<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended JUNE 30, 1998
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period from ____ to ___
COMMISSION FILE NUMBER 0-18962
CYGNUS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2978092
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
400 PENOBSCOT DRIVE, REDWOOD CITY, CALIFORNIA 94063-4719
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (650) 369-4300
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No ____
Number of shares outstanding of each of the registrant's classes of common
stock as of JULY 31, 1998:
Common Stock - 20,237,664 shares
Total pages: 18
Page number of exhibit index:17
<PAGE>
CYGNUS, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
----------
<S> <C>
Item 1: Financial Statements
Consolidated Statements of Operations for the three and six month
periods ended June 30, 1998 and 1997 (unaudited). . . . . . . . . . . . 2
Consolidated Condensed Balance Sheets at June 30,1998 (unaudited) and
December 31,1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Cash Flows for the six month periods ended
June 30,1998 and 1997 (unaudited) . . . . . . . . . . . . . . . . . . . . 4
Notes to Consolidated Condensed Financial Statements (unaudited). . . . . 5
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . 8
PART II. OTHER INFORMATION
Item 1: Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 15
Item 4: Submission of Matters to a Vote of Security Holders . . . . . . 16
Item 6: Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . 17
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
</TABLE>
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
1998 1997 1998 1997
---------- --------- --------- ----------
<S> <C> <C> <C> <C>
Product revenues $ 81 $ ---- $ 587 $ 1,700
Contract revenues 2,636 4,065 5,359 7,456
Royalty and other revenues 165 4,175 396 8,377
---------- -------- --------- ---------
TOTAL REVENUES 2,882 8,240 6,342 17,533
Costs and expenses:
Costs of products sold 937 1,587 1,960 4,009
Research and development 8,741 5,141 14,806 10,973
Marketing, general and administrative 2,800 2,170 4,716 3,862
----------- --------- --------- ---------
TOTAL COSTS AND EXPENSES 12,478 8,898 21,482 18,844
LOSS FROM OPERATIONS (9,596) (658) (15,140) (1,311)
Interest income, net (63) 348 (57) 638
----------- --------- --------- ---------
NET LOSS $ (9,659) $ (310) $ (15,197) $ (673)
----------- --------- --------- ---------
----------- --------- --------- ---------
NET LOSS PER SHARE $ (0.48) $ (0.02) $ (0.76) $ (0.04)
----------- --------- --------- ---------
----------- --------- --------- ---------
Shares used in computation of basic and
diluted net loss per share 20,239 18,832 20,040 18,788
----------- --------- --------- ---------
----------- --------- --------- ---------
(See accompanying notes.)
</TABLE>
2
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CYGNUS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
ASSETS: JUNE 30, December 31,
1998 1997
----------- -------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 26,420 $ 20,669
Short-term investments 38,911 14,163
Trade accounts receivable, net of allowance 1,019 2,040
Inventories 775 924
Prepaid expenses and other current assets 1,006 1,988
---------- ----------
TOTAL CURRENT ASSETS 68,131 39,784
Equipment and improvements, at cost 18,445 15,741
Less accumulated depreciation and amortization (12,126) (11,145)
---------- ----------
Net equipment and improvements 6,319 4,596
Deferred compensation and other assets 7,902 4,897
---------- ----------
TOTAL ASSETS $ 82,352 $ 49,277
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY):
Current liabilities:
Accounts payable $ 2,602 $ 1,294
Current portion of arbitration obligation 2,255 16,223
Accrued compensation 2,359 3,298
Accrued professional services 1,310 842
Other accrued liabilities 1,786 1,263
Customer advances 282 624
Current portion of deferred revenue 1,280 1,846
Current portion of long term debt 2,019 3,767
Current portion of capital lease obligations 338 686
--------- ----------
TOTAL CURRENT LIABILITIES 14,231 29,843
Long-term portion of deferred revenue 477 1,188
Long-term portion of debt 10,284 3,812
Long-term portion of capital lease obligations 886 390
Long-term portion of arbitration obligations 23,000 23,000
Deferred compensation and other long-term liabilities 5,685 4,844
Convertible subordinated debt 43,000 -----
Stockholders' equity (net capital deficiency):
Common stock 136,686 122,728
Accumulated deficit (151,897) (136,528)
-------- ----------
TOTAL STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) (15,211) (13,800)
-------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICENCY) $ 82,352 $ 49,277
-------- ----------
-------- ----------
</TABLE>
Note: The condensed consolidated balance sheet at December 31, 1997 has been
derived from the audited financial statements at that date but does not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements.
