SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
- ----- Exchange Act of 1934 for the quarterly period ended SEPTEMBER 30, 2000
or
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 0-18962

CYGNUS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 94-2978092
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)

400 PENOBSCOT DRIVE, REDWOOD CITY, CALIFORNIA 94063-4719
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (650) 369-4300

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 X No
----- -----

Number of shares outstanding of each of the registrant's classes of common stock
as of October 25, 2000:

Common Stock - 27,035,008 shares

Total pages: 26
Page number of exhibit index: 26

CYGNUS, INC.

INDEX

PART I. FINANCIAL INFORMATION Page No.
--------

Item 1: Financial Statements

Condensed Consolidated Statements of Operations for the three-month and nine-month periods
ended September 30, 2000 and 1999 (unaudited)............................................... 2

Condensed Consolidated Balance Sheets at September 30, 2000 (unaudited) and December 31,
1999...................................................................................... 3

Condensed Consolidated Statements of Cash Flows for the nine-month periods ended
September, 2000 and 1999 (unaudited)...................................................... 4

Notes to the Condensed Consolidated Financial Statements (unaudited)...................... 5

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations..... 8

Item 3: Quantitative and Qualitative Disclosures About Market Risk................................ 21

PART II. OTHER INFORMATION

Item 1: Legal Proceedings......................................................................... 22

Item 6: Exhibits and Reports on Form 8-K.......................................................... 22

SIGNATURES........................................................................................... 25

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CYGNUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,

2000 1999 2000 1999
------------ ------------- ------------ -----------

Contract revenues $ ---- $ 912 $ 1,038 $ 912

Costs and expenses:
Research and development 5,973 3,324 14,355 12,079
Marketing, general and administrative 3,536 937 7,677 3,501
------------ ------------- ------------ -----------
Total costs and expenses 9,509 4,261 22,032 15,580

Loss from operations (9,509) (3,349) (20,994) (14,668)

Interest income/(expense), net (519) (761) (1,304) (2,601)
------------ ------------- ------------ -----------

Loss from continuing operations before income
tax (10,028) (4,110) (22,298) (17,269)

Provision for taxes ---- (100) (100) (100)
------------ ------------- ------------ -----------

Loss from continuing operations (10,028) (4,210) (22,398) (17,369)

Discontinued operations:
Income from operations of discontinued
segment ----- 88 ---- 1,439
------------ ------------- ------------ -----------
Net loss $ (10,028) $ (4,122) $ (22,398) $ (15,930)
============ ============= ============ ===========
Net loss per share from continuing operations,
basic and diluted $ (0.38) $ (0.17) $ (0.86) $ (0.76)
============ ============= ============ ===========

Net income/(loss) per share from discontinued
segment, basic and diluted
$ ---- $ ---- $ ---- $ 0.06
=========== ============= ============ ==========
Net loss per share, basic and diluted $ (0.38) $ (0.17) $ (0.86) $ (0.70)
============ ============ ============ ===========

Shares used in computation of net loss per
share, basic and diluted 26,467 24,196 26,032 22,854
=========== ============ ============ ==========

(See accompanying notes.)

CYGNUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

SEPTEMBER 30, DECEMBER 31,
2000 1999
---------------------- ---------------------
(UNAUDITED)
---------------------- ---------------------

ASSETS:
Current assets:
Cash and cash equivalents $ 9,394 $ 28,677
Short-term investments 16,229 10,215
Trade accounts receivable ---- 62
Prepaid expenses and other current assets 923 861
---------------------- ---------------------
Total current assets 26,546 39,815

Equipment and improvements:
Equipment and improvements, at cost 9,810 8,282
Construction in progress 4,558 4,417
---------------------- ---------------------
14,368 12,699
Less accumulated depreciation and amortization (7,387) (6,610)
---------------------- ---------------------
Net equipment and improvements 6,981 6,089
Long-term investments 2,569 ----
Other assets 933 1,072
---------------------- ---------------------
Total assets $ 37,029 $ 46,976
====================== =====================
LIABILITIES AND NET CAPITAL DEFICIENCY:
Current liabilities:
Accounts payable $ 1,480 $ 2,002
Accrued compensation 2,389 2,919
Other accrued liabilities 627 640
Current portion of deferred revenue ---- 900
Current portion of long-term debt 3,995 3,243
---------------------- ---------------------
Total current liabilities 8,491 9,704
---------------------- ---------------------

Long-term portion of arbitration obligation 23,000 23,000
Long-term portion of debt ---- 3,088
Convertible Debentures, net of discount of $4,672 in 2000 14,159 12,084
and $5,595 in 1999
Other long-term liabilities 291 304

Stockholders' net capital deficiency:
Common Stock 27 25
Additional paid-in-capital 192,247 177,576
Accumulated deficit (201,188) (178,790)
Accumulated other comprehensive income 2 (15)
---------------------- ---------------------
Net capital deficiency (8,912) (1,204)
---------------------- ---------------------
Total liabilities and stockholders' net capital
deficiency $ 37,029 $ 46,976
====================== =====================

Note: The condensed consolidated balance sheet at December 31, 1999 has been
derived from the audited financial statements at that date but does not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements.

(See accompanying notes.)

CYGNUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)

NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
------------------ -------------------

Cash flows from operating activities:
Net loss $ (22,398) $ (15,930)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 820 1,335
Amortization of debt issuance and financing costs and
debt discount 1,076 1,385
Gain on sale of equipment (59) (1)
Stock-based compensation 1,026 -----
Net (increase)/decrease in assets (19) 3,629
Net decrease in liabilities (837) (4,652)
------------------ -------------------
Net cash used in operating activities (20,391) (14,234)
------------------ -------------------

Cash flows from investing activities:
Capital expenditures (2,142) (2,230)
Purchases of investments (23,691) (4,901)
Proceeds from sale of equipment 350 1
Maturity and sale of investments 15,281 19,574
------------------ -------------------
Net cash (used in)/provided by investing activities (10,202) 12,444
------------------ -------------------

Cash flows from financing activities:
Issuance of Common Stock 13,647 10,130
Net proceeds from the issuance of Convertible Debentures ---- 16,514
Principal payments of Senior Subordinated Convertible Notes
---- (12,500)
Principal payments of long-term debt (2,337) (4,122)
Payment of capital lease obligations ---- (326)
------------------ -------------------
Net cash provided by financing activities 11,310 9,696
------------------ -------------------

Net decrease in cash and cash equivalents (19,283) 7,906
Cash and cash equivalents at beginning of period 28,677 10,219
------------------ -------------------
Cash and cash equivalents at end of period $ 9,394 $ 18,125
================== ===================

(See accompanying notes.)

