TAPESTRY PHARMACEUTICALS, INC - 10-Q Quarterly Report

Use these links to rapidly review the document
Tapestry Pharmaceuticals, Inc. and Subsidiaries Table of Contents

UNITED STATES
SECURITIES 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 SEPTEMBER 29, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO

Commission File Number 0-24320

TAPESTRY PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)

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

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

(303) 516-8500
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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 October 29, 2004, the registrant had 33,335,401 shares of common stock, $0.0075 par value, outstanding.

Tapestry Pharmaceuticals, Inc. and Subsidiaries
Table of Contents

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

Exhibits

Exhibit 31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as amended.
Exhibit 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.
Exhibit 32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
Exhibit 32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).

Part I
FINANCIAL INFORMATION

Item 1. Financial Statements

Tapestry Pharmaceuticals, Inc. and Subsidiaries

Consolidated Condensed Balance Sheets

(In thousands, except per share data)

		September 29, 2004			December 31, 2003
		(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents	$	2,296		$	2,281
	Short-term investments		30,450			48,501
	Accounts receivable, net		—			1,495
	Prepaid expense and other current assets		967			596
	Assets held for sale		—			205

Total current assets			33,713			53,078
Property, plant and equipment, net			1,005			1,156
Long-term investments			8,890			—
Investment in ChromaDex, Inc.			1,414			1,414
Other assets			1,941			2,118

Total assets		$	46,963		$	57,766

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable and accrued liabilities	$	2,867		$	3,207
	Accrued payroll and payroll taxes		2,001			2,607
	Notes payable—current portion		46			81
	Deferred income		130			130

Total current liabilities			5,044			6,025
Notes payable—long term			16			41
Convertible debentures			6,167			5,702
Stockholders' equity:
	Preferred stock, $.001 par value; 2,000,000 shares authorized; none issued		—			—
	Common stock, $.0075 par value; 64,000,000 shares authorized; 33,335,401 and 30,953,952 shares issued at September 29, 2004 and December 31, 2003, respectively		250			232
	Additional paid-in capital		117,233			111,497
	Accumulated deficit		(81,690	)		(65,550	)
	Accumulated other comprehensive loss (Note 4)		(57	)		—
	Treasury stock, 54,306 shares at cost at December 31, 2003		—			(181	)

Total stockholders' equity			35,736			45,998

Total liabilities and stockholders' equity		$	46,963		$	57,766

See accompanying notes to Consolidated Condensed Financial Statements.

Tapestry Pharmaceuticals, Inc. and Subsidiaries

Consolidated Condensed Statements of Operations

(In thousands, except per share data)

(Unaudited)

		Quarter Ended						Nine Months Ended
		September 29, 2004			October 1, 2003			September 29, 2004			October 1, 2003
Operating expenses:
	Research and development	$	5,718		$	2,033		$	12,777		$	6,819
	General and administrative		2,019			2,705			6,185			8,123

Operating loss			7,737			4,738			18,962			14,942

Other income (expense):
	Interest income		206			17			501			64
	Interest expense		(242	)		(202	)		(714	)		(655	)

Net loss from continuing operations			(7,773	)		(4,923	)		(19,175	)		(15,533	)
Discontinued operations:
	Income (loss) from discontinued operations		2,995			(1,140	)		3,035			4,590

Net loss		$	(4,778	)	$	(6,063	)	$	(16,140	)	$	(10,943	)

Basic and diluted loss per share from continuing operations		$	(0.23	)	$	(0.16	)	$	(0.59	)	$	(0.51	)

Basic and diluted income (loss) per share from discontinued operations		$	0.09		$	(0.04	)	$	0.09		$	0.15

Basic and diluted loss per share		$	(0.14	)	$	(0.20	)	$	(0.50	)	$	(0.36	)

Basic and diluted weighted average shares outstanding			33,309			30,759			32,537			30,397

Diluted weighted average shares outstanding relating to discontinued operations			33,445			31,017			33,204			30,451

See accompanying notes to Consolidated Condensed Financial Statements.

