these options with the following assumptions: risk-free interest rates of3.58% for the first quarter to 4.27% for the second quarter and 2.51% to 3.55%;no expected dividend; volatility factors of 1.233 to 1.2054 and 1.028 to 1.047,and an estimated expected life range of three to six years.

 

For purposes of pro forma disclosures, the Company amortizes to expensethe estimated fair value of the options over the options’ vesting period.  Tapestry’s pro forma information is asfollows (in thousands, except per share amounts):

 
| ** **                                                                                                        | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                                        | ** ** | **June 29,  2005** | ** ** | **June 30,  2004**   | ** ** | **June 29,  2005** | ** ** | **June 30,  2004** | ** ** |
| Net loss as  reported                                                                                             |       | $                  | (4,414     | )                    | $          | (6,387 | ) | $ | (8,978 | ) | $ | (11,362 | ) |
| Deduct: Total  stock based employee compensation expense determined under fair value based  method for all awards |       | (733               | )          | (935                 | )          | (1,490 | ) | (1,816 | ) |
| Pro forma net  loss                                                                                               |       | $                  | (5,147     | )                    | $          | (7,322 | ) | $ | (10,468 | ) | $ | (13,178 | ) |
|                                                                                                              |       |               |       |                 |       |   |   |   |   |
| Basic and  diluted loss per share – as reported                                                              |       | $                  | (0.13      | )                    | $          | (0.19 | ) | $ | (0.27 | ) | $ | (0.35 | ) |
| Pro forma basic  and diluted loss per share                                                                       |       | $                  | (0.15      | )                    | $          | (0.22 | ) | $ | (0.31 | ) | $ | (0.41 | ) |

 

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123(R) (“SFAS 123(R)”), *Accounting for Stock-Based Compensation*.  SFAS 123(R)establishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services.  This statement focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions.  SFAS 123(R) requires that the fair value of such equityinstruments be recognized as an expense in the historical financial statementsas services are performed.  Prior to SFAS 123(R), only certain pro forma disclosures of fairvalue were required.  The provisions ofthis statement are effective at the beginning of the next fiscal year.  Accordingly, the Company will adopt 

 

7

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SFAS 123(R) commencing with thequarter ending March 29, 2006.  Theadoption of SFAS 123(R) is expected to have amaterial effect on the Company’s results of operations.

 

# **Note 4.**  NasdaqDelisting Notice

# ** **

On February 25, 2005,the Company received notice from the NasdaqStock Market, Inc. (“Nasdaq”) that its minimumbid price had fallen below $1.00 for 30 consecutive business days and that itscommon stock is, therefore, subject to delisting from the NasdaqSmallCap Market. The Company has until August 24, 2005 (180 calendar days fromFebruary 25, 2005) to regain compliance. The Company can regain compliance with the minimum bid pricerule if the bid price of its common stock closes at $1.00 or higher for aminimum of 10 consecutive business days during the initial 180-day period,although Nasdaq may, at its discretion, require anissuer to maintain a bid price of at least $1.00 per share for a period inexcess of ten consecutive business days (but generally no more than 20consecutive business days) before determining that the issuer has demonstratedthe ability to maintain long-term compliance. If compliance is not achieved by August 24, 2005, the Company maybe eligible for another 180 day compliance period (until February 20,2006) if it meets the Nasdaq  SmallCapMarket initial listing criteria, other than the minimum bid pricerequirement.  No assurance can be giventhat the Company will be eligible for the additional 180 day compliance periodor, if applicable, that the Company will regain compliance during anyadditional compliance period.  Ifthe Company fails to meet all applicable Nasdaq  SmallCap Market requirements and Nasdaq determines to delistits common stock, the delisting could adversely affect the market liquidity ofits common stock and the market price of its common stock could decrease.  Such delisting could then adversely affectthe Company’s ability to obtain financing for the continuation of itsoperations and/or result in the loss of confidence by investors, suppliers andemployees.

 

The Company receivedstockholder approval at its 2005 Annual Meeting granting the Board of Directorsthe ability to effect a reverse stock split as one wayto address the Nasdaq listing issues relating tominimum bid price.  The Board is notrequired to implement the reverse stock split and intends to do so only if itdetermines that a reverse stock split would be in the best interest of theCompany.

 

# **Note5.**  Discontinued Operations

# ** **

Closure of the GenomicsDivision

 

In November 2004 the Company discontinued research on its genomicsprograms, other than the Huntington’s Disease program,and sought a buyer for these programs. After efforts to sell the intellectual property assets related to thegenomics programs over the course of the fourth quarter, the Company determinedthat there were no actively interested buyers. In the fourth quarter of 2004, the Company recorded a charge of $1.7million primarily relating to an impairment of intangible assets acquired inconnection with the December 2002 acquisition of the genomics business of Pangene Corporation ($1.1 million), a charge for fixedassets likely to be disposed of at less than their book value ($150,000),severance costs ($250,000) and lease termination costs ($200,000).  Additional expenses related to the closurewere charged to discontinued operations asincurred.  Most costs relating to theclosure were incurred by the end of January 2005, although certain leasecosts continued through May 2005. In April 2005, the Company received $104,000 for certain fixed assets ofthe genomics business that were previously reserved for in the fourth quarter of2004.  In December 2003, the Companymade a decision to sell its gene isolation and service business, which wasacquired in December 2002.  Netoperating loss related to this business totaled $0 and $10,000 during thesecond quarters of 2005 and 2004, respectively. For the first six months, the net operating loss totaled $0 and $221,000for 2005 and 2004, respectively.  In thefirst quarter of 2004, the Company recorded an impairment loss of $205,000 forassets that had been identified as held for sale.

 

Assets held for sale, at June 29, 2005 and December 29, 2004,which relate to the discontinued operations of the genomics business were asfollows (in thousands):

 
| ** **                          | ** ** | **June 29,  2005** | ** ** | **December 29,  2004** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| Property, plant  and equipment, net |       | $                  | —     |                        | $          | 112 |   |
|                                     |            |                    |            |                             |            |  |  |

 

Net losses related to the Genomics Division that are included indiscontinued operations totaled $127,000 and $1.1 million for the quartersended June 29, 2005 and June 30, 2004, respectively.  Net losses related to the Genomics Divisionthat are included in discontinued operations totaled $308,000 and $2.1 millionfor the six months ended June 29, 2005 and June 30, 2004, respectively.  No material revenue was previously recognizedin this division.