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

The condensed consolidated financial statements of Cygnus, Inc. (the
"Company," "Cygnus," "us," "we," "our," etc.) as of and for the three-month and
nine-month periods ended September 30, 2000 and 1999 included herein are
unaudited, but they include all adjustments (consisting only of normal recurring
adjustments) that the management of Cygnus, Inc. believes necessary for a fair
presentation of the financial position as of the reported dates and the results
of operations for the respective periods presented. Interim financial results
are not necessarily indicative of results for a full year. The condensed
consolidated financial statements should be read in conjunction with the audited
financial statements and related notes for the year ended December 31, 1999
included in our 1999 Annual Report on Form 10-K.

2. NET LOSS PER SHARE

Basic and diluted net loss per share is computed using the weighted
average number of shares of common stock outstanding. Shares issuable from stock
options, warrants and convertible debentures are excluded from the diluted
loss-per-share computation, as their effect is anti-dilutive.

3. COMPREHENSIVE INCOME

Comprehensive income includes all changes in stockholders' equity
during a period except those resulting from investments by owners and
distributions to owners. Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income" (FAS 130), requires unrealized gains and losses
on our available-for-sale securities to be included in other comprehensive
income or loss. Unrealized gains or losses for the nine-month periods ended
September 30, 2000 and 1999 were not material and total comprehensive loss
approximated net loss for each of these periods.

4. NEW ACCOUNTING PRONOUNCEMENT

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133, as amended,
establishes methods for recording derivative financial instruments and hedging
activities related to those instruments, as well as other hedging activities. We
are required to adopt SFAS 133 effective January 1, 2001. Because we currently
do not hold any derivative instruments and do not engage in hedging activities,
we do not currently believe that the adoption of SFAS 133, as amended, will have
a significant impact on the consolidated financial position or results of
operations.

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements." SAB 101 summarizes certain areas of the staff's views in applying
generally accepted accounting

principles to revenue recognition. SAB 101 is required to be adopted by December
31, 2000. We do not expect that the implementation of SAB 101 will have a
material effect.

In March 2000 the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, Interpretation of APB Opinion No. 25." Interpretation No. 44
clarifies the application of Accounting Principle Board (APB) Opinion No. 25 to
certain issues including: (i) the definition of "employee" for purposes of
applying APB Opinion No. 25, (ii) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (iii) the accounting consequences of
various modifications to the terms of a previously fixed stock option or award,
and (iv) the accounting for an exchange of stock compensation awards in a
business combination. In general, Interpretation No. 44 is effective July 1,
2000. At present, the adoption of Interpretation No. 44 does not have a material
effect on our consolidated financial position or results of operations.

5. FINANCING INSTRUMENTS

In June 1999 we entered into two financing arrangements: a
Convertible Debenture and Warrant Purchase Agreement and a Structured Equity
Line Flexible Financing-SM- Agreement ("Equity Line"). Under the Convertible
Debenture and Warrant Purchase Agreement, convertible debentures having a
principal amount of $14.0 million were issued at a conversion price of
$12.705 per share and a due date of June 29, 2004. The Agreement also
provided for an additional $6.0 million, composed of two $3.0 million
tranches, and in September 1999 we received $3.0 million in gross proceeds
from the issuance of the first additional tranche having a conversion price
of $11.8663 and due September 29, 2004. The $3.0 million second additional
tranche is still available under this financing instrument.

The second financing arrangement, the Structured Equity Line Flexible
Financing Agreement, originally had a maximum aggregate issue price of $30.0
million over a two-year commitment period and allows us, at our sole discretion,
to sell common stock over this period. In 1999 we received proceeds of
approximately $9.5 million from the original $30.0 million. In May 2000 the
Equity Line was amended to increase the maximum aggregate issue price by an
additional $30.0 million to a total of $60.0 million, to issue warrants to
purchase up to 600,000 shares of common stock, to replace the calculation used
to determine the per share price with a formula more favorable to the Company,
and to extend the commitment period. In the first quarter of 2000, we received
approximately $1.0 million; in the second quarter of 2000, we received
approximately $5.5 million; and in the third quarter of 2000, we received
approximately $4.0 million. These proceeds resulted from the sale of
approximately 59 thousand, 459 thousand and 391 thousand shares of common stock
pursuant to the Equity Line in the above corresponding periods. Thus, to date we
have received approximately $20.0 million and have $40.0 million available under
the amended Structured Equity Line Agreement.

Five-year warrants have been issued under both of these financing
instruments. In conjunction with the Convertible Debenture, warrants to purchase
approximately 656 thousand shares of common stock at an exercise price of $13.86
per share and 139 thousand shares of

common stock at an exercise price of $16.18 per share were issued in 1999. At
the dates of grant, the fair values ascribed to these warrants were
approximately $5.5 million and $1.1 million, respectively, based on a
Black-Scholes valuation model, and these amounts are being amortized as
additional interest expense over the term of the debt. We recorded amortization
of $0.3 million for the three months ended September 30, 2000 and $1.0 million
for the nine months ended September 30, 2000. As of September 30, 2000, the
unamortized fair value amounted to $5.0 million. In conjunction with the Equity
Line, in January 2000 we issued warrants to purchase 95 thousand shares of
common stock at $11.51 per share.

6. ARBITRATION OBLIGATION

We have an accrued liability of $23 million relating to an arbitration
settlement agreement with Sanofi~Synthelabo. We have issued to Sanofi~Synthelabo
a convertible promissory note in the principal amount of $6 million, payable in
full in December 2001. In addition, we are obligated to make a payment of $2
million in December 2001, and payments of $3 million, $4 million, $4 million and
$4 million due December 2002 through 2005, respectively.

7. STATEMENTS OF CASH FLOWS DATA

Nine months ended
September 30, September 30,
2000 1999
-------------------------------------
(In thousands)

Supplemental disclosure of cash flows information
Foreign tax paid $ 100 $ 100

Supplemental schedule of non-cash investing and financing
activities
Conversion of principal and related interest of Senior
Subordinated Convertible Notes into Common Stock $ ---- $ 10,267
Fair value of the Common Stock Warrants issued to certain
Investors in connection with the Convertible Debenture $ ---- $ 6,572
Issuance of Restricted Stock grants $ ---- $ 2,019

8. DISCONTINUED OPERATIONS

On December 15, 1999, we completed the sale of substantially all of our
drug delivery business segment assets to Ortho-McNeil Pharmaceutical, Inc., a
Johnson & Johnson company. The drug delivery business has been accounted for as
a discontinued operation and the prior periods' financial statements have been
restated to report only continuing operations.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

SOME OF THE STATEMENTS IN OUR QUARTERLY REPORT ON FORM 10-Q UNDER
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND "RISK FACTORS" AND ELSEWHERE IN THIS QUARTERLY REPORT, INCLUDING
IN THE DOCUMENTS INCORPORATED BY REFERENCE, ARE FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS INCLUDE
STATEMENTS ABOUT OUR PLANS, OBJECTIVES, EXPECTATIONS, INTENTIONS AND ASSUMPTIONS
AND OTHER STATEMENTS CONTAINED IN THIS QUARTERLY REPORT, INCLUDING IN THE
DOCUMENTS INCORPORATED BY REFERENCE, THAT ARE NOT STATEMENTS OF HISTORICAL FACT.
FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, STATEMENTS ABOUT:

- - OUR ABILITY TO SECURE U.S. REGULATORY APPROVAL;
- - PLANS FOR MANUFACTURING AND COMMERCIAL SCALE-UP OF THE
GLUCOWATCH-REGISTERED TRADEMARK- SYSTEM;
- - PLANS FOR COMMERCIALIZATION ALLIANCES;
- - OUR ABILITY TO ACHIEVE MARKET ACCEPTANCE OF THE GLUCOWATCH SYSTEM; AND
- - PLANS FOR ENHANCEMENTS AND POSSIBLE MANUFACTURING CHANGES THROUGH THE
PREMARKET APPROVAL SUPPLEMENT PROCESS.

