**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 MARCH 30, 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 April 28, 2005, the registrant had 33,488,995 shares ofcommon stock, $0.0075 par value, outstanding.

 

 

----

 

**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

----

 

**Part I**

**FINANCIAL INFORMATION**

 

**Item1.**** Financial Statements**

 

**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Balance Sheets**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                               | ** ** | **March 30,  2005** | ** ** | **December 29,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                               | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                          |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $                        | 625        |                        | $          | 1,713 |   |
| Short-term  investments                                                                                                                                                                  |       | 25,332                   |       | 29,378                      |       |
| Prepaid expense  and other current assets                                                                                                                                                |       | 587                      |       | 538                         |       |
| Assets held for  sale                                                                                                                                                                    |       | 112                      |       | 112                         |       |
| Total current  assets                                                                                                                                                                    |       | 26,656                   |       | 31,741                      |       |
|                                                                                                                                                                                     |       |                     |       |                        |       |
| Property, plant  and equipment, net                                                                                                                                                      |       | 670                      |       | 676                         |       |
| Long-term  investments                                                                                                                                                                   |       | —                   |       | 4,631                       |       |
| Investment in  ChromaDex, Inc.                                                                                                                                                      |       | 1,414                    |       | 1,414                       |       |
| Other assets                                                                                                                                                                             |       | 829                      |       | 831                         |       |
| Total assets                                                                                                                                                                             |       | $                        | 29,569     |                        | $          | 39,293 |   |
|                                                                                                                                                                                     |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                            | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                                                    |       |                     |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                                                                                |       | $                        | 1,943      |                        | $          | 3,119 |   |
| Accrued payroll  and payroll taxes                                                                                                                                                       |       | 982                      |       | 2,017                       |       |
| Notes payable – current portion, net                                                                                                                                                |       | 264                      |       | 3,132                       |       |
| Total current  liabilities                                                                                                                                                               |       | 3,189                    |       | 8,268                       |       |
|                                                                                                                                                                                     |       |                     |       |                        |       |
| Notes payable –  long term, net                                                                                                                                                     |       | 3,117                    |       | 3,245                       |       |
|                                                                                                                                                                                     |       |                     |       |                        |       |
| Commitments and  contingencies                                                                                                                                                           |       |                     |       |                        |       |
|                                                                                                                                                                                     |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                                                                                              |       |                     |       |                        |       |
| Preferred stock,  $.001 par value; 2,000,000 shares authorized; none issued                                                                                                              |       | —                   |       | —                      |       |
| Common stock,  $.0075 par value; 64,000,000 shares authorized; 33,488,995 and 33,435,401  shares issued and outstanding at March 30, 2005 and December 29,  2004, respectively |       | 251                      |       | 251                         |       |
| Additional  paid-in capital                                                                                                                                                              |       | 117,415                  |       | 117,354                     |       |
| Accumulated  deficit                                                                                                                                                                     |       | (94,288                  | )          | (89,724                     | )          |
| Accumulated  other comprehensive loss                                                                                                                                                    |       | (115                     | )          | (101                        | )          |
| Total  stockholders’ equity                                                                                                                                                         |       | 23,263                   |       | 27,780                      |       |
| Total  liabilities and stockholders’ equity                                                                                                                                         |       | $                        | 29,569     |                        | $          | 39,293 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

3

----

 

**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Statements of Operations**

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

**(Unaudited)**

 
| ** **                                                     | ** ** | **Quarter Ended**        | ** ** |
|----------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                     | ** ** | **March 30,  2005** | ** ** | **March 31,  2004** | ** ** |
|                                                           |       |                     |       |   |   |
| Operating  expenses:                                           |       |                     |       |   |   |
| Research and  development                                      |       | $                        | 2,789      |   | $ | 1,753 |   |
| General and  administrative                                    |       | 1,597                    |       | 2,145 |   |
| Operating loss                                                 |       | 4,386                    |       | 3,898 |   |
|                                                           |       |                     |       |   |   |
| Other income  (expense):                                       |       |                     |       |   |   |
| Interest income                                                |       | 170                      |       | 153 |   |
| Interest expense                                               |       | (167                     | )          | (235 | ) |
| Net loss from  continuing operations                           |       | (4,383                   | )          | (3,980 | ) |
|                                                           |       |                     |       |   |   |
| Discontinued  operations:                                      |       |                     |       |   |   |
| Loss from  discontinued operations                             |       | (181                     | )          | (995 | ) |
|                                                           |       |                     |       |   |   |
| Net loss                                                       |       | $                        | (4,564     | ) | $ | (4,975 | ) |
|                                                           |       |                     |       |   |   |
| Basic and  diluted loss per share from continuing operations   |       | $                        | (0.13      | ) | $ | (0.13 | ) |
| Basic and  diluted loss per share from discontinued operations |       | $                        | (0.01      | ) | $ | (0.03 | ) |
| Basic and  diluted loss per share                              |       | $                        | (0.14      | ) | $ | (0.16 | ) |
|                                                           |       |                     |       |   |   |
| Basic and diluted  weighted average shares outstanding         |       | 33,457                   |       | 31,068 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

4

----

 