(See accompanying notes.)
3
<PAGE>
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase/(Decrease) in Cash and Cash Equivalents
(unaudited)
(In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
1998 1997
-------------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (15,197) $ (673)
Adjustments to reconcile net loss to
cash (used in)/provided by operating activities:
Depreciation and amortization 925 1,704
Decrease/(increase) in assets 1,662 4,651
Increase/(decrease) in liabilities 581 (9,269)
Increase/(decrease) in arbitration liability (13,968) ---
----------- -------
NET CASH (USED IN)/PROVIDED BY OPERATING ACTIVITIES (25,997) (3,587)
----------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,280) (1,942)
Decrease/(increase) in short-term investments (24,729) (7,816)
----------- -------
NET CASH (USED IN)/PROVIDED BY INVESTING ACTIVITIES (27,009) (9,758)
----------- -------
Cash flows from financing activities:
Issuance of common stock 13,959 1,314
Principal payments of long-term debt (1,387) (1,145)
Payment of capital lease obligations (276) (783)
Issuance of convertible subordinated debt, net 6,110 ---
Issuance of long-term debt, net 40,351 ---
----------- -------
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES 58,757 (614)
----------- -------
NET INCREASE /(DECREASE) IN CASH AND CASH EQUIVALENTS 5,751 (13,959)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,669 33,148
----------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 26,420 $ 19,189
----------- -------
----------- -------
(See accompanying notes.)
</TABLE>
4
<PAGE>
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements of Cygnus, Inc. (the "Company" or
"Cygnus") as of and for the six month periods ended June 30, 1998 and 1997
included herein are unaudited, but include all adjustments (consisting only
of normal recurring adjustments) which the management of Cygnus, Inc.
believes necessary for a fair presentation of the financial position as of
the reported dates and the results of operations for the respective periods
presented. Interim financial results are not necessarily indicative of
results for a full year. The consolidated financial statements should be read
in conjunction with the audited financial statements and related notes for
the year ended December 31, 1997 included in the Company's 1997 Annual Report
on Form 10-K.
2. NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No.
128, EARNINGS PER SHARE ("Statement 128"). Statement 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants, and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been presented and where appropriate restated to conform to
the Statement 128 requirements.
Currently, basic and diluted net loss per share is computed using the
weighted average number of shares of common stock outstanding. Shares
issuable from stock options, warrants and convertible debt outstanding are
excluded from the diluted earnings per share computation, as their effect is
anti-dilutive.
3. COMPREHENSIVE INCOME (LOSS)
As of January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new
rules for the reporting and display of comprehensive income and its
components; however, the adoption of SFAS 130 had no impact on the Company's
net loss or shareholders' equity. Comprehensive income (loss) has not
presented separately herein as it approximates the Company's net loss.
5
<PAGE>
4. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market, after appropriate consideration has been given to obsolescence and
inventories in excess of anticipated future demand. Net inventories consist of
the following (in thousands):
<TABLE>
<CAPTION> JUNE 30, December 31,
1998 1997
------------------------
<S> <C> <C>
Raw materials $ 774 $ 787
Work in process 0 86
Finished goods 0 51
------- --------
$ 774 $ 924
------- --------
------- --------
</TABLE>
Inventories at June 30, 1998 and December 31, 1997 relate to the
Company's estradiol FemPatch-Registered Trademark- (Warner-Lambert Co.,
Morris Plains, NJ) transdermal product.
