##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


Form 10-K


|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the fiscal year ended December 31, 2004                                                 
|  
|OR
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|  
|   |  | For the transition period
    from           to                                             

Commission File No. 0-18962


CYGNUS, INC.


(Exact name of Registrant as Specified in Its Charter)


|                                                                                          |  |                                         
|----------------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                                  |  | 94-2978092                              
|(State or Other Jurisdiction of
    Incorporation or Organization)                        |  | (I.R.S. Employer
    Identification No.)
|400 Penobscot Drive,
    Redwood City, California(Address of Principal Executive Offices) |  | 94063(Zip Code)                         

(650) 369-4300




None


Common Stock, $0.001 par value


þ o


o


o þ




41,009,251












---










CYGNUS, INC.


ANNUAL REPORT ON FORM 10-K


FOR THE YEAR ENDED DECEMBER 31, 2004


Table of Contents


|              |  |                                                                                                                      |    |      |    | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|              |  |                                                                                                                      |    | Page |   
|              |  |                                                                                                                      |    |      |   
|PART I       
|Item 1.       |  | Business                                                                                                             |    |      | 3  | 
|Item 2.       |  | Properties                                                                                                           |    |      | 9  | 
|Item 3.       |  | Legal Proceedings                                                                                                    |    |      | 9  | 
|Item 4.       |  | Submission of Matters to a Vote of Security
    Holders                                                              |    |      | 9  | 
|             
|PART II      
|Item 5.       |  | Market for Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities |    |      | 10 | 
|Item 6.       |  | Selected Financial Data                                                                                              |    |      | 11 | 
|Item 7.       |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                            |    |      | 13 | 
|Item 7A.      |  | Quantitative and Qualitative Disclosures
    About Market Risk                                                       |    |      | 25 | 
|Item 8.       |  | Financial Statements and Supplementary
    Data                                                                      |    |      | 25 | 
|Item 9.       |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure                             |    |      | 25 | 
|Item 9A.      |  | Controls and Procedures                                                                                              |    |      | 25 | 
|Item 9B.      |  | Other Information                                                                                                    |    |      | 26 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive Officers of the
    Registrant                                                               |    |      | 27 | 
|Item 11.      |  | Executive Compensation                                                                                               |    |      | 30 | 
|Item 12.      |  | Security Ownership of Certain Beneficial
    Owners and Management                                                   |    |      | 32 | 
|Item 13.      |  | Certain Relationships and Related
    Transactions                                                                   |    |      | 33 | 
|Item 14.      |  | Principal Accounting Fees and Services                                                                               |    |      | 33 | 
|             
|PART IV      
|Item 15.      |  | Exhibits, Financial Statement Schedules                                                                              |    |      | 35 | 
|             
|SIGNATURES    |  |                                                                                                                      | 39 |     
|             
|EXHIBIT INDEX |  |                                                                                                                      |    |     
|EXHIBIT 2.02 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



2



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##### Table of Contents






PART I







|        |          
|------- | ---------
|Item 1. | Business.

Overview


This report contains certain forward-looking statements,
including statements concerning the value of our net assets; the
outcome of the arbitration matter with Ortho-McNeil
Pharmaceutical, Inc.; the ability to satisfy our obligations
without resorting to protection under the bankruptcy laws; the
timing and amounts of distribution of liquidation proceeds to
stockholders; the estimates of ongoing expenses, including legal
expenses in pursuing the arbitration matter; and the likelihood
of stockholder value resulting from the sale of substantially
all of our assets. We intend such forward-looking statements to
be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform
Act of 1995, and are including this statement for purposes of
invoking these safe harbor provisions. Such forward-looking
statements involve known and unknown risks, uncertainties and
other important factors that could cause our actual results,
performance or achievements, or industry results, to differ
materially from our expectations of future results, performance
or achievements expressed or implied by such forward-looking
statements. These risks include the risk that we may not obtain
stockholder approval of the asset sale and the Plan of Complete
Liquidation and Dissolution or satisfy the other closing
conditions to the asset sale, that we may incur additional
liabilities that we do not now anticipate, that our expenses may
be higher than estimated and that the settlement of our
liabilities could be higher than expected or that the
arbitration matter does not result in a favorable outcome for
us, all of which conditions could substantially reduce the
distribution to our stockholders. Although we believe that the
expectations reflected in any forward-looking statements are
reasonable, we cannot guarantee future events or results. Except
as may be required under federal law, we undertake no obligation
to update publicly any forward-looking statements for any
reason, even if new information becomes available or other
events occur.








3



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Cygnus in the Year 2004










4



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Recent Developments






5



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Field of Managing Diabetes with Glucose Monitoring








6



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Our GlucoWatch G2 Biographer Solution




Status of our Business






7



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Research and Development Expenses




Intellectual Property








Customers




Government Regulation




8



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Employees




Available Information


www.cygn.com www.sec.gov







|        |            
|------- | -----------
|Item 2. | Properties.








|        |                   
|------- | ------------------
|Item 3. | Legal Proceedings.








|        |                                                         
|------- | --------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders.



9



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PART II







|        |                                                                                                                      
|------- | ---------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities.



|                              |  |      |      |  |     |   |      | 
|----------------------------- |  | ---- | ---- |  | --- | - | ---- | 
|                              |  | High |      |  | Low |  
|                              |  |      |      |  |     |  
|Year Ended December 31, 2004: |  |      |      |  |     |   |      | 
|Fourth Quarter                |  | $    | 0.17 |  |     | $ | 0.07 | 
|Third Quarter                 |  |      | 0.30 |  |     |   | 0.07 | 
|Second Quarter                |  |      | 0.56 |  |     |   | 0.22 | 
|First Quarter                 |  |      | 0.86 |  |     |   | 0.33 | 
|                             
|Year Ended December 31, 2003: |  |      |      |  |     |   |      | 
|Fourth Quarter                |  | $    | 0.72 |  |     | $ | 0.07 | 
|Third Quarter                 |  |      | 0.67 |  |     |   | 0.36 | 
|Second Quarter                |  |      | 1.09 |  |     |   | 0.27 | 
|First Quarter                 |  |      | 0.72 |  |     |   | 0.25 | 



Recent Sales of Unregistered Securities




10



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|        |                         
|------- | ------------------------
|Item 6. | Selected Financial Data.



|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |         |        |        |  
|------------------------------------------ | ---------------------------------------------------------------------------------- | ------------------------------------------------------------------------------ | ------------------------ | ------- | ------ | ------ | - | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                                           |                                                                                    | Years Ended December 31,                                                       |                         
|                                           |                                                                                    |                                                                                |                         
|                                           |                                                                                    | 2004                                                                           |                          |         | 2003   |        |   | 2002    |        |        | 2001 |         |        | 2000   |  
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           |                                                                                    | (In thousands, except per share data)                                          |                         
|Consolidated Statement of Operations Data: |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |        
|                                           | Revenues:                                                                          |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                           |                                                                                    | Net product revenues                                                           |                          | $       | 556    |        |   | $       | 2,684  |        |      | $       | 3,453  |        |   | $       | 489    |        |   | $       |       |       
|                                           |                                                                                    | Contract revenues                                                              |                          |         |       |        |   |         | 234    |        |      |         | 401    |        |   |         | 5,300  |        |   |         | 1,052  |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           |                                                                                    |                                                                                | Total revenues           |         |        | 556    |   |         |        | 2,918  |      |         |        | 3,854  |   |         |        | 5,789  |   |         |        | 1,052  |  
|                                           | Costs and expenses:                                                                |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                           |                                                                                    | Costs of product revenues                                                      |                          |         | 240    |        |   |         | 15,447 |        |      |         | 6,396  |        |   |         | 271    |        |   |         |       |       
|                                           |                                                                                    | Research and development                                                       |                          |         |       |        |   |         | 5,119  |        |      |         | 13,883 |        |   |         | 27,405 |        |   |         | 21,170 |       
|                                           |                                                                                    | Sales, marketing, general and administrative                                   |                          |         | 11,369 |        |   |         | 6,440  |        |      |         | 22,544 |        |   |         | 15,481 |        |   |         | 10,072 |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           |                                                                                    |                                                                                | Total costs and expenses |         |        | 11,609 |   |         |        | 27,006 |      |         |        | 42,823 |   |         |        | 43,157 |   |         |        | 31,242 |  
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Loss from operations                                                               |                                                                                |                          | (11,053 | )      |        |   | (24,088 | )      |        |      | (38,969 | )      |        |   | (37,368 | )      |        |   | (30,190 | )     
|                                           | Interest and other income/(expense), net                                           |                                                                                |                          | 170     |        |        |   | 114     |        |        |      | 417     |        |        |   | 2,416   |        |        |   | 1,970   |       
|                                           | Interest expense                                                                   |                                                                                |                          | (430    | )      |        |   | (2,210  | )      |        |      | (3,153  | )      |        |   | (3,721  | )      |        |   | (3,687  | )     
|                                           | Gain from Sankyo Pharma settlement                                                 |                                                                                |                          | 132     |        |        |   | 75,825  |        |        |      |        |        |        |   |        |        |        |   |        |       
|                                           | Gain on early retirement of Convertible Debentures                                 |                                                                                |                          | 2,891   |        |        |   |        |        |        |      |        |        |        |   |        |        |        |   |        |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Income/(loss) before income taxes                                                  |                                                                                |                          | (8,290  | )      |        |   | 49,641  |        |        |      | (41,705 | )      |        |   | (38,673 | )      |        |   | (31,907 | )     
|                                           | Provision for/(benefit from) income taxes                                          |                                                                                |                          | (198    | )      |        |   | 199     |        |        |      | 23      |        |        |   | 527     |        |        |   | 100     |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Net income/(loss) before cumulative effect of a change in
    accounting principle |                                                                                |                          | (8,092  | )      |        |   | 49,442  |        |        |      | (41,728 | )      |        |   | (39,200 | )      |        |   | (32,007 | )     
|                                           | Cumulative effect of a change in accounting principle                              |                                                                                |                          |        |        |        |   |        |        |        |      |        |        |        |   |        |        |        |   | (5,026  | )     
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Net income/(loss)                                                                  |                                                                                | $                        | (8,092  | )      |        | $ | 49,442  |        |        | $    | (41,728 | )      |        | $ | (39,200 | )      |        | $ | (37,033 | )     
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Amounts per share, basic:                                                          |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                           |                                                                                    | Income/(loss) before cumulative effect of a change in accounting
    principle |                          | $       | (0.20  | )      |   | $       | 1.28   |        |      | $       | (1.11  | )      |   | $       | (1.31  | )      |   | $       | (1.22  | )     
|                                           |                                                                                    | Cumulative effect of a change in accounting principle                          |                          |         |       |        |   |         |       |        |      |         |       |        |   |         |       |        |   |         | (0.19  | )     
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           |                                                                                    |                                                                                | Net income/(loss)        |         | $      | (0.20  | ) |         | $      | 1.28   |      |         | $      | (1.11  | ) |         | $      | (1.31  | ) |         | $      | (1.41  | )
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Shares used in computation of amounts per share, basic                             |                                                                                |                          | 40,444  |        |        |   | 38,480  |        |        |      | 37,580  |        |        |   | 30,028  |        |        |   | 26,315  |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Amounts per share, diluted:                                                        |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                           |                                                                                    | Income/(loss) before cumulative effect of a change in accounting
    principle |                          | $       | (0.20  | )      |   | $       | 1.01   |        |      | $       | (1.11  | )      |   | $       | (1.31  | )      |   | $       | (1.22  | )     
|                                           |                                                                                    | Cumulative effect of a change in accounting principle                          |                          |         |       |        |   |         |       |        |      |         |       |        |   |         |       |        |   |         | (0.19  | )     
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           |                                                                                    |                                                                                | Net income/(loss)        |         | $      | (0.20  | ) |         | $      | 1.01   |      |         | $      | (1.11  | ) |         | $      | (1.31  | ) |         | $      | (1.41  | )
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  
|                                           | Shares used in computation of amounts per share, diluted                           |                                                                                |                          | 40,444  |        |        |   | 49,640  |        |        |      | 37,580  |        |        |   | 30,028  |        |        |   | 26,315  |       
|                                           |                                                                                    |                                                                                |                          |         |        |        |   |         |        |        |      |         |        |        |  

11



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|                                 |                                                     |                |   |          |      |  |   |          |   |  |      |          |   |      |   |          |   |  |   |          |  
|-------------------------------- | --------------------------------------------------- | -------------- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - | ---- | - | -------- | - |  | - | -------- | -
|                                 |                                                     | December 31,   |  
|                                 |                                                     |                |  
|                                 |                                                     | 2004           |   |          | 2003 |  |   | 2002     |   |  | 2001 |          |   | 2000 |  
|                                 |                                                     |                |   |          |      |  |   |          |   |  |      |          |   |      |  
|                                 |                                                     | (In thousands) |  
|Consolidated Balance Sheet Data: |                                                     |                |   |          |      |  |   |          |   |  |      |          |   |      |   |          |   |  |   |         
|                                 | Cash, cash equivalents and short-term investments   |                | $ | 10,317   |      |  | $ | 33,483   |   |  | $    | 26,617   |   |      | $ | 23,749   |   |  | $ | 22,939   |  
|                                 | Working capital/(deficiency)                        |                | $ | 6,993    |      |  | $ | 18,265   |   |  | $    | (12,438  | ) |      | $ | 6,480    |   |  | $ | 9,869    |  
|                                 | Total assets                                        |                | $ | 12,670   |      |  | $ | 37,707   |   |  | $    | 40,477   |   |      | $ | 35,681   |   |  | $ | 32,889   |  
|                                 | Long-term obligations                               |                | $ | 7,000    |      |  | $ | 14,830   |   |  | $    | 35,690   |   |      | $ | 33,101   |   |  | $ | 32,189   |  
|                                 | Accumulated deficit                                 |                | $ | (255,401 | )    |  | $ | (247,309 | ) |  | $    | (296,751 | ) |      | $ | (255,023 | ) |  | $ | (215,823 | )
|                                 | Total stockholders equity/(net capital deficiency) |                | $ | (7       | )    |  | $ | 6,822    |   |  | $    | (42,622  | ) |      | $ | (18,048  | ) |  | $ | (13,023  | )

12



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|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations.

