**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHESECURITIES EXCHANGE ACT OF 1934.**

 

**For the Quarterly Period Ended June 30, 2004**

 

**Commission File Number 0-18044**

 

**PROCYTE CORPORATION**

(Exact name of the registrant as specified in its charter)

 

| **Washington**                                           | ** ** | **91-1307460**                       |
|----------------------------------------------------------|------------|--------------------------------------|
| (State of incorporation)                                 |       | (I.R.S. Employer Identification No.) |
|                                                     |       |                                 |
| **8511 154th Avenue N.E., Redmond, WA**                  | ** ** | **98052**                            |
| (Address of principal executive offices)                 |       | (Zip code)                           |
|                                                     |       |                                 |
| Registrant’s telephone number, including area code: | ** ** | **(425) 869-1239**                   |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes ý                                                                                     Noo

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2).

 

Yes o                                                                                     Noý

 

Asof July 31, 2004, there were issued and outstanding 15,807,171 shares of commonstock, par value $.01 per share.

** **

** **

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**ProCyte Corporation**

 

**Index**

 
| **Part I -  Financial Information**                                                                       |   |
|-----------------------------------------------------------------------------------------------------------|--------|
| Item 1. Condensed Consolidated Financial Statements (unaudited)                                           |   |
| Balance Sheets - as of June 30, 2004 and  December 31, 2003 (unaudited)                                   |   |
| Statements of Operations - Three and Six Months Ended June 30, 2004  and 2003 (unaudited)                 |   |
| Statements of Cash Flows - Six Months Ended June 30, 2004 and 2003  (unaudited)                           |   |
| Statements of Stockholders’ Equity - Six  Months Ended June 30, 2004 (unaudited)                     |   |
| Notes to Condensed Consolidated Financial Statements (unaudited)                                          |   |
| Item 2.  Management’s Discussion  and Analysis of Financial Condition and Results of Operations |   |
| Item 3.  Quantitative and  Qualitative Disclosures About Market Risk                                 |   |
| Item 4.  Controls and  Procedures                                                                    |   |
| **Part II  - Other Information**                                                                          |   |
| Item 4.  Submission of Matters  to a Vote of Security Holders                                        |   |
| Item 6.  Exhibits and Reports  on Form 8-K                                                           |   |
| **Signatures**                                                                                            |   |

 

 

2

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**Part I****- Financial Information**

 

**Item 1****.****Condensed Consolidated Financial Statements (unaudited)**

 

**BalanceSheets****- as of June 30, 2004 andDecember 31, 2003 (unaudited)**

(in thousands)

 
| ** **                                                   | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **ASSETS**                                                   |       |               |       |                   |       |
| **Current Assets**                                           |       |               |       |                   |       |
| Cash and cash equivalents                                    |       | $                  | 5,729      |                   | $          | 3,796 |   |
| Accounts receivable, net of allowance for  doubtful accounts |       | 1,202              |       | 1,336                  |       |
| Inventory                                                    |       | 2,625              |       | 2,942                  |       |
| Prepaid and other                                            |       | 217                |       | 289                    |       |
| **Total current assets**                                     |       | 9,773              |       | 8,363                  |       |
| ** **                                                   |       |               |       |                   |       |
| **Property and equipment**                                   |       |               |       |                   |       |
| Equipment                                                    |       | 325                |       | 315                    |       |
| Leasehold improvements                                       |       | 3,226              |       | 3,520                  |       |
| Less accumulated depreciation and  amortization              |       | (3,380             | )          | (3,294                 | )          |
| **Property and equipment, net**                              |       | 171                |       | 541                    |       |
| ** **                                                   |       |               |       |                   |       |
| Intangible assets                                            |       | 3,205              |       | 3,212                  |       |
| Note due from related party, net                             |       | 781                |       | 781                    |       |
| Deferred tax asset                                           |       | 7,055              |       | 7,068                  |       |
| Other assets                                                 |       | 38                 |       | 38                     |       |
| **Total Assets**                                             |       | $                  | 21,023     |                   | $          | 20,003 |   |
|                                                         |       |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                |       |               |       |                   |       |
| **Current Liabilities**                                      |       |               |       |                   |       |
| Accounts payable, trade                                      |       | $                  | 631        |                   | $          | 147 |   |
| Accrued salaries and benefits                                |       | 310                |       | 246                    |       |
| Other accrued liabilities                                    |       | 195                |       | 239                    |       |
| Deferred revenue                                             |       | 527                |       | 60                     |       |
| **Total current liabilities**                                |       | 1,663              |       | 692                    |       |
| Other liabilities                                            |       | 93                 |       | 93                     |       |
| **Total Liabilities**                                        |       | 1,756              |       | 785                    |       |
| **Stockholders’ Equity**                                |       |               |       |                   |       |
| Common stock and additional paid-in-capital                  |       | 85,440             |       | 85,419                 |       |
| Deferred compensation                                        |       | (52                | )          | (59                    | )          |
| Accumulated deficit                                          |       | (66,121            | )          | (66,142                | )          |
| **Stockholders’ Equity**                                |       | 19,267             |       | 19,218                 |       |
| **Total Liabilities and Stockholders’ Equity**          |       | $                  | 21,023     |                   | $          | 20,003 |   |

 

*See notes to condensed consolidated financialstatements*

 

3

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**Statementsof Operations****-Three and Six Months Ended June 30, 2004 and 2003 (unaudited)**

(in thousands, except per share amounts)

 
| ** **                                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues**                                |       |                             |       |                           |       |   |   |   |   |
| Product sales                               |       | $                                | 3,454      |                           | $          | 2,313 |   | $ | 6,315 |   | $ | 5,195 |   |
| Licenses and royalties                      |       | 230                              |       | 319                            |       | 589 |   | 783 |   |
| Total revenues                              |       | 3,684                            |       | 2,632                          |       | 6,904 |   | 5,978 |   |
| Cost of product sales                       |       | 1,157                            |       | 619                            |       | 2,018 |   | 1,802 |   |
| Gross profit                                |       | 2,527                            |       | 2,013                          |       | 4,886 |   | 4,176 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| **Operating Expenses**                      |       |                             |       |                           |       |   |   |   |   |
| Marketing and selling                       |       | 1,260                            |       | 814                            |       | 2,458 |   | 2,213 |   |
| Research, general, and administrative       |       | 1,057                            |       | 967                            |       | 2,148 |   | 1,934 |   |
| Loss on asset impairment                    |       | 294                              |       | —                         |       | 294 |   | — |   |
| Total operating expenses                    |       | 2,611                            |       | 1,781                          |       | 4,900 |   | 4,147 |   |
| Operating income (loss)                     |       | (84                              | )          | 232                            |       | (14 | ) | 29 |   |
| Interest and other income                   |       | 43                               |       | 37                             |       | 50 |   | 125 |   |
| Net income (loss) before tax                |       | (41                              | )          | 269                            |       | 36 |   | 154 |   |
| Provision (benefit) for income tax          |       | (12                              | )          | —                         |       | 15 |   | 18 |   |
| Net income (loss)                           |       | $                                | (29        | )                              | $          | 269 |   | $ | 21 |   | $ | 136 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| ***Net earnings per  share***               |       |                             |       |                           |       |   |   |   |   |
| Basic                                       |       | $                                | 0.00       |                           | $          | 0.02 |   | $ | 0.00 |   | $ | 0.01 |   |
| Diluted                                     |       | $                                | 0.00       |                           | $          | 0.02 |   | $ | 0.00 |   | $ | 0.01 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| ***Shares used in per  share computation*** |       |                             |       |                           |       |   |   |   |   |
| Basic                                       |       | 15,798                           |       | 15,765                         |       | 15,795 |   | 15,755 |   |
| Diluted                                     |       | 15,798                           |       | 16,040                         |       | 16,030 |   | 15,979 |   |

 

*See notes to condensed consolidated financialstatements*

 

4

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**Statementsof Cash Flows****–Six Months Ended June 30, 2004 and 2003 (unaudited)**

(in thousands)

 
| ** **                                                                                         | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| **Operating Activities**                                                                           |       |                          |       |   |   |
| Net income                                                                                         |       | $                             | 21         |   | $ | 136 |   |
| ***Adjustments to  reconcile net income to net cash provided by (used in) operating activities:*** |       |                          |       |   |   |
| Depreciation and amortization                                                                      |       | 100                           |       | 153 |   |
| Amortization of deferred proceeds                                                                  |       | —                        |       | (134 | ) |
| Non-cash expense related to stock-based  compensation                                              |       | 18                            |       | 24 |   |
| Amortization of promissory note discount                                                           |       | —                        |       | (16 | ) |
| Change in deferred tax asset, net of change  in valuation allowance                                |       | 13                            |       | — |   |
| Amortization of deferred compensation                                                              |       | 10                            |       | 4 |   |
| Loss on asset impairment                                                                           |       | 294                           |       | — |   |
|                                                                                               |       |                          |       |   |   |
| ***Change in  operating assets and liabilities:***                                                 |       |                          |       |   |   |
| Accounts receivable                                                                                |       | 134                           |       | 152 |   |
| Inventory                                                                                          |       | 310                           |       | (385 | ) |
| Prepaid and other                                                                                  |       | 72                            |       | 171 |   |
| Accounts payable, trade                                                                            |       | 484                           |       | 48 |   |
| Accrued salaries and benefits                                                                      |       | 64                            |       | (126 | ) |
| Other accrued liabilities                                                                          |       | (44                           | )          | (64 | ) |
| Deferred revenue                                                                                   |       | 467                           |       | (2 | ) |
| Other liabilities                                                                                  |       | —                        |       | 2 |   |
| ***Net cash provided  by (used in) operating activities***                                         |       | 1,943                         |       | (37 | ) |
| *** ***                                                                                       |       |                          |       |   |   |
| **Financing Activities**                                                                           |       |                          |       |   |   |
| Proceeds from issuance of common stock                                                             |       | —                        |       | 10 |   |
|                                                                                               |       |                          |       |   |   |
| **Investing Activities**                                                                           |       |                          |       |   |   |
| Purchase of property and equipment                                                                 |       | (10                           | )          | (47 | ) |
| ***Net increase  (decrease) in cash and cash equivalents***                                        |       | 1,933                         |       | (74 | ) |
| *** ***                                                                                       |       |                          |       |   |   |
| **Cash and Cash Equivalents**                                                                      |       |                          |       |   |   |
| At beginning of period                                                                             |       | 3,796                         |       | 4,556 |   |
| At end of period                                                                                   |       | $                             | 5,729      |   | $ | 4,482 |   |