5. DEBT AND EQUITY ISSUANCES
In February 1998, the Company entered into Note Purchase Agreements with
certain institutional investors to issue and sell approximately $43 million of
4% Senior Subordinated Convertible Notes due 2005 (the "Notes"). The Notes are
unsecured obligations of the Company and are subordinated to all existing and
future Senior Debt. The Notes were sold at par, mature on February 1, 2005 and
bear interest at a rate of 4% per annum. After deducting the debt issuance
costs, the Company received net proceeds of approximately $40.4 million.
Interest on the Notes may be paid in Common Stock or cash at the option of the
Company. Until February 1, 2000, the Notes are convertible into Common Stock of
the Company at a conversion price equal to the average of the two lowest trade
prices of the Common Stock as reported on the NASDAQ National Market for a
specified number of trading days immediately preceding the conversion date. The
conversion price will be subject to maximum conversion prices until February 1,
2000 and minimum conversion prices until February 1, 1999. Commencing February
1, 2000, the conversion price of the Notes will be set at a fixed price equal to
the greater of $150.00 per share or 150% of the market price of the Common Stock
for 20 trading days preceding such date.
As of June 30, 1998, all of the principal amount of these notes are
convertible immediately.
Should the Notes cease to be convertible into Common Stock, the Notes may,
at the option of the holders, be subject to mandatory redemption in whole or in
part. In addition, in the event of certain other circumstances, each holder of
Notes may, subject to certain restrictions and limitations, require the Company
to repurchase its Notes, in whole or in part.
On February 4, 1998, the Company completed a direct public offering of
905,740 shares of its Common Stock for net proceeds to the Company of
approximately $13.3 million. The Common Stock was sold at a discount from the
market price.
6
<PAGE>
6. 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 the FemPatch system). 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) paid Sanofi
$14.0 million in cash in January 1998, (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) issued in December 1997 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.
In May 1997 Cygnus reported it had initiated arbitration proceedings
against Pharmacia & Upjohn ("Pharmacia") relating to the Nicotrol-Registered
Trademark- patch (Pharmacia AB, Stockholm, Sweden), Cygnus' smoking cessation
patch. In March of 1997, Cygnus announced that Pharmacia exercised its option to
purchase the U.S. manufacturing rights for the Nicotrol patch. The agreement
between Cygnus and Pharmacia provided that Pharmacia would be obligated to pay
Cygnus for, among other things, existing inventory costs and for certain
purchase order commitments. Pharmacia disputes their obligations regarding
certain of the inventory costs and certain purchase order commitments. The
arbitration is intended to resolve these matters. In March 1998, Pharmacia added
a counterclaim against Cygnus in the arbitration, seeking approximately $1.5
million in reimbursement for an alleged overpayment in royalties for Nicotrol
units shipped in 1996 and 1997. Cygnus disputes this counterclaim. The
arbitration hearing on both Cygnus' claim and Pharmacia's counterclaim commenced
on June 15, 1998 before a panel of the American Arbitration Association.
Testimony concluded on June 24, 1998, at which time the panel heard argument and
scheduled post-hearing briefings. Both sides submitted their post-hearing briefs
on July 17, 1998. The panel has not yet closed the hearing proceedings and still
has the option to request more evidence or argument. Once the proceedings are
closed, a decision is expected within 30 days of that date.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE DISCUSSION SET FORTH BELOW CONTAINS PROJECTIONS AND FORWARD-LOOKING
STATEMENTS REGARDING FUTURE EVENTS AND THE FUTURE FINANCIAL PERFORMANCE OF
THE COMPANY. WE WISH TO CAUTION YOU THAT THESE STATEMENTS ARE ONLY OUR
PREDICTIONS AND OBJECTIVES. ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY.