Tapestry Pharmaceuticals, Inc. and Subsidiaries

Consolidated Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

			Nine Months Ended
			September 29, 2004			October 1, 2003
Operating activities:
Net loss			$	(16,140	)	$	(10,943	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization			371			2,448
	Accretion of debt issue cost			32			137
	Amortization of debt discount			433			375
	Amortization of license fee income			—			(840	)
	Amortization of investment premium			170			—
	Interest paid with common stock			54			—
	Compensation paid with common stock and options			110			113
	Retirement contributions paid with common stock			604			327
	Asset write down			—			1,048
	Impairment loss on assets held for sale			205			—
	Changes in operating assets and liabilities:
		Accounts receivable		1,495			1,134
		Inventory		—			3,810
		Prepaid expense and other assets		(84	)		150
		Accounts payable and accrued liabilities		(233	)		1,591
		Accrued payroll and payroll taxes		(606	)		636
		Deferred income		—			100

Net cash (used in) provided by operating activities				(13,589	)		86
Investing activities:
	Additions to property and equipment			(143	)		(1,255	)
	Purchases of investments			(86,045	)		—
	Proceeds from sale of investments			94,979			2,000
	Proceeds from sale of property, plant and equipment			—			168
	Acquisition of patents			—			(400	)
	Investment in ChromaDex, Inc.			—			(554	)

Net cash provided by (used in) investing activities				8,791			(41	)
Financing activities:
	Proceeds from notes payable			—			487
	Payments of notes payable			(60	)		(415	)
	Proceeds from the sale of common stock, net of issuance cost			4,837			—
	Proceeds from the exercise of common stock options			36			4

Net cash provided by financing activities				4,813			76

Net increase in cash and cash equivalents				15			121
Cash and cash equivalents at beginning of period				2,281			2,762

Cash and cash equivalents at end of period			$	2,296		$	2,883

Supplemental disclosure of cash flow information:
Interest paid in cash			$	167		$	1,313
Non-cash investing and financing activities:
	Issuance of common stock for payment of interest			107			—
	Issuance of common stock to prepay retirement plan contributions			188			109
	Transfer of fixed assets for investment in ChromaDex, Inc.			—			946
	Issuance of restricted common stock to prepay retention bonus			—			40
	Depletion of plantation costs to inventory			—			720

See accompanying notes to Consolidated Condensed Financial Statements.

Tapestry Pharmaceuticals, Inc.

Notes to Consolidated Condensed Financial Statements

September 29, 2004

(Unaudited)

Note 1. Basis of Presentation

The accompanying financial statements are unaudited. However, in the opinion of management, the financial statements reflect all adjustments, consisting of only normal recurring adjustments, necessary for fair presentation. Interim results of operations may not be indicative of results for the full year. These financial statements should be read in conjunction with the Company's Annual Report on Form 10-K, as amended, for the year ended December 31, 2003.

Note 2. Reclassifications

Certain data in the consolidated condensed financial statements of the prior year have been reclassified to conform to the current year presentation.

Note 3. Discontinued Operations

Sale of Paclitaxel Business

On December 12, 2003, the Company sold its worldwide generic injectable paclitaxel business to Mayne Pharma (USA) Inc. (f/k/a/ Faulding Pharmaceutical Co.) ("Mayne Pharma"), a subsidiary of Mayne Group Limited, for cash in the amount of $71.7 million minus an inventory adjustment of $4.6 million to reflect the Company's actual inventory as of the closing. The sale resulted in a gain of $54.6 million before taxes, and $54.1 million after taxes. Proceeds from the sale are being used to fund the development and commercialization of therapeutic products and for general corporate purposes. In addition, approximately $21.9 million of the proceeds of the purchase price was paid to Abbott Laboratories ("Abbott") to retire all outstanding debt, interest and payables the Company owed to Abbott. The assets sold to Mayne Pharma included paclitaxel manufacturing assets, yew plantations, domestic and international issued and pending paclitaxel patents, a worldwide registration dossier, worldwide development and supply agreements, inventories and settlement of accounts receivable. The Company retained all of its intellectual property not used in connection with the business sold. This transaction with Mayne Pharma provided that the Company was entitled to a portion of the cash proceeds received in connection with a patent infringement lawsuit against Mylan Laboratories, Inc. ("Mylan Laboratories") (Note 9). This lawsuit was settled in July 2004 and the Company received $3.0 million as its share of the proceeds.

