<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 MARCH 31, 1998
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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
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CYGNUS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2978092
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
400 PENOBSCOT DRIVE, REDWOOD CITY, CALIFORNIA 94063-4719
(Address of principle executive offices and zip code)
Registrant's telephone number, including area code: (650) 369-4300
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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
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Number of shares outstanding of each of the registrant's classes of common stock
as of MAY 8, 1998:
Common Stock - 20,236,954 shares
Total pages: 17
Page number of exhibit index: 16
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CYGNUS, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
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<S> <C> <C>
Item 1: Financial Statements
Condensed Consolidated Statements of Operations for the three month
periods ended March 31, 1998 and 1997 (unaudited)..................... 2
Condensed Consolidated Balance Sheets at March 31,1998
(unaudited) and December 31,1997...................................... 3
Condensed Consolidated Statements of Cash Flows for the three month
periods ended March 31,1998 and 1997 (unaudited)..................... 4
Notes to Condensed Consolidated Financial Statements (unaudited)......... 5
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 8
PART II. OTHER INFORMATION
Item 1: Legal Proceedings........................................................ 15
Item 6: Exhibits and Reports on Form 8-K......................................... 16
SIGNATURES.......................................................................... 17
</TABLE>
1
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYGNUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1998 1997
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<S> <C> <C>
Product revenues $ 506 $ 1,700
Contract revenues 2,723 3,390
Royalty and other revenues 231 4,202
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TOTAL REVENUES 3,460 9,292
Costs and expenses:
Costs of products sold 1,023 2,422
Research and development 6,065 5,831
Marketing, general and administrative 1,916 1,692
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TOTAL COSTS AND EXPENSES 9,004 9,945
LOSS FROM OPERATIONS (5,544) (653)
Interest income, net 6 290
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NET LOSS $(5,538) $ (363)
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BASIC AND DILUTED NET LOSS PER SHARE $ (0.28) $ (0.02)
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Shares used in computation of basic and diluted
net loss per share 19,841 18,744
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(See accompanying notes.)
2
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CYGNUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS: MARCH 31, December 31,
1998 1997
--------- ------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 32,334 $ 20,669
Short-term investments 35,115 14,163
Trade accounts receivable, net of allowance 1,852 2,040
Inventories 914 924
Prepaid expenses and other current assets 1,414 1,988
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TOTAL CURRENT ASSETS 71,629 39,784
Equipment and improvements, at cost 16,858 15,741
Less accumulated depreciation and amortization (11,623) (11,145)
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Net equipment and improvements 5,235 4,596
Deferred compensation and other assets 7,482 4,897
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TOTAL ASSETS $ 84,346 $ 49,277
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY):
Current liabilities:
Accounts payable 1,871 1,294
Current portion of arbitration obligation 2,158 16,223
Accrued compensation 1,553 3,298
Accrued professional services 995 842
Other accrued liabilities 1,610 1,263
Customer advances 487 624
Current portion of deferred revenue 1,577 1,846
Current portion of long term debt 3,655 3,767
Current portion of capital lease obligations 686 686
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TOTAL CURRENT LIABILITIES 14,592 29,843
Long-term portion of deferred revenue 717 1,188
Long-term portion of debt 2,925 3,812
Long-term portion of capital lease obligations 223 390
Long-term portion of arbitration obligations 23,000 23,000
Deferred compensation and other long-term liabilities 5,297 4,844
Convertible subordinated debt 43,000 --
Stockholders' equity (net capital deficiency):
Common stock 136,659 122,728
Accumulated deficit (142,067) (136,528)
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TOTAL STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICIENCY) (5,408) (13,800)
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
(NET CAPITAL DEFICENCY) $ 84,346 $ 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
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CYGNUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase/(Decrease) in Cash and Cash Equivalents
(unaudited)
(In thousands)
<TABLE>
THREE MONTHS ENDED MARCH 31,
1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,538) $ (363)
Adjustments to reconcile net loss to cash (used in)/provided by
operating activities:
Depreciation and amortization 450 1,185
Decrease/(increase) in assets 689 4,627
Increase/(decrease) in liabilities (1,092) (4,225)
Increase/(decrease) in arbitration liability (14,065) --
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NET CASH (USED IN)/PROVIDED BY OPERATING ACTIVITIES (19,556) 1,224
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,117) (639)
Decrease/(increase) in short-term investments (20,869) (11,660)
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NET CASH (USED IN)/PROVIDED BY INVESTING ACTIVITIES (21,986) (12,299)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 13,931 1,200
Principal payments of long-term debt (999) (572)
Payment of capital lease obligations (167) (405)
Issuance of Convertible subordinated debt, net 40,442 --
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NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES 53,207 223
-------- --------
NET INCREASE /(DECREASE)IN CASH AND CASH EQUIVALENTS 11,665 (10,852)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 20,669 33,148
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 32,334 $ 22,296
-------- --------
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</TABLE>
(See accompanying notes.)