IN SOME CASES, YOU CAN IDENTIFY THESE STATEMENTS BY WORDS SUCH AS "MAY," "WILL,"
"SHOULD," "ESTIMATES," "PREDICTS" "POTENTIAL," "CONTINUE," "STRATEGY,"
"BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS," "INTENDS" AND SIMILAR
EXPRESSIONS. WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE
OR ACHIEVEMENTS. OUR ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER
SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DISCREPANCY INCLUDE THOSE DISCUSSED IN "RISK
FACTORS" AND ELSEWHERE IN THIS QUARTERLY REPORT, INCLUDING IN THE DOCUMENTS
INCORPORATED BY REFERENCE. THE FORWARD-LOOKING STATEMENTS CONTAINED IN THIS
QUARTERLY REPORT ARE CURRENT ONLY AS OF ITS DATE AND WE DISCLAIM ANY INTENT OR
OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS.

General

We develop and manufacture diagnostic medical devices, utilizing
proprietary technologies to satisfy unmet medical needs cost effectively. In
1999, we sold substantially all of our drug delivery business to Ortho-McNeil
Pharmaceutical, Inc. and chose to focus on diagnostic medical devices, the
first of which is our GlucoWatch-Registered Trademark- system. The GlucoWatch
system is a frequent, automatic and non-invasive glucose monitoring device
intended for detecting trends and tracking patterns of glucose levels in
adults, 18 years and older, who have diabetes. Our GlucoWatch system, with
its durable biographer and consumable AutoSensor, represents a potential
advance in glucose monitoring technology, as compared to the currently
prevailing "finger stick" blood monitoring methods. The GlucoWatch system is
designed to measure glucose frequently, automatically and non-invasively
through the ease and convenience of a device worn like a wristwatch. The
device is intended for use at home and in health care facilities to
supplement, not replace, information obtained from standard blood glucose
monitoring devices.

In mid-1998 we established product specifications and manufacturing
processes for the GlucoWatch system that the United States Food and Drug
Administration, or FDA, is currently reviewing. Since that time, we have
developed, and continue to develop, a number of enhancements to the GlucoWatch
system and our manufacturing processes. We will submit some of these product and
manufacturing enhancements to the FDA in the form of one or more supplements to
our existing premarket approval, or PMA, application shortly after PMA approval,
assuming the FDA approves our existing PMA. Future supplements could include
enhancements to product performance, user convenience, and manufacturing
capacity, and decreases in manufacturing costs. We are in the early
developmental stages for a future telemetric product that is intended to allow
both a greater flexibility in the location of the glucose extraction component
and a new form of the monitor that stores and displays glucose data. There have
been no sales of our glucose monitoring systems to date.

On December 6, 1999, we received a unanimous recommendation for
approval of our PMA for the GlucoWatch system from the FDA's Clinical Chemistry
and Clinical Toxicology Devises Panel of the Medical Devices Advisory Committee,
subject to certain conditions. In May 2000 we received an approvable letter from
the FDA for our GlucoWatch biographer. An approvable letter means that the FDA
has reviewed our PMA application, as well as its own Advisory Committee's report
and recommendation, and believes it will approve the application, pending
specific final conditions. The FDA's conditions relate to manufacturing, final
printed labeling materials, and post-market evaluations of aspects of product
performance.

Assuming FDA approval of our PMA, we anticipate introducing the
GlucoWatch system initially on a limited basis to a small number of patients
selected by designated physicians. We also expect to begin clinical trials with
adolescents and children. In addition, we plan to initiate professional
education programs to introduce our technology to physicians and other diabetes
health care professionals. Concurrently, before we can make the GlucoWatch
system broadly available, we must qualify and validate, then submit to the FDA
for approval a PMA supplement for our large-scale production equipment and
facility. For medical device products, it is not unusual to first receive
approval of a PMA application and then to seek approval for commercial-scale
manufacturing.

It has been a priority to establish alliances to allow us to
successfully develop, manufacture, and commercialize the GlucoWatch system. We
have already entered into several agreements that include:

- - a patent license agreement with The Regents of the University of
California;

- - supply agreements with E.I. du Pont de Nemours and Company, Key Tronic
Corporation and Hydrogel Design Systems, Inc. relating to materials for our
GlucoWatch system; and

- - contract manufacturing agreements with Contract Manufacturing, Inc. for the
consumable AutoSensor and with Sanmina Corporation for the manufacture of
the durable GlucoWatch biographer.

In August, 2000, we signed a Warehouse Distribution Contract with
Livingston Healthcare Services, Inc to provide outsource logistics services in
the U.S. for our GlucoWatch system. The agreement covers receiving, storage,
customer service, technical support and shipment. However, we are still solely
responsible for the production, marketing and sales of the GlucoWatch system.
The term of the agreement is for five years, but we may terminate the agreement
before then with an early-termination payment.

In October 2000, we regained the marketing and distribution rights for
the GlucoWatch system in Japan. Yamanouchi Pharmaceutical Co., Ltd. informed us
that, due to strategic reasons, the collaboration between Cygnus and Yamanouchi
for the marketing and distribution of the GlucoWatch Biographer in Japan needed
to be terminated. Under terms of the agreement, Yamanouchi will continue to be
responsible for a potential milestone payment over the next nine months and we
assume ownership of all the Japanese clinical trial data and regulatory
submissions.

In October 2000, we shipped our first commercial GlucoWatch systems to
the United Kingdom. We have established a medical advisory board in the UK who
will provide our GlucoWatch system to select adults with diabetes in order to
understand patient and health care provider experiences with our GlucoWatch
system. In July 2000, we established Cygnus (UK) Limited, a wholly-owned
subsidiary of Cygnus, Inc., in the UK and have hired initial management,
training, and sales personnel to manage our broader launch. We are also
finalizing an agreement with one company to provide direct-to-consumer
distribution/logistics functions and a second agreement with another company to
provide call center technical services for the UK. In December 1999, we received
a CE Certificate for the GlucoWatch system, indicating that the product has met
the essential requirements and other criteria of the European Community
Directive 93/42/ECC, Annex V, Section 3.2. The CE Certificate is required for
selling products in the European Community. We are currently exploring strategic
alternatives for commercializing the GlucoWatch system in other countries in
Europe.

