<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
<PAGE>
SUBJECT TO COMPLETION, DATED NOVEMBER 25, 1997
PRELIMINARY PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED NOVEMBER 12, 1997)
$75,000,000
[LOGO]
% CONVERTIBLE SUBORDINATED NOTES DUE 2002
------------
INTEREST PAYABLE JUNE AND DECEMBER
--------------
The % Convertible Subordinated Notes due 2002 (the "Notes") of Cygnus,
Inc. (the "Company" or "Cygnus") offered hereby will mature on December , 2002.
Interest on the Notes will be paid semi-annually on June and December of each
year, commencing June , 1998. The Notes will be convertible at the option of
the Holder at any time on or after the initial issuance of the Notes and on or
prior to maturity, unless previously redeemed or repurchased, into shares of
common stock, par value $.001 per share (the "Common Stock"), of the Company at
a Conversion Price of $ per share, subject to adjustment in certain
events. On November 24, 1997, the last reported sale price of the Common Stock
as quoted on the Nasdaq National Market (symbol "CYGN") was $23.00 per share.
See "Price Range of Common Stock." Application has been made for quotation of
the Notes on the Nasdaq SmallCap Market.
The Notes are not redeemable prior to December , 2000. On or after December
, 2000, the Notes are redeemable upon 30 days' notice at the option of the
Company, in whole, or from time to time, in part, at the redemption prices set
forth herein, plus accrued and unpaid interest to the date of redemption. See
"Description of Notes--Optional Redemption." In addition, upon a Change of
Control (as defined herein), Holders of the Notes will have the right, subject
to certain restrictions and conditions, to require the Company to repurchase the
Holder's Notes, in whole or in part, at a purchase price equal to 100% of the
principal amount thereof together with accrued and unpaid interest, if any, to
the date of repurchase. See "Description of Notes--Repurchase of Notes at the
Option of Holders Upon a Change of Control."
The Notes are unsecured obligations of the Company and are subordinated to
all existing and future Senior Debt (as defined) of the Company. The Indenture
contains no limitations on the incurrence of additional indebtedness or other
liabilities by the Company. As of September 30, 1997, the Company had
approximately $15.6 million of indebtedness outstanding that would have
constituted Senior Debt. See "Description of Notes--Subordination."
-------------------
SEE "RISK FACTORS" BEGINNING ON PAGE S-7 HEREIN FOR CERTAIN INFORMATION THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
-----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING
PRICE DISCOUNTS AND PROCEEDS TO
TO PUBLIC(1) COMMISSIONS(2) COMPANY(1)(3)
<S> <C> <C> <C>
Per Note................................................. % % %
Total(4)................................................. $ $ $
</TABLE>
(1) Plus accrued interest, if any, from , 1997.
(2) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(3) Before deducting expenses, estimated at $405,000, payable by the Company.
(4) The Company has granted the Underwriters a 30-day option to purchase up to
an additional $11,250,000 principal amount of Notes on the same terms and
conditions as set forth above, solely to cover over-allotments, if any. If
such option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
-------------------
The Notes are being offered by the Underwriters, subject to prior sale,
when, as and if delivered to and accepted by them, subject to the approval of
certain legal matters by counsel for the Underwriters and certain other
conditions. The Underwriters reserve the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. It is expected that
delivery of the Notes will be made in New York, New York, on or about
, 1997.
-------------------
PAINEWEBBER INCORPORATED MORGAN STANLEY DEAN WITTER
------------
THE DATE OF THIS PROSPECTUS SUPPLEMENT IS , 1997.
<PAGE>
THE GLUCOWATCH SYSTEM
[PICTURE OF GLUCOWATCH]
GLUCOWATCH FEATURES:
<TABLE>
<S> <C>
- - PAINLESS AND BLOODLESS EXTRACTION - EVENT MARKERS TO RECORD SEVEN DIFFERENT
- - AUTOMATIC AND FREQUENT MEASUREMENTS ACTIVITIES (E.G. MEAL, INSULIN)
- - ALARMS FOR HIGH AND LOW GLUCOSE LEVELS - TIME ICON INDICATES "TIME TO NEXT
- - MEMORY CAPACITY FOR OVER 4,000 GLUCOSE MEASUREMENT"
VALUES AND EVENTS - PROGRAMMABLE DISPLAY IN 14 LANGUAGES
- - TREND INDICATOR WITH EACH GLUCOSE READING - ALARM CLOCK FUNCTION
- DEFAULT DISPLAY IS TIME AND DATE
- DISCREET WRISTWATCH DEVICE
</TABLE>
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE NOTES AND THE COMMON
STOCK OF THE COMPANY, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING
TRANSACTIONS IN SUCH SECURITIES AND THE IMPOSITION OF A PENALTY BID IN
CONNECTION WITH THIS OFFERING. FOR A DISCUSSION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
------------------------
Cygnus, the Cygnus logo, GlucoWatch and AutoSensor are trademarks of the
Company. FemPatch is a registered trademark of Warner-Lambert Company and
Nicotrol is a registered trademark of Pharmacia & Upjohn. All other trademarks
included in this Prospectus Supplement are the property of their respective
holders.
S-2
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND RELATED NOTES INCORPORATED BY REFERENCE
HEREIN AND IN THE ACCOMPANYING PROSPECTUS. UNLESS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS SUPPLEMENT ASSUMES THAT THE UNDERWRITERS' OVER-
ALLOTMENT OPTION WILL NOT BE EXERCISED. AS USED IN THIS PROSPECTUS SUPPLEMENT,
UNLESS OTHERWISE INDICATED, REFERENCES TO THE "COMPANY" AND "CYGNUS" ARE TO
CYGNUS, INC. AND ITS CONSOLIDATED SUBSIDIARIES.
IN ADDITION TO THE HISTORICAL INFORMATION CONTAINED HEREIN, THE DISCUSSION
IN THIS PROSPECTUS SUPPLEMENT CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS,
WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT AND SECTION 27E OF THE
EXCHANGE ACT, THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE
COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE CAUTIONARY
STATEMENTS MADE IN THIS PROSPECTUS SUPPLEMENT SHOULD BE READ AS BEING APPLICABLE
TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS
PROSPECTUS SUPPLEMENT. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE THOSE DISCUSSED BELOW AS WELL AS THOSE CAUTIONARY STATEMENTS
AND OTHER FACTORS SET FORTH ELSEWHERE OR INCORPORATED BY REFERENCE HEREIN.
THE COMPANY
Cygnus is engaged in the development and manufacture of diagnostic and drug
delivery systems, utilizing proprietary technologies to satisfy unmet medical
needs cost-effectively. The Company's current efforts are primarily focused on
two core areas: a painless, bloodless and automatic glucose monitoring device
(the GlucoWatch system) and transdermal drug delivery systems.
THE GLUCOWATCH SYSTEM
The Company's GlucoWatch system represents a significant advance in diabetes
care technology as compared to the currently prevailing "finger stab" blood
monitoring method. The GlucoWatch measures glucose painlessly, bloodlessly and
automatically through the ease and convenience of a device worn like a
wristwatch. Worldwide sales of blood glucose self-monitoring products were
approximately $2.5 billion in 1996, which represented an increase of
approximately 14% over 1995 levels. It is estimated that more than 40 million
people in North America, Europe, Japan and Korea have diabetes. In the U.S.
alone, more than ten million people have been diagnosed with another five
million believed to have the condition. The number of people with diabetes is
expected to continue to grow with the aging of the population, while the number
of diagnosed cases is also expected to increase with changes in diagnostic
standards and new diagnostic technologies. Clinical studies sponsored by the
National Institutes of Health indicate that better management of glucose levels
through more frequent testing would enable people with diabetes to reduce or
significantly delay many serious diabetes-related health complications. However,
largely due to the pain of repetitive finger stabbing and the associated
disruption of daily life, the Company believes most people with diabetes
currently test their glucose levels less than half as often as recommended. As a
result of the drawbacks of the finger stab method, the Company believes that
there is a significant unmet demand for a painless, bloodless, automatic
glucose-monitoring device.
To address this unmet demand, the Company has developed the GlucoWatch,
which is expected to reduce or eliminate significant drawbacks of the finger
stab testing technique. The device, which is worn like a wristwatch,
automatically extracts and measures glucose levels painlessly through intact
skin every twenty or thirty minutes. The extracted glucose is collected in a
consumable transdermal pad called the AutoSensor, which is attached to the back
of the device and replaced approximately every twelve hours. The GlucoWatch
system offers a combination of features not available in currently marketed
devices, such as: an electronic memory to store and display glucose levels; the
ability to download stored information to personal computers to analyze glucose
data and trends; alarms indicating hypo- and hyperglycemic conditions; and event
markers which record factors that affect glucose levels. The GlucoWatch can be
worn during the day and night for 24-hour glucose monitoring. The Company
believes the GlucoWatch system
S-3
<PAGE>
provides the frequent testing and trend analysis of glucose levels necessary to
enable people with diabetes to better manage their condition and eliminate the
pain and inconvenience associated with repetitively stabbing the finger to test
the blood. The Company believes this unique combination of features will result
in better control of glucose levels, improved quality of life and more
cost-effective healthcare.
In developing the GlucoWatch, the Company has sought to design a device that
would offer the above features and be substantially equivalent to finger stab
blood glucose monitoring in terms of accuracy and precision. Test results from a
clinical study using a prototype of the GlucoWatch, which were published in
NATURE MEDICINE (November 1995), indicated a level of accuracy and precision
that the Company believes is comparable to those associated with finger stab
blood glucose monitoring devices. In 1997, Cygnus completed extensive research
clinical studies using a version of the GlucoWatch designed for commercial sale.
The results of these studies demonstrated that the GlucoWatch is able to measure
glucose levels with statistically significant accuracy and precision across a
variety of conditions. Based on the Company's research clinical studies and
published performance data for certain currently marketed finger stab monitoring
devices, the Company believes the GlucoWatch has a level of accuracy and
precision comparable to such devices.
To prepare a submission to the United States Food and Drug Administration
(the "FDA") for approval of the GlucoWatch, the Company has initiated
registration clinical trials. Based on discussions with the FDA, the Company
believes that the submission will be in the form of a 510(k) notification,
although the final determination will not be made until the FDA receives the
submission. The Company anticipates submitting a 510(k) notification in the
second quarter of 1998.
In 1996, Cygnus entered into collaborations with Becton Dickinson & Company
("Becton Dickinson") and Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") for
the commercialization of the GlucoWatch. Under the Becton Dickinson agreement,
the Company has granted Becton Dickinson exclusive worldwide marketing and
distribution rights, with the exception of Japan and Korea. Under this
agreement, the Company has primary responsibility for product development,
regulatory approvals, manufacturing and customer support, and retains the option
to participate in sales and marketing. The Company also entered into an
agreement with Yamanouchi for the marketing and distribution of the GlucoWatch
in Japan and Korea. Under these agreements, Cygnus is eligible to receive
up-front and milestone payments totaling $30 million prior to commercialization
and to receive a percentage of the product's future commercial success. In June
1997, Cygnus granted Becton Dickinson worldwide marketing rights, with the
exception of Japan and Korea, for the Company's second generation glucose
monitor. Becton Dickinson has agreed to fund, in part, the development of the
product.
TRANSDERMAL DRUG DELIVERY SYSTEMS
Transdermal drug delivery systems provide for the controlled release of
drugs directly into the bloodstream through intact skin. The Company's
transdermal drug delivery products are thin multilayer systems, in the form of
small adhesive patches. Transdermal delivery can provide a number of advantages
over conventional methods of drug administration, including enhanced efficacy,
increased safety, greater convenience and improved patient compliance. By
delivering a steady flow of drugs into the bloodstream over an extended period
of time, transdermal systems can avoid the "peak and valley" effect of oral or
injectable therapy and can enable more controlled, effective treatment. By
avoiding first pass metabolism through the gastrointestinal tract and the liver,
the therapeutically equivalent dosage for the transdermal delivery of certain
compounds can be significantly less than the corresponding oral dosage,
potentially reducing dosage-related side-effects.
The Company's transdermal product line is focused on contraception, hormone
replacement therapy and smoking cessation. The Company has two marketed
products, the Nicotrol nicotine patch and the FemPatch estrogen hormone
replacement patch. The Company has strategic collaborations for its transdermal
products with Ortho Pharmaceutical Corporation, a subsidiary of Johnson &
Johnson (contraception), American Home Products Corporation, Sanofi, S.A. and
the Warner-Lambert Company (hormone replacement therapy), and Pharmacia & Upjohn
(smoking cessation).
S-4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Securities Offered................ $75,000,000 aggregate principal amount of %
Convertible Subordinated Notes due 2002.
Interest Payment Dates............ June and December of each year, commencing June ,
1998.
Maturity Date..................... December , 2002.
Conversion Rights................. The Notes are convertible into shares of Common Stock at
any time on or prior to maturity, unless previously
redeemed or repurchased, at a Conversion Price of
$ per share, subject to adjustment in certain
events. See "Description of Notes--Conversion Rights."
Subordination..................... The Notes are unsecured obligations of the Company and
subordinated in right of payment to all existing and
future Senior Debt of the Company. As of September 30,
1997, the Company had approximately $15.6 million of
outstanding indebtedness that would have constituted
Senior Debt. The Subordinated Indenture will not
restrict the incurrence of Senior Debt or other
indebtedness by the Company or any subsidiary. See
"Description of Notes--Subordination."
Optional Redemption............... The Notes are not redeemable prior to December , 2000.
On or after December , 2000, the Notes are redeemable
upon 30 days' notice at the option of the Company, in
whole, or from time to time, in part, at the redemption
prices set forth in this Prospectus Supplement, plus
accrued and unpaid interest to the date of redemption.
See "Description of Notes--Optional Redemption."
Change of Control................. In the event of a Change of Control (as defined), each
Holder of Notes may, subject to certain restrictions and
limitations, require the Company to repurchase its
Notes, in whole or in part, at a purchase price equal to
100% of the principal amount thereof, together with
accrued and unpaid interest, if any, to the date of
repurchase. See "Description of Notes--Repurchase of
Notes at the Option of Holders Upon a Change of
Control."
Use of Proceeds................... The Company will use the net proceeds of this offering
for (i) capital expenditures for equipment, and
commercialization expenses, related to the GlucoWatch,
and (ii) additional working capital, additional capital
expenditures and general corporate purposes. See "Use of
Proceeds."
Listing........................... Application has been made for quotation of the Notes on
the Nasdaq SmallCap Market. The Common Stock is quoted
on the Nasdaq National Market under the symbol "CYGN".
</TABLE>
S-5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The summary consolidated financial data presented below is qualified in its
entirety by, and should be read in conjunction with, the Company's consolidated
financial statements and notes thereto incorporated by reference herein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere herein.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Product revenues......................... $ 1,917 $ 3,704 $ 17,211 $ 12,442 $ 3,470
Contract revenues........................ 14,533 12,579 13,085 10,330 10,984
Royalty and other revenues............... 4,820 2,723 5,907 790 8,516
--------- --------- --------- --------- ---------
Total revenues......................... 21,270 19,006 36,203 23,562 22,970
--------- --------- --------- --------- ---------
Costs and expenses:
Costs of products sold................... 3,293 4,746 16,659 11,052 7,071
Research and development................. 21,605 20,029 23,165 16,881 16,353
Purchase of in-process research.......... 9,000 -- -- -- --
Marketing, general and administrative.... 5,491 7,369 9,296 6,876 6,103
Arbitration settlement................... -- -- -- -- 39,633
--------- --------- --------- --------- ---------
Total costs and expenses............... 39,389 32,144 49,120 34,809 69,160
--------- --------- --------- --------- ---------
Loss from operations....................... (18,119) (13,138) (12,917) (11,247) (46,190)
Interest and other income, net............. 759 296 1,865 1,202 910
--------- --------- --------- --------- ---------
Net loss................................... $ (17,360) $ (12,842) $ (11,052) $ (10,045) $ (45,280)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net loss per share......................... $ (1.24) $ (0.79) $ (0.60) $ (0.54) $ (2.41)
Shares used in computation
of net loss per share.................... 13,947 16,265 18,544 18,506 18,818
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
DECEMBER 31, -------------------------
1996 ACTUAL AS ADJUSTED(1)
------------ --------- --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..................... $ 49,434 $ 39,201 $ 111,501
Total assets.......................................................... 68,798 54,048 126,348
Short-term obligations, including current portion of long-term
obligations(2)...................................................... 24,148 29,656 29,656
Long-term obligations, less current portion(3)........................ 13,437 34,184 109,184
Stockholders' equity (net capital deficiency)......................... 31,213 (9,792) (9,792)
</TABLE>
- ------------------------
(1) Adjusted to reflect the issuance and sale of the Notes offered hereby and
the application of the net proceeds therefrom. See "Use of Proceeds" and
"Capitalization."
(2) September 30, 1997 data includes $16.6 million of the arbitration settlement
liability. See "Business-- Legal Proceedings."
(3) September 30, 1997 data includes $23.0 million of the arbitration settlement
liability. See "Business-- Legal Proceedings."
S-6
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE SECURITIES OFFERED HEREBY INVOLVES A HIGH DEGREE OF
RISK. THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO
THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS
SUPPLEMENT AND ACCOMPANYING PROSPECTUS BEFORE PURCHASING THE SECURITIES OFFERED
HEREBY. IN ADDITION TO THE HISTORICAL INFORMATION CONTAINED HEREIN, THE
DISCUSSION IN THIS PROSPECTUS SUPPLEMENT CONTAINS CERTAIN FORWARD-LOOKING
STATEMENTS, WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT AND SECTION
27E OF THE EXCHANGE ACT, THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE
CAUTIONARY STATEMENTS MADE IN THIS PROSPECTUS SUPPLEMENT SHOULD BE READ AS BEING
APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN
THIS PROSPECTUS SUPPLEMENT. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE THOSE DISCUSSED BELOW AS WELL AS THOSE CAUTIONARY STATEMENTS
AND OTHER FACTORS SET FORTH ELSEWHERE OR INCORPORATED BY REFERENCE HEREIN.
DEPENDENCE ON NEW PRODUCTS; UNCERTAINTY OF MARKET ACCEPTANCE
For the Company to be successful, it will need to develop, license, or
acquire new products. Several products based on the Company's technologies are
currently under development by Cygnus and its licensees. Many of these products
will require significant additional development and investment, including
preclinical and clinical testing, prior to their commercialization and are not
expected to be commercially available for several years, if at all. From time to
time the Company has experienced delays in the development of certain of its
products. For example, the Company experienced development delays in the
miniaturization of the GlucoWatch system. There can be no assurance that such
products or future products can or will be successfully developed, prove to be
safe and effective in clinical trials, meet applicable regulatory standards, be
capable of being manufactured in commercial quantities at reasonable cost or be
marketed successfully. Product development efforts can be terminated by the
Company or its licensees and there can be no assurance that initial product
development efforts or third party collaborations will be successful. See
"--Dependence on Licensees, Distributors and Collaborative Arrangements."
Before the Company can market the GlucoWatch, it must first conduct
registration clinical trials using a version of the product designed for
commercial sale, prepare a submission to the FDA and obtain clearance or
approval from the FDA. Approval from other U.S. or foreign government regulatory
agencies may also be required. Each of these stages will involve certain risks
and challenges. The Company has completed research clinical studies using a
commercial version of the product and has initiated registration clinical trials
for submission to the FDA. There can be no assurance that the commercial product
will produce results that are substantially equivalent to FDA-approved glucose
monitoring products or that will support the necessary regulatory filings and
approvals. In addition, if the Company receives the necessary regulatory
approvals for the GlucoWatch, there can be no assurance that unforeseen problems
will not occur in product manufacturing and commercial scale up or marketing or
product distribution. Any such occurrence could significantly delay the
commercialization of the GlucoWatch or prevent its market introduction entirely.
Furthermore, if the GlucoWatch is successfully developed, the commercial success
of the GlucoWatch will depend on its acceptance in the market.
The Company's revenues to date have been derived primarily from
manufacturing and royalty revenue from Nicotrol and from product development and
licensing fees related to its products under development. Pharmacia & Upjohn
("Pharmacia"), the worldwide licensee for Nicotrol, has exercised its option to
manufacture Nicotrol for North America. Thus, the Company will no longer receive
manufacturing revenue from Nicotrol, although Cygnus will continue to receive
royalties on the worldwide sales of Nicotrol. It is anticipated that total
revenues received from Nicotrol will be less in the future than the Company has
received in the past. The Company expects that a substantial portion of its
future revenues will be derived from the sale of the recently commercialized
FemPatch transdermal patch and, if regulatory approvals are obtained, sales of
the GlucoWatch and other products currently under development.
S-7
<PAGE>
HISTORY OF OPERATING LOSSES; FUTURE CAPITAL REQUIREMENTS
The Company reported a loss from operations of $45.3 million (including a
$39.6 million charge for the settlement of its litigation with Sanofi, S.A.
("Sanofi") further described in "Business--Legal Proceedings") for the nine
months ended September 30, 1997, and has experienced annual operating losses
since inception. At September 30, 1997, the Company had an accumulated deficit
of $131.3 million. The Company expects to continue to incur operating losses at
least until significant sales, if any, of the GlucoWatch commence. There can be
no assurance that the Company will generate significant revenues or achieve
profitability. The Company has, and expects to have, fluctuations in quarterly
results based on recognition of collaborative and contract revenues and
expenses. Some of these fluctuations could be significant.
The Company believes that its existing cash, cash equivalents and short-term
investments of $39.2 million, when coupled with cash from operations and
investments and the net proceeds from the offering hereby, will be sufficient to
meet its operating expenses and capital expenditure requirements at least
through the end of 1999. The amounts and timing of expenditures will depend on
the progress of ongoing research and development, the results of preclinical
testing and clinical trials, the rate at which operating losses are incurred,
the execution of any development and licensing agreements with corporate
partners, the Company's development of products, the FDA regulatory process and
other factors, many of which are beyond the Company's control.
The development of the Company's products will require the commitment of
substantial resources to conduct the research, preclinical development and
clinical trials necessary to bring such products to market and to establish
production and marketing capabilities. The Company may seek additional funding
through public or private financings, including debt or equity financings, and
through other arrangements, including collaborative arrangements. Any additional
equity financings may be dilutive to stockholders and debt financing, if
available, may involve restrictions on dividends and other restrictions on the
Company. Adequate funds, whether through financial markets or collaborative or
other arrangements with corporate partners or from other sources, may not be
available when needed or, if available, on terms acceptable to the Company. Lack
of sufficient additional funds may require the Company to delay, scale back or
eliminate some or all of its research and product development programs or to
license others to commercialize products or technologies that the Company would
otherwise seek to develop itself. See "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
REGULATORY APPROVALS UNCERTAIN
The Company's products require the approval of the FDA before they can be
marketed in the U.S. In addition, approvals are required from regulatory
agencies in most foreign countries before the Company's products can be marketed
in such countries. To date, the Company has two products which have received FDA
approval, Nicotrol and FemPatch. Before a regulatory submission can be filed
with the FDA, a product must undergo extensive clinical trials. The Company's
drug delivery systems require the filing of a New Drug Application ("NDA") with
the FDA, and the FDA's approval of the NDA. Devices such as the GlucoWatch under
development by the Company will require the filing and FDA clearance or approval
of a medical device submission. The time required for regulatory approval of the
Company's products after a filing is uncertain. There can be no assurance that
problems will not arise that could delay or prevent the commercialization of the
Company's products or that the FDA and foreign regulatory agencies will be
satisfied with the results of clinical trials or approve the marketing of any
products. Moreover, even if regulatory approval is granted, such approval may
include significant limitations on indicated uses for which any such products
could be marketed.
The Company believes that the submission to the FDA for the GlucoWatch will
be in the form of a premarket notification (a "510(k) notification"), although
the final determination of the type of submission
S-8
<PAGE>
will not be made until FDA submission. There can be no assurance that a 510(k)
notification will be accepted by the FDA. If a 510(k) notification is not
accepted by the FDA, the Company will be required to submit a pre-market
approval application ("PMA") for this product. The FDA approval process for a
PMA is typically more involved and requires more time than a 510(k) notification
and could materially delay the introduction of the GlucoWatch. There can be no
assurance as to FDA acceptance or approval of the form or timing of a 510(k)
notification, a PMA or any similar FDA submission, that the results of the
registration clinical trials for submission to the FDA will be approved by the
FDA nor that the results will be comparable to the results obtained in the
research clinical studies performed to date. Delays or failure to receive
clearance following a 510(k) notification or approval of a PMA application could
have a significant adverse effect on the Company's business, financial condition
and results of operations.
A drug or medical device and its manufacturer are subject to continual
review after approval, and later discovery of previously unknown problems with a
product or the manufacturing process may result in restrictions on such product
or the manufacturer, including withdrawal of the product or products from the
market. Failure to comply with applicable regulatory requirements may, among
other things, result in fines, suspensions of regulatory approvals, product
recalls, operating restrictions and criminal prosecution. In addition, new
government regulations may be established that could delay or prevent regulatory
approval of the Company's potential products. Cygnus is also subject to
regulation under federal, state and local regulations regarding work place
safety, environmental protection and hazardous and controlled substance
controls, among others.
DEPENDENCE ON LICENSEES, DISTRIBUTORS AND COLLABORATIVE ARRANGEMENTS
Cygnus depends on its licensees and distributors to fund a significant
portion of product development costs, to conduct clinical testing, to obtain
regulatory approvals and to market products. The Company is dependent on
Pharmacia and its sublicensee, Johnson & Johnson, for the marketing of Nicotrol.
The Company is also dependent upon Sanofi and its sublicensee, Warner-Lambert
Company ("Warner-Lambert"), for the marketing of FemPatch. If the GlucoWatch is
commercialized the Company will be dependent upon Becton Dickinson and
Yamanouchi for marketing and distribution. The Company's licensees and
distributors generally have the right to terminate the development funding or
marketing arrangements for a product at any time prior to regulatory approval
for any reason without significant penalty. 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.
The resources and attention a licensee or distributor devotes to a product
are not within the Company's control. As a result, there may be delays in
clinical testing, the preparation and processing of regulatory filings and
commercialization efforts conducted by the Company's licensees or distributors.
Certain of the Company's licensees may also be permitted to offer products that
are competitive with those of the Company, which could interfere with their
efforts on behalf of the Company. The Company's ability to develop and
commercialize products in the future will also depend on its ability to enter
into collaborative arrangements. There can be no assurance that the Company will
be able to enter into new collaborative arrangements or renew existing
collaborative arrangements. Additionally, there can be no assurance that
existing or future collaborative arrangements will be successful.