PLEASE NOTE IN PARTICULAR THROUGHOUT THIS DOCUMENT WHERE WE HAVE HIGHLIGHTED
SPECIFIC RISKS ASSOCIATED WITH THE COMPANY AND ITS ACTIVITIES. WE ALSO REFER
YOU TO DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND
EXCHANGE COMMISSION, SUCH AS ITS MOST RECENT FORM 10-K AND ITS SUBSEQUENT
FORM 10-Q AND FORM 8-K REPORTS. THESE DOCUMENTS AND THE DISCUSSION BELOW
CONTAIN IMPORTANT FACTORS, INCLUDING WITHOUT LIMITATION THOSE INVOLVING
CERTAIN ONGOING ARBITRATION PROCEEDINGS INVOLVING THE COMPANY, THAT COULD
CAUSE OUR ACTUAL RESULTS TO DIFFER FROM OUR CURRENT EXPECTATIONS AND THE
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN.
GENERAL
Cygnus is engaged in the development and manufacture of diagnostic and
drug delivery systems, 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-Registered Trademark- 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 distributors, or
both. In general, the Company's agreements provide that Cygnus will
manufacture its products and receive manufacturing revenues from sales of
these products to its licensees or distributors. Cygnus may also receive
royalties based on certain of its licensees' or distributors' 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 terminate
a product development effort at any time prior to regulation approval for any
reason without significant penalty. Such cancellations may result in delays,
suspension or abandonment of clinical testing, the preparation and processing
of regulatory filings and product development and commercialization efforts.
Licensees have exercised this right in the past, and there can be no
assurance that current and future licensees or distributors will not exercise
this right in the future. If a licensee or distributor were to cease funding
one of the Company's products, Cygnus would either self-fund development
efforts, identify and enter into an agreement with an alternative licensee or
distributor or suspend further development work on the product. There can be
no assurance that, if necessary, the Company would be able to negotiate an
agreement with an alternative licensee or distributor on acceptable terms.
Since all payments to the Company under its 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 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-
8
<PAGE>
term effect on the Company's results of operations could be favorable.
In the past some of the Company's licensees, distributors and collaborators
have approached the Company requesting modification of the terms of existing
agreements.
In 1996, the Company entered into a collaboration with Becton Dickinson &
Company ("Becton Dickinson") for the commercialization of the GlucoWatch
monitor, a continuous automatic and bloodless glucose monitoring system which
painlessly extracts and measures glucose levels for people with diabetes. Under
the Becton Dickinson agreement, the Company had granted Becton Dickinson
exclusive worldwide marketing and distribution rights, with the exception of
Japan and Korea. The agreement was amended in June 1997 to grant Becton
Dickinson worldwide marketing rights, with the exception of Japan and Korea, for
the Company's second generation glucose monitor. On March 31, 1998, the Company
announced that it had terminated its agreement with Becton Dickinson.
Consequently, the Company will not receive any future milestone payments under
the Becton Dickinson agreement and will not be obligated to share future
revenue, if any, associated with commercialization of the GlucoWatch monitor.
The Company is currently evaluating alternative distribution approaches for the
GlucoWatch monitor, as well as developing its own sales and marketing
capabilities to self-fund sales and marketing activities related to
commercialization of the GlucoWatch monitor. There can be no assurance that the
Company will be able to enter into new collaborative arrangements. In addition,
any increase in Company-sponsored sales and marketing activities will have an
immediate adverse effect on the Company's results of operations.
In July 1998, the Company was notified by American Home Products
Corporation (AHP), the licensee for two of the Company's transdermal hormone
replacement products, that AHP wanted to discuss the status of their agreement
with the Company. Meetings are scheduled to determine what impact these
discussions may have on the relationship between the parties.
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, in
part, 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 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 or distribution fees and cost 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. Up front and interim milestone payments from contracts are
generally earned and recognized based on the percentage of actual efforts
expended compared to total expected efforts during the development period for
each contract. However, contract revenues are not always aligned with the timing
of related expenses. To date, 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
9
<PAGE>
CYGNUS, INC.
