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, 1997
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 principle executive offices and zip code)
Registrant's telephone number, including area code: (415) 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 NOVEMBER 10, 1997:
Common Stock - 19,231,332 shares
Total pages: 18
Page number of exhibit index: 17
CYGNUS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1: Financial Statements
Consolidated Statements of Operations for the three
and nine month periods ended September 30, 1997
and 1996 (unaudited) ..................................... 2
Consolidated Condensed Balance Sheets at September 30, 1997
(unaudited) and December 31, 1996 ........................ 3
Consolidated Statements of Cash Flows for the nine month
periods ended September 30, 1997 and 1996 (unaudited) .... 4
Notes to Consolidated Financial Statements (unaudited) ..... 5
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations ............... 8
PART II. OTHER INFORMATION
Item 1: Legal Proceedings ................................... 16
Item 6: Exhibits and Reports on Form 8-K .................... 17
SIGNATURES ......................................................... 18
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
1997 1996 1997 1996
---------- --------- ---------- ----------
Product revenues $ 1,770 $ 7,149 $ 3,470 $ 12,442
Contract revenues 3,528 3,517 10,984 10,330
Royalty and other revenues 139 145 8,516 790
---------- --------- ---------- ----------
TOTAL REVENUES 5,437 10,811 22,970 23,562
Costs and expenses:
Costs of products sold 3,062 6,291 7,071 11,052
Research and development 5,381 5,996 16,353 16,881
Marketing, general and administrative 2,240 1,497 6,103 6,876
Arbitration settlement 39,633 -- 39,633 --
---------- --------- ---------- ----------
TOTAL COSTS AND EXPENSES 50,316 13,784 69,160 34,809
LOSS FROM OPERATIONS (44,879) (2,973) (46,190) (11,247)
Interest income, net 272 232 910 1,202
---------- --------- ---------- ----------
NET LOSS $ (44,607) $ (2,741) $ (45,280) $ (10,045)
---------- --------- ---------- ----------
---------- --------- ---------- ----------
NET LOSS PER SHARE $ (2.36) $ (0.15) $ (2.41) $ (0.54)
---------- --------- ---------- ----------
---------- --------- ---------- ----------
Shares used in computation of
net loss per share 18,879 18,584 18,818 18,506
---------- --------- ---------- ----------
---------- --------- ---------- ----------
(See accompanying notes.)
2
CYGNUS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
SEPTEMBER 30, December 31,
ASSETS: 1997 1996
------------- ------------
(unaudited)
Current assets:
Cash and cash equivalents $ 17,673 $ 33,148
Short-term investments 21,528 16,286
Trade accounts receivable, net of allowance 1,204 7,759
Inventories 1,769 2,331
Prepaid expenses and other current assets 2,968 1,010
--------- ---------
TOTAL CURRENT ASSETS 45,142 60,534
Equipment and improvements, at cost 15,324 19,462
Less accumulated depreciation and amortization (10,403) (13,872)
--------- ---------
Net equipment and improvements 4,921 5,590
Deferred compensation and other assets 3,985 2,674
--------- ---------
TOTAL ASSETS $ 54,048 $ 68,798
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable 1,126 2,153
Accrued compensation 2,599 3,177
Accrued professional services 787 691
Other accrued liabilities 1,635 2,465
Customer advances 296 1,146
Current portion of deferred revenue 2,196 10,912
Current portion of long term debt 3,635 2,289
Current portion of capital lease obligations 749 1,315
Current portion of arbitration obligations 16,633 --
--------- ---------
TOTAL CURRENT LIABILITIES 29,656 24,148
Long-term portion of deferred revenue 1,470 2,567
Long-term portion of debt 4,615 6,444
Long-term portion of capital lease obligations 600 1,076
Long-term portion of arbitration oligations 23,000 --
Deferred compensation and other long-term liabilities 4,499 3,350
Stockholders' equity:
Common stock 121,557 117,284
Accumulated deficit (131,349) (86,071)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) (9,792) 31,213
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 54,048 $ 68,798
--------- ---------
--------- ---------
Note: The condensed consolidated balance sheet at December 31, 1996 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.)