This report contains certain forward-looking statements,
including statements concerning the value of our net assets; the
outcome of the arbitration matter with Ortho-McNeil
Pharmaceutical, Inc.; the ability to satisfy our obligations
without resorting to protection under the bankruptcy laws; the
timing and amounts of distribution of liquidation proceeds to
stockholders; the estimates of ongoing expenses, including legal
expenses in pursuing the arbitration matter; and the likelihood
of stockholder value resulting from the sale of substantially
all of our assets. We intend such forward-looking statements to
be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform
Act of 1995, and are including this statement for purposes of
invoking these safe harbor provisions. Such forward-looking
statements involve known and unknown risks, uncertainties and
other important factors that could cause our actual results,
performance or achievements, or industry results, to differ
materially from our expectations of future results, performance
or achievements expressed or implied by such forward-looking
statements. These risks include the risk that we may not obtain
stockholder approval of the asset sale and the Plan of Complete
Liquidation and Dissolution or satisfy the other closing
conditions to the asset sale, that we may incur additional
liabilities that we do not now anticipate, that our expenses may
be higher than estimated and that the settlement of our
liabilities could be higher than expected or that the
arbitration matter does not result in a favorable outcome for
us, all of which conditions could substantially reduce the
distribution to our stockholders. Although we believe that the
expectations reflected in any forward-looking statements are
reasonable, we cannot guarantee future events or results. Except
as may be required under federal law, we undertake no obligation
to update publicly any forward-looking statements for any
reason, even if new information becomes available or other
events occur.




Overview






13



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Critical Accounting Policies






| |                    
| | -------------------
| | Revenue Recognition















| |                    
| | -------------------
| | Inventory Valuation



14



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| |                                
| | -------------------------------
| | Impairment of Long-Lived Assets







Results of Operations




Comparison for the Years Ended December 31, 2004 and
2003


Net product revenues


15



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Contract revenues


Costs of product revenues






Research and development expenses


Sales, marketing, general and administrative expenses


16



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Interest income and other income/(expense), net


Interest expense


Gain from Sankyo Pharma settlement




|                                                                                                                                                 |  |   |        | 
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | - | ------ | 
|Cash settlement received from Sankyo Pharma in December 2003                                                                                     |  | $ | 30,000 | 
|Recognition of deferred revenues from Sankyo Pharma (milestone
    payments)                                                                     |  |   | 25,000 | 
|Recognition of deferred revenues from Sankyo Pharma net of
    deferred costs of $8,759 of product shipments                                     |  |   | 9,306  | 
|Write-off of current portion of amount due to Sankyo Pharma(1)                                                                                   |  |   | 6,770  | 
|Write-off of long-term portion of amount due to Sankyo Pharma(2)                                                                                 |  |   | 2,324  | 
|Write-off of other liabilities due to Sankyo Pharma, partially
    offset by a write-off of $1,083 accounts receivable from Sankyo
    Pharma(3) |  |   | 2,694  | 
|Less: Legal expenses incurred in Sankyo Pharma litigation                                                                                        |  |   | 269    | 
|                                                                                                                                                 |  |   |       
|Net gain from Sankyo Pharma settlement                                                                                                           |  | $ | 75,825 | 
|                                                                                                                                                 |  |   |       






|    |                                                                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In 2002, we were required to reimburse Sankyo Pharma for their
    actual promotional expenses of $6.7 million and this
    payment, together with an amount we owed Sankyo Pharma for
    customer rebates, could have been deferred until the second
    quarter of 2004.
|   
|(2) | In 2002 and 2003, we were required to pay quarterly sales and
    marketing commissions to Sankyo Pharma; however, payment of
    these commissions could have been deferred to at least 2005.                                                                             
|   
|(3) | Other liabilities due to Sankyo Pharma primarily included
    customer advances and reserves for replacement of stale-dated
    AutoSensors.                                                                                                                               

Gain on early retirement of convertible debentures


|                                                 |                                               |   |        |        | 
|------------------------------------------------ | --------------------------------------------- | - | ------ | ------ | 
|Accrued principal and interest at March 22, 2004 |                                               | $ | 18,425 |       
|Less:                                            |                                               |   |        |       
|                                                 | Cash paid on retirement                       |   |        | 13,750 | 
|                                                 | Valuation of shares issued on retirement      |   |        | 1,295  | 
|                                                 | Write-off of debt issuance and discount costs |   |        | 489    | 
|                                                 |                                               |   |       
|Net gain                                         |                                               | $ | 2,891  |       
|                                                 |                                               |   |       

Provision for/(benefit from) income taxes


17



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Comparison for the Years Ended December 31, 2003 and
2002


Net product revenues




Contract revenues


Costs of product revenues






18



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Research and development expenses


Sales, marketing, general and administrative expenses


Interest income and other income/(expense), net


Interest expense


Gain from Sankyo Pharma settlement


Provision for/(benefit from) income taxes


Liquidity and Capital Resources






19



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|                                   |                                               |                |        |        |               |   |       |           |  |   |           |       |  |   |     |     | 
|---------------------------------- | --------------------------------------------- | -------------- | ------ | ------ | ------------- | - | ----- | --------- |  | - | --------- | ----- |  | - | --- | --- | 
|                                   |                                               | Amounts Due    |       
|                                   |                                               |                |       
|                                   |                                               | Total          |        |        | Within 1 Year |   |       | 2-3 Years |  |   | 4-7 Years |      
|                                   |                                               |                |        |        |               |   |       |           |  |   |           |      
|                                   |                                               | (In thousands) |       
|Contractual Obligations:           |                                               |                |        |        |               |   |       |           |  |   |           |       |  |   |     |    
|                                   | Arbitration obligation(1)                     |                | $      | 11,500 |               |   | $     | 4,500     |  |   | $         | 7,000 |  |   | $   |    | 
|                                   | University of California minimum royalties(2) |                |        | 1,200  |               |   |       | 200       |  |   |           | 400   |  |   |     | 600 | 
|                                   | Severance costs(3)                            |                |        | 2,600  |               |   |       | 2,600     |  |   |           |      |  |   |     |    | 
|                                   |                                               |                |        |        |               |   |       |           |  |   |           |      
|Total contractual cash obligations |                                               | $              | 15,300 |        |               | $ | 7,300 |           |  | $ | 7,400     |       |  | $ | 600 |    
|                                   |                                               |                |        |        |               |   |       |           |  |   |           |      






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In January 2005, we entered into a Second Amendment to the Final
    Arbitration Award with Sanofi-Aventis to fully satisfy the
    remaining royalty payments owed to Sanofi-Aventis, pursuant to a
    1997 Final Arbitration Award in exchange for an aggregate of
    $10.0 million, provided that the $10.0 million is paid
    prior to February 28, 2006. Additionally, in the event the
    asset sale has not closed with Animas prior to March 31,
    2005, we will owe $4.5 million at that time to
    Sanofi-Aventis, and $5.5 million upon close of the asset
    sale, for a total of $10.0 million. In the event, however,
    that we have not paid this $5.5 million prior to
    February 28, 2006, we will then owe $4.0 million at
    that time to Sanofi-Aventis and $3.0 million in February
    2007, for a total of $11.5 million.
|   
|(2) | Under the terms of the Asset Purchase Agreement, Animas would
    assume the Exclusive License Agreement with the University of
    California upon the closing of the asset sale and would be
    responsible for the 2005 minimum royalties and royalty payments
    thereafter. We are responsible for royalties due on products
    sold prior to the closing of the asset sale.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   
|(3) | The estimated cash usage for the amount of severance and
    retention we may have to pay to employees in 2005 would be
    approximately $2.6 million in the aggregate and would be
    paid on or about the closing of the Asset Purchase Agreement. Of
    this $2.6 million, an aggregate of $2.0 million would
    be paid to our Chief Executive Officer and the other executive
    officers of the Company (hereinafter referred to as the
    Named Executive Officers) and an aggregate of
    $600,000 would be paid to non-officer employees.                                                                                                                                                                                                                                                                                                  







20



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##### Table of Contents





Income Taxes






New Accounting Standards




21



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##### Table of Contents



RISK FACTORS


In determining whether to invest in our common stock, you
should carefully consider the information below in addition to
all other information provided to you in this report and in the
other reports and documents that we file with the SEC. The
statements under this caption are intended to serve as
cautionary statements within the meaning of the Private
Securities Litigation Reform Act of 1995. The following
information is not intended to limit in any way the
characterization of other statements or information under other
captions as cautionary statements for such purpose.


Our stockholders could vote against the sale of assets to
Animas, in which case we would likely file for, or be forced to
resort to, bankruptcy protection and it is unlikely that there
would be any distribution to stockholders.








We cannot predict the outcome of our arbitration with
Ortho-McNeil.




We had a net loss of $8.1 million for the year ended
December 31, 2004. As of December 31, 2004, our
accumulated deficit and net capital deficiency were
$255.4 million and $7,000, respectively. We will continue
to incur claims, liabilities and expenses that will reduce the
amount, if any, available for distribution to stockholders.




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##### Table of Contents





We will continue to incur the expenses of complying with
public company reporting requirements.




Our stockholders could vote against the Plan of Complete
Liquidation and Dissolution.




If we fail to create an adequate contingency reserve for
payment of our expenses and liabilities, our stockholders could
be held liable for payment to our creditors for amounts owed to
creditors in excess of the contingency reserve, up to the amount
actually distributed to such stockholder.




23



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##### Table of Contents





We cannot assure you of the amount, if any, of any
distribution to our stockholders under the Plan of Complete
Liquidation and Dissolution.




We may decide to wait to file the certificate of dissolution
for a year or more, though we would begin the process of winding
down our business as soon as the asset sale closes so that we
can devote resources to pursuing the arbitration matter.




Distribution of assets, if any, to our stockholders could be
delayed.




Our stock transfer books will close on the date we file the
certificate of dissolution with the Delaware secretary of state,
after which it will not be possible for stockholders to trade
our stock.




24



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##### Table of Contents



If we fail to retain the services of certain officers, the
Plan of Complete Liquidation and Dissolution may not succeed.









|         |                                                                
|-------- | ---------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk.

Interest Rate Risk








Foreign Exchange Risk









|        |                                             
|------- | --------------------------------------------
|Item 8. | Financial Statements and Supplementary Data.








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure.








|         |                         
|-------- | ------------------------
|Item 9A. | Controls and Procedures.

Evaluation of disclosure controls and
procedures.


Changes in internal controls.


25



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##### Table of Contents








Item 9B.     Other
Information.




26



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##### Table of Contents






PART III







|         |                                                    
|-------- | ---------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant.

Executive Officers




|                         |  |     |    |  |       |                                                                                                     
|------------------------ |  | --- | -- |  | ----- | ----------------------------------------------------------------------------------------------------
|Name                     |  | Age |    |  | Title
|                         |  |     |    |  |      
|Neil R. Ackerman, Ph.D.  |  |     | 61 |  |       | Chief Technical Officer and Senior Vice President,
    Research & Development and Scientific Affairs
|Craig W. Carlson         |  |     | 57 |  |       | Chief Operating Officer, Chief Financial Officer and Senior Vice
    President                      
|John C Hodgman           |  |     | 50 |  |       | Chairman of the Board, President and Chief Executive Officer                                        
|Barbara G. McClung, Esq. |  |     | 50 |  |       | General Counsel and Senior Vice President                                                           

Neil R. Ackerman, Ph.D.