 

*See notes to condensed consolidated financial statements*

 

5

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**Statementsof Stockholders’ Equity****- Six Months Ended June 30, 2004 (unaudited)**

(in thousands)

 
| ** **                                                | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Deferred  Compen-** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
|-----------------------------------------------------------|------------|------------------|------------|-------------------------|------------|-----------------------|------------|-----------------|------------|-------------|------------|
| ** **                                                | ** ** | **Shares**       | ** ** | **Par Value**           | ** ** | **Capital**           | ** ** | **sation**      | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| Balance, December 31, 2003                                |       | 15,783           |       | $                       | 158        |                  | $          | 85,261          |       | $           | (59        | ) | $ | (66,142 | ) | $ | 19,218 |   |
| Shares issued under non-employee director  stock plan     |       | 16               |       | (*                      | )          | 18                    |       | —          |       | —      |       | 18 |   |
| Re-measurement of stock options granted to  non-employees |       | —           |       | —                  |       | 3                     |       | (3              | )          | —      |       | — |   |
| Amortization of deferred compensation                     |       | —           |       | —                  |       | —                |       | 10              |       | —      |       | 10 |   |
| Net income                                                |       | —           |       | —                  |       | —                |       | —          |       | 21          |       | 21 |   |
| Balance, June 30, 2004                                    |       | 15,799           |       | $                       | 158        |                  | $          | 85,282          |       | $           | (52        | ) | $ | (66,121 | ) | $ | 19,267 |   |

 

This statement contains rounding, and (*) is placed where the numberrounds to less than $1,000.

* *

*See notes to condensed consolidated financialstatements*

 

6

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**ProCyte Corporation**

**Notes****to Condensed Consolidated Financial Statements(unaudited)**

 

**1.****             ****Basis of Presentation**

 

Theaccompanying condensed consolidated financial statements (unaudited) includethe accounts of ProCyte Corporation and its wholly-owned subsidiaries,NextDerm, Inc. (a Delaware corporation) and NextDerm, Inc. (a Washingtoncorporation) (collectively “ProCyte” or the “Company”), for the three and sixmonth periods ended June 30, 2004 and 2003, and have been prepared by theCompany in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and the instructionsto Form 10-Q and Article 10 of Regulation S-X. Pursuant to such rules and regulations, the condensed consolidatedfinancial statements do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for audited financial statements. Accordingly, this financial information should be read in conjunctionwith the complete audited financial statements, including the notes thereto,which are included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2003.  In the opinionof management, all material adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation of the financialstatements have been included.  Interimresults are not necessarily indicative of the results that may be expected forthe year.

 

*Use of Estimates in Financial Statements*

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of revenues andexpenses during the reporting period and the reported amounts of assets andliabilities and disclosure of contingent liabilities at the date of thefinancial statements, particularly with respect to the valuation of inventory,notes receivable, goodwill, leasehold improvements and deferred taxassets.  Actual results could differ fromthose estimates.

 

*Stock Based Compensation*

TheCompany follows the intrinsic value based accounting method for stock optionscontained in APB Opinion No. 25, Accounting for Stock Issued to Employees, aspermitted by SFAS No. 123, Accounting for Stock-Based Compensation.  Under this method, no compensation expensehas been recognized for employee incentive stock options, as the exercise priceof options granted equaled the fair value on the date of grant.

 

Thefollowing table represents what the Company’s pro forma amounts of net income(loss) and net income (loss) per share would have been for the three and sixmonths ended June 30, 2004 and 2003, had compensation expense for the Company’sstock options granted under the incentive compensation plan been recognizedbased upon the fair value of the awards granted.

 

7

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| ** **                                                                                  | ** ** | **(in thousands, except per share amounts)** | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                  | ** ** | **Three months ended June 30,**              | ** ** | **Six months ended June 30,** | ** ** |
| ** **                                                                                  | ** ** | **2004**                                     | ** ** | **2003** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss), as reported                                                              |       | $                                            | (29        | ) | $ | 269 |   | $ | 21 |   | $ | 136 |   |
| Stock option-based compensation (expense) benefit determined under  fair value-based method |       | (63                                          | )          | (90 | ) | 11 |   | (217 | ) |
| Pro forma net income (loss)                                                                 |       | $                                            | (92        | ) | $ | 179 |   | $ | 32 |   | $ | (81 | ) |
| Earnings per share:                                                                         |       |                                         |       |   |   |   |   |   |   |
| As reported basic                                                                           |       | $                                            | 0.00       |   | $ | 0.02 |   | $ | 0.00 |   | $ | 0.01 |   |
| As reported diluted                                                                         |       | $                                            | 0.00       |   | $ | 0.02 |   | $ | 0.00 |   | $ | 0.01 |   |
| Pro forma basic                                                                             |       | $                                            | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | (0.01 | ) |
| Pro forma diluted                                                                           |       | $                                            | (0.01      | ) | $ | 0.01 |   | $ | 0.00 |   | $ | (0.01 | ) |

 

TheCompany determined the fair value of stock options granted during the three andsix months ended June 30, 2004 and 2003 using the Black-Scholes option pricingmodel and the following assumptions: 

 
| ** **                   | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Options Granted**          | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free interest rate      |       | 2.49                            | %          | 2.58%-2.69                    | %          | 2.44%-2.61 | % | 2.58%-2.81 | % |
| Expected option life (years) |       | 6.00                            |       | 6.00                          |       | 6.00 |   | 6.00 |   |
| Dividend yield               |       | 0.00                            |       | 0.00                          |       | 0.00 |   | 0.00 |   |
| Expected volatility          |       | 63                              | %          | 59%-62                        | %          | 62%-63 | % | 59%-62 | % |

 

**2.****             ****Accounts Receivable**

 

Twocustomers represented greater than 10% of the net accounts receivable balanceat June 30, 2004 and December 31, 2003 as follows:

 
| ** ** | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|------------|------------|-------------------|------------|-----------------------|------------|
| Customer A |       | 26                | %          | 46                    | %          |
| Customer B |       | 14                | %          | —                |       |
| Customer C |       | 7                 | %          | 12                    | %          |

 

TheCompany provided an allowance for uncollectible receivables in the amount of$11,000 and $102,000 at June 30, 2004 and December 31, 2003, respective1y.  The bad debt expense, net of recoveries of$133,000 in 2004 and $3,000 in 2003, was a benefit of $187,000 and an expenseof $19,000 for the three months ended June 30, 2004 and 2003,respectively.  The bad debt expense, netof recoveries of $134,000 in 2004 and $5,000 in 2003, was a benefit of $211,000and an expense of $29,000 for the six months ended June 30, 2004 and 2003,respectively.  Accounts written off tothe allowance amounted to $12,000 and $1,000 for the three-month periods endedJune 30, 2004 and 2003, respectively. Accounts written off to the allowance account amounted to $13,000 and$13,000 for the six-month periods ended June 30, 2004 and 2003, respectively.

 

8

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**3.****             ****Inventory**

 

Inventoryconsisted of the following:

 
| ** **      | ** ** | **(in thousands)** | ** ** |
|-----------------|------------|--------------------|------------|
| ** **      | ** ** | **June 30, 2004**  | ** ** | **December 31, 2003** | ** ** |
| Finished Goods  |       | $                  | 2,074      |   | $ | 2,235 |   |
| Work in process |       | 333                |       | 406 |   |
| Raw materials   |       | 218                |       | 301 |   |
| **Total**       |       | $                  | 2,625      |   | $ | 2,942 |   |

 

**4.****             ****Intangible Assets**

 

Intangibleassets consisted of the following:

 
| ** **                             | ** ** | **(in thousands)** | ** ** |
|----------------------------------------|------------|--------------------|------------|
| ** **                             | ** ** | **June 30, 2004**  | ** ** | **December 31, 2003** | ** ** |
| Patents, net of amortization           |       | $                  | 61         |   | $ | 70 |   |
| Other intangibles, net of amortization |       | 30                 |       | 36 |   |
| Goodwill                               |       | 3,114              |       | 3,106 |   |
| **Intangible Assets, net**             |       | $                  | 3,205      |   | $ | 3,212 |   |

 

Patentsare shown net of accumulated amortization of $229,000 and $221,000, at June 30,2004 and December 31, 2003, respectively. Patents are amortized over the term of the patent and the amortizationexpense related thereto was $4,000 for each of the three-month periods endedJune 30, 2004 and 2003, respectively and $8,000 for each of the six-monthperiods ended June 30, 2004 and 2003, respectively.  Patent amortization expense is expected to be$16,000 for each of the years ending December 31, 2004 through 2007 and $6,000for the year ending December 31, 2008.

