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 JUNE 30, 1999
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: (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 AUGUST 9, 1999:
Common Stock, $.001 par value - 24,145,826 shares
Total pages: 30
Page number of exhibit index: 27
CYGNUS, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Statements of Operations for the three and six month
periods ended June 30, 1999 and 1998 (unaudited)............................ 2
Condensed Consolidated Balance Sheets at June 30,1999 (unaudited) and
December 31, 1998........................................................... 3
Condensed Consolidated Statements of Cash Flows for the six month periods
ended June 30, 1999 and 1998 (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....................................................... 11
Item 3: Quantitative and Qualitative Disclosures About Market Risk..................... 26
PART II. OTHER INFORMATION
Item 1: Legal Proceedings........................................................... 27
Item 4: Submission of Matters to a Vote of Security Holders......................... 27
Item 6: Exhibits and Reports on Form 8-K............................................ 28
SIGNATURES.................................................................................... 30
1
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 Six months ended
June 30, June 30,
------------------------------ ----------------------------
1999 1998 1999 1998
----------- ------------ ------------ -----------
Product revenues $ ---- $ 81 $ ---- $ 587
Contract revenues 3,797 2,636 6,363 5,359
Royalty and other revenues 265 165 620 396
----------- ------------ ------------ -----------
TOTAL REVENUES 4,062 2,882 6,983 6,342
Costs and expenses:
Costs of products sold ---- 937 ---- 1,960
Research and development 5,564 8,741 13,449 14,806
Marketing, general and administrative 1,996 2,800 3,466 4,716
----------- ------------ ------------ -----------
TOTAL COSTS AND EXPENSES 7,560 12,478 16,915 21,482
LOSS FROM OPERATIONS (3,498) (9,596) (9,932) (15,140)
Interest income/(expense), net (1,494) (63) (1,876) (57)
----------- ------------ ------------ -----------
NET LOSS $ (4,992) $ (9,659) $ (11,808) $ (15,197)
----------- ------------ ------------ -----------
----------- ------------ ------------ -----------
BASIC AND DILUTED NET LOSS PER SHARE $ (0.22) $ (0.48) $ (0.53) $ (0.76)
----------- ------------ ------------ -----------
----------- ------------ ------------ -----------
Shares used in computation of basic and
diluted net loss per share 22,632 20,239 22,182 20,040
----------- ------------ ------------ -----------
----------- ------------ ------------ -----------
(See accompanying notes.)
2
CYGNUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
JUNE 30, December 31,
1999 1998
------------------------------------------
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents $ 31,394 $ 10,219
Restricted cash 871 ----
Short-term investments 468 14,982
Trade accounts receivable, net of allowance 1,133 876
Inventories ---- 771
Prepaid expenses and other current assets 609 695
------------------------------------------
Total current assets 34,475 27,543
EQUIPMENT AND LEASEHOLD IMPROVEMENTS:
Equipment and leasehold improvements, at cost 21,674 19,541
Less accumulated depreciation and amortization (13,976) (13,077)
------------------------------------------
Net equipment and improvements 7,698 6,464
Long-term investments 3,810 3,622
Deferred compensation and other assets 7,374 5,825
------------------------------------------
Total Assets $ 53,357 $ 43,454
------------------------------------------
------------------------------------------
LIABILITIES AND NET CAPITAL DEFICIENCY:
CURRENT LIABILITIES:
Accounts payable $ 4,266 $ 4,459
Accrued compensation 5,013 4,593
Accrued professional services 578 729
Other accrued liabilities 1,205 943
Customer advances 157 207
Current portion of arbitration obligation 255 60
Current portion of deferred revenue 643 1,153
Current portion of long-term debt 3,533 3,415
Current portion of capital lease obligations 442 442
------------------------------------------
Total current liabilities 16,092 16,001
Long-term portion of arbitration obligation 23,909 24,158
Long-term portion of debt 6,512 8,252
Long-term portion of capital lease obligations 367 581
Senior Subordinated Convertible Notes 12,500 22,563
Convertible Debentures 14,000
Deferred compensation and other long-term liabilities 412 4,666
STOCKHOLDERS' NET CAPITAL DEFICIENCY:
Common stock 24 21
Additional paid-in-capital 167,316 143,155
Accumulated deficit (187,763) (175,955)
Accumulated other comprehensive income/(loss) (12) 12
------------------------------------------
Net capital deficiency (20,435) (32,767)
------------------------------------------
Total liabilities and stockholders' net capital
deficiency $ 53,357 $ 43,454
------------------------------------------
------------------------------------------
Note: The condensed consolidated balance sheet at December 31, 1998 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.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase/(Decrease) in Cash and Cash Equivalents
(unaudited)
(In thousands)
SIX MONTHS ENDED JUNE 30,
1999 1998
------------------ -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (11,808) $ (15,197)
Adjustments to reconcile net loss to cash used in
Operating activities:
Depreciation and amortization 926 925
Decrease/(increase) in assets 5,191 1,662
Increase/(decrease) in liabilities (4,503) 581
Increase/(decrease) in arbitration liability (53) (13,968)
------------------ -------------------
NET CASH USED IN OPERATING ACTIVITIES (10,247) (25,997)
------------------ -------------------
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,152) (2,280)
Decrease/(increase) in investments 14,218 (24,729)
------------------ -------------------
NET CASH PROVIDED BY/(USED IN) INVESTING ACTIVITIES 12,066 (27,009)
------------------ -------------------
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 7,191 13,959
Principal payments of long-term debt (1,621) (1,387)
Payment of capital lease obligations (214) (276)
Issuance of Convertible Debentures 14,000 ----
Issuance of long-term debt, net ---- 6,110
Net proceeds from the issuance of Senior Subordinated
Convertible Notes ---- 40,351
------------------ -------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 19,356 58,757
------------------ -------------------
NET INCREASE /(DECREASE) IN CASH AND CASH EQUIVALENTS 21,175 5,751
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 10,219 20,669
------------------ -------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 31,394 $ 26,420
------------------ -------------------
------------------ -------------------
(See accompanying notes.)
4
CYGNUS, INC.
June 30, 1999
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Cygnus, Inc. (All
references to "we", "us", "our", the "Company" or "Cygnus" in this Report on
Form 10-Q mean Cygnus, Inc.) as of and for the six month periods ended June
30, 1999 and 1998 included herein are unaudited, but include all adjustments
(consisting only of normal recurring adjustments) which the management of
Cygnus believes are 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, 1998 included in the Company's
1998 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 and warrants outstanding are excluded from the diluted earnings
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"), which was adopted by the
Company on January 1, 1998, requires unrealized gains and losses on the
Company's available-for-sale securities to be included in other comprehensive
income or loss. Unrealized gains or losses for the three month periods ended
June 30, 1999 and June 30, 1998 were not material and total comprehensive
loss closely approximated net loss for each of these periods.
4. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"). FAS 133 requires all
derivatives to be recorded on the balance sheet at fair value and establishes
special accounting rules for different types of hedges. Adoption of this
statement is required in the year ending December 31, 2001 and is not
expected to have a material impact on the Company's results of operations or
financial condition.
5. INVENTORIES
Net inventories of $0.8 million as of December 31, 1998 consisted of
raw materials related to the Company's estrogen transdermal product
(FemPatch-Registered Trademark-Warner-Lambert Co., Morris Plains,
NJ-system) and were stated at the lower of cost (first-in, first-out method) or
5
CYGNUS, INC.
June 30, 1999
market, after appropriate consideration was given to obsolescence and
inventories in excess of anticipated future demand.