Craig W. Carlson


John C Hodgman


Barbara G. McClung, Esq.,


27



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##### Table of Contents



Board of Directors




|                            |  |     |    |  |                      |                                                                                                                                                                                           |       |  |      | 
|--------------------------- |  | --- | -- |  | -------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----- |  | ---- | 
|                            |  |     |    |  |                      | Director                                                                                                                                                                                  |      
|Name                        |  | Age |    |  | Principal Occupation |                                                                                                                                                                                           | Since | 
|                            |  |     |    |  |                      |                                                                                                                                                                                           |       | 
|Frank T. Cary(1)(2)(3)      |  |     | 84 |  |                      | Former Chairman and Chief Executive Officer of International
    Business Machines Corporation                                                                                            |       |  | 1992 | 
|John C Hodgman(4)           |  |     | 50 |  |                      | Chairman of the Board of Directors, President and Chief
    Executive Officer of Cygnus                                                                                                   |       |  | 1998 | 
|André F. Marion(1)(2)(3)(5) |  |     | 69 |  |                      | Vice Chairman of the Board of Directors of Cygnus, Former Vice
    President of the Perkin-Elmer Corporation; Former Chairman and
    Chief Executive Officer of Applied Biosystems, Inc. |       |  | 1994 | 
|Richard G. Rogers(1)(2)(3)  |  |     | 76 |  |                      | Former President and Chief Operating Officer of Syntex
    Corporation                                                                                                                    |       |  | 1989 | 






|    |                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Member of the Audit Committee                                                                                                                        
|   
|(2) | Member of the Compensation Committee                                                                                                                 
|   
|(3) | Member of the Corporate Governance and Nominating Committee                                                                                          
|   
|(4) | Member of the Employee Stock Option Committee                                                                                                        
|   
|(5) | The Board of Directors has determined that Mr. Marion is
    Cygnus Audit Committee Financial Expert, as
    defined by SEC rules and regulations.

Frank T. Cary


John C Hodgman


André F. Marion


Richard G. Rogers


Board Independence




28



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Section 16(a) Beneficial Ownership Reporting
Compliance




Nominations for Board of Directors




Code of Ethics


www.cygn.com


29



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##### Table of Contents








|         |                        
|-------- | -----------------------
|Item 11. | Executive Compensation.

Summary of Cash and Certain Other Compensation




|                                              |  |      |      |                     |        |            |              |       |            |   |           |           |  |            |   |  |                 |  |         |  |  |   |         |    
|--------------------------------------------- |  | ---- | ---- | ------------------- | ------ | ---------- | ------------ | ----- | ---------- | - | --------- | --------- |  | ---------- | - |  | --------------- |  | ------- |  |  | - | ------- | ---
|                                              |  |      |      | Annual Compensation |        |            | Long-Term    |       |            |  
|                                              |  |      |      | ($)                 |        |            | Compensation |       |            |  
|                                              |  |      |      |                     |        |            |              |       |            |  
|                                              |  |      |      |                     |        | Awards     |              |       |           
|                                              |  |      |      |                     |        |            |              |       |           
|                                              |  |      |      |                     |        | Restricted |              |       | Securities |   |           |          
|                                              |  |      |      |                     |        | Stock      |              |       | Underlying |   |           | All Other | 
|Name and Principal Position                   |  | Year |      |                     | Salary |            |              | Bonus |            |   | Awards($) |           |  | Options(#) |   |  | Compensation($) | 
|                                              |  |      |      |                     |        |            |              |       |            |   |           |           |  |            |   |  |                 | 
|John C Hodgman                                |  |      | 2004 |                     |        | $          | 302,550      |       |            | $ |          |           |  |            |  |  |                 |  |        |  |  | $ | 56,849  | (1)
|Chairman, President and                       |  |      | 2003 |                     |        |            | 300,000      |       |            |   |          |           |  |            |  |  |                 |  | 925,000 |  |  |   |        |    
|Chief Executive Officer                       |  |      | 2002 |                     |        |            | 297,115      |       |            |   | 300,000   |           |  |            |  |  |                 |  | 100,000 |  |  |   | 150,000 |    
|Neil R. Ackerman                              |  |      | 2004 |                     |        | $          | 241,958      |       |            | $ |          |           |  |            |  |  |                 |  |        |  |  | $ | 10,525  | (1)
|Chief Technical Officer and                   |  |      | 2003 |                     |        |            | 241,231      |       |            |   |          |           |  |            |  |  |                 |  | 550,000 |  |  |   |        |    
|Senior Vice President,                        |  |      | 2002 |                     |        |            | 242,644      |       |            |   | 200,000   |           |  |            |  |  |                 |  | 75,000  |  |  |   | 100,000 |    
|Research & Development and Scientific Affairs |  |      |      |                     |        |            |              |       |            |   |           |           |  |            |   |  |                 |  |         |  |  |   |         |    
|Craig W. Carlson                              |  |      | 2004 |                     |        | $          | 250,000      |       |            | $ |          |           |  |            |  |  |                 |  |        |  |  | $ | 4,549   | (1)
|Chief Operating Officer,                      |  |      | 2003 |                     |        |            | 248,461      |       |            |   |          |           |  |            |  |  |                 |  | 590,000 |  |  |   |        |    
|Chief Financial Officer and                   |  |      | 2002 |                     |        |            | 227,788      |       |            |   | 200,000   |           |  |            |  |  |                 |  | 75,000  |  |  |   | 87,500  |    
|Senior Vice President                         |  |      |      |                     |        |            |              |       |            |   |           |           |  |            |   |  |                 |  |         |  |  |   |         |    
|Barbara G. McClung                            |  |      | 2004 |                     |        | $          | 236,808      |       |            | $ |          |           |  |            |  |  |                 |  |        |  |  | $ | 5,728   | (1)
|Senior Vice President,                        |  |      | 2003 |                     |        |            | 234,231      |       |            |   |          |           |  |            |  |  |                 |  | 425,000 |  |  |   |        |    
|General Counsel and Secretary                 |  |      | 2002 |                     |        |            | 220,928      |       |            |   | 150,000   |           |  |            |  |  |                 |  | 60,000  |  |  |   | 75,000  |    






|    |                                                                 
|--- | ----------------------------------------------------------------
|(1) | Vacation balance pay-out pursuant to Company-wide policy change.



|                |  |                              |           |                      |                         |  |         |             |  |   |               |  |  |   |   | 
|--------------- |  | ---------------------------- | --------- | -------------------- | ----------------------- |  | ------- | ----------- |  | - | ------------- |  |  | - | - | 
|                |  |                              |           | Value of Unexercised |                        
|                |  | Number of Unexercised        |           |                      | In-The-Money Options at | 
|                |  | Options at December 31, 2004 |           |                      | December 31, 2004($)    | 
|                |  |                              |           |                      |                         | 
|Name            |  | Exercisable                  |           |                      | Unexercisable           |  |         | Exercisable |  |   | Unexercisable | 
|                |  |                              |           |                      |                         |  |         |             |  |   |               | 
|John Hodgman    |  |                              | 1,486,079 |                      |                         |  | 125,000 |             |  | $ | 0             |  |  | $ | 0 | 
|Neil Ackerman   |  |                              | 994,010   |                      |                         |  | 62,500  |             |  | $ | 0             |  |  | $ | 0 | 
|Craig Carlson   |  |                              | 931,350   |                      |                         |  | 82,500  |             |  | $ | 0             |  |  | $ | 0 | 
|Barbara McClung |  |                              | 625,788   |                      |                         |  | 75,000  |             |  | $ | 0             |  |  | $ | 0 | 

Employment Agreements and Change of Control Agreements




30



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:






Compensation of our Board of Directors






Compensation Committee Interlocks and Insider
Participation




31



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|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management.





|                                                                    |  |          |           |  |                  |  |       |  
|------------------------------------------------------------------- |  | -------- | --------- |  | ---------------- |  | ----- | -
|Name of Beneficial Owner                                            |  | Owned(1) |           |  | Percent Owned(2) | 
|                                                                    |  |          |           |  |                  | 
|Neil R. Ackerman                                                    |  |          | 1,022,745 |  |                  |  | 2.24  | %
|Craig W. Carlson                                                    |  |          | 966,831   |  |                  |  | 2.12  | %
|Frank T. Cary                                                       |  |          | 145,310   |  |                  |  | *     |  
|John C Hodgman                                                      |  |          | 1,582,101 |  |                  |  | 3.47  | %
|André F. Marion                                                     |  |          | 119,591   |  |                  |  | *     |  
|Barbara G. McClung                                                  |  |          | 650,788   |  |                  |  | 1.43  | %
|Richard G. Rogers                                                   |  |          | 106,871   |  |                  |  | *     |  
|Walter B. Wriston (deceased)                                        |  |          | 113,650   |  |                  |  | *     |  
|All executive officers and directors as a group
    (eight persons) |  |          | 4,707,887 |  |                  |  | 10.33 | %






|  |                                        
|- | ---------------------------------------
|* | Less than 1% of the shares outstanding.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | This disclosure is made pursuant to certain rules and
    regulations promulgated by the SEC and, in certain instances,
    the number of shares shown as being beneficially owned may not
    be deemed to be beneficially owned for other purposes. This
    amount includes options to purchase shares exercisable as of
    May 6, 2005, within 60 days of March 7, 2005 in
    the following amounts: Mr. Ackerman, 996,698 shares;
    Mr. Carlson, 955,155 shares; Mr. Cary,
    100,464 shares; Mr. Hodgman, 1,527,745 shares;
    Mr. Marion, 118,591 shares; Ms. McClung,
    650,788 shares; Mr. Rogers, 97,820 shares;
    Mr. Wriston, 108,450 shares. The weighted average
    exercise price of the stock options described in this footnote
    is $4.85 per share.
|   
|(2) | Percentage of outstanding common stock (41,009,251 shares)
    plus common stock that may be acquired upon exercise of
    outstanding options on or before May 6, 2005 by the persons
    named above and by all directors and executive officers as a
    group (4,555,711 shares).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

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Equity Compensation Plan Information (as of December 31,
2004)


|                                                               |  |                      |           |  |                   |                      |      |                       |  |  |           | 
|-------------------------------------------------------------- |  | -------------------- | --------- |  | ----------------- | -------------------- | ---- | --------------------- |  |  | --------- | 
|                                                               |  |                      |           |  |                   | (c)                  |     
|                                                               |  |                      |           |  |                   | Number of securities |     
|                                                               |  |                      |           |  |                   | remaining available  |     
|                                                               |  | (a)                  |           |  | (b)               |                      |      | for future issuance   | 
|                                                               |  | Number of securities |           |  | Weighted-average  |                      |      | under Equity          | 
|                                                               |  | to be issued upon    |           |  | exercise price of |                      |      | Compensation Plans    | 
|                                                               |  | exercise of          |           |  | outstanding       |                      |      | (excluding securities | 
|                                                               |  | outstanding options, |           |  | options, warrants |                      |      | reflected in          | 
|Equity Compensation Plan Category                              |  | warrants and rights  |           |  | and rights        |                      |      | column(a))(1)         | 
|                                                               |  |                      |           |  |                   |                      |      |                       | 
|Equity Compensation Plans approved by
    security holders     |  |                      | 5,744,106 |  |                   | $                    | 4.52 |                       |  |  | 2,086,473 | 
|Equity Compensation Plans not approved
    by security holders |  |                      |           |  |                   |                      |      |                       |  |  |           | 
|Total                                                          |  |                      | 5,744,106 |  |                   | $                    | 4.52 |                       |  |  | 2,086,473 | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As of December 31, 2004, the amounts shown include
    1,217,518 stock options available for future issuance under the
    Companys 1999 Stock Incentive Plan (wherein the limit of
    1,200,000 shares that could have been issued as restricted
    stock, stock units or stock appreciation rights has been met)
    and 868,955 shares available for issuance under the
    Companys Amended Employee Stock Purchase Plan (the
    ESPP). As a result of the Companys stock being
    delisted from the Nasdaq Stock Market and being quoted on the
    OTC Bulletin Board, effective on January 8, 2003, the
    ESPP was suspended by our Board of Directors and no shares will
    be issued under the ESPP until such suspension is lifted.






|         |                                                
|-------- | -----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions.








|         |                                        
|-------- | ---------------------------------------
|Item 14. | Principal Accounting Fees and Services.

Audit and Related Fees for 2004 and 2003


Audit Fees.


Audit-Related Fees.


Tax Fees.


All Other Fees.




Audit Committee Authorization of Audit and Non-Audit
Services




33



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34



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##### Table of Contents






PART IV







|         |                                         
|-------- | ----------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules.