 

Otherintangible assets are shown net of accumulated amortization of $6,000 at June30, 2004.  The assets consist oftrademarks and a customer list acquired from Annette Hanson, Inc. on December30, 2003.  The trademarks and customerlist are being amortized over their expected lives and the amortization expenserelated thereto was $3,000 and $6,000 for the three and six months periodsended June 30, 2004, respectively. The amortization expense is expected to be $12,000for each of the years ending December 31, 2004 through 2006.

 

Intangibleassets also include goodwill of $3.1 million at June 30, 2004 and December 31,2003.  The Company determined that it hasone reporting unit, therefore, all of the goodwill is deemed to be associatedwith ProCyte’s overall business operations.

 

**5.****             ****Federal and State IncomeTaxes**

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. As of June 30, 2004 and December 31,2003, a partial valuation reserve for tax benefits of net operating losses anda full valuation reserve for research and development tax credit carry forwardsremains in place due to the uncertainty of realizing the full tax benefits ofthe net operating losses and tax credits as a result of their expiration.  The net changes in the valuation allowanceduring the six months ended 

 

9

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June30, 2004, and the year ended December 31, 2003, were a reduction of $33,000 and$7.9 million, respectively.

 

Asof June 30, 2004, the Company’s U.S. federal net operating loss and generalbusiness credit carry forward for income tax purposes were approximately $67.4million and $1.6 million, respectively. If not utilized, the federal net operating loss carry forward and taxcredit carry forwards will expire between 2005 and 2021 as follows:

 
| ** ** | ** ** | **(in thousands)**      | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **Net operating  loss** | ** ** | **General business  credits** | ** ** |
| 2005       |       | $                       | 2,002      |   | $ | 178 |   |
| 2006       |       | 3,928                   |       | 133 |   |
| 2007       |       | 5,173                   |       | 158 |   |
| 2008       |       | 7,912                   |       | 242 |   |
| Thereafter |       | 48,422                  |       | 865 |   |
| Total      |       | $                       | 67,437     |   | $ | 1,576 |   |

 

Futurechanges in ownership, as defined by Section 382 of the IRC, may limit the amountof net operating loss carry forward used in any one year.

 

**6.****             ****Earnings per share**

 

Basicand diluted per share results for all periods presented were computed based onthe net earnings for the respective periods. The weighted average number of common shares outstanding during theperiod was used in the calculation of basic earnings per share.  In accordance with FAS 128, “Earnings PerShare,” the weighted average number of common shares used in the calculation ofdiluted per share amounts is adjusted for the dilutive effects of stock optionsbased on the treasury stock method only if an entity records earnings fromoperations, as such adjustments would otherwise be anti-dilutive to earningsper share from operations.  For the threemonths ended June 30, 2003, 275,342 dilutive stock options were included in thecalculation of the average number of common shares outstanding for dilutedcomputations.  For the three monthperiods ended June 30, 2004 and 2003, options and warrants to purchase2,595,124 shares and 982,508 shares of common stock, respectively, were notincluded in the computation of diluted earnings per share because the effectwould have been anti-dilutive either because the exercise prices were greaterthan the average fair market value of the Company’s common stock for the periodof $1.10 and $1.16, respectively, or there was a net loss for the period.  For the six months ended June 30, 2004 and2003, 235,096 and 223,502 dilutive stock options, respectively, were includedin the calculation of the average number of common shares outstanding fordiluted computations. For the six months ended June 30, 2004 and 2003, optionsto purchase 1,600,134 shares and 982,508 shares, respectively, of common stockwith exercise prices greater than the average fair market value of theCompany’s common stock for the period of $1.14 and $1.21, respectively, werenot included in the computation of diluted earnings per share because theeffect would have been anti-dilutive.

 

**7.****             ****Stock Options**

 

TheCompany has stock option plans for directors, officers, employees andconsultants that provide for grants of nonqualified and incentive stockoptions.  Options generally are grantedat fair market value, expire between five and ten years from grant date andvest ratably over one to three years.

 

10

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Thefollowing table summarizes information about stock option activity in six-monthperiods ended June 30, 2004 and 2003: 

 
| ** **                     | ** ** | **2004**               | ** ** | **2003**                       | ** ** |
|--------------------------------|------------|------------------------|------------|--------------------------------|------------|
| **Items**                      | ** ** | **Number of  Options** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** |
| Outstanding, beginning of year |       | 2,570,167              |       | $                              | 1.41       |   | 2,185,335 |   | $ | 1.57 |   |
| Granted                        |       | 142,000                |       | $                              | 1.11       |   | 167,500 |   | $ | 1.30 |   |
| Exercised                      |       | —                 |       | $                              | —     |   | (12,000 | ) | $ | 0.86 |   |
| Canceled or expired            |       | (127,833               | )          | $                              | 1.59       |   | (85,001 | ) | $ | 3.76 |   |
| Outstanding, June 30,          |       | 2,584,334              |       | $                              | 1.38       |   | 2,255,834 |   | $ | 1.47 |   |
| Exercisable, June 30,          |       | 1,859,515              |       | $                              | 1.47       |   | 1,639,514 |   | $ | 1.52 |   |

 

Theoptions outstanding at June 30, 2004 consisted of the following: 

 
| **Range of exercise prices** | ** ** | **Number of  Options  Outstanding** | ** ** | **Wtd. Avg.  Remaining  Life** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** | **Number of  Options  Exercisable** | ** ** | **Wtd. Avg.  Exercise  Price** | ** ** |
|------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|
| $ 0.49 - $0.77          |       | 564,000                             |       | 5.57                           |       | $                              | 0.74       |                                | 564,000    |                           | $          | 0.74 |   |
| $ 0.77 - $1.09          |       | 517,500                             |       | 8.29                           |       | $                              | 1.02       |                                | 135,000    |                           | $          | 0.94 |   |
| $ 1.11 - $1.30          |       | 581,000                             |       | 7.41                           |       | $                              | 1.23       |                                | 360,171    |                           | $          | 1.25 |   |
| $ 1.31 - $1.83          |       | 538,334                             |       | 6.81                           |       | $                              | 1.57       |                                | 416,844    |                           | $          | 1.59 |   |
| $ 2.16 - $3.44          |       | 383,500                             |       | 1.64                           |       | $                              | 2.78       |                                | 383,500    |                           | $          | 2.78 |   |
| $ 0.49 - $3.44          |       | 2,584,334                           |       | 6.20                           |       | $                              | 1.38       |                                | 1,859,515  |                           | $          | 1.47 |   |

 

Theweighted average fair value of options granted during the three-month periodsended June 30, 2004 and 2003 was approximately $0.49 and $0.74,respectively.  The weighted average fairvalue of options granted during the six months ended June 30, 2004 and 2003were approximately $0.49 and $0.77, respectively.

 

OnApril 12, 2004, the Board of Directors adopted the ProCyte Corporation 2004Stock Option Plan subject to stockholder approval, which approval was obtainedon May 19, 2004.  2,000,000 shares ofcommon stock have been reserved for the plan, which provides for the grant ofnonqualified and incentive stock options. At June 30, 2004 there were 53,328 shares reserved for issuance underthe Company’s 1996 Stock Option Plan.

 

**8.****             ****Related Party Disclosures**

 

TheCompany holds a promissory note in the principal amount of $2 million fromEmerald Pharmaceutical L.P. (“Emerald”), received as partial consideration forthe sale of its contract manufacturing operations in 2001.  Emerald is in default of its obligationsunder this promissory note and, at June 30, 2004, such note is recorded net ofa valuation allowance of $1.2 million taken in December 2003.  The note is secured by a security agreementcovering substantially all of the assets of Emerald and requires Emerald tomake monthly interest-only payments equal to the effective yield on the 10 YearUS Treasury Note, adjusted quarterly. The Company also received a minority limited partnership interest inEmerald as part of the consideration received in the sale.  As part of the agreement, ProCyte subleased aportion of its current 34,532 square foot leased facility, including existingleasehold improvements, to Emerald.

 

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UntilEmerald suspended operations in February 2004, ProCyte engaged Emerald tomanufacture copper peptide compounds, and to perform incoming quality testingand other analytical services.  Emeraldbilled ProCyte a total of $382,000 for the three-month period ended June 30,2003, and $19,000 and $1.2 million for the six months ended June 30, 2004 and2003, respectively, for such products and services.  Emerald provided no products or servicesduring the three months ended June 30, 2004. ProCyte has other sources forthese products and services at prices that do not materially differ from thosecharged by Emerald.  ProCyte had no tradepayables to Emerald at June 30, 2004 and December 31, 2003.

 

Oneof the Company’s Directors also serves as Chairman and Chief Executive Officerof one of ProCyte’s customers.  ProCyte’ssales to the customer were $243,000 and $157,000 for the three month periodsended June 30, 2004 and 2003, respectively and $396,000 and $344,000 for thesix month periods ended June 30, 2004 and 2003, respectively.  The customer’s trade receivable balances were$80,000 and $165,000 on June 30, 2004 and December 31, 2003, respectively.

 

AnOfficer owed the Company $104,000 under a promissory note dated June 30,2002.  The note bore interest at 2.91%,due annually, with the principal and accrued interest being all due and payableat June 30, 2004.  The note was repaidpursuant to its terms.