**TapestryPharmaceuticals, Inc. and Subsidiaries**

**ConsolidatedCondensed Statements of Cash Flows**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Quarter Ended**       | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                   | ** ** | **March 30, 2005** | ** ** | **March 31, 2004** | ** ** |
| Operating  activities:                                                       |       |                    |       |   |   |
| Net loss                                                                     |       | $                       | (4,564     | ) | $ | (4,975 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                    |       |   |   |
| Depreciation and  amortization                                               |       | 69                      |       | 125 |   |
| Amortization of  debt issue cost                                             |       | 92                      |       | 11 |   |
| Amortization of  debt discount                                               |       | 70                      |       | 139 |   |
| Amortization of  investment premium                                          |       | 88                      |       | — |   |
| Interest paid  with common stock                                             |       | —                  |       | 30 |   |
| Compensation  paid with common stock and options                             |       | 30                      |       | 93 |   |
| Impairment loss  on assets held for sale                                     |       | —                  |       | 205 |   |
| Changes in  operating assets and liabilities:                                |       |                    |       |   |   |
| Accounts  receivable                                                         |       | —                  |       | 1,496 |   |
| Assets of  discontinued operations                                           |       | —                  |       | (250 | ) |
| Prepaid expense  and other assets                                            |       | (47                     | )          | 69 |   |
| Accounts payable  and accrued liabilities                                    |       | (1,176                  | )          | (1,533 | ) |
| Accrued payroll  and payroll taxes                                           |       | (1,035                  | )          | (1,150 | ) |
| Net cash (used  in) operating activities                                     |       | (6,473                  | )          | (5,740 | ) |
|                                                                         |       |                    |       |   |   |
| Investing  activities:                                                       |       |                    |       |   |   |
| Additions to  property and equipment                                         |       | (63                     | )          | (59 | ) |
| Purchases of  investment                                                     |       | (6,400                  | )          | (23,234 | ) |
| Proceeds from  sale of investments                                           |       | 14,975                  |       | 28,507 |   |
| Net cash  provided by investing activities                                   |       | 8,512                   |       | 5,214 |   |
|                                                                         |       |                    |       |   |   |
| Financing  activities:                                                       |       |                    |       |   |   |
| Payments of  notes payable                                                   |       | (3,158                  | )          | (26 | ) |
| Proceeds from  the sale of common stock, net of issuance cost                |       | —                  |       | 4,857 |   |
| Proceeds from  the exercise of common stock options                          |       | 31                      |       | 23 |   |
| Net cash (used  in) provided by financing activities                         |       | (3,127                  | )          | 4,854 |   |
| Net (decrease)  increase in cash and cash equivalents                        |       | (1,088                  | )          | 4,328 |   |
| Cash and cash  equivalents at beginning of period                            |       | 1,713                   |       | 2,281 |   |
| Cash and cash  equivalents at end of period                                  |       | $                       | 625        |   | $ | 6,609 |   |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

5

----

 
| ** **                                                | ** ** | **Quarter Ended**       | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                | ** ** | **March 30, 2005** | ** ** | **March 31, 2004** | ** ** |
| Supplemental  disclosure of cash flow information:        |       |                    |       |   |   |
|                                                      |       |                    |       |   |   |
| Interest paid                                             |       | $                       | 135        |   | $ | 4 |   |
|                                                      |       |                    |       |   |   |
| Non-cash  investing and financing activities:             |       |                    |       |   |   |
| Issuance of  common stock for payment of interest payable |       | —                  |       | 131 |   |
|                                                           |            |                         |            |  |  |  |  |

 

See accompanying notes toConsolidated Condensed Financial Statements.

 

6

----

 

**TapestryPharmaceuticals, Inc.**

**Notes toConsolidated Condensed Financial Statements**

**March 30,2005**

**(Unaudited)**

 

**Note 1.  Basisof Presentation**

 

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 year 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 APB No. 25,compensation expense to employees is recorded only if the fair value of theunderlying stock exceeds the exercise price on the grant date.  Stock options granted to consultants areaccounted for under the fair value method, in accordance with Statement ofFinancial Accounting Standards No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*.

 

Proforma information regarding net income and earnings per share is required bySFAS 123 and Statement of Financial Accounting Standards No. 148, *Accounting for Stock-Based Compensation Transition and Disclosure*,which requires that the information be determined as if the Company hadaccounted for employee stock options granted subsequent to December 31,1994 under the fair value method of that statement.  Tapestry estimated the fair value for theseoptions at the date of grant using a Black-Scholes option pricing model withthe following weighted-average assumptions for the quarters ended March 30,2005 and March 31, 2004, respectively: risk-free interest rates of 3.58%and 2.84% to 3.55%; no expected dividend; volatility factors of 1.233 and 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 as follows(in thousands, except per share amounts):

 
| ** **                                                                                                        | ** ** | **Quarter Ended**        | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                        | ** ** | **March 30,  2005** | ** ** | **March 31,  2004** | ** ** |
| Net loss as  reported                                                                                             |       | $                        | (4,564     | ) | $ | (4,975 | ) |
| Deduct: Total  stock based employee compensation expense determined under fair value based  method for all awards |       | (759                     | )          | (881 | ) |
| Pro forma net  loss                                                                                               |       | $                        | (5,323     | ) | $ | (5,856 | ) |
|                                                                                                              |       |                     |       |   |   |
| Basic and  diluted loss per share - as reported                                                                   |       | $                        | (0.14      | ) | $ | (0.16 | ) |
| Pro forma basic  and diluted loss per share                                                                       |       | $                        | (0.16      | ) | $ | (0.19 | ) |

 

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123(R) (“SFAS 123(R)”), *Accounting for Stock-BasedCompensation*.  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.  SFAS123(R) requires that the fair value of such equity instruments be recognized asan expense in the historical financial statements as services areperformed.  Prior to SFAS 123(R), onlycertain pro forma disclosures of fair value were required.  The provisions of this statement areeffective at the beginning of the next fiscal year.  Accordingly, the Company will adopt SFAS123(R) commencing with the quarter ending March 29, 2006.  The adoption of SFAS 123(R) is expected tohave a material effect on the Company’s results of operations.