 

8

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Sale of Paclitaxel Business

 

On December 12,2003, the Company sold its worldwide generic injectablepaclitaxel business to MaynePharma  (USA) Inc. (f/k/a/ FauldingPharmaceutical Co.) (“Mayne  Pharma”), a subsidiaryof Mayne Group Limited,for cash inthe amount of $71.7 million minus an inventory adjustment of $4.6 millionto reflect the Company’s actual inventory as of the closing.  The sale resulted in a gain of $54.6 millionbefore taxes, and $54.1 million after taxes.  Proceeds from the sale are being used to fundthe development and commercialization of products based on Tapestry’sproprietary oncology platforms and for general corporate purposes.  In addition, approximately $21.9 millionof the proceeds of the purchase price was paid to Abbott Laboratories (“Abbott”)to retire all outstanding debt, interest and payables the Company owed toAbbott.  The assets sold to Mayne  Pharma included paclitaxel manufacturing assets, yew plantations, domesticand international issued and pending paclitaxelpatents, a worldwide registration dossier, worldwide development and supplyagreements, inventories and settlement of accounts receivable.  The Company retained all of its intellectualproperty not used in connection with the business sold.

 

The paclitaxel business was reported as adiscontinued operation in 2004.   Summaryresults of the paclitaxel business’s second quarterand six months ended operations were (in thousands):

 
| ** **    | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|--------------------|------------|----------------------|------------|
| ** **    | ** ** | **June 30,  2005** | ** ** | **June 29,  2004**   | ** ** | **June 30,  2005** | ** ** | **June 29,  2004** | ** ** |
| Product sales |       | $                  | —     |                 | $          | — |   | $ | — |   | $ | — |   |
| Net income    |       | $                  | —     |                 | $          | 10 |   | $ | — |   | $ | 261 |   |

 

Paclitaxel income in 2004consisted primarily of a $250,000 business interruption insurance claim filedin 2004 for losses sustained in the third quarter of 2003, which resulted froma hurricane that disrupted operation of a contract manufacturer employed byTapestry.

 

# **Note6.**  Investments

# ** **

Short-term investments consisted of investment grade commercial paperdue within one year.  The Company’sinvestments in auction rate securities are recorded at cost, which approximatesfair market value. In accordance with ARB 43, despitethe long-term nature of their stated contractual maturities, the Company hasthe ability and intent to liquidate investments in auction rate securities withinsix months and therefore has classified these investments as short-term.  Long-term investments consisted of investmentgrade commercial paper with maturities beyond one year.  All investments are classified asavailable-for-sale and are recorded at market value.  Unrealized gains and losses are reflected inother comprehensive net loss.

 

Comprehensive loss for the Company consists of net loss and unrealizedholding gains and losses on available-for-sale investments as presented below(in thousands):

 
| ** **                                               | ** ** | **Quarter Ended**  | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                               | ** ** | **June 29,  2005** | ** ** | **June 30,  2004**   | ** ** | **June 29,  2005** | ** ** | **June 30,  2004** | ** ** |
| Net loss, as  reported                                   |       | $                  | (4,414     | )                    | $          | (6,387 | ) | $ | (8,978 | ) | $ | (11,362 | ) |
| Unrealized gain  (loss) on available-for-sale securities |       | (11                | )          | (100                 | )          | (25 | ) | (85 | ) |
| Comprehensive  net loss                                  |       | $                  | (4,425     | )                    | $          | (6,487 | ) | $ | (9,003 | ) | $ | (11,447 | ) |

 

# **Note7.**  Property, Plant and Equipment

 

Property, plant and equipment consisted of the following (inthousands):

 
| ** **                                      | ** ** | **June 29,  2005** | ** ** | **December 29,  2004** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| Furniture,  fixtures and office equipment       |       | $                  | 704        |                        | $          | 678 |   |
| Laboratory  equipment                           |       | 630                |       | 589                         |       |
| Leasehold  improvements                         |       | 50                 |       | 38                          |       |
| Construction in  progress                       |       | 38                 |       | 22                          |       |
|                                            |       | 1,422              |       | 1,327                       |       |
| Less accumulated  depreciation and amortization |       | (766               | )          | (651                        | )          |
| Property, plant  and equipment, net             |       | $                  | 656        |                        | $          | 676 |   |

 

9

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**Note 8.****  Investment in ChromaDex, Inc.**

 

In April 2003, the Company sold its technical and analyticalservices group to privately held ChromaDex, Inc.in exchange for approximately 15%, on a fully diluted basis, of the thenoutstanding common stock of ChromaDex, Inc.  The Company valued this investment atapproximately $1.4 million based upon the fair market value of the net assetssold to ChromaDex. ChromaDex is a supplier of phytochemicalreference standards for the nutraceutical, dietarysupplement and functional food industries.

 

# **Note9.**  Notes Payable, Current and Long-Term

# ** **

On February 18, 2005,the Company entered into an agreement with TL Ventures providing for a completesettlement of its ongoing litigation with them, a mutual release of claims, thepayment of approximately $3,184,000 in cash and the issuance by the Company ofpromissory notes in an aggregate amount of $4,670,000 in exchange for deliveryfor cancellation of debentures in the principal amount of $8,000,000 that hadbeen issued by the Company.  The notesare payable in monthly installments of $50,000 beginning in February 2005,$110,000 in 2006 and $150,000 in 2007, with a final payment of $1,000,000 dueon January 31, 2008.  The notes donot bear interest; however, an imputed interest rate of 18% was used todetermine a fair carrying value of the notes. Accrued interest of approximately $134,000 was included in the cashpayment made with the closing.  TheCompany recorded the obligation resulting from the settlement on its balancesheet as of December 29, 2004.

 

# **Note10.**  Stockholders’ Equity

# ** **

On March 26, 2004, the Company sold 2,000,000 shares of commonstock at $2.60 per share.  The netproceeds from the sale were approximately $4.9 million after payment ofadvisory fees and legal fees incurred in connection with the transaction.

 

# **Note11.**  Net Income (Loss) Per Share

# ** **

Basic earnings per share is measured as net income or loss divided bythe weighted average outstanding common shares for the period.  Diluted earnings per share is similar tobasic earnings per share but presents the dilutive effect on a per share basisof potential common shares (e.g. stock options, warrants and convertiblesecurities) as if they had been converted at the beginning of the periodspresented.  Potential common shares (e.g.vested stock options representing 3,000 shares at June 29, 2005 and 682,000shares at June 30, 2004) that have an antidilutiveeffect are excluded from diluted earnings per share.  Net loss per common share is computed usingthe weighted average number of shares of common stock outstanding.