June 30, 1998
in 1998. At June 30, 1998, the Company's accumulated deficit and net capital
deficiency were approximately $151.9 million and $15.2 million, respectively.
RESULTS OF OPERATIONS:
COMPARISON FOR THE QUARTERS ENDED JUNE 30, 1998 AND 1997
PRODUCT REVENUES for the quarter ended June 30, 1998 were $0.1 million,
compared to $0.0 million for the quarter ended June 30, 1997. Product
revenues were $0.6 million for the six months ended June 30, 1998 compared to
$1.7 million for the six months ended June 30, 1997. Product revenue for the
quarter and six months ended June 30, 1998 resulted from the shipments of the
FemPatch system, the Company's second commercialized product. The FemPatch
system 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. The Company expects
a decrease in product revenue related to FemPatch system production in the
second half of 1998 due to an anticipated reduction in FemPatch system
shipments. The reduction in total product revenue for the six months ended
June 30, 1998 resulted from the discontinuation of Nicotrol patch
manufacturing in the first quarter of 1997.
In May 1997 Cygnus reported it had initiated arbitration proceedings
against Pharmacia & Upjohn ("Pharmacia") relating to the Nicotrol patch,
Cygnus' smoking cessation product. In March of 1997, Cygnus announced that
Pharmacia exercised its option to purchase the United States manufacturing
rights of the Nicotrol patch. The agreement between Cygnus and Pharmacia
provided that Pharmacia would be obligated to pay Cygnus for, among other
things, existing inventory costs and for certain purchase order commitments.
Pharmacia disputes their obligations regarding certain of the inventory costs
and certain purchase order commitments. The arbitration is intended to
resolve these matters. In March 1998, Pharmacia added a counterclaim against
Cygnus in the arbitration, seeking approximately $1.5 million in
reimbursement for an alleged overpayment in royalties for Nicotrol units
shipped in 1996 and 1997. Cygnus disputes this counterclaim (see Item 1, Note
6, "Legal Proceedings").
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 period to period.
CONTRACT REVENUES for the quarter ended June 30, 1998 were $2.6 million
compared to the $4.1 million for the quarter ended June 30, 1997 and were
$5.4 million for the six months ended June 30, 1998 compared to $7.5 million
for the six months ended June 30, 1997. 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
decrease in contract revenues for the quarter and six months ended June 30,
1998 is primarily due to a payment of $1.0 million received from Pharmacia &
Upjohn for the exercise of its option to purchase the manufacturing rights
for the Nicotrol patch in the second quarter of 1997 and a reduction in
clinical billings related to one of the Company's hormone replacement
products.
10
<PAGE>
CYGNUS, INC.
June 30, 1998
As a result of the Company's termination of its agreement with Becton
Dickinson, as mentioned above, the Company will not receive any future
milestone payments under the Becton Dickinson agreement and will not be
obligated to share future revenue, if any, associated with commercialization
of the GlucoWatch monitor. Of the $5.4 million in contract revenue recognized
during the six months ended June 30, 1998, $0.2 million related to the
amortization of previously capitalized Becton Dickinson milestone payments
and was recognized in the quarter ended March 31, 1998. No related amounts
remain to be amortized in the future periods.
In July 1996, the Company entered into an agreement with Tokyo-based
Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") for the marketing and
distribution of the GlucoWatch monitor. 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 payments to the Company under
these agreements following their execution are contingent on the occurrence
of future events or sales levels, and the agreements are terminable by the
licensee, no assurance can be given as to whether the Company will receive
any particular payment thereunder or as to the amount or timing of any such
payment. The Company is unable to predict to what extent the termination of
existing contracts by current partners, or new collaborative agreements, if
any, will impact overall contract revenues in 1998 and subsequent future
periods.