3
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase/(Decrease) in Cash and Cash Equivalents
(unaudited)
(In thousands)
NINE MONTHS ENDED SEPTEMBER 30,
1997 1996
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (45,280) $ (10,045)
Adjustments to reconcile net loss to cash (used
in)/provided by operating activities:
Depreciation and amortization 3,108 1,883
Decrease/(increase) in assets 3,812 (7,781)
Increase/(decrease) in liabilities (11,861) 11,297
Increase/(decrease) in arbitration liability 39,633 ---
-------------- --------------
NET CASH (USED IN)/PROVIDED BY OPERATING ACTIVITIES (10,588) (4,646)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,588) (953)
Decrease/(increase) in short-term investments (5,048) (9,765)
-------------- --------------
NET CASH (USED IN)/PROVIDED BY INVESTING ACTIVITIES (7,636) (10,718)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale and leaseback of assets --- 282
Issuance of common stock 4,273 3,466
Issuance of long-term debt 1,331 8,000
Principal payments of long-term debt (1,813) (367)
Payment of capital lease obligations (1,042) (1,077)
-------------- --------------
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES 2,749 10,304
-------------- --------------
NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS (15,475) (5,060)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 33,148 30,445
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 17,673 $ 25,385
-------------- --------------
-------------- --------------
(See accompanying notes.)
4
CYGNUS, INC.
September 30, 1997
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements of Cygnus, Inc. (the "Company" or
"Cygnus") as of and for the three and nine month periods ended September 30,
1997 and 1996 included herein are unaudited, but include all adjustments
(consisting only of normal recurring adjustments) which 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 consolidated financial statements
should be read in conjunction with the audited financial statements and
related notes for the year ended December 31, 1996 included in the Company's
1996 Annual Report and incorporated by reference in the Form 10-K.
2. NET LOSS PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share," which is required to be adopted by
the Company on December 31, 1997. At that time, the Company will be required
to change the method currently used to compute earnings per share and to
restate all prior periods. Under the new requirements for calculating primary
earnings per share, the dilutive effect of stock options and warrants, Common
Stock Equivalents ("CSE"), will be excluded. The Company is not impacted by
Statement 128 on the calculation of primary or fully diluted loss per share
for the three and nine month periods ended September 30, 1997 and September
30, 1996, since the Company's stock options and warrants are considered CSE
and their effect is currently anti-dilutive.
Currently, net loss per share is computed using the weighted average
number of shares of common stock outstanding. CSE shares issuable from stock
options and warrants are excluded from the computation, as their effect is
anti-dilutive.
3. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method)
or market, after appropriate consideration was given to obsolescence and
inventories in excess of anticipated future demand. Net inventories consist
of the following:
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------------------------
Raw materials $ 1,601 $ 1,111
Work in process 5 842
Finished goods 163 378
------------------------------
$ 1,769 $ 2,331
------------------------------
------------------------------
Inventories at September 30, 1997 primarily relate to estradiol (FemPatch)
transdermal products. Inventories at December 31, 1996 relate to the
Company's nicotine (Nicotrol) and estradiol (FemPatch) transdermal products.
5
CYGNUS, INC.
September 30, 1997
4. LEGAL PROCEEDINGS
On June 30, 1994, Sanofi, S.A. ("Sanofi") filed a request for arbitration
against Cygnus with the International Court of Arbitration. In its request
for arbitration, Sanofi alleged that Cygnus breached its existing contract
with Sanofi by, among other things, entering into a product development
agreement with another company for the development of transdermal systems in
the field of hormone replacement therapy (which agreements pertain to each of
the Company's hormone replacement products other than FemPatch-Registered
Trademark-). Sanofi, in the original filing, sought to recover from Cygnus in
excess of $60.0 million for damages attributable to the alleged breach.
International Chambers of Commerce (the "Tribunal") announced an interim
award in the arbitration proceedings in October 1996. The Tribunal found that
two transdermal products for hormone replacement therapy licensed by Cygnus
to another company fall within the scope of an exclusive license previously
granted to Sanofi.
In September 1997, the Company and Sanofi agreed to a settlement of the
arbitration dispute. Under the terms of the settlement, Cygnus (i) will pay
Sanofi $14.0 million in cash, (ii) will make royalty payments of between 6.5%
to 8.5% of any and all net sales of two products, which are subject to
minimum payments in an aggregate amount equal to $17.0 million, commencing in
2001 and ending in 2005, whether or not any net sales of the two products
have occurred, and (iii) will issue a convertible promissory note in the
principal amount of $6.0 million payable in full at the end of four years and
bearing interest at 6.5% per annum. The note will be convertible into the
Company's Common Stock at Sanofi's option, exercisable at any time during the
four year term, at a conversion rate of $21.725 per share. Overall, Cygnus'
non-recurring expenses attributable to the arbitration settlement recorded in
the three months ended September 30, 1997 totaled $39.6 million, of which
$23.0 million is long-term.
