<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended MARCH 31, 1999
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period from ____ to ___
COMMISSION FILE NUMBER 0-18962
CYGNUS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2978092
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification No.)
400 PENOBSCOT DRIVE, REDWOOD CITY, CALIFORNIA 94063-4719
(Address of principle executive offices and zip code)
Registrant's telephone number, including area code: (650) 369-4300
---------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Number of shares outstanding of each of the registrant's classes of common stock
as of APRIL 22, 1999:
Common Stock - 22,578,076 shares
Total pages: 27
Page number of exhibit index: 25
<PAGE>
CYGNUS, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE NO.
---------
<S> <C>
Item 1: Financial Statements
Condensed Consolidated Statements of Operations for the three month periods
ended March 31, 1999 and 1998 (unaudited).......................................... 2
Condensed Consolidated Balance Sheets at March 31, 1999
(unaudited) and December 31, 1998.................................................. 3
Condensed Consolidated Statements of Cash Flows for the three month periods
ended March 31, 1999 and 1998 (unaudited)......................................... 4
Notes to Condensed Consolidated Financial Statements (unaudited)..................... 5
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................................. 9
Item 3: Quantitative and Qualitative Disclosures About Market Risk........................... 23
PART II. OTHER INFORMATION
Item 1: Legal Proceedings................................................................. 25
Item 6: Exhibits and Reports on Form 8-K.................................................. 25
SIGNATURES.......................................................................................... 27
</TABLE>
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYGNUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per-share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
--------------- -------------
<S> <C> <C>
Product revenues $ ----- $ 506
Contract revenues 2,566 2,723
Royalty and other revenues 355 231
------------ ------------
TOTAL REVENUES 2,921 3,460
Costs and expenses:
Costs of products sold ----- 1,023
Research and development 7,885 6,065
Marketing, general and administrative 1,470 1,916
------------ ------------
TOTAL COSTS AND EXPENSES 9,355 9,004
LOSS FROM OPERATIONS (6,434) (5,544)
Interest income/(expense), net (382) 6
------------ ------------
NET LOSS $ (6,816) $ (5,538)
------------ ------------
------------ ------------
BASIC AND DILUTED NET LOSS PER SHARE $ (0.31) $ (0.28)
------------ ------------
------------ ------------
Shares used in computation of basic and diluted
net loss per share 21,733 19,841
------------ ------------
------------ ------------
</TABLE>
(See accompanying notes.)
2
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CYGNUS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
MARCH 31, December 31,
1999 1998
--------------------------------------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents $ 8,480 $ 10,219
Short-term investments 13,961 14,982
Trade accounts receivable, net of allowance 1,122 876
Inventories ---- 771
Prepaid expenses and other current assets 782 695
--------------------- ---------------------
Total current assets 24,345 27,543
EQUIPMENT AND IMPROVEMENTS:
Equipment and improvements, at cost 20,873 19,541
Less accumulated depreciation and amortization (13,549) (13,077)
--------------------------------------------
Net equipment and improvements 7,324 6,464
Long-term investments 3,586 3,622
Deferred compensation and other assets 1,609 5,825
--------------------------------------------
Total Assets $ 36,864 $ 43,454
--------------------------------------------
--------------------------------------------
LIABILITIES AND NET CAPITAL DEFICIENCY:
CURRENT LIABILITIES:
Accounts payable $ 6,467 $ 4,459
Accrued compensation 4,492 4,593
Accrued professional services 745 729
Other accrued liabilities 936 943
Customer advances 182 207
Current portion of arbitration obligation 157 60
Current portion of deferred revenue 2,462 1,153
Current portion of long-term debt 3,436 3,415
Current portion of capital lease obligations 442 442
--------------------------------------------
Total current liabilities 19,319 16,001
Long-term portion of arbitration obligation 23,909 24,158
Long-term portion of debt 7,385 8,252
Long-term portion of capital lease obligations 475 581
Senior Subordinated Convertible Notes 18,500 22,563
Deferred compensation and other long-term liabilities 523 4,666
STOCKHOLDERS' NET CAPITAL DEFICIENCY:
Common stock 22 21
Additional paid-in-capital 149,500 143,155
Accumulated deficit (182,771) (175,955)
Accumulated other comprehensive income 2 12
--------------------------------------------
Net capital deficiency (32,247) (32,767)
--------------------------------------------
Total liabilities and stockholders' net
capital deficiency $ 36,864 $ 43,454
--------------------------------------------
--------------------------------------------
</TABLE>
Note: The condensed consolidated balance sheet at December 31, 1998 has been
derived from the audited financial statements at that date but does not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements.
(See accompanying notes.)
3
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CYGNUS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase/(Decrease) in Cash and Cash Equivalents
(unaudited)
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
------------------ -------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,816) $ (5,538)
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization 477 450
Decrease/(increase) in assets 4,696 689
Increase/(decrease) in liabilities (678) (1,092)
Increase/(decrease) in arbitration liability (151) (14,065)
------------------ -------------------
NET CASH USED IN OPERATING ACTIVITIES (2,472) (19,556)
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,332) (1,117)
Decrease/(increase) in investments 1,001 (20,869)
------------------ -------------------
NET CASH USED IN INVESTING ACTIVITIES (331) (21,986)
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 2,015 13,931
Principal payments of long-term debt (846) (999)
Payment of capital lease obligations (105) (167)
Net proceeds from the issuance of Senior Subordinated Convertible
Notes ---- 40,442
------------------ -------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,064 53,207
------------------ -------------------
NET INCREASE /(DECREASE) IN CASH AND CASH EQUIVALENTS (1,739) 11,665
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 10,219 20,669
------------------ -------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,480 $ 32,334
------------------ -------------------
------------------ -------------------
</TABLE>
(See accompanying notes.)
4
<PAGE>
CYGNUS, INC.
March 31, 1999
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of Cygnus, Inc. (the
"Company" or "Cygnus") as of and for the three month periods ended March 31,
1999 and 1998 included herein are unaudited, but include all adjustments
(consisting only of normal recurring adjustments) which the management of
Cygnus, Inc. believes necessary for a fair presentation of the financial
position as of the reported dates and the results of operations for the
respective periods presented. Interim financial results are not necessarily
indicative of results for a full year. The consolidated financial statements
should be read in conjunction with the audited financial statements and related
notes for the year ended December 31, 1998 included in the Company's 1998 Annual
Report on Form 10-K.
2. NET LOSS PER SHARE
Basic and diluted net loss per share is computed using the weighted
average number of shares of Common Stock outstanding. Shares issuable from stock
options and warrants outstanding are excluded from the diluted earnings per
share computation, as their effect is anti-dilutive.
3. COMPREHENSIVE INCOME
Comprehensive income includes all changes in stockholders' equity during a
period except those resulting from investments by owners and distributions to
owners. Statement of Financial Accounting Standard No. 130, "Reporting
Comprehensive Income" ("SFAS 130") which was adopted by the Company on January
1, 1998, requires unrealized gains and losses on Company's available-for-sale
securities to be included in other comprehensive income or loss. Unrealized
gains or losses for the three months periods ended March 31, 1999 and March 31,
1998 were not material and total comprehensive loss closely approximated net
loss for each of these periods.
4. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). FAS 133 requires all derivatives to be
recorded on the balance sheet at fair value and establishes special accounting
rules for different types of hedges. Adoption of this statement is required in
the year ending December 31, 2000 and is not expected to have a material impact
on the Company's results of operations or financial condition.
5. INVENTORIES
Net inventories of $771 as of December 31, 1998 consisted of raw materials
related to the Company's estrogen transdermal product (FemPatch-R- system
[Warner-Lambert Company, Morris Plains, NJ]) and were stated at the lower of
cost (first-in, first-out method) or market, after
5
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CYGNUS, INC.
March 31, 1999
appropriate consideration was given to obsolescence and inventories in excess
of anticipated future demand.
Due to the termination of the Supply Agreement between Warner-Lambert
Company ("Warner-Lambert") and the Company, all related inventory was sold or
written off against prior reserves during the three months ended March 31, 1999.
6. SENIOR SUBORDINATED CONVERTIBLE NOTES
In February 1998, the Company entered into Note Purchase Agreements
with certain institutional investors to issue and sell approximately $43 million
of 4% Senior Subordinated Convertible Notes due in 2005 (the "Notes"). On
October 28, 1998, the Company restructured the Notes. Key provisions in the
restructured Notes included the October 1998 repayment of $18.5 million in
principal (reducing the principal balance from $43 million to $24.5 million), a
delay in the convertibility of the majority of the Notes to June 30, 1999 or
after, modification of conversion prices of the Notes, the ability of the
Company to redeem at par at any time all or part of the new principal amount of
the Notes, an increase in the interest rate to 5.5% paid annually on the new
principal balance and the change in the final maturity of the Notes to October
1, 2000.
Under the terms of the restructured Notes, all of the remaining $24.5
million principal amount of the Notes is redeemable by the Company at par,
including accrued interest. $18.5 million of the Notes will not be convertible
into Common Stock by the Note Holders until June 30, 1999. The restructured
Notes were divided into three tranches. The first tranche had an original
principal amount of $6 million and was convertible in whole or in part into
Common Stock at any time, at a price that was fixed until June 30, 1999 ($3.54),
and was subject to a potential upward adjustment on February 1, 1999 based on
certain market formulas. As of December 31, 1998, $1.9 million of the first
tranche had been converted into Common Stock. The balance of the first tranche
was fully converted in January 1999. The second tranche also has an original
principal amount of $6 million and cannot be converted into Common Stock until
June 30, 1999, at which time it becomes convertible in whole or in part. On June
30, 1999, the conversion price of the second tranche will be $6.89, which was
established on February 1, 1999, based on the average of closing bid prices
using a fifteen-trading-day look-back from February 1, 1999. Subsequent to June
30, 1999, the conversion price of the second tranche will be determined based on
other market formulas containing certain look-back provisions. The third tranche
of the restructured Notes has an original principal amount of $12.5 million and
cannot be converted into Common Stock until July 1, 1999 at a conversion price
that will be determined based on market-based pricing formulas which contain
look-back provisions. Beginning July 1, 1999, no more than 15% of the second and
third tranches may be converted per calendar month at conversion prices which
reflect market-based formulas. Such formulas contain components based on various
averages of closing bid prices and low trading prices during fifteen or ten, as
the case may be, trading days look-back periods from various dates. Any portions
of the 15% monthly amounts of the second and third tranches that are not
converted in the relevant month may be rolled over for conversion in future
months. If the Company had called the second tranche of Notes ($6 million) for
redemption before February 1, 1999, the Note Holders would have been entitled to
convert not more than 50% of such Notes called before the redemption occurs. The
Company made no such call prior to February 1, 1999. If the Company calls the
third tranche of Notes ($12.5 million) for redemption before July 1, 1999, the
Note Holders will not be entitled to convert any portion of such tranche so
called. The Note Holders will
6
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CYGNUS, INC.
March 31, 1999
otherwise be entitled to convert Notes called for redemption before the
redemption occurs, at conversion prices based on market formulas.
The terms of the restructured Notes contained beneficial conversion
features relative to the first tranche, which resulted in a non-cash charge to
earnings of $4.2 million. Future tranches of the restructured Notes may also
have similar beneficial conversion features. Such beneficial features, if any,
are contingent upon future events, including timing of conversion and market
prices at the time of conversion, and accordingly the Company is not able to
estimate any potential charges at this time.
7. BUSINESS SEGMENTS
The Company operates in two business segments: diagnostics and drug
delivery. Both segments are engaged in development and manufacture, utilizing
proprietary technologies to satisfy unmet medical needs cost-effectively. The
segments are strategic business units managed separately based on the
differences in the technologies of their respective product lines.
The diagnostics division's efforts are primarily focused on an
automatic and continuous glucose monitoring device, the GlucoWatch-R- automatic
glucose monitor. The GlucoWatch-R- monitor is designed to take frequent
measurements, thus providing an abundance of glucose data to potentially better
control fluctuating glucose levels. The Company believes its proprietary
extraction and sensing technologies provide the potential to develop unique
products for glucose monitoring which could lead to improved treatment for
people with diabetes.
The drug delivery division's efforts are focused primarily on
transdermal drug delivery systems, which provide for the controlled release of
drugs directly into the bloodstream through intact skin. Cygnus' transdermal
technology is based on the objective of making transdermal products less
irritating, more comfortable and longer to wear for the patient. The Company has
received United States Food and Drug Administration ("FDA") approval for two
products and has a number of others in late-stage development, including two
hormone replacement therapy products and a contraceptive product.
There are no reconciling items between total segment revenues and
profit and loss and consolidated results. The Company utilizes the following
information for the purpose of making decisions and assessing segment
performance.
<TABLE>
<CAPTION>
BUSINESS SEGMENTS
------------------------------------------------------
MARCH 31, 1999 DIAGNOSTICS DRUG DELIVERY CORPORATE TOTAL
-------------- ----------- ------------- ---------------
<S> <C> <C> <C>
Revenue $ ---- $ 2,921 $ 2,921
Profit/(loss) $ (6,817) $ 1 $ (6,816)
Identifiable assets $ 33,517 $ 3,347 $ 36,864
MARCH 31, 1998
--------------
Revenue $ 305 $ 3,155 $ 3,460
Profit/(loss) $ (5,847) $ 309 $ (5,538)
Identifiable assets $ 78,760 $ 5,586 $ 84,346
</TABLE>
7
<PAGE>
CYGNUS, INC.
March 31, 1999
There has been no significant change from December 31, 1998 in the
basis of measurement of segment revenues and profit or loss or identifiable
assets.
All segmental revenues have been generated in the U.S. and the Company
currently does not have any long-lived assets outside the U.S.
8. SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale are carried at fair value, based on
quoted market prices, and the unrealized gains and losses have been combined
with the accumulated deficit due to immateriality. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in investment income.
The Company considers all highly liquid investments with a maturity
from the date of purchase of three months or less to be cash equivalents. The
Company invests its excess (to current demands) cash in short-term and long-term
high credit quality, highly liquid instruments. These investments have included,
but are not limited to, Treasury Notes, Federal Agency Securities, Auction Rate
Certificates, Auction Rate Preferred Stock, and Commercial Paper.
8
<PAGE>
CYGNUS, INC.