 

# **Note12.**  Subsequent Events

# ** **

On July 20, 2005, the Board of Directors authorized a reduction in theCompany’s operations.  During the third quarter,the Company expects to eliminate 14 positions (about 30% of its workforce),including executive and non-executive employees and consultants in all areas ofoperations.  Tapestry expects to incurone time costs of approximately $270,000, all of which will be in cash, and tocomplete the reduction by the end of September 2005.  The Company is taking the action to preservecash and to permit it to focus its primary effort on advancing its leadclinical programs.

 

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

##### ** **

The following discussion andanalysis provides information that management believes is relevant to anassessment and understanding of the results of operations of TapestryPharmaceuticals, Inc.  You shouldread this discussion in conjunction with the Financial Statements and Notesincluded elsewhere in this report and with Management’s Discussion andAnalysis of Financial Condition and Results of Operations for the year endedDecember 29, 2004 contained in our 2004 Annual Report on Form 10-K.  Certain statements set forth below constitute“forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended.  See “Special NoteRegarding Forward-Looking Statements.”

 

**General**

 

Tapestry Pharmaceuticals, Inc. (“we”, “Tapestry” or “the Company”) is a pharmaceutical companyfocused on thedevelopment of proprietary therapies for the treatment of cancer.  The Company’s primary development effort isfocused on TPI 287, a novel taxaneunder development for the treatment of cancer. We filed an Investigational New Drug (“IND”)application on December 21, 2004 covering TPI 287,and commenced human clinical trials with TPI 287 inthe second quarter of 2005.  Otherprograms in development include our quassinoids,peptide linked cytotoxics and oligotherapy.  Currently, we cannot predictwhen or if any of these programs will be advanced into clinicaldevelopment.  We are also activelyengaged in evaluating new therapeutic agents and/or related technologies.  Our evaluation of new products andtechnologies may involve the examination of individual molecules, classes ofcompounds, or platform technologies. Acquisitions of new products or technologies may involve the purchase orlicense of such products or technologies, or the acquisition of, or mergerwith, other companies.

 

In November 2004 we discontinued research on our genomicsprograms, other than the Huntington’s Disease program,and soughta buyer of these programs.  Aftercompleting reasonable efforts to sell the intellectual property assets relatedto the genomics programs over the course of the fourth quarter, the Companydetermined that there were no actively interested buyers.

 

We will incur substantialresearch and development expense, including expense relating to clinicaltrials, related to the development of our proprietary anti-cancer agents.  We have incurred significant losses,including losses from continuing operations of $8.7 million for the six monthsended June 29, 2005.  Our accumulateddeficit was $98.7 million as of June 29, 2005. We anticipate that losses will continue until such time, if ever, as weare able to commercialize our product candidates and generate sufficient salesto support our development operations, including the research and developmentactivity mentioned above.

 

Our ability to generatesufficient sales to support our operations currently depends upon thesuccessful development and commercialization of products based on ourproprietary oncology technologies.

 

**Research and Development**

 

Our current business is focused primarily on clinical development of TPI 287, along with research and development of other proprietary therapiesfor the treatment of cancer and Huntington’s Disease,a progressive, inherited, neurological disorder resulting in degeneration ofneural tissue.  The table below shows ourresearch and development expense by major category, with the expense related toour Genomics Division included in discontinued operations (in thousands):

 
| ** **                 | ** ** | **Quarter Ended**  | ** ** | **Six months ended** | ** ** |
|----------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                 | ** ** | **June 29,  2005** | ** ** | **June 30,  2004**   | ** ** | **June 29,  2005** | ** ** | **June 30,  2004** | ** ** |
|                       |       |               |       |                 |       |   |   |   |   |
| Oncology                   |       | $                  | 2,615      |                 | $          | 2,940 |   | $ | 5,232 |   | $ | 4,424 |   |
| Huntington’s  Disease |       | 170                |       | 224                  |       | 343 |   | 492 |   |
| Discontinued  operations   |       | 123                |       | 1,106                |       | 353 |   | 2,142 |   |
|                       |       | $                  | 2,908      |                 | $          | 4,270 |   | $ | 5,928 |   | $ | 7,058 |   |

 

The following chart identifies our four therapeutic candidate programsthat are in the most advanced stages of development.

** **
| **Program**               | ** ** | **Potential  Indication(s)**                                                   | ** ** | **Development  Status** |
|---------------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------|
| TPI 287                   |       | Prostate,  Non-Small Cell Lung, Pancreatic, Ovarian, Breast, and Colon Cancers |       | Phase  I Clinical Trial |
|                      |       |                                                                           |       |                    |
| Quassinoids               |       | Cancers                                                                        |       | Preclinical Development |
|                      |       |                                                                           |       |                    |
| Peptide Linked Cytotoxics |       | Cancers                                                                        |       | Preclinical Development |
|                      |       |                                                                           |       |                    |
| Oligo Therapy             |       | Huntington’s Disease                                                      |       | Preclinical Development |

 

•      TPI 287 is a novel third generation taxane.  On December 21, 2004, we filed anInvestigational New Drug (“IND”) application, and onJanuary 21, 2005, we were cleared to proceed into clinical trials by theU.S. Food and Drug Administration (“FDA”). In May 2005 we commenced dosing in a phase I clinical trial of TPI 287.  We expectto initiate a second phase I clinical trial of TPI287 to evaluate an alternative dosing schedule before the end of 2005.  In preclinical testing, TPI287 demonstrated the ability to inhibit tumor cell growth in a number of *in vitro* cell lines and has shown inhibition of tumors incertain animal xenograft models when tested againststandard comparative agents.  The *in vitro* activity was seen across multiple cell linesincluding cell lines known to be sensitive to taxanesand cell lines known to be resistant to taxanes.  Taxane sensitivecell lines in which TPI 287 shows activity include 

 

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cell lines derived from breastcancer, uterine cancer and small cell lung cancer.  Taxane resistantcell lines in which TPI 287 shows activity includelines derived from breast cancer, colon cancer, prostate cancer and pancreaticcancer.  In *in**vivo* animaltesting, TPI 287 demonstrated tumor growth inhibitionactivity in four tumor cell lines with multiple drug resistance, or MDR1.