Since all payments to the Company under its licensing and distribution
agreements following their 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 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 or sales and marketing efforts in order to exploit its technologies.
Any increase in Company-sponsored research and development or sales and
marketing activities will have an immediate adverse effect on the Company's
results of operations.
S-9
<PAGE>
COMPETING PRODUCTS AND CHANGES IN TECHNOLOGY
A large number of companies are involved or are becoming involved in the
development and commercialization of products incorporating diagnostic and drug
delivery systems. This field is highly competitive, and Cygnus believes that
competition will substantially increase in the future. A number of companies
have invested, and are continuing to invest, significant resources in the
development of diagnostic and drug delivery systems. Many of these companies
have greater financial, research and development and other resources than
Cygnus, as well as more experience than Cygnus in commercializing diagnostic and
transdermal drug delivery products. Such companies may improve existing drug
formulations and products more efficiently than Cygnus or may design and develop
new diagnostic and transdermal drug delivery products which are more accepted in
the marketplace than the Company's products.
The Company's primary competitors in the glucose monitoring industry are
expected to be companies that currently market finger stab method products.
These companies have established products and distribution channels. In
addition, a number of companies are engaged in the development of products using
technology which is different than that used by Cygnus, but that are also
intended to permit less painful or painless glucose monitoring. These
technologies include infrared spectroscopy, which uses radiation to measure
glucose levels, and a variety of methods (including, in one case, transdermal
technology) to extract interstitial fluid and measure the glucose concentration
therein. The Company is not aware of any products under development that offer
the range of benefits of the GlucoWatch. However, there can be no assurance that
these products will not be more accepted in the marketplace than the GlucoWatch
or will not render the Company's glucose monitor uncompetitive or obsolete. In
addition, a number of companies have developed or are seeking to develop new
drugs to treat diabetes which could reduce demand for glucose monitoring
systems. In addition, many of the Company's competitors and potential
competitors have substantially greater resources, research and development
staffs and facilities than the Company and have significantly greater experience
than the Company in developing, manufacturing and marketing glucose monitoring
devices. Competition within the glucose monitoring industry could also result in
price reductions for glucose monitoring devices such that the Company may not be
able to sell the GlucoWatch at a price level adequate for the Company to realize
a return on its investment.
The drug delivery industry is a rapidly evolving field. A number of other
companies, including major pharmaceutical companies, are also developing and
marketing transdermal and other similar systems for the controlled delivery of
drugs. Products currently on the market or under development by competitors
deliver the same drugs, or other drugs to treat the same indications as many of
the products under development by the Company. The first pharmaceutical product
to reach the market in a therapeutic area often obtains and maintains
significant market share relative to later entrants to the market. The Company's
transdermal products will also compete with drugs marketed not only in similar
drug delivery systems but also in traditional dosage forms such as oral
administration, bolus injection and continuous infusion. New drugs, new
therapeutic approaches or future developments in alternative drug delivery
technologies, such as time-release capsules, liposomes and implants, may provide
therapeutic or cost advantages over the drug delivery systems being developed by
the Company.
THIRD-PARTY REIMBURSEMENT
Successful commercialization of certain of the Company's products may depend
in part on the availability of reimbursement from third-party health care
payors, such as private insurance plans and the government. There can be no
assurance that such reimbursement will be available. Third-party payors are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new therapeutic and diagnostic products.
There can be no assurance that adequate levels of reimbursement will be
available to enable the Company to achieve market acceptance of the GlucoWatch
or other new products under development or to maintain price levels sufficient
to realize an appropriate return on its investment. In certain international
countries, the period of time needed to obtain such reimbursement can be
lengthy. The Company may delay the launch of its products into certain countries
S-10
<PAGE>
until eligibility for reimbursement is established. This could potentially have
an adverse effect on the Company.
PRODUCT LIABILITY
The design, development, manufacture and use of the Company's products
involve an inherent risk of product liability claims and associated adverse
publicity. Producers of medical products may face substantial liability for
damages in the event of product failure or if it is alleged the product caused
harm. The Company currently maintains product liability insurance. Such
insurance is expensive, difficult to obtain and may not be available in the
future on acceptable terms or at all. There can be no assurance, however, that
the Company will not be subject to product liability claims, that the Company's
current insurance would cover such claims, or that adequate insurance will
continue to be available on acceptable terms to the Company in the future. In
the event the Company is held liable for damages in excess of the limits of its
insurance coverage, or if any claim or product recall results in significant
adverse publicity against the Company, the Company's business, financial
condition and results of operations could be materially and adversely affected.
INTELLECTUAL PROPERTY
The Company's success depends in large part on its ability to obtain patent
protection for its products, preserve its trade secrets and operate without
infringing the proprietary rights of others, both in the U.S. and in other
countries. Patent applications in the U.S. are maintained in secrecy until
patents issue, and since publication of discoveries in the scientific or patent
literature tends to lag behind actual discovery by several months, Cygnus cannot
be certain that it was the first to file patent applications on such inventions.
No assurance can be made that patents will issue with respect to any of the
Company's patent applications or that any patents will provide competitive
advantages for its products or will not be challenged or circumvented by
competitors. Cygnus also relies on trade secrets and proprietary know-how that
it seeks to protect, in part, by confidentiality agreements with its licensees,
employees and consultants. There can be no assurance that these agreements will
not be breached, that the Company would have adequate remedies for any breach or
that the Company's trade secrets will not otherwise become known or be
independently developed by its 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 the
Company and significant diversion of effort by the Company's technical and
management personnel. Litigation may be necessary to enforce patents issued to
the Company or to protect trade secrets or know-how owned by the Company. A
negative determination in such proceedings in which the Company is a party could
subject the Company to significant liabilities to third parties or require the
Company 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, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms if at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the Company from manufacturing and
selling certain of its products which would have a material adverse effect on
the Company. See "Business-- Intellectual Property."
MANUFACTURING; DEPENDENCE ON THIRD PARTY SUPPLIERS
Cygnus generally retains manufacturing rights for its products. The
Company's products are manufactured using several proprietary materials and
production technologies developed by Cygnus in conjunction with equipment and
material suppliers. Production of diagnostic and transdermal drug delivery
systems requires specialized skills in several areas, such as polymer chemistry
and adhesive technology.
S-11
<PAGE>
The manufacture of the Company's products is subject to current good
manufacturing practices ("cGMP") requirements prescribed by the FDA or other
standards prescribed by the appropriate regulatory agency in the country of use.
Additionally, the Company's agreements with licensees either specify pricing
formulas for products manufactured and sold by Cygnus to its licensees or
specify that prices will be negotiated in the future. There can be no assurance
that prices for the Company's products will cover the manufacturing costs for
these products in light of the Company's limited manufacturing experience and
general supply and demand conditions in the marketplace.
The Company's GlucoWatch has not yet been manufactured for commercial sale.
To successfully commercialize the GlucoWatch, the device will have to be
manufactured in compliance with regulatory requirements, in a timely manner and
in sufficient quantities while maintaining product quality and acceptable
manufacturing costs. The Company is responsible for all aspects of manufacturing
the GlucoWatch system, although the "watch device" will be manufactured by an
outside supplier. Manufacturers often encounter difficulties in scaling up
production of new products, including problems involving production yields,
quality control and assurance and shortages of personnel. There can be no
assurance that the Company will be able to achieve and maintain product quality
and reliability if and when producing the GlucoWatch in the quantities required
for commercialization, nor that the Glucowatch can be assembled and manufactured
at an acceptable cost. See "Business--Manufacturing."
The GlucoWatch will be manufactured from components to be purchased from
outside suppliers, most of which are the Company's single source for such
components. In the event the Company is unable to obtain these components from
its suppliers, the Company would be required to obtain components from alternate
suppliers. Any interruption in the supply of GlucoWatch components could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Several materials used in the Company's transdermal products are currently
obtained from single sources. Although the Company has not experienced
difficulty acquiring these materials for the manufacture of its products for
sale or clinical trials, there can be no assurance that supply interruptions
will not occur or that the Company will not have to obtain substitute vendors,
if such vendors are available, which could require additional regulatory
submissions and approvals. Any such interruption of supplies could have a
material adverse effect on the Company's ability to develop, manufacture and
sell its transdermal products.
ATTRACTING AND RETAINING KEY EMPLOYEES
The successful development and commercialization of the Company's products
depends upon, among other things, skilled employees. In some cases, the market
for these skilled employees is highly competitive, which makes it difficult to
attract and retain key employees. There can be no assurance that the Company can
attract or retain key employees. The inability to do so could materially and
adversely affect the Company's business, financial condition and results of
operations.
LEVERAGE; SUBORDINATION OF NOTES; ABSENCE OF FINANCIAL COVENANTS
In connection with the sale of the Notes, the Company will incur
approximately $75 million of indebtedness which will result in a ratio of
long-term debt to total capitalization at September 30, 1997 of approximately
110% on an as-adjusted basis. As a result of this indebtedness, the Company's
principal and interest obligations will increase substantially. The degree to
which the Company is leveraged could materially adversely affect the Company's
ability to obtain financing for working capital, acquisitions or other purposes
and could make it more vulnerable to industry downturns and competitive
pressures. The Company's ability to meet its debt service obligations will be
dependent upon the Company's future performance, which will be subject to
financial, business and other factors affecting the operations of the Company,
many of which are beyond its control. The Notes are subordinate in right of
payment to all existing and future Senior Debt (as defined in the accompanying
Prospectus) of the Company. The
S-12
<PAGE>
Indenture does not limit the amount of additional indebtedness, including Senior
Debt, which the Company or its subsidiaries can create, incur, assume or
guarantee. By reason of such subordination of the Notes, in the event of
insolvency, bankruptcy, liquidation, reorganization, dissolution or winding up
of the business of the Company or upon default in payment with respect to any
Senior Debt of the Company or an event of default with respect to such
indebtedness resulting in the acceleration thereof, the assets of the Company
will be available to pay the amounts due on the Notes only after all Senior Debt
of the Company has been paid in full. Moreover, holders of Common Stock would
only receive the assets remaining after payment of all indebtedness and
preferred stock, if any. See "Description of Notes."
The Notes are obligations exclusively of the Company. Although the Company
does not currently conduct operations through subsidiaries, it may elect to do
so as products become commercialized. In such event, the cash flow and the
consequent ability to service debt, including the Notes, of the Company, will be
partially dependent upon the earnings of its subsidiaries and the distribution
of those earnings to, or upon loans or other payments of funds by those
subsidiaries to, the Company. The payment of dividends and the making of loans
and advances to the Company by its subsidiaries would be subject to statutory or
contractual restrictions, would be dependent upon the earnings of those
subsidiaries and would be subject to various business considerations. Any right
of the Company to receive assets of any of its subsidiaries upon their
liquidation or reorganization (and the consequent right of the Holders of the
Notes to participate in those assets) would be effectively subordinated to the
claims of that subsidiary's creditors (including trade creditors), except to the
extent that the Company is itself recognized as a creditor of such subsidiary,
in which case the claims of the Company would still be subordinate to any
security interests in the assets of such subsidiary and any indebtedness of such
subsidiary senior to that held by the Company.
As of September 30, 1997, the Company had approximately $15.6 million of
indebtedness and other liabilities (including the $6.0 million note issued to
Sanofi in connection with the Company's arbitration settlement described in
"Business--Legal Proceedings") that would have constituted Senior Debt. The
Indenture does not contain any financial covenants or restrictions on the
payment of dividends, the incurrence of indebtedness, including Senior Debt, by
the Company or the issuance or repurchase of securities by the Company. The
Indenture contains no covenants or other provisions to afford protection to
Holders of the Notes in the event of a highly leveraged transaction or a change
in control of the Company except to the extent described under "Description of
Notes--Repurchase of Notes at the Option of Holders upon a Change of Control."
As a result of the arbitration settlement, and other financial
considerations, the Company will, for a time, have a net capital deficiency. The
Company currently has a bank loan and lease lines which contain a variety of
covenants which could be compromised by the net capital deficiency. As a result
of the arbitration settlement, the Company is in violation of certain of such
covenants. Although the Company has obtained limited waivers of such defaults,
should those loans and lease lines be called upon the expiration of such
waivers, the Company would need to pay back the principal amount of the loan and
lease lines. This could potentially have a negative effect on the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
LIMITATIONS ON REPURCHASE UPON A CHANGE OF CONTROL
In the event of a Change in Control, each Holder of Notes will have the
right, at the Holder's option, to require the Company to repurchase all or a
portion of such Holder's Notes at a purchase price equal to 100% of the
principal amount thereof plus accrued interest thereon to the repurchase date.
The Company's ability to repurchase the Notes upon a Change of Control may be
limited by the terms of the Company's Senior Debt and the subordination
provisions of the Indenture. Further, the ability of the Company to repurchase
the Notes upon a Change of Control will be dependent on the availability of
sufficient funds and compliance with applicable securities and corporate laws.
Accordingly, there can be no assurance that the Company will be able to
repurchase the Notes upon a Change of Control. The term "Change of Control" is
limited to certain specified transactions and may not include other events that
S-13
<PAGE>
might adversely affect the financial condition of the Company or result in a
downgrade of the credit rating (if any) of the Notes nor would the requirement
that the Company offer to repurchase the Notes upon a Change of Control
necessarily afford Holders of the Notes protection in the event of a highly
leveraged reorganization, merger or similar transaction involving the Company.
See "Description of Notes-- Repurchase of Notes at the Option of Holders Upon a
Change of Control."
ABSENCE OF EXISTING ACTIVE PUBLIC MARKET
There can be no assurance that an active trading market for the Notes will
develop or as to the liquidity or sustainability of any such market, the ability
of the Holders to sell their Notes or the price at which Holders of the Notes
will be able to sell their Notes. Future trading prices of the Notes will depend
on many factors, including, among other things, prevailing interest rates, the
Company's operating results, the price of the Company's Common Stock and the
market for similar securities.
POSSIBLE VOLATILITY OF NOTES AND STOCK PRICE
The trading prices of the Notes and the Company's Common Stock could be
subject to substantial fluctuations in response to factors such as announcements
by the Company or its competitors of results of regulatory approval filings or
clinical trials or testing, developments or disputes governing proprietary
rights, technological innovations or new commercial products, government
regulatory action, general conditions in the medical technology industry, or
other events or factors, many of which are beyond the Company's control. In
addition, the stock market in general has experienced extreme price and volume
fluctuations in recent years, which have particularly affected the market prices
of many medical technology companies and which have been unrelated to the
operating performance of such companies. Fluctuations or decreases in the
trading price of the Notes or the Company's Common Stock may adversely affect
the market for the Notes and the Company's Common Stock.
ABSENCE OF DIVIDENDS
The Company has never declared or paid cash dividends on its Common Stock.
The Company's current bank term loan precludes it from paying dividends to
stockholders. The Company currently intends to retain any earnings for use in
its business and therefore does not anticipate paying any dividends in the
future.
S-14
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the Notes offered hereby
are estimated to be approximately $72.3 million (approximately $83.3 million if
the Underwriter's over-allotment option is exercised in full), after deducting
the underwriting discounts and commissions and estimated expenses of the
offering. The Company anticipates that approximately $13.0 million of such net
proceeds will be used towards capital expenditures for GlucoWatch production
equipment, and approximately $40.0 million of such net proceeds will be used for
the commercialization of the GlucoWatch. The balance of the proceeds will be
used for additional working capital, additional capital expenditures and general
corporate purposes, including research and development efforts.
The Company's management will have broad discretion with respect to the
specific working capital requirements to which the proceeds will be applied, and
there can be no assurance that the proceeds will be applied to any specific
working capital requirement. Pending utilization as described above, the
proceeds will be invested in short-term, investment-grade, interest-bearing
securities.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the Nasdaq National Market under the
symbol "CYGN." The following table sets forth, for the periods indicated, the
high and low last reported sale prices per share of the Common Stock as quoted
on the Nasdaq National Market.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1995:
First Quarter......................................................... $ 9.000 $ 5.625
Second Quarter........................................................ 10.250 7.500
Third Quarter......................................................... 19.875 9.875
Fourth Quarter........................................................ 22.625 14.125
1996:
First Quarter......................................................... $ 24.500 $ 19.375
Second Quarter........................................................ 23.000 15.000
Third Quarter......................................................... 17.250 11.000
Fourth Quarter........................................................ 16.875 12.000
1997:
First Quarter......................................................... $ 16.625 $ 13.375
Second Quarter........................................................ 17.250 10.625
Third Quarter......................................................... 19.750 16.000
Fourth Quarter (through November 24, 1997)............................ 24.625 18.750
</TABLE>
On November 24, 1997, the last reported sale price for the Common Stock as
quoted on the Nasdaq National Market was $23.00 per share. As of September 30,
1997, there were approximately 563 holders of record of the Common Stock.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its Common Stock.
The Company's current bank term loan precludes it from paying dividends to
stockholders. The Company currently intends to retain any earnings for use in
its business and therefore does not anticipate paying any dividends in the
future.
S-15
<PAGE>
CAPITALIZATION
The following table sets forth the actual cash, cash equivalents and
short-term investments, short-term obligations and capitalization of the Company
at September 30, 1997, and as adjusted to reflect this Offering and the
application of the estimated net proceeds therefrom. See "Use of Proceeds." This
table should be read in conjunction with the Consolidated Financial Statements
and the Notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" which are included or incorporated by
reference herein.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
------------------------
AS
ACTUAL ADJUSTED(1)
----------- -----------
(IN THOUSANDS, EXCEPT
FOR
SHARE AND PER SHARE
AMOUNTS)
<S> <C> <C>
Cash, cash equivalents, and short-term investments...................................... $ 39,201 $ 111,501
----------- -----------
----------- -----------
Short-term obligations, including current portion of long-term obligations(2)........... $ 29,656 $ 29,656
----------- -----------
----------- -----------
Long-term obligations, less current portion:
Term debt............................................................................. $ 4,615 $ 4,615
Notes offered hereby.................................................................. -- 75,000
Capital lease obligation.............................................................. 600 600
Arbitration settlement................................................................ 23,000 23,000
Other................................................................................. 5,969 5,969
----------- -----------
Total long-term obligations......................................................... 34,184 109,184
----------- -----------
Stockholders' equity:
Preferred stock, $.001 par value; 5,000,000 shares authorized; none issued and
outstanding......................................................................... -- --
Common stock, $.001 par value; 30,000,000 shares authorized; 18,934,609 shares issued
and outstanding(3).................................................................. 121,557 121,557
Accumulated deficit................................................................... (131,349) (131,349)
----------- -----------
Total stockholders' equity (net capital deficiency)................................. (9,792) (9,792)
----------- -----------
Total capitalization.................................................................... $ 24,392 $ 99,392
----------- -----------
----------- -----------
</TABLE>
- ------------------------
(1) Adjusted to reflect the issuance and sale of the Notes offered hereby and
the application of the net proceeds therefrom. See "Use of Proceeds."
(2) Short-term obligations include $16.6 million of the arbitration settlement
liability. See "Business-- Legal Proceedings."
(3) Excludes (i) 3,918,955 shares of Common Stock reserved for issuance under
the Company's Stock Option Plan, under which options to purchase 3,296,573
shares were outstanding as of September 30, 1997, (ii) 276,179 shares
issuable upon the conversion of the note payable under the arbitration
settlement; (iii) 127,719 shares reserved for issuance under the Company's
Employee Stock Purchase Plan as of September 30, 1997; and (iv) the shares
of Common Stock issuable upon conversion of the Notes offered hereby.
S-16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company as of
December 31, 1995 and 1996, and for each of the three years in the period ended
December 31, 1996, have been derived from the audited consolidated financial
statements of the Company incorporated by reference herein. The selected
consolidated financial data of the Company as of December 31, 1992, 1993 and
1994 and for each of the two years in the period ended December 31, 1993 have
been derived from audited financial statements not included or incorporated by
reference herein. The selected consolidated financial data of the Company as of
September 30, 1997 and for each of the nine months ended September 30, 1996 and
1997 are derived from unaudited condensed consolidated financial statements
incorporated by reference herein. Such unaudited financial statements, in the
opinion of the Company's management, reflect all material adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of such data. The data should be read in conjunction with the
consolidated financial statements and related notes, the information set forth
under "Management's Discussion and Analysis of Financial Conditions and Results
of Operations" and other financial information included or incorporated by
reference herein.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Product revenues............ $ 20,292 $ 8,587 $ 1,917 $ 3,704 $ 17,211 $ 12,442 $ 3,470
Contract revenues........... 5,287 7,156 14,533 12,579 13,085 10,330 10,984
Royalty and other
revenues.................. 64 1,734 4,820 2,723 5,907 790 8,516
--------- --------- --------- --------- --------- --------- ---------
Total revenues............ 25,643 17,477 21,270 19,006 36,203 23,562 22,970
Costs and expenses:
Costs of products sold...... 18,549 9,534 3,293 4,746 16,659 11,052 7,071
Research and development.... 14,718 13,675 21,605 20,029 23,165 16,881 16,353
Purchase of in-process
research.................. -- -- 9,000 -- -- -- --
Marketing, general and
administrative............ 11,017 5,846 5,491 7,369 9,296 6,876 6,103
Arbitration settlement...... -- -- -- -- -- -- 39,633
--------- --------- --------- --------- --------- --------- ---------
Total costs and
expenses................ 44,284 29,055 39,389 32,144 49,120 34,809 69,160
--------- --------- --------- --------- --------- --------- ---------
Loss from operations.......... (18,641) (11,578) (18,119) (13,138) (12,917) (11,247) (46,190)
Interest and other income,
net......................... 1,140 969 759 296 1,865 1,202 910
--------- --------- --------- --------- --------- --------- ---------
Net loss...................... $ (17,501) $ (10,609) $ (17,360) $ (12,842) $ (11,052) $ (10,045) $ (45,280)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net loss per share............ $ (1.36) $ (0.77) $ (1.24) $ (0.79) $ (0.60) $ (0.54) $ (2.41)
Shares used in computation of
net loss per share.......... 12,846 13,752 13,947 16,265 18,544 18,506 18,818
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and
short-term investments...... $ 34,512 $ 28,197 $ 28,119 $ 46,498 $ 49,434 $ 51,307 $ 39,201
Total assets.................. 52,667 46,861 38,594 57,854 68,798 69,283 54,048
Short-term obligations,
including current portion of
long-term obligations....... 11,917 14,109 12,601 11,271 24,148 23,268 29,656
Long-term obligations, less
current portion............. 4,597 6,509 7,876 8,331 13,437 14,328 34,184
Stockholders' equity (net
capital deficiency)......... 36,153 26,243 18,117 38,252 31,213 31,687 (9,792)
</TABLE>
S-17
<PAGE>
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 FORM 10-K, ITS 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, utilizing its proprietary technologies to satisfy unmet
medical needs cost-effectively. The Company's current efforts are primarily
focused on two core areas: a painless, bloodless and automatic glucose
monitoring device (the GlucoWatch 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 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 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 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 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
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reimbursement payments made by pharmaceutical licensees, the demand for its
Nicotrol 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 OF THE NINE MONTHS 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 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. Cygnus manufactures the
product.
In the first quarter of 1997, 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 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 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, a
painless, automatic glucose monitoring device being developed by Cygnus. Under
the terms of the agreement, Becton Dickinson has exclusive worldwide
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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 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.
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 future 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 potential future terminations of existing contracts by current partners,
or new collaborative agreements, if any, will impact overall contract revenues
in the remainder of 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. OTC 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
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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.
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% and 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.
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.
COMPARISON FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
PRODUCT REVENUES for the year ended December 31, 1996 were $17.2 million
compared to $3.7 million for the year ended December 31, 1995. This reflects
increased demand for additional shipments of Nicotrol during 1996 due to the
change of Nicotrol's status from a prescription to an over-the-counter ("OTC")
product. On July 3, 1996 the FDA approved Nicotrol as the first OTC smoking
cessation transdermal patch.
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In November 1993, the Company entered into an agreement pursuant to which
the Company granted Pharmacia the exclusive worldwide right to manufacture
Nicotrol in return for a royalty based on Pharmacia's sales of such products.
Prior to that, Pharmacia had the exclusive right to manufacture Nicotrol outside
of North America and was obligated to pay to Cygnus a royalty based on
Pharmacia's sales of such products outside of North America. The November 1993
agreement, as amended in November 1994, obligated Cygnus to continue to
manufacture and supply Nicotrol until December 31, 1995. In February of 1996,
the Company and Pharmacia further amended the 1993 agreement to provide that
Cygnus will continue to manufacture and supply Nicotrol for the U.S. market
through 1999. In addition to product revenues under this agreement, the Company
also earns royalties on sales within the U.S. Pharmacia has the option to
terminate this agreement and purchase the U.S. manufacturing rights upon the
payment of certain amounts to the Company. Pharmacia has exercised this option
to purchase the U.S. manufacturing rights for Nicotrol and the Company is
presently in negotiations with Pharmacia as to various transition matters
including Pharmacia's obligations for certain purchase order commitments and
existing inventory costs.
CONTRACT REVENUES for the year ended December 31, 1996 were $13.1 million
compared to the $12.6 million for the year ended December 31, 1995. 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. In 1996, the Company received up-front non-refundable
payments from Becton Dickinson and Yamanouchi.
ROYALTY AND OTHER REVENUES for the year ended December 31, 1996 were $5.9
million, compared to $2.7 million for the year ended December 31, 1995. 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. Additionally, in the first half of 1995, amounts included the
amortization of the unearned balance of prepayments from Pharmacia. As of June
30, 1995, all of the prepayments were fully amortized. The net increase in
royalty and other revenues is primarily due to the significant increase in
volume of units shipped as a result of the change of Nicotrol's status to OTC in
the U.S.
COSTS OF PRODUCTS SOLD for the year ended December 31, 1996, were $16.7
million compared to $4.7 million for the year ended December 31, 1995. Costs of
products sold include direct and indirect manufacturing costs of Nicotrol
production and facility and personnel costs required to meet production levels.
In addition, due to uncertainties related to the level of the future sales of
Nicotrol, the Company recorded in 1996 as part of cost of products sold, certain
expenses relating to estimated committed future production costs. Costs of
products sold increased primarily due to increased Nicotrol shipments as a
result of the change of Nicotrol's status to OTC in the U.S. and the expenses
related to the estimated committed future productions costs. While the Company
experienced a positive product margin during 1996 due to increased demand for
additional shipments of Nicotrol, the Company experienced negative product
margins during 1995, primarily due to low production volumes which prevented the
Company from absorbing all of the fixed costs associated with its production of
Nicotrol.
While the Company anticipates that due to decreasing short-term demand for
its Nicotrol product, the direct and indirect manufacturing cost associated with
Nicotrol production will be reduced, there can be no assurance that product
margins associated with Nicotrol production will improve or remain consistent
with current levels.