ROYALTY AND OTHER REVENUES for the quarter ended June 30, 1998 were $0.2
million compared to $4.2 million for the quarter ended June 30, 1997 and were
$0.4 million for the six months ended June 30, 1998 compared to $8.4 million
for the six months ended June 30, 1997. The net decrease in royalty and other
revenues for the quarter and six months ended June 30, 1998 compared to the
quarter and six months ended June 30, 1997 is primarily due to the 1996
launch in the United States of the non-prescription Nicotrol product. The
quarter and six months ended June 30, 1997 included the recognition of
previously deferred royalty payments associated with this launch, whereas no
such amortization was included in the quarter and six months ended June 30,
1998.
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
11
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CYGNUS, INC.
June 30, 1998
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.
COSTS OF PRODUCTS SOLD for the quarter ended June 30, 1998 were $0.9
million compared to $1.6 million for the quarter ended June 30, 1997 and were
$2.0 million for the six months ended June 30, 1998 compared to $4.0 million
for the six months ended June 30, 1997. 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 quarter and six months ended June 30, 1998 largely
reflects the reduction of direct expenses related to Nicotrol patch
production as a result of Pharmacia exercising its option to purchase the
manufacturing rights of the Nicotrol patch. Cost of products sold for the
quarter and six months ended June 30, 1998 include shipments of the FemPatch
system, the Company's second commercialized product. The Company experienced
negative product margins for the quarter and six months ended June 30, 1998
and June 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 June 30, 1998
were $8.7 million compared to $5.1 million for the quarter ended June 30,
1997 and were $14.8 million for the six months ended June 30, 1998 compared
to $11.0 million for the six months ended June 30, 1997. The increase in
research and development expenses for the quarter and six months ended June
30, 1998 is due primarily to the Company's accelerated level of clinical
activities associated with the GlucoWatch 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, the FemPatch system, was launched in September 1997 and two of
which are in clinical trials) and a contraception product. 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
June 30, 1998 were $2.8 million compared to $2.2 million for the quarter
ended June 30, 1997 and were $4.7 million for the six months ended June 30,
1998 compared to $3.9 million for the six months ended June 30, 1997. While
current levels are slightly higher than the prior year, Cygnus anticipates
that marketing, general and administrative expenses will increase in the
future as the Company expands its operations.
INTEREST INCOME/(LOSS), NET OF INTEREST AND OTHER EXPENSE for the
quarter ended June 30, 1998 were $(0.1) million compared to $0.3 million for
the quarter ended June 30, 1997 and were $(0.1) million for the six months
ended June 30, 1998 compared to $0.6 million for the six months ended June
30, 1997. The decrease for the quarter and six months ended June 30, 1998 is
due primarily to higher interest expense associated with the Company's
issuance of the convertible debt, the amortization of the financing fees
related to this debt and the interest related to the additional long-term
debt incurred in the second quarter of 1998.
12
<PAGE>
CYGNUS, INC.
June 30, 1998
LIQUIDITY AND CAPITAL RESOURCES
Through December 1997, the Company received net proceeds of approximately
$82.1 million from public offerings of its Common Stock. In February 1998, the
Company received net proceeds of approximately $13.3 million (net of issuance
costs of approximately $0.5 million) from a direct public offering of its Common
Stock.
Through 1997, the Company financed approximately $9.7 million of
manufacturing and research equipment under capital loan and lease
arrangements. In the second quarter of 1998, the Company entered into a new
loan agreement for $1.4 million to finance additional capital equipment.
Borrowings under this agreement are secured by specific Company assets.
In April of 1998, the Company consolidated its two outstanding bank
loans into an expanded credit facility with the same bank. An additional $4.7
million was advanced, increasing the total outstanding under the new
agreement to $10.0 million. This balance will be repaid through October of
2001, with monthly interest-only payments through October 1998, and monthly
principal and interest installments thereafter. As of June 30, 1998 there is
$10.0 million outstanding under this agreement.