March 31, 1999
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS, INCLUDING
BUT NOT LIMITED TO THOSE SPECIFICALLY IDENTIFIED AS SUCH, THAT INVOLVE RISKS AND
UNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-Q THAT ARE NOT
PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT, INCLUDING WITHOUT
LIMITATION STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS
OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN
THIS REPORT ON FORM 10-Q ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON
THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH
FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY
FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF A
NUMBER OF FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH IN THE "RISK
FACTORS" CONTAINED IN THE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS AND ELSEWHERE IN THIS REPORT ON FORM 10-Q.
GENERAL
Cygnus, Inc. ("Cygnus" or the "Company") is engaged in the development
and manufacture of diagnostic and drug delivery systems, utilizing its
proprietary technologies to satisfy unmet medical needs cost-effectively. The
Company's current efforts are primarily focused on two core areas: an automatic
and continuous glucose monitoring device (the GlucoWatch-R- monitor) and
transdermal drug delivery systems.
The Company's product development efforts have been and are expected to
continue to be either self-funded, funded by licensees or distributors, or both.
In general, the Company's agreements provide that Cygnus will manufacture its
products and receive manufacturing revenues from sales of these products to its
licensees or distributors. Cygnus may also receive royalties based on certain of
its licensees' or distributors' product sales. In certain circumstances, the
Company may elect to license manufacturing rights for a product to its licensee
in exchange for a technology transfer fee and/or a higher royalty rate.
Cygnus' licensees and distributors generally have the right to abandon
a product development effort at any time for any reason without significant
penalty. Such cancellations may result in delays, suspension or abandonment of
clinical testing, the preparation and processing of regulatory filings and
product development and commercialization efforts. Licensees have exercised this
right in the past, and there can be no assurance that current and future
licensees or distributors will not exercise this right in the future. If a
licensee or distributor were to cease funding one of the Company's products,
Cygnus would either self-fund development efforts, identify and enter into an
agreement with an alternative licensee or distributor or suspend further
development work on the product. There can be no assurance that, if necessary,
the Company would be able to negotiate an agreement with an alternative licensee
or distributor on acceptable terms. Since all payments to the Company under its
agreements following their execution are contingent on the occurrence of future
events or sales levels, and the agreements are terminable by the licensee or
distributor, no assurance can be given as to whether the Company will receive
any particular payment thereunder or as to the amount or timing of any such
payment. The Company may choose to self-fund certain research and development
projects in order to exploit its
9
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CYGNUS, INC.
March 31, 1999
technologies. Any increase in Company-sponsored research and development
activities will have an immediate adverse effect on the Company's results of
operations. However, should such Company-sponsored research and development
activities result in a commercial product, the long-term effect on the
Company's results of operations could be favorable. In the past some of the
Company's licensees, distributors and collaborators have approached the
Company requesting modification of the terms of existing agreements. The
Company is currently involved in discussions with several companies with
regard to a collaboration for the marketing and distribution of the
GlucoWatch-R- monitor in the U.S., Europe and those territories not included
in the agreement between the Company and Tokyo-based Yamanouchi
Pharmaceutical Co., Ltd. ("Yamanouchi"). (For more on the Yamanouchi
agreement see "Contract Revenue," under Results of Operations.) There can be
no assurance that the Company will be able to enter into new collaborative
arrangements.
For the Company to remain competitive, it will need to develop,
in-license or acquire new diagnostic and drug delivery products. Furthermore,
the Company's ability to develop and commercialize products in the future will
depend on its ability to enter into collaborative arrangements with additional
licensees on favorable terms. There can be no assurance that the Company will be
able to enter into new collaborative arrangements on such terms, if at all.
The Company's results of operations vary significantly from year to
year and depend on, among other factors, the signing of new product development
agreements and the timing of recognizing payment amounts specified thereunder,
the timing of recognizing license or distribution fees and cost reimbursement
payments made by pharmaceutical licensees, and the demand for its products.
Up-front and interim milestone payments from contracts are generally earned and
recognized based on the percentage of actual efforts expended compared to total
expected efforts during the development period for each contract. However,
contract revenues are not always aligned with the timing of related expenses. To
date, research and development expenses have generally exceeded contract revenue
in any particular period and the Company expects the same situation to continue
for the next few years. In addition, the level of revenues in any given period
is not necessarily indicative of expected revenues in future periods. The
Company has incurred net losses each year since its inception and does not
believe it will achieve profitability in 1999. At March 31, 1999, the Company's
accumulated deficit and net capital deficiency were approximately $182.8 million
and $32.2 million, respectively.
10
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CYGNUS, INC.
March 31, 1999
RESULTS OF OPERATIONS:
COMPARISON FOR THE QUARTERS ENDED MARCH 31, 1999 AND 1998
PRODUCT REVENUES for the quarter ended March 31, 1999 were $0.0
million, compared to $0.5 million for the quarter ended March 31, 1998. Product
revenue for the three months ended March 31, 1998 resulted from the shipments of
the FemPatch-R- system. The reduction in total product revenue is due to the
discontinuation of shipments of the FemPatch-R- system.
The FemPatch-R- system, commercially launched in 1997, is a low-dose,
7-day estrogen replacement transdermal patch for the treatment of menopausal
symptoms. Sanofi S.A. ("Sanofi"), the Company's worldwide licensee, had
sublicensed U.S. marketing rights to Warner-Lambert. In November 1998,
Warner-Lambert terminated its agreement with Sanofi, which also terminated the
Supply Agreement between Warner-Lambert and the Company. As a result of the
termination of the FemPatch-R- system supply agreement, the Company does not
expect any further product revenues until new products are commercialized.
Due to the above factors and the uncertainty regarding when and if
additional products will obtain approval from the FDA and when and if licensees
will sell and market such products, the Company believes that the level of
product revenues experienced to date is not indicative of future results and may
fluctuate from period to period.
CONTRACT REVENUES for the quarter ended March 31, 1999 were $2.6
million, compared to $2.7 million for the quarter ended March 31, 1998. Contract
revenues primarily reflect labor and material cost reimbursements associated
with the development of certain transdermal delivery systems and the
amortization of milestone payments relating to certain transdermal delivery
systems and the glucose monitoring device.
The Company is currently involved in discussions with several companies
with regard to a collaboration for the marketing and distribution of the
GlucoWatch-R- monitor in the U.S., Europe and those territories not included in
the agreement between the Company and Yamanouchi as described below. There can
be no assurance that the Company will be able to enter into new collaborative
arrangements.
In July 1996, the Company entered into an agreement with Tokyo-based
Yamanouchi Pharmaceutical Co., Ltd. ("Yamanouchi") for the marketing and
distribution of the GlucoWatch-R- monitor. Under the terms of this agreement,
Yamanouchi has exclusive marketing and distribution rights in Japan and Korea.
Cygnus will have primary responsibility for completing product development and
for manufacturing. In the third quarter of 1996, Cygnus received an up-front,
non-refundable payment from Yamanouchi and is eligible to receive milestone
payments as well as a percentage of the product's future commercial sales.
In 1998, the Company entered into an agreement with an undisclosed
company for the development, supply and commercialization of a nicotine
transdermal system, a smoking cessation patch being developed by Cygnus. Under
the terms of the agreement, the undisclosed company has marketing and
distribution rights in certain territories. Cygnus has exclusive manufacturing
and supply rights. The undisclosed company has primary responsibility for
obtaining regulatory
11
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CYGNUS, INC.