6
CYGNUS, INC.
September 30, 1997
5. DEBT COVENANTS
As of September 30, 1997 the Company had $0.4 million and $6.7 million
outstanding under two loan agreements with its bank (originally in the amount
of $1.7 million and $8.0 million respectively). As a result of recording the
arbitration settlement, the Company is in default of these agreements due to
the breach of several financial covenants, including those related to the
ratio of Debt to Tangible Net Worth and the total Tangible Net Worth. In the
event of a default, the outstanding balances due under the agreements could
be accelerated and payment in full required. The Company could remove the
default condition on the second bank loan by pledging cash or certificates
of deposit in the amount of 55% of the $6.7 million September 30, 1997
outstanding balance. However, since the bank has agreed to forbear from
exercising its rights under both Loan Agreements until January 30, 1998, the
Company did not provide this collateral as of September 30, 1997.
The Company is in violation of similar financial covenants with one other
leasing company and two other lenders which could also result in the
acceleration of the amounts due. One of the lenders has agreed to waive the
financial covenants for the remainder of the loan's term, which expires in
November of 1997. The other two companies, which have a combined outstanding
balance of $2.6 million as of September 30, 1997, have agreed to waive the
existing covenant defaults until December 31, 1997.
The Company is confident that it will be able to either arrange suitable
new covenants with its lenders when the forbearance and waivers terminate or
extend the waivers and forbearances. In the event that acceptable new
covenants cannot be agreed upon, or the waivers and forbearance are not
extended, or alternative sources of financing are not available, the Company
may be materially and adversely affected by collateral requirements and the
acceleration of the amounts due under the various agreements.
To ensure adequate liquidity to carry out its business plans, the Company
is considering various financing alternatives. The Company has filed a Form
S-3 shelf registration statement covering debt securities, convertible debt
securities or common stock, with proposed maximum aggregate offering proceeds
of $90.0 million. The registration statement has been declared effective by
the Securities and Exchange Commission.
7
CYGNUS, INC.
September 30, 1997
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE DISCUSSION SET FORTH BELOW CONTAINS PROJECTIONS AND FORWARD LOOKING
STATEMENTS REGARDING FUTURE EVENTS AND THE FUTURE FINANCIAL PERFORMANCE OF
THE COMPANY. WE WISH TO CAUTION YOU THAT THESE STATEMENTS ARE ONLY OUR
PREDICTIONS AND OBJECTIVES. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY.
PLEASE NOTE IN PARTICULAR THROUGHOUT THIS DOCUMENT WHERE WE HAVE HIGHLIGHTED
SPECIFIC RISKS ASSOCIATED WITH THE COMPANY AND ITS ACTIVITIES. WE ALSO REFER
YOU TO DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND
EXCHANGE COMMISSION, SUCH AS ITS MOST RECENT FORM 10-K AND ITS SUBSEQUENT
FORM 10-Q AND FORM 8-K REPORTS. THESE DOCUMENTS AND THE DISCUSSION BELOW
CONTAIN IMPORTANT FACTORS, INCLUDING WITHOUT LIMITATION THOSE INVOLVING
CERTAIN ONGOING ARBITRATION PROCEEDINGS INVOLVING THE COMPANY, THAT COULD
CAUSE OUR ACTUAL RESULTS TO DIFFER FROM OUR CURRENT EXPECTATIONS AND THE
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN.
GENERAL
Cygnus is engaged in the development and manufacture of diagnostic and
drug delivery systems, with its current efforts primarily focused on two core
areas: a painless, automatic glucose monitoring device (the GlucoWatch-TM-
system) and transdermal drug delivery systems.
The Company's product development efforts have been and are expected to
continue to be either self-funded, funded by licensees, or both. In general,
the Company's licensing agreements provide that Cygnus will manufacture its
products and receive manufacturing revenues from sales of these products to
its licensees. Cygnus may also receive royalties based on certain of its
licensees' product sales. In certain circumstances, the Company may elect to
license manufacturing rights for a product to its licensee in exchange for a
technology transfer fee and/or a higher royalty rate.