 

•      Quassinoids are complex polyfunctional,polycyclic natural products of the plant family *Simaroubaceae*, which exhibit antineoplastic activity.  We have in-licensed several quassinoid compositions as well as processes for theirisolation and synthesis.  We have completed several *in vitro* and *in vivo* preclinical studies on our proprietary quassinoid analogs, and additional preclinical studies arein progress to better delineate the antineoplasticactivity of these compounds.  Currently, we cannot predict when or if anyof these quassinoids will be advanced into clinicaldevelopment.

 

•      Peptidelinked conjugates consist of a synthetic peptide ligandchemically linked to a cytotoxic agent.  The new chemical entity thus created appearsto positively alter the therapeutic index of the cytotoxicagent in certain tumor models.  We havein-licensed intellectual property in this area. To date, we have completed several *invitro* and *in vivo*preclinicalstudies on TPI 284, a proprietary peptide linkedconjugate, which indicate that this compound has activity in certain cancercell lines.  We are currently conductingstudies on additional proprietary peptide linked compounds to further determinethe activity and therapeutic indexes of peptide linked cytotoxics.  Currently, we can not predict when or if anyof these conjugates will be advanced into clinical development.

 

•     Huntington’sDisease is a progressive, inherited, neurological disorder resulting indegeneration of neural tissue.  Thedisease is characterized by lethal huntingtin proteinaggregate formation in neural tissue. Eventually, the patient suffers dementia, uncontrolled movements anddeath.  There is no known cure for thisrare disease.  Symptoms usually appearbetween the ages of 30 and 45, although younger people can also develop thedisease.  In the United States thedisease affects approximately 1 of every 10,000 people.  We are developing an oligonucleotidetherapy, which may slow the progression of the disease or may eliminate thedeath of the nerve cells.  We are in theearly stages of this program and we can provide no assurance that we will besuccessful in this development effort. To date, we have conducted several *invitro* studies to determine the effects of our oligonucleotidetherapy in a model neuronal cell based assay and in a biochemical assay thatdetects molecules that disrupt protein aggregation.  We have also recently concluded an *in vivo* animal study of Huntington’sDisease.  The data from this studyindicated that the oligonucleotide therapy may havean effect on mitigating the motor deficits seen in Huntington’sDisease.  We are currentlyinitiating an additional study, which is designed to establish the doseresponse for the oligonucleotide therapy in atransgenic mouse model of Huntington’s Disease thatmay support the results of previous *in vitro*and *in vivo* studies as to the efficacy of the oligonucleotide.  Weexpect to have the data from this new study by the end of the third quarter of2005.  Currently, we cannot predict whenor if our oligonucleotide therapy will be advancedinto clinical development.

 

Research and development,which includes expenses related to our clinical programs, are expected to bethe most significant expense of our business going forward.  Since we began clinical testing of our thirdgeneration taxane product candidate, TPI 287, in the second quarter of 2005, we expect that ourresearch and development expenses will increase in connection with thisactivity.  We cannot estimate the cost ofthe effort necessary to complete these programs, or when, if ever, we willreceive any revenues from them. Completion of the development of any of our product candidates to anapproved product for sale in the United States and offshore will be dependentupon raising additionalcapital.  We cannot be certain that wewill be able to obtain capital on acceptable terms or at all. We have included a number of the risks and uncertainties associated withcompleting our product development plans in the “SpecialNote Regarding Forward-Looking Statements” below.

 

Results of Operations -Quarter Ended June 29, 2005 Compared to Quarter Ended June 30, 2004

 

*Research and Development Expense.*  Research and development expense fromcontinuing operations for the second quarter of 2005 was $2.8 million, a decrease of $379,000from the second quarter of 2004. Oncology research and development expenditures decreased by $325,000 to$2.6 million in the second quarter of 2005, and Huntington’sDisease related spending decreased by $54,000 to $170,000.  Decreased oncology expense was primarily dueto a reduction in outside manufacturing costs associated with preparing TPI 287 for clinical trials ($401,000), decreasedconsulting and outside service costs ($280,000) as well as increased salariesand related fringe expenses ($245,000) and supplies and maintenance($82,000).  The decrease related to the Huntington’s Disease program was due to lower compensationexpense and a reduction in consulting and contract research expenses.

 

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*General and Administrative Expense.*  General and administrative expense for thecurrent year quarter was $1.5 million, a decrease of $553,000 from the prioryear quarter.  This decrease wasprimarily due to lower compensation ($309,000), lower consulting, accountingand other outside service costs ($89,000), lower outside legal costs ($52,000),as well as lower insurance and other occupancy expense ($63,000).

 

*Interest and Other Income.*  Interest and other income for the secondquarter of 2005 increased by $68,000 compared to the prior year quarter.  The increase was attributable to a realizedgain on sale of investments.

 

*Interest and Other Expense.*  Interest and other expense for the currentyear quarter of $244,000 was $6,000 more than the prior year quarter due to a $104,000 impairment on the value of land, offset by theeffect of the restructuring of the TL Ventures convertible notes inFebruary 2005.

 

*Discontinued Operations.** *Loss from discontinued operations was $127,000 for thecurrent year quarter, a decrease of $979,000 from the prior year quarter.  This decrease was primarily the result of theclosure of the Genomics Division. Research and development expense included in discontinued operations forthe second quarter of 2005 was $123,000, a decrease of $983,000 from the secondquarter of 2004.  The decrease wasprimarily the result of the closure of the Genomics Division.  There was no general and administrative expenseincluded in discontinued operations for the second quarters of 2005 and 2004.

 

Results of Operations - SixMonths Ended June 29, 2005 Compared to Six Months Ended June 30, 2004

 

*Research and Development Expense.*  Research and development expense fromcontinuing operations for the first six months of 2005 was $5.6 million, an increase of$659,000 from the first six months of 2004. The increase was due to the increased focus on the oncologybusiness.  Oncology research anddevelopment expenditures for the six months ended June 29, 2005 was $5.2million, an increase of $808,000 from the 2004 period, and Huntington’s Diseaserelated spending decreased by $149,000. Increased oncology expense was primarily due to increased salaries($505,000), increased manufacturing costs associated with preparing TPI 287 for clinical trials ($56,000), and supplies andmaintenance ($194,000).  The decreaserelated to the Huntington’s Disease program was due tolower compensation expense and a reduction in consulting and contract researchexpenses.

