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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
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 NO. 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
(Address of Principal Executive Offices) (Zip Code)
(650) 369-4300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
$0.001 PAR VALUE
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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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing price of common stock on March 23, 2001 as
reported on the Nasdaq National Market was approximately $172,268,743.
Determination of affiliate status for this purpose is not a determination of
affiliate status for any other purpose.
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27,907,171
(Number of shares of common stock outstanding as of March 23, 2001)
DOCUMENTS INCORPORATED BY REFERENCE
Registrant's definitive Proxy Statement to be filed pursuant to
Regulation 14A for its 2001 Annual Meeting of Stockholders is incorporated by
reference into Part III hereof.
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CYGNUS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. Business.................................................... 2
ITEM 2. Properties.................................................. 7
ITEM 3. Legal Proceedings........................................... 7
ITEM 4. Submission of Matters to a Vote of Security Holders......... 7
PART II
ITEM 5. Market for Registrant's Common Stock and Related Stockholder
Matters..................................................... 8
ITEM 6. Selected Financial Data..................................... 8
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
ITEM 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 22
ITEM 8. Financial Statements and Supplementary Data................. 23
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 23
PART III
ITEM 10. Directors and Executive Officers of the Registrant.......... 24
ITEM 11. Executive Compensation...................................... 25
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 25
ITEM 13. Certain Relationships and Related Transactions.............. 25
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 25
SIGNATURES............................................................ 31
1
PART I
ITEM 1. BUSINESS.
OVERVIEW
SOME OF THE STATEMENTS IN THIS REPORT, INCLUDING IN THE DOCUMENTS
INCORPORATED BY REFERENCE, ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS INCLUDE STATEMENTS ABOUT OUR
PLANS, OBJECTIVES, EXPECTATIONS, INTENTIONS AND ASSUMPTIONS AND OTHER STATEMENTS
CONTAINED IN THIS REPORT, INCLUDING IN THE DOCUMENTS INCORPORATED BY REFERENCE,
THAT ARE NOT STATEMENTS OF HISTORICAL FACT. FORWARD-LOOKING STATEMENTS INCLUDE,
BUT ARE NOT LIMITED TO, STATEMENTS ABOUT OUR ABILITY TO MANUFACTURE AND SCALE-UP
COMMERCIALLY THE GLUCOWATCH BIOGRAPHER, PLANS FOR COMMERCIALIZATION ALLIANCES,
OUR ABILITY TO ACHIEVE MARKET ACCEPTANCE OF THE GLUCOWATCH BIOGRAPHER, AND PLANS
FOR ENHANCEMENTS AND POSSIBLE MANUFACTURING CHANGES THROUGH THE PRE-MARKET
APPROVAL (PMA) SUPPLEMENT PROCESS. IN SOME CASES, YOU CAN IDENTIFY THESE
STATEMENTS BY WORDS SUCH AS "MAY," "WILL," "SHOULD," "ESTIMATES," "PREDICTS"
"POTENTIAL," "CONTINUE," "STRATEGY," "BELIEVES," "ANTICIPATES," "PLANS,"
"EXPECTS," "INTENDS" AND SIMILAR EXPRESSIONS. WE CANNOT GUARANTEE FUTURE
RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. OUR ACTUAL RESULTS AND
THE TIMING OF CERTAIN EVENTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED
IN "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS," INCLUDING THOSE UNDER "RISK FACTORS" THEREIN, AND
ELSEWHERE IN THIS REPORT, INCLUDING IN THE DOCUMENTS INCORPORATED BY REFERENCE.
Cygnus was incorporated in California in 1985 and was merged into a Delaware
corporation in 1995. Our principal executive offices are located at 400
Penobscot Drive, Redwood City, California 94063, our telephone number at that
address is (650) 369-4300 and our facsimile number at that address is
(650) 369-5318. Additionally, our website is www.cygn.com.
We develop and manufacture diagnostic medical devices, utilizing proprietary
technologies to satisfy unmet medical needs cost-effectively. The first such
device is a frequent, automatic and non-invasive glucose monitoring device, the
GlucoWatch biographer, and enhancements thereto. On March 22, 2001, we received
approval from the United States Food and Drug Administration (FDA) to
commercially distribute our GlucoWatch biographer in the United States.
THE GLUCOWATCH-REGISTERED TRADEMARK- BIOGRAPHER
We believe that there is an unmet need for automatic, frequent and
non-invasive glucose monitoring. In an effort to address this unmet need, we
have developed the GlucoWatch biographer. The system is comprised of two
components: a durable component known as the biographer, and a consumable
component known as the AutoSensor. The durable GlucoWatch biographer is worn
like a wristwatch and displays and stores current and past glucose levels and
trend data. The extracted glucose is collected in a consumable AutoSensor that
is replaced after 12 hours. The AutoSensor, after calibration with a standard
blood glucose monitor, is attached to the back of the biographer and
automatically extracts and measures glucose levels through intact skin every 20
minutes. The GlucoWatch biographer offers, in a portable and discreet device,
features not available in currently marketed devices. These include frequent
data collection, electronic memory to store and display glucose levels, alerts
indicating hypoglycemic and hyperglycemic conditions and event markers that
record factors that affect glucose levels. The GlucoWatch biographer is designed
to be worn day and/or night for glucose monitoring and is expected to reduce
significant drawbacks of the finger stick technique, such as the pain of
repetitive sticking and the disruption of normal activities caused by cumbersome
procedures. We believe that the GlucoWatch biographer can provide additional
information that can help people with diabetes understand fluctuations in their
glucose levels.
Specifically, our GlucoWatch biographer extracts glucose molecules through
intact skin utilizing a patented sampling process. The glucose is extracted from
fluid surrounding skin cells, rather than from
2
blood, and is collected and measured by the AutoSensor. The glucose collected in
the Autosensor produces an electrochemical signal, and a custom-designed
computer chip in the biographer converts the electrochemical signal into a
glucose reading. The GlucoWatch biographer automatically measures glucose levels
at 20-minute intervals and displays the most recent readings and trends at the
push of a button. Its electronic memory capabilities permit the retrieval of
past data, allowing longer-term trend analysis.
Additionally, we are developing future generation glucose monitoring
products, as well as enhancements to the GlucoWatch biographer. Such
enhancements may include features for increased user convenience such as a
shorter warm-up period, extension of the AutoSensor measurement duration beyond
12 hours, an increase in the number of glucose measurements per hour, addition
of a delayed start feature, and personal computer linkages for downloading data,
as well as various cost reductions in the manufacturing process. Other
enhancements are also under consideration. We are in the early developmental
stages for a future product utilizing communication by radio frequency that
allows both greater flexibility in the location of the glucose extraction
component and a new form of the biographer that stores and displays glucose
data.
CYGNUS IN THE YEAR 2000
In June 2000, we established Cygnus (UK) Limited, a wholly owned subsidiary
of Cygnus, Inc., in the United Kingdom and have hired initial management,
training and sales personnel to manage our introduction of the GlucoWatch
biographer into our first European country. We established a Medical Advisory
Board in the United Kingdom, who provided our GlucoWatch biographer to select
adults with diabetes in order to improve our understanding of patient and health
care provider experiences. We entered into a contract with one company to
provide direct-to-consumer distribution/logistics functions in the United
Kingdom and a second agreement with another company to provide call center
technical services.
In the fourth quarter of 2000, we shipped our first commercial GlucoWatch
biographers to the United Kingdom. Additionally, we are currently exploring
strategic alternatives for commercializing the GlucoWatch system in other
countries in Europe. We have already entered into a contract with a company to
serve as our authorized representative in the European Economic Area (EEA),
including the United Kingdom. By way of background, in 1999, we first received a
CE Certificate for the GlucoWatch biographer system, indicating that the product
has met the essential requirements and other criteria of the European Community
Directive 93/42/ECC, Annex V, Section 3.2. The CE Certificate is required for
selling products in the European Community.
In August 2000, we signed a Warehouse Distribution Agreement with Livingston
Healthcare Services, Inc. to provide outsource logistics services in the United
States for our GlucoWatch biographer. The agreement covers receiving, storage,
customer service, technical support and shipment. However, we are still solely
responsible for the production, marketing and sales of the GlucoWatch
biographer. The term of the agreement is for five years, but we have the option
to terminate the agreement before then with an early-termination payment.
In October 2000, we regained the marketing and distribution rights for the
GlucoWatch biographer in Japan. Yamanouchi Pharmaceutical Co., Ltd. informed us
that, due to strategic reasons, the collaboration between Cygnus and Yamanouchi
for the marketing and distribution of the GlucoWatch biographer in Japan needed
to be terminated. Under terms of the agreement, Yamanouchi will continue to be
responsible for a milestone payment in 2001 and we assumed ownership of all the
Japanese clinical trial data and regulatory submissions. The parties executed a
formal Termination Agreement effective February 2001.
In December 2000, we were awarded two six-month Phase I Small Business
Innovative Research (SBIR) Grants for "Improving Performance and Reliability of
a Non-Invasive Glucose Biosensor" and
3
"Prediction of Hypoglycemia Using the GlucoWatch Biographer" from the National
Institute of Diabetes and Digestive and Kidney Diseases division of the National
Institutes of Health (NIH) in the amount of $100,000 each. We are using the
funding to investigate a predictive kinetic method to reduce the effects of
certain variables and to study prediction of incipient hypoglycemia.
RECENT DEVELOPMENTS
In March 2001, we signed a U.S. Market Research Agreement with
Lifescan, Inc., a Johnson & Johnson company, for the GlucoWatch biographer.
Under the terms of the agreement, Lifescan will have exclusive access for a
limited period of time to data from a pilot marketing program to be conducted in
the United States by Cygnus for the GlucoWatch biographer. The agreement also
calls for us to have exclusive access to any market research conducted by
Lifescan relating to the GlucoWatch biographer. In addition, the agreement
provides Lifescan a right of first refusal with respect to a Comprehensive
Collaboration Agreement from the signing of the agreement to at least sixty days
after market research data has been received by Lifescan. A Comprehensive
Collaboration Agreement is defined in the agreement as one company providing all
commercial functions necessary to market, sell, supply, distribute and support
customers in the United States. Neither party has any obligation to enter into a
Comprehensive Collaboration Agreement.
In March 2001, we established Cygnus International, Inc., a Delaware
corporation and a wholly owned subsidiary of Cygnus, Inc., to manage general and
administrative activities of our international operations.
Also in March 2001, we received approval from the FDA to market our
GlucoWatch biographer in the United States as a prescription device for adults
with diabetes.
CYGNUS' BUSINESS STRATEGY
We believe that more than 40 million people in North America, Europe, Japan
and Korea have diabetes. In the United States alone, we believe that more than
10 million people have been diagnosed with diabetes, with another six million
believed to have the condition.
Clinical studies sponsored by the United States National Institutes of
Health (NIH) indicate that better management of glucose levels through more
frequent testing and more frequent insulin injections would enable people with
diabetes to reduce or significantly delay many serious diabetes-related health
complications. However, largely due to the pain of repetitive finger sticking
and the associated disruption of daily life, most people with diabetes currently
test their glucose levels less than half as often as recommended, resulting in
limited information to make decisions that could better control glucose
fluctuations. We believe this lack of information presents a significant unmet
need for a new type of glucose monitoring device.
To address this unmet need, our GlucoWatch biographer provides frequent,
automatic and non-invasive glucose measurements and is intended for detecting
trends and tracking patterns of glucose levels in adults, 18 years and older,
who have diabetes. The device is intended for use at home and in health care
facilities to supplement, not replace, information obtained from standard home
blood glucose monitoring devices. Following a three-hour warm-up period and
calibration from a finger stick blood measurement, the device is capable of
providing up to 36 non-invasive glucose measurements over 12 hours. The
extracted glucose is collected in the AutoSensor, which is attached to the back
of the biographer and replaced after 12 hours of measurements. The GlucoWatch
biographer system (i.e., the biographer and AutoSensor) offers features such as
alerts indicating hypoglycemic and hyperglycemic conditions and event markers
that record factors affecting glucose levels.
4
It has been our priority to establish alliances to allow us to successfully
develop, manufacture and commercialize the GlucoWatch biographer. We have
already entered into several agreements, including the following:
- a patent license agreement with The Regents of the University of
California;
- supply agreements relating to materials for our GlucoWatch biographer,
including those with E.I. du Pont de Nemours and Company, Key Tronic
Corporation and Hydrogel Design Systems, Inc.;
- contract manufacturing agreements with Contract Manufacturing, Inc., now
Corium International, for the consumable AutoSensor, and with Sanmina
Corporation for the manufacture of the durable GlucoWatch biographer; and
- an outsource logistics service contract with Livingston Healthcare
Services, Inc. to provide receiving, storage, customer service, technical
support and shipment in the United States, as well as logistics contracts
with companies for the United Kingdom.
We will introduce the GlucoWatch biographer initially on a limited basis to
a small number of patients selected by designated physicians for a pilot
marketing program. We plan to conduct this program to learn more about patients'
and caregivers' firsthand experiences with the GlucoWatch biographer. To support
that effort, comprehensive training materials and curricula have been completed
and will be introduced to physicians and health care professionals. In addition,
new clinical research trials will be started to potentially expand the
indications for the GlucoWatch biographer, including its use with gestational
diabetes. We have begun clinical trials with children and adolescents (ages
7-17). We also have begun outcome studies designed to demonstrate the benefits
of our GlucoWatch biographer, collecting information that can become part of
efforts to secure reimbursement from managed care organizations. We have
initiated professional education programs to introduce our technology to
physicians and other diabetes health care professionals.
REGULATORY STATUS
In 1999, we applied to the United States Food and Drug Administration (FDA)
for approval to sell our GlucoWatch biographer. On December 6, 1999, our
pre-market approval (PMA) application received a unanimous recommendation for
approval, subject to conditions, from the FDA's Clinical Chemistry and Clinical
Toxicology Devises Panel of the Medical Devices Advisory Committee. In May 2000
we received an approvable letter from the FDA for our GlucoWatch biographer
wherein specific, final conditions relating to manufacturing, final printed
labeling materials, and post-market evaluations of certain aspects of product
performance were set forth.
On March 22, 2001, the FDA granted approval for us to market and
commercially distribute, as a prescription device for adults, the GlucoWatch
biographer in the United States. As indicated in the approvable letter,
post-market evaluation studies on certain topics are required after we begin
selling.
It was in mid-1998 that we established product specifications and
manufacturing processes for the GlucoWatch biographer system approved by the
FDA. Since that time, we have developed, and continue to develop, a number of
enhancements to the GlucoWatch biographer's performance and user convenience,
and are developing a future product utilizing communication by radio frequency.
Additionally, we are working on equipment and processes for improving
manufacturing capacity and reducing manufacturing costs. Before we can make the
GlucoWatch biographer broadly available, we must qualify and validate our
large-scale production equipment and processes. We will submit some of these
product and manufacturing enhancements to the FDA by supplementing our existing
PMA application.
In 1999, we first received a CE Certificate for the GlucoWatch biographer
system, indicating that the product has met the essential requirements and other
criteria of the European Community
5
Directive 93/42/ECC, Annex V, Section 3.2. The CE Certificate is required for
selling products in the European Community.
Our facility complies with ISO 9002, EN 46002, and United States Quality
System Regulations standards. We hold a Medical Device Manufacturing License
from the California Department of Health Services, Food and Drug Branch and a
Device Establishment Registration Number from the Center for Devices and
Radiological Health branch of the United States Food and Drug Administration. We
are currently establishing our AutoSensor and biographer commercial
manufacturing operations in two existing third-party facilities, which also
comply with applicable regulatory requirements.
COMPETITION
The medical device industry, particularly the market in which we will offer
the GlucoWatch biographer, is intensely competitive and we will compete with
other providers of personal glucose monitors. Currently the market is dominated
by finger stick blood glucose monitoring products sold by a few major companies.
These companies have established products and distribution channels. Finger
stick glucose monitoring presents a number of barriers to generating more
frequent blood glucose measurements, including the pain of repetitive finger
sticking and the disruption of normal activities, as often people with diabetes
do not want to go through the finger stick process in public. Several companies
are developing alternative invasive, semi-invasive, minimally invasive or
non-invasive methods to monitor glucose levels in a less painful or painless
manner, as well as on a continuous or continual basis. Companies are attempting
to develop a variety of methods to extract fluid surrounding skin cells and
measure the glucose concentration therein. Another technology that some
companies are pursuing is the use of infrared spectroscopy, which uses radiation
to measure glucose levels. We are not aware of any products under development
that offer the range of potential benefits of the GlucoWatch biographer.
However, there can be no assurance that other products will not be more accepted
in the marketplace than the GlucoWatch biographer or will not render our devices
noncompetitive or obsolete. Additionally, the GlucoWatch biographer or our other
enhanced products under development may fail to replace any currently used
devices or systems. A number of companies have developed or are seeking to
develop new drugs to treat diabetes that could reduce demand for glucose
monitoring systems. In addition, many of our competitors and potential
competitors have substantially greater resources, research and development
staffs and facilities than we do and have significantly greater experience in
developing, manufacturing and marketing glucose monitoring devices. Competition
within the glucose monitoring industry could also result in price reductions for
glucose monitoring devices such that we may not be able to sell the GlucoWatch
biographer at a price level adequate for us to realize a return on our
investment.
DEPENDENCE UPON A SINGLE CUSTOMER
Our 2000 revenues were solely contract revenues, of which 95% of our
contract revenues relate to an amortized milestone payment from Yamanouchi
received in 1999 and the remaining 5% relate to NIH SBIR grants. Our agreement
with Yamanouchi has been terminated, although Yamanouchi is responsible for a
milestone in 2001.
RESEARCH AND DEVELOPMENT COSTS
In 2000, we spent $21.2 million in research and development costs. In 1999,
this amount was $15.7 million, and in 1998 this amount was $25.6 million.