Due to the termination of the Supply Agreement between Warner-Lambert
Company ("Warner-Lambert") and the Company, all related inventory was sold or
written off against prior reserves during the first quarter of 1999.
6. DEBT RESTRUCTURING
In February 1998, the Company entered into Note Purchase Agreements
with certain institutional investors to issue and sell approximately $43.0
million of 4% Senior Subordinated Convertible Notes Due in 2005 (the
"Notes"). On October 28, 1998, the Company restructured the Notes. Key
provisions in the restructured Notes included the October 1998 repayment of
$18.5 million in principal (reducing the principal balance from $43 million
to $24.5 million), a delay in the convertibility of the majority of the Notes
to June 30, 1999 or after, modification of the conversion prices of the
Notes, the ability of the Company to redeem at par at any time all or part of
the new principal amount of the Notes, an increase in the interest rate to
5.5% paid annually on the new principal balance and a change in the final
maturity of the Notes to October 1, 2000.
The restructured Notes, which totaled $24.5 million, were divided into
three tranches. The first tranche had an original principal amount of $6.0
million and was fully converted by January 1999 at $3.54 per share. The
second tranche also had an original principal amount of $6.0 million and was
fully converted on June 30, 1999 at $6.89 per share. The third tranche of the
restructured Notes had an original principal amount of $12.5 million and
could not have been converted into Common Stock until July 1, 1999, at a
conversion price that would have been determined based on market-based
pricing formulas which contained look-back provisions. Also, under the terms
of the restructured Notes, if the Company called the third tranche for
redemption before July 1, 1999, the Note Holders would not be entitled to
convert any portion of that tranche. On June 29, 1999, the Company issued
redemption notices with a redemption date of July 9, 1999 for the entire
third tranche and, accordingly, the Note Holders were not entitled to convert
any portion of that tranche. On July 9, 1999, the Company paid $12.5 million
in principal and $0.4 million in accrued interest to redeem the third tranche.
In order to help finance the redemption of the third tranche discussed
above, and to provide additional potential sources of capital, the Company
entered into two new financing arrangements.
On June 29, 1999, the Company entered into a Convertible Debenture
Agreement with certain institutional investors ("the Investors") to issue and
sell $14.0 million principal amount of 8.5% Convertible Debentures Due June
29, 2004 ("Convertible Debentures"). These Convertible Debentures are
convertible into shares of Common Stock at any time at a conversion price of
$12.705 per share. The Company received gross proceeds of $14.0 million from
the issuance of the Convertible Debentures and incurred debt issuance costs
of $0.4 million. If certain trading volume, pricing and other conditions are
met, the Company and/or the Investors will have the right to require the sale
of an additional $6.0 million in additional aggregate principal amount of
Convertible Debentures in two separate tranches of $3.0 million each (each
6
CYGNUS, INC.
June 30, 1999
an "Additional Tranche"), provided that the second Additional Tranche notice
date may not be earlier than sixty days after the first Additional Tranche
notice date. The conversion price for each Additional Tranche will be the
average of the closing bid prices for the ten trading days prior to and
including the respective Additional Tranche notice date and the ten trading
days subsequent to the respective Additional Tranche notice date ("Additional
Closing Price") multiplied by 110% (see Convertible Debenture and Warrant
Purchase Agreement attached hereto as Exhibit 10.42).
In conjunction with the Convertible Debentures, the Company issued
five-year warrants to purchase approximately 656 thousand shares of Common
Stock at $13.86 per share. The Company has included $6.5 million on June 30,
1999 to reflect the fair value of the warrants, computed using the
Black-Scholes valuation model, and this amount will be amortized over the
life of the underlying warrants. The Company is also required to issue
warrants if Additional Tranches of the Convertible Debenture are sold. Such
warrants will be priced at 120% of the respective Additional Closing Price. The
number of additional warrants to be issued will be determined by dividing 50%
of the respective Additional Tranche by the respective Additional Closing Price.
On June 30, 1999, the Company also entered into a Structured Equity
Line Flexible Financing Agreement ("Equity Line") with certain institutional
investors. The Equity Line is effective for two years ("Commitment Period")
and allows the Company, at its sole discretion, to sell Common Stock with a
maximum aggregate issue price of up to $30.0 million over the Commitment
Period. On June 30, 1999, the Company received a net of approximately $3.9
million, after deducting the issuance costs, from the $4.0 million ("Initial
Investment") in exchange for approximately 346 thousand shares of Common
Stock. The number of shares of Common Stock for the Initial Investment was
determined on the basis of the average closing bid price for the ten trading
days prior to June 30, 1999 ("Initial Investment Purchase Price"). Under the
terms of the Equity Line, over the eighty days following June 30, 1999
("Initial Period") the Investors should deliver purchase notices from time to
time up to a maximum aggregate amount of $4.0 million to purchase shares of
the Company's Common Stock. The per share price for each such purchase notice
will be equal to 98% of the average of the two lowest daily trade prices
during the six trading days immediately prior to the respective purchase
notice. At the end of the Initial Period, the number of shares originally
issued will be adjusted upward, if required, to match the aggregate number of
shares covered by the $4.0 million of purchase notices. Thereafter, the
Company is under no obligation to sell any additional shares. After the
Initial Period, on a monthly basis ("Investment Period"), the Company can
elect, at its sole discretion, to sell up to $1.5 million ("Company
Election") in additional shares of Common Stock. In addition to the above and
upon the Company's approval, the Investors may also elect to purchase an
additional $1.0 million ("Investor Election") of Common Stock in each
Investment Period. In each Investment Period in which the Company has elected
to sell additional shares, the Investors will from time to time issue
purchase notices for the aggregate amount of the Company Election and the
Investor Election. The per share price of Common Stock to be sold for each
such purchase notice will equal 98% of the average of the two daily low trade
prices during the six trading days immediately prior to the respective
purchase notice. At the beginning of each Investment Period, the Company can
set a minimum sales price ("Floor Price") for its Common Stock. The Investors
may require the aggregate dollar amount of the Company Election and
7
CYGNUS, INC.
June 30, 1999
Investor Election for any Investment Period to be less than requested based
on certain market trading volume guidelines (see Form 8-K filed July 2, 1999).
In conjunction with the Equity Line, the Company will also issue
five-year warrants to the Investors to purchase shares of the Common Stock.
The price of the warrants will be determined each calendar year and will equal
120% of the weighted average per share sales price of all shares of Common
Stock sold pursuant to the Equity Line that year. The number of shares will
equal 1% of the aggregate proceeds received for all shares sold pursuant to
the Equity Line during the year. For the $4.0 million received pursuant to the
Equity Line on June 30, 1999, the Company will issue warrants to purchase 40
thousand shares of Common Stock. Warrants to purchase a minimum of 120
thousand shares must be issued under the Equity Line and, if at the end of the
Commitment Period warrants to purchase less than 120 thousand shares of Common
Stock have been issued, the Company must issue a warrant to purchase the
number of shares equal to the difference, at a price equal to 120% of the
average exercise price of all warrants previously issued pursuant to the
Equity Line.
7. CERTIFICATE OF DEPOSIT FOR LETTER OF CREDIT
In June 1999, we opened a standby letter of credit ("LC") for $0.9
million in favor of our lessor to maintain compliance with our capital lease
agreement. To secure this standby LC, we pledged a certificate of deposit,
which is considered restricted cash, to the issuing bank. The certificate of
deposit earns interest at a rate yielding 4.19% per annum.