 

*General and Administrative Expense.*  General and administrative expense for thesix months ended June 29, 2005 was $3.1 million, a decrease of $1.1 millionfrom the 2004 period.  This decrease wasprimarily due to lower compensation ($574,000), lower consulting, accountingand other outside service costs ($133,000), lower outside legal ($96,000), andlower insurance and other occupancy expense ($242,000).

 

*Interest and Other Income.*  Interest and other income for the first sixmonths of 2005 increased by $86,000 compared to the prior year period.  The increase was attributable to higherinterest rates, partially offset by a lower cash balance, as well as a $75,000realized gain on sale of investments.

 

*Interest and Other Expense.*  Interest and other expense for the first sixmonths of 2005 of $411,000 was $62,000 less than the prior year period.  Interest expense decreasedby $183,000 due to a partial repayment of our obligations to TL Ventures inFebruary 2005 in connection with the restructuring of our notes with them.  This reduction was partially offset by a $104,000 impairment on the value of land.

 

*Discontinued Operations.** *Loss from discontinued operations was $308,000 for thefirst six months of 2005, a decrease of $1.8 million from the prior yearperiod.  This decrease was primarily theresult of the closure of the Genomics Division. Research and development expense included in discontinued operations forthe first six months of 2005 was $353,000, a decrease of $1.8 million from thefirst six months of 2004.  The decreasewas primarily the result of the closure of the Genomics Division.  There was no general and administrativeexpense included in discontinued operations for the first six months of 2005and 2004.  Included in discontinuedoperations in the first six months of 2005 was a gain of approximately $41,000 resultingfrom the sale of assets related to the Genomics Division.

 

**Liquidity and Capital Resources**

 

Our working capitalrequirements for research and development have been, and will continue to be,significant.  As of June 29, 2005 we hada working capital balance of $19.4 million compared to a working capitalbalance of $23.5 million at December 29, 2004. Through June 29, 2005, we have funded our capital requirements primarilywith the net proceeds of public offerings of common stock of approximately$21.1 million, with private placements of equity securities of approximately$67.5 million, with the exercise of warrants and options of approximately $8.0million and with net 

 

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indebtedness of approximately $4.7million.  We also have funded our capitalrequirements from the net proceeds of the sale of our paclitaxelbusiness to Mayne  Pharma(USA) Inc. (f/k/a Faulding Pharmaceutical, Inc.)(“Mayne  Pharma”), a subsidiary of Mayne Group Limited, on December 12, 2003 and itsoperations prior to that date.

 

In February 2002, wesold privately $8.0 million of common stock issued at $9 per share and $8.0million principal of five-year 4% convertible subordinated debenturesconvertible into common stock at $15 per share to TL Ventures V, L.P. and oneof its affiliated funds.  No placementagent was involved in the transaction. The net proceeds were $15.6 million. As part of this transaction, we recorded a discount attributable to theconversion feature of the convertible debentures in the amount of $3.1 million,which was amortized over the term of the debentures.  In connection with the February 18, 2005settlement of litigation with TL Ventures over whether the debentures weresubject to redemption upon completion of the sale of our paclitaxelbusiness to Mayne  Pharma,we paid approximately $3,184,000 in cash and issued promissory notes in theamount of $4,670,000 in exchange for the delivery of the debentures by TLVentures to the Company for cancellation. The notes do not bear interest and are payable in monthly installmentsof $50,000 beginning in February 2005, $110,000 in 2006 and $150,000 in2007 with a $1,000,000 payment due on January 31, 2008.  Accrued interest of approximately $134,000was included in the cash payment made as part of the settlement.  We recorded the obligation resulting from thesettlement on our balance sheet as of December 29, 2004.  We imputed an interest rate of 18% on thenotes.  No gain or loss was recognized inconnection with the settlement.

 

In March 2004, we sold 2,000,000 shares of our common stock at$2.60 per share under a shelf registration statement.  The net proceeds from the transaction were$4.9 million after payment of advisory fees and legal fees in connection withthe transaction.  While additional sharesof our common stock are registered for sale under the shelf registrationstatement, we will not be able to sell shares thereunderunless and until the aggregate market value of common equity held by non-affiliatesof the company is $75 million or more. As of July 28, 2005, such aggregate market value approximated $17.1million.  As a result of ourineligibility to issue securities under a shelf registration statement, anyissuance of securities is likely to be effected through a private placement ofsuch securities followed by our registering the resale of such shares by thepurchaser.

 

Cash and cash equivalents decreased $1.0 million to $668,000 atJune 29, 2005 from $1.7 million at December 29, 2004.  Cash, cash equivalents, short-term andlong-term investments decreased $14.6 million to $21.1 million at June 29, 2005from $35.7 million at December 29, 2004. The decrease was primarily due to the $3.2 million payment for the TLVenture’s settlement, and $11.2 million net cash used by operating activities.

 

We believe existing capitalwill be adequate to fund our operations and capital expenditures for at leastthe next 12 months.  However,pharmaceutical development is a costly, risky and time intensive activity.  To bring our various programs to completionwill require us to raise additional capital in the near future, and we areactively pursuing efforts to do so. While such capital raising will likely take theform of a private placement of equity securities, it is possible it could takeanother form.  Raising additional capitalat current market prices for our common stock will result in substantialdilution to existing stockholders because our capital requirements aresubstantial relative to our current market capitalization. We cannot assure youthat we will be able to obtain additional capital on terms that will beacceptable to us or on any terms.  Inaddition, we may seek to in-license or purchase new products ortechnologies.  The cost and related capitalexpenditures of acquiring and developing such resources may be significant, andwe may not be able to obtain capital for the development of these products ortechnologies.  See the risks discussedunder “Special Note Regarding Forward-Looking Statements” below.

 

On February 25, 2005,we received notice from the NasdaqStock Market, Inc. (“Nasdaq”) that our minimumbid price had fallen below $1.00 for 30 consecutive business days and that ourcommon stock is, therefore, subject to delisting from the NasdaqSmallCap Market. We have until August 24, 2005 (180 calendar days fromFebruary 25, 2005) to regain compliance. We can regain compliance with the minimum bid price rule if the bidprice of our common stock closes at $1.00 or higher for a minimum of 10consecutive business days during the initial 180-day period, although Nasdaq may, at its discretion, require an issuer tomaintain a bid price of at least $1.00 per share for a period in excess of tenconsecutive business days (but generally no more than 20 consecutive businessdays) before determining that the issuer has demonstrated the ability tomaintain long-term compliance.  Ifcompliance is not achieved by August 24, 2005, we may be eligible foranother 180 day compliance period (until February 20, 2006) if we meet theNasdaq  SmallCap Marketinitial listing criteria, other than the minimum bid price requirement.  No assurance can be given that we will beeligible for the additional 180 day compliance period or, if applicable, thatwe will regain compliance during any additional compliance period.  If we fail to meet all applicable Nasdaq  SmallCap Marketrequirements and Nasdaqdetermines to delist our common stock, the delistingcould adversely affect the market liquidity of our common stock and the marketprice of our common stock could decrease. Such delisting could then adverselyaffect our ability to obtain financing for the continuation of our operationsand/or result in the loss of confidence by investors, suppliers and employees.