PATENTS AND PROPRIETARY RIGHTS
It is our policy to aggressively protect our investments in technology and
marketing by filing patent and trademark applications in the United States and
key foreign countries. As of December 2000, and
6
after the sale of substantially all of our drug delivery business assets,
including the intellectual property associated therewith, we have nine issued
United States patents and 21 issued foreign patents, with approximately 78
additional patent applications pending worldwide. These patents and applications
cover various aspects of analyte monitoring, including glucose monitoring
systems, and represent over 20 patent families. As of December 2000, we have
four United States trademark registrations, with seven United States trademark
applications pending or published, and about 60 foreign trademark registrations,
with approximately 12 additional foreign trademark applications pending. Our
"GlucoWatch" trademark is registered in the United States, the European
Community and other foreign countries.
Additionally, our GlucoWatch biographer incorporates technology licensed
exclusively to us by The Regents of the University of California. The Regents
hold United States and foreign patents covering technology for transdermal
extraction of glucose and other analytes.
EMPLOYEES
As of December 31, 2000, we had 112 full-time employees. Of this total
number of employees, 45 are in research and development, including process
developments, 19 in scientific affairs and quality assurance, 32 in selling and
general administrative, and 16 in operations. None of our employees is
represented by a labor union. We have experienced no work stoppages and believe
our employee relations are good.
ITEM 2. PROPERTIES.
We lease approximately 70,000 square feet in three buildings. All three
buildings are located in Redwood City, California. We have two leases. The first
lease is for a building, approximately 38,000 square feet that is used by us.
The second lease includes two buildings, one of which is approximately 11,000
square feet, was subleased to The 3DO Company through January 31, 2001 and is
currently being offered for sublease. The other building, approximately 21,000
square feet, is subleased to Ortho-McNeil, with this sublease running
concurrently with our main lease through 2003. In November 2000, we terminated a
separate lease for a building located in Menlo Park, California that was
previously used by us for storage. The three buildings in Redwood City are
leased through 2003. We have an option to renew at the then-prevailing market
rent through 2008.
The applicable Cygnus facility complies with ISO 9002, EN 46002, and United
States Quality System Regulations standards. We hold a Medical Device
Manufacturing License from the California Department of Health Services, Food
and Drug Branch and a Device Establishment Registration Number from the Center
for Devices and Radiological Health branch of the United States Food and Drug
Administration.. We are currently establishing our AutoSensor and GlucoWatch
biographer commercial manufacturing operations in two existing third-party
facilities, which also comply with applicable regulatory requirements.
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
Our common stock trades on the Nasdaq national market tier of the Nasdaq
Stock Market(SM) under the symbol "CYGN." The following table sets forth, for
the periods indicated, the high and low closing sale prices per-share of the
common stock as reported by the Nasdaq national market.
HIGH LOW
------------- -------------
2000:
First Quarter............................................ $19 15/16 $14 1/2
Second Quarter........................................... 15 15/16 7 5/32
Third Quarter............................................ 14 1/4 9 3/32
Fourth Quarter........................................... 9 11/16 4
HIGH LOW
------------- -------------
1999:
First Quarter............................................ $ 8 1/4 $ 4 1/2
Second Quarter........................................... 13 8 7/32
Third Quarter............................................ 12 1/2 9 1/4
Fourth Quarter........................................... 19 5/8 8 13/16
As of March 8, 2001, there were approximately 642 record holders of our
common stock. We have not paid any cash dividends since our inception and do not
expect to pay any cash dividends on our common stock in the foreseeable future.
In addition, we are precluded from paying any dividends under certain of our
financing arrangements.
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data presented below are derived from
the audited consolidated financial statements of Cygnus, Inc. We have restated
our consolidated statements of operations for the years ended December 31, 1999,
1998, 1997 and 1996 to reflect the results of the drug delivery business as a
discontinued operation. The following data should be read in conjunction with
the consolidated financial statements and related notes, the information set
forth under "Item 7. Management's Discussion and Analysis of Financial
Conditions and Results of Operations" and other financial information included
herein.
8
Effective June 28, 2000, we established Cygnus (UK) Limited, a wholly owned
subsidiary of Cygnus, Inc., in the United Kingdom. The condensed consolidated
financial statements include the United Kingdom transactions in United States
dollars.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Contract revenues......................................... $ 1,052 $ 2,061 $ 457 $ 2,146 $ 2,712
Costs and expenses:
Research and development................................ 21,170 15,745 25,635 16,198 11,079
Marketing, general and administrative................... 10,072 4,794 8,810 2,205 1,903
-------- -------- -------- -------- --------
Total costs and expenses.............................. 31,242 20,539 34,445 18,403 12,982
-------- -------- -------- -------- --------
Loss from operations...................................... (30,190) (18,478) (33,988) (16,257) (10,270)
Other income and (expense)................................ (1,717) (3,496) (6,446) 1,140 1,865
-------- -------- -------- -------- --------
Loss from continuing operations before tax................ (31,907) (21,974) (40,434) (15,117) (8,405)
Provision for tax......................................... (100) (200) -- -- --
-------- -------- -------- -------- --------
Loss from continuing operations........................... (32,007) (22,174) (40,434) (15,117) (8,405)
-------- -------- -------- -------- --------
Discontinued operations:
Income/(loss) from operations of a discontinued
segment............................................... -- 3,031 1,006 (35,343) (2,647)
Gain on disposal of a segment........................... -- 16,308 -- -- --
-------- -------- -------- -------- --------
Net loss before cumulative effect of a change in
accounting
principle............................................... (32,007) (2,835) (39,428) (50,460) (11,052)
Cumulative effect of a change in accounting principle..... (5,026) -- -- -- --
-------- -------- -------- -------- --------
Net loss.................................................. $(37,033) $ (2,835) $(39,428) $(50,460) $(11,052)
======== ======== ======== ======== ========
Net loss per share from continuing operations, basic and
diluted................................................. $ (1.22) $ (0.95) $ (2.00) $ (0.80) $ (0.45)
Net income/(loss) per share from a discontinued segment,
basic and diluted....................................... -- 0.83 0.05 (1.87) (0.15)
Net loss per share from cumulative effect of a change in
accounting principle.................................... (0.19) -- -- -- --
-------- -------- -------- -------- --------
Net loss per share, basic and diluted..................... $ (1.41) $ (0.12) $ (1.95) $ (2.67) $ (0.60)
======== ======== ======== ======== ========
Shares used in computation of net loss per share, basic
and diluted............................................. 26,315 23,354 20,226 18,928 18,544
======== ======== ======== ======== ========
DECEMBER 31,
--------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- --------- --------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital.......................................... $ 9,869 $ 30,111 $ 11,542 $ 9,941 $ 36,386
Total assets............................................. 32,889 46,976 43,454 49,277 68,798
Long-term obligations.................................... 32,189 38,476 60,220 33,234 13,437
Accumulated deficit...................................... (215,823) (178,790) (175,955) (136,527) (86,067)
Stockholders' equity (net capital deficiency)............ $ (13,023) $ (1,204) $ (32,767) $ (13,800) $ 31,213
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
SOME OF THE STATEMENTS IN THIS REPORT, INCLUDING IN THE DOCUMENTS
INCORPORATED BY REFERENCE, ARE FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS INCLUDE STATEMENTS ABOUT OUR
PLANS, OBJECTIVES, EXPECTATIONS, INTENTIONS AND ASSUMPTIONS AND OTHER STATEMENTS
CONTAINED IN THIS REPORT, INCLUDING IN THE DOCUMENTS INCORPORATED BY REFERENCE,
THAT ARE NOT STATEMENTS OF HISTORICAL FACT. FORWARD-LOOKING STATEMENTS INCLUDE,
BUT ARE NOT LIMITED TO, STATEMENTS ABOUT OUR ABILITY TO MANUFACTURE AND SCALE-UP
COMMERCIALLY THE GLUCOWATCH BIOGRAPHER, PLANS FOR COMMERCIALIZATION ALLIANCES,
OUR ABILITY TO ACHIEVE MARKET ACCEPTANCE OF THE GLUCOWATCH BIOGRAPHER, AND PLANS
FOR ENHANCEMENTS AND POSSIBLE MANUFACTURING CHANGES THROUGH THE PMA SUPPLEMENT
PROCESS. IN SOME CASES, YOU CAN IDENTIFY THESE STATEMENTS BY WORDS SUCH AS
"MAY," "WILL," "SHOULD," "ESTIMATES," "PREDICTS" "POTENTIAL," "CONTINUE,"
"STRATEGY," "BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS," "INTENDS" AND SIMILAR
EXPRESSIONS. WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE
OR ACHIEVEMENTS. OUR ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER
SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DISCREPANCY INCLUDE THOSE DISCUSSED BELOW IN
"RISK FACTORS" AND ELSEWHERE IN THIS REPORT, INCLUDING IN THE DOCUMENTS
INCORPORATED BY REFERENCE.
GENERAL
We are engaged in the development and manufacture of diagnostic medical
devices, utilizing proprietary technologies to satisfy unmet medical needs
cost-effectively. Our current efforts are primarily focused on a frequent,
automatic and non-invasive glucose monitoring device, the GlucoWatch biographer
for which we received FDA approval in March 2001, and enhancements thereto. In
1999, we sold substantially all of our drug delivery business to Ortho-McNeil
Pharmaceutical, Inc., and chose to focus on glucose monitoring systems. The drug
delivery business has been accounted for as a discontinued operation and prior
years' financial statements have been restated to report only continuing
operations. For us to remain competitive, we will need to develop, in-license or
acquire new diagnostic products.
Our results of operations vary significantly from year to year and have in
the past largely depended on 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 licensees and the demand for our products. The level of revenues in any given
period is not necessarily indicative of expected revenues for future periods. In
2000, 95% of our revenues were attributable to one customer. We have incurred
net losses each year since our inception and do not believe we will achieve
profitability at least in 2001. At December 31, 2000, our accumulated deficit
and net capital deficiency were approximately $215.8 million and $13.0 million,
respectively.
RESULTS OF OPERATIONS
The drug delivery business has been accounted for as a discontinued
operation and prior years' financial statements have been restated to report
only continuing operations. As a result, no product revenues, royalty revenues
or costs of products sold have been reflected in our financial statements.
COMPARISON FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999
CONTRACT REVENUES for the year ended December 31, 2000 were $1.1 million,
compared to the $2.1 million for the year ended December 31, 1999. Contract
revenues consisted primarily of the amortization of a milestone payment
associated with the GlucoWatch biographer received from Yamanouchi
Pharmaceutical Co., Ltd. in 1999. The majority of this milestone payment was
amortized in 1999, which resulted in decreased 2000 contract revenue when
compared to 1999 contract revenue.
10
Revenue from the two six-month Phase I Small Business Innovative Research
(SBIR) Grants in the aggregate amount of $200,000 is recognized as reimbursable
expenses are incurred.
RESEARCH AND DEVELOPMENT EXPENSES for the year ended December 31, 2000 were
$21.2 million, compared to $15.7 million for the year ended December 31, 1999.
The increase is primarily due to an increase in expenses incurred to develop and
test large-scale manufacturing processes for the AutoSensor. Research,
development and clinical activities primarily included support and development
for the glucose monitoring program. We anticipate that the development of new
products and technologies, along with additional clinical trials, will result in
an increase in our overall research and development expenses in 2001.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the year ended
December 31, 2000 were $10.1 million, compared to $4.8 million for the year
ended December 31, 1999. This increase is primarily due to our increased
marketing efforts (including the establishment of a subsidiary and
infrastructure in preparation for a commercial launch in the United Kingdom and
the development and preparation of sales and marketing materials) and non-cash,
stock-based compensation. We expect that marketing, general and administrative
expenses will increase in 2001 as we plan for commercialization of our
GlucoWatch biographer.
OTHER INCOME AND (EXPENSE) for the year ended December 31, 2000 was ($1.7)
million, compared to ($3.5) million for the year ended December 31, 1999. The
decrease in net interest expense is primarily due to a one-time, non-recurring
charge in connection with the write-down of the remaining unamortized debt
issuance costs associated with the retirement of the Senior Subordinated
Convertible Notes in June 1999. In addition, interest income earned for the year
ended December 31, 2000 increased in conjunction with the higher average year
2000 cash, cash equivalents and investment balances.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE. In November 2000,
the Emerging Issues Task Force (EITF) of the Financial Accounting Standards
Board (FASB) required companies to adopt a new methodology for computing the
beneficial conversion feature of convertible securities, which is to be applied
retroactively for commitments entered into on or after May 20, 1999.
Accordingly, we recorded a one-time, non-cash charge of $5.0 million to record
the cumulative effect of a change in accounting principle as required under the
guidance provided by the EITF.
DISCONTINUED OPERATIONS. No revenues or net income was recognized on the
discontinued operations for the year ended December 31, 2000 as a result of the
1999 sale of our drug delivery business. Total revenues and net income on the
discontinued operations were $12.3 million and $3.0 million, respectively, for
the year ended December 31, 1999. In 1999, we also recorded a gain of
$16.3 million on the disposal of our drug delivery business.
COMPARISON FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
CONTRACT REVENUES for the year ended December 31, 1999 were $2.1 million,
compared to the $0.5 million for the year ended December 31, 1998. Contract
revenues primarily reflect the amortization of previously deferred and
additional milestone payments relating to the GlucoWatch biographer. The
increase in contract revenue was primarily due to the amortization of an
additional milestone payment received in 1999.
RESEARCH AND DEVELOPMENT EXPENSES for the year ended December 31, 1999 were
$15.7 million, compared to $25.6 million for the year ended December 31, 1998.
This decrease reflects a reduction in clinical studies and development
expenditures associated with the GlucoWatch biographer. Research, development
and clinical activities primarily included support and development for the
glucose monitoring program.
11
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the year ended
December 31, 1999 were $4.8 million, compared to $8.8 million for the year ended
December 31, 1998. The decrease was primarily due to reduced compensation and
market research expenses.
OTHER INCOME AND (EXPENSE) for the year ended December 31, 1999 was ($3.5)
million, compared to ($6.4) million for the year ended December 31, 1998. The
decrease was due primarily to the recording in 1998 of the $4.2 million non-cash
costs of the beneficial conversion feature associated with the October 1998
restructuring of the Senior Subordinated Convertible Notes and write-off of the
previously deferred debt issuance cost of $1.0 million, in conjunction with the
partial repayment of the Senior Subordinated Convertible Notes, offset by a net
arbitration settlement with Pharmacia & Upjohn, from which Cygnus received
$2.7 million.
INCOME/LOSS FROM OPERATIONS OF A DISCONTINUED SEGMENT for the year ended
December 31, 1999 was $3.0 million, compared to $1.0 million for the year ended
December 31, 1998. The increase was due primarily to a decrease in overall
segment expenses.
DISCONTINUED OPERATIONS. Total revenues and net income on the discontinued
operations were $12.3 million and $3.0 million, respectively, for the year ended
December 31, 1999. In 1999, we also recorded a gain of $16.3 million on the
disposal of the segment.
INFLATION
While it is difficult to accurately measure the impact of inflation, we
believe that the effects of inflation on our operations have been immaterial.
FINANCING INSTRUMENTS
In June 1999, we entered into two financing arrangements: a Convertible
Debenture and Warrant Purchase Agreement ("Convertible Debenture") and a
Structured Equity Line Flexible Financing(SM) Agreement ("Equity Line"). Under
the Convertible Debenture, convertible debentures having a principal amount of
$14.0 million were issued at a conversion price of $12.705 per share. Principal
is due June 29, 2004. The Convertible Debenture also provided for an additional
$6.0 million, composed of two $3.0 million tranches, and in September 1999 we
received $3.0 million in gross proceeds from the issuance of the first
additional tranche, having a conversion price of $11.8663 and due September 29,
2004. The $3.0 million second additional tranche is still available under this
financing instrument.
The Equity Line originally had a maximum aggregate issue price of
$30.0 million over a two-year commitment period and allows us, at our sole
discretion, to sell common stock over this period. In 1999 we received proceeds
of approximately $9.5 million from the original $30.0 million. These proceeds
resulted from the sale of approximately 909,000 shares of common stock pursuant
to the Equity Line. In May 2000, the Equity Line was amended to increase the
maximum aggregate issue price by an additional $30.0 million to a total of
$60.0 million, to provide for the issuance of warrants to purchase up to 600,000
shares of common stock, to replace the calculation used to determine the per
share price with a formula more favorable to the Company and to extend the
commitment period. In 2000, we received additional proceeds of approximately
$14.2 million. These proceeds resulted from the sale of approximately 1,480,000
shares of common stock pursuant to the Equity Line. Thus, as of December 31,
2000, we have received approximately $23.7 million and have $36.3 million
available under the amended Equity Line.
Since December 31, 2000, we have received an additional $2.4 million of
proceeds, leaving $33.9 million available under the Equity Line. In March 2001,
we terminated the existing amended Equity Line and entered into a new Equity
Line with the same Investors for a maximum aggregate issue price of
$33.0 million. The terms and conditions of this new Equity Line are
substantially the
12
same as the prior amended Equity Line. We now have $33.0 million available under
the new Equity Line.
Five-year warrants have been issued under our financing instruments. In
conjunction with the Convertible Debenture, warrants to purchase approximately
656,000 shares of common stock at an exercise price of $13.86 per share and
139,000 shares of common stock at an exercise price of $16.18 per share were
issued in 1999. At the dates of grant, the fair values ascribed to these
warrants were approximately $5.5 million and $1.1 million, respectively, based
on a Black-Scholes valuation model, and these amounts are being amortized as
additional interest expense over the term of the debt. We recorded amortization
of $0.3 million for the three months ended December 31, 2000 and $1.3 million
for the 12 months ended December 31, 2000. As of December 31, 2000, the
unamortized fair value amounted to $4.7 million. In conjunction with the Equity
Line, in January 2000 we issued warrants to purchase 95,000 shares of common
stock at $11.51 per share.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and investment balances as of December 31, 2000
totaled $24.5 million. We have received net proceeds of approximately
$119.1 million from public offerings of our common stock through December 31,
2000. Since inception, we have financed approximately $11.1 million of
manufacturing and research equipment under capital loan and lease arrangements.
Borrowings under those arrangements are secured by specific Cygnus assets. We
have an outstanding bank loan agreement with Silicon Valley Bank that requires
monthly principal and interest payments through August 2001, in addition to
compliance with various financial covenants. As of December 31, 2000, there was
$2.9 million outstanding under this agreement, and borrowings are secured by
specific Cygnus assets.