March 31, 1999
approval and commercialization. Cygnus has received payment for 1998
manufacturing and development costs and will receive similar future payments.
The Company is also eligible to receive future milestone payments, as well as
a percentage of the product's future commercial success.
In December 1998, a New Drug Application ("NDA") was submitted to the
FDA and the European Dossier has been submitted to the European authorities for
the Company's 7-day estrogen patch. In July 1998, the Company was notified by
American Home Products Corporation ("AHP"), the licensee for two of the
Company's transdermal hormone replacement therapy products, including the 7-day
estrogen patch, that AHP wanted to discuss the status of its agreement with the
Company. Cygnus was notified by AHP that it intended to exercise its right under
the agreement to seek a sublicensee for these products and is now actively
involved in doing so. On November 17, 1998, AHP and Cygnus signed an amendment
to the agreement that provides Cygnus ownership of the regulatory filing
packages for the two products and the right to co-promote the two products as
well. The amendment also provides that if AHP is unable to sign an agreement
with a sublicensee within six months, the rights to the two products will revert
to Cygnus, and AHP will be obligated to continue development activities for the
two products for an additional six months. There can be no assurance that AHP
will find a sublicensee. Furthermore, if AHP is unsuccessful in finding a
sublicensee, it is uncertain what course of action the Company will take with
regard to these two products, although it is expected the Company will seek a
new collaboration for the distribution and marketing of the products.
Contract revenues are expected to fluctuate from quarter to quarter and
from year to year, and future contract revenues cannot be reasonably predicted.
The contributing factors to achieving contract revenues include, but are not
limited to, future successes in finalizing new collaborative agreements, timely
achievement of milestones under current contracts, and strategic decisions on
self-funding certain projects. The Company is unable to predict to what extent
the termination of existing contracts by current partners, or new collaborative
agreements, if any, will impact overall contract revenues in the remainder of
1999 and subsequent future periods.
ROYALTY AND OTHER REVENUES for the quarter ended March 31, 1999 were
$0.4 million, compared to $0.2 million for the quarter ended March 31, 1998. The
amounts include royalties from worldwide sales by Pharmacia & Upjohn
("Pharmacia") of the Company's nicotine transdermal product.
Royalty revenue will fluctuate from period to period, since it is
primarily based upon sales by the Company's licensees. The level of royalty
income for a product also depends on various external factors, including the
size of the market for the product, product pricing levels and the ability of
the Company's licensee to market the product. Therefore, the level of royalty
revenue for any given period is not indicative of the expected royalty revenue
for future periods.
COSTS OF PRODUCTS SOLD for the quarter ended March 31, 1999 were $0.0
million, compared to $1.0 million for the quarter ended March 31, 1998. Costs of
products sold primarily include direct and indirect production, facility and
personnel costs required to meet future anticipated production levels. The
decrease in costs of products sold for the quarter ended March 31, 1999 is
primarily due to the discontinuation of shipments of the FemPatch-R- system as a
result of the termination of the FemPatch-R- system supply agreement. Costs of
products sold for the quarter ended
12
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CYGNUS, INC.
March 31, 1999
March 31, 1998 include shipments of the FemPatch-R- system. The Company had
no product revenue or cost of products sold for the quarter ended March 31,
1999 as a result of the aforementioned and experienced negative production
margins for the quarter ended March 31, 1998 due to low production volumes
that prevented the Company from absorbing all of its fixed manufacturing
costs.
RESEARCH AND DEVELOPMENT EXPENSES for the quarter ended March 31, 1999
were $7.9 million, compared to $6.1 million for the quarter ended March 31,
1998. The increase in research and development expenses for the quarter ended
March 31, 1999 is primarily due to the increased costs associated with the
GlucoWatch-R- monitor and the AutoSensor (a consumable component which is
attached to the back of the GlucoWatch-R- monitor) in the following areas:
material, design and scale up for development efforts, and material and
outside charges for the accelerated level of clinical activities. Research
and development and clinical activities primarily include support and
development for the glucose monitoring program, the Company's hormone
replacement therapy products and a contraceptive product.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES for the quarter ended March
31, 1999 were $1.5 million, compared to $1.9 million for the quarter ended March
31, 1998. The decrease is primarily due to reduced legal and compensation
expenses.
INTEREST INCOME (EXPENSE). The Company incurred net interest expense of
$(0.4) million for the quarter ended March 31, 1999, compared to $0.0 million
for the quarter ended March 31, 1998. The increase in net interest expense is
due primarily to the interest expense associated with the Senior Subordinated
Convertible Notes, the amortization of the financing fees related to these Notes
and the interest related to the additional long-term debt incurred in the second
quarter of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Through December 1998, the Company received net proceeds of
approximately $95.4 million from public offerings of its Common Stock.
Through 1997, the Company financed approximately $9.7 million of
manufacturing and research equipment under capital loan and lease arrangements.
In the second quarter of 1998, the Company entered into a new loan agreement for
$1.4 million to finance additional capital equipment. Borrowings under this
agreement are secured by specific Company assets.
In April of 1998, the Company consolidated its two outstanding bank
loans into an expanded credit facility with the same bank. An additional $4.7
million was borrowed, increasing the total outstanding under the new agreement
to $10.0 million. In November of 1998, the April agreement was further amended
to modify the covenants. This balance will be repaid through November 2001, with
monthly interest-only payments through November 1998 and monthly
principal-and-interest installments thereafter. As of March 31, 1999 there was
$9.2 million outstanding under this agreement. Borrowings under this agreement
are secured by specific Company assets.
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CYGNUS, INC.
March 31, 1999
In February 1998, the Company entered into Note Purchase Agreements
with certain institutional investors to issue and sell approximately $43 million
of 4% Senior Subordinated Convertible Notes due 2005 (the "Notes"). On October
28, 1998, the Company restructured the Notes. Key provisions in the restructured
Notes include the October 1998 repayment of $18.5 million in principal (reducing
the principal balance from $43 million to $24.5 million), a delay in the
convertibility of the majority of the Notes to June 30, 1999, modification of
conversion prices of the Notes, the ability of the Company to redeem at par at
any time all or part of the new principal amount of the Notes, an increase in
the interest rate to 5.5% paid annually on the new principal balance and the
change in the final maturity of the Notes to October 1, 2000 (see "Senior
Subordinated Convertible Notes" Part 1, Note 6). Through December 31, 1998, $1.9
million of the first tranche of $6.0 million was converted into equity. In
January 1999, the remaining balance of $4.1 million of the original first
tranche of $6.0 million was converted into equity.
In addition to the cash received from the public offerings, issuance of
the Notes, equipment lease and short-term working capital financing, the Company
has been financing its operations primarily through revenues and interest
income.