RESEARCH AND DEVELOPMENT EXPENSES for the year ended December 31, 1996 were
$23.2 million compared to $20.0 million for the year ended December 31, 1995.
This increase reflects the Company's accelerated level of research and
development costs primarily associated with the glucose monitoring system.
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 approved by FDA on December 5,
1996 and two of which are in clinical trials), and a contraception product.
Cygnus expects that its anticipated development of new products, continued
research of new technologies and
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preparations for regulatory filings and clinicals could result in an increase in
its overall research and development expenses.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the year ended December
31, 1996 were $9.3 million, compared to $7.4 million for the year ended December
31, 1995. The increase resulted from increased legal expenses primarily related
to the Sanofi arbitration, which has been settled. The Company believes that
marketing, general and administrative expenses could increase in the future as
the Company expands its operations.
INTEREST INCOME, NET OF INTEREST AND OTHER EXPENSE for the year ended
December 31, 1996 was $1.9 million as compared to $0.3 million for the year
ended December 31, 1995. The increase is due primarily to interest earned on the
proceeds from the Company's 1995 public offering.
INCOME TAXES at December 31, 1996, the Company had federal net operating
loss and research and development tax credit carryforwards of approximately
$57.0 million and $1.3 million, respectively. The Company had state net
operating loss and tax credit carryforwards of approximately $4.3 million and
$0.9 million, respectively. These carryforwards will expire at various dates
beginning in 2000. Because of the "change in ownership" provisions of the Tax
Reform Act of 1986, a substantial portion of the Company's net operating loss
and tax credit carryforwards may be subject to annual limitations. The annual
limitation may result in the expiration of net operating losses and tax credits
before utilization.
FOURTH QUARTER LOSS for the three months ended December 31, 1996 was $1.0
million compared to $2.7 million for the three months ended December 31, 1995.
The decrease in fourth quarter losses for 1996 was primarily attributable to
increased product and royalty revenues relating to Nicotrol sales as mentioned
above.
COMPARISON FOR THE YEARS ENDED DECEMBER 31, 1995 AND 1994
PRODUCT REVENUES for the year ended December 31, 1995 were $3.7 million
compared to $1.9 million for the year ended December 31, 1994. This reflects
increased demand for additional shipments of Nicotrol in 1995. In 1994 the
Company's marketing partner was able to meet product demand by utilizing
inventories existing as of the beginning of the period.
CONTRACT REVENUES for the year ended December 31, 1995 were $12.6 million
compared to the $14.5 million for the year ended December 31, 1994. The decrease
in contract revenues primarily reflects a decrease in billings related to the
Company's first hormone replacement product due to agreed upon maximum cost
reimbursements, the mutually agreed upon termination of funding obligations
PaineWebber R&D Partners II L.P. ("PWLP") had under a research and development
agreement and the mutually agreed upon termination of the certain collaborations
to develop and market consumer and smoking cessation products. The technology
resulting from the PaineWebber partnership agreement was purchased by the
Company from PWLP in December 1994 in exchange for 1,529,941 shares of the
Company's Common Stock.
ROYALTY AND OTHER REVENUES for the year ended December 31, 1995, were $2.7
million compared to $4.8 million for the year ended December 31, 1994. The
amounts included royalties from sales by Pharmacia of the Company's nicotine
transdermal product in Europe and beginning in 1994, Canada. Additionally, the
amounts include the amortization of the unearned balance of prepayments from
Pharmacia included in "Customer Advances." As of June 30, 1995, all of the
prepayments were fully amortized. The decrease in 1995 was primarily
attributable to 1995 including a half year amortization of "Customer Advances"
compared to 1994 which included a full year of amortization as well as the sale
of $1.3 million of previously reserved excess inventory to Pharmacia.
COSTS OF PRODUCTS sold for the year ended December 31, 1995, were $4.7
million compared to $3.3 million for the year ended December 31, 1994. Costs of
products sold included direct and indirect manufacturing costs of Nicotrol
production. Costs of products sold increased primarily due to increased Nicotrol
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shipments offset in part by a $1.0 million charge to reduce the net realizable
value of Nicotrol production equipment incurred in the second quarter of 1994.
The Company experienced negative product margins during 1995 and 1994
primarily due to low production volumes which prevented the Company from
absorbing all the fixed costs associated with Nicotrol production.
RESEARCH AND DEVELOPMENT EXPENSES for the year ended December 31, 1995 were
$20.0 million compared to $21.6 million for the year ended December 31, 1994.
This decrease reflects a reduced level of materials required in ongoing
development programs and the Company's ongoing cost control measures. Research
and development and clinical activities primarily include the support of the
Company's hormone replacement therapy products, contraception products and the
glucose monitoring development program.
PURCHASE OF IN-PROCESS RESEARCH AND DEVELOPMENT expense for the year ended
December 31, 1994 represents a $9.0 million charge for the acquisition by the
Company of all rights previously held by PWLP to certain non-invasive glucose
monitoring technology developed under research and development agreements
between Cygnus and PWLP. Based on the early stage of development and the
uncertainty as to the feasibility of the technology, the acquisition cost was
expensed to in-process research and development. No such purchases were made in
1995.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the year ended December
31, 1995 were $7.4 million, compared to $5.5 million for the year ended December
31, 1994. The increase primarily reflects an increase in business development
activities related to the glucose monitoring development program and increased
legal expenses due to the Company's legal proceedings against Alza and Sanofi.
Both proceedings have since been resolved (by dismissal and by settlement,
respectively).
INTEREST INCOME, NET OF INTEREST AND OTHER EXPENSE for the year ended
December 31, 1995 was $0.3 million as compared to $0.8 million for the year
ended December 31, 1994. The decrease is primarily due to lower prevailing
interest rates and lower levels of cash and short term investments through the
first three quarters of 1995.
INCOME TAXES. At December 31, 1995, the Company has federal net operating
loss carryforwards of approximately $50.2 million and federal and state research
and development credits of approximately $1.8 million. These carryforwards will
expire beginning in 2000. Because of the "change in ownership" provision of the
Tax Reform Act of 1986, a substantial portion of the Company's net operating
loss and tax credit carryforward are subject to annual limitations.
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 was $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 was $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
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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
had 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.
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 has experienced an increase in cash usage in 1997 and anticipates an
increase in cash usage for 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 financing activities of $2.7 million for the nine
months ended September 30, 1997 included $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
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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 GlucoWatch 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 1998.
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 cash from operations and investments and the net
proceeds from the offering of the Notes hereby, will be sufficient to meet its
operating expenses and capital expenditure requirements at least through the end
of 1999. However, 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. See "Risk Factors--History of Operating
Losses; Future Capital Requirements."
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BUSINESS
OVERVIEW
Cygnus is engaged in the development and manufacture of diagnostic and drug
delivery systems, utilizing its proprietary technologies to satisfy unmet
medical needs cost-effectively. The Company's current efforts are primarily
focused on two core areas: a painless, bloodless and automatic glucose
monitoring device (the GlucoWatch system) and transdermal drug delivery systems.
THE GLUCOWATCH SYSTEM
The Company's GlucoWatch system represents a significant advance in diabetes
care technology as compared to the currently prevailing "finger stab" blood
monitoring method. The Glucowatch measures glucose painlessly, bloodlessly and
automatically through the ease and convenience of a device worn like a
wristwatch. Worldwide sales of blood glucose self-monitoring products were
approximately $2.5 billion in 1996, which represented an increase of
approximately 14% over 1995 levels. It is estimated that more than 40 million
people in North America, Europe, Japan and Korea have diabetes. In the U.S.
alone, more than ten million people have been diagnosed with another five
million believed to have the condition. The number of people with diabetes is
expected to continue to grow with the aging of the population, while the number
of diagnosed cases is also expected to increase with changes in diagnostic
standards and new diagnostic technologies. Clinical studies sponsored by the
National Institutes of Health ("NIH") indicate that better management of glucose
levels through more frequent testing would enable people with diabetes to reduce
or significantly delay many serious diabetes-related health complications.
However, largely due to the pain of repetitive finger stabbing and the
associated disruption of daily life, the Company believes most people with
diabetes currently test their glucose levels less than half as often as
recommended. As a result of the drawbacks of the finger stab method, the Company
believes that there is a significant unmet demand for a painless, bloodless,
automatic glucose-monitoring device.
To address this unmet demand, the Company has developed the GlucoWatch which
is expected to reduce or eliminate significant drawbacks of the finger stab
testing technique. The device, which is worn like a wristwatch, automatically
extracts and measures glucose levels painlessly through intact skin every twenty
or thirty minutes. The extracted glucose is collected in a consumable
transdermal pad called the AutoSensor, which is attached to the back of the
device and replaced approximately every twelve hours. The GlucoWatch system
offers a combination of features not available in currently marketed devices,
such as: an electronic memory to store and display glucose levels; the ability
to download stored information to personal computers to analyze glucose data and
trends; alarms indicating hypo- and hyperglycemic conditions; and event markers
which record factors that affect glucose levels. The GlucoWatch can be worn
during the day and night for 24-hour glucose monitoring. The Company believes
the GlucoWatch system provides the frequent testing and trend analysis of
glucose levels necessary to enable people with diabetes to better manage their
condition and eliminate the pain and inconvenience associated with repetitively
stabbing the finger to test the blood. The Company believes this unique
combination of features will result in better control of glucose levels,
improved quality of life and more cost-effective healthcare.
In developing the GlucoWatch, the Company has sought to design a device that
would offer the above features and be substantially equivalent to finger stab
blood glucose monitoring in terms of accuracy and precision. Test results from a
clinical study using a prototype of the GlucoWatch, which were published in
NATURE MEDICINE (November 1995), indicated a level of accuracy and precision
that the Company believes is comparable to those associated with finger stab
blood glucose monitoring devices. In 1997, Cygnus completed extensive research
clinical studies using a version of the GlucoWatch designed for commercial sale.
The results of these studies demonstrated that the GlucoWatch is able to measure
glucose levels with statistically significant accuracy and precision across a
variety of conditions. Based on the Company's research clinical studies and
published performance data for certain currently marketed finger stab
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monitoring devices, the Company believes the GlucoWatch has a level of accuracy
and precision comparable to such devices.
To prepare a submission to the FDA for approval of the GlucoWatch, the
Company has initiated registration clinical trials. Based on discussions with
the FDA, the Company believes that the submission will be in the form of a
510(k) notification, although the final determination will not be made until the
FDA receives the submission. The Company anticipates submitting a 510(k)
notification in the second quarter of 1998.
In 1996, Cygnus entered into collaborations with Becton Dickinson and
Yamanouchi for the commercialization of the GlucoWatch. Under the Becton
Dickinson agreement, the Company has granted Becton Dickinson exclusive
worldwide marketing and distribution rights, with the exception of Japan and
Korea. Under this agreement, the Company has primary responsibility for product
development, regulatory approvals, manufacturing and customer support, and
retains the option to participate in sales and marketing. The Company also
entered into an agreement with Yamanouchi for the marketing and distribution of
the GlucoWatch in Japan and Korea. Under these agreements, Cygnus is eligible to
receive up-front and milestone payments totaling $30 million prior to
commercialization and to receive a percentage of the product's future commercial
success. In June 1997, Cygnus granted Becton Dickinson worldwide marketing
rights, with the exception of Japan and Korea, for the Company's second
generation glucose monitor. Becton Dickinson has agreed to fund, in part, the
development of the product.
TRANSDERMAL DRUG DELIVERY SYSTEMS
Transdermal drug delivery systems provide for the controlled release of
drugs directly into the bloodstream through intact skin. The Company's
transdermal drug delivery products are thin multilayer systems, in the form of
small adhesive patches. Transdermal delivery can provide a number of advantages
over conventional methods of drug administration, including enhanced efficacy,
increased safety, greater convenience and improved patient compliance. By
delivering a steady flow of drugs into the bloodstream over an extended period
of time, transdermal systems can avoid the "peak and valley" effect of oral or
injectable therapy and can enable more controlled, effective treatment. By
avoiding first pass metabolism through the gastrointestinal tract and the liver,
the therapeutically equivalent dosage for the transdermal delivery of certain
compounds can be significantly less than the corresponding oral dosage,
potentially reducing dosage-related side-effects.
The Company's transdermal product line is focused on contraception, hormone
replacement therapy and smoking cessation. The Company has two marketed
products, the Nicotrol nicotine patch and the FemPatch estrogen hormone
replacement patch. The Company has strategic collaborations for its transdermal
products with Ortho Pharmaceutical Corporation, a subsidiary of Johnson &
Johnson (contraception), American Home Products Corporation, Sanofi and
Warner-Lambert (hormone replacement therapy), and Pharmacia (smoking cessation).
COMPANY STRATEGY
The Company's objective is to become a leader in the development and
commercialization of diagnostic and drug delivery products for a wide variety of
applications utilizing a broad array of technologies. The Company develops
differentiated products based on proprietary technologies which have the
potential to provide significant value to patients. The Company's strategy
adheres to the following general principles:
APPLY AND EXPAND ITS PROPRIETARY TECHNOLOGIES. Cygnus applies its core
competencies and proprietary technologies to the development of its diagnostic
and drug delivery products. Cygnus devotes significant resources to continued
development of new diagnostic and drug delivery technologies as well as
additional products based on its existing technologies. The Company also
maintains an active technology in-licensing
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and acquisition program. The Company's strategy is to maintain ownership of its
technology, to out-license only specific product applications and to
aggressively protect its proprietary technology.
DEVELOP A BROAD PORTFOLIO OF DIFFERENTIATED PRODUCTS. The Company's broad
range of proprietary technology has enabled it to develop a wide variety of
differentiated products. A diversity of products targeted to multiple markets
increases potential business opportunities, can provide a stream of new product
introductions over time and reduces the risks of reliance on a single product or
technology. The Company intends to expand its product line by continuing to
apply its technologies to new products.
ADDRESS LARGE MARKET OPPORTUNITIES. The Company's product development
efforts focus on large existing markets with unmet needs. The Company's target
markets (and industry estimates of their 1996 sales) include: glucose monitoring
(over $2.5 billion worldwide), hormone replacement (over $1.75 billion
worldwide), smoking cessation ($450 million worldwide) and contraception ($2.4
billion worldwide).
CONTROL PRODUCT MANUFACTURING. The Company's products are manufactured
using several proprietary materials and complex production processes. The
Company's strategy is, where appropriate, to retain manufacturing rights to its
products. By retaining manufacturing rights, the Company can exercise control
over the quality of its products and capture a larger portion of the product
revenue stream. Cygnus has manufactured drug delivery products for both clinical
trials and commercial sale for several years in its existing production
facility, and believes that this facility will have sufficient capacity to
support FemPatch and the planned market introduction of additional drug delivery
products. The Company will outsource the manufacturing of the GlucoWatch (other
than the AutoSensor component, which it will directly manufacture).
COLLABORATE WITH MARKET LEADERS. Cygnus has established and continues to
seek to establish strategic relationships with leading companies in each of its
target markets. These companies typically have significant resources and strong
franchises that, when coupled with the Company's technology, increase the
likelihood of commercial success. The Company currently has strategic
collaborations with Becton Dickinson, a leading supplier of insulin syringes for
diabetes, Yamanouchi, a significant participant in the Japanese pharmaceuticals
market, American Home Products, a leader in hormone replacement, Johnson &
Johnson, a leader in contraception, Warner-Lambert, a company with a leading
female health care franchise, and Pharmacia, a leader in smoking cessation. The
Company is increasingly taking a more active role with its collaborative
partners in the clinical trials, regulatory approval processes and marketing of
its products.
PAINLESS, BLOODLESS AND AUTOMATIC GLUCOSE MONITORING
MARKET OPPORTUNITY
People with diabetes measure blood glucose levels to adjust their diet and
insulin use to better control their glucose levels to prevent diabetes-related
complications. Currently, to measure their glucose levels, people with diabetes
must stab their fingers with a lancet, draw blood and place a drop of blood on a
glucose reagent strip inserted in an instrument which provides a glucose
reading. Each day of testing can involve numerous stabs and the complete
procedure is not only painful but disruptive to daily life. As a result of this
pain and disruption, the Company believes most people with diabetes monitor
their blood glucose levels less than twice per day, instead of the recommended
four to seven times per day. Even at this level of testing, the market for
products for self-monitoring of glucose levels by people with diabetes is quite
substantial.
Worldwide sales of products for the self-monitoring of blood glucose levels
were approximately $2.5 billion in 1996, which represented an increase of
approximately 14% over 1995 levels. The Company believes that approximately 80%
to 90% of the sales were related to disposable glucose reagent strips for finger
stab monitoring. In the U.S., a relatively small segment of people with diabetes
who measure their glucose level account for the majority of testing: for
example, of these people, just 22% (about 1.7 million)
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account for 68% of the tests performed and 37% (about 2.9 million) account for
87% of tests performed. It is estimated that more than 40 million people in
North America, Europe, Japan and Korea have diabetes. In the U.S. alone, more
than ten million people have been diagnosed with diabetes with another five
million believed to be undiagnosed. The number of people diagnosed with diabetes
has been growing and is expected to continue to grow due to the aging of the
population, changes in diagnostic standards and new diagnostic technologies.
Specifically, the diagnostic standards in the U.S. have been changed such that a
fasting plasma glucose value of greater than or equal to 126 mg/dL now indicates
a diagnosis of diabetes, whereas such diagnosis previously required a value of
greater than or equal to 140 mg/dL. Diabetes can lead to severe complications
over time, including blindness, loss of kidney function and peripheral
neuropathy, causing circulation problems to the arms and legs and pain and
potential amputation. The ADA estimated that the complications arising from
diabetes cost the U.S. healthcare system in excess of $45 billion in 1992. These
complications are largely a consequence of years of poor management of glucose
levels by people with diabetes. Results of the Diabetes Control and Complication
Trial, a major clinical trial sponsored by the NIH and published in 1993, showed
that more frequently monitored blood glucose levels and rigid adherence to a
program of diet, exercise and insulin injections could prevent or significantly
delay the onset of many of the long-term complications of diabetes.
THE GLUCOWATCH SYSTEM
The Company believes that there is a significant unmet demand for painless,
bloodless and automatic glucose monitoring. To address this unmet demand, the
Company has developed the GlucoWatch, which is worn like a wristwatch and
automatically extracts and measures glucose levels painlessly through intact
skin every twenty or thirty minutes. The GlucoWatch then displays and stores
current and past glucose levels and trend data. The extracted glucose is
collected in a consumable transdermal pad called the AutoSensor, which is
attached to the back of the device and replaced approximately every twelve
hours. The GlucoWatch system offers a combination of features not available in
currently marketed devices, in a portable and discreet device. These include
frequent data collection, electronic memory to store and display glucose levels,
personal computer downloading for trend analysis, alarms indicating hypo- and
hyperglycemic conditions and event markers which record factors that affect
glucose levels. The GlucoWatch can be worn day and night for 24-hour glucose
monitoring. The GlucoWatch is expected to reduce or eliminate significant
drawbacks of the finger stab technique, such as the pain of repetitive stabbing
and the disruption of normal activities caused by indiscreet, cumbersome
procedures. The Company believes the GlucoWatch can lead to improved disease
management, enabling people with diabetes to prevent or delay severe
complications associated with the condition.
The GlucoWatch extracts glucose molecules through intact skin utilizing a
patented proprietary process called electroosmosis, which uses low levels of
electric current. Glucose molecules are collected in the AutoSensor, which
adheres to the skin, contains a biosensor and is attached to the back of the
GlucoWatch. The collected glucose triggers an electro-chemical reaction in the
AutoSensor, generating electrons. The biosensor measures the electrons and an
application specific integrated circuit ("ASIC") in the GlucoWatch equates the
number of electrons to a concentration of glucose in the blood. The GlucoWatch
automatically measures glucose levels at frequent intervals. The GlucoWatch
displays the most recent readings and trends at the push of a button. Its
electronic memory capabilities permit the retrieval and downloading of data,
allowing longer-term trend analysis for better disease management.
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THE GLUCOWATCH SYSTEM
(Enlarged to show detail)
[PICTURE OF GLUCOWATCH AND AUTOSENSOR]
The GlucoWatch system was designed to be simple and easy to use. Each day
the rechargeable battery is replaced and a new AutoSensor is attached on the
back of the GlucoWatch. A finger stab blood glucose measurement is input into
the GlucoWatch for calibration. Measurements will then be generated
automatically by the GlucoWatch system, providing up to thirty-six glucose
measurements over a twelve hour period.
The Company believes approximately 80% to 90% of current sales in the
glucose monitoring market come from the consumable test strips on which a drop
of blood is placed and inserted into a meter. The GlucoWatch uses a similar
approach. The "watch device" is designed to function for a number of years while
the consumable AutoSensor is designed to last for approximately twelve hours.
Sales of the AutoSensors are expected to eventually constitute the majority of
GlucoWatch revenue.
RESEARCH CLINICAL RESULTS
In developing the GlucoWatch, the Company has sought to design a device that
would offer the above features and be substantially equivalent to finger stab
blood glucose monitoring in terms of accuracy and precision. Test results from a
clinical study using a prototype of the GlucoWatch, which were published in
NATURE MEDICINE (November 1995), indicated a level of accuracy and precision
that the Company believes is comparable to those associated with finger stab
blood glucose monitoring devices. A series of research
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clinical studies were conducted in 1997 to evaluate the accuracy and precision
of the commercial version of the GlucoWatch system under conditions which could
be experienced during normal use. All of these studies were conducted on people
with diabetes by outside, independent clinical investigators. GlucoWatch
measurements were compared to venous blood glucose reference measurements. The
variables studied were physiological factors (age, race, ethnicity, gender, body
mass index), environmental factors (temperature and perspiration levels) and
potential drug incompatibilities. A total of 473 data points was generated by
these studies.
Data from the research clinical studies demonstrate that the GlucoWatch
system is able to measure glucose levels with statistically significant accuracy
and precision across a variety of conditions. The results indicated a
correlation coefficient of 0.90, a mean absolute error of 0.20 and a mean bias
of 5.0%. These studies have shown that differences in physiological factors, air
temperature (50 DEG.F to 90 DEG.F) and moderate levels of perspiration do not
affect the accuracy and precision of the GlucoWatch system's glucose
measurement. Commonly used drugs also did not adversely affect the performance
of the GlucoWatch system in these studies. The accuracy and precision of the
GlucoWatch system did not vary significantly from the overall averages in the
groups in which these variables were tested. Another statistical measure of the
data, known as error grid analysis, supports the accuracy and precision of the
GlucoWatch (92% in the clinically desirable zones A and B).
To put these research clinical study results in context, it is useful to
examine the performance of currently used finger stab glucose meters when used
by people who have diabetes. Published clinical studies of several currently
marketed finger stab glucose meters showed correlation coefficients ranging from
0.85 to 0.95 for such devices. In certain cases, the studies found that the
error of these finger stab meters could vary by more than 30% from the reference
values.
The data in the following graph illustrate how well the GlucoWatch system
tracks changes in glucose levels during a representative clinical study lasting
over twelve hours. As can be seen, rapid changes in blood glucose are closely
monitored by the GlucoWatch whether glucose levels are rising or falling. This
close tracking occurred in the subject at both hypoglycemic (low) levels as well
as hyperglycemic (high) levels.
[CHART OF GLUCOWATCH MEASUREMENTS COMPARED TO REFERENCE VENOUS GLUCOSE LEVELS]
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Based on the accuracy and precision data from the Company's research
clinical studies, Cygnus believes that the GlucoWatch system performs comparably
with currently marketed glucose devices. Additional clinical studies are being
conducted to confirm the duration of use for the consumable AutoSensor portion
of the GlucoWatch system. The preliminary data suggest that the useful life of
the AutoSensor could be twelve hours or longer. A decision will be made after
the completion of these studies on the number of hours an AutoSensor should be
used as well as the number of measurements per hour that will be made.
Although the Company believes its clinical results to date are encouraging,
to seek FDA approval for the Glucowatch system, the Company will need to conduct
registration clinical trials. No assurance can be given that data generated in
such trials will be as favorable as data generated in clinical trials to date or
that, even if such data are as favorable, such data will provide a sufficient
basis for the approval of the GlucoWatch system by the FDA.
REGULATORY APPROVAL
To prepare a submission to the FDA for approval of the GlucoWatch, the
Company has initiated registration clinical trials. Based on discussions with
the FDA, the Company believes that the submission will be in the form of a
510(k) notification, although the final determination will not be made until the
FDA receives the submission. The Company anticipates submitting a 510(k)
notification in the second quarter of 1998. See "Risk-Factors--Uncertainty of
Regulatory Approval."
MARKETING AND DISTRIBUTION
In 1996, Cygnus entered into collaborations with Becton Dickinson and
Yamanouchi for the commercialization of the GlucoWatch. Under the Becton
Dickinson agreement, the Company has granted Becton Dickinson exclusive
worldwide marketing and distribution rights, with the exception of Japan and
Korea. Under this agreement, the Company has primary responsibility for product
development, regulatory approvals, manufacturing and customer support, and
retains the option to participate in sales and marketing. The Company also
entered into an agreement with Yamanouchi for the marketing and distribution of
the GlucoWatch in Japan and Korea. Under these agreements, Cygnus is eligible to
receive up-front and milestone payments totaling $30 million prior to
commercialization and to receive a percentage of the product's future commercial
success. In June 1997, Cygnus granted Becton Dickinson worldwide marketing
rights, with the exception of Japan and Korea, for the Company's second
generation glucose monitor. Becton Dickinson has agreed to fund, in part, the
development of the product. See "Risk Factors--Dependence on Licensees,
Distributors and Collaborative Arrangements."
COMPETITION
The glucose monitoring market is highly competitive. Currently the market is
dominated by finger stab blood glucose monitoring products. This monitoring
technique presents a number of barriers to generating more frequent blood
glucose measurements, including the pain of repetitive finger lancing and the
disruption of normal activities as people with diabetes typically do not want to
go through the finger stab process in public. Several companies are attempting
to develop non-invasive or less invasive methods to monitor glucose levels. One
technology that a number of companies are pursuing is the use of infrared
spectroscopy, which uses radiation to measure glucose levels. Other companies
are attempting to develop a variety of methods to extract interstitial fluid and
measure the glucose concentration therein. The Company believes that none of the
currently marketed finger stab products nor other products in development have
the range of features and benefits offered by the GlucoWatch to address the
unmet needs of this category. See "Risk Factors--Competing Products and Changes
in Technology."