The paclitaxel business was reported as a discontinued operation in 2003; accordingly, results from the prior year have been reclassified to reflect this. Summary results of operations of the paclitaxel business for the quarter and nine months ended were (in thousands):

	Quarter Ended					Nine Months Ended
	September 29, 2004		October 1, 2003			September 29, 2004		October 1, 2003
Product sales	$	—	$	7,265		$	—	$	21,711

Net income (loss)	$	2,995	$	(1,017	)	$	3,256	$	4,978

Paclitaxel income in 2004 consisted primarily of the $3.0 million patent infringement settlement with Mylan Laboratories and a $250,000 business interruption insurance claim filed and collected in

2004 for losses sustained in the third quarter of 2003, resulting from a hurricane that disrupted operations of a contract manufacturer employed by Tapestry.

Gene Isolation and Service Business

In December 2003, the Company made the decision to sell its gene isolation and service business and, therefore, accounted for it as a discontinued operation. Net operating loss related to this business totaled $0 and $123,000 during the third quarters of 2004 and 2003, respectively. For the first nine months, the net operating loss totaled $221,000 and $388,000 for 2004 and 2003, respectively. In the first quarter of 2004, the Company recorded an impairment loss of $205,000 for all assets that had previously been identified as held for sale.

Assets held for sale at December 31, 2003 that related to the discontinued operations of the gene isolation and service business were as follows (in thousands):

Property, plant and equipment, net	$	122
Other assets		83

Assets held for sale	$	205

Note 4. Investments

Short-term investments consisted of investment grade commercial paper due within one year. Long-term investments consisted of investment grade commercial paper with maturities beyond one year. All investments are classified as available-for-sale and are recorded at market value. Unrealized losses are reflected in comprehensive net loss.

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

	Quarter Ended						Nine Months Ended
	September 29, 2004			October 1, 2003			September 29, 2004			October 1, 2003
Net loss, as reported	$	(4,778	)	$	(6,063	)	$	(16,140	)	$	(10,943	)
Unrealized gain (loss) on available-for-sale securities		28			—			(57	)		—

Comprehensive net loss	$	(4,750	)	$	(6,063	)	$	(16,197	)	$	(10,943	)

Note 5. Property, Plant and Equipment

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

	September 29, 2004			December 31, 2003
Furniture, fixtures and office equipment	$	702		$	528
Laboratory equipment		1,092			754
Leasehold improvements		45			38
Construction in progress		15			391

		1,854			1,711
Less accumulated depreciation and amortization		(849	)		(555	)

Property, plant and equipment, net	$	1,005		$	1,156

Note 6. Investment in ChromaDex, Inc.

In April 2003, the Company sold its technical and analytical services group 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 at approximately $1.4 million based upon the fair market value of the net assets sold to ChromaDex. ChromaDex is a supplier of phytochemical reference standards for the nutraceutical, dietary supplement and functional food industries.