Net cash used in operating activities for the quarter ended
March 31, 1999 was $2.5 million, compared with net cash used of $19.6 million
for quarter ended March 31, 1998. Cash used in operating activities during the
quarter ended March 31, 1999 was primarily due to the Company's net loss of $6.8
million and a decrease in deferred compensation and other long term liabilities
of $4.1 million, offset by a decrease in deferred compensation, notes
receivable, prepaid expenses and other assets of $4.1 million and in inventories
of $0.8 and an increase in accounts payable and other liabilities of $2.0
million and in deferred revenue of $1.3 million. Net cash used in operating
activities during the quarter ended March 31, 1998 was primarily due to a $14.0
million cash payment made in January 1998 to Sanofi, under the terms of the
settlement, and the Company's net loss of $5.5 million.
The current level of cash used in operating activities is not
necessarily indicative of the level of future cash usage. The Company expects a
decrease in operating cash usage for 1999 primarily because the $14.0 million
payment in 1998 of the Sanofi arbitration liability will not recur in 1999.
Net cash used in investing activities of $0.3 million for the quarter
ended March 31, 1999 resulted primarily from net maturity and sales of
investments of $1.0 million and capital expenditures of $1.3 million. Net cash
used in investing activities of $22.0 million for the quarter ended March 31,
1998 resulted primarily from net purchases of investments of $20.9 million and
capital expenditures of $1.1 million.
Net cash provided by financing activities of $1.1 million for the
quarter ended March 31, 1999 includes additional stock proceeds of $2.0 million,
offset by long-term debt and capital lease repayments of $0.8 million and $0.1
million, respectively. Net cash provided by financing activities of $53.2
million for the quarter ended March 31, 1998 includes net proceeds of $40.4
million and $13.3 million from the Company's February 1998 issuance of Senior
Subordinated Convertible Notes and from a direct public offering of its Common
Stock, respectively, and additional stock proceeds of $0.5 million, offset by
long-term debt and capital lease repayments of $1.0 million and $0.2 million,
respectively.
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CYGNUS, INC.
March 31, 1999
The Company's long-term capital expenditure requirements will depend
upon numerous factors, including the progress of the Company's research and
development programs; the time required to obtain regulatory approvals; the
resources that the Company devotes to the development of self-funded products,
proprietary manufacturing methods and advanced technologies; the ability of the
Company to obtain additional licensing arrangements and to manufacture products
under those arrangements; the additional expenditures to support the manufacture
of new products, if and when approved; and possible acquisitions of products,
technologies and companies. As the Company evaluates the progress of its
development projects, in particular the GlucoWatch-R- monitor, its
commercialization plans and the lead time to set up manufacturing capabilities,
Cygnus may commence long-term planning for another manufacturing site.
Nevertheless, the Company believes that such long-term planning will not result
in any material impact on cash flows and liquidity for 1999.
Based upon current expectations for operating losses and projected
short-term capital expenditures, the Company believes that its existing cash,
cash equivalents and investments of $26.0 million as of March 31, 1999 -- when
coupled with cash from revenues and other funding, such as from potential
product funding collaborations or from public financings (including debt or
equity financings) and earnings from investments -- will be sufficient to meet
its operating expenses, debt servicing and repayments and capital expenditure
requirements at least through March 31, 2000. However, there can be no assurance
that the Company will not require additional financing, depending upon future
business strategies, results of clinical trials and management decisions to
accelerate certain research and development programs and other factors.
YEAR 2000 COMPLIANCE
The Company is preparing for the impact of the arrival of the Year 2000
("Y2K") on its business, as well as on the businesses of its customers,
suppliers and business partners. The "Y2K Issue" is a term used to describe the
problems created by systems that are unable to accurately interpret dates after
December 31, 1999. These problems are derived predominantly from the fact that
many software programs have historically categorized the "year" in a two-digit
format. The Y2K Issue creates potential risks for the Company, including
potential problems in the Company's products as well as in the Information
Technology ("IT") and non-IT systems that the Company uses in its business
operations. The Company may also be exposed to risks from third parties with
whom the Company interacts who fail to adequately address their own Y2K Issues.
The Company began its Y2K efforts early in 1998 by forming a Project
office chaired by the Company's Senior Vice President of Finance. The Board of
Directors is advised periodically on the status of the Company's Y2K compliance
program.
The project team developed a five-phase approach to identifying and
remediating Y2K Issues. These phases are:
1. Awareness
2. Inventory
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CYGNUS, INC.
March 31, 1999
3. Assessment
4. Correction and Testing
5. Implementation
The Company completed the awareness phase of the project in the third
quarter of 1998. This phase consisted of meetings with Company personnel
educating them on the issues related to Y2K. The meetings focused on internal
systems, both IT and non-IT, as well as external systems and relationships.
The Company engaged the services of an outside Y2K consulting service
to perform a comprehensive inventory of internal IT and non-IT systems and
applications. The inventory was completed during the fourth quarter of 1998.
Concurrent with the inventory, the Company's consultant performed an
assessment of the systems and applications documented in the inventory. The
result of this independent assessment showed that the majority of the Company's
internal IT systems were compliant. This is due to the fact that the Company
does not rely on in-house developed applications for its core business
applications and therefore does not have legacy code to review and test. The
Company's core business applications (Accounts Payable, Accounts Receivable,
Sales Orders, and Inventory Control) are supported by an application that has
been certified by the supplier to be fully Y2K compliant and the compliance has
been tested by the Company. The assessment did determine that the payroll
application in use was non-compliant. This was upgraded to a compliant version
in the first quarter of 1999.
Due to the regulatory requirements placed on the pharmaceutical and
medical device industry by the FDA, the Company has placed appropriate attention
on the non-IT systems. For the Company, this specifically covers all areas
governed by current Good Manufacturing Practice ("cGMP") guidelines and include
but are not limited to environmental monitoring/control systems, laboratory
instrumentation and their sub-systems, production equipment, and materials
handling equipment. The assessment identified several of these non-IT systems to
be non-compliant. The majority of these non-compliant systems are laboratory
instrumentation and their sub-systems. These systems are assessed to be
non-mission critical. The Company fully expects that these systems will be
upgraded or replaced or have a contingency plan in place by January 1, 2000.
Concurrent with the inventory and assessment of internal systems and
applications, the Company identified several providers of products and services
that are critical to its operations. The Company is working with these providers
to ensure that these critical products and services are available for continued
operations after January 1, 2000. At this time the Company is not aware of any
issues relating to these providers.
The correction and testing, as well as the implementation, phases of
the Company's Y2K compliance program are currently underway and are expected to
be completed prior to January 1, 2000.
The total cost associated with the Company's Y2K remediation is not
expected to be material to the Company's financial condition or results of
operations. The estimated total cost of
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CYGNUS, INC.
March 31, 1999
the Company's Year 2000 remediation is not expected to exceed $500,000.
Through March 31, 1999 the Company has spent approximately $100,000 in
connection with Y2K Issues. The cost of implementing the replacement for the
Company's core business applications has not been included in this figure
since the replacement of the previous applications was not accelerated due to
Y2K Issues. All Y2K expenditures are made from the respective departments'
budgets.
Although the Company assesses its Y2K issue to be moderate to low,
there can be no assurance that the Company will be completely successful in its
efforts to address Y2K Issues.
Having reasonably determined that the Company's own hardware and
software systems will be substantially Y2K compliant, management believes that
the worst case scenarios would most likely involve simultaneous Y2K-related
disruptions from the Company's key customers, suppliers, service providers
and/or other business partners. For these worst case scenarios to have maximum
adverse impact on the Company, either the vendors in question would need to be
sole-source providers, or their peer companies, who would otherwise be potential
second-source suppliers, would also need to undergo similar Y2K-related
disruption. The Company believes that such simultaneous disruptions of the
supply of basic goods and services due to Y2K-related issues are unlikely to
occur.