Net cash used in operating activities for the year ended December 31, 2000
was $28.3 million, compared with net cash used of $17.9 million for the year
ended December 31, 1999. Cash used in operating activities during the years
ended December 31, 2000 and December 31, 1999 was primarily due to the net loss
from continuing operations of $32.0 million and $22.2 million, respectively.
Net cash used in investing activities of $6.4 million for the year ended
December 31, 2000 resulted primarily from net purchases of investments of
$4.2 million and capital expenditures of $2.7 million. Net cash provided by
investing activities of $24.8 million for the year ended December 31, 1999
resulted primarily from the receipt of $20.0 million from the sale of the drug
delivery business, net sales of investments of $8.3 million, offset by capital
expenditures of $2.7 million and a contract termination fee of $800,000 in
conjunction with disposal of the drug delivery segment.
Net cash provided by financing activities totaled $14.0 million for the year
ended December 31, 2000 and included net proceeds of $13.8 million from the
sales of common stock under our Equity Line and additional stock proceeds of
$3.4 million, offset by long-term debt repayments of $3.2 million. Net cash
provided by financing activities of $11.6 million for the year ended
December 31, 1999 included net proceeds of $16.4 million and $9.2 million from
the June 1999 and September 1999 issuance of Convertible Debenture and from the
sale of common stock under the Equity Line, respectively, and additional stock
proceeds of $5.7 million, offset by the July 1999 redemption of Senior
Subordinated Convertible Notes of $12.5 million, and long-term debt and capital
lease repayments of $5.3 million and $1.9 million, respectively.
The current level of cash used in operating activities is not necessarily
indicative of the level of future cash usage. Our long-term capital expenditure
requirements will depend upon numerous factors, including, but not limited to,
(i) the progress of our research and development programs, (ii) the time
required to obtain regulatory approvals, (iii) the resources that we devote to
manufacturing, distribution and marketing of our products, (iv) the additional
expenditures to support the manufacture of new products, if and when approved,
and (v) possible acquisitions of products and technologies. As we
13
evaluate the progress of our development projects, our commercialization plans
and the lead time to set up manufacturing capabilities, we may commence
long-term planning for another manufacturing site. Nevertheless, we believe that
such long-term planning will not result in any material impact on cash flows and
liquidity for the next 12 months. We have entered into agreements to allow us to
manufacture and commercialize our GlucoWatch biographer. These contracts do not
result in any material commitment for the next 12 months.
Based upon current expectations for operating losses and projected
short-term capital expenditures, we believe that existing cash, cash equivalents
and investments of $24.5 million as of December 31, 2000--when coupled with cash
available from public financings (including debt or equity financings) and any
potential collaborations and earnings from investments--will be sufficient to
meet our operating expenses, debt servicing and repayments and capital
expenditure requirements at least for the next 12 months. However, there can be
no assurance that we will not require additional financing, depending upon
future business strategies, manufacturing and commercialization efforts, results
of clinical trials, management decisions to accelerate certain research and
development programs, and other factors.
INCOME TAXES
We recorded a $100,000 income tax provision for the year ended December 31,
2000 consisting entirely of foreign withholding taxes. At December 31, 2000, we
had federal net operating loss and research and development tax credit
carryforwards of approximately $201.4 million and $5.7 million, respectively. We
had state net operating loss and tax credit carryforwards of approximately
$58.7 million and $4.6 million, respectively. These carryforwards will expire at
various dates beginning in 2001. Because of the "change in ownership" provisions
of the Internal Revenue Code, a substantial portion of our net operating loss
and tax credit carryforwards may be subject to annual limitations. The annual
limitations may result in the expiration of the net operating losses and tax
credits before utilization.
ARBITRATION OBLIGATION
We have accrued an aggregate liability of $23 million relating to an
arbitration settlement agreement with Sanofi~Synthelabo. We have issued to
Sanofi~Synthelabo a convertible promissory note in the principal amount of
$6 million, payable in full in December 2001. In addition, we are obligated to
make a payment of $2 million in the first quarter of 2002, and payments of
$3 million, $4 million, $4 million and $4 million are due in the first quarters
of 2003 through 2006, respectively.
14
RISK FACTORS
WE WISH TO CAUTION STOCKHOLDERS AND OTHER INVESTORS THAT THE FOLLOWING
IMPORTANT FACTORS, AMONG OTHERS, IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE
COULD AFFECT, OUR ACTUAL RESULTS AND COULD CAUSE OUR ACTUAL CONSOLIDATED RESULTS
FOR 2001 AND BEYOND TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY
FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF CYGNUS. THE STATEMENTS UNDER
THIS CAPTION ARE INTENDED TO SERVE AS CAUTIONARY STATEMENTS WITHIN THE MEANING
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE FOLLOWING
INFORMATION IS NOT INTENDED TO LIMIT IN ANY WAY THE CHARACTERIZATION OF OTHER
STATEMENTS OR INFORMATION UNDER OTHER CAPTIONS AS CAUTIONARY STATEMENTS FOR SUCH
PURPOSE.
WE MAY NOT CONTINUE TO RECEIVE REGULATORY APPROVAL ON OUR PRODUCTS FROM THE
FDA AND/OR FOREIGN AGENCIES. IF WE DO NOT RECEIVE REGULATORY APPROVAL, WE WILL
NOT BE ABLE TO SELL OUR PRODUCTS OR GENERATE REVENUE IN THAT JURISDICTION.
The design, manufacturing, labeling, distribution and marketing of our
products are subject to extensive and rigorous government regulation in the
United States and certain other countries where the process of obtaining and
maintaining required regulatory clearance or approvals is lengthy, expensive and
uncertain. The FDA may not approve enhancements and possible manufacturing
changes to the GlucoWatch biographer or it may require us to file one or more
new pre-market approval (PMA) applications rather than allowing us to use a
supplement to our existing PMA application, which was approved in March 2001. In
addition, a delay in such FDA approval could substantially delay introduction of
product enhancements and our ability to cost-effectively manufacture large
quantities of the consumable component of our GlucoWatch biographer. Regulatory
requirements and procedures also vary on a country-by-country basis, and we may
not be able to obtain regulatory approval in foreign countries. Moreover, even
if regulatory approval is granted, such approval may include significant
limitations on indicated uses for which any such products could be marketed.
A medical device and its manufacturer are subject to continual review after
approval, and later discovery of previously unknown problems with a product or
the manufacturing process may result in restrictions on such product or the
manufacturer, including withdrawal of the product from the market. Failure to
comply with applicable regulatory requirements may result in, among other
things, fines, suspensions of regulatory approvals, product recalls, operating
restrictions and criminal prosecution. In addition, new government regulations
may be established that could delay or prevent regulatory approval of our
potential products. We are also subject to federal, state and local regulations
regarding workplace safety, environmental protection and hazardous material
controls, among others.
In order for us to market our products in foreign jurisdictions, we and any
of our distributors and agents must obtain required regulatory registrations or
approvals and otherwise comply with extensive regulations regarding safety,
efficacy and quality in those jurisdictions. Specifically, certain foreign
regulatory bodies have adopted various regulations governing product standards,
packaging requirements, labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. These regulations vary from country to
country. Failure to receive foreign regulatory approvals could have a material
adverse effect on our business, financial condition and results of operations.
There can be no assurance that we will obtain required regulatory registrations
or approvals in such countries or that we will not be required to incur
significant costs in obtaining or maintaining such regulatory registrations or
approvals. Delays in obtaining any registrations or approvals required to market
our products, failure to receive these registrations or approvals or future loss
of previously obtained registrations or approvals could have a material adverse
effect on our business, financial condition and results of operations.
OUR PRODUCT PIPELINE IS SEVERELY LIMITED, SO THE FAILURE OF ANY ONE PRODUCT
COULD RESULT IN THE FAILURE OF OUR ENTIRE BUSINESS.
In 1999, we sold substantially all of the assets of our drug delivery
business segment to Ortho-McNeil and terminated our remaining drug delivery
projects. We are now exclusively focused on
15
diagnostic medical devices and initially on a line of frequent, automatic and
non-invasive glucose monitoring devices. A narrow range of products subjects us
to the risk of not having alternative sources of revenue if we are unable to
commercialize our narrow line of products. We may not be successful with a
non-diversified line of products. A failure of our initial product, the
GlucoWatch biographer, could cut off our only potential source of revenue and
result in the failure of our entire business, as could the failure of any of our
future products.
For Cygnus to be successful, we will need to continue to develop glucose
monitoring products that address the needs of people with diabetes. Enhanced
glucose monitoring products based on our technologies are currently under
development. In addition, we will be evaluating new products outside of the
glucose monitoring field that can utilize our diagnostic technologies. These
products will require significant additional development and investment,
including preclinical and clinical testing, prior to their commercialization.
From time to time, we have experienced delays or setbacks in the development of
certain of our products. For example, in the past, we experienced development
delays in the miniaturization of the GlucoWatch biographer. There can be no
assurance that we will be able to successfully address problems that may arise
during the development and commercialization process. In addition, there can be
no assurance that GlucoWatch biographer enhancements or future products can or
will be successfully developed, prove to be safe and effective in clinical
trials, meet applicable regulatory standards, be capable of being manufactured
in commercial quantities at a reasonable cost, be marketed successfully or
achieve market acceptance. If any of our development programs are not
successfully completed, required regulatory approvals or clearances are not
obtained or products for which approvals or clearances are obtained are not
commercially successful, our business, financial condition and results of
operations could be materially adversely affected.
Our business is subject to the risks inherent in the development of new
products using new technologies and approaches. There can be no assurance that
unforeseen problems will not develop with these technologies or applications,
that we will be able to successfully address technological challenges we
encounter in our research and development programs or that we will be able to
develop commercially feasible products.
WE DO NOT HAVE MEDICAL DEVICE MARKETING, DISTRIBUTION, MANUFACTURING OR
SALES EXPERIENCE. IF WE ARE UNABLE TO MAKE SATISFACTORY ARRANGEMENTS FOR EACH OF
THESE, WE MAY BE UNABLE TO SUCCESSFULLY COMMERCIALIZE OUR PRODUCTS.
We may have problems in manufacturing, commercial scale-up, marketing or
distribution of our GlucoWatch biographer. We do not have any experience in any
of these areas in the medical device field. To successfully market, distribute,
manufacture and sell the GlucoWatch biographer and our other glucose monitoring
products under development, we must either develop these capabilities ourselves
or enter into arrangements with third parties. We may not succeed in either
course of action. If we attempt to develop our own capabilities, we will incur
significant start-up expenses and we will compete with other companies that have
experienced and well-funded operations. If we enter into arrangements with third
parties, any revenues we receive will depend on the third party, and we will
likely have to pay fees, sales commissions or similar amounts. If we are unable
to make satisfactory arrangements, we may be unable to successfully
commercialize our products or may experience delays in commercialization.
Our GlucoWatch biographer has been manufactured for commercial sale on a
limited basis, and we have no experience manufacturing the volumes that would be
necessary for us to achieve significant commercial sales. To successfully
commercialize the GlucoWatch biographer, we will have to manufacture the device
in compliance with regulatory requirements, in a timely manner and in sufficient
quantities while maintaining product performance, quality and acceptable
manufacturing costs. There can be no assurance that we will be able to establish
and maintain reliable, full-scale manufacturing of the GlucoWatch biographer at
commercially reasonable prices. Manufacturers often encounter difficulties in
scaling up production of new products, including problems involving product
16
performance, production yields, quality control and assurance, and shortages of
personnel. In addition, manufacturing facilities will be subject to extensive
regulations, including international quality standards and other regulatory
requirements. Difficulties encountered in manufacturing scale-up or failure by
us to implement and maintain manufacturing facilities in accordance with
international quality standards or other regulatory requirements could result in
a delay or termination of production, which could have a material adverse effect
on our business, financial condition and results of operations.
In the past, we have experienced these problems in scaling up our
transdermal drug delivery products for commercial launch. There can be no
assurance that similar problems will not be encountered in the future with our
new diagnostic devices. In addition, there can be no assurance that we will be
able to achieve and maintain product performance, quality and reliability if and
when we are able to produce our GlucoWatch biographer in the quantities required
for commercialization, or that the GlucoWatch biographer will be able to be
manufactured and assembled at an acceptable cost.
WE MAY NEED TO RELY ON AGREEMENTS WITH THIRD PARTIES IN ORDER TO
COMMERCIALIZE OUR PRODUCTS ON A WORLDWIDE BASIS. IF WE ARE UNABLE TO SECURE
THESE NECESSARY AGREEMENTS, WE MAY NOT BE ABLE TO SELL OUR PRODUCTS OR GENERATE
REVENUE.
One of our priorities is to establish alliances to secure commercialization
functions worldwide for the GlucoWatch biographer, such as distribution, sales
and customer service. We do not currently have any marketing or distribution
agreements in the United States for the GlucoWatch biographer other than an
agreement with Livingston Healthcare Services to provide receiving, storage,
customer service, technical support and shipment services as well as an
agreement with Lifescan, Inc. relating to our pilot marketing program in the
United States. We do not have a worldwide commercialization partner. Our
agreement with Yamanouchi to commercialize the GlucoWatch biographer in Japan
was terminated in October 2000. We may never enter into an agreement with a
worldwide commercialization partner. Even if we obtain a worldwide
commercialization partner, we may not do so until after the FDA approves our
large-scale manufacturing process.
We are currently outsourcing capabilities for launch without a worldwide
commercialization alliance. We may not be able to outsource some
commercialization capabilities in time for a broad launch. Third parties
performing these outsourced capabilities may, for competitive reasons, support,
directly or indirectly, a company or product that competes with one of our
products. If a third party terminates an arrangement, cannot fund or otherwise
satisfy its obligations under its arrangements or disputes or breaches a
contractual commitment, then we would likely be required to seek an alternative
third party. If we were unable to find a replacement third party, we might not
be able to perform or fund the activities of the current third party, or our
capital requirements could increase substantially.
WE MAY NEED ADDITIONAL FINANCING AND IT MAY NOT BE AVAILABLE. IF ADEQUATE
FUNDS ARE NOT AVAILABLE OR ARE NOT AVAILABLE ON ACCEPTABLE TERMS, WE MAY BE
UNABLE TO DEVELOP OR ENHANCE OUR PRODUCTS, TAKE ADVANTAGE OF FUTURE
OPPORTUNITIES OR RESPOND TO COMPETITIVE PRESSURES, WHICH COULD NEGATIVELY IMPACT
OUR PRODUCT COMMERCIALIZATION.
In order to continue to develop our diagnostic product line, we will require
substantial resources to conduct research and development and clinical trials
necessary to bring our products to market and to establish production and
marketing capabilities. Although we currently have two financing instruments in
place, we may seek additional funding through public or private financings,
including debt or equity financings. We may also seek other arrangements,
including collaborative arrangements. Any additional equity financings may
dilute the holdings of current stockholders. Debt financing, if available, may
restrict our ability to issue dividends in the future and take other actions. We
may not be able to obtain adequate funds when we need them from financial
markets or arrangements with commercialization partners or other sources. Even
if funds are available, they may not be on acceptable terms. If we cannot obtain
sufficient additional funds, we may have to delay, scale back or eliminate some
or all of our research and product development programs or license or sell
products or technologies that we
17
would otherwise seek to develop ourselves. The amounts and timing of future
expenditures will depend on progress of ongoing research and development,
results of clinical trials, rates at which operating losses are incurred,
executing possible commercialization agreements, developing our products,
manufacturing the GlucoWatch biographer, the FDA regulatory process, and other
factors, many of which are beyond our control.
WE ARE HIGHLY LEVERAGED AND MAY BE UNABLE TO SERVICE OUR DEBT. IF WE CANNOT
PAY AMOUNTS DUE UNDER OUR DEBT OBLIGATIONS, WE MAY NEED TO REFINANCE ALL OR A
PORTION OF OUR EXISTING DEBT, SELL ALL OR A PORTION OF OUR ASSETS OR SELL EQUITY
SECURITIES.
As of December 31, 2000, we had indebtedness of approximately
$45.6 million, of which $9.1 million is scheduled to become due and payable in
2001. The degree to which we are leveraged could limit our ability to obtain
financing for working capital, commercialization of products or other purposes
and could make us more vulnerable to industry downturns and competitive
pressures. Our ability to meet our debt service obligations depends upon our
future performance, which will depend upon financial, business and other
factors, many of which are beyond our control. Although we believe our cash
flows will be adequate to meet our interest payments, we may not continue to
generate cash flows in the future sufficient to cover our fixed charges or to
permit us to satisfy any redemption obligations pursuant to our indebtedness. If
we cannot generate cash flows in the future sufficient to cover our fixed
charges or to permit us to satisfy any redemption obligations pursuant to our
indebtedness and we cannot borrow sufficient funds either under our credit
facilities or from other sources, we may need to refinance all or a portion of
our existing debt, sell all or a portion of our assets, or sell equity
securities. We may not successfully complete any of these courses of action. In
the event of insolvency, bankruptcy, liquidation, reorganization, dissolution or
winding-up of our business or upon default or acceleration relating to our debt
obligations, our assets will first be available to pay the amounts due under our
debt obligations. Holders of common stock would only receive the assets
remaining, if any, after payment of all indebtedness and preferred stock, if
any.
WE HAVE INCURRED SUBSTANTIAL LOSSES, HAVE A HISTORY OF OPERATING LOSSES,
HAVE AN ACCUMULATED DEFICIT AND EXPECT CONTINUED OPERATING LOSSES.
We reported a net loss from continuing operations of $32.0 million for the
year ended December 31, 2000 and have experienced annual operating losses since
our inception. We expect to continue to incur operating losses at least until we
have significant sales, if we ever do, of the GlucoWatch biographer. We may
never generate significant revenues or achieve profitability. We may fail in our
efforts to introduce our products or to obtain required regulatory clearances.
Our products may never gain market acceptance, and we may never generate
revenues or achieve profitability. Our revenues to date have been derived
primarily from product development and licensing fees related to our products
under development and manufacturing and royalty revenues from our discontinued
operations. If we obtain regulatory approvals, we expect to significantly
increase our level of expenditures for sales, marketing and general and
administrative activities in connection with product commercialization, and
these expenditures will precede commercial revenues, if any.