We are continuing discussions for commercialization alliances with
companies ranging from international companies that would provide
commercialization functions worldwide to companies that focus on specific
geographies or commercialization functions.

On December 15, 1999, we completed the sale of substantially all of
our drug delivery business segment assets to Ortho-McNeil Pharmaceutical,
Inc.("Ortho-McNeil"), a Johnson & Johnson company. Under the terms of our
agreement with Ortho-McNeil, we received $20 million in cash at closing, and
Ortho-McNeil was subject to paying up to an additional $55 million in cash,
contingent on the achievement of certain milestones. The contingent payments
relate to the achievement of certain technical, regulatory and
commercialization milestones related to the EVRA-TM- (Johnson & Johnson, New
Brunswick, New Jersey) transdermal contraceptive patch. Because certain
milestones have not been achieved, we are now eligible to receive only up to
$35 million through 2006 of the total $55 million contingent milestones.
Because the achievement of these milestones is not within our control, we
cannot predict the likelihood or timing of these contingent payments.

10.

Our results of operations vary significantly from year to year, and
from quarter to quarter, and in the past have depended on, among other factors,
the nature of activities pursued and the level of expenses incurred, and the
signing of new agreements and the timing of recognizing payment amounts
specified thereunder. The level of revenues in any given period is not
necessarily indicative of expected revenues for future periods. We have incurred
net losses each year since our inception and do not believe we will achieve
profitability in 2001. At September 30, 2000 our accumulated deficit and net
capital deficiency were approximately $201.2 million and $8.9 million,
respectively.

RESULTS OF OPERATIONS

COMPARISON FOR THE QUARTERS AND NINE-MONTHS ENDED SEPTEMBER 30, 2000 AND 1999

NO CONTRACT REVENUES were recorded for the quarter ended September
30, 2000, compared to $0.9 million for the quarter ended September 30, 1999.
Contract revenues were $1.0 million for the nine months ended September 30,
2000, compared to $0.9 million for the nine months ended September 30, 1999.
These amounts reflect the amortization of a previously received milestone
payment. Contract revenues, if any, are expected to fluctuate from quarter to
quarter and from year to year, and future contract revenues, if any, cannot
be reasonably predicted.

RESEARCH AND DEVELOPMENT EXPENSES for the quarter ended September 30,
2000 were $6.0 million compared to $3.3 million for the quarter ended September
30, 1999 and were $14.4 million for the nine months ended September 30, 2000,
compared to $12.1 million for the nine months ended September 30, 1999. The
increase in research and development expenses for the quarter and nine months
ended September 30, 2000 is due primarily to an increase in research activities
in connection with the development and testing of a higher capacity
manufacturing process for our consumable AutoSensor.

MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the quarter ended
September 30, 2000 were $3.5 million, compared to $0.9 million for the quarter
ended September 30, 1999 and were $7.7 million for the nine months ended
September 30, 2000, compared to $3.5 million for the nine months ended September
30, 1999. The increase in marketing, general and administrative expenses for the
quarter and nine months ended September 30, 2000 is primarily due to expenses
incurred for pre-commercialization and other general support activities, and
non-cash, stock-based compensation.

INTEREST INCOME/(EXPENSE), NET for the quarter ended September 30, 2000
was $(0.5) million compared to $(0.8) million for the quarter ended September
30, 1999 and was $(1.3) million for the nine months ended September 30, 2000,
compared to $(2.6) million for the nine months ended September 30, 1999. The
decrease in net interest expense is due primarily to the June 1999 write-down of
the remaining unamortized debt issuance costs associated with the Senior
Subordinated Convertible Notes Agreement entered into in February 1998. In
addition, interest income earned for the quarter and nine months ended September
30, 2000 increased in conjunction with the higher average cash, cash equivalents
and investment balances in 2000.

11.

LIQUIDITY AND CAPITAL RESOURCES

Cash, cash equivalents and investment balances as of September 30, 2000
totaled $28.2 million. We have received net proceeds of approximately $115.4
million from public offerings of our common stock through September 30, 2000.
Since inception, we have financed approximately $11.1 million of manufacturing
and research equipment under capital loan and lease arrangements. Borrowings
under those arrangements are secured by specific Cygnus assets. We have an
outstanding bank loan agreement with Silicon Valley Bank that requires monthly
principal and interest payments through November 2001, in addition to compliance
with various financial covenants. As of September 30, 2000, there was $3.8
million outstanding under this agreement, and borrowings are secured by specific
Cygnus assets.

We have issued $17.0 million under our 1999 Convertible Debenture and
Warrant Purchase Agreement, and we have the ability to issue up to an additional
$3.0 million of convertible debt. Under our amended 1999 Structured Equity Line
Flexible Financing Agreement we have received approximately $20.0 million and we
have approximately $40.0 million available, subject to conditions.

Net cash used in operating activities for the nine months ended
September 30, 2000 was $20.4 million, compared with net cash used of $14.2
million for the nine months ended September 30, 1999. Cash used in operating
activities during the nine months ended September 30, 2000 was primarily due to
the net loss of $22.4 million from continuing operations.

The current level of cash used in operating activities is not
necessarily indicative of the level of future cash usage. We expect an increase
in operating cash usage for the remainder of 2000.

Net cash used in investing activities of $10.2 million for the nine
months ended September 30, 2000 resulted primarily from net purchases of
investments of $8.4 million and capital expenditures of $2.1. Net cash provided
by investing activities of $12.4 million for the nine months ended September 30,
1999 resulted primarily from net sales of investments of $14.6 million, offset
by capital expenditures of $2.2 million.

Net cash provided by financing activities totaled $11.3 million for the
nine months ended September 30, 2000 and included net proceeds of $10.3 million
from the sales of common stock under our 1999 Structured Equity Line Flexible
Financing Agreement and additional stock proceeds of $3.3 million, offset by
long-term debt repayments of $2.3 million. Net cash provided by financing
activities of $9.7 million for the nine months ended September 30, 1999 included
net proceeds of $16.5 million and $7.7 million from the June 1999 and September
1999 issuance of 8.5% Convertible Debentures and from the sale of common stock
under the Equity Line, respectively, and additional stock proceeds of $2.4
million, offset by the July 1999 redemption of Senior Subordinated Convertible
Notes of $12.5 million, and long-term debt and capital lease repayments of $4.1
million and $0.3 million, respectively.

12.