TRANSDERMAL DRUG DELIVERY SYSTEMS
Transdermal drug delivery systems provide for the controlled release of
drugs directly into the bloodstream through intact skin. The Company's
transdermal drug delivery products are thin multilayer systems, in the form of
small adhesive patches. Transdermal delivery can provide a number of advantages
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over conventional methods of drug administration, including enhanced efficacy,
increased safety, greater convenience and improved patient compliance. By
delivering a steady flow of drugs into the bloodstream over an extended period
of time, transdermal systems can avoid the "peak and valley" effect of oral or
injectable therapy and can enable more controlled, effective treatment. By
avoiding first pass metabolism through the gastrointestinal tract and the liver,
the therapeutically equivalent dosage for the transdermal delivery of certain
compounds can be significantly less than the corresponding oral dosage,
potentially reducing dosage-related side-effects.
Cygnus has established a comprehensive, integrated approach to the
development of transdermal delivery systems. Cygnus develops a unique product
profile for each transdermal product based on an evaluation of several key
variables that change with each drug and therapeutic indication. Based on its
assessment of the product profile and the interrelationship between the drug and
the physical and biological characteristics of the skin, Cygnus formulates the
appropriate materials and designs the structure of the transdermal system to
achieve desired product characteristics such as comfort, extended wear, delayed
or enhanced onset and controlled release.
CONTRACEPTION
The contraceptive market is estimated to have had 1996 worldwide sales of
$2.4 billion. The market is dominated by oral contraceptive pills. There are no
transdermal patches currently marketed. The Company believes a seven day
contraceptive patch could lead to improved dosing compliance and is developing
such a product under an agreement with Ortho Pharmaceutical Corporation
("Ortho"), a subsidiary of Johnson & Johnson. Ortho has exclusive worldwide
marketing rights to the product. Cygnus received up-front payments and will
receive milestone payments as well as a percentage of net sales, and is
responsible for the development and manufacture of the product. This product is
currently in Phase 3 clinical trials.
HORMONE REPLACEMENT
The hormone replacement market is large, with $1.75 billion in sales
worldwide in 1996, and is expected to grow as more women reach the age of
menopause. The Company believes that its transdermal hormone replacement
products have a competitive advantage over certain transdermal hormone
replacement products as a result of their seven-day extended delivery systems
and superior patient comfort profile. Many hormone replacement products under
development by competitors last for only 3.5 days. The Company believes, based
in part on its market research, that patients and physicians prefer 7-day
systems to 3.5 day systems because of increased convenience and comfort, which
could also lead to improved compliance.
The Company has three hormone replacement products. FemPatch, a 7-day
estrogen patch launched in 1997, was developed under an agreement with Sanofi.
Warner-Lambert, which is Sanofi's sublicensee, is marketing FemPatch in North
America. For a discussion of the Company's recent arbitration settlement with
Sanofi, see "Business--Legal Proceedings." Cygnus' two other hormone replacement
products, a 7-day estrogen patch, and an estrogen/progestin combination patch
are currently in Phase 3 clinical trials. These products are being developed
under an agreement with American Home Products. Under the terms of the
agreement, American Home Products has worldwide marketing rights with respect to
the products resulting from the collaboration. Cygnus received up-front fees and
is entitled to receive milestone payments as well as a percentage of net sales
on all products to be manufactured by Cygnus for the worldwide market. In
addition, American Home Products will pay for all clinical trial expenses.
Cygnus is otherwise responsible for financing the development and manufacture of
the products.
SMOKING CESSATION
The smoking cessation market is estimated to have had 1996 worldwide sales
of $450 million. The Company's Nicotrol product was initially introduced in the
U.S. as a prescription product in 1992 and subsequently approved for
over-the-counter sale in the U.S. in 1996. Nicotrol is currently marketed in
North America by Johnson & Johnson and many European countries by Pharmacia.
Cygnus receives
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royalties on the worldwide sales of Nicotrol. The Company is developing a second
generation nicotine patch designed to address currently unsatisfied patient
needs. These products are being developed to match the nicotine dosing level
with the patient's level of addiction. Phase 2 clinical trials have been
completed and the Company is seeking a marketing collaboration to fund further
work on this product. The Company believes that the number of people who wish to
stop smoking will increase, which could positively affect the smoking cessation
category.
MANUFACTURING
The Company is responsible for all aspects of manufacturing for the
GlucoWatch system. The "watch device" will be manufactured by an outside
supplier, who currently manufactures a variety of medical devices. The
consumable component, or AutoSensor, will be under Cygnus' manufacturing
control. The manufacture of the AutoSensor utilizes the Company's transdermal
expertise. Sales of the consumable AutoSensor are expected to eventually
constitute the majority of revenue for the GlucoWatch business.
The Company has established specifications and quality control procedures
for each supplier of the components of the GlucoWatch. Currently, most suppliers
for the GlucoWatch represent a single source for its components. However, the
Company plans to have more than one source for each component in the future. The
Company may decide, in the future, to bring more aspects of GlucoWatch
manufacturing in-house to capture more of the economic value.
The Company recently received ISO 9002 certification. Consequently, the
Company expects to receive approval for the use of the "CE" mark for sales of
its products in Europe.
The Company's transdermal products are manufactured using several
proprietary materials and production technologies developed by Cygnus in
conjunction with equipment and material suppliers. Since the Company designs a
unique transdermal system for each drug, Cygnus' process development engineers
become involved early in the product design process. The Company believes that
close interaction at the design stage permits development of efficient
manufacturing techniques. In addition, Cygnus performs analytical testing
in-house for each aspect of the manufacturing process, from raw material studies
to final product characterization. The Company has developed proprietary assays
to measure patch characteristics such as drug release rate, drug and solvent
residues, and product stability. The Company has patented certain aspects of its
manufacturing processes.
Several materials used in the Company's drug delivery products are currently
obtained from single sources. Although the Company has not experienced
difficulty acquiring these materials for the manufacture of its products for
sale or clinical trials, there can be no assurance that supply interruptions
will not occur or that the Company will not have to obtain substitute vendors,
if such vendors are available, which would require additional regulatory
submissions and approvals. Any such interruption of supplies could have a
material adverse effect on the Company's ability to develop, manufacture and
sell its products.
The Company leases a 21,000 square foot manufacturing facility used in the
commercial production of FemPatch and the clinical supply of other products. The
Company believes this facility will have sufficient capacity to support the
planned market introduction of its current drug delivery products. The Company
is currently establishing its commercial AutoSensor manufacturing operations in
an existing third-party facility. Each of the foregoing facilities complies with
applicable regulatory requirements. See "Risk Factors--Manufacturing; Dependence
on Third Party Suppliers."
INTELLECTUAL PROPERTY
It is the Company's policy to aggressively protect its investments in
technology and marketing by filing patent and trademark applications in the U.S.
and key foreign countries. The Company also relies on trade secrets, know-how,
licensing opportunities, and collaborative relationships to develop and maintain
its competitive position.
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As of September 1997, the Company had approximately 40 U.S. patents and more
than 80 foreign patents issued or allowed. These patents cover various aspects
of transdermal technology including transdermal patch formulations (such as
those used in hormone replacement therapy, contraception, and nicotine
dependence therapy), and glucose monitoring systems. The Company has numerous
additional patent applications pending worldwide.
The Company's GlucoWatch system incorporates technology developed in-house
as well as technology licensed exclusively to the Company by the Regents of the
University of California ("Regents"). Regents holds several U.S. patents
covering technology for transdermal extraction of glucose and other analytes.
Corresponding foreign patent applications are also pending. The Company has an
exclusive license worldwide under these patents. See "Risk Factors--Intellectual
Property."
GOVERNMENT REGULATION
The development, manufacture and marketing of drug delivery systems and
diagnostic devices are subject to regulation by the FDA and other U.S. and
foreign federal, state and local entities. These entities regulate, among other
things, research and development activities and the testing, manufacture,
safety, effectiveness, labeling, storage, record keeping, approval, advertising
and promotion of the Company's products. Sales of the Company's products outside
the U.S. are subject to comparable regulatory requirements. These requirements
vary widely from country to country.
FDA permission to market and distribute a new device can be obtained in one
of two ways. If a new or significantly modified device is "substantially
equivalent" to an existing legally marketed device, the new device can be
commercially introduced after submission of a 510(k) notification to the FDA,
and after the subsequent clearance or approval by the FDA. Changes to existing
devices that do not significantly affect safety or effectiveness can be made by
the Company without a 510(k) notification.
The second, more comprehensive approval process applies to a new device that
is not substantially equivalent to an existing product. First, the Company must
conduct clinical trials in compliance with testing protocols approved by an
Institutional Review Board ("IRB") for the participating research institution
and the FDA's investigational device exemption regulations. Second, the Company
must submit a PMA application that contains, among other things, the results of
the clinical trials. The PMA application also contains other information
required under the Federal Food, Drug, and Cosmetic Act, such as a full
description of the device and its components, a full description of the methods,
facilities and controls used for manufacturing and proposed labeling. Finally,
the manufacturing site for the product subject to the PMA must operate using
cGMP and pass an FDA Pre-Approval Inspection ("PAI") before product approvals.
The process required by the FDA before a drug delivery system may be
marketed in the U.S. depends on whether the compound has existing approval for
use in other dosage forms. If the drug is a new chemical entity that has not
been approved, then the process includes (i) pre-clinical laboratory and animal
tests, (ii) the filing of an Investigational New Drug ("IND") application, (iii)
adequate and controlled human clinical trials to establish the safety and
efficacy of the drug in its intended indication and (iv) FDA approval of an NDA.
If the drug has been previously approved, then the approval process is similar,
except that certain toxicity tests normally required for the IND and NDA
applications may not be necessary. In addition to the foregoing, the FDA
requires proof that the drug delivery system delivers sufficient quantities of
the drug to the bloodstream to produce the desired therapeutic result.
The results of preclinical studies and clinical studies are submitted to the
FDA in a submission for approval or clearance of the marketing and commercial
shipment of a drug delivery or diagnostic system. The FDA may deny a clearance
or approval if applicable regulatory criteria are not satisfied, or may require
additional clinical testing. Even if such data are submitted, the FDA may
ultimately decide that the submission does not satisfy the criteria for
clearance or approval. Product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur after the product
reaches the
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<PAGE>
market. The FDA may require testing in addition to surveillance programs to
monitor the effect of products that have been commercialized, and it has the
power to prevent or limit further marketing of the product based on the results
of these post-marketing programs.
Cygnus' drug delivery product licensees historically have been responsible
for the clinical and regulatory approval procedures. Cygnus has participated in
this process by submitting to the licensee portions of the Drug Master File
maintained by Cygnus and data concerning the manufacturing process for the drug
delivery system. Cygnus' ability to manufacture and sell products developed
under contract depends upon the licensee's completing satisfactory clinical
trials and obtaining the foregoing approvals or clearances. Cygnus may prepare
and submit an IND application, or obtain Non-Significant Risk device
investigation status from an IRB, and perform initial clinical studies before
licensing the product for marketing. The Company is increasingly taking a more
active role with its collaborative partners in the clinical trials and
regulatory processes of its products.
On November 21, 1997, the President signed into law the Food and Drug
Administration Modernization Act of 1997. This legislation changes a number of
provisions of the Food, Drug, and Cosmetic Act, in an effort to improve the
regulation of food, drugs, devices and biologic products. Among other things,
the changes will affect the 510(k) notification and PMA processes, and also will
affect device standards and data requirements, tracking and postmarket
surveillance, accredited third party review, and the dissemination of off label
information. In addition, the new legislation contains general findings, without
regard to any particular product, that "the pain associated with existing blood
testing devices creates a disincentive for people with diabetes to test blood
glucose levels, particularly children" and that "a safe and effective
noninvasive blood glucose meter would likely improve control and management of
diabetes by increasing the number of tests conducted by people with diabetes,
particular children." Notwithstanding these findings, the Company cannot predict
how or when these changes will be implemented or what effect the changes will
have on the regulation of the Company's products.
There can be no assurance that problems will not arise that could delay or
prevent the commercialization of the Company's products, or that the FDA, state
and foreign regulatory agencies will be satisfied with the results of the
clinical trials and approve the marketing of any products. See "Risk Factors--
Regulatory Approvals Uncertain."
LEGAL PROCEEDINGS
On June 30, 1994, 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%
and 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-
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recurring expenses attributable to the arbitration settlement recorded in the
quarter ended September 30, 1997 totaled $39.6 million, of which $23 million is
long-term.
EMPLOYEES
As of September 30, 1997, the Company had 158 full time employees. Of this
total number of employees, 67 were engaged in research and development,
including process development, 26 in scientific affairs and quality assurance,
25 in general administrative, and 40 in operations. None of the Company's
employees is represented by a labor union. Cygnus has experienced no work
stoppages and it believes its employee relations are good.
The Company's success will depend in large part on the continued services of
its scientific, managerial and manufacturing personnel. The loss of a
significant group of key personnel could have a material adverse effect on the
Company. The Company's success also depends upon its ability to continue to
attract and retain other highly qualified scientific, managerial and
manufacturing personnel. Competition for such personnel is intense. In this
respect, the Company competes with numerous pharmaceutical and health care
companies, as well as universities and nonprofit research organizations. There
can be no assurance that the Company will continue to be able to attract and
retain sufficient qualified personnel.
PROPERTIES
Cygnus leases approximately 92,000 square feet in four buildings. Three are
located in Redwood City, California and the fourth is located in Menlo Park,
California. The headquarters building, approximately 38,000 square feet, is used
for laboratories and administrative offices. The manufacturing building,
approximately 21,000 square feet, is wholly dedicated to manufacturing and
support. The third facility, also in Redwood City, California, has approximately
11,000 square feet of which approximately 8,000 square feet are utilized for
additional administrative offices and the remainder is reserved for expansion
purposes. The fourth facility, which is located in Menlo Park, has approximately
22,000 square feet, and is used for storage of manufacturing materials and final
products.
The three facilities in Redwood City are leased through 1998 with an option
to renew at the then fair market value through 2003. The facility in Menlo Park
is leased over a three year period ending in 1999.
The manufacturing facility was designed and constructed to comply with cGMP
standards. Cygnus has received licenses from the California Department of Health
Services and the United States Drug Enforcement Agency for the manufacture of
drug products in this facility, and has filed a Drug Master File for the
facility with the FDA. The Company believes that this manufacturing facility has
sufficient capacity to meet current operating requirements and satisfy
foreseeable future demands for its commercial products. To the extent that the
manufacturing facility is not used for commercial production, the Company
intends to maintain a minimum level of staffing and utilize the excess capacity
for producing clinical supplies and process improvement.
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<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Certain information about the Company's directors and executive officers as
of November 24, 1997 is listed below:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Gary W. Cleary, Ph.D............. 55 Chairman of the Board of Directors and Chief
Technical Officer
Gregory B. Lawless, Ph.D......... 57 President, Chief Executive Officer and Director
Neil R. Ackerman, Ph.D........... 54 Senior Vice President, Research & Development
Craig W. Carlson................. 49 Senior Vice President, Finance
James F. Grady, Jr., Ph.D........ 49 Senior Vice President, Human Resources &
Administration
John C. Hodgman.................. 43 President, Cygnus Diagnostics; Chief Financial
Officer
Stephen N. Kirnon................ 35 President, Drug Delivery Division
Alan F. Russell, Ph.D............ 55 Senior Vice President, Scientific Affairs
Frank T. Cary.................... 76 Director
Andre Marion..................... 61 Director
Richard G. Rogers................ 68 Director
Walter B. Wriston................ 78 Director
</TABLE>
DR. CLEARY, the Company's founder and Chairman of the Board of Directors,
also served as the Company's President and Chief Executive Officer from its
inception until July 1986. Since 1986, Dr. Cleary has served as Chief Technical
Officer of the Company. During his professional career, Dr. Cleary has served as
an investigator with the U.S. Food and Drug Administration and held research and
management positions at Cutter Labs, Alza Corporation, Key Pharmaceuticals, Inc.
and Genentech Inc. Dr. Cleary holds an M.B.A. in Health Sciences from the
University of Miami, a Ph.D. in Pharmaceutical Sciences from Rutgers University
and a Pharm.D. in Pharmacy from the University of California, San Francisco.
DR. LAWLESS joined Cygnus in January 1992 as President, Chief Executive
Officer and Director. From March 1989 to January 1992, Dr. Lawless was President
and Chief Operating Officer of Chiron Corporation, a biopharmaceutical company.
Prior to joining Chiron he held various positions with the DuPont Co. from May
1969 to February 1989, including serving as Chief Operating Officer of its
pharmaceutical subsidiary and as Director of DuPont Specialty Diagnostic
Division. He holds a Ph.D. in Pharmaceutical Chemistry from Temple University.
DR. ACKERMAN joined Cygnus in May of 1994 as Vice President, Research &
Development. In January 1997, Dr. Ackerman was promoted to Senior Vice
President, Research & Development. From 1990 to May 1994, Dr. Ackerman served as
Vice President of Research and Development for Glycomed, leading its discovery
efforts focused on cardiovascular and inflammatory diseases. From 1982 to 1990,
he was Research Director, Cancer and Inflammatory Diseases with DuPont
Pharmaceuticals, responsible for leading a 100-person staff that had the
objective of discovering therapeutics for cancer, inflammatory and immune-based
diseases. Prior to that he was employed by Syntex Corporation and Pfizer, Inc.
in research and management capacities. Dr. Ackerman received B.S. and Ph.D.
degrees from the University of Maryland and completed a post-doctoral fellowship
at Stanford University.
MR. CARLSON joined the Company in July 1993 as Vice President, Corporate
Communications, after 15 years in the advertising and marketing industry. In
September 1997, Mr. Carlson was given additional responsibilities for Finance
and Information Technology. His current title is Senior Vice President, Finance.
From 1988 to July 1993, he was Vice President and Group Director at Young &
Rubicam
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Advertising in San Francisco. Prior to that, Mr. Carlson was Vice President of
Campbell-Mithun Advertising. He holds a B.A. from Union College and an M.B.A.
from Stanford University.
DR. GRADY joined the Company in May 1993 as Vice President, Human Resources.
From June 1995 to September 1997, Dr. Grady also served as Vice President of
Operations at the Company. In September 1997, he was appointed Senior Vice
President, Human Resources and Administration. From January 1989 to May 1993,
Dr. Grady led the human resources department for a division of Beckman
Instruments. From 1986 to January 1989, Dr. Grady held various positions with
SmithKline Beckman (now SmithKline Beechman), including Director of Compensation
& Organizational Development for its worldwide research and development business
unit. He received a B.S. in Psychology and a Ph.D. in Education from the
University of Pittsburgh.
MR. HODGMAN joined Cygnus in August 1994 as Vice President, Finance and
Chief Financial Officer. In June 1995, Mr. Hodgman was additionally appointed
President of Cygnus Diagnostics. Prior to joining Cygnus, Mr. Hodgman served as
Vice President of Operations and Finance and Chief Financial Officer for Central
Point Software, a personal computer and networking software company. Prior to
that, he was the Vice President of Finance and Administration and Chief
Financial Officer of Ateq Corporation. Mr. Hodgman holds a B.S. degree from
Brigham Young University and an M.B.A. from the University of Utah.
MR. KIRNON joined Cygnus in April 1993 as Director, Business Development. In
September 1997, Mr. Kirnon was promoted to President, Drug Delivery Division.
Prior to joining Cygnus, Mr. Kirnon served as the National Sales & Marketing
Manager for BioGenex, Inc. Prior to that, he worked at SmithKline Beecham
Corporation. Mr. Kirnon holds a B.A. in Biochemical Sciences from Harvard
University and an M.B.A. from Pepperdine University in General Management.
DR. RUSSELL joined the Company in May 1992 as Vice President, Scientific
Affairs, and was promoted to Senior Vice President, Scientific Affairs in
November 1994. Dr. Russell was Vice President for Scientific Affairs at Chiron
Corporation from 1987 to April 1992. He held the same position at Beecham
Laboratories from 1983 to 1987, prior to which he held various positions at
Syntex Corporation from 1971 to 1983, including Director of Regulatory Affairs
for Investigational Drugs. He holds a Ph.D. in Organic Chemistry from the
University of New South Wales in Australia and M.B.A. and J.D. degrees from the
University of Santa Clara.
MR. CARY has served as a director of the Company since July 1992. He was
Chairman of the Board of International Business Machines Corporation ("IBM")
from 1973 until his retirement in 1983, and was Chief Executive Officer of IBM
from 1973 to 1981. Mr. Cary is also a director of Capital Cities/ABC Inc.,
Celgene Corporation, ICOS Corporation, Texaco, Inc., and PepsiCo., Inc.
MR. MARION has served as a director of the Company since August 1994. Mr.
Marion was a founder of Applied Biosystems, Inc., a supplier of instruments for
biotechnology research, and served as its Chairman of the Board and Chief
Executive Officer from 1981 until February 1993, when it merged with the Perkin-
Elmer Corporation, a manufacturer of analytical instruments. Mr. Marion served
as Vice President of Perkin-Elmer and President of its Applied Biosystems
Division until his retirement in February 1995. Mr. Marion is also a director of
Applied Imaging Systems, Inc.
MR. ROGERS has served as a director of the Company since October 1989. He
was President and Chief Operating Officer of Syntex Corporation from 1982 until
his retirement in 1986.
MR. WRISTON has served as a director of the Company since July 1992. He was
Chairman of the Board of Citicorp/Citibank, N.A. from 1970 through 1984 and its
Chief Executive Officer from 1967 until his retirement in 1984. Mr. Wriston is
also a Director of AEA Investors Inc., Bio Research Labs, General Electric
Company, ICOS Corporation, Tandem Computers Inc., United Meridian Corp., York
International Corporation, and Fremont Group, Inc.
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<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of Common Stock of
the Company as of September 30, 1997, by (a) each person known by the Company to
own beneficially more than 5% of the outstanding Common Stock; (b) the Chief
Executive Officer of the Company; (c) each of the four other most highly
compensated executive officers of the Company (determined at fiscal year-end
1996); (d) each director of the Company; and (e) all directors and executive
officers of the Company as a group:
<TABLE>
<CAPTION>
NUMBER OF SHARES
BENEFICIALLY APPROXIMATE
NAME OWNED(1) PERCENT OWNED
- ------------------------------------------------------------------------------- ----------------- ---------------
<S> <C> <C>
Amerindo Investment Advisors, Inc.(2).......................................... 3,743,500 20.00%
388 Market Street, Suite 950
San Francisco, CA 94111
Neil R. Ackerman(3)............................................................ 102,441 *
Frank T. Cary(4)............................................................... 49,631 *
Gary W. Cleary(5).............................................................. 822,358 4.34%
John C. Hodgman(6)............................................................. 103,705 *
Gregory B. Lawless(7).......................................................... 715,127 3.78%
Andre F. Marion(8)............................................................. 22,846 *
Richard G. Rogers(9)........................................................... 14,626 *
Alan F. Russell(10)............................................................ 191,728 1.01%
Walter B. Wriston(11).......................................................... 30,231 *
All executive officers and directors as a group (12 persons)(12)............... 2,243,370 11.95%
</TABLE>
- ------------------------
* Less than 1%
(1) Except as indicated in the footnotes to this table, the stockholders named
in the table are known to the Company to have sole voting and investment
power with respect to all shares of Common Stock shown as beneficially owned
by them, subject to community property laws where applicable.
(2) Information as of December 31, 1996, per Schedule 13G filed pursuant to Rule
13d-1(b) or 13d-2(b) of the Securities Exchange Act of 1934, as amended.
(3) Includes options to purchase 96,998 shares exercisable within 60 days of
September 30, 1997.
(4) Incudes options to purchase 22,771 shares exercisable within 60 days of
September 30, 1997.
(5) Includes options to purchase 107,922 shares exercisable within 60 days of
September 30, 1997. Excludes approximately 32,000 shares previously owned by
Dr. Cleary which were transferred to irrevocable trusts for the benefit of
Dr. Cleary's two children. Dr. Cleary disclaims beneficial ownership of
these shares and has no rights, benefits of ownership or authority over such
trusts. Dr. Cleary also disclaims beneficial ownership of any shares held by
Margaret Cleary.
(6) Includes options to purchase 94,723 shares exercisable within 60 days of
September 30, 1997.
(7) Includes options to purchase 670,434 shares exercisable within 60 days of
September 30, 1997.
(8) Incudes options to purchase 21,846 shares exercisable within 60 days of
September 30, 1997.
(9) Includes options to purchase 8,785 shares exercisable within 60 days of
September 30, 1997. Excludes shares previously held by Mr. Rogers, but
subsequently transferred to an irrevocable trust for the benefit of his
grandchildren. Mr. Rogers disclaims beneficial ownership of such shares and
has no rights, benefits of ownership or authority over the trust.
(10) Includes options to purchase 189,105 shares exercisable within 60 days of
September 30, 1997.
(11) Includes options to purchase 30,031 shares exercisable within 60 days of
September 30, 1997.
(12) Includes officers' and directors' shares listed above; also includes
185,927 shares held directly or beneficially owned by three officers of the
Company not listed above, including options to purchase 163,854 shares
exercisable within 60 days of September 30, 1997.
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<PAGE>
DESCRIPTION OF NOTES
The Notes will be issued under the Subordinated Indenture to be dated as
of , 1997, as supplemented by the Supplemental Indenture to be dated
as of , 1997 (the "Supplemental Indenture" and the Subordinated
Indenture, as supplemented by the Supplemental Indenture, is hereinafter
referred to as the "Indenture"). The following discussion includes a summary
description of material terms of the Supplemental Indenture and the Notes (which
represent a series of, and are referred to in the accompanying Prospectus as,
"Debt Securities"). The following description of the terms of the Notes offered
hereby supplements, and should be read in conjunction with, the statements under
"Description of Debt Securities" in the accompanying Prospectus. The following
summary does not purport to be complete and is subject to, and is qualified in
its entirety by reference to, all of the provisions of the Subordinated
Indenture and the Supplemental Indenture. Capitalized terms used and not defined
herein have the meanings given to them in the Subordinated Indenture and the
Supplemental Indenture. As used in this Description of Notes, the "Company"
refers only to Cygnus, Inc. and does not, unless the context otherwise
indicates, include any of its subsidiaries.
GENERAL
The Notes will be unsecured subordinated obligations of the Company, will be
limited to $75,000,000 aggregate principal amount (plus up to an additional
$11,250,000 aggregate principal amount to cover over-allotments, if any) and
will mature on December , 2002. The Notes will bear interest at % per
annum from the date of original issuance of the Notes, or from the most recent
date to which interest has been paid or provided for, payable in arrears
semiannually on June and December of each year, commencing on June
, 1998, to Holders of record of the Notes on the immediately preceding
and . Interest will be computed on the basis of a 360-day
year comprised of twelve 30-day months.