(a) Financial Statements and Report of Independent
Registered Public Accounting Firm


|                                                                                               |  |      |     | 
|---------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                               |  | Page |    
|                                                                                               |  |      |    
|Report of Independent Registered Public Accounting Firm                                        |  |      | F-2 | 
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                   |  |      | F-3 | 
|Consolidated Statements of Operations for the years ended                                      |  |      |     | 
|December 31, 2004, 2003 and 2002                                                               |  |      | F-4 | 
|Consolidated Statements of Stockholders Equity/(Net Capital                                   |  |      |     | 
|Deficiency) for the years ended December 31, 2004, 2003 and
    2002                           |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the years ended
    December 31, 2004, 2003 and 2002 |  |      | F-6 | 
|Notes to Consolidated Financial Statements for the year ended
    December 31, 2004            |  |      | F-7 | 

(b) Exhibits




| |    |      |  |                                                                                                                                                                                                                                                                                                                                                                                             
| | -- | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2  | .01  |  | Asset Purchase Agreement dated December 16, 2004 between
    the Registrant, Animas Corporation and Animas Technologies LLC,
    incorporated by reference to Exhibit 99.2 of the
    Registrants Form 8-K filed December 17, 2004.                                                                                                                                                        
| | 2  | .02  |  | Plan of Complete Liquidation and Dissolution of Cygnus, Inc.                                                                                                                                                                                                                                                                                                                                
| | 3  | .01  |  | Bylaws of the Registrant, as amended, incorporated by reference
    to Exhibit 99.1 of the Registrants Form 8-K,
    filed on March 7, 2005.                                                                                                                                                                                                                                               
| | 3  | .02  |  | Restated Articles of Incorporation of the Registrant, as amended
    to date, incorporated by reference to Exhibit 3.02 of
    Registrants Form 10-Q for the quarter ended
    June 30, 2002.                                                                                                                                                                                              
| | 4  | .01  |  | Specimen of Common Stock Certificate of the Registrant,
    incorporated by reference to Exhibit 4.1 of the
    Registrants Registration Statement on Form S-1 (File
    No. 33-38363) filed on December 21, 1990
    (Form S-1).                                                                                                                                                          
| | 4  | .02  |  | Reserved.                                                                                                                                                                                                                                                                                                                                                                                   
| | 4  | .03  |  | Registration Rights Agreement dated June 30, 1999 between
    the Registrant and Cripple Creek Securities, L.L.C.,
    incorporated by reference to Exhibit 4.11 of the
    Registrants Form 10-Q for the quarter ended
    June 30, 1999.                                                                                                                                                 
| | 4  | .04  |  | Registration Rights Agreement dated June 29, 1999 between
    the Registrant and the listed Investors on Schedule I
    thereto, incorporated by reference to Exhibit 4.12 of the
    Registrants Form 10-Q for the quarter ended
    June 30, 1999.                                                                                                                                       
| | 4  | .05  |  | Registration Rights Agreement dated October 1, 2001 between
    Cygnus, Inc. and Cripple Creek Securities, L.L.C., incorporated
    by reference to Exhibit 4.1 of the Registrants
    Registration Statement on Form S-3 (File
    No. 333-71524) filed on October 12, 2001.                                                                                                              
| | 10 | .001 |  | Ten-year Industrial Net Lease Agreement (Building No. 2)
    dated September  27, 1988 between the Registrant and
    Seaport Centre Venture Phase I, incorporated by reference
    to Exhibit 10.26 of the Registrants Form S-1.                                                                                                                                                          
| | 10 | .002 |  | Reserved.                                                                                                                                                                                                                                                                                                                                                                                   
| | 10 | .003 |  | First Amendment to Ten-year Industrial Net Lease Agreement
    (Building No. 2) dated June 9, 1998 between the
    Registrant and Metropolitan Life Insurance Company, a New York
    corporation (predecessor in interest to Seaport Centre Venture
    Phase I), incorporated by reference to Exhibit 10.30
    of the Registrants Form 10-K for the period ending
    December 31, 1998.
| | 10 | .004 |  | through 10.007 Reserved.                                                                                                                                                                                                                                                                                                                                                                    

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| |     |      |  |                                                                                                                                                                                                                                                                                                                                                           
| | --- | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10  | .008 |  | Lease Termination Agreement (Building 8) dated
    October 15, 2003 between the Registrant and Metropolitan
    Life Insurance Company, a New York corporation (predecessor in
    interest to Seaport Centre Venture Phase I), incorporated
    by reference to Exhibit 10.008 of the Registrants
    Form 10-K for the period ending December 31, 2003.
| | 10  | .009 |  | Lease Termination Agreement (Building 2) dated
    December 16, 2004 between the Registrant and Metropolitan
    Life Insurance Company, a New York corporation (predecessor in
    interest to Seaport Centre Venture Phase I), incorporated
    by reference to Exhibit 99.3 of the Registrants
    Form 8-K, filed on December 17, 2004.              
| | 10  | .010 |  | through 10.099 Reserved.                                                                                                                                                                                                                                                                                                                                  
| | 10  | .101 |  | through 10.123 Reserved.                                                                                                                                                                                                                                                                                                                                  
| | 10  | .124 |  | Amendment to the Final Arbitration Award between Registrant and
    Sanofi-Synthelabo dated November 3, 2003, incorporated by
    reference to Exhibit 10.124 of the Registrants
    Form 10-K for the period ending December 31, 2003.                                                                                                                  
| | 10  | .125 |  | Security Agreement between Registrant and Sanofi-Synthelabo
    dated November 3, 2003, incorporated by reference to
    Exhibit 10.125 of the Registrants Form 10-K for
    the period ending December 31, 2003.                                                                                                                                        
| | 10  | .126 |  | Grant of Security Interest (Patents) between Registrant and
    Sanofi-Synthelabo dated January 18, 2004, incorporated by
    reference to Exhibit 10.126 of the Registrants
    Form 10-K for the period ending December 31, 2003.                                                                                                                      
| | 10  | .127 |  | Exchange Agreement between Registrant and the debenture holders
    dated March 23, 2004, incorporated by reference to
    Exhibit 99.2 of the Registrants Form 8-K filed
    March 25, 2004.                                                                                                                                                            
| | 10  | .128 |  | Notice of Termination of Structured Equity Line Flexible
    Financing Agreement dated March 24, 2004, incorporated by
    reference to Exhibit 10.128 of the Registrants
    Form 10-K for the period ending December 31, 2003.                                                                                                                         
| | 10  | .129 |  | Second Amendment to the Final Arbitration Award dated
    January 27, 2005 between Registrant and Sanofi-Aventis
    (formerly known as Sanofi-Synthelabo), incorporated by reference
    to Exhibit 99.1 of the Registrants Form 8-K
    filed January 28, 2005.                                                                                        
| | 10  | .130 |  | through 10.199 Reserved.                                                                                                                                                                                                                                                                                                                                  
| | 10  | .201 |  | Reserved.                                                                                                                                                                                                                                                                                                                                                 
| | *10 | .202 |  | Product Supply Agreement between the Registrant and Contract
    Manufacturing, Inc. dated July 15, 1997, incorporated by
    reference as Exhibit 10.202 of the Registrants
    Form 10-K for the period ending December 31, 1999.
    [Confidential Treatment Requested]                                                                               
| | 10  | .203 |  | Reserved.                                                                                                                                                                                                                                                                                                                                                 
| | *10 | .204 |  | Supply Agreement between the Registrant and Hydrogel Design
    Systems, Inc. dated December 31, 1999, incorporated by
    reference to Exhibit 10.206 of the Registrants
    Form 10-K for the period ending December 31, 1999.
    [Confidential Treatment Requested]                                                                                  
| | *10 | .205 |  | Supply Agreement between the Registrant and Sanmina Medical
    Products Division, a division of Sanmina Corporation, dated
    March  1, 2000, incorporated by reference to
    Exhibit 10.207 of the Registrants Form 10-Q for
    the quarter ended June 30, 2000. [Confidential Treatment
    Requested]                                             
| | *10 | .206 |  | Supply Agreement between the Registrant and E.I. du Pont de
    Nemours & Co. dated June 23, 2000, incorporated by
    reference to Exhibit 10.208 of the Registrants
    Form 10-Q for the quarter ended June 30, 2000.
    [Confidential Treatment Requested]                                                                                          
| | 10  | .207 |  | through 10.210 Reserved.                                                                                                                                                                                                                                                                                                                                  
| | *10 | .211 |  | Sales, Marketing and Distribution Agreement between the
    Registrant and Sankyo Pharma Inc. dated July 8, 2002,
    incorporated by reference to Exhibit 10.211 of the
    Registrants Form 10-Q/ A for the period ending
    September 30, 2002. [Confidential Treatment Requested]                                                                   
| | 10  | .212 |  | through 10.213 Reserved.                                                                                                                                                                                                                                                                                                                                  
| | *10 | .214 |  | First Amendment to the Sales, Marketing and Distribution
    Agreement between the Registrant and Sankyo Pharma Inc. dated
    January 23, 2003, incorporated by reference to
    Exhibit 10.214 of the Registrants Form 10-K for
    the period ending December 31, 2002. [Confidential
    Treatment Requested]                                        

36



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| |     |      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | --- | ---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *10 | .215 |  | Supply Agreement between the Registrant and Sankyo Pharma Inc.
    dated January 23, 2003, incorporated by reference to
    Exhibit 10.215 of the Registrants Form 10-K for
    the period ending December 31, 2002. [Confidential
    Treatment Requested]                                                                                                                                                                                   
| | *10 | .216 |  | Memorandum of Understanding (TheraCom) to the Sales, Marketing
    and Distribution Agreement between the Registrant and Sankyo
    Pharma Inc. dated January 23, 2003, incorporated by
    reference to Exhibit 10.216 to the Registrants
    Form 10-K for the period ending December 31, 2002.
    [Confidential Treatment Requested]                                                                                                      
| | 10  | .217 |  | Binding purchase commitment letter dated March 19, 2003 by
    Sankyo Pharma Inc., incorporated by reference to
    Exhibit 10.217 of the Registrants Form 10-Q for
    the period ending March 31, 2003.                                                                                                                                                                                                                                     
| | 10  | .218 |  | Deferral of advertising and promotional amount letter dated
    March 19, 2003 by Sankyo Pharma Inc., incorporated by
    reference to Exhibit 10.218 of the Registrants
    Form 10-Q for the period ending March 31, 2003.                                                                                                                                                                                                                  
| | *10 | .219 |  | Manufacturing Agreement dated May 1, 2003 between the
    Registrant and Key Tronic Corporation, incorporated by reference
    to Exhibit 10.219 of the Registrants Form 10-Q
    for the period ending June 30, 2003. [Confidential
    Treatment Requested]                                                                                                                                                                                 
| | 10  | .220 |  | Agreement for Global Resolution and Mutual Release of All Claims
    between the Registrant and Sankyo Pharma Inc. dated
    December 23, 2003, incorporated by reference to
    Exhibit 99.3 of the Registrants Form 8-K filed
    December 23, 2003.                                                                                                                                                                                        
| | 10  | .221 |  | through 10.299 Reserved.                                                                                                                                                                                                                                                                                                                                                                                                                       
| | *10 | .301 |  | Exclusive License Agreement between the Registrant and The
    Regents of the University of California dated
    January  31, 1995, incorporated by reference to
    Exhibit 10.301 of the Registrants Form 10-K for
    the period ending December 31, 1999. [Confidential
    Treatment Requested]                                                                                                                                          
| | *10 | .302 |  | License Agreement Amendment between the Registrant and The
    Regents of the University of California dated
    April  23, 1998, incorporated by reference to
    Exhibit 10.302 of the Registrants Form 10-K for
    the period ending December 31, 1999. [Confidential
    Treatment Requested]                                                                                                                                            
| | *10 | .303 |  | Second Amendment to the Exclusive License Agreement Dated
    January 31, 1995 for Device for Iontophoretic Non-Invasive
    Sampling or Delivery of Substances between the Registrant and
    The Regents of the University of California dated
    September 19, 2002, incorporated by reference to
    Exhibit 10.303 of the Registrants
    Form  10-Q/ A for the period ending September 30,
    2002. [Confidential Treatment Requested]
| | 10  | .304 |  | through 10.399 Reserved.                                                                                                                                                                                                                                                                                                                                                                                                                       
| | *10 | .401 |  | Asset Purchase Agreement dated November 17, 1999 between
    the Registrant and Ortho-McNeil Pharmaceutical, Inc.,
    incorporated by reference to Exhibit 10.49 of the
    Registrants Form 8-K filed December 30, 1999.
    [Confidential Treatment Requested]                                                                                                                                                                             
| | 10  | .402 |  | through 10.499 Reserved.                                                                                                                                                                                                                                                                                                                                                                                                                       
| | 10  | .501 |  | Registrants 1999 Stock Incentive Plan (as Amended and
    Restated January  27, 2003), incorporated by reference
    to Exhibit 10.501 of the Registrants Form 10-K
    for the period ending December 31, 2002.                                                                                                                                                                                                                             
| | 10  | .502 |  | Registrants Amended 1991 Employee Stock Purchase Plan (as
    Amended and Restated March 1, 2000), incorporated by
    reference to Exhibit 10.502 of the Registrants
    Form 10-K for the period ending December 31, 1999.                                                                                                                                                                                                                 
| | 10  | .503 |  | Written Compensation Agreement dated August 28, 1998
    between the Registrant and André F. Marion, incorporated by
    reference to Exhibit 99.7 of the Registrants
    Form S-8 Registration (File No. 333-67331) filed on
    November 16, 1998.                                                                                                                                                                                          
| | 10  | .504 |  | Stock Option Agreement between the Registrant and André F.
    Marion, incorporated by reference to Exhibit 99.8 of the
    Registrants Form S-8 (File No. 333-67331) filed
    November 16, 1998.                                                                                                                                                                                                                                            
| | 10  | .505 |  | Form of Employment Agreement between the Registrant and each of
    the Companys Officers, incorporated by reference to
    Exhibit 10.511 of the Registrants Form 10-K for
    the period ending December 31, 2000.                                                                                                                                                                                                                         