Although the Company has not yet developed a comprehensive contingency
plan to address situations that may result if the Company or any of the third
parties upon which the Company is dependent is unable to achieve Y2K readiness,
the Company's Y2K compliance program is ongoing and its ultimate scope, as well
as the consideration of contingency plans, will continue to be evaluated as new
information becomes available.
The foregoing Y2K discussion contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs and the dates by
which the Company expects to complete certain actions, are based on management's
best current estimates, which were derived utilizing numerous assumptions about
future events, including the continued availability of certain resources,
representations received from third parties and other factors. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to, the ability to
identify and remediate all relevant IT and non-IT systems, results of Year 2000
testing, adequate resolution of Y2K Issues by businesses and other third parties
who are service providers, suppliers or customers of the Company, unanticipated
system costs, the adequacy of and ability to develop and implement contingency
plans and similar uncertainties. The "forward-looking statements" made in the
foregoing Y2K discussion speak only as of the date on which such statements are
made, and the Company undertakes no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made or to reflect the occurrence of unanticipated events.
RISK FACTORS
CYGNUS WISHES TO CAUTION STOCKHOLDERS AND INVESTORS THAT THE FOLLOWING
IMPORTANT FACTORS, AMONG OTHERS, IN SOME CASES HAVE AFFECTED, AND IN THE FUTURE
COULD AFFECT, CYGNUS' ACTUAL RESULTS AND COULD CAUSE CYGNUS' ACTUAL CONSOLIDATED
RESULTS FOR 1999, AND BEYOND, TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN ANY
FORWARD-LOOKING
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CYGNUS, INC.
March 31, 1999
STATEMENTS MADE BY OR ON BEHALF OF CYGNUS. THE STATEMENTS UNDER THIS CAPTION
ARE INTENDED TO SERVE AS CAUTIONARY STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE FOLLOWING INFORMATION
IS NOT INTENDED TO LIMIT IN ANY WAY THE CHARACTERIZATION OF OTHER STATEMENTS
OR INFORMATION UNDER OTHER CAPTIONS AS CAUTIONARY STATEMENTS FOR SUCH PURPOSE.
HISTORY OF OPERATING LOSSES; FUTURE CAPITAL REQUIREMENTS
The Company has a limited operating history upon which its prospects
can be evaluated. Such prospects must be considered in light of the substantial
risks, expenses and difficulties encountered by entrants into the medical device
and drug delivery industry. The Company reported a net loss of $6.8 million for
the first quarter of 1999 and has experienced annual operating losses since
inception. The Company expects to continue to incur operating losses at least
until significant sales, if any, of the GlucoWatch-R- monitor or the
contraceptive patch (which is in phase III clinical trials and is currently in
development with Ortho-McNeil Pharmaceutical, Inc. ("Ortho"), a subsidiary of
Johnson & Johnson) commence. There can be no assurance that the Company will
generate significant revenues or achieve profitability. The Company has, and
expects to have, fluctuations in quarterly results based on recognition of
collaborative and contract revenues and expenses. Some of these fluctuations
could be significant.
To date the Company has generated limited revenues from product sales
and does not have significant experience in manufacturing, marketing or selling
its products. There can be no assurance that the Company's future development
efforts will result in commercially viable products, that the Company will be
successful in introducing its products, or that required regulatory clearances
or approvals will be obtained in a timely manner, or at all. There can be no
assurance that the Company's products will ever gain market acceptance or that
the Company will continue to generate revenues or achieve profitability.
The Company's revenues to date have been derived primarily from product
development and licensing fees related to its products under development, as
well as from manufacturing and royalty revenues from the Nicotrol-R- (Pharmacia
AB, Stockholm, Sweden) nicotine patch and the FemPatch-R- system. The Company
will no longer receive manufacturing revenue from the Nicotrol-R- patch or the
FemPatch-R- system. The Company will, however, continue to receive royalty
payments for the Nicotrol-R- patch. The Company expects that a substantial
portion of its future revenues will be derived, if regulatory approvals are
obtained, from sales of the GlucoWatch-R- monitor and other products currently
under development.
The continued development of the Company's products will require the
commitment of substantial resources to conduct the research, preclinical
development and clinical trials necessary to bring such products to market and
to establish production and marketing capabilities. The Company may seek
additional funding through public or private financings, including debt or
equity financings, and through other arrangements, including collaborative
arrangements. Any additional equity financings may be dilutive to stockholders
and debt financing, if available, may involve restrictions on dividends and
other restrictions on the Company. Adequate funds, whether through financial
markets or collaborative or other arrangements with corporate partners or from
other sources, may not be available when needed or, if available, on terms
acceptable to the Company. Lack of sufficient additional funds may require the
Company to delay, scale back or eliminate some or all of its research and
product development programs or to license others to commercialize products or
technologies that the Company would otherwise seek to develop itself.
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CYGNUS, INC.
March 31, 1999
The Company believes that its existing cash, cash equivalents and
investments -- when coupled with cash from revenues and other funding, such as
from potential product funding collaborations or from public financings
(including debt or equity financings) and earnings from investments -- will be
sufficient to meet its operating expenses, debt servicing and repayments and
capital expenditure requirements at least through March 31, 2000. The amounts
and timing of expenditures will depend on the progress of ongoing research and
development, the results of preclinical testing and clinical trials, the rate at
which operating losses are incurred, the execution of any development and
licensing agreements with corporate partners, the Company's development of
products, the FDA regulatory process and other factors, many of which are beyond
the Company's control.
DEPENDENCE ON LICENSEES, DISTRIBUTORS AND COLLABORATIVE ARRANGEMENTS
The Company's business strategy for the development, clinical testing,
regulatory approval, manufacturing and commercialization of its products
depends, in large part, upon the Company's ability to selectively enter into and
maintain collaborative arrangements with licensees and distributors. If the
GlucoWatch-R- monitor is commercialized, the Company will be dependent upon
Yamanouchi Pharmaceutical Co., Ltd. for marketing and distribution of the
GlucoWatch-R- monitor in Japan and Korea. The Company does not currently have
any marketing or distribution agreements for the GlucoWatch-R- monitor other
than the Yamanouchi collaboration. However, the Company is currently involved in
discussions with several companies with regard to a collaboration for the
marketing and distribution of the GlucoWatch-R- monitor in the U.S., Europe and
those territories not included in the agreement between the Company and
Yamanouchi as described above. The Company's licensees and distributors
generally have the right to terminate a product development effort at any time
prior to regulatory approval for any reason without significant penalty. Such
cancellations may result in delays, suspension or abandonment of clinical
testing, the preparation and processing of regulatory filings and product
development and commercialization efforts. Licensees have exercised this right
in the past, and there can be no assurance that current and future licensees or
distributors will not exercise this right in the future.