 

**9.****             ****Loss on Asset Impairment**

 

InFebruary 2004, the General Partner of Emerald informed the Company that Emeraldhad suspended operations and terminated all employees in an effort to conserveremaining capital while it sought other entities to operate or purchase thefacility.  Emerald was not successful inreturning to operations and, therefore, ProCyte terminated the facilitysublease effective June 25, 2004.  Inaddition, effective July 16, 2004, ProCyte, as a secured party, completed astrict foreclosure process of accepting substantially all of Emerald’s assetsin satisfaction of Emerald’s obligations under the $2 million promissorynote.  The Company is currently innegotiations to sell substantially all the assets it accepted under the strictforeclosure process to a third party. The proposed sale is contingent upon entering into a binding definitiveasset purchase agreement and the successful negotiation of new leases underterms acceptable to both ProCyte and the proposed buyer.  Based upon the information known at thistime, including management’s assessment of the probability of completing thesale and considering the estimated fair value of the assets received, ProCytehas taken an impairment charge of $294,000 at June 30, 2004. 

 

**10.****      ****Subsequent Event**

** **

OnJuly 7, 2004 the Company received $166,761 representing full settlement of ajudgment obtained in July 2003 against Osmotics Corporation for product androyalty receivables from 2000.  The baddebt recovery and interest earned is included in the Company’s statement of operationsfor the second quarter of 2004.

 

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**Item 2****.****  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statements. Thesestatements relate to future events or future financial performance.  In some cases you can identify forward-lookingstatements by terminology such as “may,” “will,” “should,” “expect,” “plan,”“intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,”“propose” or “continue,” the negative of these terms, or other terminology.  These statements are only predictions.  Actual events or results may differmaterially.  In evaluating thesestatements, you should specifically consider various factors described below inthe section entitled “Additional Information About theCompany’s Business; Risk Factors.” These factors may cause our actual resultsto differ materially from any forward-looking statement. 

 

Althoughwe believe the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, productdemand, performance or achievements.  Youshould not place undue reliance on our forward-looking statements, which speakonly as of the date of this report. We undertake no obligation to publiclyupdate any forward-looking statements, whether as a result of new information,future events or otherwise. 

 

*Recent Events*

 

OnJune 25, 2004, the Company terminated its facility sublease with EmeraldPharmaceutical, L.P. (“Emerald”).  OnJuly 16, 2004, the Company, as a secured party, completed the strict foreclosureprocess of accepting substantially all of Emerald’s assets in satisfaction ofEmerald’s obligations under the $2 million promissory note.  The Company currently is in negotiations tosell substantially all the assets it accepted under the strict foreclosureprocess.  The sale is contingent uponentering into a binding definitive asset purchase agreement with the buyer andthe successful negotiation of new leases with the landlord, under termsacceptable to both ProCyte and the prospective buyer.  Based upon the information known at thistime, including management’s assessment of the probability of completing thesale and considering the estimated fair value of the assets received, ProCytehas taken an impairment charge of $294,000 at June 30, 2004. 

 

OnJune 30, 2004 the company received $106,520 from John F. Clifford in fullpayment of the outstanding principal and accrued interest pursuant to the termsof a promissory note dated June 30, 2002. 

 

OnJuly 7, 2004 the Company received $166,761 representing full settlement of ajudgment obtained in July 2003 against Osmotics Corporation for invoices androyalties due the Company from 2000.  Thebad debt recovery and interest earned is included in the Company’s statement ofoperations for the second quarter of 2004.

 

*Critical Accounting Policies and Estimates*

 

The“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” as well as disclosures included elsewhere in this Form 10-Q, arebased upon our condensed consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America.  Thepreparation of these consolidated financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure ofcontingencies.  On an ongoing basis, weevaluate the estimates used, including those related to impairment and usefullives of intangible assets, allowances for accounts receivable and notesreceivable, and for excess and obsolete inventory.  We base our estimates on historicalexperience, current conditions and on various other assumptions that arebelieved to be

 

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reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources as well asidentifying and assessing our accounting treatment with respect to commitmentsand contingencies.  Actual results maydiffer from these estimates under different assumptions or conditions.  We believe the following critical accountingpolicies involve the more significant judgments and estimates used in thepreparation of the consolidated financial statements.

 

Underthe guidance of SFAS 109, “Accounting for Income Taxes,” we review our netdeferred tax assets to determine which amounts, if any, are “more likely thannot” to be utilized in future periods. Our analysis of whether these tax assets will be utilized involved asubstantial amount of judgment related to our ability to generate taxable netincome in future periods, including revenue trends, product mix, and estimatedmargins, the amount and timing of which impacts the amount of net operating taxlosses that could be utilized prior to their expiration.  

 

Productrevenues are recognized when products are shipped, license fees are recognizedover the term of the license agreement, and royalties are recognized whenearned.  On occasion, we will receiveadvance deposits with customer purchase orders. These deposits are reported as a deferred revenue liability, until theproduct is shipped to the customer.

 

Underthe guidance of SFAS 142, “Goodwill and Other Intangible Assets,” we analyzewhether the fair value of recorded goodwill is impaired on an annualbasis.  Application of the goodwillimpairment test requires judgment, including the identification of reportingunits and determining the fair value of each reporting unit.  Significant judgments required to estimatethe fair value of the reporting unit include estimating future cash flows,determining appropriate discount rates and other assumptions. Changes in theseestimates and assumptions could materially affect the determination of fairvalue.

 

Wemaintain an allowance for doubtful accounts for estimated losses resulting fromthe potential inability of our customers or other debtors to make requiredpayments.  The allowance is based uponhistorical experience and a review of individual customer balances.  If the financial condition of our customersor other debtors were to deteriorate, resulting in an impairment of theirability to make payments to us, additional allowances may be required.

 

Inventoriesare stated at the lower of cost or market value.  Cost is principally determined by thefirst-in, first-out method.  We recordadjustments to the value of inventory based upon forecasted plans to sell ourinventories.  The physical condition(e.g., age and quality) of the inventories is also considered in establishingits valuation.  These adjustments areestimates, which could vary significantly, either favorably or unfavorably,from the amounts that we may ultimately realize upon the disposition ofinventories, if future economic conditions, customer inventory levels, productdiscontinuances or competitive conditions differ from our estimates andexpectations.

 

Werecord impairment losses on long-lived assets used in operations when eventsand circumstances indicate that assets might be impaired and the undiscountedcash flows estimated to be generated by those assets are less than the carryingamount of those assets.  Estimation offuture values for the long-lived assets requires a significant amount ofjudgment related to assessing the possible outcomes and the timing related toeach outcome.  The adjustments areestimates, which could vary significantly, either favorably or unfavorably,from the amounts that we may ultimately realize for these assets if the actualevents differ significantly from our estimates and expectations.

 

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***Results of Operations***

 

***Three Months Ended June 30, 2004 and 2003***

 

*Revenue*

 
| ** **              | ** ** | **(in thousands)**              | ** ** | ** ** | ** ** |
|-------------------------|------------|---------------------------------|------------|------------|------------|
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **2004**                        | ** ** | **2003**   | ** ** | **% Change** | ** ** |
| Products                |       | $                               | 2,730      |       | $          | 2,021 |   | 35 | % |
| Copper peptide compound |       | 724                             |       | 292        |       | 148 | % |
| Royalties               |       | 230                             |       | 319        |       | (28 | )% |
|                    |       | $                               | 3,684      |       | $          | 2,632 |   | 40 | % |

 

*Product* revenues for the second quarter of 2004 increased $709,000, or 35percent over the second quarter of 2003. The increase was primarily due to a 31 percent increase in sales tophysicians and the additional sales related to the spa distribution businessincluded in the 2004 second quarter.  Inaddition, product revenues in the second quarter of 2003 had been impacted bythe slowdown in patient traffic experienced by our dermatology, plastic andcosmetic surgery customers at the beginning of the 2003 year.  Product revenues began recovering during thesecond half of 2003, in part reflecting certain actions taken such as changingour hiring profile for sales representatives, increasing sales training andexpanding customer education programs. Sales to physicians and distributorshave been increasing since the third quarter of 2003.

 

*Copper peptide compound* shipments are driven by the purchasingpatterns of our largest licensee, Neutrogena, which can vary based uponproduction cycles, adjustments in safety stock and other factors beyond ourcontrol.  Neutrogena ordered more copperpeptide compound in the second quarter of 2004 to support a new productexpected to be launched later in 2004. Management expects demand from Neutrogena for copper peptide compound,on an annualized basis, to be the same as or slightly higher than the 2003 fullyear.  Therefore, the increase in thesecond quarter of 2004 as compared to the comparable 2003 quarter is notindicative of the results to be expected in subsequent periods. 

 

*Royalty*revenue**is based uponsales generated by our licensees. Royalty revenues may fluctuate from quarter to quarter, due to thelicensees’ timing of new market launches, special promotions and other factorsbeyond the Company’s control.  Royaltiesreceived from Neutrogena in the second quarter of 2004 were 28 percent lower thanthe comparable 2003 quarter primarily due to differences in the timing of ourlicensees’ promotions and expansions into new territories.  New territory introductions, such as thosewhich occurred in the 2003 quarter, require initial shipments that are largerthan normal to support the product introductions and fill the pipeline, whichcan cause variations in quarterly comparisons. Upon the expiration of the underlying patent in February 2005, theagreement specifies that lower royalty percentages be used for the remainingterm, the impact of which is a reduction in the average effective royalty rateof approximately 32 percent. The actual dollar amount of royalty incomerecognized in future periods is dependent upon both the royalty percentages ineffect during the period and the actual applicable sales reported byNeutrogena, which can vary from quarter to quarter.  Therefore, the historical growth in royaltyrevenue may not be an indication of future results.