37



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| |    |      |  |                                                                                                                                                                                                                                                         
| | -- | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10 | .506 |  | Form of Employment Agreement between the Registrant and Key
    Employees, incorporated by reference to Exhibit 10.512 of
    the Registrants Form 10-K for the period ending
    December 31, 2000.                                                   
| | 10 | .507 |  | Form of Indemnification Agreement for Directors and Officers,
    incorporated by reference to Exhibit 10.513 of the
    Registrants Form 10-K for the period ending
    December 31, 2000.                                                            
| | 10 | .508 |  | Form of Retention Letter Agreement between the Registrant and
    each of the Companys Officers dated December 18,
    2003, incorporated by reference to Exhibit 10.508 of the
    Registrants Form 10-K for the period ending
    December 31, 2003.
| | 23 | .1   |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                               
| | 24 | .1   |  | Power of Attorney (see page 41).                                                                                                                                                                                                                        
| | 31 | .1   |  | Certification of Principal Executive Officer Pursuant to
    Securities Exchange Act Rule 13a-14, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                             
| | 31 | .2   |  | Certification of Principal Financial Officer Pursuant to
    Securities Exchange Act Rule 13a-14, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                             
| | 32 | .1   |  | Certification of Principal Executive Officer Pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                          
| | 32 | .2   |  | Certification of Principal Financial Officer Pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                          






|  |                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------
|* | A confidential treatment request has been applied for or granted
    with respect to a portion of this document.

(c) Schedules




38



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##### Table of Contents






SIGNATURES






| |             
| | ------------
| | CYGNUS, INC.



| |    |                    
| | -- | -------------------
| | By | /s/ John C. Hodgman

| |                                                
| | -----------------------------------------------
| |                                                
| | Chairman, President and Chief Executive Officer
| | (Principal Executive Officer)                  

39



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POWER OF ATTORNEY








|                                           |  |                                                                                                                                                   |  |                |  | 
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                                  |  | Title                                                                                                                                             |  | Date          
|                                           |  |                                                                                                                                                   |  |               
|                                          
|/s/ John C. HodgmanJohn
    C. Hodgman     |  | Chairman of the Board of Directors, President and Chief
    Executive Officer (Principal Executive Officer)                                       |  | March 16, 2005
|                                          
|/s/ Craig W. CarlsonCraig
    W. Carlson   |  | Chief Operating Officer, Chief Financial Officer and Senior Vice
    President (Principal Financial Officer and Principal Accounting
    Officer) |  | March 16, 2005
|                                          
|/s/ André F.
    MarionAndré
    F. Marion |  | Vice Chairman of the
    Board of Directors                                                                                                       |  | March 16, 2005
|                                          
|/s/ Frank T. CaryFrank
    T. Cary         |  | Director                                                                                                                                          |  | March 16, 2005
|                                          
|/s/ Richard G. RogersRichard
    G. Rogers |  | Director                                                                                                                                          |  | March 16, 2005

40



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CYGNUS, INC.


CONSOLIDATED FINANCIAL STATEMENTS


For the Years Ended December 31, 2004, 2003 and 2002


Contents


|                                                            |                                                                              |  |     |     | 
|----------------------------------------------------------- | ---------------------------------------------------------------------------- |  | --- | --- | 
|Report of Independent Registered Public
    Accounting Firm |                                                                              |  | F-2 |    
|Audited Consolidated Financial Statements:                  |                                                                              |  |     |    
|                                                            | Consolidated Balance Sheets                                                  |  |     | F-3 | 
|                                                            | Consolidated Statements of Operations                                        |  |     | F-4 | 
|                                                            | Consolidated Statements of
    Stockholders Equity/(Net Capital Deficiency) |  |     | F-5 | 
|                                                            | Consolidated Statements of Cash Flows                                        |  |     | F-6 | 
|                                                            | Notes to Consolidated Financial
    Statements                               |  |     | F-7 | 

F-1



---



##### Table of Contents






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM














| |                      
| | ---------------------
| | /s/ Ernst & Young LLP





F-2



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##### Table of Contents






CYGNUS, INC.


CONSOLIDATED BALANCE SHEETS


|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |   |        |          |        | 
|-------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------ | ----- | -------- | ------ | - | ------ | -------- | ------ | 
|                                                                                 |                                                                                                                                                                    | December 31,                                                             |      
|                                                                                 |                                                                                                                                                                    |                                                                          |      
|                                                                                 |                                                                                                                                                                    | 2004                                                                     |       |          | 2003   |  
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | (In thousands,                                                           |      
|                                                                                 |                                                                                                                                                                    | except per share data)                                                   |      
|ASSETS                                                                          
|Current assets:                                                                  |                                                                                                                                                                    |                                                                          |       |          |        |   |        |         
|                                                                                 | Cash and cash equivalents                                                                                                                                          |                                                                          | $     | 10,317   |        |   | $      | 33,483   |       
|                                                                                 | Inventories                                                                                                                                                        |                                                                          |       |         |        |   |        | 62       |       
|                                                                                 | Accounts receivable                                                                                                                                                |                                                                          |       | 131      |        |   |        | 31       |       
|                                                                                 | Current portion of employee notes receivable                                                                                                                       |                                                                          |       |         |        |   |        | 25       |       
|                                                                                 | Other current assets                                                                                                                                               |                                                                          |       | 532      |        |   |        | 719      |       
|                                                                                 | Equipment held for sale                                                                                                                                            |                                                                          |       | 1,690    |        |   |        |         |       
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | Total current assets                                                     |       |          | 12,670 |   |        |          | 34,320 | 
|Equipment and improvements:                                                      |                                                                                                                                                                    |                                                                          |       |          |        |   |        |         
|                                                                                 | Manufacturing, office and laboratory equipment                                                                                                                     |                                                                          |       | 830      |        |   |        | 11,908   |       
|                                                                                 | Leasehold improvements                                                                                                                                             |                                                                          |       | 197      |        |   |        | 377      |       
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    |                                                                          | 1,027 |          |        |   | 12,285 |         
|                                                                                 | Less accumulated depreciation and amortization                                                                                                                     |                                                                          |       | (1,027   | )      |   |        | (9,080   | )     
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | Net equipment and improvements                                           |       |          |       |   |        |          | 3,205  | 
|Long-term portion of employee notes receivable                                   |                                                                                                                                                                    |                                                                          |      |          |        |   | 15     |         
|Other assets                                                                     |                                                                                                                                                                    |                                                                          |      |          |        |   | 167    |         
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | TOTAL ASSETS                                                             |       | $        | 12,670 |   |        | $        | 37,707 | 
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                
|LIABILITIES AND STOCKHOLDERS EQUITY/(NET CAPITAL
    DEFICIENCY)               
|Current liabilities:                                                             |                                                                                                                                                                    |                                                                          |       |          |        |   |        |         
|                                                                                 | Accounts payable                                                                                                                                                   |                                                                          | $     | 306      |        |   | $      | 814      |       
|                                                                                 | Accrued compensation                                                                                                                                               |                                                                          |       | 260      |        |   |        | 381      |       
|                                                                                 | Other accrued liabilities                                                                                                                                          |                                                                          |       | 611      |        |   |        | 505      |       
|                                                                                 | Current portion of arbitration obligation                                                                                                                          |                                                                          |       | 4,500    |        |   |        |         |       
|                                                                                 | Current portion of convertible debentures                                                                                                                          |                                                                          |       |         |        |   |        | 14,281   |       
|                                                                                 | Current portion of capital lease obligations                                                                                                                       |                                                                          |       |         |        |   |        | 74       |       
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | Total current liabilities                                                |       |          | 5,677  |   |        |          | 16,055 | 
|Long-term portion of arbitration obligation                                      |                                                                                                                                                                    |                                                                          | 7,000 |          |        |   | 11,500 |         
|Long-term portion of convertible debentures, net of discount of
    $709 in 2003 |                                                                                                                                                                    |                                                                          |      |          |        |   | 3,291  |         
|Other long-term liabilities                                                      |                                                                                                                                                                    |                                                                          |      |          |        |   | 39     |         
|Commitments and contingencies (Notes 3 and 4)                                    |                                                                                                                                                                    |                                                                          |       |          |        |   |        |         
|Total stockholders equity/ (net capital deficiency):                            |                                                                                                                                                                    |                                                                          |       |          |        |   |        |         
|                                                                                 | Preferred stock, $0.001 par value: 5,000 shares
    authorized; no shares issued and outstanding                                                                   |                                                                          |       |         |        |   |        |         |       
|                                                                                 | Common stock, $0.001 par value: 95,000 shares
    authorized; issued and outstanding: 41,009 and
    38,480 shares at December 31, 2004 and 2003,
    respectively |                                                                          |       | 41       |        |   |        | 38       |       
|                                                                                 | Additional paid-in capital                                                                                                                                         |                                                                          |       | 255,353  |        |   |        | 254,093  |       
|                                                                                 | Accumulated deficit                                                                                                                                                |                                                                          |       | (255,401 | )      |   |        | (247,309 | )     
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | Total stockholders equity/ (net capital deficiency)                     |       |          | (7     | ) |        |          | 6,822  | 
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  
|                                                                                 |                                                                                                                                                                    | TOTAL LIABILITIES AND STOCKHOLDERS EQUITY/ (NET
    CAPITAL DEFICIENCY) |       | $        | 12,670 |   |        | $        | 37,707 | 
|                                                                                 |                                                                                                                                                                    |                                                                          |       |          |        |  



F-3



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##### Table of Contents



CYGNUS, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                                       |                                                    |                                       |         |        |        |   |         |        |        |   |         |        |        | 
|---------------------------------------------------------------------- | -------------------------------------------------- | ------------------------------------- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                       |                                                    | Years Ended December 31,              |        
|                                                                       |                                                    |                                       |        
|                                                                       |                                                    | 2004                                  |         |        | 2003   |   |         | 2002   |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|                                                                       |                                                    | (In thousands, except per share data) |        
|Revenues:                                                              |                                                    |                                       |         |        |        |   |         |        |        |   |         |       
|                                                                       | Net product revenues                               |                                       | $       | 556    |        |   | $       | 2,684  |        |   | $       | 3,453  |       
|                                                                       | Contract revenues                                  |                                       |         |       |        |   |         | 234    |        |   |         | 401    |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|                                                                       |                                                    | Total revenues                        |         |        | 556    |   |         |        | 2,918  |   |         |        | 3,854  | 
|Costs and expenses:                                                    |                                                    |                                       |         |        |        |   |         |        |        |   |         |       
|                                                                       | Costs of product revenues                          |                                       |         | 240    |        |   |         | 15,447 |        |   |         | 6,396  |       
|                                                                       | Research and development                           |                                       |         |       |        |   |         | 5,119  |        |   |         | 13,883 |       
|                                                                       | Sales, marketing, general and administrative       |                                       |         | 11,369 |        |   |         | 6,440  |        |   |         | 22,544 |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|                                                                       |                                                    | Total costs and expenses              |         |        | 11,609 |   |         |        | 27,006 |   |         |        | 42,823 | 
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Loss from operations                                                   |                                                    |                                       | (11,053 | )      |        |   | (24,088 | )      |        |   | (38,969 | )     
|                                                                       | Interest income and other income/(expense), net    |                                       |         | 170    |        |   |         | 114    |        |   |         | 417    |       
|                                                                       | Interest expense                                   |                                       |         | (430   | )      |   |         | (2,210 | )      |   |         | (3,153 | )     
|                                                                       | Gain from Sankyo Pharma settlement                 |                                       |         | 132    |        |   |         | 75,825 |        |   |         |       |       
|                                                                       | Gain on early retirement of convertible debentures |                                       |         | 2,891  |        |   |         |       |        |   |         |       |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Income/(loss) before income taxes                                      |                                                    |                                       | (8,290  | )      |        |   | 49,641  |        |        |   | (41,705 | )     
|Provision for/(benefit from) income taxes                              |                                                    |                                       | (198    | )      |        |   | 199     |        |        |   | 23      |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Net income/(loss)                                                      |                                                    | $                                     | (8,092  | )      |        | $ | 49,442  |        |        | $ | (41,728 | )     
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Net income/(loss) per share, basic                                     |                                                    | $                                     | (0.20   | )      |        | $ | 1.28    |        |        | $ | (1.11   | )     
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Shares used in computation of net income/(loss) per share,
    basic   |                                                    |                                       | 40,444  |        |        |   | 38,480  |        |        |   | 37,580  |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Net income/(loss) per share, diluted                                   |                                                    | $                                     | (0.20   | )      |        | $ | 1.01    |        |        | $ | (1.11   | )     
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       
|Shares used in computation of net income/(loss) per share,
    diluted |                                                    |                                       | 40,444  |        |        |   | 49,640  |        |        |   | 37,580  |       
|                                                                       |                                                    |                                       |         |        |        |   |         |        |       