Since all payments to the Company under its licensing and distribution
agreements following their execution are contingent on the occurrence of future
events or sales levels, and the agreements are terminable by the licensee or
distributor, no assurance can be given as to whether the Company will receive
any particular payment thereunder or as to the amount or timing of any such
payment. In the past some of the Company's licensees, distributors and
collaborators have approached the Company requesting modification of the terms
of existing agreements. If a licensee or distributor were to cease funding one
of the Company's products, Cygnus would either self-fund development efforts,
identify and enter into an agreement with an alternative licensee or
distributor, or suspend further development work on the product. There can be no
assurance that, if necessary, the Company would be able to negotiate an
agreement with an alternative licensee or distributor on acceptable terms.
Additionally, the Company may choose to self-fund certain research and
development projects in order to exploit its technologies. However, should such
Company-sponsored research and development activities result in a commercial
product, the long-term effect on the Company's results of operations could be
favorable. Any increase in Company-sponsored research and development or sales
and marketing activities will have an immediate adverse effect on the Company's
results of operations.
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CYGNUS, INC.
March 31, 1999
Furthermore, the resources and attention a licensee or distributor
devotes to a product are not within the Company's control. As a result, there
may be delays in clinical testing, the preparation and processing of regulatory
filings and commercialization efforts conducted by the Company's licensees or
distributors. There can be no assurance that one or more of the Company's
licensees or distributors will not, for competitive reasons, support, directly
or indirectly, a company or product that competes with the Company's product
that is the subject of its license or distributor agreement with the Company.
Furthermore, any dispute between the Company and one of its licensees or
distributors might require the Company to initiate or defend against expensive
litigation or arbitration proceedings.
Any termination of any license or distributor arrangement by one of the
Company's licensees or distributors, any inability of a licensee or distributor
to fund or otherwise satisfy its obligations under its arrangements with the
Company and any significant dispute with or breach of a contractual commitment
by a licensee or distributor would likely require the Company to seek and reach
agreement with another licensee or distributor or to assume, to the extent
possible and at its own expense, all the responsibilities being undertaken by
the licensee or distributor. There can be no assurance that the Company would be
able to reach agreement with a replacement licensee or distributor. If the
Company were not able to find a replacement licensee or distributor, there can
be no assurance that the Company would be able to perform or fund the activities
for which such licensee or distributor is currently responsible. Even if the
Company were able to perform and fund these activities, the Company's capital
requirements would increase substantially. In addition, the further development
and the clinical testing, regulatory approval process, marketing, distribution
and sale of the product covered by such licensee or distributor would be
significantly delayed. (See "Risk Factors - Limited Marketing and Sales
Experience.")
For the Company to be competitive, it will need to develop, in-license
or acquire new diagnostic and drug delivery products. Furthermore, the Company's
ability to develop and commercialize products in the future will depend, in
part, on its ability to enter into collaborative arrangements with additional
licensees on favorable terms. There can be no assurance that the Company will be
able to enter into new collaborative arrangements on such terms, if at all.
Additionally, there can be no assurance that existing or future collaborative
arrangements will be successful.
Any of the foregoing circumstances could have a material adverse effect
upon the Company's business, financial condition, and results of operations.
DEPENDENCE ON LICENSED PATENT APPLICATIONS AND PROPRIETARY TECHNOLOGY
The Company's success depends in large part on its ability to obtain
patent protection for its products, preserve its trade secrets and operate
without infringing the proprietary rights of others, both in the U.S. and in
other countries. Patent applications in the U.S. are maintained in secrecy until
patents are issued, and since publication of discoveries in the scientific or
patent literature tends to lag behind actual discovery by several months, Cygnus
cannot be certain that it was the first to file patent applications on such
inventions or that it will not infringe third party patents once issued. No
assurance can be made that patents will be issued with respect to any of the
Company's patent applications or that any patents will provide competitive
advantages for its products or will
20
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CYGNUS, INC.
March 31, 1999
not be challenged or circumvented by competitors. Cygnus also relies on trade
secrets and proprietary know-how that it seeks to protect, in part, by
confidentiality agreements with its licensees, employees and consultants.
There can be no assurance that these agreements will not be breached, that
the Company would have adequate remedies for any breach or that the Company's
trade secrets will not otherwise become known or be independently developed
by its competitors.
Any litigation, in the U.S. or abroad, as well as foreign opposition
and/or domestic interference proceedings, could result in substantial expense to
the Company and significant diversion of effort by the Company's technical and
management personnel. Litigation may be necessary to enforce patents issued to
the Company or to protect trade secrets or know-how owned by the Company as well
at to defend against infringement charges. A negative determination in such
proceedings in which the Company is a party could subject the Company to
significant liabilities to third parties or require the Company to seek licenses
from third parties. Although patent and intellectual property disputes in the
pharmaceutical product area have often been settled through licensing or similar
arrangements, costs associated with such arrangements may be substantial and
could include ongoing royalties. Furthermore, there can be no assurance that
necessary licenses would be available to the Company on satisfactory terms, if
at all. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent the Company
from manufacturing and selling certain of its products, which would have a
material adverse effect on the Company.
HIGHLY LEVERAGED; ABILITY TO SERVICE DEBT
As of March 31, 1999, the Company had indebtedness of $54.3 million,
including a balance of $18.5 million remaining on its Notes. As of March 31,
1999, the first tranche of $6.0 million of the restructured Notes was converted
into equity. The degree to which the Company is leveraged could materially and
adversely affect the Company's ability to obtain financing for working capital,
acquisitions or other purposes and could make it more vulnerable to industry
downturns and competitive pressures. The Company's ability to meet its debt
service obligations will be dependent upon the Company's future performance,
which will be subject to financial, business and other factors affecting the
operations of the Company, many of which are beyond its control. Although the
Company believes its cash flows will be adequate to meet its interest payments,
there can be no assurance that the Company will continue to generate cash flows
in the future sufficient to cover its fixed charges or to permit the Company to
satisfy any redemption obligations pursuant to the Notes (see below). If the
Company is unable to generate cash flows in the future sufficient to cover its
fixed charges or to permit the Company to satisfy any redemption obligations
pursuant to the Notes, and the Company is unable to borrow sufficient funds
either under its credit facilities or from other sources, it may be required to
refinance all or a portion of its existing debt, to sell all or a portion of its
assets, or to sell equity securities. There can be no assurance that a
refinancing would be possible, nor can there be any assurance as to the timing
of any asset sales or sales of equity securities or the proceeds which the
Company could realize therefrom.
The Notes are subordinate in right of payment to all existing and
future Senior Debt (as defined in the First Supplemental Indenture). By reason
of such subordination of the Notes, in the event of insolvency, bankruptcy,
liquidation, reorganization, dissolution or winding up of the business of the
Company or upon default in payment with respect to any Senior Debt of the
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CYGNUS, INC.
March 31, 1999
Company or an event of default with respect to such indebtedness resulting in
the acceleration thereof, the assets of the Company will be available to pay the
amounts due on the Notes only after all Senior Debt of the Company has been paid
in full. Moreover, holders of Common Stock would only receive the assets
remaining , if any, after payment of all indebtedness and preferred stock.