OUR STOCK PRICE IS VOLATILE, AND YOU MAY NOT BE ABLE TO RESELL CYGNUS SHARES
AT OR ABOVE THE PRICE YOU PAID, OR AT ALL.
The market price for shares of our common stock has been highly volatile.
Factors such as the results of clinical trials for our products or products of
our competitors, announcements of technological innovations, commencement or
termination of strategic relationships, new product introductions by us or our
competitors, regulatory approvals or delays, changes in securities analysts'
recommendations and developments relating to our patent or proprietary rights or
those of our competitors, as well as period-to-period fluctuations in financial
results, may have a significant impact on the market price of the common stock.
18
In addition, the stock market in general has experienced extreme price and
volume fluctuations in recent years and even in recent months that have
particularly affected the market prices of many medical technology companies,
unrelated to the operating performance of these companies. Fluctuations or
decreases in the trading price of our common stock may discourage investors from
purchasing our common stock. In the past, following periods of volatility in the
market price for a company's securities, securities class action litigation
often has been instituted. Such litigation could result in substantial costs to
us and divert management's attention and resources from developing and
commercializing the GlucoWatch biographer.
OWNERSHIP DILUTION CAUSED BY THE ISSUANCE OF SHARES UNDER THE EQUITY LINE OR
BY ADDITIONAL SHARES OF OUR COMMON STOCK BECOMING AVAILABLE FOR SALE IN THE
FUTURE COULD LOWER OUR STOCK PRICE. IF OUR STOCK PRICE DECLINES, YOU MAY NOT BE
ABLE TO RESELL OUR SHARES AT OR ABOVE THE PRICE YOU PAID, OR AT ALL.
Under the Equity Line, each month we may sell up to $4 million of common
stock and our investors may exercise their option to purchase, subject to our
approval, up to an additional $3 million of common stock during each month in an
investment period. The total number of shares that may be issued under the
Equity Line depends on the market price of our common stock at the time that the
shares are sold, whether we choose to sell shares, and the number of shares we
choose to sell. The following table illustrates hypothetically the effect of
variations in the market price in our common stock and resulting variations in
sales prices to our investors, on the number of shares issued in a one month
period, assuming that we choose to sell all possible shares under the Equity
Line. This table illustrates hypothetically how the ownership dilution resulting
from the sale of the maximum number of shares available under the Equity Line
increases as the market value of our common stock declines.
PRICE PER SHARE NUMBER OF SHARES ISSUED
- --------------- -----------------------
(ONE MONTH)
$15.................................................... 466,667
$10.................................................... 700,000
$5..................................................... 1,400,000
Our decision to choose to sell all possible shares under the Equity Line
would be influenced by whether it is in the best interests of our stockholders
to sell at lower market prices, given our financing requirements and access to
alternative sources of financing. We expect to satisfy substantially all of our
expected financing needs during 2001 through sales under the Equity Line.
Under our new March 2001 Equity Line, we have also agreed to issue warrants
to purchase shares in an amount equal to 10 percent of the number of shares
issued under the new Equity Line in any given year. The warrants will be issued
after the end of each calendar year. The warrants are exercisable for five years
from the date they are issued at an exercise price based on the weighted average
price at which shares were sold during the preceding calendar year.
IF OUR STOCK TRADES BELOW $5 PER SHARE FOR 30 CONSECUTIVE TRADING DAYS, OUR
SHARES COULD BE DE-LISTED FROM THE NASDAQ STOCK MARKET. IF OUR SHARES ARE
DE-LISTED, OUR STOCKHOLDERS MAY EXPERIENCE SUBSTANTIALLY DECREASED LIQUIDITY IN
THEIR SHARES, AND THE OUTSTANDING AMOUNTS UNDER OUR CONVERTIBLE DEBENTURE COULD
BECOME IMMEDIATELY DUE AND PAYABLE.
Our stock is currently traded on the Nasdaq Stock Market. Nasdaq requires
companies, such as ours, without at least $4 million in net tangible assets, to
maintain a minimum closing bid of $5 per share for 30 consecutive business days
for continued listing. A company whose stock does not meet this criterion may be
put on probationary notice. If, after probationary notice, such a stock has not
maintained a $5 bid price for 10 consecutive trading days over the next
90 days, Nasdaq may institute de-listing proceedings. In the event Nasdaq were
to institute de-listing procedures on our stock, we plan to explore the
possibility of a reverse stock split to maintain our listing. If our stock is
de-listed from the Nasdaq Stock Market, our stockholders would find it more
difficult to dispose of their shares, or
19
obtain accurate quotations as to their market value, and the market price of our
stock would likely decline further.
Additionally, under the terms of our Convertible Debenture, we are required
to maintain our listing with Nasdaq. We currently have outstanding Convertible
Debentures in the amount of $19.2 million (including accrued interest). In the
event our shares are de-listed, the holders could assert that a default has
occurred. A default would result in all outstanding principal and interest
becoming immediately due and payable. Payment of these amounts would require us
to obtain alternative financing, which may not be available on acceptable terms,
if at all, and could lead to bankruptcy.
INTENSE COMPETITION IN THE MARKET FOR GLUCOSE DIAGNOSTIC PRODUCTS COULD
PREVENT US FROM INCREASING OR SUSTAINING OUR REVENUE AND PREVENT US FROM
ACHIEVING OR SUSTAINING PROFITABILITY.
The medical device industry, particularly the market in which we will offer
the GlucoWatch biographer, is intensely competitive and we will compete with
other providers of personal glucose monitors. Currently the market is dominated
by finger stick blood glucose monitoring products sold by a few major companies.
These companies have established products and distribution channels. Finger
stick glucose monitoring presents a number of barriers to generating more
frequent blood glucose measurements, including the pain of repetitive finger
sticking and the disruption of normal activities, as often people with diabetes
do not want to go through the finger stick process in public. Several companies
are developing alternative invasive, semi-invasive, minimally invasive or
non-invasive methods to monitor glucose levels in a less painful or painless
manner, as well as on a continuous or continual basis. Companies are attempting
to develop a variety of methods to extract interstitial fluid and measure the
glucose concentration therein. Another technology that some companies are
pursuing is the use of infrared spectroscopy, which uses radiation to measure
glucose levels. We are not aware of any products under development that offer
the range of potential benefits of the GlucoWatch biographer. However, there can
be no assurance that other products will not be more accepted in the marketplace
than the GlucoWatch biographer or will not render our devices noncompetitive or
obsolete. Additionally, the GlucoWatch biographer or our other enhanced products
under development may fail to replace any currently used devices or systems. A
number of companies have developed or are seeking to develop new drugs to treat
diabetes that could reduce demand for glucose monitoring systems. In addition,
many of our competitors and potential competitors have substantially greater
resources, research and development staffs and facilities than we do and have
significantly greater experience in developing, manufacturing and marketing
glucose monitoring devices. Competition within the glucose monitoring industry
could also result in price reductions for glucose monitoring devices such that
we may not be able to sell the GlucoWatch biographer at a price level adequate
for us to realize a return on our investment.
IF THE MARKET DOES NOT ACCEPT OUR NEW TYPE OF PRODUCTS, WE MAY NOT GENERATE
REVENUES AND ACHIEVE OR SUSTAIN PROFITABILITY.
We are focusing our efforts predominantly on a line of frequent, automatic
and non-invasive glucose monitoring devices. The market may not accept our
products, given that they are different from the established finger stick
glucose monitors currently on the market. Additionally, some of our competitors
have announced, and others may be developing, new glucose monitoring devices
that are frequent, automatic and less invasive. The introduction of competing
products may decrease our future market sales.
IF THIRD PARTIES DO NOT REIMBURSE THE COSTS OF OUR MEDICAL DEVICES,
PATIENTS, HOSPITALS AND PHYSICIANS MAY DECIDE NOT TO USE OUR PRODUCTS,
DIMINISHING OUR PRODUCT SALES.
Successful commercialization of our products may depend in part on the
availability of reimbursement from third-party health care payers, such as
private insurance plans and the government. There can be no assurance that such
reimbursement will be available. We plan to conduct outcome studies for
reimbursement; however, reimbursement may not be available in a sufficient time
frame. Third-party payers are increasingly attempting to contain health care
costs by limiting both
20
coverage and the level of reimbursement for new therapeutic and diagnostic
products. Adequate levels of reimbursement may not be available to enable us to
achieve market acceptance of the GlucoWatch biographer or other new products
under development or to maintain price levels sufficient to realize an
appropriate return on our investment. In the United States and foreign
countries, the period of time needed to obtain such reimbursement can be
lengthy. We may delay the launch of our products in some countries until we have
established our eligibility for reimbursement. This delay could potentially harm
our business.
WE DEPEND ON THIRD-PARTY SUPPLIERS. ANY INTERRUPTION IN THE SUPPLY OF SYSTEM
COMPONENTS OR THE PRICING OF THESE COMPONENTS COULD PREVENT US FROM
MANUFACTURING OUR PRODUCTS.
The GlucoWatch biographer is manufactured from components purchased from
outside suppliers, most of whom are our single source for such components. In
the event that we are unable, for whatever reason, to obtain these components
from our suppliers or that the components obtained from these suppliers do not
pass quality standards, we will be required to obtain the components from
alternative suppliers. Additionally, in the event a current supplier is unable
to meet our component requirements, we might not be able to rapidly find another
supplier of the particular component or an alternative supply at the same price
or lead time. An interruption in the supply of the GlucoWatch biographer
components or excessive pricing of these components could prevent us from
manufacturing our products.
WE DEPEND ON PROPRIETARY TECHNOLOGY. IF WE FAIL TO OBTAIN PATENT PROTECTION
FOR OUR PRODUCTS, PRESERVE OUR TRADE SECRETS AND OPERATE WITHOUT INFRINGING UPON
THE PROPRIETARY RIGHTS OF OTHERS, WE MAY NOT GENERATE PROFITS.
Our success depends in large part on our ability to obtain patent protection
for our products, preserve our trade secrets and operate without infringing upon
the proprietary rights of others, both in the United States and abroad.
Currently, many patent applications in the United States are maintained in
secrecy until issuance, and publication of discoveries in the scientific or
patent literature tends to lag behind actual discovery by several months. Thus,
we may not have been the first to file patent applications on our inventions or
we may have infringed upon third-party patents. Our patent applications may fail
to issue any patents. Any patents that are issued may not provide competitive
advantages for our products or may be challenged or circumvented by our
competitors. We also rely on trade secrets and proprietary know-how that we seek
to protect, in part, by confidentiality agreements with our employees, suppliers
and consultants. These agreements could be breached, and we might not have
adequate remedies for any breach. Additionally, our trade secrets could
otherwise become known or be independently developed by our competitors. Any
litigation, in the United States or abroad, as well as foreign opposition and/or
domestic interference proceedings, could result in substantial expenses to us
and significant diversion of effort by our technical and management personnel.
We may resort to litigation to enforce our patents or protect trade secrets or
know-how, as well as to defend against infringement charges. A negative
determination in such proceedings could subject us to significant liabilities or
require us to seek licenses from third parties. Although patent and intellectual
property disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and could include ongoing royalties. Furthermore, necessary
licenses may not be available to us on satisfactory terms, if at all.
Accordingly, an adverse determination in a judicial or administrative proceeding
or failure to obtain necessary licenses could prevent us from manufacturing and
selling our products.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT ARE COSTLY TO DEFEND AND
COULD LIMIT OUR ABILITY TO USE SOME TECHNOLOGIES IN THE FUTURE.
The design, development, manufacture and use of our medical products involve
an inherent risk of product liability claims and associated adverse publicity.
Producers of medical products may face substantial liability for damages in the
event of product failure or allegations that the product caused harm. We
currently maintain product liability insurance, but it is expensive and
difficult to obtain and
21
may not be available in the future on acceptable terms. We may become subject to
product liability claims, our current insurance may not cover any claims, and
adequate insurance may not be available on acceptable terms in the future. We
could be held liable for damages in excess of the limits of our insurance
coverage, and any claim or product recall could create significant adverse
publicity.
THE COMPETITION FOR QUALIFIED PERSONNEL IS PARTICULARLY INTENSE IN OUR
INDUSTRY AND IN NORTHERN CALIFORNIA. IF WE ARE UNABLE TO RETAIN OR HIRE KEY
PERSONNEL, WE MAY NOT BE ABLE TO SUSTAIN OR GROW OUR BUSINESS.
Our ability to operate successfully and manage our potential future growth
depends significantly upon retaining key scientific, technical, sales,
marketing, managerial and financial personnel, and attracting and retaining
additional highly qualified personnel in these areas. We face intense
competition for such personnel, and we may not be able to attract and retain
these individuals. We compete with numerous pharmaceutical and health care
companies, as well as universities and nonprofit research organizations in the
highly competitive northern California business area. The loss of key personnel
or our inability to hire and retain additional qualified personnel in the future
could prevent us from sustaining or growing our business. Our success will
depend in large part on the continued services of our scientific, managerial and
manufacturing personnel. There can be no assurance that we will continue to be
able to attract and retain sufficient qualified personnel.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INTEREST RATE RISK
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio and long-term debt obligations. We do not use
derivative financial instruments in our investment portfolio. We place our
investments with high credit quality issuers and, by policy, limit the amount of
credit exposure to any one issuer. As stated in our policy, we are averse to
principal loss and ensure the safety and preservation of our invested funds by
limiting default risk, market risk and reinvestment risk.
We mitigate default risk by investing in only the highest credit quality
securities. The portfolio includes only marketable securities with active
secondary or resale markets to ensure portfolio liquidity.
We have no cash flow exposure due to rate changes for our $17.0 million
Convertible Debenture, our $0.2 million equipment loans and our $6.0 million
convertible promissory note related to the Sanofi~Synthelabo arbitration award,
which all have fixed rates. We also have no cash flow exposure due to the rate
change for certain long-term portions of our Sanofi~Synthelabo arbitration award
obligations, as such obligations are not interest bearing. We do have cash flow
exposure on our $2.9 million bank term loan due to its variable interest rate
(prime plus 1.0%). We primarily enter into debt obligations to support general
corporate purposes, including capital expenditures and working capital needs.
22
The table below presents principal amounts and related weighted-average
interest rates by year of maturity for our investment portfolio and debt
obligations.
2001 2002 2003 2004 2005 TOTAL FAIR VALUE
-------- -------- -------- -------- -------- -------- ----------
(DOLLARS IN THOUSANDS)
ASSETS:
Cash equivalents
Variable rate...................... $ 4,716 -- -- -- -- $ 4,716 $ 4,716
Average rate....................... 6.36% -- -- -- -- 6.36% --
Short-term investments
Fixed rate......................... $13,060 -- -- -- -- $13,060 $13,131
Average rate....................... 6.13% -- -- -- -- 6.13% --
Long-term investments
Fixed rate......................... $ 1,546 -- -- -- -- $ 1,546 $ 1,547
Average rate....................... 7.13% -- -- -- -- 7.13% --
Total investments
Securities......................... $19,322 -- -- -- -- $19,322 $19,394
Average rate....................... 6.26% -- -- -- -- 6.26% --
LIABILITIES:
Total long-term debt, including current
portion
Senior Subordinated Convertible
Notes.............................. -- -- -- $17,000 -- $17,000 $17,000
Fixed.............................. -- -- -- 8.5% -- 8.5% --
Other
Fixed rate......................... $ 6,151 -- -- -- -- $ 6,151 $ 6,151
Average rate....................... 6.56% -- -- -- -- 6.56% --
Variable rate...................... $ 2,938 -- -- -- -- $ 2,938 $ 2,938
Average rate....................... 9.50% -- -- -- -- 9.50% --
FOREIGN EXCHANGE RISK
Effective June 28, 2000, we established Cygnus (UK) Limited, a wholly owned
subsidiary of Cygnus, Inc., in the United Kingdom. We keep most of our highly
liquid assets in United States dollars to reduce our exposure to foreign
exchange rate fluctuations. Our exposure to gains and losses resulting from
foreign currency exchange rate fluctuations on foreign net assets was not
material as of December 31, 2000. No material foreign exchange rate gain or loss
has been recorded on our consolidated financial statements during the 12 months
ended December 31, 2000. We do not anticipate any material adverse effect on our
consolidated financial position, results of operations or cash flows resulting
from foreign exchange rate fluctuations in the future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and supplementary data for the years
ended December 31, 2000, 1999 and 1998 are incorporated herein by reference and
submitted as a separate section of this Form 10-K. (See Item 14.)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The executive officers of the Company, who serve at the discretion of the
Board of Directors, are as follows, in alphabetical order:
NAME AGE TITLE
- ---- -------- -----------------------------------------
Neil R. Ackerman, Ph.D............................... 57 Chief Technical Officer and Senior Vice
President, Research & Development and
Scientific Affairs
Craig W. Carlson..................................... 53 Chief Operating Officer, Chief Financial
Officer and Senior Vice President
John C Hodgman....................................... 46 Chairman of the Board, President and
Chief Executive Officer
Barbara G. McClung................................... 46 Senior Vice President, General Counsel
and Secretary
DR. ACKERMAN was appointed Chief Technical Officer in December 2000 and has
served as Senior Vice President, Research & Development and Scientific Affairs
since September 1998. Dr. Ackerman joined Cygnus in May 1994 as Vice President,
Research & Development and, from January 1997 to September 1998, Dr. Ackerman
served as Senior Vice President, Research & Development. From 1990 to May 1994,
Dr. Ackerman served as Vice President of Research and Development for Glycomed,
leading its discovery efforts focused on cardiovascular and inflammatory
diseases. From 1982 to 1990, he was Research Director, Cancer and Inflammatory
Diseases with DuPont Pharmaceuticals. Prior to that he had research and
management positions at Syntex Corporation and Pfizer, Inc. Dr. Ackerman
received B.S. and Ph.D. degrees from the University of Maryland and completed a
post-doctoral fellowship at Stanford University.
MR. CARLSON was appointed Chief Operating Officer in December 2000 and has
served as Chief Financial Officer since 1998, with responsibilities for the
Finance, Corporate Communications, Information Technology and, since 2000,
Marketing and European Operation functions at Cygnus. He joined Cygnus in
July 1993 as Vice President, Corporate Communications, became Vice President,
Strategic Planning and Corporate Marketing, then assumed responsibility for the
Finance and Information Technologies functions in 1997 as Senior Vice President,
Finance. From 1988 to July 1993, he was Vice President and Group Director at
Young & Rubicam Advertising in San Francisco. Prior to that, Mr. Carlson was
Vice President of Campbell-Mithun Advertising. He holds a B.A. from Union
College and an M.B.A. from Stanford University.