F-4



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##### Table of Contents



CYGNUS, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS


EQUITY/(NET CAPITAL DEFICIENCY)


|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | -------------- | -- | ---------- | ------- | - | ------- | ----------- | ------------------- | - | ------------------- | - |  | - | ------- | -
|                                                                                                                |  |                |    | Additional |         |   |         |             | Total Stockholders |  
|                                                                                                                |  | Common         |    |            | Paid-In |   |         | Accumulated |                     |   | Equity/(Net Capital |  
|                                                                                                                |  | Stock          |    |            | Capital |   |         | Deficit     |                     |   | Deficiency)         |  
|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |  
|                                                                                                                |  | (In thousands) |   
|Balances at December 31, 2001                                                                                   |  | $              | 33 |            |         | $ | 236,942 |             |                     | $ | (255,023            | ) |  | $ | (18,048 | )
|Issuance of 226 shares of common stock under the 1999 Stock
    Incentive Plan and Employee Stock Purchase Plan |  |                |   |            |         |   | 554     |             |                     |   |                    |   |  |   | 554     |  
|Issuance of 338 shares of common stock in lieu of cash
    bonuses                                              |  |                |   |            |         |   | 1,408   |             |                     |   |                    |   |  |   | 1,408   |  
|Stock-based compensation                                                                                        |  |                |   |            |         |   | 4       |             |                     |   |                    |   |  |   | 4       |  
|Issuance of 170 shares of common stock pursuant to equity
    lines, net of issuance costs                      |  |                |   |            |         |   | 452     |             |                     |   |                    |   |  |   | 452     |  
|Public offering of 4,600 shares of common stock, net of
    issuance costs                                      |  |                | 5  |            |         |   | 14,731  |             |                     |   |                    |   |  |   | 14,736  |  
|Net and comprehensive loss                                                                                      |  |                |   |            |         |   |        |             |                     |   | (41,728             | ) |  |   | (41,728 | )
|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |  
|Balances at December 31, 2002                                                                                   |  |                | 38 |            |         |   | 254,091 |             |                     |   | (296,751            | ) |  |   | (42,622 | )
|Issuance of 1.6 shares of common stock under the 1999 Stock
    Incentive Plan                                  |  |                |   |            |         |   | 1       |             |                     |   |                    |   |  |   | 1       |  
|Stock-based compensation                                                                                        |  |                |   |            |         |   | 1       |             |                     |   |                    |   |  |   | 1       |  
|Net and comprehensive income                                                                                    |  |                |   |            |         |   |        |             |                     |   | 49,442              |   |  |   | 49,442  |  
|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |  
|Balances at December 31, 2003                                                                                   |  |                | 38 |            |         |   | 254,093 |             |                     |   | (247,309            | ) |  |   | 6,822   |  
|Issuance of 29 shares of common stock under the 1999 Stock
    Incentive Plan                                   |  |                |   |            |         |   | 13      |             |                     |   |                    |   |  |   | 13      |  
|Issuance of 2,500 shares of common stock as convertible
    debentures payment                                  |  |                | 3  |            |         |   | 1,292   |             |                     |   |                    |   |  |   | 1,295   |  
|Write-off of debt issuance cost associated with convertible
    debentures                                      |  |                |   |            |         |   | (45     | )           |                     |   |                    |   |  |   | (45     | )
|Net and comprehensive loss                                                                                      |  |                |   |            |         |   |        |             |                     |   | (8,092              | ) |  |   | (8,092  | )
|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |  
|Balances at December 31, 2004                                                                                   |  | $              | 41 |            |         | $ | 255,353 |             |                     | $ | (255,401            | ) |  | $ | (7      | )
|                                                                                                                |  |                |    |            |         |   |         |             |                     |   |                     |  



F-5



---



##### Table of Contents



CYGNUS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |         |       |         |  
|------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------ | ------------------------------------------------------ | ----------------------------------------------------------------------------------- | ------- | ------ | ------- | ------ | ------ | ------- | ------ | ------ | ------- | ----- | ------- | -
|                                                                          |                                                                                                        | Years Ended December 31,                               |                                                                                    
|                                                                          |                                                                                                        |                                                        |                                                                                    
|                                                                          |                                                                                                        | 2004                                                   |                                                                                     |         | 2003   |         |        | 2002   |        
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|                                                                          |                                                                                                        | (In thousands)                                         |                                                                                    
|Cash flows from operating activities:                                     |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |        
|                                                                          | Net income/(loss)                                                                                      |                                                        | $                                                                                   | (8,092  | )      |         | $      | 49,442 |         |        | $      | (41,728 | )    
|                                                                          | Adjustments to reconcile net income/(loss) to net cash provided
    by/(used in) operating activities: |                                                        |                                                                                     |         |        |         |        |        |         |        |        |         |      
|                                                                          |                                                                                                        | Depreciation and amortization                          |                                                                                     |         | 1,479  |         |        |        | 1,921   |        |        |         | 2,041 |        
|                                                                          |                                                                                                        | (Gain)/loss on sales of equipment                      |                                                                                     |         | 36     |         |        |        | (4      | )      |        |         | 19    |        
|                                                                          |                                                                                                        | Impairment of fixed assets                             |                                                                                     |         |       |         |        |        |        |        |        |         | 1,491 |        
|                                                                          |                                                                                                        | Amortization of deferred financing costs               |                                                                                     |         | 282    |         |        |        | 1,397   |        |        |         | 1,435 |        
|                                                                          |                                                                                                        | Stock-based compensation                               |                                                                                     |         |       |         |        |        | 1       |        |        |         | 4     |        
|                                                                          |                                                                                                        | Write-off of employee notes receivable                 |                                                                                     |         | 40     |         |        |        | 122     |        |        |         | (40   | )      
|                                                                          |                                                                                                        | Accrued interest on convertible debentures             |                                                                                     |         | 144    |         |        |        |        |        |        |         |      |        
|                                                                          |                                                                                                        | Gain on early retirement of convertible debentures     |                                                                                     |         | (2,891 | )       |        |        |        |        |        |         |      |        
|                                                                          |                                                                                                        | Non-cash portion of gain from Sankyo Pharma settlement |                                                                                     |         |       |         |        |        | (46,094 | )      |        |         |      |        
|                                                                          |                                                                                                        | Change in operating assets and liabilities:            |                                                                                     |         |        |         |        |        |         |        |        |         |       |        
|                                                                          |                                                                                                        |                                                        | Accounts receivable from Sankyo Pharma                                              |         |        |        |        |        |         | (586   | )      |         |       | (497    | )
|                                                                          |                                                                                                        |                                                        | Inventories                                                                         |         |        | 62      |        |        |         | 6,566  |        |         |       | (4,641  | )
|                                                                          |                                                                                                        |                                                        | Other assets                                                                        |         |        | 148     |        |        |         | 410    |        |         |       | 66      |  
|                                                                          |                                                                                                        |                                                        | Other                                                                               |         |        | (1      | )      |        |         | 2      |        |         |       | 28      |  
|                                                                          |                                                                                                        |                                                        | Accounts payable and other accrued liabilities                                      |         |        | (402    | )      |        |         | (1,808 | )      |         |       | 870     |  
|                                                                          |                                                                                                        |                                                        | Accrued compensation                                                                |         |        | (121    | )      |        |         | (2,247 | )      |         |       | 503     |  
|                                                                          |                                                                                                        |                                                        | Advances from Sankyo Pharma                                                         |         |        |        |        |        |         | 2,395  |        |         |       | 1,382   |  
|                                                                          |                                                                                                        |                                                        | Deferred revenues from Sankyo Pharma                                                |         |        |        |        |        |         |       |        |         |       | 20,000  |  
|                                                                          |                                                                                                        |                                                        | Deferred revenues from Sankyo Pharma net of deferred costs of
    product shipments |         |        |        |        |        |         | 1,107  |        |         |       | 8,199   |  
|                                                                          |                                                                                                        |                                                        | Amount due to Sankyo Pharma                                                         |         |        |        |        |        |         | 1,857  |        |         |       | 7,237   |  
|                                                                          |                                                                                                        |                                                        | Arbitration obligation                                                              |         |        |        |        |        |         | (3,500 | )      |         |       | (8,390  | )
|                                                                          |                                                                                                        |                                                        | Other long-term liabilities                                                         |         |        | (39     | )      |        |         | 39     |        |         |       | (161    | )
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|                                                                          |                                                                                                        |                                                        | Net cash provided by/(used in) operating activities                                 |         |        | (9,355  | )      |        |         | 11,020 |        |         |       | (12,182 | )
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|Cash flows from investing activities:                                     |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |        
|                                                                          | Capital expenditures                                                                                   |                                                        |                                                                                     |        |        |         |        | (83    | )       |        |        | (601    | )    
|                                                                          | Proceeds from sales of equipment                                                                       |                                                        |                                                                                     |        |        |         |        | 7      |         |        |        | 5       |      
|                                                                          | Purchases of investments                                                                               |                                                        |                                                                                     |        |        |         |        | (800   | )       |        |        | (14,246 | )    
|                                                                          | Sales of investments                                                                                   |                                                        |                                                                                     |        |        |         |        | 4,000  |         |        |        | 15,550  |      
|                                                                          | Maturity of investments                                                                                |                                                        |                                                                                     |        |        |         |        |       |         |        |        | 2,074   |      
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|                                                                          |                                                                                                        |                                                        | Net cash provided by investing activities                                           |         |        |        |        |        |         | 3,124  |        |         |       | 2,782   |  
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|Cash flows from financing activities:                                     |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |        
|                                                                          | Issuance of common stock                                                                               |                                                        |                                                                                     | 13      |        |         |        | 1      |         |        |        | 15,742  |      
|                                                                          | Principal payments of convertible debentures                                                           |                                                        |                                                                                     | (13,750 | )      |         |        | (4,000 | )       |        |        |        |      
|                                                                          | Principal payments of capital lease obligations                                                        |                                                        |                                                                                     | (74     | )      |         |        | (77    | )       |        |        | (69     | )    
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|                                                                          |                                                                                                        |                                                        | Net cash provided by/(used in) financing activities                                 |         |        | (13,811 | )      |        |         | (4,076 | )      |         |       | 15,673  |  
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|Net increase/(decrease) in cash and cash equivalents                      |                                                                                                        |                                                        | (23,166                                                                             | )       |        |         | 10,068 |        |         |        | 6,273  |        
|Cash and cash equivalents at the beginning of the year                    |                                                                                                        |                                                        | 33,483                                                                              |         |        |         | 23,415 |        |         |        | 17,142 |        
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|Cash and cash equivalents at the end of the year                          |                                                                                                        | $                                                      | 10,317                                                                              |         |        | $       | 33,483 |        |         | $      | 23,415 |        
|                                                                          |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |        
|Supplemental disclosure of cash flow information:                         |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |        
|                                                                          | Interest paid                                                                                          |                                                        | $                                                                                   | 148     |        |         | $      | 757    |         |        | $      | 220     |      
|                                                                          | Foreign income taxes paid                                                                              |                                                        | $                                                                                   |        |        |         | $      | 21     |         |        | $      | 27      |      
|Supplemental schedule of non-cash investing and financing
    activities: |                                                                                                        |                                                        |                                                                                     |         |        |         |        |        |         |        |        |        
|                                                                          | Value of shares granted in lieu of bonus                                                               |                                                        | $                                                                                   |        |        |         | $      |       |         |        | $      | 1,408   |      
|                                                                          | Value of shares issued as convertible debentures payment                                               |                                                        | $                                                                                   | 1,295   |        |         | $      |       |         |        | $      |        |      
|                                                                          | Write-off of debt issuance cost associated with convertible
    debentures                             |                                                        | $                                                                                   | (46     | )      |         | $      |       |         |        | $      |        |      



F-6



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##### Table of Contents



CYGNUS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


For the Year Ended December 31, 2004




|        |                                                                         
|------- | ------------------------------------------------------------------------
|Note 1: | Basis of Presentation and Summary of Significant Accounting
    Policies