 

*Gross Profit*

 

Grossprofit for the 2004 second quarter increased by $514,000, or 26 percent, overthe second quarter of 2003 to $2.5 million. Gross margin for the 2004 quarter was 69 percent as compared to 77percent in the

 

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2003quarter.  The increase in gross profit isprimarily from the 35% increase in product revenues for the second quarter,which was partially offset by the decrease in royalty revenue for the 2004quarter.  The decrease in gross marginpercentage is primarily due to the lower margin copper peptide compound salesrepresenting 20% of revenue in the 2004 second quarter as compared to 11% ofrevenue in the 2003 second quarter. Gross margin is sensitive to the revenue mix of packaged products,copper peptide compound and royalty revenue and will vary from period to periodas a result.

 

Operating Expenses

 
| ** **                           | ** ** | **(in thousands)**              | ** ** | ** ** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **                           | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **2004**                        | ** ** | **2003**   | ** ** | **% Change** | ** ** |
| Marketing and selling                |       | $                               | 1,260      |       | $          | 814 |   | 55 | % |
| Research, general and administrative |       | 1,057                           |       | 967        |       | 9 | % |
| Loss on asset impairment             |       | 294                             |       | —     |       | — |   |
| Total operating expenses             |       | $                               | 2,611      |       | $          | 1,781 |   | 47 | % |

 

*Marketing and selling* expenses for the second quarter of 2004increased primarily due to increased salary, benefit and travel costs fromadditional headcount in the 2004 second quarter, higher commission expenserelated to the 35% increase in current quarter product sales and $226,000 ofexpenses related to the spa distribution business in the 2004 quarter.  This is partially offset by $79,000 in costsrelated to the development and testing of an infomercial included in the secondquarter of 2003 and not repeated in 2004.

 

*Research, general and administrative* expenses for the 2004 second quarterincreased 9 percent over the comparable 2003 period.  This was primarily due to Emerald not makingrental and other payments of approximately $120,000 under its sublease andother agreements with ProCyte because of Emerald’s cessation of businessoperations in February 2004.  Suchpayments offset the Company’s rent expense in the 2003 period.  In addition, when comparing the 2004 secondquarter to the comparable 2003 period, compensation and employee benefitexpenses increased due to the addition of personnel and general market increases,legal expenses increased due to the timing of patent related work, operatingcosts increased due to higher shipping volume, and the addition of spaoperations in the 2004 second quarter period. These increased expenses were partially offset by a $207,000 decrease inbad debt expense due to the receipt of payments in 2004 from accountspreviously written off in prior periods and a lower accrual for estimatedbonuses in the 2004 second quarter as compared to the comparable 2003 period.

 

*Loss on asset impairment* relates to the portion of our facilityformerly sub-leased to Emerald.  TheCompany currently is in negotiations to sell substantially all the assetsrelated to its former manufacturing operation (which it accepted from Emeraldunder the foreclosure process described above). The sale is contingent upon entering into a binding definitive assetpurchase agreement with the buyer and the successful negotiation of new leaseswith the landlord, under terms acceptable to both ProCyte and the prospectivebuyer.  Based upon the information knownat this time, including management’s assessment of the probability ofcompleting the sale and considering the estimated fair value of the assetsreceived, ProCyte has taken an impairment charge of $294,000 at June 30, 2004. 

 

*Interest and Other Income*

 

Interestand other income earned during the second quarter of 2004 increased primarilydue to interest income of $34,000 recognized on the final settlement ofaccounts receivable from a former licensee and

 

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written off in 2002. This increase was partially offset by a decrease in interest notreceived on the Emerald note.

 

*Net Loss*

 

Forthe second quarter ended June 30, 2004, ProCyte reported a net loss of $29,000as compared to net income of $269,000 for the comparable 2003 period.  This decrease was primarily due to the$294,000 asset impairment charge recognized in June 2004.  The effect of this impairment was partiallyoffset by a gross profit that increased at a greater rate than operatingexpenses, excluding the impairment.

 

***Six Months Ended June 30, 2004 and 2003***

 

###### *Revenue*

 
| ** **              | ** ** | **(in thousands)**            | ** ** | ** ** | ** ** |
|-------------------------|------------|-------------------------------|------------|------------|------------|
| ** **              | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **2004**                      | ** ** | **2003**   | ** ** | **% Change** | ** ** |
| Products                |       | $                             | 5,151      |       | $          | 3,980 |   | 29 | % |
| Copper peptide compound |       | 1,164                         |       | 1,215      |       | (4 | )% |
| Royalties               |       | 589                           |       | 783        |       | (25 | )% |
|                    |       | $                             | 6,904      |       | $          | 5,978 |   | 16 | % |

 

*Product* revenues for the first half of 2004 increased $1.2 million, or 29percent, over the first half of 2003. The increase was primarily due to a 28 percent increase in sales tophysicians and the additional sales related to the spa distribution businessincluded in the 2004 period.  Productrevenues in the first half of 2003 had been impacted by the slowdown in patienttraffic experienced by our dermatology, plastic and cosmetic surgery customersat the beginning of the 2003 year. Product revenues began recovering during the second half of 2003, inpart reflecting certain actions taken such as changing our hiring profile forsales representatives, increasing sales training and expanding customereducation programs. 

 

*Copper peptide compound* shipments are driven by the purchasingpatterns of our largest licensee, Neutrogena, which can vary based uponproduction cycles, adjustments in safety stock and other factors beyond ourcontrol.  As a result of the additionalorders of copper peptide compound from Neutrogena in the second quarter of2004, the amount of copper peptide compound delivered to Neutrogena during thefirst half of 2004 is comparable to the amount delivered in the first half of2003. 

 

*Royalty*revenue**is based uponsales generated by our licensees. Royalty revenues may fluctuate from quarter to quarter, due to thelicensees’ timing of new market launches, special promotions and other factorsbeyond the Company’s control.  Royaltiesreceived from Neutrogena in the first half of 2004 were 25 percent lower thanthe corresponding 2003 period principally due to a large one-time customershipment by Neutrogena, mostly in the 2003 first quarter.

 

*Gross Profit*

 

Grossprofit for the first half of 2004 increased by $710,000, or 17 percent, to $4.9million.  Gross margin for the first halfof 2004 was 71 percent as compared to 70 percent in the corresponding 2003period.  The increase in gross profitduring the first half of 2004 is primarily due to the 29% increase in productsales which was partially offset by the decrease in royalty revenue whencompared to the first

 

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half of 2003. The increase in gross marginpercentage is due to a slightly different revenue mix in the two periods beingcompared.

 

*Operating Expenses*

 
| ** **                           | ** ** | **(in thousands)**            | ** ** | ** ** | ** ** |
|--------------------------------------|------------|-------------------------------|------------|------------|------------|
| ** **                           | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **2004**                      | ** ** | **2003**   | ** ** | **% Change** | ** ** |
| Marketing and selling                |       | $                             | 2,458      |       | $          | 2,213 |   | 11 | % |
| Research, general and administrative |       | 2,148                         |       | 1,934      |       | 11 | % |
| Loss on asset impairment             |       | 294                           |       | —     |       | — |   |
| Total operating expenses             |       | $                             | 4,900      |       | $          | 4,147 |   | 18 | % |

 

*Marketing and selling* expenses for the first half of 2004increased primarily due to increased activity during the period.  Of the increase, approximately $550,000 wasrelated to higher salary, benefit and travel costs from increased headcountsupporting selling efforts in the 2004 period, higher commission expenserelated to the 29% increase in current period product sales and increased legalexpenses related to the establishment and defense of the Company’strademarks.  In addition, the first halfof 2004 includes approximately $367,000 of expenses related to the spadistribution business not included in the 2003 period.  These increases are partially offset by$687,000 in costs related to the development and testing of an infomercialincluded in the 2003 period and not repeated in 2004.

 

*Research, general and administrative* expenses for the first half of 2004increased 11 percent over the comparable 2003 period.  This was primarily due to Emerald not makingrental and other payments totaling $210,000 under its sublease and otheragreements with ProCyte because of Emerald’s cessation of business operationsin February 2004.  Such payments offsetthe Company’s rent expense in the 2003 period. In addition, when comparing the first half of 2004 to the comparable2003 period, compensation and employee benefit expenses increased due to theaddition of personnel and general market increases, legal expenses increaseddue to the timing of patent related work, operating costs increased due tohigher shipping volume, and the addition of spa operations in the 2004period.  These increased expenses weremostly offset by a $240,000 decrease in bad debt expense due to the receipt ofpayments in 2004 from accounts previously written off or included in theallowance for doubtful accounts in prior periods and a lower accrual forestimated bonuses in the first half of 2004 as compared to the comparable 2003period.

 

*Interest and Other Income*

 

Interestand other income earned during the first half of 2004 decreased $75,000 to$50,000 primarily due to a decrease of $53,000 in interest income notrecognized on the Emerald note in the 2004 period due to Emerald’s suspensionof operations in February 2004 and a termination settlement of $50,000 receivedfrom Merck KGaA in the first half of 2003. These decreases were partially offset by interest income of $34,000recognized on the final settlement of accounts receivable from a formerlicensee and written off in 2002. 