The Notes will be unsecured obligations of the Company and will be
subordinated in right of payment to all present and future Senior Debt (as
defined in the accompanying Prospectus) of the Company. Neither the Notes nor
the Indenture limit or restrict the amount or terms of other indebtedness which
may be incurred or issued by the Company or its subsidiaries or contain any
financial or similar covenants of, or restrictions on, the Company or its
subsidiaries. The Notes will be effectively subordinated in right of payment to
all indebtedness and liabilities of the Company's subsidiaries.
The Notes will be convertible into Common Stock initially at the Conversion
Price (as defined) stated on the cover page hereof, subject to adjustment upon
the occurrence of certain events described under "-- Conversion Rights," at any
time on or after issuance of the Notes and prior to the close of business on the
maturity date, unless previously redeemed or repurchased.
BOOK-ENTRY SYSTEM
The Notes will be issued in registered form, without coupons, and in
denominations of $1,000 and integral multiples thereof. The Notes will initially
be issued in the form of a Global Security held in book-entry form. Accordingly,
The Depository Trust Company ("DTC") or its nominee will be the sole registered
Holder of the Notes for all purposes under the Indenture. Owners of beneficial
interests in the Notes represented by the Global Security will hold such
interests pursuant to the procedures and practices of DTC and must exercise any
rights in respect of their interests (including any right to convert or require
repurchase of their interests) in accordance with those procedures and
practices. Such beneficial owners will not be Holders, and will not be entitled
to any rights under the Global Security or the Indenture, with respect to the
Global Security, and the Company and the Trustee, and any of their respective
agents, may treat DTC as the sole holder and owner of the Global Security.
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<PAGE>
CONVERSION RIGHTS
Each Holder of Notes will have the right at any time on or prior to
maturity, unless previously redeemed or repurchased, at the Holder's option, to
convert any portion of the principal amount hereof that is an integral multiple
of $1,000 into shares of Common Stock at any time at the Conversion Price set
forth on the cover of this Prospectus Supplement (subject to adjustment as
described below). The right to convert a Note called for redemption or delivered
for repurchase will terminate at the close of business on the Business Day
immediately prior to the Redemption Date or Repurchase Date for such Note,
unless the Company subsequently fails to pay the applicable Redemption Price or
Repurchase Price, as the case may be.
Beneficial owners of interests in a Global Security may exercise their right
of conversion by delivering to DTC the appropriate instruction form for
conversion pursuant to DTC's conversion program. Such notice of conversion can
be obtained at the office of any conversion agent. The conversion date will be
the date on which the Note and the duly signed and completed notice of
conversion are so delivered. As promptly as practicable on or after the
conversion date, the Company will issue and deliver to the Trustee a certificate
or certificates for the number of full shares of Common Stock issuable upon
conversion, together with payment in lieu of any fraction of a share; such
certificate will be sent by the Trustee to the conversion agent for delivery to
the Holder. All shares of Common Stock issuable upon conversion of the Notes, in
accordance with the provisions of the Indenture, will be fully paid and
nonassessable and will rank PARI PASSU with the other shares of Common Stock of
the Company outstanding from time to time.
Any Note surrendered for conversion during the period from the close of
business on any Regular Record Date to the opening of business on the next
succeeding Interest Payment Date (except Notes (or portions thereof) called for
redemption on a Redemption Date during the period beginning at the close of
business on a Regular Record Date and ending on the opening of business on the
first Business Day after the next succeeding Interest Payment Date, or if such
Interest Payment Date is not a Business Day, the second such Business Day) must
be accompanied by payment of an amount equal to the interest payable on such
Interest Payment Date on the principal amount of Notes being surrendered for
conversion, and the interest on the principal amount of Notes being surrendered
for conversion will be paid to the registered Holder of such Notes on such
Regular Record Date, except as provided in the Indenture. Any Note surrendered
for conversion on an Interest Payment Date need not be accompanied by any
payment and the interest on the principal amount of the Note being surrendered
for conversion will be paid on such Interest Payment Date to the registered
Holder of such Note on the relevant Record Date. No other payment or adjustment
for interest, or for any dividends in respect of Common Stock, will be made upon
conversion. Holders of Common Stock issued upon conversion will not be entitled
to receive any dividends payable to holders of Common Stock as of any record
time or date before the close of business on the conversion date. No fractional
shares will be issued upon conversion but, in lieu thereof, an appropriate
amount will be paid in cash by the Company based on the market price of Common
Stock at the close of business on the last trading day prior to date of
conversion.
A Holder delivering a Note for conversion will not be required to pay any
taxes or duties in respect of the issue or delivery of Common Stock on
conversion but will be required to pay any tax or duty which may be payable in
respect of any transfer involved in the issue or delivery of the Common Stock in
a name other than that of the Holder of the Note. Certificates representing
shares of Common Stock will not be issued or delivered unless all taxes and
duties, if any, payable by the Holder have been paid.
The Conversion Price is subject to adjustment upon the occurrence of certain
events, including (i) the issuance of shares of Common Stock as a dividend or
distribution on the Common Stock; (ii) the subdivision, combination or
reclassification of the outstanding Common Stock; (iii) the issuance to all or
substantially all holders of Common Stock of rights, warrants or options to
subscribe for or purchase Common Stock (or securities convertible into Common
Stock) at a price per share less than the then current market price per share
(determined as set forth below); (iv) the distribution of shares of capital
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<PAGE>
stock of the Company (other than Common Stock), evidences of indebtedness or
other assets (excluding dividends payable exclusively in cash and any issuance
of capital stock pursuant to a reclassification covered by clause (ii) above) to
all or substantially all holders of Common Stock; (v) the distribution to all or
substantially all of the holders of Common Stock of rights or warrants to
subscribe for capital stock of the Company (excluding those covered by clause
(iii) above) at a price per share less than the then current market price per
share of such capital stock of the Company; (vi) the issuance of Common Stock
for a price per share less than the current market price per share (determined
as set forth below) on the date the Company fixes the offering price of such
additional shares (other than issuances of Common Stock under certain employee
benefit plans of the Company and certain other issuances described in the
Indenture); (vii) the distribution, by dividend or otherwise, of cash (excluding
any cash portion of a distribution resulting in an adjustment pursuant to clause
(iv) above) to all holders of Common Stock in an aggregate amount that, combined
together with (A) all other distributions of cash that did not trigger a
Conversion Price adjustment to all holders of Common Stock within the 12 months
preceding the date fixed for determining the stockholders entitled to such
distribution plus (B) any cash and the fair market value of consideration that
did not trigger a Conversion Price adjustment payable in respect of any tender
offer by the Company or any of its subsidiaries for Common Stock (as described
in clause (viii) below) consummated within the 12 months preceding the date
fixed for determining the shareholders entitled to such distribution, exceeds
15% of the product of the current market price per share (determined as set
forth below) on the date fixed for the determination of stockholders entitled to
receive such distribution times the number of shares of Common Stock outstanding
on such date; and (viii) the completion of a tender offer made by the Company or
any of its subsidiaries for Common Stock involving an aggregate consideration
that, together with (A) any cash and the fair market value of any consideration
that did not trigger a Conversion Price adjustment paid or payable in respect of
any previous tender offer by the Company or a subsidiary for Common Stock
consummated within the 12 months preceding the consummation of such tender offer
plus (B) the aggregate amount of any distribution of cash that did not trigger a
Conversion Price adjustment (as described in clause (vii) above) to all holders
of Common Stock within the 12 months preceding the consummation of such tender
offer, exceeds 15% of the product of the current market price per share
(determined as set forth below) immediately prior to the expiration of such
offer times the number of shares of Common Stock outstanding at the expiration
of such offer. In the event of a distribution to all or substantially all
holders of Common Stock of rights to subscribe for additional shares of the
Company's capital stock (other than those referred to in clause (iii) above),
the Company may, instead of making an adjustment in the Conversion Price, make
proper provisions so that each Holder of a Note who converts such Note after the
record date for such distribution and prior to the expiration or redemption of
such rights shall be entitled to receive upon such conversion, in addition to
shares of Common Stock, an appropriate number of such rights. No adjustment of
the Conversion Price will be made until cumulative adjustments amount to one
percent or more of the Conversion Price as last adjusted.
In the event of a taxable distribution to holders of Common Stock (or other
transaction) which results in any adjustment of the Conversion Price, the
Holders of Notes may, in certain circumstances, be deemed to have received a
distribution subject to United States income tax as a dividend; in certain other
circumstances, the absence of such an adjustment may result in a taxable
dividend to the holders of Common Stock. See "Certain United States Federal
Income Tax Consequences."
The Company from time to time may, to the extent permitted by law, reduce
the Conversion Price of the Notes by any amount for any period of at least 20
days, in which case the Company shall give at least 15 days' notice of such
decrease, if the Board of Directors has made a determination that such decrease
would be in the best interests of the Company, which determination shall be
conclusive. The Company may, at its option, make such reductions in the
Conversion Price, in addition to those set forth above, as the Board of
Directors deems advisable to avoid or diminish any income tax to holders of
Common Stock resulting from any dividend or distribution of stock (or rights to
acquire stock) or from any event treated as such for income tax purposes. See
"Certain United States Federal Income Tax Consequences."
S-44
<PAGE>
In the Supplemental Indenture, the "current market price" per share of
Common Stock or of any capital stock of the Company on any date shall be deemed
to be the average of the Daily Market Prices for the shorter of (i) 30
consecutive Business Days ending on the last full trading day on the exchange or
market referred to in determining such Daily Market Prices prior to the time of
determination or (ii) the period commencing on the date next succeeding the
first public announcement of the issuance of such rights or warrants or such
distribution through such last full trading day prior to the time of
determination.
In case of any consolidation or merger of the Company with or into another
Person or any merger of another Person into the Company (other than a merger
which does not result in any reclassification, conversion, exchange or
cancellation of the Common Stock), or in case of any sale, transfer or lease of
all or substantially all of the assets of the Company, each Note then
outstanding will, without the consent of the Holder of any Note, become
convertible only into the kind and amount of securities, cash and other property
receivable upon such consolidation, merger, sale, transfer or lease by a holder
of the number of shares of Common Stock into which such Note was convertible
immediately prior thereto (assuming such holder of Common Stock failed to
exercise any rights of election and that such Note was then convertible).
SUBORDINATION
The payment of the principal of, premium, if any, and interest on the Notes
and any amounts payable upon the redemption or the repurchase of the Notes will
be subordinated in right of payment to the extent set forth in the Indenture to
the prior payment in full of the principal of, premium, if any, interest and
other amounts in respect of all Senior Debt of the Company. See "Description of
Debt Securities-- Subordination of Subordinated Debt Securities" in the
accompanying Prospectus.
The Notes will be structurally subordinated to all indebtedness and other
liabilities (including trade payables) of the Company's subsidiaries, as any
right of the Company to receive any assets of its subsidiaries upon their
liquidation or reorganization (and the consequent right of the Holders of the
Notes to participate in those assets) will be effectively subordinated to the
claims of the subsidiary's creditors (including trade creditors), except to the
extent that the Company itself is recognized as a creditor of such subsidiary,
in which case the claims of the Company would still be subordinate to any
security interest in the assets of such subsidiary and any indebtedness of such
subsidiary senior to that held by the Company.
As of September 30, 1997, the Company had approximately $15.6 million of
indebtedness and other liabilities (including the $6.0 million note issued to
Sanofi in connection with the Company's arbitration settlement described in
"Business--Legal Proceedings") that would have constituted Senior Debt. As of
September 30, 1997, the Company's subsidiaries had no indebtedness or other
liabilities as to which the Notes would have been effectively subordinated. The
Indenture does not limit the Company's or its subsidiaries' ability to incur,
create, assume or guarantee Senior Debt or any other indebtedness or
liabilities. The Company expects from time to time to incur, create, assume or
guarantee additional indebtedness and other liabilities, including Senior Debt.
See "Risk Factors--Leverage; Subordination of Notes; Absence of Financial
Covenants."
OPTIONAL REDEMPTION
The Notes are not entitled to any sinking fund. The Notes are not redeemable
by the Company prior to December 1, 2000. On or after December 1, 2000, the
Notes are redeemable upon 30 days' notice at the option of the Company, in
whole, or from time to time, in part, at the redemption prices set forth below
(expressed as percentages of the principal amount), in each case together with
accrued and unpaid interest to, but excluding, the date fixed for redemption.
S-45
<PAGE>
If redeemed during the 12-month period beginning December (December ,
2000 through , 2001 in the case of the first such period):
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
- --------------------------------------------------------------------------------- -----------
<S> <C>
2000............................................................................. %
2001.............................................................................
</TABLE>
and 100% on December , 2002; provided that any semi-annual payment of interest
becoming due on the date fixed for redemption shall be payable to the Holders of
record on the relevant record date of the Notes being redeemed. Notwithstanding
the foregoing, the Company may not redeem any Notes unless all accrued and
unpaid interest has been paid on all outstanding Notes for all interest periods
terminating on or prior to the last interest payment date before the date of
redemption.
If fewer than all the Notes are to be redeemed, the Trustee will select the
Notes to be redeemed in principal amounts of $1,000 or multiples thereof by lot
or, in its discretion, on a PRO RATA basis. If any Note is to be redeemed in
part only, a new Note or Notes in principal amount equal to the unredeemed
principal portion thereof will be issued. If a portion of a Holder's Notes is
selected for partial redemption and such Holder converts a portion of such Note,
such converted portion shall be deemed to be taken from the portion selected for
redemption.
REPURCHASE OF NOTES AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL
The Indenture will provide that in the event that a Change of Control (as
defined below) has occurred, each Holder will have the right, at such Holder's
option, pursuant to an irrevocable and unconditional offer by the Company (the
"Repurchase Offer"), to require the Company to repurchase all or any part of
such Holder's Notes (provided, that the principal amount of such Notes must be
$1,000 or an integral multiple thereof) on the date (the "Repurchase Date") that
is no later than 90 days after the occurrence of such Change of Control at a
cash price equal to 100% of the principal amount thereof, together with accrued
and unpaid interest, if any, to the Repurchase Date (the "Repurchase Price").
The Repurchase Offer shall be made within 30 days following a Change of Control
and shall remain open for a period specified by the Company but not less than 20
Business Days following its commencement (the "Repurchase Offer Period"). Upon
expiration of the Repurchase Offer Period, the Company shall purchase all Notes
tendered in response to the Repurchase Offer in the manner described below. If
required by applicable law or regulatory authority, the Repurchase Date and the
Repurchase Offer Period may be extended to the extent required; however, if so
extended, it shall nevertheless constitute an Event of Default if the Repurchase
Date does not occur within 90 days of the Change of Control.
The Indenture will provide that a "Change of Control" will be deemed to have
occurred when: (i) any "person" or "group" (as such terms are used for purposes
of Sections 13(d) and 14(d) of the Exchange Act, whether or not applicable) is
or becomes the "beneficial owner," directly or indirectly, of shares
representing more than 50% of the combined total voting power of the then
outstanding securities entitled to vote generally in elections of directors of
the Company ("Voting Stock"), (ii) the Company consolidates with or merges into
any other person or conveys, transfers or leases, whether directly or
indirectly, all or substantially all of its assets to any person, or any other
person merges into the Company, and, in the case of any such transaction, the
outstanding Common Stock of the Company is changed or exchanged as a result,
unless the stockholders of the Company immediately before such transaction own,
directly or indirectly immediately following such transaction, at least a
majority of the combined voting power of the outstanding voting securities of
the corporation resulting from such transaction in substantially the same
proportion as their ownership of the Voting Stock immediately before such
transaction, (iii) at any time the Continuing Directors (as defined below) do
not constitute the majority of the Board of Directors of the Company (or, if
applicable, a successor corporation to the Company), or (iv) the Common Stock of
the Company (or other common stock into which the Notes are then convertible) is
neither listed for trading
S-46
<PAGE>
on a United States national securities exchange or approved for trading on an
established automatic over-the-counter trading market in the United States
during ten consecutive Trading Days; PROVIDED that a Change of Control shall not
be deemed to have occurred if either (x) the Daily Market Price of the Common
Stock for any five trading days during the ten trading days immediately
preceding the Change of Control is at least equal to 105% of the Conversion
Price in effect on such day or (y) in the case of a merger, consolidation or
other transaction otherwise constituting a Change of Control, all of the
consideration (excluding cash payments for fractional shares) in such merger,
consolidation or other transaction constituting the Change of Control consists
of common stock traded on a United States national securities exchange or quoted
on the Nasdaq National Market (or which will be so traded or quoted when issued
or exchanged in connection with such Change of Control) and as a result of such
transaction or transactions the Notes become convertible solely into such common
stock. "Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (i) was a member of the Board of
Directors on the date of this Prospectus Supplement or (ii) was nominated for
election or elected to such Board of Directors with the approval of a majority
of the Continuing Directors who were members of the Board of Directors at the
time of such nomination or election.
On or before the Repurchase Date, the Company will (i) accept for payment
Notes or portions thereof properly tendered pursuant to the Repurchase Offer,
(ii) deposit with the Paying Agent cash sufficient to pay the Repurchase Price
of all Notes so tendered and (iii) deliver to the Trustee all Notes or portions
thereof so accepted, together with an Officers' Certificate listing the Notes or
portions thereof being purchased by the Company. The Paying Agent will promptly
mail to the Holders of Notes so accepted payment in an amount equal to the
Repurchase Price (together with accrued and unpaid interest, if any, to, but
excluding, the Repurchase Date), and the Trustee will promptly authenticate and
mail or deliver to such Holders a new Note or Notes equal in principal amount to
any unpurchased portion of the Notes surrendered. Any Notes not so accepted will
be promptly mailed or delivered by the Company to the Holder thereof. The
Company will publicly announce the results of the Repurchase Offer on or as soon
as practicable after the Repurchase Date.
The phrase "all or substantially all" of the assets of the Company is likely
to be interpreted by reference to applicable state law at the relevant time, and
will be dependent on the facts and circumstances existing at such time. As a
result, there may be a degree of uncertainty in ascertaining whether a sale or
transfer of "all or substantially all" of the assets of the Company has
occurred. In addition, no assurances can be given that the Company will be able
to acquire the Notes tendered upon the occurrence of a Change of Control.
For purposes of the definition of Change of Control, (i) the terms "person"
and "group" shall have the meaning used for purposes of Rules 13d-3 and 13d-5 of
the Exchange Act as in effect on the Issuance Date, whether or not applicable;
and (ii) the term "beneficial owner" shall have the meaning used in Rules 13d-3
and 13d-5 under the Exchange Act as in effect on the Issuance Date, whether or
not applicable, except that a "person" shall be deemed to have "beneficial
ownership" of all shares that any such person has the right to acquire, whether
such right is exercisable immediately or only after the passage of time or upon
the occurrence of certain events.
The repurchase option upon a Change of Control may in certain circumstances
make more difficult or discourage a takeover of the Company and, thus, the
removal of incumbent management. The Change of Control repurchase feature,
however, is not the result of management's knowledge of any specific effort to
accumulate the Company's stock or to obtain control of the Company by means of a
merger, tender offer, solicitation or otherwise, or part of a plan by management
to adopt a series of anti-takeover provisions. Instead, the Change of Control
repurchase feature is a result of negotiation between the Company and the
Underwriters. Management has no present intention to engage in a transaction
involving a Change of Control, although it is possible the Company could decide
to do so in the future. Subject to the limitations on mergers, consolidations
and sale of assets described herein, the Company could, in the future, enter
into certain transactions, including acquisitions, refinancings, restructurings
or other recapitalizations, that
S-47
<PAGE>
would not constitute a Change of Control under the Indenture, but that could
increase the amount of indebtedness (including Senior Debt) outstanding at such
time or otherwise affect the Company's capital structure or credit ratings. The
payment of the repurchase price in the event of a Change of Control is
subordinated to the prior payment of Senior Debt as described under
"--Subordination."
To the extent applicable and if required by law, the Company will comply
with Section 14 of the Exchange Act and the provisions of Regulation 14E and any
other tender offer rules under the Exchange Act and any other securities laws,
rules and regulations that may then be applicable to any offer by the Company to
purchase the Notes at the option of Holders upon a Change of Control.
If a Change of Control were to occur, there can be no assurance that the
Company would have sufficient financial resources, or would be able to arrange
financing to pay the repurchase price for all Notes tendered by Holders thereof.
The Company's ability to repurchase the Notes may also be limited or prohibited
by the terms of its then-existing borrowing arrangements and applicable law.
Moreover, any future credit agreements or other agreements relating to other
indebtedness (including Senior Debt) to which the Company becomes a party may
contain restrictions on or prohibitions of the repurchase of the Notes by the
Company. In the event a Change of Control occurs at a time when the Company is
prohibited from repurchasing Notes, the Company could seek the consent of its
lenders to the repurchase of the Notes or could attempt to refinance the
borrowings that contain such prohibition. If the Company does not obtain such a
consent or repay such borrowings, the Company would remain prohibited from
repurchasing the Notes. In such case, the Company's failure to repurchase the
Notes would constitute an Event of Default under the Indenture, whether or not
payment of the repurchase price is permitted by the subordination provisions of
the Indenture. Any such default may, in turn, cause a default under Senior Debt
of the Company. Moreover, the occurrence of a Change of Control in and of itself
may constitute an event of default under Senior Debt of the Company. As a
result, in either case, payment of the repurchase price of the Notes with cash
would, absent a waiver, be prohibited under the subordination provisions of the
Indenture until the Senior Debt is paid in full. See "--Subordination."
DEFEASANCE AND COVENANT DEFEASANCE
The provisions described under "Description of Debt Securities--Defeasance
and Covenant Defeasance" in the accompanying Prospectus shall apply to the
Notes.
EVENTS OF DEFAULT
In addition to the Events of Default described under "Description of Debt
Securities--Events of Default" in the accompanying Prospectus, the following
will constitute an Event of Default under the Indenture with respect to the
Notes: (i) failure by the Company to comply with the provisions described under
"--Repurchase of Notes at the Option of Holders Upon a Change of Control"; (ii)
default under any mortgage, indenture or instrument under which there is issued
or by which there is secured or evidenced any indebtedness for money borrowed by
the Company or any of its Significant Subsidiaries (or the payment of which is
guaranteed by the Company or any of its Significant Subsidiaries) whether such
indebtedness or guarantee now exists, or is created after the date of the
Indenture, which default (a) is caused by a failure to pay principal of or
premium, if any, or interest on such indebtedness prior to the expiration of the
grace period provided in such indebtedness on the date of such default (a
"Payment Default") or (b) results in the acceleration of such indebtedness prior
to its express maturity and, in each case, the principal amount of any such
indebtedness, together with the principal amount of any other such indebtedness
under which there has been a Payment Default or the maturity of which has been
so accelerated, is an amount which, in the aggregate, is equal to or greater
than $10.0 million and continuance of such default for 30 days after notice
given in accordance with the Indenture; and (iii) failure by the Company or any
of its Significant Subsidiaries to pay final judgments in an amount which, in
the aggregate, exceeds $10.0 million and which judgments are not paid,
discharged, bonded or stayed within 60 days after their entry.
S-48
<PAGE>
TRANSFER AND EXCHANGE
The Company has initially appointed the Trustee as security registrar,
transfer agent and conversion agent, acting through its Corporate Trust Office.
The Company reserves the right to vary or terminate the appointment of the
security registrar or of any transfer agent or conversion agent or to appoint
additional or other transfer agents or conversion agents or to approve any
change in the office through which any security registrar or any transfer agent
or conversion agent acts.
PURCHASE AND CANCELLATION
The Company or any subsidiary may at any time and from time to time purchase
Notes at any price in the open market or otherwise.
All Notes surrendered for payment, redemption, repurchase, registration of
transfer or exchange or conversion shall, if surrendered to any Person other
than the Trustee, be delivered to the Trustee. All Notes so delivered to the
Trustee shall be canceled promptly by the Trustee. No Notes shall be
authenticated in lieu of or in exchange for any Notes canceled as provided in
the Indenture.
REPLACEMENT OF NOTES
Notes that become mutilated, destroyed, stolen or lost will be replaced by
the Company at the expense of the Holder upon delivery to the Trustee of the
mutilated Notes or evidence of the loss, theft or destruction thereof
satisfactory to the Company and the Trustee. In the case of a lost, stolen or
destroyed Note, indemnity satisfactory to the Trustee and the Company may be
required at the expense of the Holder of such Note before a replacement Note
will be issued.
GOVERNING LAW
The Subordinated Indenture, the Supplemental Indenture and the Notes will be
governed by and construed in accordance with the laws of the State of New York.
THE TRUSTEE
In case an Event of Default shall occur (and shall not be cured), the
Trustee will be required to use the degree of care of a prudent person in the
conduct of his own affairs in the exercise of its powers. Subject to such
provisions, the Trustee will be under no obligation to exercise any of its
rights or powers under the Indenture at the request of any of the Holders of
Notes, unless they shall have offered to the Trustee reasonable security or
indemnity.
S-49
<PAGE>
UNDERWRITING
Subject to the terms and conditions of an Underwriting Agreement, dated
, 1997 (the "Underwriting Agreement"), among the Company and the
underwriters named below (the "Underwriters"), the Underwriters have severally
agreed to purchase from the Company, and the Company has agreed to sell to the
Underwriters, the respective principal amount of Notes set forth opposite their
names below:
<TABLE>
<CAPTION>
PRINCIPAL
UNDERWRITERS AMOUNT
- ------------------------------------------------------------------------------- -------------
<S> <C>
PaineWebber Incorporated....................................................... $
Morgan Stanley & Co. Incorporated..............................................
-------------
Total...................................................................... $ 75,000,000
-------------
-------------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
to pay for and accept delivery of the Notes is subject to approval of certain
legal matters by their counsel and to certain other conditions. The Underwriters
are obligated to take and pay for all of the Notes if any are taken. The price
at which the Notes are being offered may be changed at any time without notice.
The Company has granted to the Underwriters an option exercisable for 30
days from the date of this Prospectus Supplement to purchase up to an additional
$11,250,000 aggregate principal amount of Notes solely to cover over-allotments,
if any.
The Underwriting Agreement provides that the Company will indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.
The Company's executive officers and directors have agreed that for a period
of 90 days after the date of this Prospectus Supplement they will not, without
the prior written consent of PaineWebber Incorporated, offer to sell, contract
to sell or otherwise sell, dispose of, loan, pledge or grant any rights with
respect to any shares of Common Stock, options or warrants to purchase Common
Stock or any securities convertible into or exchangeable for shares of Common
Stock now owned or hereafter acquired directly by such holders or with respect
to which they have or hereafter acquire the power of disposition.