Description of Business










F-7



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






Basis of Consolidation




Financial Presentation




Use of Estimates






Customer and Other Concentrations






Foreign Currency Translation




F-8



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Accounting for Stock-Based Compensation










|                                                                                                                          |                      |                                          |        |       |      |   |        |      |  |   |         |       |  
|------------------------------------------------------------------------------------------------------------------------- | -------------------- | ---------------------------------------- | ------ | ----- | ---- | - | ------ | ---- |  | - | ------- | ----- | -
|                                                                                                                          |                      | Years Ended December 31,                 |       
|                                                                                                                          |                      |                                          |       
|                                                                                                                          |                      | 2004                                     |        |       | 2003 |   |        | 2002 | 
|                                                                                                                          |                      |                                          |        |       |      |   |        |      | 
|                                                                                                                          |                      | (In thousands, except per share amounts) |       
|Net income/(loss), as reported                                                                                            |                      | $                                        | (8,092 | )     |      | $ | 49,442 |      |  | $ | (41,728 | )    
|Deduct: Total stock-based employee compensation expense
    determined under fair value method for all awards, net of tax |                      |                                          | (708   | )     |      |   | (1,119 | )    |  |   | (2,873  | )    
|                                                                                                                          |                      |                                          |        |       |      |   |        |      | 
|Pro forma net income/(loss)                                                                                               |                      | $                                        | (8,800 | )     |      | $ | 48,323 |      |  | $ | (44,601 | )    
|                                                                                                                          |                      |                                          |        |       |      |   |        |      | 
|Net income/(loss), per share:                                                                                             |                      |                                          |        |       |      |   |        |      |  |   |         |      
|                                                                                                                          | Basic, as reported   |                                          | $      | (0.20 | )    |   | $      | 1.28 |  |   | $       | (1.11 | )
|                                                                                                                          | Basic, pro forma     |                                          | $      | (0.22 | )    |   | $      | 1.26 |  |   | $       | (1.19 | )
|                                                                                                                          | Diluted, as reported |                                          | $      | (0.20 | )    |   | $      | 1.01 |  |   | $       | (1.11 | )
|                                                                                                                          | Diluted, pro forma   |                                          | $      | (0.22 | )    |   | $      | 0.99 |  |   | $       | (1.19 | )

F-9



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                        |  |                          |      |   |      |  |      |      |  |  |      |  
|----------------------- |  | ------------------------ | ---- | - | ---- |  | ---- | ---- |  |  | ---- | -
|                        |  | Years Ended December 31, |     
|                        |  |                          |     
|                        |  | 2004                     |      |   | 2003 |  |      | 2002 | 
|                        |  |                          |      |   |      |  |      |      | 
|Risk-free interest rate |  |                          | 2.37 | % |      |  | 2.82 | %    |  |  | 4.20 | %
|Volatility              |  |                          | 1.68 |   |      |  | 1.05 |      |  |  | 0.83 |  
|Dividend yield          |  |                          | 0    |   |      |  | 0    |      |  |  | 0    |  
|Expected life (years)   |  |                          | 2    |   |      |  | 3    |      |  |  | 5    |  



|                        |  |                              |      |  
|----------------------- |  | ---------------------------- | ---- | -
|                        |  | Year Ended December 31, 2002 |     
|                        |  |                              |     
|Risk-free interest rate |  |                              | 1.13 | %
|Volatility              |  |                              | 1.25 |  
|Dividend yield          |  |                              | 0    |  
|Expected life (years)   |  |                              | 0.5  |  





Accounting for Impairment or Disposal of Long-Lived Assets




F-10



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








Revenue Recognition










F-11



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)










Research and Development




Advertising Expenses




F-12



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Net Income/(Loss) Per Share




|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |        |  |   |         |   | 
|------------ | ------------------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------- | - | ------ | ---- |  | - | ------ | ------ |  | - | ------- | - | 
|             |                                                                                            | Years Ended December 31,                                                                                                                              |  
|             |                                                                                            |                                                                                                                                                       |  
|             |                                                                                            | 2004                                                                                                                                                  |   |        | 2003 |  |   | 2002   |       
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|             |                                                                                            | (In thousands, except per share data)                                                                                                                 |  
|Numerator:   |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |        |  |   |        
|             | Numerator for basic net income/(loss) per share: net
    income/(loss)                     |                                                                                                                                                       | $ | (8,092 | )    |  | $ | 49,442 |        |  | $ | (41,728 | )
|             | Interest associated with convertible debentures                                            |                                                                                                                                                       |   |       |      |  |   | 745    |        |  |   |        |  
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|             | Numerator for dilutive net income/(loss) per share                                         |                                                                                                                                                       | $ | (8,092 | )    |  | $ | 50,187 |        |  | $ | (41,728 | )
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|Denominator: |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |        |  |   |        
|             | Denominator for basic net income/(loss) per share: weighted
    average shares outstanding |                                                                                                                                                       |   | 40,444 |      |  |   | 38,480 |        |  |   | 37,580  |  
|             |                                                                                            | Weighted average dilutive potential common shares from stock
    options and shares subject to issuance upon conversion of
    convertible debentures |   |        |     |  |   |        | 11,160 |  |   |         |  | 
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|             | Denominator for diluted net income/(loss) per share                                        |                                                                                                                                                       |   | 40,444 |      |  |   | 49,640 |        |  |   | 37,580  |  
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|             | Basic net income/(loss) per share                                                          |                                                                                                                                                       | $ | (0.20  | )    |  | $ | 1.28   |        |  | $ | (1.11   | )
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       
|             | Diluted net income/(loss) per share                                                        |                                                                                                                                                       | $ | (0.20  | )    |  | $ | 1.01   |        |  | $ | (1.11   | )
|             |                                                                                            |                                                                                                                                                       |   |        |      |  |   |        |       



Cash, Cash Equivalents and Short-Term Investments








F-13



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Inventory












Shipping and Handling Costs




Equipment and Improvements




Comprehensive Income/(Loss)




F-14



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Segment Information




|               |  |                          |     |  |      |   |       |      |  |   |       | 
|-------------- |  | ------------------------ | --- |  | ---- | - | ----- | ---- |  | - | ----- | 
|               |  | Years Ended December 31, |    
|               |  |                          |    
|               |  | 2004                     |     |  | 2003 |   |       | 2002 | 
|               |  |                          |     |  |      |   |       |      | 
|               |  | (In thousands)           |    
|United States  |  | $                        | 419 |  |      | $ | 2,533 |      |  | $ | 3,098 | 
|United Kingdom |  |                          | 137 |  |      |   | 151   |      |  |   | 355   | 
|               |  |                          |     |  |      |   |       |      | 
|Total          |  | $                        | 556 |  |      | $ | 2,684 |      |  | $ | 3,453 | 
|               |  |                          |     |  |      |   |       |      | 



New Accounting Standards




F-15



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 2:     Cygnus and Sankyo
Pharma




|                                                                                                                                              |  |   |        | 
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ------ | 
|Cash settlement received from Sankyo Pharma in December 2003                                                                                  |  | $ | 30,000 | 
|Recognition of deferred revenues from Sankyo Pharma (milestone
    payments)                                                                  |  |   | 25,000 | 
|Recognition of deferred revenues from Sankyo Pharma net of
    deferred costs of $8,759 of product shipments                                  |  |   | 9,306  | 
|Write-off of current portion of amount due to Sankyo Pharma                                                                                   |  |   | 6,770  | 
|Write-off of long-term portion of amount due to Sankyo Pharma                                                                                 |  |   | 2,324  | 
|Write-off of other liabilities due to Sankyo Pharma, partially
    offset by a write-off of $1,083 accounts receivable from Sankyo
    Pharma |  |   | 2,694  | 
|Less: Legal expenses incurred in Sankyo Pharma litigation                                                                                     |  |   | 269    | 
|                                                                                                                                              |  |   |       
|Net gain from Sankyo Pharma settlement                                                                                                        |  | $ | 75,825 | 
|                                                                                                                                              |  |   |       





|        |                                                 
|------- | ------------------------------------------------
|Note 3: | Manufacturing and Other Contractual Arrangements



F-16



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|        |                
|------- | ---------------
|Note 4: | Operating Lease







|        |                      
|------- | ---------------------
|Note 5: | Financing Instruments



F-17



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                       
| | ----------------------
| | Convertible Debentures



|                                                 |                                               |   |        |        | 
|------------------------------------------------ | --------------------------------------------- | - | ------ | ------ | 
|Accrued principal and interest at March 22, 2004 |                                               | $ | 18,425 |       
|Less:                                            |                                               |   |        |       
|                                                 | Cash paid on retirement                       |   |        | 13,750 | 
|                                                 | Valuation of shares issued on retirement      |   |        | 1,295  | 
|                                                 | Write-off of debt issuance and discount costs |   |        | 489    | 
|                                                 |                                               |   |       
|Net gain                                         |                                               | $ | 2,891  |       
|                                                 |                                               |   |       



| |            
| | -----------
| | Equity Line







|        |                     
|------- | --------------------
|Note 6: | Stockholders Equity

Common Stock




F-18



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Warrants




|                 |  |                     |        |  |          |   |      |               |  |  |             |  |  |   |         | 
|---------------- |  | ------------------- | ------ |  | -------- | - | ---- | ------------- |  |  | ----------- |  |  | - | ------- | 
|                 |  |                     |        |  |          |   |      | Fair Value of | 
|                 |  | Number of Shares    |        |  | Exercise |   |      | Expiration    |  |  | Warrants at | 
|Date of Warrants |  | Covered by Warrants |        |  | Price    |   |      | Date          |  |  | Issuance    | 
|                 |  |                     |        |  |          |   |      |               |  |  |             | 
|05/09/01         |  |                     | 11,178 |  |          | $ | 9.85 |               |  |  | 05/09/06    |  |  | $ | 51,195  | 
|01/08/02         |  |                     | 49,914 |  |          | $ | 7.74 |               |  |  | 01/08/07    |  |  | $ | 163,219 | 
|08/01/03         |  |                     | 16,511 |  |          | $ | 3.72 |               |  |  | 08/01/08    |  |  | $ | 2,642   | 

Employee Stock Purchase Plan




Stock Incentive Plan








F-19



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                                                           |  |                |       |   |          |   |                |            |  |  |          |                |  |            |      |  |          |  |       |   |  |   |       | 
|---------------------------------------------------------- |  | -------------- | ----- | - | -------- | - | -------------- | ---------- |  |  | -------- | -------------- |  | ---------- | ---- |  | -------- |  | ----- | - |  | - | ----- | 
|                                                           |  | 2004           |       |   | 2003     |   |                | 2002       | 
|                                                           |  |                |       |   |          |   |                |            | 
|                                                           |  | Number of      |       |   | Weighted |   |                | Number of  |  |  | Weighted |                |  | Number of  |      |  | Weighted | 
|                                                           |  | Shares         |       |   | Average  |   |                | Shares     |  |  | Average  |                |  | Shares     |      |  | Average  | 
|                                                           |  | Underlying     |       |   | Exercise |   |                | Underlying |  |  | Exercise |                |  | Underlying |      |  | Exercise | 
|                                                           |  | Options        |       |   | Price    |   |                | Options    |  |  | Price    |                |  | Options    |      |  | Price    | 
|                                                           |  |                |       |   |          |   |                |            |  |  |          |                |  |            |      |  |          | 
|                                                           |  | (In thousands) |       |   |          |   | (In thousands) |            |  |  |          | (In thousands) |  |            |     
|Total outstanding at beginning of year                     |  |                | 6,615 |   |          | $ | 4.82           |            |  |  | 4,015    |                |  | $          | 8.71 |  |          |  | 4,072 |   |  | $ | 9.68  | 
|Granted                                                    |  |                | 128   |   |          | $ | 0.37           |            |  |  | 3,630    |                |  | $          | 0.40 |  |          |  | 1,241 |   |  | $ | 1.79  | 
|Exercised                                                  |  |                | (29   | ) |          | $ | 0.46           |            |  |  | (2       | )              |  | $          | 0.46 |  |          |  | (278  | ) |  | $ | 0.37  | 
|Forfeited                                                  |  |                | (784  | ) |          | $ | 5.78           |            |  |  | (929     | )              |  | $          | 4.72 |  |          |  | (993  | ) |  | $ | 6.21  | 
|Expired                                                    |  |                | (156  | ) |          | $ | 8.47           |            |  |  | (99      | )              |  | $          | 1.23 |  |          |  | (27   | ) |  | $ | 14.38 | 
|                                                           |  |                |       |   |          |   |                |            |  |  |          |                |  |            |      |  |          | 
|Outstanding at end of year                                 |  |                | 5,774 |   |          | $ | 4.52           |            |  |  | 6,615    |                |  | $          | 4.82 |  |          |  | 4,015 |   |  | $ | 8.71  | 
|                                                           |  |                |       |   |          |   |                |            |  |  |          |                |  |            |      |  |          | 
|Exercisable at end of year                                 |  |                | 5,322 |   |          | $ | 4.89           |            |  |  | 4,040    |                |  | $          | 7.23 |  |          |  | 2,764 |   |  | $ | 10.24 | 
|Weighted-average fair value of options granted during year |  |                |       |   |          | $ | 0.29           |            |  |  |          |                |  | $          | 0.21 |  |          |  |       |   |  | $ | 3.69  | 