MR. HODGMAN was appointed Chairman of the Board in 1999 and has served as a
director, President and Chief Executive Officer since August 1998. He was
President, Cygnus Diagnostics from May 1995 to August 1998, for which he was
responsible for all commercialization efforts for the GlucoWatch biographer, and
was also Chief Financial Officer. Mr. Hodgman joined Cygnus in August 1994 as
Vice President, Finance and Chief Financial Officer. Prior to joining Cygnus,
Mr. Hodgman served as Vice President of Operations and Finance and Chief
Financial Officer for Central Point Software, a personal computer and networking
software company. Prior to that, he was the Vice President of Finance and
Administration and Chief Financial Officer of Ateq Corporation. Mr. Hodgman
holds a B.S. degree from Brigham Young University and an M.B.A. from the
University of Utah.
MS. McCLUNG was appointed Senior Vice President, General Counsel and
Corporate Secretary in December 1998 and also assumed responsibilities for Human
Resources function shortly thereafter. Ms. McClung joined Cygnus in
January 1998 as Vice President, Intellectual Property. In August 1998,
Ms. McClung was promoted to Vice President and General Counsel. Prior to joining
Cygnus, from
24
August 1990 to January 1998, she was Corporate Patent Counsel at Chiron
Corporation, a biotechnology company. Prior to that she was Patent Counsel at
DuPont. She is a member of the California, Delaware, and Pennsylvania bars, as
well as being a registered patent attorney before the United States Patent and
Trademark Office. Ms. McClung received a J.D. from the University of
Pennsylvania Law School, as well as a B.A. from the University of California,
San Diego, and an M.A. from the University of Pennsylvania.
Each executive officer of the Company adopted in February 2001 a
Rule 10b5-1 trading plan in compliance with the Company's insider trading
policy. The first trades that can be executed under these trading plans are not
permitted to occur before the filing of the Company's Annual Report on
Form 10-K.
We incorporate by reference the information set forth under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance" in our definitive
Proxy Statement to be filed pursuant to Regulation 14A for our 2001 Annual
Meeting of Stockholders.
Additionally, we incorporate by reference the information concerning our
directors set forth under the heading "Proposal One--Re-election of Directors"
in our definitive Proxy Statement to be filed pursuant to Regulation 14A for our
2001 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION.
We incorporate by reference the information set forth under the heading
"Executive Compensation and Other Information" in our definitive Proxy Statement
to be filed pursuant to Regulation 14A for our 2001 Annual Meeting of
Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
We incorporate by reference the information set forth under the heading
"Security Ownership of Certain Beneficial Owners and Management" in our
definitive Proxy Statement to be filed pursuant to Regulation 14A for our 2001
Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
We incorporate by reference the information set forth under the headings
"Proposal One--Re-election of Directors" and "Executive Compensation and Other
Information" in our definitive Proxy Statement to be filed pursuant to
Regulation 14A for our 2001 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
A.1) FINANCIAL STATEMENTS AND REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
PAGE
--------
Report of Ernst & Young LLP, Independent Auditors........... F-3
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-4
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998.......................... F-5
Consolidated Statements of Stockholders' Equity/(net capital
deficiency) for the years ended December 31, 2000, 1999
and 1998.................................................. F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................... F-7
Notes to Consolidated Financial Statements for the year
ended December 31, 2000................................... F-8
25
A.2) FINANCIAL STATEMENT SCHEDULE
Valuation and Qualifying Accounts (Schedule II)............. S-1
All other schedules have been omitted because the required information is
not present or is not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements, including the notes thereto.
B) REPORTS ON FORM 8-K
We have recently filed the following Current Reports on Form 8-K.
On October 17, 2000, we filed a Current Report on Form 8-K, reporting under
Item 5 that we shipped our first commercial GlucoWatch biographers to the United
Kingdom. We have established a United Kingdom Medical Advisory Board to provide
our GlucoWatch biographer to select adults with diabetes. We also announced that
we regained the marketing and distribution rights for the GlucoWatch biographer
in Japan and that the collaboration between Cygnus and Yamanouchi for the
marketing and distribution of the GlucoWatch biographer in Japan would be
terminated. We further announced that we signed a Warehouse Distribution
Contract with Livingston Healthcare Services, Inc. to provide outsource
logistics services in the United States for our GlucoWatch biographer.
On December 19, 2000, we filed a Current Report on Form 8-K, reporting under
Item 5 that the United States Patent and Trademark Office recently issued three
patents relating to our glucose monitoring devices, including the GlucoWatch
biographer.
C) EXHIBITS
The following exhibits are filed herewith or incorporated by reference:
3.01 Bylaws of the Registrant, as amended, incorporated by
reference to Exhibit 3.01 of Registrant's Form 10-Q for the
quarter ended March 31, 2000.
3.02 Restated Articles of Incorporation of the Registrant, as
amended to date, incorporated by reference to 3.02 of
Registrant's Form 10-Q for the quarter ended March 31, 2000.
4.01 Specimen of Common Stock Certificate of the Registrant,
incorporated by reference to Exhibit 4.1 of the Registrant's
Registration Statement Form S-1 No. 33-38363.
4.02 Form of Senior Indenture, incorporated by reference to
Exhibit 4.1 filed with the Registrant's Registration
Statement on Form S-3 (File No. 33-39275) declared effective
by the Securities and Exchange Commission on November 12,
1997 (the "November 1997 Form S-3").
4.03 Form of Subordinated Indenture, incorporated by reference to
Exhibit 4.2 filed with the Registrant's November 1997
Form S-3.
4.04 Form of Senior Debt Security (included in Exhibit 4.1),
incorporated by reference to Exhibit 4.3 filed with the
Registrant's November 1997 Form S-3.
4.05 Form of Subordinated Debt Security (included in
Exhibit 4.2), incorporated by reference to Exhibit 4.4 filed
with the Registrant's November 1997 Form S-3.
4.06 First Supplemental Indenture dated as of February 3, 1998 by
and between the Registrant and State Street Bank and Trust
Company of California, N.A., incorporated by reference to
Exhibit 4.5 of the Registrant's Form 8-K dated February 4,
1998.
26
4.07 Second Supplemental Indenture dated as of October 28, 1998,
by and between the Registrant and State Street Bank and
Trust Company of California, N.A., to the Indenture dated as
of February 3, 1998 and the First Supplemental Indenture
dated as of February 3, 1998, incorporated by reference to
Exhibit 4.8 of the Registrant's Form 8-K filed on
October 30, 1998.
4.08 Amended and Restated Rights Agreement dated October 27, 1998
between the Registrant and ChaseMellon Shareholder Services,
L.L.C. (the "Rights Agent" successor to Chemical Trust),
which includes the Certificate of Determination for the
Series A Junior Participating Preferred Stock as
Exhibit A, the form of Rights Certificate as Exhibit B and
the Summary of Rights to purchase Preferred Shares as
Exhibit C, incorporated by reference to Exhibit 99.2 of the
Registrant's Form 8A/A filed on December 14, 1998,
Registration No. 0-19962.
4.09 Registration Rights Agreement dated June 30, 1999 between
the Registrant and Cripple Creek Securities, L.L.C.,
incorporated by reference to Exhibit 4.11 of the
Registrant's Form 10-Q for the quarter ended June 30, 1999.
4.10 Registration Rights Agreement dated June 29, 1999 between
the Registrant and the listed Investors on Schedule I
thereto, incorporated by reference to Exhibit 4.12 of the
Registrant's Form 10-Q for the quarter ended June 30, 1999.
10.001 Ten-year Industrial Net Lease Agreement (Building No. 2)
dated September 27, 1988 between the Registrant and Seaport
Centre Venture Phase I, incorporated by reference to
Exhibit 10.26 of the Registrant's Form S-1 Registration
Statement No. 33-38363.
10.002 Ten-year Industrial Net Lease Agreement (Building No. 8)
dated September 27, 1988 between the Registrant and Seaport
Centre Venture Phase I, incorporated by reference to
Exhibit 10.27 of the Registrant's Form S-1 Registration
Statement No. 33-38363.
10.003 Lease Agreement dated as of October 15, 1991 between the
Registrant and Lincoln Menlo Associates Limited, a
California Limited Partnership, incorporated by reference to
Exhibit 10.34 of the Registrant's Form S-1 Registration
Statement No. 33-45180.
10.004 First Amendment to Ten-year Industrial Net Lease Agreement
(Building No. 2) dated June 9, 1998 between the Registrant
and Metropolitan Life Insurance Company, a New York
corporation (predecessor in interest to Seaport Centre
Venture Phase I), incorporated by reference to
Exhibit 10.29 of the Registrant's Form 10-K for the period
ending December 31, 1998.
10.005 Third Amendment to Ten-year Industrial Net Lease Agreement
(Building No. 8) dated June 9, 1998 between the Registrant
and Metropolitan Life Insurance Company, a New York
corporation (predecessor in interest to Seaport Centre
Venture Phase I), incorporated by reference to
Exhibit 10.29 of the Registrant's Form 10-K for the period
ending December 31, 1998.
10.006 Sublease Agreement dated February 19, 1999 between the
Registrant and The 3DO Company, incorporated by reference to
Exhibit 10.39 of the Registrant's Form 10-Q for the period
ending March 31, 1999.
10.007 Amendment No. 4, Lease Extension, dated July 20, 1999
between the Registrant and Lincoln Menlo Associates Limited,
a California Limited Partnership, incorporated by reference
to Exhibit 10.44 of the Registrant's Form 10-Q for the
period ending March 31, 1999.
10.008 Sublease dated December 15, 1999 between the Registrant and
Ortho-McNeil Pharmaceutical, Inc., incorporated by reference
to Exhibit 10.008 of the Registrant's Form 10-K for the
period ending December 31, 1999.
27
10.009 Agreement to Terminate Lease dated November 6, 2000 between
the Registrant and AMB Property, L.P., a Delaware Limited
Partnership (successor in interest to Lincoln Menlo
Associates, Limited, a California Limited Partnership).
10.010 through 10.099 reserved.
10.101 Structured Equity Line Flexible Financing Agreement, dated
June 30, 1999 between the Registrant and Cripple Creek
Securities, L.L.C., incorporated by reference to Exhibit 1
of the Registrant's Form 8-K filed on July 2, 1999.
10.102 Convertible Debenture and Warrant Purchase Agreement dated
June 29, 1999 between the Registrant and the listed
Investors on Schedule I thereto, incorporated by reference
to Exhibit 10.41 of the Registrant's Form 10-Q for the
quarter ended June 30, 1999.
10.103 Form of 8.5% Convertible Debenture Due June 29, 2004,
incorporated by reference to Exhibit 10.42 of the
Registrant's Form 10-Q for the quarter ended June 30, 1999.
10.104 Form of Common Stock Purchase Warrant, incorporated by
reference to Exhibit 10.43 of the Registrant's Form 10-Q for
the quarter ended June 30, 1999.
10.105 Amendment No. 1 to Structured Equity Line Flexible Financing
Agreement dated September 29, 1999 between the Registrant
and Cripple Creek Securities, L.L.C., incorporated by
reference to Exhibit 1.1 of the Registrant's Form 8-K filed
on October 7, 1999.
10.106 Form of Note Purchase Agreement dated as of February 2, 1998
between the Registrant and certain institutional Investors,
incorporated by reference to Exhibit 10.28 of the
Registrant's Form 8-K dated February 4, 1998.
10.107 Form of Common Stock Purchase Agreement dated February 2,
1998 between the Registrant and certain institutional
Investors, incorporated by reference to Exhibit 10.29 of
the Registrant's Form 8-K dated February 4, 1998.
10.108 Amended and Restated Loan and Security Agreement between the
Registrant and Silicon Valley Bank entered into as of
April 30, 1998, incorporated by reference to Exhibit 10.45
of the Registrant's Form 10-Q for the quarter ended
September 30, 1998.
10.109 Amendment No. 2 to Structured Equity Line Flexible Financing
Agreement between the Registrant and Cripple Creek
Securities, L.L.C., dated March 27, 2000, incorporated by
reference to Exhibit 10.109 of the Registrant's Form 10-Q
for the quarter ended March 31, 2000.
10.110 Amendment No. 3 to Structured Equity Line Flexible Financing
Agreement between the Registrant and Cripple Creek
Securities, L.L.C., dated May 9, 2000, incorporated by
reference to Exhibit 10.110 of the Registrant's Form 10-Q
for the quarter ended June 30, 2000.
10.111 Amendment No. 4 to Structured Equity Line Flexible Financing
Agreement between the Registrant and Cripple Creek
Securities, L.L.C., dated October 27, 2000.
10.112 through 10.199 reserved.
*10.201 Product Supply and Distribution Agreement between the
Registrant and Yamanouchi Pharmaceutical Co., Ltd. dated
July 14, 1996, incorporated by reference to Exhibit 10.2 of
the Registrant's Form 10-Q for the quarter ended June 30,
1996.
*10.202 Product Supply Agreement between the Registrant and Contract
Manufacturing, Inc. dated July 15, 1997, incorporated by
reference to Exhibit 10.202 of the Registrant's Form 10-K
for the period ending December 31, 1999.
28
*10.203 Supply Agreement dated June 19, 1998 between the Registrant
and E.I. du Pont de Nemours & Co., a Delaware corporation,
incorporated by reference to Exhibit 10.34 of the
Registrant's Form 10-K for period ending December 31, 1998.
*10.204 Detection of Analytes Product Development and License
Agreement dated June 19, 1998 between the Registrant and
E.I. du Pont de Nemours & Co., a Delaware corporation,
incorporated by reference to Exhibit 10.35 the Registrant's
Form 10-K for period ending December 31, 1998.
*10.205 Supply Agreement between the Registrant and Key Tronic
Corporation dated December 1, 1999, incorporated by
reference to Exhibit 10.205 of the Registrant's Form 10-K
for the period ending December 31, 1999.
*10.206 Supply Agreement between the Registrant and Hydrogel Design
Systems, Inc. dated December 31, 1999, incorporated by
reference to Exhibit 10.206 of the Registrant's Form 10-K
for the period ending December 31, 1999.
*10.207 Supply Agreement between the Registrant and Sanmina Medical
Products Division, a division of Sanmina Corporation, dated
March 1, 2000, incorporated by reference to Exhibit 10.207
of the Registrant's Form 10-Q for the quarter ended
June 30, 2000.
*10.208 Supply Agreement between the Registrant and E.I. du Pont de
Nemours & Co. and Registrant dated June 23, 2000,
incorporated by reference to Exhibit 10.208 of the
Registrant's Form 10-Q for the quarter ended June 30, 2000.
(This Agreement supercedes and replaces Exhibits 10.203 and
10.204 above.)
*10.209 Warehouse Distribution Contract between the Registrant and
Livingston Healthcare Services, Inc. dated August 25, 2000,
incorporated by reference to Exhibit 10.209 of the
Registrant's Form 8-K filed on October 17, 2000.
*10.210 U.S. Market Research Agreement between the Registrant and
Lifescan, Inc. dated February 22, 2001.
*10.211 Termination Agreement between the Registrant and Yamanouchi
Pharmaceutical Co., Ltd. dated February 26, 2001.
10.212 through 10.299 Reserved.
*10.301 Exclusive License Agreement between the Registrant and The
Regents of the University of California dated January 31,
1995, incorporated by reference to Exhibit 10.301 of the
Registrant's Form 10-K for the period ending December 31,
1999.
*10.302 License Agreement Amendment between the Registrant and The
Regents of the University of California dated April 23,
1998, incorporated by reference to Exhibit 10.302 of the
Registrant's Form 10-K for the period ending December 31,
1999.
10.303 through 10.399 Reserved.
*10.401 Asset Purchase Agreement dated November 17, 1999 between the
Registrant and Ortho-McNeil Pharmaceutical, Inc.,
incorporated by reference to Exhibit 10.49 of the
Registrant's Form 8-K filed December 30, 1999.
10.402 through 10.499 Reserved
10.501 Registrant's 1999 Stock Incentive Plan (as Amended and
Restated March 1, 2000), incorporated by reference to
Exhibit 10.501 of the Registrant's Form 10-K for the period
ending December 31, 1999.
10.502 Registrant's Amended 1991 Employee Stock Purchase Plan (as
Amended and Restated March 1, 2000), incorporated by
reference to Exhibit 10.502 of the Registrant's Form 10-K
for the period ending December 31, 1999.
29
10.503 Form of Indemnification Agreement for Directors and
Officers, incorporated by reference to Exhibit 10.29 of the
Registrant's Form S-1 Registration Statement No. 33-38363.
10.504 Form of Agreement (Termination of Employment Without
Cause--Officers) between the Registrant and each of the
Company's Officers, incorporated by reference to
Exhibit 10.46 of the Registrant's Form 10-Q for the period
ended September 30, 1998.
10.505 Form of Agreement (Change of Control) between the Registrant
and each of the Company's Officers, incorporated by
reference to Exhibit 10.47 of the Registrant's Form 10-Q for
the period ended September 30, 1998.
10.506 Form of Special Addendum to Stock Option Agreement
(Termination of Employment Without Cause--Officers),
incorporated by reference to Exhibit 99.4 of the
Registrant's Form S-8 Registration Statement No. 333-67331,
filed November 16, 1998.
10.507 Form of Special Addendum to Stock Option Agreement
(Termination of Employment Without Cause--Key Employees),
incorporated by reference to Exhibit 99.5 of the
Registrant's Form S-8 Registration Statement No. 333-67331,
filed November 16, 1998.
10.508 Form of Special Addendum to Stock Option Agreement (Change
in Control), incorporated by reference to Exhibit 99.3 of
the Registrant's Form S-8 Registration Statement
No. 333-67331, filed November 16, 1998.
10.509 Written Compensation Agreement dated August 28, 1998 between
the Registrant and Andre F. Marion, incorporated by
reference to Exhibit 99.7 of the Registrant's Form S-8
Registration Statement No. 333-67331, filed November 16,
1998.