4
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CYGNUS, INC.
March 31, 1998
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements of Cygnus, Inc. (the "Company" or
"Cygnus") as of and for the three month periods ended March 31, 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. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market, after appropriate consideration was given to obsolescence and
inventories in excess of anticipated future demand. Net inventories consist of
the following:
<TABLE>
<CAPTION>
MARCH 31, December 31,
1998 1997
--------------------------
<S> <C> <C>
Raw materials $ 767 $ 787
Work in process 9 86
Finished goods 138 51
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$ 914 $ 924
--------------------------
--------------------------
</TABLE>
Inventories at March 31, 1998 and December 31, 1997 relate to the Company's
estradiol (FemPatch-R-) transdermal product.
5
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CYGNUS, INC.
March 31, 1998
4. 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.
One half of the principal amount of these notes is convertible
immediately. The other half is convertible from and after June 5, 1998.
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 restriction and limitation,
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 $13.4 million. The Common Stock was sold at a discount from the
market price.
6
<PAGE>
5. 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) 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 Nicotrol-Registered
Trademark-, Cygnus' smoking cessation patch. In March of this year, Cygnus
announced that Pharmacia exercised its option to purchase the U.S.
manufacturing rights for Nicotrol. 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 and intends to
defend against it vigorously in this arbitration proceeding. The arbitration
proceeding is expected to commence in mid 1998.
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-TM- system) and transdermal drug delivery
systems.
The Company's product development efforts have been and are expected to
continue to be either self-funded, funded by licensees or 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, a
painless, bloodless and automatic glucose monitoring system being developed
by the Company 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 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. The Company is
currently evaluating alternative distribution approaches for the GlucoWatch
as well as expanding its own sales and marketing efforts to self-fund sales
and marketing activities related to commercialization of the GlucoWatch.
There can be no assurance that the Company will be able to enter into new
collaborative arragements. In addition, any increase in Company-sponsored
sales and marketing activities will have an immediate adverse effect on the
Company's results of operations.
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 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 in 1998. At March 31, 1998, the
Company's accumulated deficit and net capital deficiency were approximately
$142.1 million and $5.4 million, respectively.
9
<PAGE>
RESULTS OF OPERATIONS:
COMPARISON FOR THE QUARTERS ENDED MARCH 31, 1998 AND 1997
PRODUCT REVENUES for the quarter ended March 31, 1998 were $0.5 million,
compared to $1.7 million for the quarter ended March 31, 1997. Product
revenue for the quarter ended March 31, 1998 resulted from the shipments of
FemPatch, the Company's second commercialized product. 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. The reduction in total
product revenue for the three months ended March 31, 1998 resulted from the
discontinuation of Nicotrol manufacturing in the first quarter of 1997.
In May 1997 Cygnus reported it had initiated arbitration proceedings
against Pharmacia & Upjohn ("Pharmacia") relating to Nicotrol, Cygnus'
smoking cessation patch. In March of 1997, Cygnus announced that Pharmacia
exercised its option to purchase the United States manufacturing right of
Nicotrol . 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 and intends to defend against it
vigorously in this arbitration proceeding. The arbitration proceeding is
expected to commence in mid 1998.
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 March 31, 1998 were $2.7
million, compared to $3.4 million for the quarter ended March 31, 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
ended March 31, 1998 is primarily due to a reduction in clinical billings
related to one of the Company's hormone replacement products.
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. Of the $2.7 million in contract revenue recognized during
the quarter ended March 31, 1998, $0.2 million related to the amortization of
previously capitalized Becton Dickinson milestone payments. No related
amounts remain to be amortized in the future periods.