8. STATEMENTS OF CASH FLOWS DATA
JUNE 30, JUNE 30,
1999 1998
----------------------------------
(in thousands)
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 $ 6,515 $ ----
9. BUSINESS SEGMENTS
We operate in two business segments: diagnostics and drug delivery.
Both segments are engaged in development and manufacture, utilizing
proprietary technologies to satisfy unmet medical needs cost-effectively. The
segments are strategic business units managed separately based on the
differences in the technologies of their respective product lines.
The diagnostics division's efforts are primarily focused on a frequent
automatic and non- invasive glucose monitoring device, the
GlucoWatch-Registered Trademark- monitor. The GlucoWatch-Registered
Trademark- monitor is designed to take frequent measurements, thus providing
an abundance of glucose data to
8
CYGNUS, INC.
June 30, 1999
potentially better control fluctuating glucose levels. We believe our
proprietary extraction and sensing technologies provide the potential to
develop unique products for glucose monitoring which could lead to improved
treatment for people with diabetes.
The drug delivery division's efforts are focused primarily on
transdermal drug delivery systems, which provide for the controlled release
of drugs directly into the bloodstream through intact skin. Cygnus'
transdermal technology is based on the objective of making transdermal
products less irritating, more comfortable and longer to wear for the
patient. We have received United States Food and Drug Administration ("FDA")
approval for two products and have a number of others in late-stage
development, including two hormone replacement therapy products and a
contraceptive product.
There are no reconciling items between total segment revenues and
profit and loss and consolidated results. We utilize the following
information for the purpose of making decisions and assessing segment
performance.
BUSINESS SEGMENTS
SIX MONTHS ENDED ---------------------------------------------------
JUNE 30, 1999 DIAGNOSTICS DRUG DELIVERY CORPORATE TOTAL
------------- ----------- ------------- ---------------
Revenue $ ---- $ 6,984 $ 6,984
Profit/(loss) $ (12,964) $ 1,156 $ (11,808)
SIX MONTHS ENDED
JUNE 30, 1998
-------------
Revenue $ 457 $ 5,885 $ 6,342
Profit/(loss) $ (14,345) $ (852) $ (15,197)
THREE MONTHS ENDED
JUNE 30, 1999
-------------
Revenue $ ---- $ 4,062 $ 4,062
Profit/(loss) $ (6,147) $ 1,155 $ (4,992)
THREE MONTHS ENDED
JUNE 30, 1998
-------------
Revenue $ 152 $ 2,730 $ 2,882
Profit/(loss) $ (8,498) $ (1,161) $ (9,659)
BUSINESS SEGMENTS
---------------------------------------------------
JUNE 30, 1999 DIAGNOSTICS DRUG DELIVERY CORPORATE TOTAL
------------- ----------- ------------- ---------------
Identifiable assets $ 49,981 $ 3,376 $ 53,357
JUNE 30, 1998
-------------
Identifiable assets $ 77,334 $ 5,018 $ 82,352
9
CYGNUS, INC.
June 30, 1999
There has been no significant change from December 31, 1998 in the
basis of measurement of segment revenues and profit or loss. The change in
identifiable assets from June 30, 1998 to June 30, 1999 is primarily due to
operating losses and the partial redemption of Senior Subordinated Convertible
Notes.
Essentially all segmental revenues have been generated in the U.S. and
we currently do not have any long-lived assets outside the U.S.
10. SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale are carried at fair value, based on
quoted market prices, and the unrealized gains and losses have been combined
with the accumulated deficit due to immateriality. Realized gains and losses
and declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income/expense. The cost of securities
sold is based on the specific identification method. Interest and dividends
on securities classified as available-for-sale are also included in interest
income/expense.
We consider all highly liquid investments with a maturity from the date
of purchase of three months or less to be cash equivalents. We invest our
excess (to current demands) cash in short-term and long-term high credit
quality, highly liquid instruments. These investments have included, but are
not limited to, Treasury Notes, Federal Agency Securities, Auction Rate
Certificates, Auction Rate Preferred Stock, and Commercial Paper.
10
CYGNUS, INC.
June 30, 1999
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS,
INCLUDING BUT NOT LIMITED TO THOSE SPECIFICALLY IDENTIFIED AS SUCH, THAT
INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS REPORT ON
FORM 10-Q THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF
THE EXCHANGE ACT, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING OUR
EXPECTATIONS, BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ON FORM 10-Q ARE BASED ON
INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION
TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS
AS A RESULT OF A NUMBER OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET
FORTH IN THE "RISK FACTORS" CONTAINED IN THIS MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND ELSEWHERE IN
THIS REPORT ON FORM 10-Q.
GENERAL
We are engaged in the development and manufacture of diagnostic and
drug delivery systems, utilizing proprietary technologies to satisfy unmet
medical needs cost-effectively. Our efforts are primarily focused on two core
areas: a frequent, automatic and non-invasive glucose monitoring device (the
GlucoWatch-Registered Trademark- monitor) and transdermal drug delivery
systems.
Our product development efforts have been and are expected to continue
to be either self-funded, funded by licensees or distributors, or both. In
general, our agreements provide that we will manufacture our products and
receive manufacturing revenues from sales of these products to our licensees
or distributors. We may also receive royalties based on certain of our
licensees' or distributors' product sales. In certain circumstances, we may
elect to license manufacturing rights for a product to our licensee in
exchange for a technology transfer fee and/or a higher royalty rate.
Our licensees and distributors 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 product development and commercialization efforts. Licensees have
exercised this right in the past, and there can be no assurance that current
and future licensees or distributors will not exercise this right in the
future. If a licensee or distributor were to cease funding one of our
products, we would either self-fund development efforts, identify and enter
into an agreement with an alternative licensee or distributor or suspend
further development work on the product. There can be no assurance that, if
necessary, we would be able to negotiate an agreement with an alternative
licensee or distributor on acceptable terms. Since all payments to us under
our agreements following execution are contingent on the occurrence of future
events or sales levels, and the agreements are terminable by the licensee or
distributor, no assurance can be given as to whether we will receive any
particular payment thereunder or as to the amount or timing of any such
payment. We may choose to self-fund certain research and development projects
in order to exploit our technologies. Any increase in Company-sponsored
research and development activities will have an immediate adverse effect on
our results of operations. However, should such Company-sponsored research
and development activities result in a commercial product, the long-
11
CYGNUS, INC.
June 30, 1999
term effect on our results of operations could be favorable. In the past some
of our licensees, distributors and collaborators have approached us
requesting modification of the terms of existing agreements.
We are currently involved in discussions with a short list of companies
with regard to a collaboration for the marketing and distribution of the
GlucoWatch-Registered Trademark- monitor in the United States, Europe and
those territories not included in the agreement between us and Tokyo-based
Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi"). (For more on the
Yamanouchi agreement see "Contract Revenue," under Results of Operations.)
There can be no assurance that we will be able to enter into such a
collaboration agreement.
To remain competitive, we will need to develop, in-license or acquire
new diagnostic and drug delivery products. Furthermore, our ability to
develop and commercialize products in the future will depend on our ability
to enter into collaboration arrangements with additional licensees on
favorable terms. There can be no assurance that we will be able to enter into
new collaboration arrangements on such terms, if at all.
Our results of operations vary significantly from year to year and
quarter to quarter 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 or distribution
fees and cost reimbursement payments made by pharmaceutical licensees, and the
demand for such products. Up-front and interim milestone payments from
contracts 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, our research and
development expenses have generally exceeded contract revenue in any particular
period and we expect 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. We have incurred net losses
each year since our inception and do not believe we will achieve profitability
in 1999. At June 30, 1999, our accumulated deficit and net capital
deficiency were approximately $187.8 million and $20.4 million, respectively.