The Company has agreed that it will not, without the prior written consent
of PaineWebber Incorporated, issue, sell, contract to sell or otherwise dispose
of any shares of Common Stock, any options or warrants to purchase Common Stock
or any securities convertible into or exchangeable for Common Stock, for 90 days
after the date of this Prospectus Supplement other than shares issued pursuant
to employee benefit plans.
The Company has applied for quotation of the Notes on the Nasdaq SmallCap
Market. The common stock is quoted on the Nasdaq National Market under the
symbol "CYGN".
In order to facilitate the offering of the Notes and the Common Stock, the
Underwriters may engage in transactions that stabilize, maintain or otherwise
affect the price of the Notes and the Common Stock. Specifically, the
Underwriters may over-allot in connection with the offering, creating a short
position in the Notes and the Common Stock for their own account. In addition,
to cover over-allotments or to stabilize the price of the Notes and the Common
Stock, the Underwriters may reclaim selling concessions allowed to an
Underwriter or a dealer for distributing the Notes and Common Stock in
transactions to cover Underwriter short positions, in stabilization transactions
or otherwise. Any of these activities may stabilize or maintain the market price
of the Notes and the Common Stock above independent market levels. The
Underwriters are not required to engage in these activities, and may end any of
these activities at any time.
S-50
<PAGE>
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a general discussion of certain United States federal
income tax considerations to holders of the Notes and the Common Stock into
which the Notes may be converted. This discussion is based upon the Internal
Revenue Code of 1986, as amended (the "Code"), Treasury Regulations, Internal
Revenue Service ("IRS") rulings, and judicial decisions now in effect, all of
which are subject to change (possibly with retroactive effect) or different
interpretations.
This discussion does not deal with all aspects of United States federal
income taxation that may be important to holders of the Notes or the Common
Stock into which the Notes may be converted and does not deal with tax
consequences arising under the laws of any foreign, state or local jurisdiction.
This discussion is for general information only, and does not purport to address
all tax consequences that may be important to particular purchasers in light of
their personal circumstances, or to certain types of purchasers (such as certain
financial institutions, insurance companies, tax-exempt entities, dealers in
securities or persons who hold the Notes or the Common Stock in connection with
a straddle) that may be subject to special rules. This discussion assumes that
each holder holds the Notes and the Common Stock into which the Notes may be
converted as capital assets.
The term "U.S. Holder" means (i) a citizen or resident of the United States,
(ii) a corporation, partnership or other entity created or organized under the
laws of the United States or any state thereof, (iii) an estate the income of
which is subject to federal income tax regardless of its source, or (iv) a trust
with respect to which (a) a United States court may exercise primary supervision
over its administration and (b) one or more U.S. Holders have the authority to
control all substantial decisions.
PROSPECTIVE PURCHASERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS REGARDING
THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THEIR PURCHASE,
OWNERSHIP AND DISPOSITION OF THE NOTES, INCLUDING CONVERSION OF THE NOTES, AND
THE OWNERSHIP AND DISPOSITION OF THE COMMON STOCK INTO WHICH THE NOTES MAY BE
CONVERTED.
UNITED STATES HOLDERS
INTEREST ON NOTES. Stated interest on the Notes will be taxable to a U.S.
Holder as ordinary interest income at the time such interest is received or
accrued, in accordance with such holder's regular method of accounting for
United States federal income tax purposes. The Company expects that the Notes
will not be issued with original issue discount ("OID") within the meaning of
the Code. The Company intends to take the position that a repurchase upon a
Change of Control, as described under "Description of Notes-- Repurchase of
Notes at the Option of Holders Upon a Change of Control", is remote under
applicable Treasury Regulations and does not intend to treat the possibility of
such a repurchase as affecting the yield to maturity of the Notes.
CONSTRUCTIVE DIVIDEND. Certain corporate transactions, such as
distributions of assets to holders of Common Stock, may cause a deemed
distribution to the holders of the Notes if the Conversion Price of the Notes is
adjusted to reflect such corporate transaction. Such deemed distributions will
be taxable as a dividend, return of capital, or capital gain in accordance with
the earnings and profits rules discussed under "Dividends on Common Stock." U.S.
Holders therefore could have taxable income as a result of an event to which the
holder received no cash or property.
CONVERSION OF NOTES. A U.S. Holder of Notes will not recognize gain or loss
on the conversion of the Notes into Common Stock. The U.S. Holder's tax basis in
the Common Stock received upon conversion of the Notes will be equal to the
holder's aggregate basis in the Notes exchanged therefor (less any portion
thereof allocable to cash received in lieu of a fractional share). The holding
period of the Common Stock received by the holder upon conversion of the Notes
will generally include the period during which the holder held the Notes prior
to the conversion.
S-51
<PAGE>
Cash received in lieu of a fractional share of Common Stock should be
treated as a payment in exchange for such fractional share rather than as a
dividend. Gain or loss recognized on the receipt of cash paid in lieu of such
fractional share generally will equal the difference between the amount of cash
received and the amount of tax basis allocable to the fractional share.
DIVIDENDS ON COMMON STOCK. Distributions, if any, paid on the Common Stock
will constitute dividends for United States federal income tax purposes to the
extent of current or accumulated earnings and profits of the Company as
determined under United States federal income tax principles. Dividends paid to
corporations may qualify for the dividends-received deduction.
To the extent, if any, that a U.S. Holder receives distributions on the
Common Stock that would otherwise constitute dividends for United States federal
income tax purposes but that exceed current and accumulated earnings and profits
of the Company, such distributions will be treated first as a non-taxable return
of capital reducing the holder's basis in the Common Stock. Any such
distributions in excess of the U.S. Holder's basis in the Common Stock will be
treated as capital gain.
SALE OR EXCHANGE OF NOTES OR COMMON STOCK. In general, subject to the
market discount rules discussed below, a U.S. Holder of Notes will recognize
capital gain or loss upon the sale, redemption, retirement or other disposition
of the Notes or shares measured by the difference between the amount of cash and
the fair market value of any property received (except to the extent
attributable to the payment of accrued interest not previously included in
income, which will be taxable as ordinary interest income) and the Holder's
adjusted tax basis in the Notes. A U.S. Holder's tax basis in Notes generally
will equal the cost of the Notes to the U.S. Holder increased by the amount of
market discount, if any, previously included in income by the holder or
decreased by any bond premium theretofore amortized by the holder with respect
to the Notes. In general, subject to the market discount rules discussed below,
each U.S. Holder of Common Stock into which the Notes have been converted will
recognize capital gain or loss upon the sale, exchange, redemption or other
disposition of the Common Stock. However, special rules may apply to redemptions
of Common Stock which may result in the amount paid being treated as a dividend.
With respect to U.S. Holders who are individuals, trusts or estates, the
Taxpayer Relief Act of 1997 (the "Act") provides a maximum tax rate of 20% on
net capital gains derived from securities held for more than 18 months and
provides a maximum tax rate of 28% on net capital gains derived from securities
held for more than one year and for not more than 18 months ("mid-term gains").
Net gain recognized by such U.S. Holders on securities held for one year or less
in excess of net long-term capital loss continues to be short-term capital gain
subject to tax at ordinary income rates. The Act generally does not affect the
taxation of capital gains to corporations. (For the basis and holding period of
the Common Stock, see "Conversion of Notes.")
MARKET DISCOUNT. The resale of Notes may be affected by the "market
discount" provisions of the Code. For this purpose, the market discount on a
Note will generally be equal to the amount, if any, by which the stated
redemption price at maturity of the Note immediately after its acquisition
exceeds the holder's tax basis in the Note. Subject to a de minimis exception,
these provisions generally require a holder of a Note acquired at a market
discount to treat as ordinary income any gain recognized on the disposition of
such Note to the extent of the "accrued market discount" on such Note at the
time of disposition, unless the holder elects to include accrued market discount
in income currently. In general, market discount on a Note will be treated as
accruing on a straight-line basis over the term of such Note, or, at the
election of the holder, under a constant yield method. A holder of a Note
acquired at a market discount who does not elect to include accrued market
discount in income currently may be required to defer the deduction of a portion
of the interest on any indebtedness incurred or maintained to purchase or carry
the Note until the Note is disposed of in a taxable transaction. If a holder
acquires a Note at a market discount and receives Common Stock upon conversion
of the Note, the amount of accrued market discount not previously included in
income with respect to the converted Note through the date of conversion will be
treated as ordinary income upon the disposition of the Common Stock.
S-52
<PAGE>
NON-U.S. HOLDERS
INTEREST ON NOTES. Generally, interest paid on the Notes to a Non-U.S.
Holder will not be subject to United States federal income tax or withholding
tax if: (i) such interest is not effectively connected with the conduct of a
trade or business within the United States by such Non-U.S. Holder; (ii) the
Non-U.S. Holder does not actually or constructively own 10% or more of the total
voting power of all classes of stock of the Company entitled to vote and is not
a controlled foreign corporation with respect to which the Company is a "related
person" within the meaning of the Code; and (iii) the beneficial owner, under
penalty of perjury, certifies that the owner is not a "United States person"
within the meaning of the Code and provides the owner's name and address. If
certain requirements are satisfied, the certification described in clause (iii)
above may be provided by a securities clearing organization, a bank, or other
financial institution that holds customers' securities in the ordinary course of
its trade or business. For this purpose, the holder of Notes would be deemed to
own constructively the Common Stock into which it could be converted. A holder
that is not exempt from tax under these rules will be subject to United States
federal income tax withholding at a rate of 30% (or lower treaty rate) unless
the interest is effectively connected with the conduct of a United States trade
or business, in which case the interest will be subject to the United States
federal income tax on net income that applies to United States persons
generally. Non-U.S. Holders should consult applicable income tax treaties, which
may provide different rules.
CONVERSION OF NOTES. A Non-U.S. Holder generally will not be subject to
United States federal income tax on the conversion of a Note into Common Stock.
To the extent a Non-U.S. Holder receives cash in lieu of a fractional share on
conversion, such cash may give rise to gain that would be subject to the rules
described below with respect to the sale or exchange of the Notes or the Common
Stock.
DIVIDENDS ON COMMON STOCK. Generally, any distribution on the Common Stock
to a Non-U.S. Holder will be subject to United States federal income tax
withholding at a rate of 30% unless the dividend is effectively connected with
the conduct of trade or business within the United States by the Non-U.S.
Holder, in which case the dividend will be subject to the United States federal
income tax on net income that applies to United States persons generally (and,
with respect to corporate holders and under certain circumstances, the branch
profits tax). Non-U.S. Holders should consult any applicable income tax
treaties, which may provide for a lower rate of withholding or other rules
different from those described above. A Non-U.S. Holder may be required to
satisfy certain certification requirements in order to claim a reduction of or
exemption from withholding under the foregoing rules.
SALES OR EXCHANGE OF NOTES OR COMMON STOCK. A Non-U.S. Holder generally
will not be subject to United States federal income tax on gain recognized upon
the sale or other disposition of the Notes or the Common Stock unless (i) the
gain is effectively connected with the conduct of a trade or business within the
United States by the Non-U.S. Holder, or (ii) in the case of a Non-U.S. Holder
who is a nonresident alien individual and holds the Notes or shares of Common
Stock as a capital asset, such holder is present in the United States for 183 or
more days in the taxable year and certain other circumstances are present.
Non-U.S. Holders should consult applicable income tax treaties, which may
provide different rules.
If the Company is a "United States real property holding corporation"
("USRPHC") (which the Company does not believe that it is or is likely to
become), a Non-U.S. Holder may be subject to United States federal income tax
with respect to gain realized on the disposition of such Notes or Common Stock
as if it were effectively connected with a United States trade or business and
the amount realized will be subject to withholding at the rate of 10%. The
amount withheld pursuant to these rules will be creditable against such Non-U.S.
Holder's United States federal income tax liability and may entitle such
Non-U.S. Holder to a refund upon furnishing the required information to the IRS.
However, a Non-U.S. Holder will not be subject to these rules, even if the
Company were a USRPHC, as long as Common Stock is regularly traded on NASDAQ or
another established securities market, provided that such holder did not during
a specified five-year period actually or constructively own more than 5% of the
Common Stock of the Company (including any Common Stock that may be received on
the conversion of the Notes).
S-53
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INFORMATION REPORTING AND BACKUP WITHHOLDING
U.S. HOLDERS. Information reporting and backup withholding may apply to
payments of interest or dividends on or the proceeds from the sale or other
disposition of the Notes or the Common Stock made by the Company with respect to
certain non-corporate U.S. Holders. Such U.S. Holders generally will be subject
to backup withholding at a rate of 31% unless the recipient of such payment
supplies a taxpayer identification number, certified under penalties of perjury,
as well as certain other information, or otherwise establishes, in the manner
prescribed by law, an exemption from backup withholding. Any amount withheld
under backup withholding is allowable as a credit against the U.S. Holder's
federal income tax, upon furnishing the required information.
NON-U.S. HOLDERS. Generally, information reporting and backup withholding
of United States federal income tax at a rate of 31% may apply to payments of
principal, interest and premium (if any) on the Notes to Non-U.S. Holders if the
payee fails to certify that the holder is a Non-U.S. person or if the Company or
its paying agent has actual knowledge that the payee is a United States person.
The 31% backup withholding tax generally will not apply to dividends paid to
foreign holders outside the United States that are subject to 30% withholding as
discussed above or that are subject to a tax treaty that reduces such
withholding.
The payment of the proceeds from the disposition of the Notes or the Common
Stock to or through the United States office of a United States or foreign
broker will be subject to information reporting and backup withholding unless
the owner provides the certification described above or otherwise establishes an
exemption.
On October 6, 1997, the IRS issued final regulations relating to
withholding, backup withholding and information reporting that unify current
certification procedures and forms and clarify reliance standards (the "Final
Regulations"). The Final Regulations will generally be effective for payments
made after December 31, 1998.
LEGAL MATTERS
Certain legal matters with respect to the legality of the Notes and the
validity of the securities offered hereby are being passed upon for the Company
by Brobeck, Phleger & Harrison LLP, Palo Alto, California. Certain legal matters
related to the Offering will be passed upon for the Underwriters by Shearman &
Sterling, San Francisco, California.
S-54
<PAGE>
PROSPECTUS
$90,000,000
CYGNUS, INC.
DEBT SECURITIES AND COMMON STOCK
------------------------
Cygnus, Inc. ("Cygnus" or the "Company") may from time to time offer,
together or separately, its (i) debt securities (the "Debt Securities"), which
may be either senior debt securities (the "Senior Debt Securities") or
subordinated debt securities (the "Subordinated Debt Securities") and (ii)
shares of its Common Stock, $.001 par value per share (the "Common Stock"). The
Debt Securities and the Common Stock are collectively referred to herein as the
"Securities".
The Securities offered pursuant to this Prospectus may be issued in one or
more series or issuances and will be limited to $90,000,000 aggregate public
offering price (or its equivalent (based on the applicable exchange rate at the
time of the sale) in one or more foreign currencies, currency units or composite
currencies as shall be designated by the Company). Certain specific terms of the
particular Securities in respect of which this Prospectus is being delivered are
set forth in the accompanying Prospectus Supplement (the "Prospectus
Supplement"), including, where applicable, (i) in the case of Debt Securities,
the specific title, aggregate principal amount, the denomination, whether such
Debt Securities are secured or unsecured obligations, whether such Debt
Securities are senior or subordinated, maturity, premium, if any, the interest
rate or rates (which may be fixed, floating or adjustable), the time and method
of calculating payment of interest, if any, the place or places where principal
of (and premium, if any) and interest, if any, on such Debt Securities will be
payable, the currency in which principal of (and premium, if any) and interest,
if any, on such Debt Securities will be payable, any terms of redemption at the
option of the Company or the Holder, any sinking fund provisions, terms for any
conversion into other Securities, the initial public offering price and other
special terms and (ii) in the case of Common Stock, the number of shares offered
for sale by the Company and the initial public offering price or method of
determining the initial public offering price. If so specified in the applicable
Prospectus Supplement, Debt Securities of a series may be issued in whole or in
part in the form of one or more temporary or permanent global securities. The
Company's Common Stock is listed on the Nasdaq National Market under the symbol
"CYGN." Any Common Stock sold pursuant to a Prospectus Supplement will be listed
for quotation on such market.
Unless otherwise specified in a Prospectus Supplement, the Senior Debt
Securities, when issued, will be unsecured and will rank equally with all other
unsecured and unsubordinated indebtedness of the Company. The Subordinated Debt
Securities, when issued, will be subordinated in right of payment to all Senior
Debt (as defined) of the Company, including any outstanding Senior Debt
Securities. See "Description of Debt Securities--Subordination of Subordinated
Debt Securities."
The Prospectus Supplement may contain information concerning U.S. federal
income tax considerations, if applicable to the Securities offered.
The Securities may be sold directly, through agents, underwriters or dealers
as designated from time to time, or through a combination of such methods. See
"Plan of Distribution." If agents of the Company or any dealers or underwriters
are involved in the sale of the Securities in respect of which the Prospectus is
being delivered, the names of such agents, dealers or underwriters and any
applicable commissions or discounts, if any, are set forth in or may be
calculated from the Prospectus Supplement with respect to such Securities.
This Prospectus may not be used to consummate sales of Securities unless
accompanied by a Prospectus Supplement. Any statement contained in this
Prospectus will be deemed to be modified or superseded by any inconsistent
statement contained in the accompanying Prospectus Supplement.
SEE "RISK FACTORS" ON PAGE 3 OF THIS PROSPECTUS FOR A DESCRIPTION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE
SECURITIES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
THE DATE OF THIS PROSPECTUS IS NOVEMBER 12, 1997.
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, 450 Fifth Street, NW, Washington, D.C. 20549, and at the Commission's
Regional Offices located at Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York,
New York 10048. Copies of such material can be obtained from the Public
Reference Section of the Commission, 450 Fifth Street, NW, Washington, D.C.
20549, at prescribed rates. The Commission maintains a World Wide Web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission. The address
of the World Wide Web site is http://www.sec.gov. The Common Stock is listed for
quotation on the Nasdaq National Market under the symbol "CYGN." Reports and
other information concerning the Company may be inspected at the offices of the
Nasdaq Stock Market at 1735 K Street, Washington, D.C. 20006.
The Company has filed with the Commission a registration statement on Form
S-3 (herein, together with all amendments and exhibits, referred to as the
"Registration Statement") under the Securities Act of 1933, as amended (the
"Securities Act"), with respect to the Securities. This Prospectus which
constitutes part of the Registration Statement does not contain all of the
information set forth in the Registration Statement, certain parts of which are
omitted in accordance with the rules and regulations of the Commission. For
further information with respect to the Company and the securities offered
hereby, reference is made to the Registration Statement.
Statements contained in this Prospectus as to the contents of any contract
or other document are not necessarily complete, and in each instance, reference
is made to the copy of such contract or document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents have been filed with the Commission and are
incorporated herein by reference:
(a) The Company's Annual Report on Form 10-K for the year ended December
31, 1996;
(b) The Company's Quarterly Reports on Form 10-Q for the quarters ended
March 31 and June 30, 1997; and
(c) The description of the Company's Common Stock contained in the
Company's Registration Statement on Form 8-A for such securities, including
any amendments or reports filed for the purpose of updating such
description.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Registration Statement of which
this Prospectus forms a part and prior to the termination of the offering of the
Securities offered hereby shall be deemed to be incorporated by reference into
this Prospectus and be a part hereof from the dates of filing of such documents.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of the Registration Statement or this Prospectus to the extent that
a statement contained herein, in a Prospectus Supplement or in any other
document subsequently filed with the Commission which also is or is deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded
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<PAGE>
shall not be deemed, except as so modified or superseded, to constitute a part
of the Registration Statement or this Prospectus.
The Company will furnish without charge to each person, including any
beneficial owner, to whom this Prospectus is delivered, on the written or oral
request of such person, a copy of any or all of the documents incorporated by
reference, other than exhibits to such documents. Requests should be directed to
Corporate Marketing, Cygnus, Inc., at the principal executive offices of the
Company. Cygnus, Inc., 400 Penobscot Drive, Redwood City, California 94063-4719,
telephone: (650) 369-4300.
THE COMPANY
Cygnus, Inc. ("Cygnus" or the "Company") is engaged in the development of
diagnostic and drug delivery systems, designed to satisfy unmet medical needs
cost-effectively. The Company's current efforts are primarily focused on two
technological platforms: a painless, bloodless and automatic glucose monitoring
device and transdermal drug delivery systems. The Company's products in the most
advanced stages of development include two in the market
(Nicotrol-Registered Trademark- and FemPatch-Registered Trademark-) and several
in different stages of clinical trials.
Cygnus, the Cygnus logo, GlucoWatch and AutoSensor are trademarks of the
Company. FemPatch is a registered trademark of Warner-Lambert and Nicotrol is a
registered trademark of Pharmacia & Upjohn. All other trademarks included in
this Prospectus are the property of their respective holders.
The Company was incorporated in the State of California in 1985, and
reincorporated in the State of Delaware in 1994. The Company's corporate
headquarters and principal executive offices are located at 400 Penobscot Drive,
Redwood City, California 94063-4719, telephone number (650) 369-4300.
RECENT DEVELOPMENTS
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. The 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
specific 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 related 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 quarter ended September 30, 1997 totalled
approximately $39.6 million, of which $23.0 million is long-term.
RISK FACTORS
Prior to making an investment decision with respect to the Securities
offered hereby, prospective investors should carefully consider the specific
factors set forth under the caption "Risk Factors" in the applicable Prospectus
Supplement pertaining thereto, together with all of the other information
appearing herein or therein or incorporated by reference herein, in light of
their particular investment objectives and financial circumstances.
3
<PAGE>
USE OF PROCEEDS
Unless otherwise indicated in an accompanying Prospectus Supplement, the net
proceeds to be received by the Company from the sale of the Securities will be
used for general corporate purposes, including capital expenditures and to meet
working capital needs. Pending such uses, the Company will invest the net
proceeds in interest-bearing securities.
RATIO OF EARNINGS TO FIXED CHARGES
The Company has a history of operating and net losses, and therefore no
earnings have been available to cover fixed charges. Fixed charges consist of
interest, whether expensed or capitalized, and totalled $307,222, $449,383,
$291,964, $548,387, $744,311 and $718,730 for each of the five years in the
period ended December 31, 1996 and for the nine months ended September 30, 1997,
respectively.
DESCRIPTION OF DEBT SECURITIES
The Senior Debt Securities are to be issued under an Indenture (the "Senior
Indenture"), between the Company, as Issuer, and State Street Bank and Trust
Company of California, N.A., as Trustee (the "Trustee"). The Subordinated Debt
Securities are to be issued under a separate Indenture (the "Subordinated
Indenture"), also between the Company, as issuer, and State Street Bank and
Trust Company of California, N.A., as Trustee. The Senior Indenture and the
Subordinated Indenture are sometimes referred to collectively as the
"Indentures." A copy of the form of each Indenture is filed as an exhibit to the
Registration Statement of which this Prospectus is a part. The Debt Securities
may be issued from time to time in one or more series. The particular terms of
each series, or of Debt Securities forming a part of a series, which are offered
by a Prospectus Supplement will be described in such Prospectus Supplement.
The following summaries of certain provisions of the Indentures do not
purport to be complete and are subject, and are qualified in their entirety by
reference, to all the provisions of the Indentures, including the definitions
therein of certain terms, and, with respect to any particular Debt Securities,
to the description of the terms thereof included in the Prospectus Supplement
relating thereto. Wherever particular Sections or defined terms of the
Indentures are referred to herein or in a Prospectus Supplement, such Sections
or defined terms are incorporated by reference herein or therein, as the case
may be.
GENERAL
The Indentures will provide that Debt Securities in separate series may be
issued thereunder from time to time without limitation as to aggregate principal
amount. The Company may specify a maximum aggregate principal amount for the
Debt Securities of any series. (Section 301) The Debt Securities are to have
such terms and provisions which are not inconsistent with the Indentures,
including as to maturity, principal and interest, as the Company may determine.
Unless otherwise specified in the applicable Prospectus Supplement, the Senior
Debt Securities when issued will be unsecured and unsubordinated obligations of
the Company and will rank on a parity with all other unsecured and
unsubordinated indebtedness of the Company. The Subordinated Debt Securities
when issued will be subordinated in right of payment to the prior payment in
full of all Senior Debt of the Company, including any outstanding Senior Debt
Securities, as described under "Subordination of Subordinated Debt Securities"
and in the applicable Prospectus Supplement.