|                         |  |                     |       |           |                  |  |           |       |  |                |        |           |  |       |       |  |  |   |       | 
|------------------------ |  | ------------------- | ----- | --------- | ---------------- |  | --------- | ----- |  | -------------- | ------ | --------- |  | ----- | ----- |  |  | - | ----- | 
|                         |  | Options Outstanding |       |           | Exercisable      | 
|                         |  |                     |       |           |                  | 
|                         |  |                     |       | Weighted- |                  |  | Weighted- |       |  |                |        | Weighted- | 
|                         |  |                     |       | Average   |                  |  | Average   |       |  |                |        | Average   | 
|                         |  |                     |       | Remaining |                  |  | Exercise  |       |  |                |        | Exercise  | 
|Range of Exercise Prices |  | Number              |       |           | Contractual Life |  |           | Price |  |                | Number |           |  | Price |      
|                         |  |                     |       |           |                  |  |           |       |  |                |        |           |  |       |      
|                         |  | (In thousands)      |       |           | (In years)       |  |           |       |  | (In thousands) |        |           | 
|$ 0.095 - $ 0.12         |  |                     | 754   |           |                  |  | 8.97      |       |  | $              | 0.12   |           |  |       | 376   |  |  | $ | 0.12  | 
|$ 0.27  - $ 0.46         |  |                     | 2,248 |           |                  |  | 8.16      |       |  | $              | 0.45   |           |  |       | 2,174 |  |  | $ | 0.46  | 
|$ 0.47  - $ 5.00         |  |                     | 1,150 |           |                  |  | 6.34      |       |  | $              | 3.84   |           |  |       | 1,150 |  |  | $ | 3.84  | 
|$ 5.75  - $14.50         |  |                     | 993   |           |                  |  | 3.68      |       |  | $              | 9.77   |           |  |       | 993   |  |  | $ | 9.77  | 
|$15.13  - $21.75         |  |                     | 629   |           |                  |  | 3.65      |       |  | $              | 17.24  |           |  |       | 629   |  |  | $ | 17.24 | 
|                         |  |                     |       |           |                  |  |           |       |  |                |        |           |  |       |      
|                         |  |                     | 5,774 |           |                  |  | 6.64      |       |  | $              | 4.52   |           |  |       | 5,322 |  |  | $ | 4.89  | 
|                         |  |                     |       |           |                  |  |           |       |  |                |        |           |  |       |      

Common Stock Reserved for Future Issuance




|                             |  |                |       | 
|---------------------------- |  | -------------- | ----- | 
|                             |  | (In thousands) |      
|Stock Incentive Plan         |  |                | 6,992 | 
|Employee Stock Purchase Plan |  |                | 869   | 
|Outstanding warrants         |  |                | 78    | 
|                             |  |                |      
|Total common stock reserved  |  |                | 7,939 | 
|                             |  |                |      

F-20



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|        |             
|------- | ------------
|Note 7: | Income Taxes



|        |         |                          |      |      |      |   |     |      |  |   |    |    | 
|------- | ------- | ------------------------ | ---- | ---- | ---- | - | --- | ---- |  | - | -- | -- | 
|        |         | Years Ended December 31, |     
|        |         |                          |     
|        |         | 2004                     |      |      | 2003 |   |     | 2002 | 
|        |         |                          |      |      |      |   |     |      | 
|        |         | (In thousands)           |     
|Current |         |                          |      |      |      |   |     |      |  |   |    |   
|        | Federal |                          | $    | (198 | )    |   | $   | 198  |  |   | $  |   | 
|        | State   |                          |      |     |      |   |     |     |  |   |    |   | 
|        | Foreign |                          |      |     |      |   |     | 1    |  |   |    | 23 | 
|        |         |                          |      |      |      |   |     |      | 
|Total   |         | $                        | (198 | )    |      | $ | 199 |      |  | $ | 23 |   
|        |         |                          |      |      |      |   |     |      | 



|                             |                                             |                          |      |        |      |   |     |         |   |   |    |         |  
|---------------------------- | ------------------------------------------- | ------------------------ | ---- | ------ | ---- | - | --- | ------- | - | - | -- | ------- | -
|                             |                                             | Years Ended December 31, |     
|                             |                                             |                          |     
|                             |                                             | 2004                     |      |        | 2003 |   |     | 2002    |  
|                             |                                             |                          |      |        |      |   |     |         |  
|                             |                                             | (In thousands)           |     
|U.S. Federal taxes/(benefit) |                                             |                          |      |        |      |   |     |         |   |   |    |        
|                             | At statutory rate                           |                          | $    | (2,832 | )    |   | $   | 17,361  |   |   | $  | (14,188 | )
|                             | Federal alternative minimum taxes           |                          |      | (198   | )    |   |     | 198     |   |   |    |        |  
|                             | State income taxes                          |                          |      |       |      |   |     |        |   |   |    |        |  
|                             | Foreign income taxes                        |                          |      |       |      |   |     | 1       |   |   |    | 23      |  
|                             | Unutilized/ (utilized) net operating losses |                          |      | 2,832  |      |   |     | (17,361 | ) |   |    | 14,188  |  
|                             |                                             |                          |      |        |      |   |     |         |  
|Total                        |                                             | $                        | (198 | )      |      | $ | 199 |         |   | $ | 23 |        
|                             |                                             |                          |      |        |      |   |     |         |  



|                                                  |  |                   |         |   |      |   |          |  
|------------------------------------------------- |  | ----------------- | ------- | - | ---- | - | -------- | -
|                                                  |  | December 31, 2004 |        
|                                                  |  |                   |        
|                                                  |  | 2004              |         |   | 2003 |  
|                                                  |  |                   |         |   |      |  
|                                                  |  | (In thousands)    |        
|Deferred tax assets:                              |  |                   |         |   |      |   |          |  
|Net operating loss carryforwards                  |  | $                 | 81,750  |   |      | $ | 85,067   |  
|Research and development tax credit carryforwards |  |                   | 9,448   |   |      |   | 9,531    |  
|Arbitration obligation accrual                    |  |                   | 4,600   |   |      |   | 4,600    |  
|Capitalized research and development              |  |                   | 3,648   |   |      |   | 4,404    |  
|Other                                             |  |                   | 256     |   |      |   | 132      |  
|                                                  |  |                   |         |   |      |  
|Total deferred tax assets                         |  |                   | 99,702  |   |      |   | 103,734  |  
|Valuation allowance for deferred tax assets       |  |                   | (99,702 | ) |      |   | (103,734 | )
|                                                  |  |                   |         |   |      |  
|Net deferred tax assets                           |  | $                 |        |   |      | $ |         |  
|                                                  |  |                   |         |   |      |  



F-21



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|        |                       
|------- | ----------------------
|Note 8: | Arbitration Obligation







F-22



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##### Table of Contents



CYGNUS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|        |                      
|------- | ---------------------
|Note 9: | Employee Benefit Plan





|         |                                              
|-------- | ---------------------------------------------
|Note 12: | Selected Quarterly Financial Data (unaudited)

|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |   |  |   |        |   |  |   |        |  
|---------------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------- | - | ------ | -------- |  | - | --------- | - |  | ------------ | ------ | - | ------------- | - | ------ | -------- |  | - | --------- | - |  | - | ------ | - |  | - | ------ | -
|                                                                       |  | Three Months Ended                    |       
|                                                                       |  |                                       |       
|                                                                       |  | December 31,                          |        |   | September 30, |   |        | June 30, |  |   | March 31, |   |  | December 31, |        |   | September 30, |   |        | June 30, |  |   | March 31, |  
|                                                                       |  | 2004                                  |        |   | 2004          |   |        | 2004     |  |   | 2004      |   |  | 2003         |        |   | 2003          |   |        | 2003     |  |   | 2003      |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|                                                                       |  | (In thousands, except per share data) |       
|Total revenues                                                         |  | $                                     | 227    |   |               | $ | 236    |          |  | $ | 47        |   |  | $            | 46     |   |               | $ | 931    |          |  | $ | 1,100     |   |  | $ | 539    |   |  | $ | 348    |  
|Costs of product revenues                                              |  |                                       | 27     |   |               |   | 50     |          |  |   | 47        |   |  |              | 116    |   |               |   | 2,863  |          |  |   | 7,520     |   |  |   | 3,271  |   |  |   | 1,793  |  
|Total other costs and expenses                                         |  |                                       | 3,639  |   |               |   | 2,267  |          |  |   | 2,516     |   |  |              | 2,947  |   |               |   | 2,013  |          |  |   | 2,156     |   |  |   | 3,539  |   |  |   | 3,851  |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Loss from operations                                                   |  |                                       | (3,439 | ) |               |   | (2,081 | )        |  |   | (2,516    | ) |  |              | (3,017 | ) |               |   | (3,945 | )        |  |   | (8,576    | ) |  |   | (6,271 | ) |  |   | (5,296 | )
|Interest income/(expense) and other, net                               |  |                                       | 53     |   |               |   | 17     |          |  |   | 30        |   |  |              | (360   | ) |               |   | (571   | )        |  |   | (491      | ) |  |   | (521   | ) |  |   | (513   | )
|Gain from Sankyo Pharma settlement                                     |  |                                       |       |   |               |   |       |          |  |   | 60        |   |  |              | 72     |   |               |   | 75,825 |          |  |   |          |   |  |   |       |   |  |   |       |  
|Gain on early retirement of convertible debentures                     |  |                                       |       |   |               |   |       |          |  |   |          |   |  |              | 2,891  |   |               |   |       |          |  |   |          |   |  |   |       |   |  |   |       |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Income/(loss) before income taxes                                      |  |                                       | (3,386 | ) |               |   | (2,064 | )        |  |   | (2,426    | ) |  |              | (414   | ) |               |   | 71,309 |          |  |   | (9,067    | ) |  |   | (6,792 | ) |  |   | (5,809 | )
|Provision for/(benefit from) income taxes                              |  |                                       | (198   | ) |               |   |       |          |  |   |          |   |  |              |       |   |               |   | 197    |          |  |   |          |   |  |   | 1      |   |  |   | 1      |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Net income/(loss)                                                      |  | $                                     | (3,188 | ) |               | $ | (2,064 | )        |  | $ | (2,426    | ) |  | $            | (414   | ) |               | $ | 71,112 |          |  | $ | (9,067    | ) |  | $ | (6,793 | ) |  | $ | (5,810 | )
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Net income/(loss) per share, basic                                     |  | $                                     | (0.08  | ) |               | $ | (0.05  | )        |  | $ | (0.06     | ) |  | $            | (0.01  | ) |               | $ | 1.85   |          |  | $ | (0.24     | ) |  | $ | (0.18  | ) |  | $ | (0.15  | )
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Shares used in computation of net income/(loss) per share, basic       |  |                                       | 41,009 |   |               |   | 41,009 |          |  |   | 41,009    |   |  |              | 38,748 |   |               |   | 38,480 |          |  |   | 38,480    |   |  |   | 38,479 |   |  |   | 38,479 |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Net income/(loss) per share, diluted                                   |  | $                                     | (0.08  | ) |               | $ | (0.05  | )        |  | $ | (0.06     | ) |  | $            | (0.01  | ) |               | $ | 1.24   |          |  | $ | (0.24     | ) |  | $ | (0.18  | ) |  | $ | (0.15  | )
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  
|Shares used in computation of net income/(loss) per share,
    diluted |  |                                       | 41,009 |   |               |   | 41,009 |          |  |   | 41,009    |   |  |              | 38,748 |   |               |   | 57,757 |          |  |   | 38,480    |   |  |   | 38,479 |   |  |   | 38,479 |  
|                                                                       |  |                                       |        |   |               |   |        |          |  |   |           |   |  |              |        |   |               |   |        |          |  |   |           |  

F-23



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##### Table of Contents






EXHIBIT INDEX


| |      |  |  |                                                                                                                                                                            
| | ---- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2.02 |  |  | Plan of Complete Liquidation and Dissolution of Cygnus, Inc.                                                                                                               
| | 23.1 |  |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                  
| | 31.1 |  |  | Certification of Principal Executive Officer Pursuant to
    Securities Exchange Act Rule 13a-14, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.
| | 31.2 |  |  | Certification of Principal Financial Officer Pursuant to
    Securities Exchange Act Rule 13a-14, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.
| | 32.1 |  |  | Certification of Principal Executive Officer Pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.             
| | 32.2 |  |  | Certification of Principal Financial Officer Pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.