Cygnus' licensees generally have the right to abandon a product
development effort at any time for any reason without significant penalty.
Such cancellations may result in delays, suspension or abandonment of
clinical testing, the preparation and processing of regulatory filings and in
product development and commercialization efforts. Licensees have exercised
this right in the past, and there can be no assurance that current and future
licensees will not exercise this right in the future. If a licensee were to
cease funding one of the Company's products, Cygnus would either self-fund
development efforts, identify and enter into an agreement with an alternative
licensee or suspend or abandon further development work on the product. There
can be no assurance that, if necessary, the Company would be able to
negotiate an agreement with an alternative licensee on acceptable terms.
Since all payments to the Company under its licensing agreements following
their execution are contingent on the occurrence of future events or sales
levels, and the agreements are terminable by the licensee, no assurance can
be given as to whether the Company will receive any particular payment
thereunder or as to the amount or timing of any such payment. The Company
may choose to self-fund certain research and development projects in order to
exploit its technologies. Any increase in Company-sponsored research and
development activities will have an immediate adverse effect on the Company's
results of operations. However, should such Company-sponsored
8
CYGNUS, INC.
September 30, 1997
research and development activities result in a commercial product, the
long-term effect on the Company's results of operations could be favorable.
For the Company to remain competitive, it will need to develop,
in-license or acquire new diagnostic and drug delivery products.
Furthermore, the Company's ability to develop and commercialize products in
the future will depend on its ability to enter into collaborative
arrangements with additional licensees on favorable terms. There can be no
assurance that the Company will be able to enter into new collaborative
arrangements on such terms, if at all.
The Company's results of operations vary significantly from quarter to
quarter and year to year and depend on, among other factors, the signing of
new product development agreements and the timing of recognizing payment
amounts specified thereunder, the timing of recognizing license fees and cost
reimbursement payments made by pharmaceutical licensees, the demand for its
Nicotrol-Registered Trademark- product, the demand for and shipments of its
FemPatch product, and the costs associated with its manufacture. The
Company's contract revenues are generally earned and recognized based on the
percentage of actual efforts expended compared to total expected efforts
during the development period for each contract. However, contract revenues
are not always aligned with the timing of related expenses. To date, research
and development expenses have generally exceeded contract revenue in any
particular period and the Company expects the same situation to continue for
the next few years. In addition, the level of revenues in any given period is
not necessarily indicative of expected revenues in future periods. The
Company has incurred net losses each year since its inception and does not
believe it will achieve profitability in 1997. At September 30, 1997, after
recording the $39.6 million arbitration settlement discussed below, the
Company's accumulated deficit and net capital deficiency were approximately
$131.3 million and $9.8 million, respectively.
RESULTS OF OPERATIONS:
COMPARISON FOR THE QUARTERS ENDED SEPTEMBER 30, 1997 AND 1996
PRODUCT REVENUES for the quarter ended September 30, 1997 were $1.8
million, compared to $7.1 million for the quarter ended September 30, 1996.
Product revenues were $3.5 million for the nine months ended September 30,
1997, compared to $12.4 million for the nine months ended September 30, 1996.
Product revenue for the quarter ended September 30, 1997 resulted from the
initial shipments of FemPatch, the Company's second commercialized product.
The reduction in total product revenue for the three and nine months ended
September 30, 1997 resulted from the discontinuation of Nicotrol
manufacturing in the first quarter of 1997.
FemPatch is a low-dose, 7-day estrogen replacement transdermal patch for
the treatment of menopausal symptoms. Sanofi, the Company's worldwide
licensee, has sublicensed U.S. marketing rights to Warner-Lambert Company.
Cygnus manufactures the product.
In the first quarter of 1997, Pharmacia & Upjohn ("Pharmacia") exercised
its option to purchase the U.S. manufacturing rights for Nicotrol from
Cygnus. Cygnus will continue to receive royalty revenue from the worldwide
sales of Nicotrol. The Company has been unsuccessful in reaching an agreement
with Pharmacia regarding Pharmacia's obligations for certain purchase order
9
CYGNUS, INC.
September 30, 1997
commitments and existing inventory costs. Cygnus has initiated arbitration
proceedings against Pharmacia relating to these disputed matters.