The applicable Prospectus Supplement will set forth whether the Debt
Securities offered shall be Senior Debt Securities or Subordinated Debt
Securities, and the price or prices at which the Debt Securities to be offered
will be issued, and will describe the following terms of such Debt Securities:
(1) the title of such Debt Securities; (2) any limit on the aggregate principal
amount of such Debt Securities or the series of which they are a part; (3) the
Person to whom any interest on a Debt Security shall be payable, if other than
the Person in whose name that Debt Security (or one or more predecessor Debt
Securities) is registered at the close of business on the Regular Record Date
for such interest; (4) the date or dates on
4
<PAGE>
which the principal of any of such Debt Securities will be payable; (5) the rate
or rates at which any of such Debt Securities will bear interest, if any, the
date or dates from which any such interest will accrue, the Interest Payment
Dates on which any such interest will be payable and the Regular Record Date for
any such interest payable on any Interest Payment Date; (6) the place or places
where the principal of and any premium and interest on any of such Debt
Securities will be payable; (7) the period or periods within which, the price or
prices at which and the terms and conditions on which any of such Debt
Securities may be redeemed, in whole or in part, at the option of the Company;
(8) the obligation, if any, of the Company to redeem or purchase any of such
Debt Securities pursuant to any sinking fund or analogous provision or at the
option of the Holder thereof, and the period or periods within which, the price
or prices at which and the terms and conditions on which any of such Debt
Securities will be redeemed or purchased, in whole or in part, pursuant to any
such obligation; (9) the denominations in which any of such Debt Securities will
be issuable, if other than denominations of $1,000 and any integral multiple
thereof; (10) if the amount of principal of or any premium or interest on any of
such Debt Securities may be determined with reference to an index or pursuant to
a formula, the manner in which such amounts will be determined; (11) if other
than the currency of the United States of America, the currency, currencies or
currency units in which the principal of or any premium or interest on any of
such Debt Securities will be payable (and the manner in which the equivalent of
the principal amount thereof in the currency of the United States of America is
to be determined for any purpose, including for the purpose of determining the
principal amount deemed to be Outstanding at any time); (12) if the principal of
or any premium or interest on any of such Debt Securities is to be payable, at
the election of the Company or the Holder thereof, in one or more currencies or
currency units other than those in which such Debt Securities are stated to be
payable, the currency, currencies or currency units in which payment of any such
amount as to which such election is made will be payable, the periods within
which and the terms and conditions upon which such election is to be made and
the amount so payable (or the manner in which such amount is to be determined);
(13) if other than the entire principal amount thereof, the portion of the
principal amount of any of such Debt Securities which will be payable upon
declaration of acceleration of the Maturity thereof; (14) if the principal
amount payable at the Stated Maturity of any of such Debt Securities will not be
determinable as of any one or more dates prior to the Stated Maturity, the
amount which will be deemed to be such principal amount as of any such date for
any purpose, including the principal amount thereof which will be due and
payable upon any Maturity other than the Stated Maturity or which will be deemed
to be Outstanding as of any such date (or, in any such case, the manner in which
such deemed principal amount is to be determined); (15) if applicable, that such
Debt Securities, in whole or any specified part, are defeasible pusuant to the
provisions of the Indentures described under "Defeasance and Covenant
Defeasance--Defeasance and Discharge" or "Defeasance and Covenant
Defeasance--Defeasance of Certain Covenants," or under both such captions; (16)
if applicable, the terms of any right to convert Debt Securities into shares of
Common Stock of the Company or other securities or property; (17) whether any of
such Debt Securities will be issuable in whole or in part in the form of one or
more Global Securities and, if so, the respective Depositaries for such Global
Securities, the form of any legend or legends to be borne by any such Global
Security in addition to or in lieu of the legends referred to under "Form,
Exchange and Transfer" or "Global Securities" and, if different from those
described under such captions, any circumstances under which any such Global
Security may be exchanged in whole or in part for Securities registered, and any
transfer of such Global Security in whole or in part may be registered, in the
names of Persons other than the Depositary for such Global Security or its
nominee; (18) any addition to or change in the Events of Default applicable to
any of such Debt Securities and any change in the right of the Trustee or the
Holders to declare the principal amount of any of such Debt Securities due and
payable; (19) any addition to or change in the covenants in the Indentures
described under "Restrictive Covenants" applicable to any of such Debt
Securities; and (20) any other terms of such Debt Securities not inconsistent
with the provisions of the relevant Indenture. (Section 301)
Debt Securities, including Original Issue Discount Securities, may be sold
at a substantial discount below their principal amount. Certain special United
States federal income tax considerations (if any)
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<PAGE>
applicable to Debt Securities sold at an original issue discount will be
described in the applicable Prospectus Supplement under "United States
Taxation." In addition, certain special United States federal income tax or
other considerations (if any) applicable to any Debt Securities which are
denominated in a currency or currency unit other than United States dollars will
be described in the applicable Prospectus Supplement.
CONVERSION RIGHTS
The terms on which Debt Securities of any series are convertible into Common
Stock or other securities or property will be set forth in the Prospectus
Supplement relating thereto. Such terms shall include provisions as to whether
conversion is mandatory or at the option of the Holder and may include
provisions pursuant to which the number of shares of Common Stock or other
securities or property to be received by the Holders of Debt Securities upon
conversion would be calculated according to the market price of Common Stock or
other securities or property as of a time stated in the applicable Prospectus
Supplement. (Article Fourteen)
SUBORDINATION OF SUBORDINATED DEBT SECURITIES
Unless otherwise indicated in the Prospectus Supplement, the following
provisions will apply to the Subordinated Debt Securities.
The Subordinated Debt Securities will, to the extent set forth in the
Subordinated Indenture, be subordinate in right of payment to the prior payment
in full of all Senior Debt, including the Senior Debt Securities. In the event
of any insolvency or bankruptcy case or proceeding, or any receivership,
liquidation, reorganization, debt restructuring or other similar case or
proceeding in connection therewith, relative to the Company or to its creditors,
as such, or to its assets, or any liquidation, dissolution or other winding up
of the Company, whether voluntary or involuntary and whether or not involving
insolvency or bankruptcy, or any assignment for the benefit of creditors or any
other marshaling of assets and liabilities of the Company, the holders of Senior
Debt will be entitled to receive payment in full of all amounts due or to become
due on or in respect of all Senior Debt in cash or other payment satisfactory to
the holders of Senior Debt before the Holders of the Subordinated Debt
Securities are entitled to receive any payment on account of principal of or any
premium or interest on the Subordinated Debt Securities or on account of the
purchase, redemption or other acquisition of Subordinated Debt Securities or
before the Company may make any sinking fund or defeasance payment to the
Trustee or any Paying Agent in accordance with the Subordinated Indenture.
Notwithstanding the foregoing, any amounts previously deposited by the Company
with the Trustee or Paying Agent in accordance with the subordination provisions
of Article Fifteen of the Subordinated Indenture at the time of such deposit may
be paid to the Holders of Subordinated Debt Securities ("Defeased Payments").
(Section 1502)
By reason of such subordination, in the event of liquidation or insolvency,
creditors of the Company who are not holders of Senior Debt may recover less,
ratably, than holders of Senior Debt and may recover more, ratably, than the
Holders of the Subordinated Debt Securities.
In the event that any Subordinated Debt Securities are declared due and
payable before their Stated Maturity as a result of an Event of Default, the
holders of the Senior Debt outstanding at the time such Subordinated Debt
Securities so become due and payable will be entitled to receive payment in full
of all amounts due or to become due on or in respect of all Senior Debt in cash
or other payment satisfactory to the holders of Senior Debt before the Holders
of the Subordinated Debt Securities are entitled to receive any payment by the
Company on account of the principal of or any premium or interest on the
Subordinated Debt Securities or on account of the purchase, redemption or other
acquisition of Subordinated Debt Securities or before the Company may make any
sinking fund or defeasance payment to the Trustee or any Payment Agent in
accordance with the Subordinated Indenture (other than Defeased Payments). If
the payment of Subordinated Debt Securities is accelerated because of an Event
of Default,
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the Company and the Trustee are required under the Subordinated Indenture to
promptly notify holders of Senior Debt of the acceleration. (Section 1503)
The Company may not make any payment of principal (or premium, if any) or
interest, if any, in respect of the Subordinated Debt Securities or on account
of the purchase, redemption or other acquisition of Subordinated Debt Securities
or any payment constituting a sinking fund or defeasance payment to the Trustee
or Paying Agent in accordance with the Subordinated Indenture (other than
Defeased Payments) if (i) a default in the payment of principal, premium, if
any, or interest (including a default under any repurchase or redemption
obligation) or other amounts with respect to any Senior Debt occurs and is
continuing beyond the applicable grace period or (ii) any other event of default
occurs and is continuing with respect to Designated Senior Debt (as defined)
that permits the holders thereof or their representatives to accelerate the
maturity thereof, and the Trustee under the Subordinated Indenture receives a
notice of such default (a "Payment Blockage Notice") from the Company, a holder
of such Designated Senior Debt or other person permitted to give such notice
under the Subordinated Indenture. The Company may and shall resume payments on
the Subordinated Debt Securities and may purchase, redeem or otherwise acquire
the Subordinated Debt Securities and may make a sinking fund or defeasance
payment to the Trustee or Paying Agent in accordance with the Subordinated
Indenture (a) in the case of a payment default, upon the date on which such
default is cured or waived or ceases to exist and (b) in the case of a
nonpayment default, the earlier of the date on which such nonpayment default is
cured or waived or ceases to exist or 179 days after the date on which the
applicable Payment Blockage Notice is received (unless the subordination
provisions of Article Fifteen of the Indenture prohibit the payment, purchase,
redemption, acquisition, sinking fund payment or defeasance payment at the time
of such payment, purchase, redemption, acquisition, sinking fund payment or
defeasance payment (including, without limitation, in the case of a nonpayment
referred to in clase (ii) above, as a result of a payment default with respect
to applicable Senior Debt as a consequence of the acceleration of the maturity
thereof or otherwise)). No new period of payment blockage may be commenced
unless and until 365 days have elapsed since the effectiveness of the
immediately prior Payment Blockage Notice. No nonpayment default that existed or
was continuing on the date of delivery of any Payment Blockage Notice to the
Trustee under the Subordinated Indenture shall be, or be made, the basis for a
subsequent Payment Blockage Notice. (Section 1504) In the case of Subordinated
Debt Securities that are convertible at the option of the Holder, the payment,
issuance and delivery of cash, property or securities (other than stock and
certain subordinated securities of the Company) upon conversion of a
Subordinated Debt Security will be deemed to constitute payment on account of
the principal of such Subordinated Debt Security. (Section 1515)
"Senior Debt" is defined in the Indenture to mean: the principal of (and
premium, if any) and interest, if any (including interest accruing on or after
the filing of any petition in bankruptcy or for reorganization relating to the
Company whether or not such claim for post-petition interest is allowed in such
proceeding), on, rent with respect to, and all fees and other amounts payable in
connection with, the following, whether absolute or contingent, secured or
unsecured, due or to become due, outstanding on the date of the Subordinated
Indenture or thereafter created, incurred or assumed: (a) indebtedness for
borrowed money of the Company evidenced by a credit or loan agreement, note,
bond, debenture or other written obligation, (b) all other obligations of the
Company for money borrowed, (c) all obligations of the Company evidenced by a
note or similar instrument given in connection with the acquisition of any
businesses, properties or assets of any kind, (d) obligations of the Company (i)
as lessee under leases required to be capitalized on the balance sheet of the
lessee under generally accepted accounting principles, (ii) as lessee under
other leases for facilities, equipment or related assets, whether or not
capitalized, entered into or leased after the date of the Subordinated Indenture
for financing purposes (as determined by the Company) or (iii) under any lease
or related document (including a purchase agreement) that provides that the
Company is contractually obligated to purchase or cause a third party to
purchase the leased property and the obligations of the Company under such lease
or related document to purchase or to cause a third party to purchase such
leased property, (e) all obligations of the Company under interest rate and
currency swaps, caps, floors, collars, hedge agreements, forward contracts, or
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similar agreements or arrangements, (f) all obligations of the Company with
respect to letters of credit, bankers' acceptances or similar facilities
(including reimbursement obligations with respect to any of the foregoing), (g)
all obligations of the Company issued or assumed as the deferred purchase price
of property or services (but excluding trade accounts payable arising in the
ordinary course of business), (h) all obligations of the type referred to in
clauses (a) through (g) above of another Person and all dividends of another
Person, the payment of which, in either case, the Company has assumed or
guaranteed (or in effect guaranteed through an agreement to purchase or
otherwise (including, without limitation, "take or pay" and similar
arrangements)), or for which the Company is responsible or liable, directly or
indirectly, jointly or severally, as obligor, guarantor, or otherwise, or which
is secured by a lien on property of the Company, and all obligations of the
Company with respect thereto, and (i) renewals, extensions, modifications,
replacements, restatements and refundings of, or any indebtedness or obligation
issued in exchange for, any such indebtedness or obligation described in clauses
(a) through (h) of this paragraph; provided, however, that Senior Debt shall not
include the Subordinated Debt Securities or any such indebtedness or obligation
if the terms of such indebtedness or obligation (or the terms of the instrument
under which, or pursuant to which it is issued) expressly provide that such
indebtedness or obligation is not superior in right of payment to the
Subordinated Debt Securities.
"Designated Senior Debt" means certain existing Senior Debt (including the
Company's obligations under its existing bank term loan agreement) and the
Company's obligations under any other particular Senior Debt having an
outstanding principal amount or commitment in excess of $10.0 million in which
the instrument creating or evidencing the same or the assumption or guarantee
thereof (or related agreements or documents to which the Company is a party)
expressly provides that such Senior Debt shall be "Designated Senior Debt" for
purposes of the Subordinated Indenture and any Senior Debt so designated as
Designated Senior Debt by the Company in the applicable Prospectus Supplement
(provided that such instrument, agreement or other document may place
limitations and conditions on the right of such Senior Debt to exercise the
rights of Designated Senior Debt).
The Subordinated Indenture does not limit or prohibit the incurrence of
additional Senior Debt, which may include indebtedness that is senior to the
Subordinated Debt Securities, but subordinate to other obligations of the
Company. The Senior Debt Securities, when issued, will constitute Senior Debt.
The Prospectus Supplement may further describe the provisions, if any,
applicable to the subordination of the Subordinated Debt Securities of a
particular series.
FORM, EXCHANGE AND TRANSFER
The Debt Securities of each series will be issuable only in fully registered
form, without coupons, and, unless otherwise specified in the applicable
Prospectus Supplement, only in denominations of $1,000 and integral multiples
thereof. (Section 302)
At the option of the Holder, subject to the terms of the Indentures and the
limitations applicable to Global Securities, Debt Securities of each series will
be exchangeable for other Debt Securities of the same series of any authorized
denomination and of a like tenor and aggregate principal amount. (Section 305)
Subject to the terms of the Indentures and the limitations applicable to
Global Securities, Debt Securities may be presented for exchange as provided
above or for registration of transfer (duly endorsed or with the form of
transfer endorsed thereon duly executed) at the office of the Security Registrar
or at the office of any transfer agent designated by the Company for such
purposes. No service charge will be made for any registration or transfer or
exchange of Debt Securities, but the Company may require payment of a sum
sufficient to cover any tax or other governmental charge payable in connection
therewith. Such transfer or exchange will be effected upon the Security
Registrar or such transfer agent, as the case may be, being satisfied with the
documents of title and identity of the person making the request. The Company
has appointed the Trustee as Security Registrar. Any transfer agent (in addition
to the
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Security Registrar) initially designated by the Company for any Debt Securities
will be named in the applicable Prospectus Supplement. (Section 305) The Company
may at any time designate additional transfer agents or rescind the designation
of any transfer agent or approve a change in the office through which any
transfer agent acts, except that the Company will be required to maintain a
transfer agent in each Place of Payment for the Debt Securities of each series.
(Section 1002)
If the Debt Securities of any series (or of any series and specified tenor)
are to be redeemed in part, the Company will not be required to (i) issue,
register the transfer of or exchange any Debt Security of that series (or of
that series and specified tenor, as the case may be) during a period beginning
at the opening of business 15 days before the day of mailing of a notice of
redemption of any such Debt Security that may be selected for redemption and
ending at the close of business on the day of such mailing or (ii) register the
transfer of or exchange any Debt Security so selected for redemption, in whole
or in part, except the unredeemed portion of any such Debt Security being
redeemed in part. (Section 305)
GLOBAL SECURITIES
Some or all of the Debt Securities of any series may be represented, in
whole or in part, by one or more global securities which will have an aggregate
principal amount equal to that of the Debt Securities represented thereby (a
"Global Security"). Each Global Security will be registered in the name of a
depositary (the "Depositary") or a nominee thereof identified in the applicable
Prospectus Supplement, will be deposited with such Depositary or nominee or a
custodian therefor and will bear a legend regarding the restrictions on
exchanges and registration of transfer thereof referred to below and any such
other matters as may be provided for pursuant to the Indentures.
Notwithstanding any provision of the Indentures or any Debt Security
described herein, no Global Security may be exchanged in whole or in part for
Debt Securities registered, and no transfer of a Global Security in whole or in
part may be registered, in the name of any Person other than the Depositary for
such Global Security or any nominee of such Depositary unless (i) the Depositary
has notified the Company that it is unwilling or unable to continue as
Depositary for such Global Security or has ceased to be qualified to act as such
as required by the Indentures, (ii) there shall have occurred and be continuing
an Event of Default with respect to the Debt Securities represented by such
Global Security or (iii) there shall exist such circumstances, if any, in
addition to or in lieu of those described above as may be described in the
applicable Prospectus Supplement. All securities issued in exchange for a Global
Security or any portion thereof will be registered in such names as the
Depositary may direct. (Sections 204 and 305)
As long as the Depositary, or its nominee, is the registered Holder of a
Global Security, the Depositary or such nominee, as the case may be, will be
considered the sole owner and Holder of such Global Security and the Debt
Securities represented thereby for all purposes under the Debt Securities and
the Indentures. Except in the limited circumstances referred to above, owners of
beneficial interests in a Global Security will not be entitled to have such
Global Security or any Debt Securities represented thereby registered in their
names, will not receive or be entitled to receive physical delivery of
certificated Debt Securities in exchange therefor and will not be considered to
be the owners or Holders of such Global Security or any Debt Securities
represented thereby for any purpose under the Debt Securities or the Indentures.
All payments of principal of and any premium and interest on a Global Security
will be made to the Depositary or its nominee, as the case may be, as the Holder
thereof. The laws of some jurisdictions require that certain purchasers of
securities take physical delivery of such securities in definitive form. Those
laws may impair the ability to transfer beneficial interests in a Global
Security.
Ownership of beneficial interests in a Global Security will be limited to
institutions that have accounts with the Depositary or its nominee
("participants") and to persons that may hold beneficial interests through
participants. In connection with the issuance of any Global Security, the
Depositary will credit, on its book-entry registration and transfer system, the
respective principal amounts of Debt Securities represented by the Global
Security to the accounts of its participants. Ownership of beneficial interests
in a
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Global Security will be shown only on, and the transfer of those ownership
interests will be effected only through, records maintained by the Depositary
(with respect to participants' interests) or any such participant (with respect
to interests of persons held by such participants on their behalf). Payments,
transfers, exchanges and other matters relating to beneficial interests in a
Global Security may be subject to various policies and procedures adopted by the
Depositary from time to time. None of the Company, the Trustee or any agent of
the Company or the Trustee will have any responsibility or liability for any
aspect of the Depositary's or any participant's records relating to, or for
payments made on account of, beneficial interests in a Global Security, or for
maintaining, supervising or reviewing any records relating to such beneficial
interests.
PAYMENT AND PAYING AGENTS
Unless otherwise indicated in the applicable Prospectus Supplement, payment
of interest on a Debt Security on any Interest Payment Date will be made to the
Person in whose name such Debt Security (or one or more Predecessor Debt
Securities) is registered at the close of business on the Regular Record Date
for such interest. (Section 307)
Unless otherwise indicated in the applicable Prospectus Supplement,
principal of and any premium and interest on the Debt Securities of a particular
series will be payable at the office of such Paying Agent or Paying Agents as
the Company may designate for such purpose from time to time, except that at the
option of the Company payment of any interest may be made by check mailed to the
address of the Person entitled thereto as such address appears in the Security
Register. Unless otherwise indicated in the applicable Prospectus Supplement,
the Corporate Trust Office of the Trustee will be designated as the Company's
sole Paying Agent for payments with respect to Debt Securities of each series.
Any other Paying Agents initially designated by the Company for the Debt
Securities of a particular series will be named in the applicable Prospectus
Supplement. The Company may at any time designate additional Paying Agents or
rescind the designation of any Paying Agent or approve a change in the office
through which any Paying Agent acts, except that the Company will be required to
maintain a Paying Agent in each Place of Payment for the Debt Securities of a
particular series. (Section 1002)
All moneys paid by the Company to a Paying Agent for the payment of the
principal of or any premium or interest on any Debt Security which remain
unclaimed for a period ending the earlier of 10 business days prior to the date
such money would escheat to the State or at the end of two years after such
principal, premium or interest has become due and payable will be repaid in the
Company, and the Holder of such Debt Security thereafter may look only to the
Company for payment thereof. (Section 1003)
RESTRICTIVE COVENANTS
Unless otherwise indicated in the applicable Prospectus Supplement, the
following provisions will apply to the Senior Debt Securities.
LIMITATIONS ON LIENS
The Senior Indenture will provide that the Company will not issue, incur,
create, assume or guarantee, and will not permit any Restricted Subsidiary (as
defined below) to issue, incur, create, assume or guarantee, any debt for
borrowed money secured by a mortgage, security interest, pledge, lien, charge or
other encumbrance ("mortgages") upon any Principal Property (as defined below)
of the Company or any Restricted Subsidiary or upon any shares of stock or
indebtedness of any Restricted Subsidiary (whether such Principal Property,
shares or indebtedness are now existing or owned or hereafter created or
acquired) without in any such case effectively providing concurrently with the
issuance, incurrence, creation, assumption or guarantee of any such secured
debt, or the grant of a mortgage with respect to any such indebtedness, that the
Senior Debt Securities (together with, if the Company shall so determine, any
other indebtedness of or guarantee by the Company or such Restricted Subsidiary
ranking equally with the
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Senior Debt Securities) shall be secured equally and ratably with (or, at the
option of the Company, prior to) such secured debt. The foregoing restriction,
however, will not apply to: (a) mortgages on property existing at the time of
acquisition thereof by the Company or any Subsidiary, provided that such
mortgages were in existence prior to the contemplation of such acquisition, (b)
mortgages on property, shares of stock or indebtedness or other assets of any
corporation existing at the time such corporation becomes a Restricted
Subsidiary, provided that such mortgages are not incurred in anticipation of
such corporation becoming a Restricted Subsidiary; (c) mortgages on property,
shares of stock or indebtedness existing at the time of acquisition thereof by
the Company or a Restricted Subsidiary or mortgages thereon to secure the
payment of all or any part of the purchase price thereof, or mortgages on
property, shares of stock or indebtedness to secure any indebtedness for
borrowed money incurred prior to, at the time of, or within 270 days after, the
latest of the acquisition thereof, or, in the case of property, the completion
of construction, the completion of improvements, or the commencement of
substantial commercial operation of such property for the purpose of financing
all or any part of the purchase price thereof, such construction, or the making
of such improvements; (d) mortgages to secure indebtedness owing to the Company
or to a Restricted Subsidiary; (e) mortgages existing at the date of the Senior
Indenture; (f) mortgages on property of a corporation existing at the time such
corporation is merged into or consolidated with the Company or a Restricted
Subsidiary or at the time of a sale, lease or other disposition of the
properties of a corporation as an entirety or substantially as an entirety to
the Company or a Restricted Subsidiary, provided that such mortgage was not
incurred in anticipation of such merger or consolidation or sale, lease or other
disposition; (g) mortgages in favor of the United States or any State, territory
or possession thereof (or the District of Columbia), or any department, agency,
instrumentality or political subdivision of the United States or any State,
territory or possession thereof (or the District of Columbia), to secure
partial, progress, advance or other payments pursuant to any contract or statute
or to secure any indebtedness incurred for the purpose of financing all or any
part of the purchase price or the cost of constructing or improving the property
subject to such mortgages; (h) mortgages created in connection with the
acquisition of assets or a project financed with, and created to secure, a
Nonrecourse Obligation (as defined below); and (i) extensions, renewals,
refinancings or replacements of any mortgage referred to in the foregoing
clauses (a), (b), (c), (d), (e), (f), (g), and (h), provided, however, that any
mortgages permitted by any of the foregoing clauses (a), (b), (c), (d), (e),
(f), (g), and (h) shall not extend to or cover any property of the Company or
such Restricted Subsidiary, as the case may be, other than the property, if any,
specified in such clauses and improvements thereto, and provided further that
any refinancing or replacement of any mortgages permitted by the foregoing
clauses (g) and (h) shall be of the type referred to in such clauses (g) or (h),
as the case may be.
Notwithstanding the restrictions described in the preceding paragraph, the
Company or any Restricted Subsidiary will be permitted to issue, incur, create,
assume or guarantee debt secured by a mortgage which would otherwise be subject
to such restrictions, without equally and ratably securing the Senior Debt
Securities, provided that after giving effect thereto, the aggregate amount of
all debt so secured by mortgages (not including mortgages permitted under
clauses (a) through (i) above) does not exceed 15% of the Consolidated Net
Tangible Assets (as defined below) of the Company as most recently determined on
or prior to such date.
LIMITATIONS ON SALE AND LEASE BACK TRANSACTIONS
The Senior Indenture will provide that the Company will not, nor will it
permit any Restricted Subsidiary to, enter into any Sale and Lease-Back
Transaction (as defined below) with respect to any Principal Property, other
than any such transaction involving a lease for a term of not more than three
years or any such transaction between the Company and a Restricted Subsidiary or
between Restricted Subsidiaries, unless (a) the Company or such Restricted
Subsidiary would be entitled to incur indebtedness secured by a mortgage on the
Principal Property involved in such transaction at least equal in amount to the
Attributable Debt (as defined below) with respect to such Sale and Lease-Back
Transaction, without equally and ratably securing the Senior Debt Securities,
pursuant to the limitation on liens in the Senior
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Indenture; or (b) the Company shall apply an amount equal to the greater of the
net proceeds of such sale or the Attributable Debt with respect to such Sale and
Lease-Back Transaction within 180 days of such sale to either (or a combination
of) the retirement (other than any mandatory retirement, mandatory prepayment or
sinking fund payment or by payment at maturity) of debt for borrowed money of
the Company or a Restricted Subsidiary that matures more than 12 months after
the creation of such indebtedness or the purchase, construction or development
of other comparable property.
CERTAIN DEFINITIONS APPLICABLE TO COVENANTS
The term "Attributable Debt" when used in connection with a Sale and
Lease-Back Transaction involving a Principal Property shall mean, at the time of
determination, the lesser of: (a) the fair value of such property (as determined
in good faith by the Board of Directors of the Company); or (b) the present
value of the total net amount of rent required to be paid under such lease
during the remaining term thereof (including any renewal term or period for
which such lease has been extended), discounted at the rate of interest set
forth or implicit in the terms of such lease or if not practicable to determine
such rate, the weighted average interest rate per annum (in the case of Original
Issue Discount Securities, the imputed interest rate) borne by the Senior Debt
Securities of each series outstanding pursuant to the Indenture compounded
semi-annually. For purposes of the foregoing definition, rent shall not include
amounts required to be paid by the lessee, whether or not designated as rent or
additional rent, on account of or contingent upon maintenance and repairs,
insurance, taxes, assessments, water rates and similar charges. In the case of
any lease which is terminable by the lessee upon the payment of a penalty, such
net amount shall be the lesser of the net amount determined assuming termination
upon the first date such lease may be terminated (in which case the net amount
shall also include the amount of the penalty, but no rent shall be considered as
required to be paid under such lease subsequent to the first date upon which it
may be so terminated) and the net amount determined assuming no such
termination.
The term "Consolidated Net Tangible Assets" shall mean, as of any particular
time, total assets (excluding applicable reserves and other properly deductible
items) less: (a) total current liabilities, except for (1) notes and loans
payable, (2) current maturities of long-term debt and (3) current maturities of
obligations under capital leases; and (b) goodwill, patents and trademarks, to
the extent included in total assets; all as set forth on the most recent
consolidated balance sheet of the Company and its Restricted Subsidiaries and
computed in accordance with generally accepted accounting principles.
The term "Nonrecourse Obligation" means indebtedness or other obligations
substantially related to (i) the acquisition of assets not previously owned by
the Company or any Restricted Subsidiary or (ii) the financing of a project
involving the development or expansion of properties of the Company or any
Restricted Subsidiary, as to which the obligee with respect to such indebtedness
or obligation has no recourse to the Company or any Restricted Subsidiary or any
assets of the Company or any Restricted Subsidiary other than the assets which
were acquired with the proceeds of such transaction or the project financed with
the proceeds of such transaction (and the proceeds thereof).