 

7

----

 

# **Note 4.**  NasdaqDelisting Notice

 

On February 25, 2005, theCompany received notice from the Nasdaq Stock Market, Inc. (“Nasdaq”) thatits minimum bid price had fallen below $1.00 for 30 consecutive business daysand that its common stock is, therefore, subject to delisting from the NasdaqSmallCap Market.  The Company has until August 24,2005 (180 calendar days from February 25, 2005) to regain compliance.  The Company can regain compliance with theminimum bid price rule if the bid price of its common stock closes at$1.00 or higher for a minimum of 10 consecutive business days during theinitial 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 willbe eligible for another 180 day compliance period (until February 20,2006) if we meet the Nasdaq SmallCap Market initial listing criteria, otherthan the minimum bid price requirement. No assurance can be given that the Company will be eligible for theadditional 180 day compliance period or, if applicable, that the Company willregain compliance during any additional compliance period.  If the Company fails to meet allapplicable Nasdaq SmallCap Market requirements and Nasdaq determines to delist itscommon stock, the delisting could adversely affect the market liquidity of itscommon stock and the market price of its common stock could decrease. Suchdelisting could then adversely affect the Company’s ability to obtain financingfor the continuation of its operations and/or result in the loss of confidenceby investors, suppliers and employees.

 

The Company is seekingstockholder approval at its 2005 Annual Meeting to grant authority for theBoard of Directors to effect a reverse stock split as one way to address theNasdaq listing issues relating to minimum bid price.  If stockholder approval is obtained, theBoard is not required to implement the reverse stock split, but would do soonly if it determines it to be in the best interests of the Company.

 

# **Note 5.  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 forthese programs.  After efforts to sellthe intellectual property assets related to the genomics programs over the 

 

8

----

 

course of the fourth quarter, the Company determined that there were noactively interested buyers.  The Companyrecorded in the fourth quarter of 2004 a charge of $1.7 million primarilyrelating to an impairment of intangible assets acquired in connection with the December 2002acquisition of the genomics business of Pangene Corporation ($1.1 million), acharge for fixed assets 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 as incurred.  Most costs relating to the closure wereincurred by the end of January 2005, although certain lease costs willcontinue through May 2005.

 

In December 2003, the Company made a decision to sell its geneisolation and service business, which was acquired in December 2002 andwas accounted for as a discontinued operation.  Net operating loss related to this businesstotaled $0 and $211,000 during the first quarter of 2005 and 2004,respectively.  In the first quarter of2004, the Company recorded an impairment loss of $205,000 for assets that hadbeen identified as held for sale.

 

Assets held for sale, at March 30, 2005 and December 29, 2004,which relate to the discontinued operations of the genomics business were asfollows (in thousands):

 
| ** **                          | ** ** | **March 30,  2005** | ** ** | **December 29,  2004** | ** ** |
|-------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Property, plant  and equipment, net |       | $                        | 112        |                        | $          | 112 |   |
|                                     |            |                          |            |                             |            |  |  |

 

Net losses related to the Genomics Division that are included in discontinuedoperations totaled $181 thousand and $1.04 million at March 30, 2005 and March 31,2004, respectively.  No material revenuewas previously recognized in this division.

 

Sale of PaclitaxelBusiness

 

On December 12,2003, the Company sold its worldwide generic injectable paclitaxel business toMayne Pharma (USA)Inc. (f/k/a/ Faulding Pharmaceutical Co.) (“MaynePharma”), a subsidiary of 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 fund the development andcommercialization of products based on Tapestry’s proprietary oncologyplatforms and for general corporate purposes. In addition, approximately $21.9 million of the proceeds of thepurchase price was paid to Abbott Laboratories (“Abbott”) to retire alloutstanding debt, interest and payables the Company owed to Abbott.  The assets sold to Mayne Pharma includedpaclitaxel manufacturing assets, yew plantations, domestic and internationalissued and pending paclitaxel patents, a worldwide registration dossier,worldwide development and supply agreements, inventories and settlement ofaccounts receivable.  The Companyretained all of its intellectual property not used in connection with thebusiness sold.

 

The paclitaxel business was reported as a discontinued operation in the2004.   Summary results of the paclitaxel business’sfirst quarter operations were (in thousands):

 
| ** **    | ** ** | **March 30,  2005** | ** ** | **March 31,  2004** | ** ** |
|---------------|------------|--------------------------|------------|--------------------------|------------|
| Product sales |       | $                        | —     |                     | $          | — |   |
| Net income    |       | $                        | —     |                     | $          | 251 |   |

 

Paclitaxel income in the first quarter of 2004 consisted primarily of a$250,000 business interruption insurance claim filed in 2004 for lossessustained in the third quarter of 2003, which resulted from a hurricane thatdisrupted operations of a contract manufacturer employed by Tapestry.