Note 7. Net Income (Loss) Per Share

Basic earnings per share is measured as the income or loss available to common stockholders divided by the weighted average outstanding common shares for the period. Diluted earnings per share is similar to basic earnings per share but presents the dilutive effect on a per share basis of potential common shares (e.g. stock options, warrants and convertible securities) as if they had been converted at the beginning of the periods presented. Potential common shares that have an antidilutive effect are excluded from diluted earnings per share. Net loss per common share is computed using the weighted average number of shares of common stock outstanding. The following is a reconciliation of the shares (denominator) of the basic and diluted per share computations (in thousands):

		Quarter Ended		Nine Months Ended
		September 29, 2004	October 1, 2003	September 29, 2004	October 1, 2003
Basic weighted average common shares outstanding		33,309	30,759	32,537	30,397
Effect of dilutive securities:
	Employee stock options	136	258	667	54

Diluted weighted average common shares outstanding for income from discontinued operations		33,445	31,017	33,204	30,451

Note 8. Stock Options

Tapestry accounts for its stock options to employees and directors in accordance with Accounting Principles Board Opinion No. 25 ("APB 25"), Accounting for Stock Issued to Employees, and related interpretations. Pursuant to APB No. 25, compensation expense to employees is recorded only if the fair value of the underlying stock exceeds the exercise price on the date of grant. Stock options granted to consultants are accounted for under the fair value method, in accordance with Statement of Financial Accounting Standards No. 123 ("SFAS 123"), Accounting for Stock-Based Compensation.

Pro forma information regarding net income and earnings per share is required by SFAS 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 had accounted for employee stock options granted subsequent to December 31, 1994 under the fair value method of that statement. Tapestry estimated the fair value for these options at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the quarters ended September 29, 2004 and October 1, 2003, respectively: risk-free interest rates of 3.81% and 1.98% to 2.65%; no expected dividend; volatility factors of 1.237 and 1.228; and generally an estimated expected life range of four to six years. For the nine months ended September 29, 2004 and October 1, 2003, respectively, Tapestry estimated the fair market value of these options with the following assumptions: risk-free interest rates of 2.51% to 3.81% and 1.98% to 3.22%; no expected dividend;

volatility factors of 1.028 to 1.237 and 1.187 to 1.228; and generally an estimated expected life range of four to six years.

For purposes of pro forma disclosures, the Company amortizes to expense the 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						Nine Months Ended
	September 29, 2004			October 1, 2003			September 29, 2004			October 1, 2003
Net loss as reported	$	(4,778	)	$	(6,063	)	$	(16,140	)	$	(10,943	)
Deduct: Total stock based employee compensation expense determined under fair value based method for all awards		(638	)		(935	)		(2,454	)		(2,857	)

Pro forma net loss	$	(5,416	)	$	(6,998	)	$	(18,594	)	$	(13,800	)

Basic and diluted loss per share—as reported	$	(0.14	)	$	(0.20	)	$	(0.50	)	$	(0.36	)

Pro forma basic and diluted loss per share	$	(0.16	)	$	(0.23	)	$	(0.57	)	$	(0.45	)

Note 9. Mylan Litigation Settlement

On July 6, 2004, the Company announced Mayne Pharma reached an agreement to settle the patent infringement lawsuit against Mylan Laboratories regarding stabilized formulations of paclitaxel. Pursuant to the terms of the agreement, the Company received a $3.0 million cash payment as its share of the proceeds from this settlement, which was recorded in discontinued operations in the third quarter of 2004 (Note 3).

Note 10. Recent Accounting Pronouncements

We have evaluated all recent accounting pronouncements and believe that such accounting pronouncements do not have a material effect on our consolidated financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of the results of operations of Tapestry Pharmaceuticals, Inc. You should read this discussion in conjunction with the Financial Statements and Notes included elsewhere in this report and with Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2003 contained in our 2003 Annual Report on Form 10-K, as amended. Certain statements set forth below constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, referred to as the "Reform Act." See "Special Note Regarding Forward-Looking Statements."

General

Tapestry Pharmaceuticals, Inc. ("we," "Tapestry" or "the Company") is a pharmaceutical company focused on the development of proprietary therapies for the treatment of cancer and hereditary disease. We believe that our compounds function by novel biological and/or chemical mechanisms and, therefore, if successful in clinical trials, may add to the amelioration of their specific disease targets.