10
<PAGE>
In July 1996, the Company entered into an agreement with Tokyo-based
Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") for the marketing and
distribution of the GlucoWatch. Under the terms of this agreement, Yamanouchi
has exclusive marketing and distribution rights in Japan and Korea. Cygnus
will have primary responsibility for completing product development and for
manufacturing. In the third quarter of 1996, Cygnus received an up-front,
non-refundable payment from Yamanouchi and is eligible to receive milestone
payments as well as a percentage of the product's future commercial sales. In
July 1996, the Company also entered into a development and marketing
agreement with Yamanouchi for a 7-day transdermal product to deliver a
proprietary Yamanouchi compound. Under the terms of the agreement, Cygnus
will receive funding for the development of the transdermal product and will
have exclusive rights to manufacture and supply Yamanouchi with the product
and Yamanouchi will have exclusive worldwide marketing rights to the product.
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 March 31, 1998 were
$0.2 million, compared to $4.2 million for the quarter ended March 31, 1997.
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 decrease in royalty and other revenues
for the quarter ended March 31, 1998 compared to the quarter ended March 31,
1997 is primarily due to the 1996 launch in the United States of the
non-prescription Nicotrol product. The quarter ended March 31, 1997 included
the recognition of previously deferred royalty payments associated with this
launch, whereas no such amortization was included in the quarter ended March
31, 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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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 March 31, 1998 were $1.0
million, compared to $2.4 million for the quarter ended March 31, 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 ended March 31, 1998
largely reflects the reduction of direct expenses related to Nicotrol
production as a result of Pharmacia exercising its option to purchase the
manufacturing rights of Nicotrol. Cost of products sold for the quarter ended
March 31, 1998 include the shipments of FemPatch, the Company's second
commercialized product. The Company experienced negative product margins for
the quarters ended March 31, 1998 and March 31, 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 March 31, 1998
were $6.1 million, compared to $5.8 million for the quarter ended March 31,
1997. 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 slightly higher than 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
March 31, 1998 were $1.9 million, compared to $1.7 million for the quarter
ended March 31, 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, NET OF INTEREST AND OTHER EXPENSE for the quarter ended
March 31, 1998 was $0.0 million, compared to $0.3 million for the quarter
ended March 31, 1997. The decrease for the quarter ended March 31, 1998 is
due primarily to higher interest expense associated with the Company's
issuance of the convertible debt and the amortization of the financing fees
related to this debt.
LIQUIDITY AND CAPITAL RESOURCES
Through October 1995, 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 $13.4 million ( net of
issuance costs of approximately $0.4 million) from a direct public offering
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. Borrowings under this
agreement are secured by specific Company Assets.
12
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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 March 31, 1998 there is $0.1 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 March 31, 1998 there is $5.4 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. After deducting the debt issuance costs, the Company received
approximately $40.4 million ( See Note 4. "Debt and Equity issuances" in the
Notes to the Condensed Consolidated Financial Statements).
On March 30, 1998, the Company signed an agreement to expand its current
bank line of credit which resulted in an additional $4.5 million of available
funds. The Company also received approval for a $1.5 million loan to be
secured by capital purchases. No advances under either line were made as of
March 31, 1998.
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 quarter ended March 31,
1998 was $19.6 million, compared with net cash provided of $1.2 million for
the quarter ended March 31, 1997. Cash used in operating activities during
the quarter ended March 31, 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 $5.5 million. Cash provided in
operating activities during the period ended March 31, 1997 was primarily due
to a decrease in accounts receivable of $6.0 million, and an increase of $0.7
million in deferred compensation and other liabilities, offset by decreases
in deferred revenue of $3.0 million, a decrease of $1.6 million in accrued
compensation and an increase of $1.3 million in notes receivable, prepaid
expenses and other current liabilities.
The current level of cash used in operating activities is not
necessarily indicative of the level of future cash usage. As a result of
increased expenditures for the development of new products, preparation for
regulatory filings and clinical trials and the expected reduction in product
revenues, the Company anticipates an increase in cash usage for 1998 and
future operating activities.
Net cash used in investing activities of $22.0 million for the quarter
ended March 31, 1998 resulted primarily from net purchases of short-term
investments of $20.9 million and capital expenditures of $1.1 million. Net
cash used in investing activities of $12.3 million for the quarter ended
March 31, 1997 resulted primarily from net purchases of short-term
investments of $11.7 million and capital expenditures of $0.6 million.