 

# **Note 6.  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, despite the long-term nature oftheir stated contractual maturities, the Company has the ability and intent to liquidateinvestments in auction rate securities within

 

9

----

 

six 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**        | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **March 30,  2005** | ** ** | **March 31,  2004** | ** ** |
| Net loss, as  reported                                   |       | $                        | (4,564     | ) | $ | (4,975 | ) |
| Unrealized gain  (loss) on available-for-sale securities |       | (14                      | )          | 15 |   |
| Comprehensive  net loss                                  |       | $                        | (4,578     | ) | $ | (4,960 | ) |

 

# **Note 7.  Property, Plant and Equipment**

 

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

 
|                                            |   | **March 30,  2005** | ** ** | **December 29,  2004** |   |
|-------------------------------------------------|--------|--------------------------|------------|-----------------------------|--------|
| Furniture,  fixtures and office equipment       |   | $                        | 696        |                        | $      | 678 |   |
| Laboratory  equipment                           |   | 644                      |       | 589                         |   |
| Leasehold  improvements                         |   | 38                       |       | 38                          |   |
| Construction in  progress                       |   | 12                       |       | 22                          |   |
|                                            |   | 1,390                    |       | 1,327                       |   |
| Less accumulated  depreciation and amortization |   | (720                     | )          | (651                        | )      |
| Property, plant  and equipment, net             |   | $                        | 670        |                        | $      | 676 |   |

 

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

 

In April 2003, the Company sold its technical and analytical servicesgroup to privately held ChromaDex, Inc. in exchange for approximately 15%,on a fully diluted basis, of the then outstanding 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 asupplier of phytochemical reference standards for the nutraceutical, dietarysupplement and functional food industries.

 

# **Note 9.  Notes Payable, Current and Long-Term**

# ** **

On February 18, 2005, theCompany entered into an agreement with TL Ventures providing for a completesettlement of our 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 deliveryof the debentures to the Company for cancellation.  The notes are payable in monthly installmentsof $50,000 beginning in February 2005, $110,000 in 2006 and $150,000 in2007, with a final payment of $1,000,000 due on January 31, 2008.  The notes do not bear interest; however, animputed interest rate of 18% was used to determine a fair carrying value of thenotes.  Accrued interest of approximately$134,000 was included in the cash payment made with the closing.  The Company recorded the obligation resultingfrom the settlement on our balance sheet as of December 29, 2004.

 

# **Note 10.  Stockholders’ Equity**

# ** **

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

 

10

----

 

# **Note 11.  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 17,670 shares at March 30, 2005 and154,172 shares at March 31, 2004) that have an antidilutive effect areexcluded from diluted earnings per share. Net loss per common share is computed using the weighted average numberof shares of common stock outstanding.

 

11

----

 

##### **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 ended December 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.  We are also actively engaged in evaluating new therapeuticagents and/or related technologies.  Ourevaluation of new products and technologies may involve the examination ofindividual molecules, classes of compounds, or platform technologies.  Acquisitions of new products or technologiesmay involve the purchase or license of such products or technologies, or theacquisition of, or merger with, other companies.

 

Until the end of 2003, the primary focus of our business was theproduction, approval and sale of paclitaxel (a naturally occurringchemotherapeutic anti-cancer agent found in certain species of yew, or *Taxus,* trees) in the United States andother countries around the world.  Themajority of our efforts had been devoted to this endeavor.  Due to the decline in price of paclitaxel inconsequence of the generic competition in the United States, on December 12,2003, we sold our worldwide genericinjectable paclitaxel business to Mayne Pharma for cash in the amount of$71.7 million minus an inventory adjustment of $4.6 million to reflect theCompany’s actualinventory as of the closing.  Inaddition, Mayne Pharma assumed certain liabilities associated with ourpaclitaxel business.  Approximately$21.9 million****of the proceedsof the transaction were paid to Abbott to retire all outstanding debt andpayables we owed to Abbott.  Theremaining proceeds from the sale are being used to fund our clinical trials,development of our proprietary products and for general corporate purposes.

 

In November 2004 we discontinued research on our genomicsprograms, other than the Huntington’s Disease program, and sought a buyer ofthese programs.  After completingreasonable 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.

 

We will incur substantialresearch and development expense related to the development of our proprietaryanti-cancer agents.  We have incurredsignificant losses, including losses from continuing operations of $4.4 millionfor the three months ended March 30, 2005. Our accumulated deficit was $94.3 million as of March 30, 2005.  We anticipate that losses will continue untilsuch time, if ever, as we are able to commercialize our product candidates and generatesufficient sales to support our development operations, including the researchand development activity 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.  Ouroncology program consists of developing both targeted as well as non-targetedchemical compounds for the treatment of cancer.

 

We filed an Investigational New Drug (“IND”) application on December 21,2004 covering TPI 287, a novel third generation taxane, and on January 21,2005, we were cleared to proceed into clinical trials by the U.S. Food and DrugAdministration (“FDA”).  Accordingly, webelieve we will be able to commence human clinical trials with TPI 287 in thesecond quarter of 2005.  Other programsin development include our quassinoids, peptide linked cytotoxics and oligotherapy.  Currently, we cannot predictwhen or if any of these programs will be advanced into clinical development.