10.510 Stock Option Agreement between the Registrant and Andre F.
Marion, incorporated by reference to Exhibit 99.8 of the
Registrant's Form S-8 Registration Statement No. 333-67331,
filed November 16.1998.
10.511 Form of Employment Agreement between the Registrant and each
of the Company's Officers. (This Agreement supercedes and
replaces Exhibits 10.504, 10.505, 10.506 and 10.508 above.)
10.512 Form of Employment Agreement between the Registrant and Key
Employees. (This Agreement supercedes and replaces
Exhibit 10.507 above.)
10.513 Form of Indemnification Agreement for Directors and
Officers. (This Agreement supercedes and replaces
Exhibit 10.503 above.)
- ------------------------
21.0 List of Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors (see page
32)
24.1 Power of Attorney (see page 31)
- ------------------------
* A confidential treatment request has been applied for or granted with respect
to a portion of this document.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, on the 26th day of March,
2001.
CYGNUS, INC.
By: /s/ JOHN C HODGMAN
------------------------------------------
John C Hodgman
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE
OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints John C Hodgman attorney-in-fact for the
undersigned, with the power of substitution, for the undersigned in any and all
capacities, to sign any and all amendments to this Report on Form 10-K, and to
file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorney-in-fact, or his substitute or substitutes, may
do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the date indicated opposite his/her name.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
Chairman of the Board of Directors,
/s/ JOHN C HODGMAN President and Chief Executive
- ---------------------------------- Officer (Principal Executive March 26, 2001
John C Hodgman Officer)
Chief Operating Officer, Chief
/s/ CRAIG W. CARLSON Financial Officer and Senior Vice
- ---------------------------------- President (Principal Financial March 26, 2001
Craig W. Carlson Officer and Principal Accounting
Officer)
/s/ ANDRE F. MARION
- ---------------------------------- Vice Chairman of the Board of March 26, 2001
Andre F. Marion Directors
/s/ FRANK T. CARY
- ---------------------------------- Director March 26, 2001
Frank T. Cary
/s/ RICHARD G. ROGERS
- ---------------------------------- Director March 26, 2001
Richard G. Rogers
/s/ WALTER B. WRISTON
- ---------------------------------- Director March 26, 2001
Walter B. Wriston
31
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 333-18357, 333-67331 and 333-89377) pertaining to the Amended
1991 Employee Stock Purchase Plan and the 1999 Stock Incentive Plan of
Cygnus, Inc. of our report dated February 2, 2001 with respect to the
consolidated financial statements of Cygnus, Inc. included in the Annual Report
(Form 10-K) for the year ended December 31, 2000.
Palo Alto, California /s/ ERNST & YOUNG LLP
March 26, 2001
32
CYGNUS, INC.
Consolidated Financial Statements
For the Years ended December 31, 2000, 1999 and 1998
with
Report of Independent Auditors
F-1
CYGNUS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
For the Years ended December 31, 2000, 1999 and 1998
CONTENTS
Report of Ernst & Young LLP, Independent Auditors........... F-3
Audited Consolidated Financial Statements:
Consolidated Balance Sheets................................. F-4
Consolidated Statements of Operations....................... F-5
Consolidated Statements of Stockholders' Equity/(net capital
deficiency)............................................... F-6
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8
F-2
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Cygnus, Inc.
We have audited the accompanying consolidated balance sheets of
Cygnus, Inc. as of December 31, 2000 and 1999 and the related consolidated
statements of operations, stockholders' equity/(net capital deficiency) and cash
flows for each of the three years in the period ended December 31, 2000. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
Cygnus' management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Cygnus, Inc. at December 31, 2000 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, present fairly in all material respects the information set forth
therein.
As discussed more fully in Note 1, Cygnus, Inc. has changed its accounting
for the embedded beneficial conversion feature of convertible debentures.
/s/ ERNST & YOUNG LLP
Palo Alto, California
February 2, 2001
F-3
CYGNUS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
---------------------
2000 1999
--------- ---------
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents................................. $ 8,058 $ 28,677
Short-term investments.................................... 14,881 10,215
Prepaid expenses and other current assets................. 369 560
Current portion of employee notes receivable.............. 81 162
Current portion of unamortized deferred financing cost.... 203 201
--------- ---------
Total current assets.................................. 23,592 39,815
EQUIPMENT AND IMPROVEMENTS:
Office and laboratory equipment........................... 11,527 7,856
Leasehold improvements.................................... 461 426
Construction in progress.................................. 2,798 4,417
--------- ---------
14,786 12,699
Less accumulated depreciation and amortization............ (7,688) (6,610)
--------- ---------
Net equipment and improvements........................ 7,098 6,089
Long-term investments....................................... 1,547 --
Long-term portion of employee notes receivable.............. 96 201
Unamortized portion of deferred financing cost.............. 514 709
Other assets................................................ 42 162
--------- ---------
Total Assets.......................................... $ 32,889 $ 46,976
========= =========
LIABILITIES AND NET CAPITAL DEFICIENCY:
CURRENT LIABILITIES:
Accounts payable.......................................... $ 2,969 $ 2,002
Accrued compensation...................................... 1,033 2,919
Other accrued liabilities................................. 632 640
Deferred revenue.......................................... -- 900
Current portion of arbitration obligation................. 6,000 --
Current portion of long-term debt......................... 3,089 3,243
--------- ---------
Total current liabilities............................. 13,723 9,704
Long-term portion of arbitration obligation................. 17,000 23,000
Long-term portion of debt................................... -- 3,088
Convertible Debentures, net of discount of $4,364 in 2000
and $5,595 in 1999........................................ 14,870 12,084
Other long-term liabilities................................. 319 304
STOCKHOLDERS' NET CAPITAL DEFICIENCY:
Preferred stock, $0.001 par value: 5,000 shares
authorized; no shares issued and outstanding............ -- --
Common stock, $0.001 par value: 55,000 and 40,000 shares
authorized; issued and outstanding: 27,476 and 25,411
shares at December 31, 2000 and 1999, respectively...... 27 25
Additional paid-in-capital................................ 201,011 177,576
Accumulated deficit....................................... (215,823) (178,790)
Accumulated other comprehensive income/(loss)............. 1,762 (15)
--------- ---------
Net capital deficiency.................................... (13,023) (1,204)
--------- ---------
Total liabilities and stockholders' net capital
deficiency.......................................... $ 32,889 $ 46,976
========= =========
See accompanying notes.
F-4
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
CONTRACT REVENUES........................................... $ 1,052 $ 2,061 $ 457
COSTS AND EXPENSES:
Research and development.................................. 21,170 15,745 25,635
Marketing, general and administrative..................... 10,072 4,794 8,810
-------- ------- --------
TOTAL COSTS AND EXPENSES................................ 31,242 20,539 34,445
LOSS FROM OPERATIONS........................................ (30,190) (18,478) (33,988)
Interest and other income................................. 1,970 194 3,284
Interest and other expense................................ (3,687) (3,690) (9,730)
-------- ------- --------
LOSS FROM CONTINUING OPERATIONS BEFORE TAX.................. (31,907) (21,974) (40,434)
Provision for tax........................................... (100) (200) --
-------- ------- --------
LOSS FROM CONTINUING OPERATIONS............................. (32,007) (22,174) (40,434)
DISCONTINUED OPERATIONS:
Income from operations of a discontinued segment.......... -- 3,031 1,006
Gain on disposal of a segment............................. -- 16,308 --
-------- ------- --------
NET LOSS BEFORE CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE................................................. (32,007) (2,835) (39,428)
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE....... (5,026) -- --
-------- ------- --------
NET LOSS.................................................... $(37,033) $(2,835) $(39,428)
======== ======= ========
NET LOSS PER SHARE FROM CONTINUING OPERATIONS, BASIC AND
DILUTED................................................... $ (1.22) $ (0.95) $ (2.00)
NET INCOME PER SHARE FROM A DISCONTINUED SEGMENT, BASIC AND
DILUTED................................................... -- 0.83 0.05
NET LOSS PER SHARE FROM CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE, BASIC AND DILUTED................... (0.19) -- --
-------- ------- --------
NET LOSS PER SHARE, BASIC AND DILUTED....................... $ (1.41) $ (0.12) $ (1.95)
======== ======= ========
SHARES USED IN COMPUTATION OF NET LOSS PER SHARE, BASIC AND
DILUTED................................................... 26,315 23,354 20,226
======== ======= ========
See accompanying notes.
F-5
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY/(NET CAPTIAL DEFICIENCY)
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(IN THOUSANDS)
ACCUMULATED TOTAL
OTHER STOCKHOLDERS'
COMMON ADDITIONAL ACCUMULATED COMPREHENSIVE NET CAPITAL
STOCK PAID-IN-CAPITAL DEFICIT INCOME/(LOSS) DEFICIENCY
-------- --------------- ------------ -------------- -------------
BALANCE, DECEMBER 31, 1997................ $19 $122,709 $(136,527) $ (1) $(13,800)
Issuance of 144 shares of common stock
under the Employee Stock Option Plan and
Employee Stock Purchase Plan............ -- 892 -- -- 892
Issuance of 906 shares of common stock in
fourth public offering, net of issuance
costs................................... 1 13,326 -- -- 13,327
Issuance of 565 shares arising upon
conversion of the Senior Subordinated
Notes................................... 1 1,998 -- -- 1,999
Additional paid-in capital arising from
the beneficial conversion feature in
connection with the restructuring of the
Senior Subordinated Notes............... -- 4,230 -- -- 4,230
Net loss.................................. -- -- (39,428) -- (39,428)
Unrealized gain on available-for-sale
securities.............................. -- -- -- 13 13
--------
Net comprehensive loss.................... -- -- -- -- (39,415)
--- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1998................ $21 $143,155 $(175,955) $ 12 $(32,767)
=== ======== ========= ====== ========
Issuance of 1,103 shares of common stock
under the Employee Stock Option Plan and
Employee Stock Purchase Plan............ 1 6,694 -- -- 6,695
Issuance of 259 shares of common stock for
services rendered....................... -- 864 -- -- 864
Valuation for stock-based compensation.... -- 378 -- -- 378
Issuance of 991 shares of common stock
pursuant to the Equity Line, net of
issuance costs.......................... 1 9,117 -- -- 9,118
Issuance of 120 shares of common stock
upon exercise of warrant................ -- 531 -- -- 531
Issuance of 2,053 shares upon conversion
of the Senior Subordinated Convertible
Notes................................... 2 10,265 -- -- 10,267
Issuance of warrants in connection with
the Convertible Debentures.............. -- 6,572 -- -- 6,572
Net loss.................................. -- -- (2,835) -- (2,835)
Unrealized loss on available-for-sale
securities.............................. -- -- -- (27) (27)
--------
Net comprehensive loss.................... -- -- -- -- (2,862)
--- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1999................ $25 $177,576 $(178,790) $ (15) $ (1,204)
=== ======== ========= ====== ========
Issuance of 568 shares of common stock
under the Employee Stock Option Plan and
Employee Stock Purchase Plan............ 1 3,462 -- -- 3,463
Issuance of 17 shares of common stock for
services rendered....................... -- 86 -- -- 86
Valuation for stock-based compensation.... -- 1,044 -- -- 1,044
Issuance of 1,480 shares of common stock
pursuant to the Equity Line, net of
issuance costs.......................... 1 13,817 -- -- 13,818
Additional paid-in capital arising from
the cumulative effect of a change in
accounting principle related to the
beneficial conversion feature associated
with the Convertible Debentures......... -- 5,026 -- -- 5,026
Net loss.................................. -- -- (37,033) -- (37,033)
Unrealized gain on available-for-sale
securities.............................. -- -- -- 1,777 1,777
--------
Net comprehensive loss.................... -- -- -- -- (35,256)
--- -------- --------- ------ --------
BALANCE, DECEMBER 31, 2000................ $27 $201,011 $(215,823) $1,762 $(13,023)
=== ======== ========= ====== ========
See accompanying notes.
F-6
CYGNUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................................... $(37,033) $ (2,835) $(39,428)
Adjustments to reconcile net loss to net cash (used
in)/provided by operating activities:
Depreciation.............................................. 1,267 1,850 1,665
Amortization.............................................. (190) 12 256
Gain on sale of equipment................................. (107) (1) (19)
Beneficial conversion feature of Convertible Debenture.... 5,026 -- --
Beneficial conversion feature of restructured Senior
Subordinated Convertible Notes.......................... -- -- 4,230
Amortization of debt issuance and financing costs and debt
discount................................................ 1,435 1,743 1,561
Stock-based compensation.................................. 1,130 378 --
Gain on disposal of segment............................... -- (16,308) --
Change in operating assets and liabilities
Inventories............................................... -- 771 153
Deferred compensation, prepaid expenses and other
assets.................................................. 498 5,223 2,617
Other..................................................... (55) 77 (125)
Accounts payable and other accrued liabilities............ 2,501 (3,351) 2,316
Accrued compensation...................................... (1,886) 317 1,295
Deferred revenue.......................................... (900) (253) (1,881)
Arbitration liability..................................... -- (1,157) (15,005)
Deferred compensation and other liabilities............... 15 (4,362) (178)
-------- -------- --------
Net cash used in operating activities................... $(28,299) $(17,896) $(42,543)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures........................................ (2,566) (2,725) (3,365)
Proceeds from disposal of segment........................... -- 20,000 --
Proceeds from sale of equipment............................. 398 1 19
Contract termination fee in conjunction with disposal of
segment................................................... -- (750) --
Purchases of investments.................................... (26,722) (11,301) (48,314)
Maturity and sale of investments............................ 22,531 19,574 44,073
-------- -------- --------
Net cash provided by/(used in) investing activities..... $ (6,359) $ 24,799 $ (7,587)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock.................................... 17,281 14,926 14,219
Net proceeds from the issuance of Senior Subordinated
Convertible Notes......................................... -- -- 40,351
Net proceeds from the issuance of convertible debentures.... -- 16,407 --
Proceeds from issuance of long-term debt.................... -- -- 6,110
Principal payments of Senior Subordinated Convertible
Notes..................................................... -- (12,500) (18,500)
Principal payments of long-term debt........................ (3,242) (5,335) (2,023)
Payment of capital lease obligations........................ -- (1,943) (477)
-------- -------- --------
Net cash provided by financing activities............... $ 14,039 $ 11,555 $ 39,680
-------- -------- --------
Net increase/(decrease) in cash and cash equivalents........ (20,619) 18,458 (10,450)
Cash and cash equivalents at beginning of year.............. 28,677 10,219 20,669
-------- -------- --------
Cash and cash equivalents at end of year.................... $ 8,058 $ 28,677 $ 10,219
======== ======== ========
STATEMENTS OF CASH FLOWS DATA:
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid............................................... $ 890 $ 1,352 $ 2,834
Foreign tax paid............................................ $ 100 $ 200 $ --
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES
Conversion of principal and related interest of Senior
Subordinated Convertible Notes into common stock.......... $ -- $ 10,267 $ --
Fair value of the common stock Warrants issued to certain
Investors and placement agent in connection with the
Convertible Debenture..................................... $ -- $ 6,572 $ --
See accompanying notes.
F-7
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 1: BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Cygnus was incorporated in California in 1985 and was merged into a Delaware
corporation in 1995. We are engaged in the development and manufacture of
diagnostic systems, utilizing proprietary technologies to satisfy unmet medical
needs cost-effectively. Our current efforts are primarily focused on a frequent,
automatic and non-invasive glucose monitoring device, the GlucoWatch biographer,
and enhancements thereto.
CONSOLIDATION
The consolidated financial statements include the accounts of Cygnus and its
wholly-owned subsidiaries after elimination of all material inter-company
balances and transactions. Cygnus' subsidiaries in the United States were
inactive since inception and were dissolved effective February 21, 2000.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
In June 1999 and September 1999, we issued convertible debentures of
$14.0 million and $3.0 million, at conversion prices of $12.705 and $11.8663,
respectively. The debentures were immediately convertible into shares of common
stock and have a coupon rate of 8.5%. In connection with the issuance of these
debentures, we also issued to debenture holders warrants to purchase an
aggregate of 745 thousand shares of common stock. At the time of the issuance of
convertible debentures, we determined that, based on the fair value of common
stock and specified conversion prices and in accordance with the then applicable
accounting pronouncements, these debentures did not contain embedded beneficial
conversion features.
In November 2000, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board (FASB) reached a consensus on Issue 00-27,
Application of EITF Issue 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios to
Certain Convertible Instruments," and concluded that an issuer should calculate
the intrinsic value of a conversion option using the effective conversion price
based on the proceeds received for or allocated to the convertible instrument
instead of the specified conversion price in the instrument. The EITF required
companies to apply the proscribed methodology for computing the beneficial
conversion feature of convertible securities through a cumulative catch-up
accounting change in the quarter that includes November 2000 for any such
security issued after May 20, 1999, the effective date of EITF 98-5.
Accordingly, we recorded a one-time, non-cash charge of $5.0 million in the
fourth quarter of 2000 to record the cumulative effect of a change in accounting
principle as required by the EITF.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
F-8
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
DISCONTINUED OPERATIONS
On December 15, 1999, we completed the sale of substantially all of our drug
delivery business segment assets to Ortho-McNeil, except for certain assets with
a net book value of $505 thousand, of which assets with a net book value of
$205 thousand were written off prior to December 31, 1999. The remaining
$300 thousand in assets were sold in April 2000.
We have restated our consolidated statements of operations for the year
ended December 31, 1998 to reflect the results of the drug delivery business as
a discontinued operation, in accordance with Accounting Principles Board Opinion
No. 30 (APB 30).
REVENUE RECOGNITION
Our contract revenues include up-front and interim milestone payments from
development contracts. The amortization of the initial fees and interim
milestone payments is based on the total person hours expended to date by
project, as compared to the estimated total project person hours required, a
manner similar to the percentage of completion methodology. Due to the nature of
the projects we have undertaken, revenue recognized using our current policy
approximates the revenue that would be recognized using a straight-line basis.
However, contract revenues are not always aligned with the timing of related
expenses. To date, research and development expenses generally have exceeded
contract revenues in any particular period. Deferred revenue includes the
portion of up-front and interim milestone payments received on research,
development and distribution agreements that have been deferred and will be
recognized over the related development period in relation to efforts expended
under the agreement.