Net cash provided by financing activities of $53.2 million for the
quarter ended March 31, 1998 includes, as mentioned above, net proceeds of
$40.4 million and $13.4 million from the
13
<PAGE>
Company's February 1998 issuance of Senior Subordinated Convertible Notes and
from a direct public offering of its Common Stock, respectively, and
additional stock proceeds of $0.5 million, offset by long-term debt and
capital lease repayments of $1.0 million and $0.2 million, respectively. Net
cash provided by financing activities of $0.2 million for the quarter ended
March 31, 1997 includes $1.2 million of common stock issuance proceeds,
offset by long-term debt and capital lease repayments of $0.6 million and
$0.4 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 $67.5 million as of March 31, 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 the
quarter end March 31, 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>
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 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) 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. Overall, Cygnus' non-recurring expenses attributable to
the arbitration settlement recorded in the quarter ended September 30, 1997
totaled $39.7 million. Of the total related liability of $39.2, at December
31, 1997, $23.0 million is long-term.
In May 1997 Cygnus reported it had initiated arbitration proceedings
against Pharmacia & Upjohn ("Pharmacia") relating to Nicotrol-Registered
Trademark-, Cygnus' smoking cessation patch. In March of this year, Cygnus
announced that Pharmacia exercised its option to purchase the U.S.
manufacturing rights for Nicotrol. 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 and intends to
defend against it vigorously in this arbitration proceeding. The arbitration
proceeding is expected to commence in mid 1998.
15
<PAGE>
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 filed two Reports on Form 8-K during the quarter ended
March 31, 1998.
Item 5. Other Events:
The first report was dated February 4, 1998 (the "Note Purchase
Agreements Form 8-K"). The Note Purchase Agreements Form 8-K reported
that on February 4, 1998, Cygnus entered into Note Purchase Agreements
with certain institutional investors to issue and sell, in a direct
public offering, 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.
Interest on the Notes may be paid in Common Stock or cash at the option
of the Company. 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 or 150% of the market price of the
Common Stock for 20 trading days preceding such date.
The form of First Supplemental Indenture and Note Purchase Agreement
executed in connection with the Notes by the Company are incorporated by
reference to the Company's Form 8-K dated February 4, 1998 as Exhibits
4.5 and 10.38, respectively.
The second report was dated February 4, 1998 (the "Common Stock
Agreement Form 8-K"). The Common Stock Agreement Form 8-K reported that
on February 4, 1998, Cygnus entered into Stock Purchase Agreements to
issue and sell 905,740 shares of its Common Stock in a direct public
offering to certain institutional investors. The total proceeds
received by the Company in the offering was approximately $13.8 million.
The form of Common Stock Purchase Agreement executed in connection with
the sale of Common Stock by the Company is incorporated by reference to
the Company's Form 8-K dated February 4, 1998 as Exhibit 10.37.
16
<PAGE>
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: May 14, 1998 By: /s/ John C. Hodgman
---------------------- --------------------------------------------
John C. Hodgman
President, Cygnus Diagnostics
and Chief Financial Officer
(and Principal Accounting Officer)
17
<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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 32,334
<SECURITIES> 35,115<F1>
<RECEIVABLES> 1,981
<ALLOWANCES> 400
<INVENTORY> 914
<CURRENT-ASSETS> 71,629
<PP&E> 16,858
<DEPRECIATION> 11,623
<TOTAL-ASSETS> 84,346
<CURRENT-LIABILITIES> 14,592
<BONDS> 69,148
0
0
<COMMON> 136,659
<OTHER-SE> (142,067)
<TOTAL-LIABILITY-AND-EQUITY> 84,346
<SALES> 506
<TOTAL-REVENUES> 3,460
<CGS> 256
<TOTAL-COSTS> 1,023
<OTHER-EXPENSES> 7,981
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 394
<INCOME-PRETAX> (5,536)
<INCOME-TAX> 2
<INCOME-CONTINUING> (5,538)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,538)
<EPS-PRIMARY> (0.28)
<EPS-DILUTED> (0.28)
<FN>
<F1>THIS AMOUNT REPRESENTS SHORT-TERM INVESTMENTS HELD BY THE COMPANY ON 3/31/98
</TABLE>