Our long-term capital expenditure requirements will depend upon
numerous factors, including, but not limited to: (i) the progress of our
research and development programs, (ii) the time required to obtain regulatory
approvals, (iii) the resources that we devote to manufacturing, distribution and
marketing of our products, (iv) the additional expenditures to support the
manufacture of new products, if and when approved, and (v) possible acquisitions
of products and technologies. As we evaluate the progress of our development
projects (in particular the GlucoWatch system and our enhanced glucose
monitoring products in development), our commercialization plans and the lead
time to set up manufacturing capabilities, we may commence long-term planning
for another manufacturing site. Nevertheless, we believe that such long-term
planning will not result in any material impact on cash flows and liquidity for
the next twelve months.

Based upon current expectations for operating losses and projected
short-term capital expenditures, we believe that existing cash, cash equivalents
and investments of $28.2 million as of September 30, 2000 - when coupled with
cash available from public financings (including debt or equity financings) and
any potential collaborations and earnings from investments - will be sufficient
to meet our operating expenses, debt servicing and repayments and capital
expenditure requirements at least for the next twelve months. However, there can
be no assurance that we will not require additional financing, depending upon
future business strategies, manufacturing and commercialization efforts, results
of clinical trials, management decisions to accelerate certain research and
development programs, and other factors.

RISK FACTORS

WE WISH TO CAUTION STOCKHOLDERS AND INVESTORS THAT THE FOLLOWING
IMPORTANT FACTORS, AMONG OTHERS, IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE
COULD AFFECT, OUR ACTUAL RESULTS AND COULD CAUSE OUR FUTURE RESULTS TO DIFFER
MATERIALLY FROM THOSE EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON
BEHALF OF CYGNUS. THE STATEMENTS UNDER THIS CAPTION ARE INTENDED TO SERVE AS
CAUTIONARY STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. THE FOLLOWING INFORMATION IS NOT INTENDED TO LIMIT IN ANY
WAY THE CHARACTERIZATION OF OTHER STATEMENTS OR INFORMATION UNDER OTHER CAPTIONS
AS CAUTIONARY STATEMENTS FOR SUCH PURPOSE.

WE MAY NOT RECEIVE REGULATORY APPROVAL ON OUR PRODUCTS FROM THE FDA
AND/OR FOREIGN REGULATORY AGENCIES.

Although in May 2000 we received an approvable letter from the FDA for
our GlucoWatch biographer, there can be no assurance that we can meet the
pending specific final conditions or, if we can, that the FDA will approve the
product. Furthermore, as we seek regulatory approval for enhancements and
manufacturing changes to the GlucoWatch system through the PMA supplement
process, there can be no assurance that these supplements will be approved or
that we will not need to file one or more new PMAs. The timing for approval of
PMA supplements could substantially delay introduction of product enhancements
and our ability to cost-effectively manufacture large quantities of AutoSensors.
Regulatory requirements and procedures also vary on a country-by-country basis,
and we may not be able to obtain regulatory approval in foreign countries.
Furthermore, even if the GlucoWatch system is successfully developed, its
commercial success will depend on its market acceptance.

13.

OUR PRODUCT PIPELINE IS SEVERELY LIMITED.

With the sale of substantially all of our drug delivery business
segment assets to Ortho-McNeil Pharmaceutical, Inc. and the termination of our
remaining drug delivery projects, we are now exclusively focused on diagnostic
medical devices, initially on a line of frequent, automatic and non-invasive
glucose monitoring devices. There is an inherent risk in not having a broad base
of products in development, and we cannot assure you that we will be successful
with this narrow, non-diversified line of diagnostic medical device products.

WE DO NOT HAVE MEDICAL DEVICE MARKETING, DISTRIBUTION, MANUFACTURING OR
SALES EXPERIENCE.

Even if we receive the necessary regulatory approvals for the
GlucoWatch system and our large-scale manufacturing process, we may have
unforeseen problems in product manufacturing, commercial scale-up, marketing or
product distribution. We do not have any experience marketing, distributing,
manufacturing or selling medical device products. To successfully market,
distribute, manufacture and sell the GlucoWatch system and our other glucose
monitoring products under development, we must either develop these capabilities
or enter into arrangements with third parties. We cannot assure you that we will
successfully implement either course of action. If we maintain our own
capabilities, we will compete with other companies that have experienced and
well-funded operations. If we enter into arrangements with third parties, any
revenues we receive will depend on the third party, and we will likely have to
pay a sales commission or similar amount to the third party. If we are unable to
make satisfactory arrangements, we may be unable to successfully commercialize
our products after FDA approval or may experience delays in commercialization.

WE MAY NOT BE ABLE TO ENTER INTO AGREEMENTS NECESSARY FOR
COMMERCIALIZATION OF OUR PRODUCTS.

One of our priorities is to establish one or more alliances to secure
commercialization functions, such as distribution, sales and customer service,
for the GlucoWatch system. We have recently entered into a distribution
agreement for the U.S. We are continuing discussions for commercialization
alliances with companies ranging from international companies that would provide
commercialization functions worldwide to companies that focus on specific
geographies or commercialization functions. However, we may not obtain a
worldwide commercialization partner, if we ever do, until well after our
large-scale manufacturing process is approved by the FDA. Any commercialization
partners we do find may, for competitive reasons, support, directly or
indirectly, a company or product that competes with our product. Furthermore,
any dispute with a commercialization partner might require us to initiate or
defend against expensive litigation or arbitration proceedings. If a third party
terminates an arrangement, cannot meet its obligations under its arrangements,
or disputes or breaches a significant contractual commitment, then we would
likely be required to seek an alternative third party. If we were unable to find
a replacement partner, we might not be able to perform or fund the partner's
activities. Even if we were able to perform and fund these activities, our
capital requirements could increase substantially.

14.

THIRD PARTIES MAY NOT REIMBURSE THE COSTS OF OUR GLUCOWATCH SYSTEM.

Successful commercialization of our products may depend in part on the
availability of reimbursement from third-party health care payers, such as
private insurance plans and the government. We plan to conduct outcome studies
for reimbursement; however, there can be no assurance as to whether such
reimbursement will be available or in what time frame. Third-party payers are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new therapeutic and diagnostic products.
There can be no assurance that adequate levels of reimbursement will be
available to enable us to achieve market acceptance of the GlucoWatch system or
other new products under development or to maintain price levels sufficient to
realize an appropriate return on our investment. In both the U.S. and foreign
countries, the period of time needed to obtain such reimbursement can be
lengthy. We may delay the launch of our products in some countries until
eligibility for reimbursement is established. This delay could potentially harm
our business, financial condition and results of operations.

WE CANNOT PREDICT THE MARKET ACCEPTANCE OF OUR GLUCOWATCH SYSTEM.