CUSTOMER AND OTHER CONCENTRATIONS
One customer provided 95% of the 2000 contract revenues. In 1999 and 1998,
this customer provided 97% and 40% of our contract revenues, respectively.
Another customer provided 60% of our contract revenues in 1998. No contract
revenues were provided by this customer in 1999 and 2000. No other customer
provided more than 10% of contract revenues during the three years ended
December 31, 2000.
We maintain our cash, cash equivalents and investments primarily with a bank
and two brokerage houses. This practice is consistent with our policy to
maintain high liquidity and to ensure safety of principal.
RESEARCH AND DEVELOPMENT
Research and development expenses are expensed as incurred.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are recorded at the lower of cost or net
realizable value. Depreciation of equipment is computed on a straight-line basis
over the estimated useful lives of eighteen months to sixty months. Leasehold
improvements and assets recorded under capital leases are amortized using the
straight-line method over the shorter of the estimated useful life of the assets
or the term of the leases. Amortization expense related to assets under capital
leases is included in depreciation expense. No depreciation charge is computed
on assets under construction.
F-9
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE
DISPOSED OF
The Financial Accounting Standards Board Statement of Financial Accounting
Standard No. 121, "Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed Of" (FAS 121), prescribes the accounting for
the impairment of long-lived assets, such as property, plant, equipment and
intangible assets, as well as the accounting for long-lived assets that are held
for disposal. We review property, plant, equipment and other long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability is measured
by comparison of the assets' carrying amount to the future net cash flows the
assets are expected to generate. If such assets are considered to be impaired,
the impairment is recognized and is measured as the amount by which the carrying
amount of the assets exceeds the present value of the future net cash flows. In
December 1999, as part of the disposal of the drug delivery business segment, we
recorded an impairment charge of $205 thousand. No charge was incurred during
1998 and 2000.
NET LOSS PER SHARE
Basic and diluted net loss per share is computed using the weighted average
number of shares of common stock outstanding. Shares issuable from stock
options, warrants and convertible debentures outstanding are excluded from the
diluted-earnings-per-share computation, as their effect is anti-dilutive.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Under Statement of Financial Accounting Standard No. 123, "Accounting for
Stock-Based Compensation" (FAS 123), stock-based compensation expense to
employees is measured using either the intrinsic-value method as prescribed by
Accounting Principle Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25), or the fair-value method described in FAS 123. We have
elected to follow APB 25 and related interpretations in accounting for our
employee stock options and disclose only the pro forma impact of the fair value
method on net income and earnings per share. (See Note 6, Stockholders' Equity.)
Any options and warrants granted to consultants and other nonemployees are
accounted for at fair value determined by using the Black-Scholes valuation
model in accordance with the Emerging Issues Task Force (EITF) Consensus
No. 96-18, "Accounting for Equity Investments that are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling Goods, or Services."
These options may be subject to periodic revaluation over their vesting terms.
The assumptions used to value stock-based awards to consultants are similar to
those used for employees.
FOREIGN CURRENCY TRANSLATION
The functional and reporting currency of Cygnus and its subsidiaries is the
United States dollar in accordance with Statement of Financial Accounting
Standard No. 52, "Foreign Currency Translation" (FAS 52). Assets and liabilities
of Cygnus and its subsidiaries denominated in foreign currency are translated
into United States dollar equivalents at the exchange rate in effect on the
balance sheet date. Revenue and expenses are translated at the weighted average
exchange rate for the year. Remeasurement of monetary assets and liabilities
that are not denominated in the functional currency is included currently in
operating results. Translation gains/(losses) included in operating results have
been insignificant for all periods presented.
F-10
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
COMPREHENSIVE INCOME/(LOSS)
Comprehensive income includes changes in stockholders' equity during a
period, except those resulting from investments by owners and distributions to
owners. Other comprehensive income/(loss) consists primarily of unrealized gains
and losses on available-for-sale securities.
INCOME TAXES
We account for income taxes in accordance with the liability method. Under
this method, deferred tax assets and liabilities are measured based on
differences between the financial reporting and tax basis of assets and
liabilities using enacted tax rates and laws that will be in effect when
differences are expected to arise.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
We consider all highly liquid investments with a maturity from the date of
purchase of three months or less to be cash equivalents. We invest our excess
cash in high credit quality, highly liquid instruments. These investments have
included Treasury Notes, Federal Agency Securities, Auction Rate Certificates,
Auction Rate Preferred Stock and Commercial Paper.
In addition to the above securities, during the fourth quarter of 2000, we
requested re-issuance of a stock certificate for 400 thousand shares of common
stock of Depomed, Inc. and recorded unrealized gain of $1.8 million. This is
included on our balance sheet with other short-term investments and accumulated
other comprehensive income.
We consider all short-term investments as available-for-sale. As such,
short-term investments are carried at estimated fair value with related
unrealized gains and losses included in stockholders' net capital deficiency.
Realized gains and losses and declines in value judged to be other than
temporary on available-for-sale securities are included in other income and
expense. The cost of securities sold is based on the specific identification
method. Interest and dividends on securities classified as available-for-sale
are included in investment income.
DEFERRED FINANCING COSTS
Deferred financing costs relate to costs incurred in connection with debt
financing that are amortized over the term of the related debt.
FINANCIAL PRESENTATION
Certain prior-year amounts have been reclassified to conform to the current
year's presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). FAS 133, as amended, establishes methods for
recording derivative financial instruments and hedging activities related to
those instruments, as well as other hedging activities. We are required to adopt
FAS 133 effective January 1, 2001. Because we currently do not hold any
derivative instruments and do not engage in hedging activities, we do not
currently believe that the adoption of FAS 133, as amended, will have a
significant impact on the consolidated financial position or results of
operations.
F-11
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB
101). SAB 101 summarizes certain areas of the staff's views in applying
generally accepted accounting principles to revenue recognition. SAB 101 was
required to be adopted by December 31, 2000. The implementation of SAB 101 has
not had a significant impact on the consolidated financial position or results
of operations.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation, Interpretation of APB Opinion No. 25" (FIN 44). FIN 44 clarifies
the application of Accounting Principle Board Opinion No. 25 (APB 25) to certain
issues, including (i) the definition of "employee" for purposes of applying APB
25, (ii) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (iii) the accounting consequences of various modifications
to the terms of a previously fixed stock option or award, and (iv) the
accounting for an exchange of stock compensation awards in a business
combination. In general, FIN 44 is effective July 1, 2000. At present, the
adoption of FIN 44 does not have a material effect on our consolidated financial
position or results of operations.
F-12
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 2: FAIR VALUE OF FINANCIAL INSTRUMENTS
The following is a summary of cash equivalents and investments as of
December 31, 2000 and 1999:
AVAILABLE-FOR-SALE SECURITIES (IN THOUSANDS)
-----------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
AS OF DECEMBER 31, 2000:
Cash Equivalents:
Money Market Fund.................................. $ 4,716 $ -- $ -- $ 4,716
------- ------ ---- -------
Total Cash Equivalents........................... $ 4,716 $ -- $ -- $ 4,716
======= ====== ==== =======
Short-term Investments:
Federal Agency Securities.......................... 4,016 2 -- 4,018
Auction Rate Certificates.......................... 4,911 -- -- 4,911
Corporate Note/Commercial Paper.................... 4,193 9 -- 4,202
Marketable Equity Securities....................... -- 1,750 -- 1,750
------- ------ ---- -------
Total Short-term Investments................... $13,120 $1,761 $ -- $14,881
======= ====== ==== =======
Long-term Investments:
Federal Agency Securities.......................... 1,546 1 -- 1,547
------- ------ ---- -------
Total Long-term Investments.................... $ 1,546 $ 1 $ -- $ 1,547
======= ====== ==== =======
AS OF DECEMBER 31, 1999:
Cash Equivalents:
Money Market Fund.................................. $20,744 $ -- $ -- $20,744
Certificate of Deposit............................. 871 -- -- 871
Corporate Note/Commercial Paper.................... 5,971 -- -- 5,971
------- ------ ---- -------
Total Cash Equivalents........................... $27,586 $ -- $ -- $27,586
======= ====== ==== =======
Short-term Investments:
Federal Agency Securities.......................... 3,819 -- (15) 3,804
Auction Rate Certificates.......................... 6,411 -- -- 6,411
------- ------ ---- -------
Total Short-Term Investments................... $10,230 $ -- $(15) $10,215
======= ====== ==== =======
NOTE 3: CREDIT LINES AND LONG-TERM DEBT
In June 1997, we entered into a loan agreement for $1.3 million to finance
capital equipment. Borrowings under this equipment financing arrangement bore
interest at a fixed rate of 9.39%, were repayable on a monthly basis through
June 2000 and were secured by the assets financed. As of December 31, 1999,
$0.3 million was outstanding under this facility. The amounts were fully repaid
during the fiscal year 2000.
In 1998, we consolidated our then-existing working capital bank loans into a
new $10.0 million facility. The borrowings under the new facility are payable
through August 2001 and bear interest at one percentage point above the prime
rate (9.5% in total as of December 31, 2000). This facility is
F-13
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
secured by company assets. The borrowings under this facility are $2.9 million
and $5.6 million as of December 31, 2000 and 1999, respectively.
In the second quarter of 1998, we entered into another loan agreement for
$1.4 million to finance additional capital equipment. This line bears interest
at a fixed rate of 8.87% per year. Borrowings under this agreement are being
repaid monthly through June 2001. Borrowings under this facility amounted to
$0.2 million and $0.4 million as of December 31, 2000 and 1999, respectively.
All loan agreements are subject to certain financial covenants, including
minimum cash balances and tangible net worth. In the event of non-compliance
with these covenants, the lenders may require collateral of the amounts
outstanding. In the event of default, the lenders may, at their option, exercise
their rights to remedies specified in the loan agreements, which include, among
other things, the acceleration of amounts due under the agreements. As of
December 31, 2000, we were in compliance with all these covenants.
NOTE 4: LEASES AND COMMITMENTS
CAPITAL LEASES
In conjunction with the sale of our drug delivery business, we repaid all
our lease liabilities and, consequently, as of December 31, 1999, we did not
have any borrowings under capital lease.
OPERATING LEASES
We lease our facilities under non-cancelable operating leases expiring in
2003. The terms of the leases provide for rental payments on a graduated scale.
We are recognizing rent expense on a straight-line method over the periods of
the leases and therefore have accrued for the rent expense incurred but not
paid. Additionally, we leased an off-site warehouse; however we terminated the
lease for this warehouse in November 2000.
Rent expense amounted to $1.1 million, $1.9 million and $1.1 million, net of
sublease payments of $1.0 million, $0.2 million and $0.0 million, for the years
ended December 31, 2000, 1999 and 1998, respectively. Currently, one building is
under a sublease that runs concurrently with the operating lease and we are
offering another building for sublease. Minimum future rental commitments and
minimum future sublease rental receipts under the operating leases on
December 31, 2000 are as follows:
MINIMUM FUTURE MINIMUM FUTURE
RENTAL SUBLEASE RENTAL
COMMITMENTS RECEIPTS
--------------- ---------------
(IN THOUSANDS)
---------------------------------
Years ending December 31,
2001...................................................... $1,958 $ 623
2002...................................................... 2,018 605
2003...................................................... 1,961 585
------ ------
Total rental commitments and sublease rental receipts,
respectively.............................................. $5,937 $1,813
====== ======
F-14
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 5: FINANCING INSTRUMENTS
In June 1999, we entered into two financing arrangements: a Convertible
Debenture and Warrant Purchase Agreement ("Convertible Debenture") and a
Structured Equity Line Flexible Financing(SM) Agreement ("Equity Line").
CONVERTIBLE DEBENTURES
Under the Convertible Debenture, 8.5% convertible debentures having a
principal amount of $14.0 million due June 29, 2004 were issued at a conversion
price of $12.705 per share. The Convertible Debenture also provided for the
issuance of an additional $6.0 million of convertible debentures, composed of
two $3.0 million tranches (the "additional tranches") for similar terms and
conditions except for the determination of conversion prices upon issuance of
additional tranches. The conversion prices for the additional tranches were to
be determined based on certain market-based formulas defined in the original
Convertible Debenture. In September 1999, we issued convertible debentures for
$3.0 million pursuant to the terms of additional tranches. The first additional
tranche due on September 29, 2004 had a conversion price of $11.8663. The
$3.0 million under the second additional tranche is still available.
In conjunction with the issuance of convertible debentures, in June 1999 and
September 1999 we issued to the debenture holders warrants to purchase
approximately 606 thousand shares and 139 thousand shares of common stock,
respectively, at the respective exercise price of $13.86 per share and $16.18
per share. Each tranche of warrants had a contractual term of five years from
the date of respective grant. At the respective dates of grant, the fair values
ascribed to these warrants were approximately $5.0 million and $1.1 million,
respectively, based on a Black-Scholes valuation model, were recorded as debt
discount and are being amortized as additional interest expense over the debt
term. We recorded amortization of $1.2 million and $0.6 million in 2000 and
1999, respectively. As of December 31, 2000, the aggregate unamortized fair
value of the warrants amounted to $4.3 million.
We had previously determined that the issuance of Convertible Debentures in
June 1999 and September 1999 did not contain any embedded beneficial conversion
features. However, as explained in detail in the third and fourth paragraphs of
Note 1, as a result of the adoption of a new methodology for computing the
embedded beneficial conversion feature of convertible securities by the EITF in
November 2000, we have reassessed our accounting and have determined that the
beneficial conversion features of the above convertible debentures, valued under
the new methodology, amounted to $5.0 million. The amount was recorded as a
non-cash charge in the fourth quarter of 2000.
In connection with the issuance of convertible debentures, we also issued to
the placement agent warrants to purchase 50 thousand shares of common stock at
the exercise price of $13.86 per share. At the date of grant, the fair value
ascribed to the warrants was approximately $417 thousand, based on a
Black-Scholes valuation model, and that amount was recorded as deferred
financing cost and is being amortized as additional interest expense over the
debt term. We recorded amortization of $83 thousand and $42 thousand in 2000 and
1999, respectively.
The convertible debentures have a stated interest rate of 8.5% and an
effective interest rate of 18.20%. The effective interest rate includes a
non-cash charge of $6.6 million for the amortization of the implicit value of
warrants issued in connection with the convertible debentures.
F-15
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
STRUCTURED EQUITY LINE FINANCING AGREEMENT
The Equity Line originally had a maximum aggregate issue price of
$30.0 million over a two-year commitment period and allows us, at our sole
discretion, to sell common stock over this period. We were also required to
issue warrants to purchase a minimum of 120 thousand shares at the exercise
price equal to 120% of the weighted-average per share sale price of all shares
sold under the Equity Line. In 1999, we received aggregate proceeds of
approximately $9.5 million from the original $30.0 million, from the sale of
909 thousand shares of common stock pursuant to the Equity Line. The per share
purchase price of shares issued under the Equity Line was determined on certain
market-based pricing formulas. In May 2000, the Equity Line was amended (the
"amended Equity Line") to increase the maximum aggregate issue price by an
additional $30.0 million to a total of $60.0 million, to provide for the
issuance of warrants to purchase up to 600 thousand shares of common stock, to
replace the calculation used to determine the per share price with a formula
more favorable to Cygnus and to extend the commitment period to June 30, 2003.
In 2000, we received additional proceeds of approximately $14.2 million. These
proceeds resulted from the sale of approximately 1.5 million shares of common
stock pursuant to the amended Equity Line. Thus, as of December 31, 2000, we
have received approximately $23.7 million and have $36.3 million available under
the amended Equity Line. In conjunction with the amended Equity Line, in
January 2000 we also issued warrants to purchase 95 thousand shares of common
stock at an exercise price of $11.51 per share.
In March 2001, we terminated the amended Equity Line and entered into a new
Equity Line ("the March 2001 Equity Line") with the same investors, as discussed
more fully in Note 13.
NOTE 6: STOCKHOLDERS' EQUITY
PREFERRED SHARE PURCHASE RIGHTS PLAN
Pursuant to our Stockholder Rights Plan, the Board of Directors declared a
dividend distribution of one Preferred Share Purchase Right ("Right") for each
outstanding share of common stock, issuable on October 18, 1993 to stockholders
of record on that date. These Rights will remain outstanding until
September 21, 2003.
WARRANTS
Currently, we account for all warrants issued in connection with services
rendered on the basis of the fair value of the warrants. We estimate the fair
value of such instruments by running a Black-Scholes valuation model, and the
fair value thus computed is then recognized over the period for which the
underlying services are rendered. The following table details warrants
outstanding as of December 31, 2000.
OUTSTANDING
NUMBER OF FAIR VALUE OF
SHARES COVERED WARRANTS AT
DATE OF WARRANTS BY WARRANTS EXERCISE PRICE EXPIRATION DATE ISSUANCE
- ---------------- -------------- -------------- --------------- -------------
06/29/99................................. 606,059 $13.86 06/29/04 $5,048,488
06/29/99................................. 50,000 $13.86 06/29/04 $ 416,500
09/29/99................................. 139,050 $16.18 09/29/04 $1,106,838
01/05/00................................. 95,000 $11.51 01/05/05 $1,335,700
F-16
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
EMPLOYEE STOCK PURCHASE PLAN
As part of an employee retention program, we established the Amended 1991
Employee Stock Purchase Plan, as Amended and Restated as of March 1, 2000 (the
"Stock Purchase Plan") to provide employees with an opportunity to purchase our
common stock through payroll deductions. A total of 1.975 million shares of
common stock were reserved for issuance to eligible employees under the Stock
Purchase Plan. The Stock Purchase Plan will terminate in 2011 unless sooner
terminated by the Board of Directors. Under this Stock Purchase Plan, our
employees, subject to certain restrictions, may purchase shares of common stock
at 85% of the lesser of the fair market value of the common stock on the date of
either the beginning of the two-year offering or the end of the purchase period.
During 2000, 1999 and 1998, 252 thousand shares, 251 thousand shares and
116 thousand shares, respectively, were purchased under the Stock Purchase Plan
and, as of December 31, 2000, 909 thousand shares were available for issuance.