 

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We received stockholderapproval at our 2005 Annual Meeting granting the Board of Directors theauthority to effect a reverse stock split as one wayto address the Nasdaq listing issues relating tominimum bid price.  The Board is notrequired to implement the reverse stock split, and intends to do so only if itdetermines that a reverse stock split would be in the best interest of theCompany.

 

###### **Critical Accounting Policies**

###### ** **

The Company’s critical accounting policies are presented in its AnnualReport on Form 10-K for the year ended December 29, 2004.  There were no changes to these criticalaccounting policies during the quarter ended June 29, 2005.

 

In accordance with Statement of Financial Accounting Standards No. 144(“SFAS 144”), *Accounting for theImpairment of Long-Lived Assets*, we review the carrying amount oflong-lived assets when facts and circumstances suggest they may beimpaired.  If this review indicateslong-lived assets will not be recoverable as determined based on theundiscounted cash flow estimated to be generated by these assets, we reduce thecarrying amount of these long-lived assets to estimated fair value ordiscounted cash flow, as appropriate.  Aspart of our preparation of these financial statements, we recognized animpairment charge on land of $104,000 in the second quarter.  This impairment charge was the onlyimpairment of long-lived assets recorded in the second quarter.

 

# **Recent AccountingPronouncement**

# ** **

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123(R) (“SFAS 123(R)”), *Accounting for Stock-Based Compensation*.  SFAS 123(R)establishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services.  This statement focuses primarily onaccounting for transactions in which an entity obtains employee services inshare-based payment transactions.  SFAS 123(R) requires that the fair value of such equityinstruments be recognized as an expense in the historical financial statementsas services are performed.  Prior to SFAS 123(R), only certain pro forma disclosures of fairvalue were required.  The provisions ofthis statement are effective at the beginning of the next fiscal year.  Accordingly, the Company will adopt SFAS 123(R) commencing with the quarter endingMarch 29, 2006.  The adoption of SFAS 123(R) is expected to have a material effect on theCompany’s results of operations.

 

**Special Note Regarding Forward-Looking Statements**

 

The statements in this report that are not historical facts areforward-looking statements that represent management’s beliefs and assumptionsas of the date of this report, based on currently available information.  Forward-looking statements can be identifiedby the use of words such as “believe”, “intend”, “estimate”, “may”, “will”, “should”,“anticipated”, “expected,” “trusts” or comparable terminology or by discussionsof strategy.  Such forward-lookingstatements may include, among others:

 

•      statementsconcerning the success of TPI 287 in clinical trialsand our ability to pursue additional clinical trials relating to TPI 287, and the timing of any such further clinicaldevelopment;

 

•      statements concerning our plans, objectives and future economicprospects, such as matters relative to developing new products;

 

•      the availability of patent and other protection for ourintellectual property;

 

•      the completion of preclinical studies, clinical trials andregulatory filings;

 

•      the prospects for, and timing of, regulatory andinstitutional review board approvals;

 

•      the need and plans for, and availability of, additionalcapital;

 

•      the amount and timing of capital expenditures;

 

•      the ability to outsource activities;

 

•      the future acquisition of technology, products or businessentities;

 

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•      prospects for future operations; and

 

•      other statements of expectations, beliefs, future plans andstrategies, anticipated events or trends and similar expressions concerningmatters that are not historical facts.

 

Although we believe that the expectations reflected in suchforward-looking statements are reasonable, we cannot assure you that theseexpectations will prove to be correct. Such forward-looking statements involve known and unknown risks,uncertainties and other factors, which may cause our actual results,performance or achievements, or industry results, to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements.   Factors that could cause or contribute to suchdifferences include, but are not limited to, those mentioned in the discussionbelow and those described in the “Risk Factors” discussion of our AnnualReport on Form 10-K for the year ended December 29, 2004 filed withthe Securities and Exchange Commission (“SEC”). As a result, you should not place undue reliance on theseforward-looking statements.

 

*RisksRelated to Financing Our Operations*

 

•      We have ahistory of net losses. We expect to continue to incur net losses, and we maynot achieve or maintain profitability.

 

•      If we fail to obtain the capital necessary to fund our operations whenneeded, we may be forced to reduce or discontinue our operations.

 

•      Any significant financing activity we undertake is likely to result insubstantial dilution to existing holders of common stock because the tradingprice of our common stock is low relative to our requirements for additionalcapital.

 

•      Any significant financing activity we undertake is likely to result in a “changeof ownership” as described in Section 382 of the Internal Revenue Code,which would have the effect of limiting the Company’s ability to utilize itsnet operating loss and tax credit carryforwards.  As of December 29, 2004, the Company hadapproximately $84.8 million in net operating loss carryforwardsand $2.6 million tax credit carryforwards that wouldbe so limited if a change of ownership were to occur.

 

*RisksRelated to Research and Development*

 

•      Our product candidates and technologies arein an early state of development and there is a high risk that they may neverbe commercialized either because of the costs of continuing development orbecause our research and development fails to produce any products ofvalue.  The results of clinical testingmay show that our product candidates are unsafe and/or ineffective andtherefore are not suitable as human therapeutics.

 

•      Our research and development efforts over a broad range of new potentialproducts and technologies may materially adversely affect our financialposition.

 

•      Our potential products and technologies must undergo rigorous clinicaltesting and regulatory approvals, which may substantially delay or prevent usfrom marketing any products.

 

•      Our oncologyand Huntington’s Disease treatment technologies are still new and indevelopment; very little data exists relative to the amount of data necessaryto have the products approved in the United States and new information mayarise which may cause us delays in designing our protocols, submittingapplications that satisfy all necessary regulatory review requirements, andultimately initiating and completing the clinical trials of our products.  There are no generally recognized and wellestablished animal models or other preclinical protocols relating to Huntington’s Disease, which makes assessment of thepotential effectiveness of our technology difficult.