12
CYGNUS, INC.
June 30, 1999
RESULTS OF OPERATIONS:
COMPARISON FOR THE QUARTERS ENDED JUNE 30, 1999 AND 1998
PRODUCT REVENUES for the quarter ended June 30, 1999 were $0.0 million,
compared to $0.1 million for the quarter ended June 30, 1998. Product
revenues for the six months ended June 30, 1999 were $0.0 million, compared
to $0.6 million for the six months ended June 30, 1998. Product revenues for
the three and six months ended June 30, 1998 resulted from the shipments of
the FemPatch-Registered Trademark- (Warner-Lambert Co., Morris Plains, NJ)
system. The reduction in total product revenues is due to the discontinuation
of shipments of the FemPatch-Registered Trademark- system.
The FemPatch-Registered Trademark- system, commercially launched in
1997, is a low-dose, 7-day estrogen replacement transdermal patch for the
treatment of menopausal symptoms. Sanofi S.A. ("Sanofi"), our worldwide
licensee, had sublicensed U.S. marketing rights to Warner-Lambert. In
November 1998, Warner-Lambert terminated its agreement with Sanofi, which
also terminated the Supply Agreement between Warner-Lambert and Cygnus.
Consequently, we do not expect product revenue related to the the
FemPatch-Registered Trademark- system in 1999.
Due to the above factors and the uncertainty regarding when and if
additional products will obtain approval from the FDA and when and if
licensees will sell and market such products, we believe that the level of
product revenues experienced to date is not indicative of future results and
may fluctuate from period to period.
CONTRACT REVENUES for the quarter ended June 30, 1999 were $3.8
million, compared to $2.6 million for the quarter ended June 30, 1998 and
were $6.4 million for the six months ended June 30, 1999 compared to $5.4
million for the six months ended June 30, 1998. Contract revenues primarily
reflect labor and material cost reimbursements associated with the
development of 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 three and
six months ended June 30, 1999 is primarily due to the acceleration of the
amortization of a previously deferred milestone payment of $1.8 million
received from American Home Products ("AHP") acting through its Wyeth-Ayerst
division. This acceleration resulted from AHP's notification to us that AHP
would not be exercising its option to reacquire rights under the amendment to
the Agreement discussed below. In addition, there were increased development
billings related to our contraception product.
We are currently involved in discussions with a short list of companies
with regard to a collaboration for the marketing and distribution of the
GlucoWatch-Registered Trademark- monitor in the U.S., Europe and those
territories not included in the agreement between Cygnus and Yamanouchi as
described below. There can be no assurance that we will be able to enter into
such a collaboration arrangement.
In July 1996, we entered into an agreement with Tokyo-based Yamanouchi
Pharmaceutical Co., Ltd. ("Yamanouchi") for the marketing and distribution of
the GlucoWatch-Registered Trademark- monitor. Under the terms of this
agreement, Yamanouchi has exclusive marketing and distribution rights in
Japan and Korea. We have primary responsibility for completing product
development and for manufacturing. In the third quarter of 1996, we received
an up-front, non-
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CYGNUS, INC.
June 30, 1999
refundable payment from Yamanouchi. In July of 1999, we received a
non-refundable milestone payment from Yamanouchi and we are eligible to
receive further milestone payments as well as a percentage of the product's
future commercial sales.
In 1998, we entered into an agreement with an undisclosed company for
the development, supply and commercialization of a nicotine transdermal
system, a smoking cessation patch being developed by Cygnus. Under the terms
of the agreement, the undisclosed company has marketing and distribution
rights in certain territories. We have exclusive manufacturing and supply
rights. The undisclosed company has primary responsibility for obtaining
regulatory approval and commercialization. We have received payments for 1999
and 1998 manufacturing and development costs and will receive similar future
payments. We are also eligible to receive future milestone payments, as well
as a percentage of the product's future commercial success.
In December 1998, a New Drug Application ("NDA") was submitted to the
FDA and the European Dossier was submitted to the European authorities for
our 7-day estrogen patch. In July 1998, we were notified by American Home
Products Corporation ("AHP"), the licensee for two of our transdermal hormone
replacement products, that AHP wanted to discuss the status of its agreements
with us and that it intended to exercise its right under the agreements to
seek a sublicensee for the products. In November 1998, we negotiated with AHP
an amendment to the agreements that provided us immediate ownership of the
regulatory filing packages for the two products and the right to co-promote
the two products as well. The amendment also provided that, if AHP was unable
to sign an agreement with a sublicensee or opted not to reacquire its rights
within six months, the rights to the two products would revert to Cygnus.
However, AHP would still be obligated to continue development activities for
the two products for an additional six months. In June 1999, AHP notified us
that a sublicense agreement was not signed and that AHP would not be
exercising its option to reacquire rights, but that it would support
development activities until mid-November 1999 pursuant to the amendment. We
have not decided on any course of action with regard to these two products.
Contract revenues are expected to fluctuate from quarter to quarter and
from year to year, and future contract revenues cannot reasonably be
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. We are 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 the remainder of 1999 and future periods.
ROYALTY AND OTHER REVENUES for the quarter ended June 30, 1999 were
$0.3 million compared to $0.2 million for the quarter ended June 30, 1998 and
were $0.6 million for the six months ended June 30, 1999 compared to $0.4
million for the six months ended June 30, 1998. The amounts reflect royalties
from worldwide sales by Pharmacia & Upjohn ("Pharmacia") of the Company's
nicotine transdermal product.
Royalty revenues will fluctuate from period to period, since they are
primarily based upon sales by our 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 our
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CYGNUS, INC.
June 30, 1999
licensees to market the product. Therefore, the level of royalty revenues for
any given period is not indicative of the expected royalty revenues for future
periods.
COSTS OF PRODUCTS SOLD for the quarter ended June 30, 1999 were $0.0
million compared to $0.9 million for the quarter ended June 30, 1998 and were
$0.0 million for the six months ended June 30, 1999 compared to $2.0 million
for the six months ended June 30, 1998. Costs of products sold primarily
include direct and indirect production, facility and personnel costs required
to meet anticipated production levels. The decrease in costs of products sold
for the three and six months ended June 30, 1999 is due to the discontinuation
of shipments of the FemPatch-Registered Trademark- system as a result of the
termination of the FemPatch-Registered Trademark- system supply agreement.
Cost of products sold for the three and six months ended June 30, 1998 include
shipments of the FemPatch-Registered Trademark- system. We do not have any
product revenue or costs of products sold for the three and six months ended
June 30, 1999 as a result of the aforementioned and experienced negative
production margins for the three and six months ended June 30, 1998 due to
low production volumes that prevented us from absorbing all of our fixed
manufacturing costs.
RESEARCH AND DEVELOPMENT EXPENSES for the quarter ended June 30, 1999
were $5.6 million compared to $8.7 million for the quarter ended June 30,
1998 and were $13.4 million for the six months ended June 30, 1999 compared
to $14.8 million for the six months ended June 30, 1998. The decrease in
research and development expenses for the three and six months ended June 30,
1999 is primarily due to decreased design costs and clinical studies
associated with the GlucoWatch-Registered Trademark- monitor and the
AutoSensor (a consumable component which is attached to the back of the
GlucoWatch-Registered Trademark- monitor). Research and development and
clinical activities primarily include support and development for the glucose
monitoring program, hormone replacement therapy products and a contraceptive
product.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the quarter ended
June 30, 1999 were $2.0 million compared to $2.8 million for the quarter
ended June 30, 1998 and were $3.5 million for the six months ended June 30,
1999 compared to $4.7 million for the six months ended June 30, 1998. The
decrease is primarily due to reduced legal and compensation expenses.