In February 1998, the Company entered into Note Purchase Agreements with
certain institutional investors to issue and sell approximately $43 million
of 4% Senior Subordinated Convertible Notes due 2005 (the "Notes"). The Notes
were sold at par, mature on February 1, 2005 and bear interest at a rate of
4% per annum. The Notes are convertible into Common Stock of the Company at a
conversion price equal to the average of the two lowest trade prices of the
Common Stock as reported on the Nasdaq National Market for a specified number
of trading days immediately preceding the conversion date until February 1,
2000. The conversion price will be subject to maximum conversion prices,
until February 1, 2000, and minimum conversion prices until February 1, 1999.
Commencing February 1, 2000, the conversion price of the Notes will be set
at a fixed price equal to the greater of $150.00 per share and 150% of the
market price of the Common Stock for 20 trading days preceding such date.
After deducting the debt issuance costs, the Company received approximately
$40.4 million (see Note 5, "Debt and Equity issuances" in the Notes to the
Condensed Consolidated Financial Statements).
Net cash used in operating activities for the six months ended June 30,
1998 was $26.0 million, compared with net cash used of $3.6 million for the
six months ended June 30, 1997. Cash used in operating activities during the
six months ended June 30, 1998 was primarily due to a $14.0 million cash
payment made in January 1998 to Sanofi under the terms of the settlement
mentioned above, and the Company's net loss of $15.2 million, offset by an
increase in accounts payable and other accrued liabilities of $1.8 million
and a decrease in accounts receivable of $1.0 million. Cash used in operating
activities during the period ended June 30, 1997 was primarily due to a
decrease in deferred revenue of $8.7 million and an increase in notes
receivable, prepaid expenses and other current assets of $1.4 million, offset
by a decrease in accounts receivable of $6.6 million.
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.
13
<PAGE>
CYGNUS, INC.
June 30, 1998
The current level of cash used in operating activities is not
necessarily indicative of the level of future cash usage. As a result of
increased expenditures for the development of new products, preparation for
regulatory filings and clinical trials and the expected reduction in product
revenues, the Company anticipates an increase in cash usage for 1998 and
future operating activities.
Net cash used in investing activities of $27.0 million for the six
months ended June 30, 1998 resulted primarily from net purchases of
short-term investments of $24.7 million and capital expenditures of $2.3
million. Net cash used in investing activities of $9.8 million for the six
months ended June 30, 1997 resulted primarily from net purchases of
short-term investments of $7.8 million and capital expenditures of $1.9
million.
Net cash provided by financing activities of $58.8 million for the six
months ended June 30, 1998 includes, as mentioned above, net proceeds of
$40.4 million and $13.3 million from the Company's February 1998 issuance of
Senior Subordinated Convertible Notes and from a direct public offering of
its Common Stock, respectively, additional stock proceeds of $0.7 million and
$6.1 million from the issuance of long-term debt, offset by long-term debt
and capital lease repayments of $1.4 million and $0.3 million, respectively.
Net cash used in financing activities of $0.6 million for the six months
ended June 30, 1997 includes $1.3 million of common stock issuance proceeds
offset by $1.9 million in long-term debt and capital lease repayments.
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 system 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 $65.3 million as of June 30, 1998, when coupled with cash from
revenues and earnings from investments, will be sufficient to meet its
operating expenses and capital expenditure requirements at least through June
30, 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.
14
<PAGE>
CYGNUS, INC.
June 30, 1998
PART II. OTHER INFORMATION
ITEM 1. 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 the FemPatch system).
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) paid
Sanofi $14.0 million in cash in January 1998, (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) issued in December 1997 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.
In May 1997 Cygnus reported it had initiated arbitration proceedings
against Pharmacia & Upjohn ("Pharmacia") relating to the Nicotrol patch,
Cygnus' smoking cessation product. In March of 1997, Cygnus announced that
Pharmacia exercised its option to purchase the U.S. manufacturing rights for
the Nicotrol patch. The agreement between Cygnus and Pharmacia provided that
Pharmacia would be obligated to pay Cygnus for, among other things, existing
inventory costs and for certain purchase order commitments. Pharmacia
disputes their obligations regarding certain of the inventory costs and
certain purchase order commitments. The arbitration is intended to resolve
these matters. In March 1998, Pharmacia added a counterclaim against Cygnus
in the arbitration, seeking approximately $1.5 million in reimbursement for
an alleged overpayment in royalties for Nicotrol units shipped in 1996 and
1997. Cygnus disputes this counterclaim. The arbitration hearing on both
Cygnus' claim and Pharmacia's counterclaim commenced on June 15, 1998 before
a panel of the American Arbitration Association. Testimony concluded on June
24, 1998, at which time the panel heard argument and scheduled post-hearing
briefings. Both sides submitted their post-hearing briefs on July 17, 1998.