We are focusing our efforts predominantly on a line of frequent,
automatic, and non-invasive glucose monitoring devices. We cannot predict market
acceptance or penetration of our products, given that they are different from
any glucose diagnostic products currently on the market. There is a risk in
introducing a very new type of product in a market of established finger stick
glucose monitors, and we cannot assure you whether our products will be accepted
or to what degree. Additionally, some of our competitors have announced, and
others may be developing, new glucose monitoring devices that are frequent,
automatic, and non-invasive (or minimally invasive, semi-invasive or
less-invasive). We cannot predict what impact the introduction of competing
products will have on our market sales. Furthermore, market acceptance is also
influenced by the level of reimbursement, if any.

WE FACE INTENSE COMPETITION.

The medical device industry in general, and the market in which we
expect to offer the GlucoWatch system in particular, is intensely competitive.
Even if we successfully develop, gain FDA approval for and manufacture the
GlucoWatch system, we will compete with other providers of personal glucose
monitors. A number of our competitors are currently marketing traditional finger
stick glucose monitors. These monitors are widely accepted in the health care
industry and have long histories of acceptable accuracy and effective use.
Furthermore, a number of companies have announced that they are developing
products that permit less-painful or painless, as well as continual or
continuous, glucose monitoring. Accordingly, we expect competition to increase.
Many of our competitors have substantially greater resources than we do and have
greater name recognition and lengthier operating histories in the health care
industry. We cannot assure you that we will be able to compete effectively
against our competitors. Additionally, we cannot assure you that the GlucoWatch
system or our other enhanced products under development will replace any
currently used devices or systems. Our competitors may also develop and
commercialize, even before we commercialize the

15.

GlucoWatch system or our other enhanced products under development, devices and
technologies that permit more efficient and less expensive glucose monitoring
devices. Pharmaceutical or other health care companies may also develop
therapeutic drugs, treatments or other products that will substantially reduce
or even eradicate the prevalence of diabetes or otherwise render our products
obsolete.

WE DEPEND ON PROPRIETARY TECHNOLOGY.

Our success depends in large part on our ability to obtain patent
protection for our products, preserve our trade secrets and operate without
infringing upon the proprietary rights of others, both in the U.S. and abroad.
Currently, patent applications in the U.S. are maintained in secrecy until
issuance, and publication of discoveries in the scientific or patent literature
tends to lag behind actual discovery by several months. Thus, we cannot be
certain that we were the first to file patent applications on our inventions or
that we will not infringe upon third-party patents. We cannot assure you that
any patents will issue or will be upheld with respect to any of our patent
applications or that any patents will provide competitive advantages for our
products or will not be challenged or circumvented by our competitors. We also
rely on trade secrets and proprietary know-how that we seek to protect, in part,
by confidentiality agreements with our suppliers, employees and consultants. We
cannot assure you that these agreements will not be breached, that we would have
adequate remedies for any breach or that our trade secrets will not otherwise
become known or be independently developed by our competitors. Any litigation,
in the U.S. or abroad, as well as foreign opposition and/or domestic
interference proceedings, could result in substantial expense to us and
significant diversion of effort by our technical and management personnel. We
may resort to litigation to enforce our patents or protect trade secrets or
know-how, as well as to defend against infringement charges. A negative
determination in such proceedings could subject us to significant liabilities or
require us to seek licenses from third parties. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. Furthermore, we cannot
assure you that necessary licenses would be available to us on satisfactory
terms, if at all. Accordingly, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
us from manufacturing and selling certain of our products, and could severely
harm our business.

WE DEPEND ON THIRD-PARTY SUPPLIERS FOR KEY COMPONENTS OF OUR GLUCOWATCH
SYSTEM.

The GlucoWatch system is manufactured from components purchased from
outside suppliers, most of which are our single source for such components. In
the event that we are unable, for whatever reason, to obtain these components
from our suppliers or that the components obtained from these suppliers do not
pass quality standards, we will be required to obtain the components from
alternative suppliers. Additionally, we cannot assure you that, in the event a
current supplier were unable to meet our component requirements, we would be
able to rapidly find another supplier of the particular component or that the
alternate supply would be at the same price or have the same lead time. Any
interruption in the supply of the

16.

GlucoWatch system components or the pricing of these components
could severely harm our business.

WE MAY NEED ADDITIONAL FINANCING AND IT MAY NOT BE AVAILABLE.

In order to continue to develop our diagnostic products, we will
require substantial resources to conduct research and development and clinical
trials necessary to bring our products to market and to establish production and
marketing capabilities. We may seek additional funding through public or private
financings, including debt or equity financings. We may also seek other
arrangements, including collaborative arrangements. Any additional equity
financings may dilute the holdings of current stockholders. Debt financing, if
available, may restrict our ability to issue dividends in the future and take
other actions. We may not be able to obtain adequate funds when we need them
from financial markets or arrangements with commercialization partners or other
sources. Even if funds are available, they may not be on acceptable terms. If we
cannot obtain sufficient additional funds, we may have to delay, scale back or
eliminate some or all of our research and product development programs or
license or sell products or technologies that we would otherwise seek to develop
ourselves. We believe that our existing cash, cash equivalents and investments,
plus cash from revenues, other fundings (such as financings or potential product
funding collaborations), and earnings from investments, will suffice to meet our
operating expenses, debt servicing and repayments, and capital expenditure
requirements at least for the next twelve months. The amounts and timing of
future expenditures will depend on progress of ongoing research and development,
results of clinical trials, rates at which operating losses are incurred,
executing possible commercialization agreements, developing our products,
manufacturing of the GlucoWatch system, the FDA regulatory process, and other
factors, many of which are beyond our control.

17.

WE ARE HIGHLY LEVERAGED AND MAY BE UNABLE TO SERVICE OUR DEBT.

As of September 30, 2000, we had indebtedness of approximately $45.8
million. The degree to which we are leveraged could limit our ability to obtain
financing for working capital, commercialization of products or other purposes
and could make us more vulnerable to industry downturns and competitive
pressures. Our ability to meet our debt service obligations depends upon our
future performance, which will depend upon financial, business and other
factors, many of which are beyond our control. Although we believe our cash
flows will be adequate to meet our interest payments, we cannot assure you that
we will continue to generate cash flows in the future sufficient to cover our
fixed charges or to permit us to satisfy any redemption obligations pursuant to
our indebtedness. If we cannot generate cash flows in the future sufficient to
cover our fixed charges or to permit us to satisfy any redemption obligations
pursuant to our indebtedness, and we cannot borrow sufficient funds either under
our credit facilities or from other sources, we may need to refinance all or a
portion of our existing debt, sell all or a portion of our assets, or sell
equity securities. There is no assurance that we could successfully complete any
of these courses of action. In the event of insolvency, bankruptcy, liquidation,
reorganization, dissolution or winding-up of our business or upon default or
acceleration relating to our debt obligations, our assets will first be
available to pay the amounts due under our debt obligations. Holders of common
stock would only receive the assets remaining, if any, after payment of all
indebtedness and preferred stock, if any.

WE HAVE INCURRED SUBSTANTIAL LOSSES, HAVE A HISTORY OF OPERATING
LOSSES, HAVE AN ACCUMULATED DEFICIT AND EXPECT CONTINUED OPERATING LOSSES.