 

*Net Income*

 

Forthe six months ended June 30, 2004, ProCyte reported net income of $21,000 ascompared to net income of $136,000 for the comparable 2003 period.  This decrease was primarily due to the$294,000 asset impairment charge recognized in June 2004.  The effect of this impairment was partiallyoffset by gross profit that increased at a greater rate than operatingexpenses, excluding the impairment. 

 

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***Liquidity and Capital Resources***

 

TheCompany relies primarily on cash flow from operations to fund its operationsand capital expenditures.  At June 30,2004, the Company had approximately $5.7 million in cash and cash equivalents,compared to $3.8 million at December 31, 2003. The net change in cash and cash equivalents during the first half of2004 reflects a net increase in cash of $1.9 million.  The significant components of this positivecash increase are from the net reduction of the Company’s copper peptidecompound inventory, the reduction in accounts receivable, the receipt ofpayment on a note due from an officer, an increase in trade payables forinventory received near the end of the period, and the receipt of a customerdeposit under a supply contract. Positive cash generated was partially offset by the reduction in cashflow from Emerald as discussed below, the payment of the 2003 managementbonuses in March 2004 and net cash used in support of the recently acquired spaproducts distribution business (“Spa”).  

 

Asof February 2004, Emerald Pharmaceuticals, L.P. suspended operations and infiscal 2003 ProCyte recorded an impairment related to its $2.0 million notereceivable due to the uncertainty that the full amount would be collected.  Emerald also leased its facility from ProCyteunder an operating sublease.  During thefirst half of 2004, except for January rent, ProCyte did not receive theinterest and rental payments due under its agreements with Emerald.  Therefore, cash flow from operations has beenreduced by $40,000 per month, from the comparable 2003 period.  ProCyte terminated the sublease on June 25,2004 in order to take back the facility and protect the Company’s collateraland other interests.  Effective thatdate, ProCyte become responsible for facility related operating expenses suchas utilities, insurance and security estimated to be an additional $11,000 permonth.  In addition, ProCyte will beresponsible for facility shut down costs estimated to be $35,000 to $50,000.

 

Dueto inventory limitations and the need to change certain packaging, Spa saleshave developed slower than originally planned at the time of the acquisitionand as such Spa sales activity has not provided positive cash from operationsas of June 30, 2004.  Based upon recentexperience and current plans, ProCyte believes that additional cash of up to$200,000 could be required over the next two quarters.

 

Wemay see fluctuations in operating cash flows in future periods as they dependin large part on the timing of deposits received from our licensees and theirinitiation of new product introductions and the timing of shipments to andpayments received from our customers.  Inaddition to these factors, the second half of 2004 will have cash inflows of$167,000 from the cash payment the Company received in July 2004 as fullsettlement of a judgment ProCyte obtained against a former licensee. ProCyte isalso in negotiations to sell substantially all the assets related to its formermanufacturing operation to a third party. The sale is contingent upon entering into a binding definitive assetpurchase agreement with the proposed buyer and the successful negotiation ofnew leases with the landlord under terms acceptable to both ProCyte and theproposed buyer.  Based upon theinformation known at this time, including management’s assessment of theprobability of completing the sale and considering the estimated fair value ofthe assets received, ProCyte took an impairment charge of $294,000.

 

TheCompany believes that its existing cash and cash equivalents and interestthereon, will be sufficient to meet its working capital requirements for atleast the next two years.  However, therecan be no assurance that the underlying forecasts of revenue and expense willprove to have been accurate.  The Company’sactual cash requirements will depend upon numerous factors, including thelevels of resources that the Company devotes to taking advantage of strategicacquisitions and/or establishing and maintaining marketing, sales anddistribution capabilities, the emergence of competitive products and otheradverse market developments, the timing and amount of revenues and expensereimbursements resulting from relationships with third parties, the Company’sdegree of success in commercializing new

 

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products and the cost of preparing, filing,prosecuting, maintaining and enforcing patent claims and intellectual propertyrights, and actions by regulatory authorities. The Company will depend on product revenues, royalties and license fees,interest income, equity financing, and funding from corporate alliances to meetits future capital needs.  See“Additional Information About the Company’s Business;Risk Factors.”

 

**Additional Information About the Company’s Business; RiskFactors**

 

###### *Loss of orReduction in Orders by Significant Customers Could Adversely Affect Our NetRevenues and Results of Operations*

 

Althoughthe Company’s customer base is made up of a large number of customers,Neutrogena accounted for approximately 25 percent of the Company’s net revenueduring the first half of 2004 and our top 10 customers comprised approximately32 percent of such net revenues.  Anydecrease in or loss of revenues from these customers could have an adverseeffect on our net revenues and results of operations or impair our ability toincrease net revenues.  The Neutrogenatechnology license agreement expires in April 2010, however the royaltypayments related to each territory continue for a period not less thanfive-years from the date products were first sold in each territory, which mayextend the royalty period beyond 2010 for certain territories.  Royalty revenue from the Neutrogena licenseagreement accounted for 8 percent and 13 percent of the Company’s net revenuesin the first half of 2004 and 2003, respectively.  The patent related to the Neutrogena licenseagreement expires February 5, 2005, the effect of which will be a reduction inthe percentage paid as royalty during the remaining royalty period as set forthin the agreement.  Revenues from sale ofcopper peptide compound to Neutrogena pursuant to a related supply agreement,accounted for 17 percent and 20 percent of net revenues in the first half of2004 and 2003, respectively. The supply agreement expires in April 2005, withextensions for additional two-year terms by mutual consent of the parties up toApril 2010.  There can be no assurancethat this agreement will be extended beyond April 2005, or if extended, that itwill be extended to April 2010.  Also,the timing of copper peptide compound shipments are driven by Neutrogena’spurchasing patterns, which can vary based upon production cycles, adjustmentsin safety stock and other factors beyond our control, causing the revenue fromcopper peptide compound sales to fluctuate from quarter to quarter.

 

Weexpect that we will continue to depend on revenue from larger customers,generally under multi-year license or supply agreements.  Such agreements can be terminated undercertain circumstances, including our inability to supply product withinrequired time frames.  Any downturn inthe business from these customers or the inability to renew or replaceagreements with new customers as they expire could significantly decrease salesto such customers, which could adversely affect our net revenues and results ofoperations.

 

Furthermore,we ship most orders when received. Virtually all orders are shipped within 48 hours and therefore we do nothave a substantial non-cancelable backlog of orders.  Variations in the timing of orders can causesignificant fluctuations in our quarterly operating results, and thecancellation or deferral of product orders or overproduction due to the failureof anticipated orders to materialize could result in us holding excess orobsolete inventory, which has resulted and could again in the future result inwrite-downs of inventory that would have a material adverse effect on ouroperating results.

 

###### *Dependenceon and Management of Existing and Future Corporate Alliances*

 

Thesuccessful commercialization of the Company’s existing and future products inthe mass retail, prestige, specialty retail, and home shopping categories andwound care markets will depend upon ProCyte’s ability to enter into andeffectively manage corporate alliances. There can be no assurance

 

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that the Company will be successful inestablishing corporate alliances in the future, or that it will be successfulin performing and maintaining existing or any future corporate alliances.  Moreover, there can be no assurance that theinterests and motivations of any distributor, licensee or other alliance partywould be or remain consistent with those of the Company, or that the Company andsuch distributors,  licensees or allianceparty will successfully perform the necessary technology transfer, clinicaldevelopment, regulatory compliance, manufacturing, marketing, commercializationand other obligations under their agreements. Any of these failures could havea material adverse effect on the Company’s business, financial condition andresults of operations.

 

###### *RecentProfitability; Profitability May Fluctuate in Future Periods*

 

TheCompany has been marketing products based on its proprietary copper peptidetechnology since 1996.  In addition tosales of products based on its proprietary copper peptide technology, theCompany’s revenues have historically included sales of non-proprietaryproducts, license fees and royalties, revenue from contract manufacturing andinterest income.  The contractmanufacturing operation was sold in July 2001. During fiscal 2002, the Company reported net profits and positive cashflow from operations for the first time in its operating history.  During 2003, the Company reported net incomebefore tax benefit and break even cash flow from operations.  During the first half of 2004, the companyreported a net profit and positive cash flow from operations.  Attaining consistent profitability isdependent upon a wide variety of factors, including successfully manufacturingand marketing of the Company’s products, entering into and maintainingagreements with third parties for commercialization of the Company’s products,successfully licensing the Company’s products and technology and generaleconomic conditions, including those which affect demand for the services ofour dermatologist, plastic and cosmetic surgery customers.  Payments under corporate alliances andlicensing arrangements may be subject to fluctuations in both timing andamounts and therefore the level of profitability may vary significantly fromquarter to quarter.

 

###### *We Rely OnThird Party Manufacturers for Our Products*

 

Weuse third party manufacturers to make products. In many cases, third partymanufacturers are not obligated under contracts that fix the term of theircommitments and they may discontinue production upon little or no advancenotice.  Manufacturers also mayexperience problems with product quality or timeliness of product delivery.  We rely on these manufacturers to comply withapplicable current quality system regulations (“QSR”).  The loss of a contract manufacturer may forceus to shift production to in-house facilities and possibly cause manufacturingdelays, disrupt our ability to fill orders, or require us to suspend productionuntil we find another third party manufacturer. We are not able to control the manufacturing efforts of these thirdparty manufacturers as closely as we control our business.  Should any of these manufacturers fail tomeet the applicable standards, we or our third-party manufacturer could facevarious enforcement actions, which would have an adverse effect on our netrevenues and results of operations.