INTEREST INCOME/(EXPENSES), NET for the quarter ended June 30, 1999
were $(1.5) million compared to $(0.1) million for the quarter ended June 30,
1998 and were $(1.9) million for the six months ended June 30, 1999 compared
to $(0.1) million for the six months ended June 30, 1998. The increase in net
interest expense is due primarily to the 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 has decreased in conjunction with the decrease in the
cash and cash equivalents balance.
LIQUIDITY AND CAPITAL RESOURCES
Through December 1998, we received net proceeds of approximately $95.4
million from public offerings of our Common Stock.
Through December 1998, we financed approximately $11.1 million of
manufacturing and research equipment under capital loan and lease arrangements.
Borrowings under those arrangements are secured by specific Company assets.
15
CYGNUS, INC.
June 30, 1999
In April 1998, we consolidated our two outstanding bank loans into
an expanded credit facility with the same bank. An additional $4.7 million
was borrowed, increasing the total outstanding under the new agreement to
$10.0 million. In November of 1998, the April agreement was further amended
to modify the covenants. This balance will be repaid through November 2001,
with monthly interest-only payments through November 1998 and monthly
principal-and-interest installments thereafter. As of June 30, 1999 there was
$8.5 million outstanding under this agreement. Borrowings under this
agreement are secured by specific Company assets.
In February 1998, the Company entered into Note Purchase Agreements
with certain institutional Investors to issue and sell approximately $43
million of 4% Senior Subordinated Convertible Notes Due 2005 (the "Notes").
On October 28, 1998, the Company restructured the Notes. Key provisions in
the restructured Notes include the October 1998 repayment of $18.5 million in
principal (reducing the principal balance from $43 million to $24.5 million),
a delay in the convertibility of the majority of the Notes to June 30, 1999,
modification of conversion prices of the Notes, the ability of the Company to
redeem at par at any time all or part of the new principal amount of the
Notes, an increase in the interest rate to 5.5% paid annually on the new
principal balance and the change in the final maturity of the Notes to
October 1, 2000. Through June 30, 1999, $6.0 million was converted into
Common Stock at a price of $3.54 per share and $6.0 million was converted
into Common Stock at a price of $6.89 per share. The remaining $12.5
million and accrued interest was redeemed in July 1999.
In June 1999, we entered into agreements with certain institutional
Investors to issue and sell $14 million aggregate principal amount of 8.5%
Convertible Debentures Due June 29, 2004. On June 30, 1999 we also entered
into an Equity Line agreement. The Equity Line is effective for two years and
allows us, at our sole discretion, to sell shares of Cygnus Common Stock with
a maximum aggregate sales price of up to $30 million. As of June 30, 1999, we
received gross proceeds of $14.0 million from the issuance of 8.5%
Convertible Debentures and $4.0 million from the sale of Common Stock under
the Equity Line (see Note 6 to the financial statements contained in this
report).
In June 1999, we opened a standby letter of credit ("LC") for $0.9
million in favor of our lessor to maintain compliance with our capital lease
agreement. To secure this standby LC, we pledged a certificate of deposit,
which is considered restricted cash, to the issuing bank. The certificate of
deposit earns interest at a rate yielding 4.19% per annum.
In addition to the cash received from the public offerings, issuance of
the Notes, Equity Line, equipment lease and short-term working capital
financing, we have financed our operations primarily through revenues and
interest income.
Net cash used in operating activities for the six months ended June 30,
1999 was $10.2 million, compared with net cash used of $26.0 million for the
six months ended June 30, 1998. Cash used in operating activities during the
six months ended June 30, 1999 was primarily due to our net loss of $11.8
million and decreases in provision for doubtful accounts of $2.0 million,
deferred compensation and other assets of $4.3 million and deferred revenue of
$0.5 million, offset by decreases in notes receivable, prepaid expenses and
other current assets of $4.4 million, accounts receivable of $1.8 million
and increases in amortization of debt issuance cost of $1.1 million and
16
CYGNUS, INC.
June 30, 1999
depreciation and amortization of $0.9 million. Cash used in operating
activities during the six months ended June 30, 1998 was primarily due to a
$14.0 million cash payment made in January 1998 to Sanofi under the terms of
the settlement agreement and our net loss of $15.2 million, offset by an
increase in accounts payable and other accrued liabilities of $1.8 million
and a decrease in accounts receivable of $1.0 million.
The current level of cash used in operating activities is not
necessarily indicative of the level of future cash usage. We expect a
decrease in operating cash usage for 1999 primarily due to the $14.0 million
payment in 1998 of the Sanofi arbitration liability, which will not recur
in 1999.
Net cash provided by investing activities of $12.1 million for the six
months ended June 30, 1999 resulted primarily from net sales of investments
of $14.2 million, offset by capital expenditures of $2.1 million. Net cash
used in investing activities of $27.0 million for the six months ended June
30, 1998 resulted primarily from net purchases of investments of $24.7
million and capital expenditures of $2.3 million.
Net cash provided by financing activities of $19.4 million for the six
months ended June 30, 1999 includes, as mentioned above, gross proceeds of
$14.0 million and $4.0 million from the June 1999 issuance of 8.5%
Convertible Debentures and from the sale of Common Stock under the Equity
Line, respectively, and additional stock proceeds of $3.2 million, offset by
long-term debt and capital lease repayments of $1.6 million and $0.2 million,
respectively. Net cash provided by financing activities of $58.8 million for
the six months ended June 30, 1998 includes net proceeds of $40.4 million and
$13.3 million from the February 1998 issuance of Senior Subordinated
Convertible Notes and from a direct public offering of our Common Stock,
respectively; additional stock proceeds of $0.7 million; and $6.1 million
from the issuance of long-term debt, offset by long-term debt and capital
lease repayments of $1.4 million and $0.3 million, respectively. In July
1999, we redeemed $12.5 million of the Convertible Debentures and paid $0.4
million accrued interest on these Debentures.
Our long-term capital expenditure requirements will depend upon
numerous factors, including the progress of our research and development
programs; the time required to obtain regulatory approvals; the resources
that we devote to the development of self-funded products, proprietary
manufacturing methods and advanced technologies; our ability 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 we evaluate the progress of our development
projects, in particular the GlucoWatch-Registered Trademark- monitor, 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 unrestricted cash,
cash equivalents and investments of $35.6 million as of June 30, 1999 ($22.7
million net of the $12.9 million, July 1999 redemption of Senior Subordinated
Convertible Notes and accrued interest) -- when coupled with cash from
revenues and other funding, such as from potential product funding
collaborations or from public financings (including debt or equity
financings) and earnings from investments -- will be sufficient to meet our
operating expenses, debt servicing and repayments and capital expenditure
requirements at least through June 30, 2000. However, there can be no
assurance that we will not require additional financing, depending
17
CYGNUS, INC.
June 30, 1999
upon future business strategies, results of clinical trials and management
decisions to accelerate certain research and development programs and other
factors.