We reported a net loss from continuing operations of $22.4 million
for the nine months ended September 30, 2000 and have experienced annual
operating losses since our inception. We expect to continue to incur
operating losses at least until we have significant sales, if we ever do, of
the GlucoWatch system. We cannot assure you that we will generate significant
revenues or achieve profitability. We do not have experience in
manufacturing, marketing or selling our medical device products. Our future
development efforts may not result in commercially viable products. We may
fail in our efforts to introduce our products or to obtain required
regulatory clearances. Our products may never gain market acceptance, and we
may never generate revenues or achieve profitability. Our revenues to date
have been derived primarily from product development and licensing fees
related to our products under development and manufacturing and royalty
revenues from our discontinued operations, including Nicotrol-Registered
Trademark- (Pharmacia AB, Stockholm, Sweden) nicotine patch and the
FempatCh-Registered Trademark- (Warner-Lambert Co., Morris Plains, New
Jersey) system. As a result of the sale of our drug delivery business in
December 1999, we will no longer receive manufacturing revenue or royalty
payments from the Nicotrol patch or the Fempatch system. If we obtain
regulatory approvals, we expect to significantly increase our level of
expenditures for sales, marketing and general and administrative activities
in connection with product commercialization, and these expenditures will
precede commercial revenues, if any.

18.

WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS.

The design, development, manufacture and use of our medical products
involve an inherent risk of product liability claims and associated adverse
publicity. Producers of medical products may face substantial liability for
damages in the event of product failure or allegations that the product caused
harm. We currently maintain product liability insurance, but it is expensive and
difficult to obtain and may not be available in the future on acceptable terms.
We cannot assure you that we will not be subject to product liability claims,
that our current insurance will cover any claims, or that adequate insurance
will continue to be available on acceptable terms in the future. In the event we
are held liable for damages in excess of the limits of our insurance coverage,
or if any claim or product recall creates significant adverse publicity, our
business could be severely harmed.

WE MAY NOT BE ABLE TO RETAIN OR HIRE KEY PERSONNEL.

Our ability to operate successfully and manage our potential future
growth significantly depends upon retaining key scientific, technical, sales,
marketing, managerial and financial personnel, and attracting and retaining
additional highly qualified scientific, technical, sales, marketing, managerial
and financial personnel. We face intense competition for qualified personnel in
these areas, and we cannot assure you that we will be able to attract and retain
qualified personnel. The loss of key personnel or our inability to hire and
retain additional qualified personnel in the future could severely harm our
business.

OUR STOCK PRICE IS VOLATILE.

The trading price of our common stock fluctuates substantially in
response to factors such as, but not limited to, announcements by us or our
competitors of results of regulatory approval filings or clinical trials or
testing; developments or disputes governing proprietary rights; technological
innovations or new commercial products; government regulatory action; general
conditions in the medical technology industry; changes in securities analysts'
recommendations; or other events or factors, many of which are beyond our
control.

In addition, the stock market in general has experienced extreme price
and volume fluctuations in recent years and even in recent months that have
particularly affected the market prices of many medical technology companies,
unrelated to the operating performance of these companies. Fluctuations or
decreases in the trading price of our common stock may adversely affect the
market for our common stock. In the past, following periods of volatility in the
market price for a company's securities, securities class action litigation
often has been instituted. Such litigation could result in substantial costs and
a diversion of management attention and resources, which could severely harm our
business.

19.

OUR RESTATED CERTIFICATE OF INCORPORATION AND OUR BYLAWS HAVE
ANTI-TAKEOVER PROVISIONS.

Our Restated Certificate of Incorporation and our Bylaws contain
several provisions that may make the acquisition of control of Cygnus more
difficult or expensive. The Certificate of Incorporation and the Bylaws, among
other things: provide that directors may be removed only for cause and only upon
the affirmative vote of the holders of at least a majority of the outstanding
shares of voting stock entitled to vote for such directors; permit the remaining
directors (but not the stockholders, unless the directors so resolve) to fill
vacancies and newly created directorships on the Board; eliminate the ability of
stockholders to act by written consent; and require the vote of stockholders
holding at least 66 2/3% of the outstanding shares of voting stock to amend,
alter or repeal the Bylaws and certain provisions of the Restated Certificate of
Incorporation, including the provisions described above.

These provisions may make the removal of incumbent directors more
difficult and time consuming and may have the effect of discouraging a tender
offer or other takeover attempt not previously approved by the Board of
Directors. Under our Restated Certificate of Incorporation, the Board of
Directors also has the authority to issue shares of Preferred Stock in one or
more series and to fix the powers, preferences and rights of any such series
without stockholder approval. The Board of Directors could, therefore, issue,
without stockholder approval, Preferred Stock with voting and other rights that
could adversely affect the voting power of the holders of common stock and could
make it more difficult for a third party to gain control of Cygnus. In addition,
we have adopted a Stockholder Rights Plan which, under certain circumstances,
would significantly dilute the equity interest of persons seeking to acquire
control over us without the prior approval of the Board of Directors.

OUR STOCK PRICE COULD BE ADVERSELY AFFECTED BY THE RISK OF OWNERSHIP
DILUTION CAUSED BY THE ISSUANCE OF SHARES UNDER THE EQUITY LINE OR BY ADDITIONAL
SHARES OF OUR COMMON STOCK BECOMING AVAILABLE FOR SALE IN THE FUTURE. IF OUR
STOCK PRICE DECLINES, YOU MAY NOT BE ABLE TO RESELL OUR SHARES AT OR ABOVE THE
PRICE YOU PAID, OR AT ALL.

Under our Equity Line, each month we may sell up to $4 million of
common stock and Cripple Creek may exercise its option to purchase up to an
additional $3 million of common stock during each month in an investment period
(up to an aggregate of $60 million during the term of the equity line) at a
price equal to the average of the two lowest volume-weighted average prices for
the stock during the six trading days preceding the sale, but in no event lower
than a designated minimum per share price we indicate in our notice to Cripple
Creek. Because the price of the shares that may be sold under our Equity Line is
based on the market value of the common stock at the time of the sale, the
number of shares sold will be greater if the price of the common stock declines,
which would cause greater ownership dilution. In addition, the perceived risk of
dilution resulting from the sale of shares could cause some of our stockholders
to sell their stock, thus causing the price of our stock to further decline.

The total number of shares that may be issued under our Equity Line
depends on the market price of our common stock at the time that the shares are
sold and whether we choose to sell shares, and the number of shares we choose to
sell from time to time, to Cripple Creek. The

20.

following table illustrates the effect of variations in the market price in our
common stock, and resulting variations in sales prices to Cripple Creek, on the
number of shares issued in a one month period, assuming that we choose to sell
all possible shares under our Equity Line. This table illustrates how the
ownership dilution resulting from the sale of shares under our Equity Line
agreement increases as the market value of our common stock declines.