 

###### *Need forAdditional Capital*

 

TheCompany generated positive cash from operations in the first half ended June30, 2004 and break even cash flow from operations in 2003.  The Company currently expects that it willgenerate positive cash flow from operations in 2004.  As of June 30, 2004, the Company had cash andcash equivalents of $5.7 million.  The Companyestimates that, at its planned rate of spending, its existing cash and cashequivalents and the interest income thereon will be sufficient to meet itsoperating and capital requirements for at least the next two years.  There can be no assurance, however, that ourunderlying assumed levels of revenue and expense will prove accurate.  Whether or not these assumptions prove to beaccurate, the Company may need to raise additional capital as the Company mayrequire additional

 

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funds to expand or enhance its sales and marketingactivities, to accelerate product development, or to acquire a product line orcompany.  The Company may be required toseek this additional funding through public or private financing, includingequity financing, or through collaborative arrangements.  Adequate funds for these purposes, whetherobtained through financial markets or from collaborative or other arrangements,may not be available when needed or may not be available on terms favorable tothe Company.  If we issue equitysecurities to raise additional funds, dilution to existing shareholders willresult.  If funding is insufficient atany time in the future, the Company may be required to: delay, scale back oreliminate some or all of its marketing and research and development programs;or license to third parties the rights to commercialize products ortechnologies that the Company would otherwise seek to develop on its own.  Furthermore, the terms of any such license agreementsor asset sales might be less favorable than if the Company were negotiatingfrom a stronger position.

 

###### *Uncertaintyof Patent Position and Proprietary Rights*

 

Thepatent positions of biotechnology, medical device and healthcare productscompanies are often uncertain and involve complex legal and factual questions,and the breadth of claims allowed in such patents cannot be predicted.  The Company’s success will depend on itsability to obtain patents and licenses to patent rights, to maintain tradesecrets, and to operate without infringing on the proprietary rights of others,both in the United States and in other countries.  The failure of the Company or its licensorsto obtain, maintain and enforce patent protection for the Company’s technologycould have a material adverse effect on the Company.

 

ProCyte’ssuccess depends, in part, upon its ability to protect its products, technologyand trademarks under intellectual property laws in the United States andabroad.  The Company receives a significantamount of its revenue from technology licensing agreements, which are dependentupon patents, and expects to continue licensing its technology for certainmarkets.  Royalty revenue from theNeutrogena license agreement accounted for 8 percent and 13 percent of theCompany’s net revenues in the first half of 2004 and 2003, respectively and isbased upon Neutrogena’s applicable sales, as set forth in the agreement,multiplied by specified royalty percentages. The patent related to the Neutrogena license agreement expires February5, 2005.  Upon expiration of this patent,the agreement specifies that lower royalty percentages be used for theremaining term, the impact of which is a reduction in the average effective royaltyrate of approximately 32 percent.  Theactual amount of royalty income recognized in future periods is dependent uponthe royalty percentages in effect during the period and the actual applicablesales reported by Neutrogena, which can vary from quarter to quarter.    The expiration of the patent would alsoallow others, including Neutrogena, to manufacture the compound.  The supply agreement expires in April 2005,with extensions for additional two-year terms by mutual consent of the partiesup to April 2010.  There can be noassurance that this agreement will be extended beyond April 2005, or ifextended, that it will be extended to April 2010.

 

Asof July 31, 2004, the Company had 19 issued US patents expiring between 2005and 2017 and numerous issued foreign patents and patent registrations.  In addition, the Company has 12 patentsapplied for of which 6 have been published and are pending action by the UnitedStates Patent & Trademark Office. The patents relate to use of the Company’s copper peptide-basedtechnology for a variety of healthcare applications, and to the composition ofcertain biologically active, synthesized compounds.  The Company’s strategy has been to apply forpatent protection for certain compounds and their discovered uses that arebelieved to have potential commercial value in countries that offer significantmarket potential.  There can be noassurance that patent applications relating to the technology used by theCompany will result in patents being issued. Nor can there be any assurance that any patent issued to the Companywill not be subject to further proceedings limiting the scope of the rightsunder the patent or that such patent will provide a competitive advantage, willafford protection

 

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against competitors with similar technology, or willnot be successfully challenged, invalidated or circumvented by competitors.

 

TheCompany’s processes and potential products may conflict with patents that havebeen or may be granted to competitors and others.  As the biotechnology, medical device andhealthcare industries expand and more patents are issued, the risk increasesthat the Company’s processes and potential products may give rise to claimsthat they infringe the patents of others. Such other persons could bring legal actions against the Companyclaiming damages and seeking to enjoin clinical testing, manufacturing andmarketing of the affected product or use of the affected process.  Litigation may be necessary to enforcepatents issued to the Company, to protect trade secrets or know-how owned bythe Company or to determine the enforceability, scope and validity ofproprietary rights of others.  If theCompany becomes involved in such litigation, it could result in substantialexpense to the Company and significant diversion of effort by the Company’stechnical and management personnel.  Inaddition to any potential liability for significant damages, the Company couldbe required to obtain a license to continue to manufacture or market theaffected product or use the affected process. Costs associated with any licensing arrangement may be substantial andcould include ongoing royalties.  Therecan be no assurance that any license required under any such patent would bemade available to the Company on acceptable terms, if at all.  If such licenses could not be obtained onacceptable terms, the Company could be prevented from manufacturing andmarketing existing or potential products. Accordingly, an adverse determination in such litigation could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.  The Company isnot aware of any conflicts at this time.

 

TheCompany also relies upon non-patented proprietary technology.  There can be no assurance that the Companycan meaningfully protect its rights to such non-patented technology, that anyobligation to maintain the confidentiality of such proprietary technology willnot be breached by employees, consultants, collaborators or others or thatothers will not independently develop or acquire substantially equivalenttechnology.  To the extent that licenseesor consultants apply Company technological information independently developedby them or by others to Company projects or apply Company technology orknow-how to other projects, disputes may arise as to the ownership ofproprietary rights to such information. Any failure to protect non-patented proprietary technology or any breachof obligations designed to protect such technology or development of equivalenttechnology may have a material adverse effect on the Company’s business,financial condition and results of operations.

 

###### *Uncertaintyof Government Regulatory Requirements*

 

TheFederal Food, Drug and Cosmetic Act, and the regulations promulgatedthereunder, and other federal and state statutes govern, among other things,the testing, manufacture, safety, labeling, storage, record-keeping,advertising and promotion of cosmetic products and medical devices.  The Company’s products and product candidatesmay be regulated by any of a number of divisions of the FDA and in othercountries by similar health and regulatory authorities.  The process of obtaining and maintainingregulatory approvals for the manufacturing or marketing of the Company’sexisting and potential products is costly and time-consuming and is subject tounanticipated delays.  Regulatoryrequirements ultimately imposed could also adversely affect the ability of theCompany to clinically test, manufacture or market products.

 

Inthe United States, products that do not seek to make effectiveness claims basedon human clinical evaluation may be subject to review and regulation under theFDA’s cosmetic, drug or 510(k) medical device guidelines.  Similar guidelines exist for such products inother countries.  Such 510(k) products,which include wound care dressings and certain ointments and gels, must showsafety and substantial equivalency with predicate products already cleared bythe FDA to be marketed.  There can be no

 

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assurancethat product applications submitted to the FDA or similar agencies in othercountries will receive clearance to be marketed, or that the labeling claimssought will be approved, or that, if cleared, such products will be commerciallysuccessful or free from third party claims relating to the effectiveness orsafety of such products.

 

TheCompany also is or may become subject to various other federal, state, localand foreign laws, regulations and policies relating to, among other things,safe working conditions, good laboratory practices, and the use and disposal ofhazardous or potentially hazardous substances used in connection with researchand development.

 

Failureto obtain regulatory approvals where appropriate for its product candidates orto attain or maintain compliance with QSR or other manufacturing requirementswould have a material adverse effect on the Company’s business, financialcondition and results of operations.

 

###### *IntenseCompetition*

 

Competitionin the wound care, skin health and hair care markets is intense.  The Company’s competitors includewell-established pharmaceutical, cosmetic and healthcare companies such asObagi, La Roche Posay, Allergan, Pevonia, Declore and Murad.  These competitors have substantially morefinancial and other resources, larger research and development staffs, and moreexperience and capabilities in researching, developing and testing products inclinical trials, in obtaining FDA and other regulatory approvals and inmanufacturing, marketing and distribution than the Company.  In addition, a number of smaller companiesare developing or marketing competitive products.  The Company’s competitors may succeed indeveloping and commercializing products or obtaining patent protection or otherregulatory approvals for products more rapidly than the Company.  In addition, competitive products may bemanufactured and marketed more successfully than the Company’s potentialproducts.  Such developments could renderthe Company’s existing or potential products less competitive or obsolete andcould have a material adverse effect on the Company’s business, financialcondition and results of operations.

 

###### *ProductLiability Claims*

 

Thetesting, manufacturing, marketing and sale of our products may subject theCompany to product liability claims. ProCyte maintains insurance coverage against product liability risks upto an aggregate annual limit of $10 million. However, continuing insurance coverage may not be available at anacceptable cost, if at all.  The Companymay not be able to obtain insurance coverage that will be adequate to satisfyany liability that may arise.  Regardlessof merit or eventual outcome, product liability claims may result in decreaseddemand for a product, injury to its reputation, withdrawal of clinical trialvolunteers and loss of revenues.  As aresult, regardless of whether the Company is insured, a product liability claimor product recall may result in losses that could be material to ProCyte.