Due to the above factors, the uncertainty of the success of the Company's
recently launched FemPatch product, and the uncertainty regarding when and if
additional products will obtain clearance from the Food and Drug
Administration ("FDA") and when and if licensees will sell and market such
products, the Company believes that the level of product revenues experienced
to date are not indicative of future results and may fluctuate from quarter
to quarter. In particular, the Company anticipates that total revenue from
Nicotrol during 1997 will be well below 1996 levels as a result of the
discontinuation of Nicotrol manufacturing.
CONTRACT REVENUES for the quarter ended September 30, 1997 were $3.5
million, compared to the $3.5 million for the quarter ended September 30,
1996 and were $11.0 million for the nine months ended September 30, 1997,
compared to $10.3 million for the nine months ended September 30, 1996.
Contract revenues primarily reflect labor and material cost reimbursements
associated with certain transdermal delivery systems and the amortization of
milestone payments relating to certain transdermal delivery systems and the
glucose monitoring device. The increase in contract revenues for the nine
months ended September 30, 1997 is primarily due to a $1.0 million payment
from Pharmacia for the exercise of its option to purchase the manufacturing
rights for Nicotrol, as noted above.
In February 1996, the Company entered into an agreement with Becton
Dickinson and Company for the marketing and distribution of the
GlucoWatch-TM-, a painless, automatic glucose monitoring device being
developed by Cygnus. Under the terms of the agreement, Becton Dickinson has
exclusive worldwide marketing and distribution rights, with the exception of
Japan and Korea. Cygnus will have primary responsibility for completing
product development, obtaining regulatory approvals and manufacturing. In
addition, Cygnus may participate in sales, marketing and customer service and
support for the product. In the first half of 1996, Cygnus received an
up-front, non-refundable payment from Becton Dickinson. The Company is also
eligible to receive future milestone payments as well as a percentage of the
product's future commercial success.
In July 1996, the Company entered into an agreement with Tokyo-based
Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") for the marketing and
distribution of the GlucoWatch. Under the terms of this agreement, Yamanouchi
has exclusive marketing and distribution rights in Japan and Korea. Cygnus
will have primary responsibility for completing product development and for
manufacturing. In the third quarter of 1996, Cygnus received an up-front,
non-refundable payment from Yamanouchi and is eligible to receive milestone
payments as well as a percentage of the product's future commercial sales. In
July 1996, the Company also entered into a development and marketing
agreement with Yamanouchi for a 7-day transdermal product to deliver a
proprietary Yamanouchi compound. Under the terms of the agreement, Cygnus
will receive funding for the development of the transdermal product and will
have exclusive rights to manufacture and supply Yamanouchi with the product
and Yamanouchi will have exclusive worldwide marketing rights to the product.
10
CYGNUS, INC.
September 30, 1997
Contract revenues are expected to fluctuate from quarter to quarter and
from year to year, and future contract revenues cannot be reasonably
predicted. The contributing factors to achieving contract revenues include,
but are not limited to, future successes in finalizing new collaborative
agreements, timely achievement of milestones under current contracts, and
strategic decisions on self-funding certain projects. Cygnus' licensees
generally have the ability to abandon the rights to a product and the
obligation to make related payments. Since all payments to the Company under
these agreements following their execution are contingent on the occurrence
of future events or sales levels, and the agreements are terminable by the
licensee, no assurance can be given as to whether the Company will receive
any particular payment thereunder or as to the amount or timing of any such
payment. The Company is unable to predict to what extent the termination of
existing contracts by current partners, or new collaborative agreements, if
any, will impact overall contract revenues in 1997 and subsequent future
periods.
ROYALTY AND OTHER REVENUES for the quarter ended September 30, 1997 were
$0.1 million, compared to $0.1 million for the quarter ended September 30,
1996 and were $8.5 million for the nine months ended September 30, 1997,
compared to $0.8 million for the nine months ended September 30, 1996. The
amounts include royalties from sales by Pharmacia of the Company's nicotine
transdermal product in Europe and Canada, and by Pharmacia's marketing
partner in the U.S. The net increase in royalty and other revenues for the
nine months ended September 30, 1997 is primarily due to the recognition of
previously deferred royalty payments associated with the U.S.
non-prescription sales of Nicotrol during the second half of 1996.
Royalty revenue will fluctuate from period to period since it is
primarily based upon sales by the Company's licensees. The level of royalty
income for a product also depends on various external factors, including the
size of the market for the product, product pricing levels and the ability of
the Company's licensee to market the product. Therefore, the level of royalty
revenue for any given period is not indicative of the expected royalty
revenue for future periods. As a result of the Company's marketing partner's
customers ability to meet product demand by utilizing existing inventory,
royalty revenue for the fourth quarter of 1997 will be lower than the
comparable quarter of 1996.