Price Per Share Number of Shares Issued
--------------- -----------------------
(one month)

$15 466,667
$10 700,000
$5 1,400,000

Our decision to choose to sell all possible shares under our Equity
Line would be influenced by, among other things, whether it is in the best
interests of our stockholders to sell at lower market prices, given our
financing requirements and access to alternative sources of financing. As of the
date of this prospectus, we expect to satisfy substantially all of our expected
financing needs during 2001 through sales under our Equity Line.

We have also agreed to issue to Cripple Creek warrants to purchase
10,000 shares for every $1,000,000 in gross proceeds from the sale of common
stock under the equity line agreement. The warrants will be issued after the end
of each calendar year. The warrants are exercisable for 5 years from the date
they are issued at an exercise price equal to the weighted average price at
which shares were sold during the preceding calendar year.

WE DO NOT PAY DIVIDENDS.

We have never declared or paid cash dividends on our common stock. Our
current bank term loan agreement precludes us from paying dividends to
stockholders. We currently intend to retain any earnings for use in our business
and therefore do not anticipate paying any dividends in the future.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Reference is made to Part II, Item 7A, Quantitative and Qualitative
Disclosures About Market Risk, in our Annual Report on Form 10-K for the year
ended December 31, 1999.

21.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a) EXHIBITS

The following exhibits are filed herewith or incorporated by reference:

3.01 Bylaws of Cygnus, Inc., as amended, incorporated by reference to
Exhibit 3.01 of our Form 10-Q for the quarter ended March 31, 2000.

3.02 Restated Certificate of Incorporation of Cygnus, Inc., as amended
to date, incorporated by reference to Exhibit 3.02 of our Form 10-Q
for the quarter ended March 31, 2000.

4.01 Specimen of Common Stock certificate of Cygnus, Inc., incorporated
by reference to Exhibit 4.1 of our Registration Statement Form S-1
No. 33-38363.

4.02 Form of Senior Indenture incorporated herein by reference to
Exhibit 4.1 filed with our Registration Statement on Form S-3 (File
No. 33-39275) declared effective by the Securities and Exchange
Commission on November 12, 1997 (the "November 1997 Form S-3").

4.03 Form of Subordinated Indenture incorporated herein by reference to
Exhibit 4.2 filed with our November 1997 Form S-3.

4.04 Form of Senior Debt Security (included in Exhibit 4.1) incorporated
herein by reference to Exhibit 4.3 filed with our November 1997
Form S-3.

4.05 Form of Subordinated Debt Security (included in Exhibit 4.2)
incorporated herein by reference to Exhibit 4.4 filed with our
November 1997 Form S-3.

4.06 First Supplemental Indenture, dated as of February 2, 1998, by and
between Cygnus, Inc. and State Street Bank and Trust Company of
California, N.A. incorporated by reference to Exhibit 4.5 of our
Form 8-K dated February 4, 1998.

4.07 Second Supplemental Indenture, dated as of October 28, 1998, by and
between Cygnus, Inc. and State Street Bank and Trust Company of
California, N.A. to the Indenture dated as of February 3, 1998 and
the First Supplemental Indenture dated as of February 3, 1998,
incorporated by reference to Exhibit 4.8 of our Form 8-K filed on
October 30, 1998.

22.

4.08 Amended and Restated Rights Agreement dated October 27, 1998
between Cygnus, Inc. and ChaseMellon Shareholder Services, LLC (the
"Rights Agent" successor to Chemical Trust), which includes the
Certificate of Determination for the Series A Junior Participating
Preferred Stock as Exhibit A, the form of Rights Certificate as
Exhibit B and the Summary of Rights to Purchase Preferred Shares as
Exhibit C, incorporated by reference to Exhibit 99.2 of our Form
8A/A filed on December 14, 1998, Registration No. 0-19962.

4.09 Registration Rights Agreement dated June 30, 1999 between Cygnus,
Inc. and Cripple Creek Securities, LLC, incorporated by reference
to Exhibit 4.11 of our Form 10-Q for the quarter ended June 30,
1999.

4.10 Registration Rights Agreement dated June 29, 1999 between Cygnus,
Inc. and the listed Investors on Schedule I thereto, incorporated
by reference to Exhibit 4.12 of our Form 10-Q for the quarter ended
June 30, 1999.

10.109 Amendment No. 2 to Structured Equity Line Flexible Financing
Agreement between Cygnus, Inc. and Cripple Creek Securities, LLC,
dated March 27, 2000, incorporated by reference to Exhibit 10.109
of our Form 10-Q for the quarter ended March 31, 2000.

10.110 Amendment No. 3 to our Structured Equity Line Flexible Financing
Agreement between Cygnus, Inc. and Cripple Creek Securities, LLC,
dated May 9, 2000, incorporated by reference to Exhibit 10.110 of
our Form 10-Q for the quarter ended June 30, 2000.

*10.207 Supply Agreement between Cygnus, Inc. and Sanmina Medical Products
Division, a division of Sanmina Corporation, dated March 1, 2000,
incorporated by reference to Exhibit 10.207 of our Form 10-Q for
the quarter ended June 30, 2000.

*10.208 Supply Agreement between Cygnus, Inc. and E.I. du Pont de Nemours
and Company, dated June 23, 2000, incorporated by reference to
Exhibit 10.208 of our Form 10-Q for the quarter ended June 30,
2000.

*10.209 Warehouse Distribution Contract between Cygnus, Inc. and Livingston
Healthcare Services Inc., dated August 25, 2000, incorporated by
reference to Exhibit 10.209 of our Form 8-K filed on October 17,
2000.

27.0 Financial Data Schedule

- --------------------
*A confidential treatment request has been applied for or granted with respect
to a portion of this document.

23.

b) REPORTS ON FORM 8-K

On October 17, 2000, we filed a Current Report on Form 8-K reporting
under Item 5 that we shipped our first commercial GlucoWatch systems to
the UK. We have established a UK medical advisory board to provide our
GlucoWatch biographer to select adults with diabetes. We also announced
that we regained the marketing and distribution rights for the
GlucoWatch system in Japan and that the collaboration between Cygnus
and Yamanouchi for the marketing and distribution of the GlucoWatch
system in Japan would be terminated.

24.

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 the
undersigned, thereunto duly authorized.

CYGNUS, INC.

Date: October 27, 2000 By: /s/ John C Hodgman
---------------------- -----------------------------------
John C Hodgman
Chairman, President and Chief Executive Officer
(Principal Executive Officer)

Date: October 27, 2000 By: /s/ Craig W. Carlson
---------------------- -------------------------------------
Craig W. Carlson
Chief Financial Officer
(Principal Accounting Officer)

25.

INDEX OF EXHIBITS

The following exhibits are included herein:

Exhibit 27.0 Financial Data Schedule.

26.