The panel has not yet closed the hearing proceedings and still has the option
to request more evidence or argument. Once the proceedings are closed, a
decision is expected within 30 days of that date.
15
<PAGE>
CYGNUS, INC.
June 30, 1998
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 12, 1998 the Annual Meeting of Stockholders was held. The
following Directors were re-elected at this meeting:
Frank T. Cary Andre F. Marion
Gary W. Cleary Richard G. Rogers
Gregory B. Lawless Walter B. Wriston
Other matters voted upon:
<TABLE>
<CAPTION>
Votes
----------------------------------------------
Broker
Affirmative Negative Abstain Non-Votes
----------- -------- ------- ---------
<S> <C> <C> <C> <C>
To approve an amendment to
the Certificate of
Incorporation to increase the 15,666,473 633,381 60,664 3,275
number of shares of Common
Stock authorized for issuance
thereunder by an additional
10,000,000 shares.
To approve an amendment to
the 1994 Stock Option/Award
Plan to increase the number 7,087,396 2,877,475 190,258 6,208,664
of shares of Common Stock
authorized for issuance over
the term of the Plan by
2,000,000 shares.
To approve an amendment to
the 1991 Employee Stock
Purchase Plan to increase the 9,472,318 499,139 183,662 6,208,674
number of shares of Common
Stock authorized for issuance
over the term of the Plan by
350,000 shares.
To re-appoint Ernst & Young
LLP to serve as the Company's 16,275,769 48,455 39,569 0
independent auditors.
</TABLE>
16
<PAGE>
CYGNUS, INC.
June 30, 1998
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
The following exhibits are filed herewith or incorporated by reference:
27. Financial Data Schedule
b) REPORTS ON FORM 8-K
The Company did not file any Reports on Form 8-K during the quarter
ended June 30, 1998.
17
<PAGE>
CYGNUS, INC.
June 30, 1998
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CYGNUS, INC.
Date: August 3, 1998 By: /s/ John C. Hodgman
--------------------------- ----------------------------------
John C. Hodgman
President, Cygnus Diagnostics
and Chief Financial Officer
(and Principal Accounting Officer)
18
<PAGE>
INDEX OF EXHIBITS
The following exhibits are included herein:
Exhibit 27 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 26,420
<SECURITIES> 38,911<F1>
<RECEIVABLES> 1,157
<ALLOWANCES> 400
<INVENTORY> 775
<CURRENT-ASSETS> 68,131
<PP&E> 18,445
<DEPRECIATION> 12,126
<TOTAL-ASSETS> 82,352
<CURRENT-LIABILITIES> 14,231
<BONDS> 77,170
0
0
<COMMON> 136,686
<OTHER-SE> (151,897)
<TOTAL-LIABILITY-AND-EQUITY> 82,352
<SALES> 587
<TOTAL-REVENUES> 6,342
<CGS> 414
<TOTAL-COSTS> 1,960
<OTHER-EXPENSES> 19,522
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,569
<INCOME-PRETAX> (15,191)
<INCOME-TAX> 6
<INCOME-CONTINUING> (15,197)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,197)
<EPS-PRIMARY> (0.76)
<EPS-DILUTED> (0.76)
<FN>
<F1>THIS AMOUNT REPRESENTS SHORT-TERM INVESTMENTS HELD BY THE COMPANY AT
JUNE 30, 1998.
</FN>
</TABLE>