YEAR 2000 COMPLIANCE
We are preparing for the impact of the arrival of the Year 2000 ("Y2K")
on our business, as well as on the businesses of our customers, suppliers and
business partners. The "Y2K Issue" is a term used to describe the problems
created by systems that are unable to accurately interpret dates after
December 31, 1999. These problems are derived predominantly from the fact
that many software programs have historically categorized the "year" in a
two-digit format. The Y2K Issue creates potential risks for Cygnus, including
potential problems in our products as well as in the Information Technology
("IT") and non-IT systems that we use in our business operations. We may also
be exposed to risks from third parties with whom we interact who fail to
adequately address their own Y2K Issues.
We began our Y2K efforts early in 1998 by forming a Project office
chaired by the Senior Vice President of Finance. The Board of Directors is
advised periodically on the status of our Y2K compliance program.
The project team developed a five-phase approach to identifying and
remediating Y2K Issues. These phases are:
1. Awareness
2. Inventory
3. Assessment
4. Correction and Testing
5. Implementation
We completed the awareness phase of the project in the third quarter of
1998. This phase consisted of meetings with our personnel to educate them on
the issues related to Y2K. The meetings focused on internal systems, both IT
and non-IT, as well as external systems and relationships.
We engaged the services of an outside Y2K consulting service to perform
a comprehensive inventory of internal IT and non-IT systems and applications.
The inventory was completed during the fourth quarter of 1998.
Concurrent with the inventory, our consultant performed an assessment
of the systems and applications documented in the inventory. The result of
this independent assessment showed that the majority of our internal IT
systems were compliant. This is due to the fact that we do not rely on
in-house developed applications for our core business applications and
therefore do not have legacy code to review and test. Our core business
applications (Accounts Payable, Accounts Receivable, Sales Orders and
Inventory Control) are supported by an application that has been certified by
the supplier to be fully Y2K compliant and the compliance has been tested by
us. Additionally, we use a third party application for tracking our
Intellectual Property assets. This application has been certified by the
vendor to be fully compliant. The assessment did determine
18
CYGNUS, INC.
June 30, 1999
that the payroll application in use was non-compliant. This was upgraded to a
compliant version in the first quarter of 1999.
Due to the regulatory requirements placed on the pharmaceutical and
medical device industry by the FDA, we have placed appropriate attention on
the non-IT systems. For us, this specifically covers all areas governed by
current Good Manufacturing Practice ("cGMP") guidelines and includes but is
not limited to environmental monitoring/control systems, laboratory
instrumentation and their sub-systems, production equipment, and materials
handling equipment. The assessment identified several of these non-IT systems
to be non-compliant. The majority of these non-compliant systems are
laboratory instrumentation and their sub-systems. These systems are assessed
to be non-mission critical. We fully expect that these systems will be
upgraded or replaced or have a contingency plan in place by January 1, 2000.
Concurrent with the inventory and assessment of internal systems and
applications, we identified several providers of products and services that
are critical to our operations. We are working with these providers to ensure
that these critical products and services are available for continued
operations after January 1, 2000. At this time we are not aware of any issues
relating to these providers.
The correction and testing, as well as the implementation phases of our
Y2K compliance programs, are currently underway and are expected to be
completed prior to January 1, 2000.
The total cost associated with our Y2K remediation is not expected to
be material to our financial condition or results of operations. The
estimated total cost of our Year 2000 remediation is not expected to exceed
$500,000. Through June 30, 1999 we have spent approximately $100,000 in
connection with Y2K Issues. The cost of implementing the replacement for our
core business applications has not been included in this figure since the
replacement of the previous applications was not accelerated due to Y2K
Issues. All Y2K expenditures are made from the respective departments'
budgets.
Although we assess our Y2K Issue to be moderate to low, there can be no
assurance that we will be completely successful in our efforts to address Y2K
Issues.
Having reasonably determined that our own hardware and software systems
will be substantially Y2K compliant, management believes that the worst case
scenarios would most likely involve simultaneous Y2K-related disruptions from
our key customers, suppliers, service providers and/or other business
partners. For these worst case scenarios to have maximum adverse impact on
Cygnus, either the vendors in question would need to be sole-source
providers, or their peer companies, who would otherwise be potential
second-source suppliers, would also need to undergo similar Y2K-related
disruption. We believe that such simultaneous disruptions of the supply of
basic goods and services due to Y2K-related issues is unlikely to occur.
Although we have not yet developed a comprehensive contingency plan to
address situations that may result if we or any of the third parties upon
which we are dependent are unable to achieve Y2K readiness, our Y2K
compliance program is ongoing and its ultimate
19
CYGNUS, INC.
June 30, 1999
scope, as well as the consideration of contingency plans, will continue to be
evaluated as new information becomes available.
The foregoing Y2K discussion contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
Such statements, including, without limitation, anticipated costs and the
dates by which we expect to complete certain actions, are based on
management's best current estimates, which were derived utilizing numerous
assumptions about future events, including the continued availability of
certain resources, representations received from third parties and other
factors. However, there can be no guarantee that these estimates will be
achieved, and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are
not limited to, the ability to identify and remediate all relevant IT and
non-IT systems; results of Year 2000 testing; adequate resolution of Y2K
Issues by businesses and other third parties who are service providers,
suppliers or customers of Cygnus; unanticipated system costs; the adequacy of
and ability to develop and implement contingency plans; and similar
uncertainties. The "forward-looking statements" made in the foregoing Y2K
discussion speak only as of the date on which such statements are made, and
we undertake no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which such statements are made or
to reflect the occurrence of unanticipated events.
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 ACTUAL
CONSOLIDATED RESULTS FOR 1999, AND BEYOND, TO DIFFER MATERIALLY FROM THOSE
EXPRESSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY US OR ON BEHALF OF US.
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 HAVE INCURRED SUBSTANTIAL LOSSES AND ANTICIPATE CONTINUING LOSSES.
We have a limited operating history to evaluate our prospects. You
should consider our prospects in light of the substantial risks, expenses and
difficulties encountered by companies entering into the medical device and
drug delivery industry. We reported a net loss of $5.0 million for the
quarter ended June 30, 1999 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-Registered
Trademark- monitor or the contraceptive patch. We cannot assure you that we
will generate significant revenues or achieve profitability. We have, and
expect to continue to have, fluctuations in quarterly results based on
varying contract revenues and expenses associated with our contracts and
collaborative projects. Some of these fluctuations could be significant. To
date, we have generated limited revenues from product sales. We do not have
significant experience in manufacturing, marketing or selling our products.
Our future development efforts may not result in commercially viable
products. We may fail in our efforts
20
CYGNUS, INC.
June 30, 1999
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 the Nicotrol-Registered
Trademark- (Pharmacia AB, Stockholm, Sweden) nicotine patch and
the FemPatch-Registered Trademark- (Warner-Lambert Co., Morris
Plains, NJ) system.
In the future, we will no longer receive manufacturing revenue from the
Nicotrol-Registered Trademark- patch or the FemPatch-Registered Trademark-
system. We will, however, continue to receive royalty payments for the
Nicotrol-Registered Trademark- patch. If we obtain regulatory approvals, we
expect that a substantial portion of our future revenues will be derived from
sales of the GlucoWatch-Registered Trademark- monitor and other products
currently under development.
WE MAY NEED ADDITIONAL FINANCING AND IT MAY NOT BE AVAILABLE.
To continue the development of our products, we will require
substantial resources to conduct research and conduct preclinical 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 and take other actions. We may not be able to obtain
adequate funds when we need them from financial markets or arrangements with
corporate 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 to 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 potential product funding
collaborations or financings; and earnings from investments will suffice to
meet our operating expenses, debt servicing and repayments and capital
expenditure requirements at least through June 30, 2000. The amounts and
timing of future expenditures will depend on:
- - progress of ongoing research and development;
- - results of preclinical testing and clinical trials;
- - rates at which operating losses are incurred;
- - executing any development and licensing agreements with corporate partners;
- - developing our products;
21
CYGNUS, INC.