STOCK INCENTIVE PLAN
We have a 1999 Stock Incentive Plan, as Amended and Restated as of March 1,
2000 (the "Stock Plan"), that authorizes the Board of Directors to grant
incentive stock options, nonstatutory stock options, stock purchase rights,
stock and restricted stock to employees and consultants. The Stock Plan
authorizes the issuance of up to 9.916 million common shares, of which
2.997 million were available for grant as of December 31, 2000. Under the Stock
Plan, stock options must be granted at no less than the fair market value at the
date of grant, as determined by the Board of Directors or a committee thereof.
Options generally vest over a four-year period and are exercisable for a term of
ten years after issuance, unless otherwise determined by the Board of Directors
or a committee thereof.
We have elected to follow APB 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for our employee stock
options because the alternative fair value accounting provided for under
FAS 123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of our employee stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
OPTION ACTIVITY SUMMARY FOR THE YEAR ENDED DECEMBER 31:
------------------------------------------------------------------------------------
2000 1999 1998
-------------------------- -------------------------- --------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
(IN THOUSANDS) PRICE (IN THOUSANDS) PRICE (IN THOUSANDS) PRICE
-------------- --------- -------------- --------- -------------- ---------
Outstanding at beginning of
year........................... 3,179 $10.31 4,427 $11.34 3,277 $13.26
Granted.......................... 846 $13.34 973 $ 6.78 1,458 $ 7.72
Granted outside Plan............. -- -- -- -- 20 $ 3.25
Exercised........................ (316) $ 8.44 (852) $ 6.97 (25) $ 8.51
Forfeited........................ (413) $13.30 (1,369) $13.20 (303) $14.36
----- ------ -----
Outstanding at end of year....... 3,296 $10.79 3,179 $10.31 4,427 $11.34
===== ====== =====
Exercisable at end of year....... 1,847 $10.51 1,567 $12.90 2,512 $12.65
===== ====== =====
Weighted-average fair value of
options granted during the
year........................... $7.81 $ 3.83 $4.26
F-17
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
A summary of our stock option position as of December 31, 2000 is as
follows:
OPTIONS OUTSTANDING EXERCISABLE
--------------------------------------------- --------------------------
NUMBER WEIGHTED- WEIGHTED- NUMBER WEIGHTED-
OUTSTANDING AVERAGE AVERAGE EXERCISABLE AVERAGE
RANGE OF EXERCISE AT YEAR END REMAINING EXERCISE AT YEAR END EXERCISE
PRICES (IN THOUSANDS) CONTRACTUAL LIFE PRICE (IN THOUSANDS) PRICE
- ----------------- -------------- ---------------- --------- -------------- ---------
$3.2500 - $ 5.7500 1,071 6.37 $ 4.6347 669 $ 4.2335
$ 5.8125 - $11.1250 681 6.90 $ 8.8841 336 $ 8.6085
$11.1875 - $15.6250 659 6.54 $14.1213 515 $14.3139
$15.7500 - $17.2500 664 8.44 $16.1472 126 $17.1749
$17.8750 - $22.5000 221 5.58 $20.4272 201 $20.6199
----- -----
3,296 6.88 $10.7853 1,847 $10.5102
===== =====
Pro forma information regarding net income and earnings per share is
required by FAS 123, which also requires that the information be determined as
if we had accounted for our employee stock options granted under the fair-value
method of FAS 123. The fair value for these options and the fair value for the
stocks issued under the Stock Purchase Plan were estimated at the date of grant
using a Black-Scholes option valuation model with the following weighted-average
assumptions for 2000, 1999 and 1998: risk-free interest rate of 5.75%, 5.88% and
4.25%, respectively; a dividend yield of 0.0%; volatility factors of the
expected market price of our common stock of 0.82, 0.82 and 0.78, respectively;
and a weighted-average expected life of the option of five years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion the
existing models do not necessarily provide a reliable single measure of the fair
value of our employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options issued under the Stock Plan is amortized to expense over the vesting
period of the options. The estimated fair value of the compensation benefit
received under the Stock Purchase Plan is expensed in the year of purchase. Our
pro forma information follows:
2000 1999 1998
-------- -------- --------
Pro forma net loss (In thousands)............... $(41,209) $(8,576) $(44,898)
Pro forma net loss per share, basic and
diluted....................................... $ (1.57) $ (0.37) $ (2.22)
Under the Stock Plan, stock may be sold and stock bonuses or rights to
purchase common stock may be granted by the Board of Directors or a committee
thereof for past services at the fair market value at the date of grant. The
Board may impose certain repurchase rights, in favor of Cygnus, in the event
that an employee is terminated prior to certain predetermined vesting dates. As
of December 31, 2000, 1999 and 1998, no shares were subject to repurchase.
On February 23, 1999, we issued two warrants to a consultant to purchase
60 thousand shares each for the exercise price of $0.01 and $3.25, respectively,
in connection with financing services rendered by the consultant. A fair value
of $335 thousand, computed on the basis of a Black-Scholes valuation
F-18
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
model, was ascribed to these warrants and was expensed at the time the services
were rendered. These warrants were exercised in February 1999 and April 1999,
respectively.
COMMON STOCK RESERVED FOR FUTURE ISSUANCE
At December 31, 2000, the total number of shares of common stock reserved
for issuance is as follows:
COMMON
STOCK
RESERVED
(IN THOUSANDS)
---------------
Under all employee stock plans.............................. 7,202
Convertible Debenture....................................... 1,809
Outstanding warrants........................................ 890
Other potential issuances................................... 368
------
Total common stock reserved............................... 10,269
======
NOTE 7: INCOME TAXES
The Company recorded a $100 thousand and $200 thousand income tax provision
for the years ended December 31, 2000 and December 31, 1999, respectively,
consisting entirely of foreign withholding taxes. An income tax benefit was not
accrued on net losses for the year ended December 31, 1998 due to the
uncertainty regarding the Company's future profitability.
Significant components of the Company's deferred tax assets as of
December 31, 2000 and 1999 are as follows:
YEAR ENDED
DECEMBER 31,
----------------------
2000 1999
-------- --------
(IN THOUSANDS)
----------------------
DEFERRED TAX ASSETS:
Net operating loss carryforwards..................... $ 71,800 $ 54,000
Research and development credits..................... 8,700 5,800
Reserves and accruals................................ 550 700
Capitalized R&D...................................... 4,100 4,400
Sanofi~Synthelabo arbitration award.................. 9,100 9,500
Other--Net........................................... 1,450 4,400
-------- --------
Total deferred tax assets.......................... 95,700 78,800
Valuation allowance for deferred tax assets.......... (95,700) (78,800)
-------- --------
Net deferred tax assets............................ $ -- $ --
-------- --------
Realization of deferred tax assets is dependent on future earnings, if any,
the timing and amount of which are uncertain. Accordingly, a valuation allowance
in an amount equal to the net deferred tax assets as of December 31, 2000 and
1999 has been established to reflect these uncertainties. The
F-19
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
deferred tax asset valuation allowance increased by $16.9 million, $4.1 million
and $17.4 million in 2000, 1999 and 1998, respectively.
At December 31, 2000, we had federal net operating loss and research and
development tax credit carryforwards of approximately $201.4 million and
$5.7 million, respectively. We had state net operating loss and tax credit
carryforwards of approximately $58.7 million and $4.6 million, respectively.
These carryforwards will expire at various dates beginning in 2001.
Because of the "change in ownership" provisions of the Internal Revenue Code
of 1986, as amended, a substantial portion of the Company's net operating loss
and tax credit carryforwards may be subject to annual limitations. The annual
limitation may result in the expiration of net operating losses and tax credits
before utilization.
NOTE 8: ARBITRATION AWARD OBLIGATION
On December 11, 1997, the International Court of Arbitration issued a Final
Award, which was not appealable, in an arbitration matter between Sanofi, S.A.,
now Sanofi~Synthelabo, and Cygnus relating to transdermal hormone replacement
therapy systems. This Final Award was entered as a judgment of the United States
District Court for the Northern District of California. Under the terms of the
Final Award, we have accrued for the following obligations as of December 31,
2000: (i) payments of an aggregate amount equal to $17.0 million as minimum
royalty payments for the period 2001 through 2005, payable 60 days after the end
of each fiscal year ($2.0 million for the year 2001, $3.0 million for the year
2002, $4.0 million for the year 2003, $4.0 million for the year 2004 and
$4.0 million for the year 2005), and (ii) a convertible promissory note in the
principal amount of $6.0 million, issued in December 1997, payable in
December 2001 and bearing interest at 6.5% per annum. (The note will be
convertible into our common stock at Sanofi~Synthelabo's option, exercisable at
any time during the four year term, at a conversion rate of $21.725 per share.)
The underlying agreement, which was the subject matter of the arbitration, was
terminated on December 15, 1999.
NOTE 9: DISCONTINUED OPERATIONS
On December 15, 1999, we completed the sale of substantially all of our drug
delivery business segment assets to Ortho-McNeil Pharmaceutical, Inc.
(Ortho-McNeil), a Johnson & Johnson company. The revenues of the drug delivery
business were $12.3 million and $11.2 million for the years ended December 31,
1999 and 1998, respectively. The net income/(loss) of the drug delivery business
was $3.0 million and $1.0 million for the years ended December 31, 1999 and
1998, respectively. Under the terms of our agreement with Ortho-McNeil, we
received $20.0 million in cash at closing, and Ortho-McNeil was subject to
paying up to an additional $55.0 million in cash, contingent on the achievement
of certain milestones. The contingent payments relate to the achievement of
certain technical, regulatory and commercialization milestones related to the
EVRA-TM- (Johnson & Johnson, New Brunswick, New Jersey) transdermal
contraceptive patch. Certain milestones were not met and we are now eligible
through 2006 to receive up to $35.0 million of the original $55.0 million
contingent milestones. Because the achievement of these milestones is not within
our control, we cannot predict the likelihood or timing of these contingent
payments.
F-20
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 10: BUSINESS SEGMENTS
Prior to December 15, 1999, we operated in two business segments:
diagnostics and drug delivery. Both segments were engaged in development and
manufacture, utilizing proprietary technologies to satisfy unmet medical needs
cost-effectively. The segments were strategic business units managed separately,
based on the differences in the technologies of their respective product lines.
On December 15, 1999, we completed the sale of substantially all of our drug
delivery business segment assets to Ortho-McNeil, except for certain assets with
a net book value of $505 thousand, of which assets with a net book value of
$205 thousand were written off prior to December 31, 1999. The remaining drug
delivery assets, which had an estimated value of $300 thousand, were sold in
April 2000. All financial results related to the drug delivery business are
accounted for as discontinued operations in accordance with APB 30. We now
operate as a one-segment company.
The accounting policies of the business segments were the same as those
described in the summary of significant accounting policies. We did not have a
measure of interest income or interest expense by business segment. We utilized
the following information for the purpose of making decisions and assessing
segments' performance.
The table below details the segment information subsequent and prior to the
sale of the drug delivery business, with a reconciling column to reflect totals
related to continuing operations.
BUSINESS SEGMENTS (IN THOUSANDS)
----------------------------------------------------
CONTINUING
DRUG OPERATIONS
DIAGNOSTICS DELIVERY RECONCILIATION TOTAL
----------- -------- -------------- ----------
2000
Revenue........................... $ 1,052 $ -- $ -- $ 1,052
Profit/(loss)..................... (37,033) -- -- (37,033)
Depreciation and amortization..... 1,267 -- -- 1,267
Identifiable assets............... 32,889 -- -- 32,889
1999
Revenue........................... $ 2,061 $12,293 $(12,293) $ 2,061
Profit/(loss)..................... (22,174) 3,031 (3,031) (22,174)
Depreciation and amortization..... 993 869 (869) 993
Other significant items:
Gain on sale of segment......... -- 16,308 (16,308) --
Identifiable assets............... 46,976 1,036 (1,036) 46,976
1998
Revenue........................... $ 457 $11,198 $(11,198) $ 457
Profit/(loss)..................... (40,434) 1006 (1,006) (40,434)
Depreciation and amortization..... 950 971 (971) 950
Other significant items:
Beneficial conversion costs..... 4,230 -- -- 4,230
Identifiable assets............... 39,130 4,324 -- 43,454
All segment revenues have been generated in the United States and we
currently do not have any long-lived assets outside the United States.
F-21
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 11: EMPLOYEE BENEFIT PLAN
We have an employee savings plan ("Plan") covering substantially all
employees that qualifies as a deferred salary arrangement under Section 401(k)
of the Internal Revenue Code. The Plan provides for employee contributions up to
15% of their annual pre-tax compensation or to a maximum of 17% of their
combined pre-tax and after-tax compensation, as defined in the Plan. The Plan
provides for Cygnus to match a portion of the contributions. For the years ended
December 31, 2000, 1999 and 1998, we incurred defined contribution expense of
$0.08 million, $0.08 million and $0.1 million, respectively.
NOTE 12: RELATED PARTY TRANSACTIONS
We do business with two companies that are principally owned by a former
Cygnus non-officer employee whose employment with us terminated in March 2000.
The two companies primarily design and build manufacturing equipment for the
GlucoWatch Autosensor and manufacture components of the GlucoWatch Autosensor.
During 2000, 1999 and 1998, we purchased approximately $2.9 million,
$3.2 million and $4.0 million, respectively, of goods and services from these
companies.
NOTE 13: SUBSEQUENT EVENTS (UNAUDITED)
Subsequent to December 31, 2000, substantially all of our Depomed, Inc.
shares (see Note 2) were liquidated and we recorded a realized gain of
$1.1 million on sale of marketable equity securities.
In March 2001, we terminated our existing amended Equity Line and we entered
into a new Equity Line for a maximum aggregate issue price of $33 million with
the same Investors. The terms and conditions of this new Equity Line are
substantially the same as the prior amended Equity Line, and the commitment
period ends June 30, 2003.
F-22
CYGNUS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2000
NOTE 14: SELECTED QUARTERLY FINANCIAL DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
---------------------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 31, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 31, JUNE 30, MARCH 31,
2000 2000 2000 2000 1999 1999 1999 1999
------------ ------------- -------- --------- ------------ ------------- -------- ---------
Contract revenues.... $ 14 $ -- $ -- $ 1,038 $ 1,149 $ 912 $ -- $ --
Total costs and
expenses........... 9,210 9,509 6,786 5,737 4,959 4,261 4,785 6,534
-------- -------- -------- -------- ------- ------- ------- -------
Loss from
operations......... (9,196) (9,509) (6,786) (4,699) (3,810) (3,349) (4,785) (6,534)
Interest income and
(expense) and other
net................ (413) (519) (469) (316) (794) (761) (1,460) (381)
-------- -------- -------- -------- ------- ------- ------- -------
Loss from continuing
operations before
tax................ (9,609) (10,028) (7,255) (5,015) (4,604) (4,110) (6,245) (6,915)
Provision for
tax.............. -- -- -- (100) (200) (100) -- --
-------- -------- -------- -------- ------- ------- ------- -------
Loss from
continuing
operations....... (9,609) (10,028) (7,255) (5,115) (4,804) (4,210) (6,245) (6,915)
-------- -------- -------- -------- ------- ------- ------- -------
Discontinued
operations:
Income/(loss) from
operations of a
discontinued
segment............ -- -- -- -- 1,591 88 1,253 99
Gain on disposal of a
segment............ -- -- -- -- 16,308 -- -- --
-------- -------- -------- -------- ------- ------- ------- -------
Net income/(loss)
before cumulative
effect of a change
in accounting
principle.......... (9,609) (10,028) (7,255) (5,115) 13,095 (4,122) (4,992) (6,816)
Cumulative effect of
a change in
accounting
principle.......... (5,026) -- -- -- -- -- -- --
-------- -------- -------- -------- ------- ------- ------- -------
Net income/(loss).... $(14,635) $(10,028) $(7,255) $ (5,115) $13,095 $(4,122) $(4,992) $(6.816)
======== ======== ======== ======== ======= ======= ======= =======
Net loss per share
from continuing
operations, basic
and diluted........ $ (0.35) $ (0.38) $ (0.28) $ (0.20) $ (0.19) $ (0.17) $ (0.28) $ (0.32)
Net income/(loss) per
share from a
discontinued
segment, basic and
diluted............ -- -- -- -- 0.72 -- 0.06 0.01
Net loss per share
from cumulative
effect of a change
in accounting
principle.......... (0.19) -- -- -- -- -- -- --
-------- -------- -------- -------- ------- ------- ------- -------
Net loss per share,
basic and
diluted............ $ (0.54) $ (0.38) $ (0.28) $ (0.20) $ 0.53 $ (0.17) $ (0.22) $ (0.31)
======== ======== ======== ======== ======= ======= ======= =======
Shares used in
computation of net
loss per share,
basic and
diluted............ 27,164 26,467 26,277 25,527 24,854 24,196 22,632 21,733
======== ======== ======== ======== ======= ======= ======= =======
F-23
SCHEDULE II
CYGNUS, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(IN THOUSANDS)
BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT END
BEGINNING OF YEAR AND EXPENSES OTHER ACCOUNTS DEDUCTIONS OF YEAR
----------------- ---------------- -------------- ---------- --------------
YEAR ENDED DECEMBER 31, 2000:
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL
ACCOUNTS.................... $ -- $ -- $ -- $ -- $ --
WARRANTY RESERVE.............. -- -- -- -- --
---- ----- ----- --------- ----
$ -- $ -- $ -- $ -- $ --
==== ===== ===== ========= ====
YEAR ENDED DECEMBER 31, 1999:
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL
ACCOUNTS.................... $123 $ -- $(123) $ -- $ --
WARRANTY RESERVE.............. 435 (435) -- -- --
---- ----- ----- --------- ----
$558 $(435) $(123) $ -- $ --
==== ===== ===== ========= ====
YEAR ENDED DECEMBER 31, 1998:
DEDUCTED FROM ASSET ACCOUNTS:
ALLOWANCE FOR DOUBTFUL
ACCOUNTS.................... $123 $ -- $ -- $ -- $123
WARRANTY RESERVE.............. 435 -- -- -- 435
---- ----- ----- --------- ----
$558 $ -- $ -- $ -- $558
==== ===== ===== ========= ====
S-1