 

12

----

 

**Research and Development**

 

Our current business is focused on research and development of proprietary therapiesfor the treatment of cancer and Huntington’s Disease, a progressive, inherited,neurological disorder resulting in degeneration of neural tissue.  The table below shows our research anddevelopment expense by major category, with the expense related to our GenomicsDivision included in discontinued operations (in thousands):

 

 
| ** **                 | ** ** | **Three months ended**    | ** ** |
|----------------------------|------------|---------------------------|------------|
| ** **                 | ** ** | **March 30,   2005** | ** ** | **March 31,   2004** | ** ** |
|                       |       |                      |       |   |   |
| Oncology                   |       | $                         | 2,617      |   | $ | 1,485 |   |
| Huntington’s  Disease |       | 172                       |       | 268 |   |
| Discontinued  operations   |       | 230                       |       | 1,035 |   |
|                       |       | $                         | 3,019      |   | $ | 2,788 |   |

 

13

----

 

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, and Colon Cancers |       | Received  FDA clearance to commence Phase I Clinical Trial |
|                       |       |                                                                   |       |                                                       |
| Quassinoids                |       | Cancers                                                                |       | Preclinical Development                                    |
|                       |       |                                                                   |       |                                                       |
| Peptide Linked  Cytotoxics |       | Cancers                                                                |       | Preclinical Development                                    |
|                       |       |                                                                   |       |                                                       |
| Oligo Therapy              |       | Huntington’s Disease                                              |       | Preclinical Development                                    |

 

•                  TPI287 is a novel third generation taxane. On December 21, 2004, we filed an Investigational New Drug (“IND”)application, and on January 21, 2005, we were cleared to proceed into clinicaltrials by the U.S. Food and Drug Administration (“FDA”).  Assuming that we are able to manufacture andformulate sufficient quantities of TPI 287 for clinical testing, and we obtainauthorization from institutional review boards and other relevant bodies, webelieve we will be able to commence human clinical trials with TPI 287 in the secondquarter of 2005.  In preclinical testing,TPI 287 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 against standard comparativeagents.  The *in vitro*activity was seen across multiple cell lines including cell lines known to besensitive to taxanes and cell lines known to be resistant to taxanes.  Taxane sensitive cell lines in which TPI 287shows activity include cell lines derived from breast cancer, uterine cancerand small cell lung cancer.  Taxaneresistant cell lines in which TPI 287 shows activity include lines derived frombreast cancer, colon cancer, prostate cancer and pancreatic cancer.  In *in vivo* animaltesting, TPI 287 demonstrated tumor growth inhibition activity in four tumorcell lines with multiple drug resistance, or MDR1.

 

•                  Quassinoidsare complex polyfunctional, polycyclic natural products of the plant family *Simaroubaceae*, which exhibitantineoplastic activity.  We have in-licensed several quassinoidcompositions as well as their isolation and synthesis.  We have completedseveral *in vitro* and *in vivo* preclinical studies on ourproprietary quassinoid analogs, and additional preclinical studies are inprogress to better delineate the antineoplastic activity of thesecompounds.  Currently, we can not predict when or if any of these quassinoidswill be advanced into clinical development.

 

•                  Peptidelinked conjugates consist of a synthetic peptide ligand chemically linked to acytotoxic agent.  The new chemical entitythus created appears to 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 linked conjugate, which indicate thatthis compound has activity in certain cancer cell lines.  We are currently conducting studies onadditional proprietary peptide linked compounds to further determine theactivity 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 protein aggregate formation inneural tissue.  Eventually, the patientsuffers dementia, uncontrolled movements and death.  There is no known cure for this raredisease.  Symptoms usually appear betweenthe ages of 30 and 45, although younger people can also develop thedisease.  In the United States the diseaseaffects approximately 1 of every 10,000 people. We are developing an oligonucleotide therapy, which may slow theprogression of the disease or may eliminate the death of the nerve cells.  We are in the early stages of this programand we can provide no assurance that we will be successful in this developmenteffort.  To date, we have conductedseveral *in vitro* studies to 

 

14

----

 

determine the effects of our oligonucleotide therapyin a model neuronal cell based assay and in a biochemical assay that detectsmolecules that disrupt protein aggregation. We have also recently concluded an *in vivo* animalstudy of Huntington’s Disease.  The datafrom this study indicated that the oligonucleotide therapy may have an effecton mitigating the motor deficits seen in Huntington’s Disease.  We are currently initiating an additionalstudy, which is designed to establish the dose response for the oligonucleotidetherapy in a transgenic mouse model of Huntington’s Disease that may supportthe results of previous *in vitro*and *in vivo* studies as to the efficacy of theoligonucleotide.  We expect to have thedata from this new study by the end of the third quarter of 2005.

 

Research and development,including expenses related to our clinical programs, are expected to be themost significant expense of our business going forward.  Since we anticipate beginning clinicaltesting of our third generation taxane product candidate, TPI 287, in thesecond quarter of 2005, we expect that our research and development expenseswill increase in connection with this activity. We cannot be surethat we will begin clinical testing for this program at the time we haveprojected.  We also cannot estimate thecost of the effort necessary to complete these programs, or when, if ever, wewill receive any revenues from it.  Completionof the development of this program to an approved product for sale in theUnited States and offshore is dependent upon raising additional capital.  We cannot be certain that we will be able to obtain capital onacceptable terms or at all.  We have included a number of the risks anduncertainties associated with completing our product development plans on schedule inthe “Special Note Regarding Forward-Looking Statements” below.

 

15

----

 

Results of Operations - QuarterEnded March 30, 2005 Compared to Quarter Ended March 31, 2004

 

*Research and Development Expense.*  Research and development expense fromcontinuing operations for the first quarter of 2005 was $2.8 million, an increase of $1million from the first quarter of 2004.  Theincrease was due to the increased focus on the oncology business.  Oncology research and developmentexpenditures increased by $1.1 million to $2.6 million in the first quarter of2005, and Huntington’s Disease related spending decreased by $96 thousand.  Increased oncology expense was primarily dueto manufacturing costs associated with preparing TPI 287 for clinical trials($459,000), increased consulting and outside service costs ($294,000) as wellas increased salaries ($188,000) and supplies ($108,000).  The decrease related to the Huntington’sDisease program was due to lower compensation expense and a reduction inconsulting and contract research expenses.