June 30, 1999
- - the FDA regulatory process; and
- - other factors, many of which are beyond our control.
WE DEPEND ON LICENSEES, DISTRIBUTORS AND COLLABORATIVE ARRANGEMENTS.
Our strategy to develop, clinically test, obtain regulatory approval,
manufacture and commercialize our products depends, in large part, upon our
ability to selectively enter into and maintain collaborative arrangements
with licensees and distributors. If we commercialize our
GlucoWatch-Registered Trademark- monitor, we will depend upon Yamanouchi
Pharmaceutical Co., Ltd. to market and distribute the GlucoWatch-Registered
Trademark- monitor in Japan and Korea. We do not have any marketing or
distribution agreements for the GlucoWatch-Registered Trademark- monitor
other than the Yamanouchi collaboration. However, we are currently involved
in discussions with a short list of companies about collaborating to market
and distribute the GlucoWatch-Registered Trademark-monitor in the U.S.,
Europe and elsewhere outside Japan and Korea.
Our licensees and distributors generally have the right to terminate
product development at any time before we are granted regulatory approval,
for any reason and without significant penalty. These cancellations may cause
us to delay, suspend or abandon our clinical testing, regulatory filings and
product development and commercialization efforts. Licensees have exercised
this right in the past, and we cannot assure you that current and future
licensees or distributors will not exercise this right in the future. All
payments to us under our licensing and distribution agreements depend on
future events or sales levels, and the licensee or distributor may terminate
these agreements. As a result, we cannot assure you when or if we will
receive any particular payment. In the past, some of our licensees,
distributors and collaborators have asked us to modify the terms of existing
agreements. If a licensee or distributor stopped funding one of our products,
we would either fund development efforts ourselves, enter into an agreement
with an alternative licensee or distributor, or suspend further development
work on the product. We cannot assure you that we would be able to negotiate
an acceptable agreement with an alternative licensee or distributor.
Additionally, we may choose to self-fund certain research and
development projects in order to exploit our technologies. If these
activities result in a commercial product, they will help our long-term
operating results. However, any increase in self-sponsored research and
development or sales and marketing activities will negatively affect our
short-term operating results. Furthermore, we cannot control the resources
and attention a licensee or distributor devotes to a product. As a result, we
may experience delays in clinical testing, regulatory filings and
commercialization efforts conducted by our licensees or distributors. We
cannot assure you that our licensees or distributors will not, for
competitive reasons, support, directly or indirectly, a company or product
that competes with one of our products that is the subject of its license or
distribution agreement with us. Furthermore, any dispute between us and one
of our licensees or distributors might require us to initiate or defend
against expensive litigation or arbitration proceedings. If one of our
licensees or distributors terminates an arrangement, cannot fund or otherwise
satisfy its obligations under its arrangements, or significantly disputes or
breaches a contractual commitment, then we would likely be required to seek an
alternative licensee or distributor. We cannot assure you that we would be
able to reach agreement with a replacement licensee or distributor. If we
were unable to find a replacement licensee or distributor, we might
22
CYGNUS, INC.
June 30, 1999
not be able to perform or fund the activities of the current licensee or
distributor. Even if we were able to perform and fund these activities, our
capital requirements would increase substantially. In addition, the further
development and the clinical testing, regulatory approval process, marketing,
distribution and sale of the product covered by such licensee or distributor
would be significantly delayed. (See "Risk Factors - We Have Limited
Marketing and Sales Experience.")
For us to be competitive, we will need to develop, license or acquire
new diagnostic and drug delivery products. Furthermore, our ability to
develop and commercialize products in the future will depend, in part, on our
ability to enter into collaborative arrangements with additional licensees on
favorable terms. We cannot assure you that we will be able to enter into new
collaborative arrangements on favorable terms, if at all, or that existing or
future collaborative arrangements will succeed.
WE DEPEND ON LICENSED PATENT APPLICATIONS AND 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 the proprietary rights of others, both in the U.S. and abroad.
Since patent applications in the U.S. are secret until issuance, and
publication of discoveries in the scientific or patent literature tends
to lag behind actual discovery by several months, we cannot be certain that
we were the first to file our patent applications or that we will not
infringe upon third party patents. We cannot assure you that any patents
will be issued 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 licensees, 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
pharmaceutical product 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
materially adversely affect us.
WE ARE HIGHLY LEVERAGED AND MAY BE UNABLE TO SERVICE OUR DEBT.
As of June 30, 1999, we had indebtedness of $62.2 million ($49.7
million net of the $12.5 million, July 1999 Senior Subordinated Convertible
Notes redemption). The degree to which we are leveraged could materially and
adversely affect our ability to obtain financing for
23
CYGNUS, INC.
June 30, 1999
working capital, acquisitions 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, to sell all or a portion of our assets, or to sell
equity securities. There is no assurance that we could successfully
refinance, sell our assets or sell equity securities, or, if we could, we
cannot give any assurance as to the amount of proceeds we could realize.
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. Although we do not currently conduct operations through
subsidiaries, we may elect to do so as products become commercialized. In
such event, our cash flow and our ability to service debt would partially
depend upon the earnings of our subsidiaries and the distribution, loaning or
other payments of funds by those subsidiaries to us. The payment of dividends
and the making of loans and advances to us by our subsidiaries would be
subject to statutory or contractual restrictions, would depend upon the
earnings of those subsidiaries and would be subject to various business
considerations. Our right to receive assets of any of our subsidiaries upon
their liquidation or reorganization would be effectively subordinated to the
claims of our subsidiaries' creditors, except to the extent that we are
recognized as a creditor of such subsidiary, in which case our claims would
still be subordinate to any security interests in the assets of such
subsidiary and any senior indebtedness.
WE HAVE LIMITED MARKETING AND SALES EXPERIENCE.
We have limited experience marketing or selling medical device
products. To successfully market and sell the GlucoWatch-Registered
Trademark- monitor or our other products under development, we must either
develop a more extensive marketing and sales force or enter into arrangements
with third parties to market and sell our products. We cannot assure you that
we could successfully develop a more extensive marketing and sales force or
that we could enter into acceptable marketing and sales agreements with third
parties. If we maintain our own marketing and sales capabilities, we will
compete with other companies that have experienced and well-funded marketing
and sales operations. If we enter into a marketing arrangement with a third
party, any revenues we receive will depend on the third party, and we will
likely have to pay a sales commission or similar amount.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS.
The design, development, manufacture and use of our products involve an
inherent risk of product liability claims and associated adverse publicity.
Producers of medical products may face
24
CYGNUS, INC.
June 30, 1999
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
would 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,
financial condition and results of operations could be materially and
adversely affected.
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,
managerial and financial personnel, and attracting and retaining additional
highly qualified scientific, technical, 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 adversely affect our
business, financial condition and operating results.
OUR STOCK PRICE IS VOLATILE.
The trading price of our Common Stock substantially fluctuates in
response to factors such as:
- - 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, and 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 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 have a material
adverse effect on our business, financial condition and operating results.
25
CYGNUS, INC.
June 30, 1999
WE DO NOT PAY DIVIDENDS.
We have never declared or paid cash dividends on our Common Stock. Our
current bank term loan 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 the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
26
CYGNUS, INC.