The term "Principal Property" shall mean the land, land improvements,
buildings and fixtures (to the extent they constitute real property interests,
including any leasehold interest therein) constituting the principal corporate
office, any manufacturing facility or any distribution center (whether now owned
or hereafter acquired) which: (a) is owned by the Company or any Subsidiary; (b)
is located within any of the present 50 states of the United States (or the
District of Columbia); (c) has not been determined in good faith by the Board of
Directors of the Company not to be materially important to the total business
conducted by the Company and its Subsidiaries taken as a whole; and (d) has a
market value on the date as of which the determination is being made in excess
of 2.0% of Consolidated Net Tangible Assets of the Company as most recently
determined on or prior to such date.
The term "Restricted Subsidiary" shall mean any Subsidiary that owns any
Principal Property; provided, however, that the term "Restricted Subsidiary"
shall not include (a) any Subsidiary which is
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principally engaged in financing receivables, or which is principally engaged in
financing the Company's operations outside the United States of America or (b)
any Subsidiary less than 80% of the voting stock of which is owned, directly or
indirectly, by the Company or by one or more other Subsidiaries, or by the
Company and one or more other Subsidiaries if the common stock of such
Subsidiary is traded on any national securities exchange or quoted on the Nasdaq
National Market or other over-the-counter market.
The term "Sale and Lease-Back Transaction" shall mean any arrangement with
any person providing for the leasing by the Company or any Restricted Subsidiary
of any Principal Property which property has been or is to be sold or
transferred by the Company or such Restricted Subsidiary to such person.
The term "Subsidiary" shall mean any corporation of which at least a
majority of the outstanding voting stock having the power to elect a majority of
the board of directors of such corporation is at the time owned, directly or
indirectly, by the Company or by one or more other Subsidiaries, or by the
Company and one or more other Subsidiaries, and the accounts of which are
consolidated with those of the Company in its most recent consolidated financial
statement in accordance with generally accepted accounting principles. For the
purposes of this definition, "voting stock" means stock which ordinarily has
voting power for the election of directors, whether at all times or only so long
as no senior class of stock has such voting power by reason of any contingency.
CONSOLIDATION, MERGER AND SALE OF ASSETS
The Indentures will provide that the Company may not consolidate with or
merge into any other Person (in a transaction in which the Company is not the
surviving corporation), or convey, transfer or lease its properties and assets
substantially as an entirety to, any Person (a "Successor Person"), unless (i)
the Successor Person (if any) is a corporation, limited liability company,
partnership, trust or other entity organized and existing under the laws of any
domestic jurisdiction and assumes the Company's obligations on the Debt
Securities and under the Indentures, (ii) immediately after giving effect to the
transaction, and treating any indebtedness which becomes an obligation of the
Company or any Subsidiary as a result of the transaction as having been incurred
by it at the time of the transaction, no Event of Default, and no event which,
after notice or lapse of time or both, would become an Event of Default, shall
have occurred and be continuing and (iii) certain other conditions are met.
(Section 801)
EVENTS OF DEFAULT
Each of the following will constitute an Event of Default under the
Indentures with respect to Debt Securities of any series: (a) failure to pay
principal of or any premium on any Debt Security of that series when due,
whether or not such payment is prohibited by the subordination provisions of the
Subordinated Indenture; (b) failure to pay any interest on any Debt Securities
of that series when due, continued for 30 days, whether or not such payment is
prohibited by the subordination provisions of the Subordinated Indenture; (c)
failure to deposit any sinking fund payment, when due, in respect of any Debt
Security of that series, whether or not such deposit is prohibited by the
subordination provisions of the Subordinated Indenture; (d) failure to perform
any other covenant of the Company in the Indentures (other than a covenant
included in the Indentures solely for the benefit of a series other than that
series), continued for 60 days after written notice has been given by the
Trustee, or the Holders of at least 25% in aggregate principal amount of the
Outstanding Securities of that series, as provided in the Indentures; (e)
certain events in bankruptcy, insolvency or reorganization with respect to the
Company; and (f) any other Event of Default specified in the applicable
Prospectus Supplement. (Section 501)
The Indentures will provide that, if an Event of Default (other than an
Event of Default described in clause (e) above) with respect to the Debt
Securities of any series at the time Outstanding shall occur and be continuing,
either the Trustee or the Holders of at least 25% in aggregate principal amount
of the Outstanding Securities of that series by notice as provided in the
Indentures may declare the principal amount of the debt securities of that
series (or, in the case of any Debt Security that is an Original Issue
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Discount Security or the principal amount of which is not then determinable,
such portion of the principal amount of such Debt Security, or such other amount
in lieu of such principal amount, as may be specified in the terms of such Debt
Security) to be due and payable immediately. If an Event of Default described in
clause (e) above with respect to the Debt Securities of any series at the time
Outstanding shall occur, the principal amount of all the Debt Securities of that
series (or, in the case of any such Original Issue Discount Security or other
Debt Security, such specified amount) will automatically, and without any action
by the Trustee or any Holder, become immediately due and payable. Any payment by
the Company on the Subordinated Debt Securities following any such acceleration
will be subject to the subordination provisions of Article Fifteen of the
Subordinated Indenture. After any such acceleration, but before a judgment or
decree based on acceleration, the Holders of a majority in aggregate principal
amount of the Outstanding Securities of that series may, under certain
circumstances, rescind and annul such acceleration if all Events of Default,
other than the non-payment of accelerated principal (or other specified amount),
have been cured or waived as provided in the Indentures. (Section 502) For
information as to waiver of defaults, see "Modification and Waiver."
Subject to the provisions of the Indentures relating to the duties of the
Trustee in case an Event of Default shall occur and be continuing, the Trustee
will be under no obligation to exercise any of its rights or powers under the
Indentures at the request or direction of any of the Holders, unless such
Holders shall have offered to the Trustee reasonable indemnity. (Section 603)
Subject to such provisions of the indemnification of the Trustee, the Holders of
a majority in aggregate principal amount of the Outstanding Securities of any
series will have the right to direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee or exercising any trust
or power conferred on the Trustee with respect to the Debt Securities of that
series. (Section 512)
No holder of a Debt Security of any series will have any right to institute
any proceeding with respect to the Indentures, or for the appointment of a
receiver or trustee, or for any other remedy thereunder, unless (i) such Holder
has previously given to the Trustee written notice of a continuing Event of
Default with respect to the Debt Securities of that series, (ii) the Holders of
at least 25% in aggregate principal amount of the Outstanding Securities of that
series have made a written request, and such Holder or Holders have offered
reasonable indemnity, to the Trustee to institute such proceeding as trustee and
(iii) the Trustee has failed to institute such proceeding, and has not received
from the Holders of a majority in aggregate principal amount of the Outstanding
Securities of that series a direction inconsistent with such request, within 60
days after such notice, request and offer. (Section 507) However, such
limitations do not apply to a suit instituted by a Holder of a Debt Security for
the enforcement of payment of the principal of or any premium or interest on
such Debt Security on or after the applicable due date specified in such Debt
Security. (Section 508)
The Indentures will include a covenant requiring the Company to furnish to
the Trustee annually a statement by certain of its officers as to whether or not
the Company, to their knowledge, is in default in the performance or observance
of any of the terms, provisions and conditions of the Indentures and, if so,
specifying all such known defaults. (Section 1004)
MODIFICATION AND WAIVER
Modifications and amendments of the Indentures may be made by the Company
and the Trustee with the consent of the Holders of a majority in aggregate
principal amount of the Outstanding Securities of each series affected by such
modification or amendment; provided, however, that no such modification or
amendment may, without the consent of the Holder of each Outstanding Security
affected thereby, (a) change the Stated Maturity of the principal of, or any
installment of principal of or interest on, any Debt Security, (b) reduce the
principal amount of, or any premium or interest on, any Debt Security, (c)
reduce the amount of principal of an Original Issue Discount Security or any
other Debt Security payable upon acceleration of the Maturity thereof, (d)
change the place or currency of payment of principal of, or any premium or
interest on, any Debt Security, (e) impair the right to institute suit for the
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<PAGE>
enforcement of any payment on or with respect to any Debt Security, (f) in the
case of Subordinated Debt Securities, modify the subordination provisions in a
manner materially adverse to the Holders of the Subordinated Debt Securities,
(g) reduce the percentage in principal amount of Outstanding Securities of any
series, the consent of whose Holders is required for modification or amendment
of the Indentures, (h) reduce the percentage in principal amount of Outstanding
Securities of any series necessary for waiver of compliance with certain
provisions of the Indentures or for waiver of certain defaults or (i) modify
such provisions with respect to modification and waiver. (Section 902)
The Indentures will provide that the Holders of a majority in aggregate
principal amount of the Outstanding Securities of any series may waive, on
behalf of the Holders of all Debt Securities of such series, compliance by the
Company with certain restrictive provisions of the Indentures. (Sections 1010
and 1008 of the Senior Indenture and the Subordinated Indenture, respectively).
The Holders of a majority in principal amount of the Outstanding Securities of
any series may waive any past default under the Indentures, except a default in
the payment of principal, premium or interest and certain covenants and
provisions of the Indentures which cannot be amended without the consent of the
Holder of each Outstanding Security of such series affected. (Section 513)
The Indentures will provide that in determining whether the Holders of the
requisite principal amount of the Outstanding Securities have given or taken any
direction, notice, consent, waiver or other action under the Indentures as of
any date, (i) the principal amount of an Original Issue Discount Security that
will be deemed to be Outstanding will be the amount of the principal thereof
that would be due and payable as of such date upon acceleration of the Maturity
thereof to such date, (ii) if, as of such date, the principal amount payable at
the Stated Maturity of a Debt Security is not determinable (for example, because
it is based on an Index), the principal amount of such Debt Security deemed to
be Outstanding as of such date will be an amount determined in the manner
prescribed for such Debt Security and (iii) the principal amount of a Debt
Security denominated in one or more foreign currencies or currency units that
will be deemed to be Outstanding will be the U.S. dollar equivalent, determined
as of such date in the manner prescribed for such Debt Security, of the
principal amount of such Debt Security (or, in the case of a Debt Security
described in clause (i) or (ii) above, of the amount described in such clause).
Certain Debt Securities, including those for whose payment or redemption money
has been deposited or set aside in trust for the Holders and those that have
been fully defeased pursuant to Section 1302, will not be deemed to be
Outstanding. (Section 101)
Except in certain limited circumstances, the Company will be entitled to set
any day as a record date for the purpose of determining the Holders of
Outstanding Securities of any series entitled to give or take any direction,
notice, consent, waiver or other action under the Indentures, in the manner and
subject to the limitations provided in the Indentures. In certain limited
circumstances, the Trustee will be entitled to set a record date for action by
Holders. If a record date is set for any action to be taken by Holders of a
particular series, such action may be taken only by persons who are Holders of
Outstanding Securities of that series on the record date. To be effective, such
action must be taken by Holders of the requisite principal amount of such Debt
Securities within a specified period following the record date. For any
particular record date, this period will be 180 days or such other shorter
period as may be specified by the Company (or the Trustee, if it set the record
date), and may be shortened or lengthened (but not beyond 180 days) from time to
time. (Section 104)
DEFEASANCE AND COVENANT DEFEASANCE
If and to the extent indicated in the applicable Prospectus Supplement, and
subject to such other conditions and limitations as may be set forth in the
applicable Prospectus Supplement, the Company may elect, at its option at any
time, to have the provisions of Section 1302, relating to defeasance and
discharge of indebtedness, or Section 1303, relating to defeasance of certain
restrictive covenants in the Indenture, applied to the Debt Securities of any
series, or to any specified part of a series. (Section 1301)
15
<PAGE>
DEFEASANCE AND DISCHARGE. The Indentures will provide that, upon the
Company's exercise of its option (if any) to have Section 1302 applied to any
Subordinated Debt Securities, the provisions of Article Fifteen of the
Subordinated Indenture relating to subordination will cease to be effective and,
with respect to any Debt Securities, the Company will be discharged from all its
obligations with respect thereto (except for certain obligations to exchange or
register the transfer of Debt Securities, to replace stolen, lost or mutilated
Debt Securities, to maintain paying agencies, to hold moneys for payment in
trust and, if applicable, to effect conversions of Debt Securities) upon the
deposit in trust for the benefit of the Holders of such Debt Securities of money
or U.S. Government Obligations, or both, which, through the payment of principal
and interest in respect thereof in accordance with their terms, will provide
money in an amount sufficient to pay the principal of and any premium and
interest on such Debt Securities on the respective Stated Maturities in
accordance with the terms of the Indentures and such Debt Securities. Such
defeasance or discharge may occur only if, among other things, the Company has
delivered to the Trustee an Opinion of Counsel to the effect that the Company
has received from, or there has been published by, the United States Internal
Revenue Service a ruling, or there has been a change in tax law, in either case
to the effect that Holders of such Debt Securities will not recognize gain or
loss for federal income tax purposes as a result of such deposit, defeasance and
discharge and will be subject to federal income tax on the same amount, in the
same manner and at the same times as would have been the case if such deposit,
defeasance and discharge were not to occur. (Sections 1302 and 1304)
DEFEASANCE OF CERTAIN COVENANTS. The Indentures will provide that, upon the
Company's exercise of its option (if any) to have Section 1303 applied to any
Debt Securities, the Company may omit to comply with certain restrictive
covenants, including those described under "Restrictive Covenants" and any that
may be described in the applicable Prospectus Supplement, and the occurrence of
certain Events of Default, which are described above in clause (d) (with respect
to such restrictive covenants) under "Events of Default" and any that may be
described in the applicable Prospectus Supplement, will be deemed not to be or
result in an Event of Default, in each case with respect to such Debt
Securities, and, in the case of the Subordinated Indenture, the provisions of
Article Fifteen relating to subordination will cease to be effective with
respect to any Subordinated Debt Securities. The Company, in order to exercise
such option, will be required to deposit, in trust for the benefits of the
Holders of such Debt Securities, money or U.S. Government Obligations, or both,
which, through the payment of principal and interest in respect thereof in
accordance with their terms, will provide money in an amount sufficient to pay
the principal of and any premium and interest on such Debt Securities on the
respective Stated Maturities in accordance with the terms of the Indentures and
such Debt Securities. The Company will also be required, among other things, to
deliver to the Trustee an Opinion of Counsel to the effect that Holders of such
Debt Securities will not recognize gain or loss for federal income tax purposes
as a result of such deposit and defeasance of certain obligations and will be
subject to federal income tax on the same amount, in the same manner and at the
same times as would have been the case if such deposit and defeasance were not
to occur. In the event the Company exercised this option with respect to any
Debt Securities and such Debt Securities were declared due and payable because
of the occurrence of any Event of Default, the amount of money and U.S.
Government Obligations so deposited in trust would be sufficient to pay amounts
due on such Debt Securities at the time of their respective Stated Maturities
but may not be sufficient to pay amounts due on such Debt Securities upon any
acceleration resulting from such Event of Default, in such case, the Company
would remain liable for such payments. (Sections 1303 and 1304)
The Company may, at its option, satisfy and discharge each of the Indentures
(except for certain obligations of the Company and the Trustee, (including,
among others, the obligations to apply money held in trust) when (i) either (a)
all Debt Securities under such Indenture previously authenticated and delivered
(other than (1) Debt Securities that were destroyed, lost or stolen and that
have been replaced or paid and (2) Debt Securities for the payment of which
money has been deposited in trust or segregated and held in trust by the Company
and thereafter repaid to the Company or discharged from such trust) have been
delivered to the Trustee for cancellation or discharge from such trust) have
been delivered to the Trustee for cancellation or (b) all such Debt Securities
under such Indenture not theretofore delivered to
16
<PAGE>
the Trustee for cancellation (1) have become due and payable, (2) will become
due and payable at their Stated Maturity within one year, or (3) are to be
called for redemption within one year under arrangements satisfactory to the
Trustee for the giving of notice of redemption by the Trustee in the name and at
the expense of the Company, and the Company has deposited or caused to be
deposited with the Trustee as trust funds in trust for such purpose an amount
sufficient to pay and discharge the entire indebtedness on such Debt Securities
under such Indenture not previously delivered to the Trustee for cancellation,
for principal and any premium and interest to the date of such deposit (in the
case of Debt Securities under such Indenture which have become due and payable)
or to the Stated Maturity or redemption date as the case may be, (ii) the
Company has paid or caused to be paid all other sums payable under such
Indenture by the Company, and (iii) the Company has delivered to the Trustee an
Officer's Certificate and an Opinion of Counsel, each to the effect that all
conditions precedent relating to the satisfaction and discharge of such
Indenture have been satisfied.
NOTICES
Notices to Holders of Debt Securities will be given by mail to the addresses
of such Holders as they may appear in the Security Register. (Sections 101 and
106)
TITLE
The Company, the Trustee and any agent of the Company or the Trustee may
treat the Person in whose name a Debt Security is registered as the absolute
owner thereof (whether or not such Debt Security may be overdue) for the purpose
of making payment and for all other purposes. (Section 308)
GOVERNING LAW
The Indentures and the Debt Securities will be governed by, and construed in
accordance with, the law of the State of New York. (Section 112)
REGARDING THE TRUSTEE
The Indentures contain certain limitations on the right of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases or to realize for its own account on certain property received in
respect of any such claim as security or otherwise. (Section 613) The Trustee is
permitted to engage in certain other transactions; however, if it acquires any
conflicting interest and there is a default under the Securities of any series
for which the Trustee serves as trustee, the Trustee must eliminate such
conflict or resign. (Section 608)
DESCRIPTION OF CAPITAL STOCK
The Company's Certificate of Incorporation authorizes capital stock
consisting of 30,000,000 shares of Common Stock, $0.001 par value per share, of
which 18,934,609 shares were outstanding as of September 30, 1997, and 5,000,000
shares of preferred stock, $0.001 par value per share, none of which is
outstanding. The following summary is qualified in its entirety by reference to
the Company's Amended and Restated Certificate of Incorporation and Bylaws.
COMMON STOCK
The holders of Common Stock are entitled to one vote per share on all
matters submitted to a vote of the stockholders, including the election of
directors, and are entitled to receive ratably such dividends, if any, as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. The Company's Amended and Restated Certificate of
Incorporation does not provide for cumulative voting with respect to the
election of directors. As a result, the holders of a majority of the shares
voting in the election of directors can elect all of the directors then standing
for election. In the event of liquidation
17
<PAGE>
or dissolution of the Company, the holders of Common Stock are entitled to
receive all assets available for distribution to the stockholders, subject to
any preferential rights of any preferred stock then outstanding. The holders of
Common Stock have no preemptive or other subscription rights, and there are no
conversion rights or redemption or sinking fund provisions with respect to the
Common Stock. All outstanding shares of Common Stock are fully paid and
nonassessable.
PREFERRED STOCK
The Company is authorized to issue 5,000,000 shares of "blank check"
preferred stock that may be issued from time to time in one or more series upon
authorization by the Company's Board of Directors. The Board of Directors,
without further approval of the stockholders, is authorized to fix the dividend
rights and terms, conversion rights, voting rights, redemption rights and terms,
liquidation preferences, and any other rights, preferences, privileges and
restrictions applicable to each series of preferred stock. The issuance of
preferred stock, while providing flexibility in connection with possible
acquisitions and other corporate purposes could, among other things, adversely
affect the voting power of the holders of Common Stock and, under certain
circumstances, make it more difficult for a third party to gain control of the
Company, discourage bids for the Company's Common Stock at a premium or
otherwise adversely affect the market price of the Common Stock. The Company has
no current plans to issue any preferred stock.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Amended and Restated Certificate of Incorporation limits the
liability of directors to the maximum extent permitted by Delaware law. Delaware
law provides that directors of a corporation will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except for
liability (i) for any breach of their duty of loyalty to the corporation or its
stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) for unlawful
payments of dividends or unlawful stock repurchases or redemptions as provided
in Section 174 of the Delaware General Corporation Law, or (iv) for any
transaction from which the director derived an improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its directors
and may indemnify its officers and employees and other agents to the fullest
extent permitted by law. The Company believes that indemnification under its
Bylaws covers at least negligence and gross negligence on the part of
indemnified parties. The Company's Bylaws also permit it to secure insurance on
behalf of any officer, director, employee or other agent for any liability
arising out of his actions in such capacity, regardless of whether the Bylaws
would permit indemnification.
The Company has entered into agreements to indemnify its directors and
executive officers, in addition to indemnification provided for in the Company's
Bylaws and Amended and Restated Certificate of Incorporation. These agreements,
among other things, indemnify the Company's directors and executive officers for
certain expenses (including attorneys' fees), judgments, fines and settlement
amounts incurred by any such person in any action or proceeding, including any
action by or in the right of the Company, arising out of such person's services
as a director or executive officer of the Company, any subsidiary of the Company
or any other company or enterprise to which the person provides services at the
request of the Company. The Company believes that these provisions and
agreements are necessary to attract and retain qualified persons as directors
and executive officers.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that might result in a claim for such indemnification.
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<PAGE>
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law. In general, Section 203 prohibits a publicly held
Delaware corporation from engaging in a "business combination" transaction with
any "interested stockholder" for a period of three years after the date of the
transaction in which the person became an "interested stockholder," unless the
business combination is approved in a prescribed manner. For purposes of Section
203, a "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to the interested stockholder, and an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years, did own) 15% or more of a corporation's
voting stock. By virtue of the Company's decision not to elect out of the
statute's provisions, the statute applies to the Company. The statute could
prohibit or delay the accomplishment of mergers or other takeover or change in
control attempts with respect to the Company and, accordingly, may discourage
attempts to acquire the Company.
Stockholders who are officers and directors or their affiliates may be able
to significantly influence the election of the Company's directors and the
determination of the outcome of corporate actions requiring stockholder
approval, such as mergers and acquisitions. This may have a significant effect
in delaying, deferring or preventing a change in control of the Company and may
adversely affect the voting and other rights of other holders of Common Stock.
Certain provisions of the Company's Certificate of Incorporation, Bylaws and
equity compensation plans and Delaware law may also discourage certain
transactions involving a change in control of the Company. This may, when
combined with the Company's classified Board of Directors and the ability of the
Board of Directors to issue blank check Preferred Stock without further
stockholder approval, have the effect of delaying, deferring or preventing a
change in control of the Company and may adversely affect the voting and other
rights of other holders of Common Stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services, L.L.C. Its telephone number is (415) 743-1424.
PLAN OF DISTRIBUTION
The Company may sell the Securities separately or together, (i) to one or
more underwriters or dealers for public offering and sale by them and (ii) to
investors directly or through agents. The distribution of the Securities may be
effected from time to time in one or more transactions at a fixed price or
prices (which may be changed from time to time), at market prices prevailing at
the time of sale, at prices related to such prevailing market prices or at
negotiated prices. Each Prospectus Supplement will describe the method of
distribution of the Securities offered thereby.
In connection with the sale of the Securities, underwriters, dealers or
agents may receive compensation from the Company or from purchasers of the
Securities for whom they may act as agents, in the form of discounts,
concessions or commissions. The underwriters, dealers or agents which
participate in the distribution of the Securities may be deemed to be
underwriters under the Securities Act and any discounts or commissions received
by them and any profit on the resale of the Securities received by them may be
deemed to be underwriting discounts and commissions thereunder. Any such
underwriter, dealer or agent will be identified and any such compensation
received from the Company will be described in the Prospectus Supplement. Any
initial public offering price and any discounts or concessions allowed or
reallowed or paid to dealers may be changed from time to time.
Under agreements that may be entered into with the Company, underwriters,
dealers and agents may be entitled to indemnification by the Company against
certain civil liabilities, including liabilities under the Securities Act, or to
contribution with respect to payments which the underwriters, dealers or agents
may be required to make in respect thereof.
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<PAGE>
The Company may grant underwriters who participate in the distribution of
Securities an option to purchase additional Securities to cover over-allotments,
if any.
All Debt Securities will be new issues of securities with no established
trading market. Any underwriters to whom Debt Securities are sold by the Company
for public offering and sale may make a market in such securities, but such
underwriters will not be obligated to do so and may discontinue any market
making at any time without notice. No assurance can be given as to the liquidity
of the trading market for any Debt Securities.
Certain of the underwriters or agents and their associates may be customers
of, engage in transactions with or perform services for the Company in the
ordinary course of business.
LEGAL OPINIONS
The validity of the Securities is being passed upon for the Company by
Brobeck, Phleger & Harrison LLP, Palo Alto, California.
EXPERTS
The consolidated financial statements of Cygnus Inc. incorporated by
reference in the Cygnus, Inc. Annual Report on Form 10-K for the year ended
December 31, 1996 have been audited by Ernst & Young LLP, independent auditors,
as set forth in their report thereon incorporated by reference therein and
incorporated herein by reference. Such consolidated financial statements are
incorporated herein by reference in reliance upon such report, given on the
authority of such firm as experts in accounting and auditing.
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH OTHER INFORMATION AND REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. NEITHER THE DELIVERY
OF THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS DO NOT CONSTITUTE AN
OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE
REGISTERED SECURITIES TO WHICH IT RELATES. THIS PROSPECTUS SUPPLEMENT AND THE
ACCOMPANYING PROSPECTUS DO NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF
AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Prospectus Supplement
Summary.............................................. S-3
Risk Factors......................................... S-7
Use of Proceeds...................................... S-15
Price Range of Common Stock.......................... S-15
Dividend Policy...................................... S-15
Capitalization....................................... S-16
Selected Consolidated Financial Data................. S-17
Management's Discussion and Analysis of Financial
Condition and Results of Operations................ S-18
Business............................................. S-27
Management........................................... S-39
Security Ownership of Certain Beneficial Owners and
Management......................................... S-41
Description of Notes................................. S-42
Underwriting......................................... S-50
Certain United States Federal Income Tax
Consequences....................................... S-51
Legal Matters........................................ S-54
Prospectus
Available Information................................ 2
Incorporation of Certain Documents by Reference...... 2
The Company.......................................... 3
Recent Developments.................................. 3
Risk Factors......................................... 3
Use of Proceeds...................................... 4
Ratio of Earnings to Fixed Charges................... 4
Description of Debt Securities....................... 4
Description of Capital Stock......................... 17
Plan of Distribution................................. 19
Legal Opinions....................................... 20
Experts.............................................. 20
</TABLE>
$75,000,000
[LOGO]
% CONVERTIBLE
SUBORDINATED NOTES
DUE 2002
----------------
PROSPECTUS
SUPPLEMENT
----------------
PAINEWEBBER INCORPORATED
MORGAN STANLEY DEAN WITTER
------------
, 1997
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