Apollo Endosurgery, Inc. - Quarter Report: 2010 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2010

OR

For the transition period from              to             

Commission File Number: 000-50344

LPATH, INC.

(Exact name of registrant as specified in its charter)

6335 Ferris Square, Suite A, San Diego, CA 92121

(Address of principal executive offices, including zip code)

(858) 678-0800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of issuer’s outstanding Class A common stock as of August 11, 2010 was 53,097,234.

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LPATH, INC.

FORM 10-Q

June 30, 2010

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

LPATH, INC.

Condensed Consolidated Balance Sheets

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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LPATH, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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LPATH, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

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LPATH, INC.

Notes to Condensed Consolidated Financial Statements

June 30, 2010

Note 1 – BASIS FOR PRESENTATION

The unaudited condensed consolidated financial information has been prepared by Lpath, Inc. (“Lpath” or “the company”) without audit. The condensed consolidated financial statements, in the opinion of management, include all adjustments considered necessary for a fair presentation have been included. Except as otherwise disclosed, all such adjustments are of a normal recurring nature. The condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and in accordance with the regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain information and note disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such SEC rules and regulations. These unaudited condensed consolidated financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes for the fiscal year ended December 31, 2009 included in the company’s Annual Report on Form 10-K. Operating results for the three and six month period ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Please see the company’s more critical accounting policies identified below as well as in the Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

Note 2 – GOING CONCERN UNCERTAINTY

The accompanying consolidated financial statements have been prepared assuming that the company will continue as a going concern. Lpath utilized cash of $1.3 million during the six months ended June 30, 2010 and $1.6 million during the year ended December 31, 2009. The company expects to continue to incur cash losses from operations during the remainder of 2010. These conditions raise substantial doubt about the company’s ability to continue as a going concern. Management’s plans with regard to these matters are discussed below. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As of June 30, 2010, the company had cash totaling $4.9 million. Additional near-term sources of cash include the recently-awarded $3 million BRDG-SPAN grant from the National Eye Institute (part of the National Institutes of Health) to support iSONEP-related trials, and the three year, $3 million grant from NIH awarded in 2009 that still has two years and $2 million remaining to support ASONEP clinical trials. As they are currently planned, the costs of Lpath’s ongoing drug discovery and development efforts, including general and administrative expenses, would consume between $14 and $19 million through the end of 2011. However, in the event we are unable to obtain additional funding in the second half of 2010, certain planned research and development activities will be deferred or curtailed. Accordingly, if those research and development activities were deferred or curtailed, the company believes that its existing cash, together with its committed grant funding, will be sufficient to meet its operating requirements at least through June 2011. The company is seeking additional funding to finance its research and development activities beyond 2010 and beyond by:

Future financings through equity investments may be dilutive to existing stockholders. Also, the terms of securities we may issue in future capital transactions may be more favorable for our new investors. If we raise additional funds through collaboration or licensing arrangements, we may be required to relinquish potentially valuable rights to our product candidates or proprietary technologies, or grant licenses on terms that are not favorable to us. There can be no assurance that additional funds will be available when needed from any source or, if available, will be available on terms that are acceptable to us. If we are unable to raise funds to satisfy our capital needs on a timely basis, we may be required to curtail our operations and current business plans.

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Note 3 – RESEARCH AND DEVELOPMENT COLLABORATIVE AGREEMENT

On October 28, 2008 (the “Effective Date”), Lpath entered into a License Agreement (the “Merck Agreement”) with Merck KGaA, (“Merck”), pursuant to which Merck agreed to collaborate, through its Merck Serono division, with the company to develop and commercialize ASONEP^TM, Lpath’s monoclonal antibody which is currently being evaluated as a drug candidate for the treatment of certain cancers. Pursuant to the terms of the Merck Agreement, the company licensed to Merck exclusive, worldwide rights to develop and commercialize ASONEP across all non-ocular indications.