COSTS OF PRODUCTS SOLD for the quarter ended September 30, 1997 were $3.0
million, compared to $6.3 million for the quarter ended September 30, 1996
and were $7.0 million for the nine months ended September 30, 1997, compared
to $11.1 million for the nine months ended September 30, 1996. Costs of
products sold primarily include direct and indirect production, facility and
personnel costs required to meet future anticipated production levels. The
decrease in costs of products sold for the three and nine months ended
September 30, 1997 largely reflects the reduction of direct expenses related
to Nicotrol production. As a result of Pharmacia's exercise of its option to
purchase the manufacturing rights of Nicotrol, the Company will incur no
manufacturing costs associated with Nicotrol production, but consequently,
will achieve no production margins associated with such production. Cost of
products sold for the three months ended September 30, 1997 include the
initial shipments of FemPatch, the Company's second commercialized product.
The Company experienced negative product margins for the three and nine
months ended September 30, 1997 due to low production volumes which prevented
the Company from absorbing all of its fixed manufacturing costs.
11
CYGNUS, INC.
September 30, 1997
RESEARCH AND DEVELOPMENT EXPENSES for the quarter ended September 30,
1997 were $5.4 million, compared to $6.0 million for the quarter ended
September 30, 1996 and were $16.4 million for the nine months ended September
30, 1997, compared to $16.9 million for the nine months ended September 30,
1996. Research and development and clinical activities primarily include the
glucose monitoring development program, the support of the Company's hormone
replacement therapy products (one of which, FemPatch, was launched in
September 1997 and two of which are in clinical trials) and a contraception
product. While current levels are consistent with the prior year, Cygnus
anticipates that the development of new products, continued research of new
technologies and preparation for regulatory filings and clinical trials will
result in an increase in its overall research and development expenses.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the quarter ended
September 30, 1997 were $2.2 million, compared to $1.5 million for the
quarter ended September 30, 1996 and were $6.1 million for the nine months
ended September 30, 1997, compared to $6.9 million for the nine months ended
September 30, 1996. The decrease for the nine months ended September 30, 1997
primarily reflects decreased professional fees associated with the Company's
legal proceedings involving Sanofi. The Company expects that marketing,
general and administrative expenses will increase in the future as the
Company expands its operations.
ARBITRATION SETTLEMENT EXPENSE AND CORRESPONDING ACCRUALS for the quarter
and nine months ended September 30, 1997 consists of a $39.6 million
non-recurring arbitration settlement expense, of which $23.0 million is
long-term. Under the terms of the settlement, Cygnus (i) will pay Sanofi
$14.0 million in cash, (ii) will make royalty payments of between 6.5% to
8.5% of any and all net sales of two products, which are subject to minimum
payments in an aggregate amount equal to $17.0 million, commencing in 2001 and
ending in 2005, whether or not any net sales of the two products have
occurred, and (iii) will issue a convertible promissory note in the principal
amount of $6.0 million payable in full at the end of four years and bearing
interest at 6.5% per annum. The note will be convertible into the Company's
Common Stock at Sanofi's option, exercisable at any time during the four year
term, at a conversion rate of $21.725 per share. Overall, Cygnus'
non-recurring expenses attributable to the arbitration settlement recorded in
the three months ended September 30, 1997 totaled $39.6 million, of which
$23.0 million is long-term.
INTEREST INCOME, NET OF INTEREST AND OTHER EXPENSE for the quarter ended
September 30, 1997 was $0.3 million, compared to $0.2 million for the quarter
ended September 30, 1996 and was $0.9 million for the nine months ended
September 30, 1997, compared to $1.2 million for the nine months ended
September 30, 1996. The decrease for the nine months ended September 30, 1997
is due primarily to higher interest expense associated with the Company's
June 1996 $8.0 million bank loan agreement for short-term working capital. In
addition, interest income earned has decreased in conjunction with the
decrease in the cash and cash equivalents balance.
12
CYGNUS, INC.