 

•      We may berequired to obtain rights to proprietary technologies to further develop our business,which may not be available or may be costly.

 

•      Adverse eventsin the field of oncology may negatively impact regulatory approval or publicperception of our potential products and technologies resulting in decreaseddemand.

 

•      Our ability tomaintain our licenses for intellectual property is dependent upon our ultimatesuccess in our development programs.

 

•      We may beunable to attract and retain the qualified employees we need to be successful.

 

•      Testing of ourpotential products and technologies relies heavily on the voluntaryparticipation of both study centers and patients in our clinical trials, whichare not within our control.  Difficultiesin obtaining cooperation with clinical study centers, or difficulty in accruingvolunteers to participate in our clinical trials, would substantially delay usfrom completing development of our products. Clinical trials of other companies with competing products could makepatient recruitment more difficult for our trials.

 

•      If we acquire any other products orbusiness operations, we will incur a variety of costs, and we may never realizethe anticipated benefits of the acquisition.

 

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•      We may not besuccessful in obtaining required foreign regulatory approvals, which wouldprevent us from marketing our products internationally.

 

•      We rely onthird-parties to perform certain services for us and any interruption ortermination of these arrangements would adversely affect our business.

 

•      Our use ofhazardous materials exposes us to the risk of material environmentalliabilities, and we may incur substantial additional cost to comply withenvironmental laws in connection with the operation of our research andmanufacturing facilities.

 

*RisksRelated to the Pharmaceutical Business We May Develop in the Future*

 

•      Acceptance ofour potential products in the marketplace is uncertain, and failure to achievemarket acceptance will limit our ability to generate revenue and becomeprofitable.

 

•      We expect that we will face significant competition, which may limit ourability to become profitable.

 

•       Technologicalchange and approvals of competitive products may make any products andtechnologies we develop less attractive or obsolete.

 

•      If we areunable or fail to adequately protect our proprietary technologies, thirdparties may be able to use our technology, which could impair our ability tocommercialize our potential products, and to compete in the marketplace.

 

•      Litigation or third-party claims of intellectual property infringementwould require us to spend substantial time and money and adversely affect ourability to develop and commercialize future products.

 

•      We have no experience in manufacturing our potential therapeuticproducts, and currently no manufacturing facilities, which raises anuncertainty about our ability to manufacture our potential therapeutic productscost-effectively.

 

•      We have no experience in marketing or selling our potential therapeuticproducts and technologies, which raises an uncertainty about our ability tocommercialize our potential therapeutic products cost-effectively.

 

•      We may be required to rely on strategic partners for the development,marketing and manufacturing of future products and technologies which may delayor impair our ability to generate significant revenue and may otherwiseadversely affect our profitability.

 

•      In the event we receive regulatoryapproval for our product candidates, we will be subject to ongoing regulatoryobligations.

 

•      Legislative and regulatory proposals toreduce the cost of health care may adversely affect our business.

 

•      If productliability lawsuits are successfully brought against us, we may incursubstantial liabilities and may be required to limit commercialization of ourproduct candidates.

 

•      We may beunable to effectively price our products or obtain adequate reimbursement forsales of our products, which would prevent our products from becomingprofitable.

 

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*RisksRelated to Our Status as a Public Company*

 

•      Our stock price is volatile, and your investment in our stock coulddecline in value.

 

•      Future sales and issuances of common stock may dilute our stockholders orcause our stock price to decline.

 

•      We received notice from the NasdaqStock Market, Inc. on February 25, 2005 that the minimum bid price ofour common stock had fallen below $1.00 for 30 consecutive days and that ourcommon stock will be delisted if the minimum bidprice does not exceed $1.00 per share during the periods permitted by theirrules to regain compliance.  If wedo not regain compliance and Nasdaqdelists our common stock, the delisting couldadversely affect the market liquidity of our common stock and the market priceof our common stock could decrease.

 

*OtherRisks Related to Our Business*

 

•      The loss of our Chairman and Chief Executive Officer, Leonard P. Shaykin, or other key executives, could severely harm ourbusiness.

 

•      We may beunable to renew or extend the leases on our leased facilities.

 

These and other factors related to the Company’s business are describedin more detail under the caption “Risk Factors” or “Special Note RegardingForward-Looking Statements” in the Company’s documents filed from time to timewith the SEC.  Should one or more of theserisks materialize (or the consequences of such a development worsen), or shouldthe underlying assumptions prove incorrect, actual results could differmaterially from those forecasted or expected. We undertake no obligation to update any of the forward-lookingstatements after the date of this Quarterly Report on Form 10-Q to conformsuch statements to actual results, except to the extent required by law.

 

**Item 3.****  Quantitativeand Qualitative Disclosures about Market Risk**

 

We currently invest our excess cash balances in money market accounts,and short-term and long-term investments that are subject to interest raterisk.  The amount of interest income we earn on these funds will change asinterest rates in general change.  Our investments are subject to a lossof principal if market interest rates increase and they are sold prior tomaturity.  However, due to the short-termnature of the majority of our investments, the high credit quality of ourportfolio and our ability to hold our investments until maturity, an immediate 1%change in interest rates would not have a material impact on our financialposition, results of operations or cash flows.

 

###### **Item4.**  Controls and Procedures

###### ** **

The Company maintains a system of disclosure controls andprocedures.  The term “disclosure controls and procedures,” as defined by regulations of the SEC, means controls andother procedures that are designed to ensure that information required to bedisclosed in the reports that the Company files or submits to the SEC under theSecurities Exchange Act of 1934, as amended (“the Act”), is recorded,processed, summarized andreported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bythe Company in the reports that it files or submits to the SEC under the Act isaccumulated and communicated to the Company’smanagement, including its Principal Executive Officer and its PrincipalFinancial Officer, as appropriate to allow timely decisions to be maderegarding required disclosure.  TheCompany carried out an evaluation, under the supervision and with theparticipation of the Company’smanagement, including the Company’s 

 

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Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’sdisclosure controls and procedures as of June 29, 2005.  Based upon that evaluation, the Company’sChief Executive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to the Company required to be included in theCompany’s periodic SEC filings.

 

Any system of controls, however well designed and operated,can provide only reasonable, and not absolute, assurance that the objectives ofthe system are met.  In addition, thedesign of any control system is based in part upon certain assumptions aboutthe likelihood of future events.  Becauseof these and other inherent limitations of control systems, there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.