In March 2010, Merck acknowledged that we had achieved a development milestone, for which we earned $2 million. Later in March 2010, Merck proposed moving forward with the partnership via an extension of the Initial Development Period (as defined in the Merck Agreement). However the terms of that proposal were rejected by Lpath’s Board of Directors as not being in the best interests of Lpath or its stockholders. Consequently, on March 25, 2010, Merck notified us of their decision to terminate the License Agreement. Pursuant to the terms of the Agreement, the termination was effective April 24, 2010, and Merck relinquished all rights to the ASONEP program. Merck may, under certain circumstances following termination of the Agreement, have a right of first refusal for a period of 12 months to Lpath’s next most advanced oncology drug candidate.

The company accounts for the Merck Agreement as a single unit of accounting. Revenue was recognized using the straight-line method over the remaining term of the agreement. During the six months ended June 30, revenue was recognized related to the upfront licensing fee and initial development funding totaling $2,659,573 and $5,000,000 in 2010 and 2009, respectively. In the first half of 2010, Lpath also recognized revenue of $2,000,000 related to the achievement of certain development objectives.

Note 4 – SHARE-BASED PAYMENTS

The company recognized share-based compensation expense as follows:

As of June 30, 2010, there was a total of $1.1 million unrecognized compensation expense related to unvested stock-based compensation under the plan. That expense is expected to be recognized over a weighted average period of 2.0 years. Because of its net operating loss carryforwards, the company did not realize any tax benefits for the tax deductions from share-based payment arrangements during the periods ended June 30, 2010 and 2009.

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Note 5 – FAIR VALUE MEASUREMENTS

The company’s recurring fair value measurements at June 30, 2010 were as follows:

The unrealized gain for the six months ended June 30, 2010 is included on the income statement as change in fair value of warrants.

Recurring Level 3 Activity, Reconciliation, and Basis for Valuation

The table below provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant unobservable inputs (Level 3). The table reflects net gains and losses for the six months ended June 30, 2010 for all financial assets and liabilities categorized as Level 3 as of June 30, 2010.

Fair Value Measurements Using Significant Unobservable Inputs (Level 3):

The company determined the fair value of the warrants using a Black-Scholes model with consideration given to their “down-round” protection provisions that reduce the exercise price if the company issues new warrants or equity at a price lower than the stated exercise price. The model considered amounts and timing of future possible equity and warrant issuances and historical volatility of the company’s stock price.

Note 6 – Subsequent Event

On July 26, 2010, Lpath was awarded a $3.0 million grant by the National Eye Institute’s (NEI) BRDG-SPAN Program to support Phase II clinical development of Lpath’s iSONEP^™ in treating exudative (or wet) AMD and possibly other ocular disorders during the next three years. The NEI’s BRDG-SPAN Program was created to provide grants of up to $3.0 million to accelerate the transition from the development to commercialization of innovative technologies that improve human health, advance the mission of NIH, and create significant economic stimulus. The program also aims to foster partnerships among a variety of R&D collaborators working toward these objectives.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and notes thereto included in this quarterly report on Form 10-Q (the “Quarterly Report”) and the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2009 (the “2009 Annual Report”), as filed with the Securities and Exchange Commission (the “SEC”). In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors including but not limited to those identified under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009. As a result of these risks and uncertainties, our actual results or performance may differ materially from any future results or performance expressed or implied by the forward-looking statements. These forward-looking statements represent beliefs and assumptions only as of the date of this report. We undertake no obligation to release publicly the results of any revisions or updates to these forward-looking statements to reflect events or circumstances arising after the date of this report that may cause our actual results to be materially different from those expressed in or implied by these statements.