September 30, 1997
LIQUIDITY AND CAPITAL RESOURCES
Through October 1995, the Company received net proceeds of approximately
$82.1 million from public offerings of its Common Stock. Through 1996, the
Company financed approximately $8.4 million of manufacturing and research
equipment under capital loan and lease arrangements. In 1997, the Company
entered into a new loan agreement for $1.3 million to finance additional
capital equipment. As of September 30, 1997 this loan was fully secured by
deposits.
In December of 1994, the Company borrowed $1.7 million under a bank line
of credit to finance the purchase of manufacturing and research equipment.
This line is being repaid in monthly installments through June 30, 1998. As
of September 30, 1997 there is $0.4 million outstanding under this agreement.
In June 1996, the Company received $8.0 million under a bank loan agreement
for short-term working capital. This loan is being repaid monthly through
December 1999. As of September 30, 1997 there is $6.7 million outstanding
under this agreement. The bank loans are subject to a number of financial and
other covenants. In the event of default the Bank may, at its option,
exercise its rights to remedies specified in the loan agreements which
include, among other things, the acceleration of amounts due under the
agreements. As a result of recording the arbitration settlement, the Company
is in default of these agreements due to the breach of several financial
covenants, including those related to the ratio of Debt to Tangible Net Worth
and the total Tangible Net Worth. The Company could remove the default
condition on the June 1996 loan by pledging cash or certificates of deposit
in the amount of 55% of the $6.7 million September 30, 1997 outstanding
balance. However, since the bank has agreed to forbear from exercising its
rights under the Loan Documents until January 30, 1998, the Company did not
provide this collateral as of September 30, 1997.
The Company is in violation of similar financial covenants with one other
leasing company and two other lenders which could also result in the
acceleration of the amounts due. One of the lenders has agreed to waive the
financial covenants for the remainder of the loan's term, which expires in
November of 1997. The other two companies, which have a combined outstanding
balance of $2.6 million as of September 30, 1997, have agreed to waive the
existing covenant defaults until December 31, 1997.
The Company is confident that it will be able to either arrange suitable
new covenants with its lenders when the forbearance and waivers terminate or
extend the waivers and forbearance. In the event that acceptable new
covenants cannot be agreed upon, or the waivers and forbearance are not
extended, or alternative sources of financing are not available, the Company
may be materially and adversely affected by collateral requirements and the
acceleration of the amounts due under the various agreements.
After recording the arbitration settlement in September of 1997, the
Company has a negative net worth of $9.8 million. However, $23.0 million of
the $39.6 million settlement is long-term, with payments spread between 2001
and 2005.
13
CYGNUS, INC.
September 30, 1997
In addition to the cash received from the public offerings, equipment
lease and short-term working capital financing, the Company has been
financing its operations primarily through revenues and interest income.
Net cash used in operating activities for the nine month period ended
September 30, 1997 was $10.6 million, compared with net cash used of $4.6
million for the period ended September 30, 1996. Cash used in operating
activities during the period ended September 30, 1997 was primarily due to
the Company's net loss of $45.3 million, decrease of $10.0 million in
deferred revenue and an increase of $3.3 million in notes receivable, prepaid
expenses and other current assets. This was offset by the $39.6 million
increase in Sanofi obligations and a decrease of $7.0 million in accounts
receivable. Cash used in operating activities during the period ended
September 30, 1996 was primarily due to the Company's net loss of $10.0
million, increases in accounts receivable, inventories and prepaid and other
assets and the decrease in accrued professional services, offset by increases
in accounts payable, deferred revenue and deferred compensation and other
liabilities.
The current level of cash used in operating activities is not necessarily
indicative of the level of future cash usage. As a result of increased
expenditures for the development of new products, preparation for regulatory
filings and clinical trials and the expected reduction in product revenues,
the Company anticipates an increase in cash usage for 1997 and future
operating activities.
Net cash used in investing activities of $7.6 million for the nine months
ended September 30, 1997 resulted primarily from net purchases of short-term
investments of $5.0 million and capital expenditures of $2.6 million. Net
cash used in investing activities of $10.7 million for the nine months ended
September 30, 1996 resulted primarily from net purchases of short-term
investments of $9.8 million and capital expenditures of $0.9 million.
Net cash provided by in financing activities of $2.7 million for the nine
months ended September 30, 1997 includes $2.5 million from the exercise of
warrants to purchase common stock and $1.7 million of common stock issuance
proceeds offset by $1.5 million in long-term debt and capital lease
repayments. Net cash provided by financing activities of $10.3 million for
the nine months ended September 30, 1996 includes $8.0 million received from
the short-term working capital loan and security agreement, $3.5 million of
common stock issuance proceeds and $0.3 million from the sale and leaseback
of equipment offset by long-term debt and capital lease repayments of $0.4
million and $1.1 million, respectively.