 

*General and Administrative Expense.*  General and administrative expense for thecurrent year quarter was $1.6 million, a decrease of $548,000 from the prioryear quarter.  This decrease wasprimarily due to lower compensation ($207,000), lower consulting ($105,000), aswell as lower insurance and other occupancy expense ($180,000).

 

*Interest Income.*  Interest income forthe first quarter of 2005 increased by $17,000 compared to the prior yearquarter.  The increase was attributableto higher interest rates, partially offset by our lower cash balance.

 

*Interest Expense.*  Interest expensefor the current year quarter of $167,000 was $68,000 less than the prior yearquarter due to repayment of the TL Ventures convertible notes in February 2005in connection with the settlement of our litigation with them.

 

*Discontinued Operations.  *Loss from discontinuedoperations was $181,000 for the current year quarter, a decrease of $814,000from the prior year quarter.  Thisdecrease was primarily the result of the closure of the Genomics Division.

 

Research and developmentexpense included in discontinued operations for the first quarter of 2005 was$230,000, a decrease of $805,000 from the first quarter of 2004.  The decrease was primarily the result of theclosure of the Genomics Division.

 

There was no general andadministrative expense included in discontinued operations for the firstquarter 2005 and 2004.

 

Included in discontinuedoperations in the first quarter of 2005 was approximately $49,000 of gain onthe 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.  We had a working capitalbalance of $23.5 million at March 30, 2005 and December 29, 2004.  Through March 30, 2005, we have fundedour capital requirements primarily with the net proceeds of public offerings ofcommon stock of approximately $21.1 million, with private placements of equitysecurities of approximately $67.5 million, with the exercise of warrants andoptions of approximately $8.0 million, with net indebtedness of approximately $4.7million.  We also have funded our capitalrequirements from the net proceeds of the sale of our paclitaxel business toMayne Pharma (USA) Inc. (f/k/a Faulding Pharmaceutical, Inc.)(“MaynePharma”), a subsidiary of Mayne Group Limited, on December 12, 2003 andits operations 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.  Thenet proceeds were $15.6 million.  As partof this transaction, we recorded a discount attributable to the conversionfeature of the convertible debentures in the amount of $3.1 million, which wasamortized 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 paclitaxel business toMayne Pharma, we paid approximately $3,184,000 in cash and issued promissorynotes in the amount of $4,670,000 in exchange for the delivery of thedebentures by TL Ventures to the Company for cancellation.  The notes do not bear interest and are payablein monthly installments of $50,000 beginning in February 2005, $110,000 in2006 and $150,000 in 2007 with a $1,000,000 payment due on January 31,2008.

 

16

----

 

Accrued interest ofapproximately $134,000 was included in the cash payment made as part of thesettlement.  We recorded the obligationresulting from the settlement on our balance sheet as of December 29,2004.  We imputed an interest rate of 18%on the notes.  No gain or loss wasrecognized in connection 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 registration statement,we will not be able to sell shares thereunder unless and until the aggregatemarket value of common equity held by non-affiliates of the company is $75million or more.  As of April 28,2005, such aggregate market value approximated $19.3 million.  As a result of our ineligibility to issuesecurities under a shelf registration statement, any issuance of securities islikely to be effected through a private placement of such securities followedby our registering the resale of such shares by the purchaser.

 

Cash and cash equivalents decreased $1.1 million to $625thousand at March 30, 2005 from $1.7 million at December 29,2004.  Cash, cash equivalents, short-termand long-term investments decreased $9.7 million to $26 million at March 30,2005 from $35.7 million at December 29, 2004.  The decrease was primarily due to the $3.2million payment for the TL Venture’s settlement, and $6.5 million net cash usedby 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.  Raising additional capital at current marketprices for our common stock will result in substantial dilution to existingstockholders because our capital requirements are substantial relative to ourcurrent market capitalization. We cannot assure you that we will be able toobtain additional capital on terms that will be acceptable to us or on anyterms.  In addition, we may seek toin-license or purchase new products or technologies.  The cost and related capital expenditures ofacquiring and developing such resources may be significant, and we may not beable 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, theCompany received notice from the Nasdaq Stock Market, Inc. (“Nasdaq”) thatits minimum bid price had fallen below $1.00 for 30 consecutive business daysand that its common stock is, therefore, subject to delisting from the NasdaqSmallCap Market.  The Company has until August 24,2005 (180 calendar days from February 25, 2005) to regain compliance.  The Company can regain compliance with theminimum bid price rule if the bid price of its common stock closes at$1.00 or higher for a minimum of 10 consecutive business days during theinitial 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 willbe eligible for another 180 day compliance period (until February 20,2006) if we meet the Nasdaq SmallCap Market initial listing criteria, otherthan the minimum bid price requirement. No assurance can be given that the Company will be eligible for theadditional 180 day compliance period or, if applicable, that the Company willregain compliance during any additional compliance period.  If the Company fails to meet allapplicable Nasdaq SmallCap Market requirements and Nasdaq determines to delist itscommon stock, the delisting could adversely affect the market liquidity of itscommon stock and the market price of its common stock could decrease. Suchdelisting could then adversely affect the Company’s ability to obtain financingfor the continuation of its operations and/or result in the loss of confidenceby investors, suppliers and employees.