Overview

We are a biotechnology company focused on the discovery and development of lipidomic-based therapeutics. Lipidomics is an emerging field of medical science whereby bioactive signaling lipids are targeted to treat important human diseases. Our first product candidate, ASONEP^TM, is a monoclonal antibody against sphingosine-1-phosphate (S1P). ASONEP completed a Phase 1 clinical trial in the first quarter of 2010, and we believe that it holds promise for the treatment of cancer and other diseases. Our second product candidate, iSONEP^TM (another formulation of the same S1P-targeted antibody) has completed Phase I clinical trials and demonstrated promising results in treating patients afflicted with age-related macular degeneration. Studies conducted in models of human ocular disease indicate that iSONEP may also be useful in treating other ocular diseases including retinopathy and glaucoma. Our third product candidate, Lpathomab^TM, is an antibody against lysophosphatidic acid (LPA), a key bioactive lipid that has been long recognized as a valid disease target. Our ability to generate novel antibodies against bioactive lipids is based on our ImmuneY2^TM technology, a series of proprietary processes we have developed. We are currently applying the Immune Y2 process to other lipid-signaling agents that are validated targets for disease treatment, thereby potentially creating a pipeline of monoclonal antibody-based drug candidates.

As is discussed further in the Liquidity and Capital Resources section below, Lpath has incurred significant net losses since its inception and has limited funds to support its operations. As of June 30, 2010, Lpath had an accumulated deficit of approximately $33.1 million. Lpath expects its operating losses to increase for the next several years as it pursues the clinical development of its product candidates. The continuation of our current clinical development plans beyond 2010 is dependent upon our ability to obtain additional funding during the second half of 2010. In the event we are unable to obtain additional funding in 2010, certain planned research and development activities will be deferred or curtailed. Even if we reduce our research and development expenses, the continuation of our operations subsequent to June 2011 is dependent on our ability to obtain additional funding.

Results of Operations

Comparison of the Three Months Ended June 30, 2010 and June 30, 2009

Grant and Royalty Revenue. Grant and royalty revenue for the quarter ended June 30, 2010 was $17,000 compared to $269,000 for the quarter ended June 30, 2009. The decrease of $252,000 reflects conclusion of work in the first quarter of 2010 on grants awarded to Lpath by the National Institutes of Health (“NIH”) in 2009.

Research and Development Revenue under Collaborative Agreement. As described in Note 3 to the financial statements, work under the Merck Agreement terminated on April 24, 2010. During the three months ended June 30, Lpath recognized revenue related to the upfront licensing fee and initial development funding of $1.0 million during the three months ended June 30, 2010. During the corresponding period in 2009, Lpath received research and development funding of $1.5 million and recognized $1.0 million of revenue related to the $4.0 million upfront licensing fee received in November 2008.

Research and Development Expenses. Research and development expenses increased to $2.8 million for the three months ended June 30, 2010 from $1.8 million for the three months ended 2009, an increase of $1.0 million. Outside services, consulting, and lab supplies expenses increased by $1.2 million in 2010 due to costs incurred to perform 13-week toxicology studies, begin manufacturing the drug supplies, and other tasks required to prepare for the initiation of Phase 2 clinical trials for iSONEP.

General and Administrative Expenses. General and administrative expenses were $1.0 million for the three-month period ended June 30, 2010 compared to $1.1 million for the same period in 2009, a decrease of $0.1 million. Stock compensation expense decreased by $0.1 in 2010. This decrease is due principally to the decline in Lpath’s stock price compared to 2009.

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Change in Fair Value of Warrants. Various factors are considered in the Black-Scholes model we use to value the warrants, including the company’s current stock price, the remaining life of the warrants, the volatility of the company’s stock price, and the risk free interest rate. Future changes in these factors will have a significant impact on the computed fair value of the warrant liability. The most significant factor in the valuation model is the company’s stock price. Lpath’s stock is very thinly traded and relatively small transactions can impact the company’s quoted stock price significantly. As a result, the company’s stock price volatility factor is approximately 95%. As such, we expect future changes in the fair value of the warrants to continue to vary significantly from quarter to quarter. Management cautions that the $1.4 million decrease in fair value of the warrants, and corresponding credit to the results of operations, recognized during the three months ended June 30, 2010 and all future such changes, should not be given undue importance when considering the financial condition of Lpath and the results of its operations. Management does not believe that these adjustments, which are required by current generally accepted accounting principles, reflect economic activities or financial obligations undertaken by the company.