 

There have been no changes in our internal controls over financialreporting during the fiscal quarter ended March 30, 2005 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**Part II- Other Information**

** **

**Item 1.****  Legal Proceedings**

 

See the Company’s Quarterly Report on Form10-Q for the quarter ended March 30, 2005 for a discussion of the settlement ofour litigation with TL Ventures in February 2005.

 

**Item 2.****  UnregisteredSales of Equity Securities and Use of Proceeds**

 

The Company transferred 750,000 shares of common stock to its EmployeeStock Ownership Plan in April 2005.  As atransfer by the Company to a noncontributory benefit plan, no sale ofsecurities was involved.

 

##### **Item 3.**  Defaults uponSenior Securities

##### ** **

Not applicable.

 

**Item 4.****  Submission ofMatters to a Vote of Security Holders**

 

The Company’s 2005 annual meeting of stockholders was held on June 10,2005.  A total of 31,131,299 shares ofthe Company’s voting common stock were present in person or by proxy at themeeting, representing 93% of the Company’s outstanding voting common stock onthe record date.  All directors wereelected and all other matters submitted to a vote of the Company’s stockholderswere approved as follows:

 

1.             The election of threedirectors to hold office until the 2008 Annual Meeting:

 
| **Nominee**           | ** ** | **FOR**    | ** ** | **WITHHOLD/ABSTAIN** | ** ** |
|-----------------------|------------|------------|------------|----------------------|------------|
|                  |       |       |       |                 |       |
| Dr. Stephen K. Carter |       | 29,880,787 |       | 1,250,512            |       |
|                  |       |       |       |                 |       |
| George M. Gould       |       | 29,491,654 |       | 1,680,105            |       |
|                  |       |       |       |                 |       |
| Elliot M. Maza        |       | 29,914,474 |       | 1,257,185            |       |

 

2.             Approval of theCompany’s second amended and restated certificate of incorporation:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
|       |       |        |       |        |       |
| 28,644,206 |       | 2,315,578   |       | 211,975     |       |

 

3.             Approval of anamendment to the Company’s certificate of incorporation:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
|       |       |        |       |        |       |
| 29,015,378 |       | 2,122,685   |       | 33,695      |       |

 

4.             Approval of anamendment to the Company’s 2004 Equity Incentive Plan:

 
| **FOR**   | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|
|      |       |        |       |        |       |
| 8,340,397 |       | 4,668,520   |       | 44,249      |       |

 

5.            Ratificationof the selection by the Audit Committee of the Board of Directors of GrantThornton LLP as independent auditors of the Companyfor its fiscal year endingDecember 28, 2005:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
|       |       |        |       |        |       |
| 30,698,915 |       | 401,345     |       | 71,499      |       |

 

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**Item 5.****  Other Information**

 

On July 20, 2005, the Board of Directors authorized a reduction in theCompany’s operations.  During the thirdquarter, the Company expects to eliminate 14 positions (about 30% of itsworkforce), including executive and non-executive employees and consultants inall areas of operations.  Tapestryexpects to incur one time costs of approximately $270,000, all of which will bein cash, and to complete the reduction by the end of September 2005.  The Company is taking the action to preservecash and to permit it to focus its primary effort on advancing its leadclinical programs.

 

**Item 6.****  Exhibits**

 
| **Exhibit  Number** | ** ** | **Description  of Exhibit**                                                                                                                                                                                                                    |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                |       | Certification of Chief Executive Officer (pursuant  to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of  1934, as amended)                                                                                              |
| 31.2                |       | Certification of Chief Financial Officer (pursuant  to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of  1934, as amended)                                                                                              |
| 32.1#               |       | Certification of Chief Executive Officer (pursuant  to Rule 13a-14(b) of the Securities Exchange Act of 1934, as  amended, and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. Section 1350)) |
| 32.2#               |       | Certification of Chief Financial Officer (pursuant  to Rule 13a-14(b) of the Securities Exchange Act of 1934, as  amended, and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. Section 1350)) |

 

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#              This certification “accompanies” theForm 10-Q to which it relates, is not deemed filed with the SEC and is notto be incorporated by reference into any filing of the Company under theSecurities Act of 1933, as amended, or the Securities Exchange Act of 1934, asamended (whether made before or after the date of the Form 10-Q),irrespective of any general incorporation language contained in such filing.

 

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# **Signatures**

# ** **

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

 
|           | TAPESTRY PHARMACEUTICALS, INC.            |
|----------------|-------------------------------------------|
|           |                                      |
| August 3, 2005 | By:                                       | /s/ Leonard P. Shaykin |   |
| ** **     | **Leonard P. Shaykin**                    |
| ** **     | **Chairman of the Board of Directors,**   |
| ** **     | **Chief Executive Officer**               |
| ** **     | ** **                                |
|           |                                      |
| August 3, 2005 | By:                                       | /s/ Gordon Link |   |
| ** **     | **Gordon Link**                           |
| ** **     | **Senior Vice President,**                |
| ** **     | **Chief Financial Officer**               |
| ** **     | **(Principal Financial Officer)**         |
| ** **     | ** **                                |
|           |                                      |
| August 3, 2005 | By:                                       | /s/ Bruce W. Fiedler |   |
| ** **     | **Bruce W. Fiedler**                      |
| ** **     | **Vice President, Corporate  Controller** |
| ** **     | **(Principal Accounting Officer)**        |

 

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**Indexof Exhibits**

 
| **Exhibit  Number** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                     |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                |       | Certification of Chief Executive Officer (pursuant  to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of  1934, as amended)                                                                                              |
| 31.2                |       | Certification of Chief Financial Officer (pursuant  to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of  1934, as amended)                                                                                              |
| 32.1#               |       | Certification of Chief Executive Officer (pursuant  to Rule 13a-14(b) of the Securities Exchange Act of 1934, as  amended, and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. Section 1350)) |
| 32.2#               |       | Certification of Chief Financial Officer (pursuant  to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended,  and Section 1350 of Chapter 63 of Title 18 of the United States Code (18  U.S.C. Section 1350)) |

 

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#              This certification “accompanies” theForm 10-Q to which it relates, is not deemed filed with the SEC and is notto be incorporated by reference into any filing of the Company under theSecurities Act of 1933, as amended, or the Securities Exchange Act of 1934, asamended (whether made before or after the date of the Form 10-Q),irrespective of any general incorporation language contained in such filing.

 

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