 

The Company is seekingstockholder approval at its 2005 Annual Meeting to grant authority for theBoard of Directors to effect a reverse stock split as one way to address theNasdaq listing issues relating to minimum bid price.  If stockholder approval is obtained, theBoard is not required to implement the reverse stock split, but would do soonly if it determines it to be in the best interests of the Company.

 

###### **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 March 30, 2005.

 

17

----

 

# **Recent AccountingPronouncement**

# ** **

In December 2004, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandard No. 123(R) (“SFAS 123(R)”), *Accounting for Stock-BasedCompensation*.  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.  SFAS123(R) requires that the fair value of such equity instruments be recognized asan expense in the historical financial statements as services areperformed.  Prior to SFAS 123(R), onlycertain pro forma disclosures of fair value were required.  The provisions of this statement areeffective at the beginning of the next fiscal year.  Accordingly, the Company will adopt SFAS123(R) commencing with the quarter ending March 29, 2006.  The adoption of SFAS 123(R) is expected tohave a material effect on the Company’s results of operations.

 

**Special Note Regarding Forward-LookingStatements**

 

The statements in this report that are not historical facts are forward-lookingstatements that represent management’s beliefs and assumptions as of the dateof 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 our plans, objectives and future economic prospects, such as mattersrelative to developing new products;

 

•                  theavailability of patent and other protection for our intellectual property;

 

•                  thecompletion of preclinical studies, clinical trials and regulatory filings;

 

•                  theprospects for, and timing of, regulatory and institutional review board approvals;

 

•                  theneed and plans for, and availability of, additional capital;

 

•                  theamount and timing of capital expenditures;

 

•                  thetiming of product introductions and sales;

 

•                  theavailability of raw materials;

 

•                  theability to outsource activities;

 

•                  thefuture acquisition of products or business entities;

 

•                  prospectsfor future operations; and

 

•                  otherstatements of expectations, beliefs, future plans and strategies, anticipatedevents or trends and similar expressions concerning matters that are nothistorical facts.

 

Although we believe that the expectations reflected in such forward-lookingstatements are reasonable, we cannot assure you that these expectations willprove to be correct.  Such forward-lookingstatements involve known and unknown risks, uncertainties and other factors,which may cause our actual results, performance or achievements, or industryresults, to be materially different from any future results, performance orachievements expressed or implied by such 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.

 

18

----

 

*RisksRelated to Research and Development*

 

•                  Our product candidates and technologies are in an early state of developmentand there is a high risk that they may never be commercialized either becauseof the costs of continuing development or because our research and developmentfails to produce any products of value.

 

•                  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 oncology and Huntington’s Disease treatment technologies are stillnew and in development; very little data exists relative to the amountnecessary to have the products approved in the United States and new informationmay arise 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.

 

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

 

•                  Adverse events in the field of oncology may negatively impact regulatoryapproval or public perception of our potential products and technologiesresulting in decreased demand.

 

•                  Our ability to maintain our licenses for intellectual property isdependent upon our ultimate success in our development programs.

 

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

 

•                  Testing of our potential products and technologies relies heavily on thevoluntary participation of both study centers and patients in our clinicaltrials, which are not within our control, and would, therefore, substantiallydelay or prevent us from completing development of our products.

 

•                  If weacquire any other products or business operations, we will incur a variety ofcosts, and we may never realize the anticipated benefits of the acquisition.

 

•                  We may not be successful in obtaining required foreign regulatoryapprovals, which would prevent us from marketing our products internationally.

 

•                  We rely on third-parties to perform certain services for us and anyinterruption or termination of these arrangements would adversely affect ourbusiness.

 

•                  Our use of hazardous materials exposes us to the risk of materialenvironmental liabilities, and we may incur substantial additional cost tocomply with environmental laws in connection with the operation of our researchand manufacturing facilities.

 

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

 

•                  Acceptance of our potential products in the marketplace is uncertain, andfailure to achieve market acceptance will limit our ability to generate revenueand become profitable.

 

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

 

19

----

 

•                  Technological change may make any products and technologies we developless attractive or obsolete.

 

•                  If we are unable or fail to adequately protect our proprietarytechnologies, third parties may be able to use our technology, which couldimpair our ability to commercialize our potential products, and to compete inthe 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 eventwe receive regulatory approval for our product candidates, we will be subjectto ongoing regulatory obligations.

 

•                  Legislativeand regulatory proposals to reduce the cost of health care may adversely affectour business.

 

•                  If product liability lawsuits are successfully brought against us, we mayincur substantial liabilities and may be required to limit commercialization ofour product candidates.

 

•                  We may be unable to effectively price our products or obtain adequatereimbursement for sales of our products, which would prevent our products frombecoming profitable.

 

*RisksRelated to Financing Our Operations*

 

•                  We have a history of net losses. We expect to continue to incur netlosses, and we may not 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 carryforwards and $2.6million tax credit carryforwards that would be so limited if a change ofownership were to occur.

 

*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.

 

20

----

 

•                  We received notice from the Nasdaq Stock Market, Inc. on February 25,2005 that the minimum bid price of our common stock had fallen below $1.00 for30 consecutive days and that our common stock will be delisted if the minimumbid price does not exceed $1.00 per share during the periods permitted by theirrules to regain compliance.  If we donot regain compliance and Nasdaq delists our common stock, the delisting couldadversely affect the market liquidity of our common stock and the market priceof our common stock could decrease.