Comparison of the Six Months Ended June 30, 2010 and June 30, 2009

Grant and Royalty Revenue. Grant and royalty revenue for the six months ended June 30, 2010 was $423,000 compared to $447,000 for the six months ended June 30, 2009. The decrease of $24,000 reflects conclusion of work in 2010 on three grants awarded to Lpath by the National Institutes of Health (“NIH”) in 2009.

Research and Development Revenue under Collaborative Agreement. As described in Note 3 to the financial statements, the Merck Agreement terminated on April 24, 2010. During the six months ended June 30, Lpath recognized revenue related to the upfront licensing fee and initial development funding of $2.7 million and $5.0 million during the first half of 2010 and 2009, respectively. In the first six months of 2010, Lpath also recognized revenue of $2.0 million related to the achievement of certain development objectives.

Research and Development Expenses. Research and development expenses increased to $5.5 million for the six months ended June 30, 2010 from $3.7 million for the first half of 2009, an increase of $1.8 million. Outside services, consulting, and lab supplies expenses increased by $2.1 million in 2010 due to costs incurred to perform 13-week toxicology studies of iSONEP in two different species, begin manufacturing the drug supplies, and other tasks required to prepare for the initiation of Phase 2 clinical trials for iSONEP. Employee compensation and benefits decreased by $0.4 million in 2010 compared to 2009 due to reduced staffing.

General and Administrative Expenses. General and administrative expenses were $1.9 million for the six-month period ended June 30, 2010 compared to $2.1 million for the same period in 2009, a decrease of $0.2 million. Stock compensation expense decreased by $0.2 million in 2010. This decrease is due principally to the decline in Lpath’s stock price compared to 2009.

Change in Fair Value of Warrants. Various factors are considered in the Black-Scholes model we use to value the warrants, including the company’s current stock price, the remaining life of the warrants, the volatility of the company’s stock price, and the risk free interest rate. Future changes in these factors will have a significant impact on the computed fair value of the warrant liability. The most significant factor in the valuation model is the company’s stock price. Lpath’s stock is very thinly traded and relatively small transactions can impact the company’s quoted stock price significantly. As a result, the company’s stock price volatility factor is approximately 95%. As such, we expect future changes in the fair value of the warrants to continue to vary significantly from quarter to quarter. Management cautions that the $1.6 million decrease in fair value of the warrants, and corresponding credit to the results of operations, recognized during the six months ended June 30, 2010 and all future such changes, should not be given undue importance when considering the financial condition of Lpath and the results of its operations. Management does not believe that these adjustments, which are required by current generally accepted accounting principles, reflect economic activities or financial obligations undertaken by the company.

Liquidity and Capital Resources

Since Lpath’s inception, its operations have been financed principally through the private placement of equity and debt securities. Through June 30, 2010, Lpath had received net proceeds of approximately $36.4 million from the sale of equity securities and from the issuance of convertible promissory notes. In the fourth quarter of 2008, Lpath began to receive substantial funding from a research and development arrangement with Merck. Through June 30, 2010, Lpath had received $17.0 million from this collaborative research and development agreement. In addition, since its inception Lpath has been awarded grants from the National Institutes of Health totaling approximately $10 million, of which $5 million remains available.

As of June 30, 2010, Lpath had cash and cash equivalents totaling $4.9 million. We have prepared our condensed consolidated financial statements in this Form 10-Q on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The continuation of our current clinical development plans beyond 2010 is dependent upon our ability to obtain additional funding during the second half of 2010. In the event we are unable to obtain additional funding in 2010, certain planned research and development activities will be deferred or curtailed. Even if we reduce our research and development expenses, the continuation of our operations subsequent to June 2011 is dependent on our ability to obtain additional funding. There can be no assurance that additional funds will be available when needed from any source or, if available, will be available on terms that are acceptable to us.