 

###### *PotentialVolatility of Stock Price; Bulletin Board Listing*

 

Themarket prices for securities of healthcare, pharmaceutical and biotechnologycompanies are subject to volatility, and the market has from time to timeexperienced significant fluctuations that are unrelated to the operations ofthe Company.  ProCyte’s market price hasfluctuated over a wide range since the Company’s initial public offering in1989, and since March 25, 1999, the Company’s common stock has traded on theNASD OTC bulletin board.  Becausereal-time price information may not be easily available for bulletin boardsecurities, an investor is likely to find it more difficult to dispose of, orto obtain accurate quotations on the market value of, the Company’s securitiesthan if they were listed on a the Nasdaq or a national exchange.  In addition, purchases and sales of theCompany’s securities may

 

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becomesubject to Rule 15g-9 of the Securities Exchange Act of 1934, which imposesvarious sales practice requirements on broker-dealers, or to the “penny stock”rules, either of which would likely reduce the level of trading activity in thesecondary market for the Company’s securities and make selling the securitiesmore difficult for an investor.

 

Announcementsconcerning the Company or its competitors, including fluctuations in operatingresults, research and development program direction, results of clinicaltrials, addition or termination of corporate alliances, technology licenses,clearance or approval to market products, announcements of technologicalinnovations or new products by the Company or its competitors, changes ingovernment regulations, healthcare reform, developments in patent or otherproprietary rights of the Company or its competitors, litigation concerningbusiness operations or intellectual property, or public concern as to safety ofproducts, as well as changes in general market conditions and mergers andacquisitions, may have a significant effect on the market price of ProCyte’scommon stock.

 

## **Item 3****.****  Quantitative and Qualitative Disclosures About Market Risk**

 

Fora discussion of our market risks, refer to the Item 7A, “Quantitative andQualitative Disclosures About Market Risk,” in ourAnnual Report on Form 10-K for the year ended December 31, 2003. There havebeen no material changes to the information provided that would requireadditional information with respect to the six months ended June 30, 2004.

 

## **Item 4****.****  Controls and Procedures**

 

Asof the end of the period covered by this report, the Company conducted anevaluation, under the supervision and with the participation of its principalexecutive officer and principal financial officer, of the effectiveness anddesign of its disclosure controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e) under the Securities Exchange Act of 1934 (the “ExchangeAct”)).  Based on this evaluation, theprincipal executive officer and principal financial officer concluded thatthese disclosure controls and procedures were effective as of June 30, 2004, inensuring that the information required to be disclosed by the Company inreports it files or submits under the Exchange Act within the time periodsspecified in the SEC rules and forms.

 

Therewere no changes in the Company’s internal controls over financial reportingduring the second quarter of 2004 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PartII****- OtherInformation**

 

## **Item 4****.****  Submission of Matters to a Vote of SecurityHolders**

 

Theannual meeting of the shareholders of the Company was held on May 19,2004.  Three matters were submitted tothe shareholders for a vote:  election ofdirectors, the approval of the ProCyte Corporation 2004 Stock Option Plan, andratifying the appointment of Deloitte & Touche LLP as independent auditorsof the Company for the year ending December 31, 2004.  As of April 2, 2004, the record date, therewere 15,798,747 shares eligible to vote at the meeting, of which, 93.8% or14,821,136 were represented at the meeting, constituting a quorum.

 

Thefour nominees for election as directors were elected to serve until the 2005annual meeting of the shareholders, and until the election and qualification oftheir respective successors.  The votefor each director follows:

 
| **Directors**       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|---------------------|------------|------------|------------|--------------|------------|
| John F. Clifford    |       | 14,155,349 |       | 665,787      |       |
| Matt L. Leavitt     |       | 14,164,083 |       | 657,053      |       |
| Robert E. Patterson |       | 14,188,443 |       | 632,693      |       |
| John M. Hammer      |       | 13,826,533 |       | 994,603      |       |

 

Thesecond proposal was approved by the shareholders.  The vote was as follows:

 
| **Proposal**                                            | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|---------------------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| Approve the ProCyte Corporation 2004 Stock  Option Plan |       | 3,559,459 |       | 1,189,575   |       | 155,015     |       |

 

Thethird proposal was approved by the shareholders.  The vote was as follows:

 
| **Proposal**                                                                                                                      | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|
| Ratify the appointment of Deloitte &  Touche LLP as independent auditors of the Company for the year ended December  31, 2004 |       | 14,573,645 |       | 177,469     |       | 70,022      |       |

 

## **Item 6****.****  Exhibits and Reports on Form 8-K**

 

(a)Exhibits

 

SeeExhibit Index below.

 

(b)Reports on Form 8-K

 

Form8-K filed May 5, 2004 announcing the Company’s earnings for the first quarterended March 31, 2004.

 

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**Signatures**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

 
| ** **                  | **ProCyte Corporation** |
|-----------------------------|-------------------------|
| ** **                  | ** **              |
| ** **                  | ** **              |
| Date:  August 12, 2004 | By:                     | /s/  John F. Clifford |
|                        |                    |   |
|                        |                    | John  F. Clifford, Chairman and CEO |
|                        |                    |   |
| Date:  August 12, 2004 | By:                     | /s/  Robert W. Benson |
|                        |                    |   |
|                        |                    | Robert  W. Benson, Chief Financial Officer |

 

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ExhibitIndex

 
| **Exhibit**     | ** ** | **Description**                                                                                                                          | ** ** | **Note** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **3.1**         | ** ** | **Restated Articles of Incorporation of the Registrant**                                                                                 | ** ** | **A**    |
| **3.2**         | ** ** | **Restated Bylaws of the Registrant**                                                                                                    | ** ** | **A**    |
| **4.1**         | ** ** | **Rights Agreement between the Registrant and American  Securities Transfer and Trust as of December 7, 1994**                           | ** ** | **G**    |
| **10.1***       | ** ** | **1987 Stock Benefit Plan of ProCyte Corporation**                                                                                       | ** ** | **A**    |
| **10.2***       | ** ** | **ProCyte Corporation 1989 Restated Stock Option Plan**                                                                                  | ** ** | **B**    |
| **10.3***       | ** ** | **ProCyte Corporation 1991 Restated Stock Option Plan for  Non-employee Directors and amendments thereto**                               | ** ** | **D**    |
| **10.4†**  | ** ** | **Teachers Insurance & Annuity Association Lease dated as  of October 1, 1993 and second amendment thereto dated February 28, 1997** | ** ** | **D**    |
| **10.5***       | ** ** | **1996 Stock Option Plan**                                                                                                               | ** ** | **D**    |
| **10.6***       | ** ** | **ProCyte Corporation 1998 Non-employee Director Stock Plan**                                                                            | ** ** | **F**    |
| **10.7***       | ** ** | **Change of Control Agreement for Ms. Robin Carmichael**                                                                                 | ** ** | **K**    |
| **10.8***       | ** ** | **Change of Control Agreement for Mr. John Clifford**                                                                                    | ** ** | **K**    |
| **10.9***       | ** ** | **Change of Control Agreement for Mr. Robert Benson**                                                                                    | ** ** | **K**    |
| **10.13***      | ** ** | **Form of Indemnity Agreement dated February 23, 1995 between  the Registrant and each of Dr. Blake, Mr. Patterson and Mr. Clifford.**   | ** ** | **C**    |
| **10.14***      | ** ** | **Form of Indemnity Agreement between ProCyte Corporation and  each of various of its Officers and Directors**                           | ** ** | **F**    |
| **10.15***      | ** ** | **Severance Agreement for Mr. John Clifford**                                                                                            | ** ** | **K**    |
| **10.16***      | ** ** | **Form of Promissory Note between ProCyte Corporation and Mr.  John Clifford**                                                           | ** ** | **H**    |
| **10.17†** | ** ** | **License Agreement dated April 19, 2000 between ProCyte  Corporation and Neutrogena Corporation**                                       | ** ** | **I**    |
| **10.18***      | ** ** | **ProCyte Corporation 2004 Stock Option Plan**                                                                                           | ** ** | **K**    |
| **31.1**        | ** ** | **Rule 13a-14(a)/15d-14(a) Certification of Chief Executive  Officer**                                                                   | ** ** | **K**    |
| **31.2**        | ** ** | **Rule 13a-14(a)/15d-14(a) Certification of Chief Financial  Officer**                                                                   | ** ** | **K**    |
| **32.1**        | ** ** | **Section 1350 Certification of Chief Executive Officer**                                                                                | ** ** | **K**    |
| **32.2**        | ** ** | **Section 1350 Certification of Chief Financial Officer**                                                                                | ** ** | **K**    |

 

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*                 Managementcontract or compensatory plan or arrangement.

†                  Confidentialtreatment has been granted or requested with respect to portions of thisexhibit.

A              Incorporated by reference to the Registrant’sRegistration Statement of Form S-1 (No. 33-31353).

B                Incorporatedby reference to the Registrant’s Registration Statement of Form S-1 (No.33-46364).

C                Incorporatedby reference to the Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 1994.

D               Incorporatedby reference to the Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 1996.

F                 Incorporatedby reference to the Registrant’s Quarterly Report on Form 10-Q for the Quarterended June 30, 1998.

G                Incorporatedby reference to the Registrant’s Amended Annual Report on Form 10-K/A dated December31, 1997.

H               Incorporatedby reference to the Registrant’s Amended Annual Report on Form 10-K/A datedDecember 31, 1998.

I                    Incorporated by reference to the Registrant’s Quarterly Report on Form10-Q for the Quarter ended March 31, 2000.

J                   Incorporated by reference to the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2003.

K               Filedherewith.

 

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