The Company's long-term capital expenditure requirements will depend upon
numerous factors, including: the progress of the Company's research and
development programs; the time required to obtain regulatory approvals; the
resources that the Company devotes to the development of self-funded
products, proprietary manufacturing methods and advanced technologies; the
ability of the Company to obtain additional licensing arrangements and to
manufacture products under those arrangements; the additional expenditures to
support the manufacture of new products if and when approved; and possible
acquisitions of products, technologies and companies. As the Company
evaluates the progress of its development projects, in particular the glucose
monitoring
14
CYGNUS, INC.
September 30, 1997
device and hormone replacement products, its commercialization plans and the
lead time to set up manufacturing capabilities, Cygnus may commence long-term
planning for another manufacturing site. Nevertheless, the Company believes
that such long-term planning will not result in any material impact on cash
flows and liquidity for 1997.
Based upon current expectations for operating losses, arbitration
settlement payments, and projected short-term capital expenditures, the
Company believes that its existing cash, cash equivalents and short-term
investments of $39.2 million, when coupled with expected future product sales
and royalty revenue, contract revenues from development agreements, interest
income and possible equipment financing, will be sufficient to meet its
operating expenses and capital expenditure requirements at least through the
middle of 1998. To ensure adequate liquidity to carry out its business
plans, the Company is considering various financing alternatives. The
Company has filed a Form S-3 shelf registration statement covering debt
securities, convertible debt securities or common stock with proposed maximum
aggregate offering proceeds of $90.0 million. The registration statement has
been declared effective by the Securities and Exchange Commission. However,
there can be no assurance that the Company will be able to obtain the
financing required for its future business strategies. Additionally, there
can be no assurance that the Company will not require additional financing
depending upon future business strategies, results of clinical trials and
management decisions to accelerate certain research and development programs
and other factors.
15
CYGNUS, INC.
September 30, 1997
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On June 30, 1994, Sanofi, S.A. ("Sanofi") filed a request for arbitration
against Cygnus with the International Court of Arbitration. In its request
for arbitration, Sanofi alleged that Cygnus breached its existing contract
with Sanofi by, among other things, entering into a product development
agreement with another company for the development of transdermal systems in
the field of hormone replacement therapy (which agreements pertain to each of
the Company's hormone replacement products other than FemPatch). Sanofi, in
the original filing sought to recover from Cygnus in excess of $60.0 million
for damages attributable to the alleged breach. International Chambers of
Commerce (the "Tribunal") announced an interim award in the arbitration
proceedings in October 1996. The Tribunal found that two transdermal products
for hormone replacement therapy licensed by Cygnus to another company fall
within the scope of an exclusive license previously granted to Sanofi.
In September 1997, the Company and Sanofi agreed to a settlement of the
arbitration dispute. Under the terms of the settlement, Cygnus (i) will pay
Sanofi $14.0 million in cash, (ii) will make royalty payments of between 6.5%
to 8.5% of any and all net sales of two products, which are subject to
minimum payments in an aggregate amount equal to $17.0 million, commencing in
2001 and ending in 2005, whether or not any net sales of the two products
have occurred, and (iii) will issue a convertible promissory note in the
principal amount of $6.0 million payable in full at the end of four years and
bearing interest at 6.5% per annum. The note will be convertible into the
Company's Common Stock at Sanofi's option, exercisable at any time during the
four year term, at a conversion rate of $21.725 per share. Overall, Cygnus'
non-recurring expenses attributable to the arbitration settlement recorded in
the three months ended September 30, 1997 totaled $39.6 million, of which
$23.0 million is long-term.
16
CYGNUS, INC.
September 30, 1997
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
The following exhibits are filed herewith or incorporated by reference:
27. Financial Data Schedule
b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended September 30, 1997.
17
CYGNUS, INC.
September 30, 1997
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: November 14, 1997 By: /s/ John C. Hodgman
---------------------------- ----------------------------------
John C. Hodgman
Chief Financial Officer (Principal
Accounting Officer) and Vice
President, Finance; President,
Cygnus Diagnostics
18
INDEX OF EXHIBITS
The following exhibits are included herein:
Exhibit 27 Financial Data Schedule