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During the six months ended June 30, 2010 we used net cash of $1.0 million for operating activities compared to $2.1 million in the six months ended June 30, 2009. The $1.1 million decrease in net cash used by operating activities in 2010 was driven primarily by the receipt, in the first quarter of 2010, of $2.0 million from a milestone payment from Merck, partially offset by increased research and development costs incurred to perform 13-week toxicology studies, begin manufacturing the drug supplies, and other tasks required to prepare for the initiation of Phase 2 clinical trials for iSONEP. Net cash used in investing activities during the six months ended June 30, 2010 was $306,000 compared to $287,000 during the same period in 2009. Of the amount used for investing activities in 2010, $303,000 was invested in the prosecution of patents compared to $248,000 in 2009. In addition, acquisitions of equipment and leasehold improvements amounted to $2,000 during the six-months ended June 30, 2010 compared to $39,000 in 2009.

During the six-moth period ended June 30, 2010 approximately $8,000 was used in financing activities, related to repayment of leasehold improvement debt, while $25,000 was provided from financing activities during the same period of 2009. In the first half of 2009 we received $32,000 from the exercise of stock options.

On July 26, 2010, we were awarded a $3.0 million grant by the National Eye Institute’s BRDG-SPAN Program to support Phase II clinical development of Lpath’s iSONEP^™ in treating exudative (or wet) AMD and possibly other ocular disorders during the next three years. The NEI’s BRDG-SPAN Program was created to provide grants of up to $3 million to accelerate the transition from the development to commercialization of innovative technologies that improve human health, advance the mission of NIH, and create significant economic stimulus. The program also aims to foster partnerships among a variety of R&D collaborators working toward these aims.

In July 2010, we submitted two applications for grants from the US Treasury under section 48D of the Internal Revenue Code for qualifying therapeutic discovery projects related to our two drug candidates ASONEP and iSONEP. We understand that such applications will be evaluated and grantees will be notified during the fourth quarter of 2010 regarding the amounts of grants awarded. Although we believe our applications meet the requirements of the program, we have no assurance that any grant will be issued, and we cannot estimate the amount of any such grant.

Critical Accounting Policies, Estimates, and Judgments

Our financial statements are prepared in accordance with accounting principles that are generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We continually evaluate our estimates and judgments, the most critical of which are those related to revenue recognition, valuation of long-lived assets and warrant liability, share-based compensation, the timing of the achievement of drug development milestones, and income taxes. We base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known.

In addition, the accompanying condensed consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The company’s continuation as a going concern is dependent on its ability to obtain additional financing to fund operations, implement its business model, and ultimately, to attain profitable operations. The company intends to raise additional financing to fund its operations through various means, including equity or debt financing, funding from a corporate partnership or licensing arrangement or any similar financing. However, there is no assurance that sufficient financing will be available or, if available, on terms that would be acceptable to the Company. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the company be unable to continue as a going concern.

Besides the estimates identified above that are considered critical, we make many other accounting estimates in preparing our financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets, liabilities, revenues and expenses, as well as disclosures of contingent assets and liabilities. These estimates and judgments are also based on historical experience and other factors that are believed to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known, even for estimates and judgments that are not deemed critical.

For further information, refer to the consolidated financial statements and notes thereto included in the company’s annual report on Form 10-K for the year ended December 31, 2009.

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Item 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Under the supervision of our principal executive officer and principal financial officer, and with the participation of all members of management, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were designed and operating effectively as of the end of the period covered by this Quarterly Report on Form 10-Q.

Our management, including our principal executive officer and our principal financial officer, cannot be certain that our disclosure controls and procedures or our internal controls will prevent all instances of errors and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during the quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

None.

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

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

Item 4. (REMOVED AND RESERVED)

Item 5. OTHER INFORMATION

None.

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Item 6. EXHIBITS

The following exhibit index shows those exhibits filed with this report and those incorporated herein by reference:

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

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