June 30, 1999
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are not currently involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 11, 1999 our Annual Meeting of Stockholders was held. The
following Directors were re-elected at this meeting:
Directors For Withheld
--------- --- --------
Frank T. Cary 20,522,139 77,142
Gary W. Cleary 20,167,795 431,486
John C. Hodgman 20,543,185 56,096
Andre F. Marion 20,542,606 56,675
Richard G. Rogers 20,505,349 93,932
Walter B. Wriston 20,518,932 80,349
Other matters voted upon:
Votes
--------------------------------------------------------------------
Broker
Affirmative Negative Abstain Non-Votes
----------- -------- ------- ---------
To approve an amendment to the Certificate of
Incorporation to increase the number of
shares of Common Stock authorized for 19,138,154 1,386,462 74,665 0
issuance thereunder by an additional
15,000,000 shares.
To approve an amendment to the 1991 Employee
Stock Purchase Plan to increase the number of
shares of Common Stock authorized for 19,661,509 855,208 82,564 0
issuance over the term of the Purchase Plan
by 350,000 shares.
To re-appoint Ernst & Young LLP to serve as
the Company's independent auditors. 20,520,868 46,012 32,401 0
27
CYGNUS, INC.
June 30, 1999
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
The following exhibits are filed herewith or incorporated by reference:
3.1 Bylaws of the Registrant, as amended, incorporated by reference to
Exhibit 3.3 of the Registrant's Registration Statement Form S-1 No.
33-38363.
3.2 Restated Articles of Incorporation of the Registrant, as amended and
filled with the Office of the Secretary of State of Delaware on May 21,
1999.
4.1 Specimen of Common Stock certificate of the Registrant, incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement
Form S-1 No. 33-38363.
4.2 Rights Agreement dated September 21, 1993 between the Company and
Chemical Trust Bank of California (the "Transfer Agent"), which
includes the Certificate of Determination for the Series A Junior
Participating Preferred Stock as Exhibit A, the Form of Right
Certificate as Exhibit B and the Summary of Rights to purchase
Preferred Shares as Exhibit C, incorporated by reference to Exhibit I
of the Registrant's Form 8-A filed on October 21, 1993, Registration
No. 0-18962.
4.3 Form of Senior Indenture incorporated herein by reference to Exhibit
4.1 filed with the Company's 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").
4.4 Form of Subordinated Indenture incorporated herein by reference to
Exhibit 4.2 filed with the Company's November 1997 Form S-3.
4.5 Form of Senior Debt Security (included in Exhibit 4.1) incorporated
herein by reference to Exhibit 4.3 filed with the Company's November
1997 Form S-3.
4.6 Form of Subordinated Debt Security (included in Exhibit 4.2)
incorporated herein by reference to Exhibit 4.4 filed with the
Company's November 1997 Form S-3.
4.7 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 the
Company's Form 8-K dated February 4, 1998.
4.8 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 the Company's Form 8-K filed on October
30, 1998.
4.9 First Amendment to the Rights Agreement dated October 26, 1998 between
the Company and ChaseMellon Shareholder Services, L.L.C. (the "Rights
Agent" successor to Chemical Trust), incorporated by reference to
Exhibit 99.1 of the Registrant's Form 8-A/A filed on December 14, 1998,
Registration No. 0-18962.
4.10 Amended and Restated Rights Agreement dated October 27, 1998 between
the Company and ChaseMellon Shareholder Services, L.L.C. (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 Right Certificate as Exhibit B and the Summary
of Rights to purchase Preferred Shares as Exhibit C, incorporated by
reference to Exhibit 99.2 of the Registrant's Form 8A/A filed on
December 14, 1998, Registration No. 0-19962.
28
CYGNUS, INC.
June 30, 1999
4.11 Registration Rights Agreement dated June 30, 1999 between the
Registrant and Cripple Creek Securities, LLC.
4.12 Registration Rights Agreement dated June 29, 1999 between the
Registrant and the listed investors on Schedule I thereto.
10.39 Sublease Agreement dated February 19, 1999 between the Registrant and
The 3DO Company, incorporated by reference to Exhibit 10.39 of the
Registrant's Form 10-Q for the period ending March 31, 1999, filed
April 27, 1999.
10.40 Structured Equity Line Flexible Financing Agreement, dated June 30,
1999 between the Registrant and Cripple Creek Securities, LLC,
incorporated by referenced to Exhibit 1 of the Registrant's Form 8-K
filed on July 2, 1999.
10.41 Convertible Debenture and Warrant Purchase Agreement dated June 29,
1999 between the Registrant and the listed investors on Schedule I
thereto.
10.42 Form of 8.5% Convertible Debenture Due June 29, 2004.
10.43 Form of Common Stock Purchase Warrant.
27 Financial Data Schedule
B) REPORTS ON FORM 8-K
Cygnus filed four Reports on Form 8-K during the quarter ended June 30,
1999.
On June 7, 1999, Cygnus filed a Current Report on Form 8-K, reporting
under Item 5 the submission of the second and final module of our
Pre-Market Approval Application (PMA) to the United States Food and
Drug Administration (FDA) for the GlucoWatch-Registered Trademark-
automatic glucose monitor. We also announced that we are in discussion
with a short list of potential partners for the marketing and
distribution of the GlucoWatch-Registered Trademark- monitor in North
America and Europe.
On July 2, 1999, Cygnus filed a Current Report on Form 8-K, reporting
under Item 5 that we entered into a Structured Equity Flexible
Financing Agreement with Cripple Creek Securities, LLC.
On July 20, 1999, Cygnus filed a Current Report on Form 8-K, reporting
under Item 5 that John C. Hodgman, Cygnus' President and Chief
Executive Officer, was named Chairman of the Board, succeeding Gary
Cleary, Ph.D. Dr. Cleary will serve as Chairman Emeritus of the Board
of Directors.
On July 28, 1999, Cygnus filed a Current Report on Form 8-K, reporting
under Item 5 that the United States Food and Drug Administration (FDA)
notified Cygnus that the Pre-Market Approval Application (PMA) for the
GlucoWatch-Registered Trademark- monitor has been deemed suitable for
filing. The FDA also granted an expedited review status for Cygnus'
GlucoWatch-Registered Trademark- monitor.
29
CYGNUS, INC.
June 30, 1999
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: August 16, 1999 By: /S/ JOHN C. HODGMAN
---------------------- -------------------------------------
John C. Hodgman
President and Chief Executive Officer
and Chairman
(Principal Executive Officer)
Date: August 16, 1999 By: /S/ CRAIG W. CARLSON
---------------------- -------------------------------------
Craig W. Carlson
Senior Vice President, Finance
and Chief Financial Officer
(Principal Accounting Officer)
30
INDEX OF EXHIBITS
The following exhibits are included herein:
Exhibit 3.2 Restated Articles of Incorporation of the Registrant, as amended
and filled with the Office of the Secretary of State of Delaware on May
21, 1999.
Exhibit 4.11 Registration Rights Agreement, dated June 30, 1999 between the
Registrant and Cripple Creek Securities, LLC.
Exhibit 4.12 Registration Rights Agreement dated June 29, 1999 between the
Registrant and the listed investors on Schedule I thereto.
Exhibit 10.41 Convertible Debenture and Warrant Purchase Agreement dated June
29, 1999 between the Registrant and the listed investors on Schedule I
thereto.
Exhibit 10.42 Form of 8.5% Convertible Debenture Due June 29, 2004.
Exhibit 10.43 Common Stock Purchase Warrant.
Exhibit 27 Financial Data Schedule