 

•                  We implemented anti-takeover provisions, in 1996, that may reduce themarket price of our common stock.

 

*OtherRisks Related to Our Business*

 

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

 

•                  We may be unable 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 ofthese risks materialize (or the consequences of such a development worsen), orshould the 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.

 

**Item3****.  Quantitative and Qualitative Disclosuresabout 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 declinewith a decline in interest rates.  Our investments are subject to a lossof principal with an increase in interest rates if sold prior to their maturity.  However, due to the short-term nature of themajority of our investments, the high credit quality of our portfolio and ourability to hold our investments until maturity, an immediate 1% change ininterest rates would not have a material impact on our financial position,results of operations or cash flows.

 

###### **Item 4**.  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 Principal FinancialOfficer, as appropriate to allow timely decisions to be made regarding requireddisclosure.  The Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’sChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of the Company’sdisclosure controls and procedures as of March 30, 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 no assurancethat any design will succeed in achieving its stated goals under all potentialfuture conditions, regardless of how remote.

 

21

----

 

There have been no changes in our internal controls over financial reportingduring the fiscal quarter ended March 30, 2005 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

**Part II**- Other Information

** **

**Item1.****  Legal Proceedings**

 

TL Ventures advised usbefore the sale of our paclitaxel business to Mayne Pharma that it believedcompletion of such sale entitled it to have its $8.0 million of Company 4%convertible subordinated debentures redeemed. By their terms, these debentures were due on February 12,2007.  We disputed TL Ventures’position.  On September 8, 2003, TLVentures Funds reasserted its position and informed us that, if we could notresolve this issue promptly, it intended to pursue legal remedies.  On September 11, 2003, we filed a complaintin a case captioned *NaPro BioTherapeutics, Inc.v. TL Ventures V L.P. and TL Ventures V Interfund L.P.*, Case No. 2003-CV-1812,District Court, Boulder County, Colorado. In our complaint, we sought a declaratory judgment from the court thatthe asset sale to Mayne Pharma did not permit TL Ventures to have the 4%convertible subordinated debentures redeemed. TL Ventures filed a motion to dismiss the suit, and filed an action in acase captioned *TL Ventures V L.P. and TLVentures V Interfund L.P. v. NaPro BioTherapeutics, Inc.*, Case No. 110-N,Delaware Court of Chancery, alleging that TL Ventures is entitled to redeem its4% convertible subordinated debentures. The Colorado action was dismissed, and the case proceeded in theDelaware Court of Chancery.

 

On February 18, 2005, theCompany entered into an agreement with TL Ventures providing for a completesettlement of our 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 deliveryof the debentures to the Company for cancellation.  The notes do not bear interest and arepayable 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.  Accruedinterest of approximately $134,000 was included in the cash payment made aspart of the settlement.  The Companyrecorded the obligation resulting from the settlement on our balance sheet asof December 29, 2004.

 

**Item2.****  Unregistered Sales of Equity Securities andUse of Proceeds**

 

Not applicable.

 

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

##### ** **

Not applicable.

 

**Item4****.  Submission of Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item5****.  Other Information**

 

In December 2004 and January 2005, the Compensation Committeeof the Board of Directors of the Company granted increases in annual salariesand awarded bonuses to the employees identified as named executive officers inthe Proxy Statement for the Company’s 2005 Annual Shareholders Meeting, who arecurrently executive officers of the Company.  The bonuses were for effortsand services of those officers on behalf of the Company in 2004, while thesalary increases provide for future services and for the benefits to theCompany as a result of these services.  These bonuses and 2005 salariesare summarized in a table included in Exhibit 10.1 to this Form 10-Q,which is incorporated herein by this reference.

 

22

----

 

**Item6.**** Exhibits**

 
| **Exhibit   Number** | ** ** | **Description  of Exhibit**                                                                                                                                                                                                                    |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                 |       | Salaries and Bonuses of Named Executive Officers                                                                                                                                                                                               |
| 10.2                 |       | Compensation of Directors                                                                                                                                                                                                                      |
| 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)) |

 

----

#                                         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.

 

23

----

 

# **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.          |
|------------------|-----------------------------------------|
|             |                                    |
| May 4, 2005 | By: /s/ Leonard P. Shaykin              |   |
|             | **Leonard P. Shaykin**                  |
|             | **Chairman of the Board of Directors,** |
|             | **Chief Executive Officer**             |
|             | ** **                              |
|             |                                    |
| May 4, 2005 | By: /s/ Gordon Link                     |   |
|             | **Gordon Link**                         |
|             | **Senior Vice President,**              |
|             | **Chief Financial Officer**             |
|             | **(Principal Financial Officer)**       |
|             | ** **                              |
|             |                                    |
| May 4, 2005 | By: /s/ Bruce W. Fiedler                |   |
|             | **Bruce W. Fiedler**                    |
|             | **Controller**                          |
|             | **(Principal Accounting Officer)**      |

 

24

----

 

**Indexof Exhibits**

 
| **Exhibit   Number** | ** ** | **Description  of Exhibit**                                                                                                                                                                                                                    |
|----------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1                 |       | Salaries and Bonuses of Named Executive Officers                                                                                                                                                                                               |
| 10.2                 |       | Compensation of Directors                                                                                                                                                                                                                      |
| 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)) |

 

----

#                                         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.

 

----