We are also actively engaged in evaluating the in-licensing or purchasing of new therapeutic agents and/or related technologies. Our evaluation of new products and technologies may involve the examination of individual molecules, classes of compounds, or platform technologies, in cancer as well as other therapeutic areas. Acquisitions of new products or technologies may involve the purchase or licensing of such products or technologies, or the acquisition of, or merger with, other companies.

We incur substantial research and development expense related to the development of our proprietary anti-cancer agents, and the development of our proprietary genomic technologies. We incurred significant losses, including losses from continuing operations of $7.8 million and $19.2 million for the three and nine month periods, respectively, ended September 29, 2004. Our accumulated deficit was $81.7 million as of September 29, 2004. We anticipate that losses will continue until such time, if ever, as we are able to generate sufficient revenue to support our development operations, including the research and development activity discussed below.

Our ability to raise capital to support our operations currently depends upon the successful development and commercialization of products based on our proprietary oncology and genomic technologies. Our oncology program consists of developing both targeted as well as non-targeted compounds for the treatment of cancer. Our lead program in hereditary disease is for the treatment of Huntington's Disease. All of our products and technologies are in the early stages of development and we cannot assure you that our efforts will be successful.

Research and Development

Our current business is focused on research and development of proprietary therapies for the treatment of cancer and hereditary disease. In 2003, we were also engaged in research and development related to our paclitaxel business, which is aggregated in discontinued operations. The following table lists our research and development expense by division (in thousands):

	Quarter Ended				Nine Months Ended
	September 29, 2004		October 1, 2003		September 29, 2004		October 1, 2003
Oncology	$	4,585	$	1,014	$	8,981	$	3,562
Genomics		1,133		1,019		3,796		3,257
Discontinued operations		—		220		—		924

	$	5,718	$	2,253	$	12,777	$	7,743

The following chart identifies our four therapeutic products that are in the most advanced stages of development. All of these products are in preclinical research. We are focusing our efforts and resources on the development of these products.

Product		Potential Indication(s)
TPI 287		Prostate Cancer, Non-Small Cell Lung Cancer, Pancreatic Cancer, Ovarian Cancer
TPI 273		Multiple Myeloma, Pancreatic Cancer, Prostate Cancer, Squamous Cell Carcinomas
TPI 284		Squamous Cell Carcinomas of the head, neck and lung
Oligo Therapy		Huntington's Disease

The chart above does not reflect ongoing research programs for which a development lead has not been advanced into preclinical development. It also excludes the Sickle Cell hereditary disease program and the Bombesin targeted oncology program. These programs have been removed from development status until either additional ongoing research warrants their return to development status or a final decision has been made to cancel research in these programs.

•: TPI 287 is a third generation taxane, designed to overcome one of the primary mechanisms leading to taxane drug resistance, specifically the development of multi-drug resistance. To date, we have completed some in vitro and in vivo preclinical studies on TPI 287 that indicate activity of TPI 287 in several cancer cell lines. We are currently conducting additional preclinical studies on TPI 287 designed to better delineate the antineoplastic activity of TPI 287. We are assembling a regulatory package for filing an Investigational New Drug ("IND") application with the FDA. Assuming that we are able to manufacture and formulate sufficient quantities of TPI 287 to complete our preclinical studies, and assuming the results of the currently ongoing preclinical study demonstrate sufficient efficacy and do not demonstrate any safety concerns, we expect to file this IND with the U.S. Food and Drug Administration ("FDA") by the end of 2004. Assuming that the IND is filed by the end of this year, that we are able to manufacture and formulate sufficient quantities of TPI 287 for clinical testing, and that the FDA allows us to proceed with clinical trials under such IND without requiring submission of additional information, we believe we will be able to commence human clinical trials with TPI 287 in the first half of 2005.