The Notes are obligations exclusively of the Company. Although the
Company does not currently conduct operations through subsidiaries, it may elect
to do so as products become commercialized. In such event, the cash flow and the
consequent ability to service debt, including the Notes, of the Company will be
partially dependent upon the earnings of its subsidiaries and the distribution
of those earnings to, or upon loans or other payments of funds by those
subsidiaries to, the Company. The payment of dividends and the making of loans
and advances to the Company by its subsidiaries would be subject to statutory or
contractual restrictions, would be dependent upon the earnings of those
subsidiaries and would be subject to various business considerations. Any right
of the Company to receive assets of any of its subsidiaries upon their
liquidation or reorganization (and the consequent right of the holders of the
Notes [the "Holder(s)"] to participate in those assets) would be effectively
subordinated to the claims of that subsidiary's creditors (including trade
creditors), except to the extent that the Company is itself recognized as a
creditor of such subsidiary, in which case the claims of the Company would still
be subordinate to any security interests in the assets of such subsidiary and
any indebtedness of such subsidiary senior to that held by the Company. Under
certain circumstances, including the delisting of the Company's securities from
the Nasdaq National Market, each holder of Notes will have the right, at the
Holder's option, to require the Company to repurchase all or a portion of such
Holder's Notes at a purchase price equal to 110% of the principal amount thereof
plus accrued interest thereon to the repurchase date.
LIMITED MARKETING AND SALES EXPERIENCE
The Company has limited experience in marketing or selling medical
device products. In order to successfully market and sell the GlucoWatch-R-
monitor or the Company's other products under development, the Company must
either develop a more extensive marketing and sales force or enter into
arrangements with third parties to market and sell such products. There can be
no assurance that the Company will be able to successfully develop a more
extensive marketing and sales force or that it will be able to enter into
marketing and sales agreements with third parties on acceptable terms, if at
all. If the Company maintains its own marketing and sales capabilities, it will
compete with other companies that have experienced and well-funded marketing and
sales operations. If the Company enters into a marketing arrangement with a
third party for the marketing and sales of the Company's products, any revenues
to be received by the Company from such products will be dependent on the third
party, and the Company will likely be required to a pay a sales commission or
similar amount to such party.
PRODUCT LIABILITY
The design, development, manufacture and use of the Company's products
involve an inherent risk of product liability claims and associated adverse
publicity. Producers of medical products may face substantial liability for
damages in the event of product failure or if it is alleged that the product
caused harm. The Company currently maintains product liability insurance. Such
insurance is expensive and difficult to obtain and may not be available in the
future on acceptable
22
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CYGNUS, INC.
March 31, 1999
terms or at all. There can be no assurance that the Company will not be
subject to product liability claims, that the Company's current insurance
would cover such claims, or that adequate insurance will continue to be
available on acceptable terms to the Company in the future. In the event the
Company is held liable for damages in excess of the limits of its insurance
coverage, or if any claim or product recall results in significant adverse
publicity against the Company, the Company's business, financial condition
and results of operations could be materially and adversely affected.
ATTRACTING AND RETAINING KEY EMPLOYEES
The Company's ability to operate successfully and manage its potential
future growth depends in significant part upon the continued service of certain
key scientific, technical, managerial and financial personnel, and its ability
to attract and retain additional highly qualified scientific, technical,
managerial and financial personnel. The Company faces intense competition for
qualified personnel in these areas, many of whom are often subject to competing
employment offers, and there can be no assurance that the Company will be able
to attract and retain such personnel. The loss of key personnel or inability to
hire and retain additional qualified personnel in the future could have a
material adverse effect on the Company's business, financial condition and
results of operations.
VOLATILITY OF STOCK PRICE
The trading price of the Company's Common Stock is subject to
substantial fluctuations in response to factors such as announcements by the
Company or its competitors of results of regulatory approval filings or clinical
trials or testing, developments or disputes governing proprietary rights,
technological innovations or new commercial products, government regulatory
action, general conditions in the medical technology industry, changes in
securities analysts' recommendations, or other events or factors, many of which
are beyond the Company's control. In addition, the stock market in general has
experienced extreme price and volume fluctuations in recent years which have
particularly affected the market prices of many medical technology companies and
which have been unrelated to the operating performance of such companies.
Fluctuations or decreases in the trading price of the Company's Common Stock may
adversely affect the market for the Company's Common Stock. In the past,
following periods of volatility in the market price for a company's securities,
securities class action litigation often has been instituted. Such litigation
could result in substantial costs and a diversion of management attention and
resources, which could have a material adverse effect on the Company's business,
financial condition and operating results.
ABSENCE OF DIVIDENDS
The Company has never declared or paid cash dividends on its Common
Stock. The Company's current bank term loan precludes it from paying dividends
to stockholders. The Company currently intends to retain any earnings for use in
its business and therefore does not anticipate paying any dividends in the
future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
23
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CYGNUS, INC.
March 31, 1999
Reference is made to Part II, Item 7A, Quantitative and Qualitative
Disclosures About Market Risk, in the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998.
24
<PAGE>
CYGNUS, INC.
March 31, 1999
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not currently involved in any material legal
proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
The following exhibits are filed herewith or incorporated by reference:
3.1 Bylaws of the Registrant, as amended, incorporated by reference to
Exhibit 3.3 of the Registrant's Registration Statement Form S-1 No.
33-38363.
3.2 Restated Articles of Incorporation of the Registrant, as amended to
date, incorporated by reference to Exhibit 3.4 of the Registrant's
Registration Statement Form S-1 No. 33-38363.
4.1 Specimen of Common Stock certificate of the Registrant, incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement
Form S-1 No. 33-38363.
4.2 Rights Agreement dated September 21, 1993 between the Company and
Chemical Trust Bank of California (the "Transfer Agent"), which
includes the Certificate of Determination for the Series A Junior
Participating Preferred Stock as Exhibit A, the form of Right
Certificate as Exhibit B and the Summary of Rights to purchase
Preferred Shares as Exhibit C, incorporated by reference to Exhibit I
of the Registrant's Form 8-A filed on October 21, 1993, Registration
No. 0-18962.
4.3 Form of Senior Indenture incorporated herein by reference to Exhibit
4.1 filed with the Company's Registration Statement on Form S-3 (File
No. 33-39275) declared effective by the Securities and Exchange
Commission on November 12, 1997 (the "November 1997 Form S-3").
4.4 Form of Subordinated indenture incorporated herein by reference to
Exhibit 4.2 filed with the Company's November 1997 Form S-3.
4.5 Form of Senior Debt Security (included in Exhibit 4.1) incorporated
herein by reference to Exhibit 4.3 filed with the Company's November
1997 Form S-3.
4.6 Form of Subordinated Debt Security (included in Exhibit 4.2)
incorporated herein by reference to Exhibit 4.4 filed with the
Company's November 1997 Form S-3.
4.7 First Supplemental Indenture dated as of February 2, 1998 by and
between Cygnus, Inc. and State Street Bank and Trust Company of
California, N.A., incorporated by reference to Exhibit 4.5 of the
Company's Form 8-K dated February 4, 1998.
4.8 Second Supplemental Indenture, dated as of October 28, 1998, by and
between Cygnus, Inc. and State Street Bank and Trust Company of
California, N.A., to the Indenture dated as of February 3, 1998 and the
First Supplemental Indenture dated as of February 3, 1998, incorporated
by reference to Exhibit 4.8 of the Company's Form 8-K filed on October
30, 1998.
4.9 First Amendment to the Rights Agreement dated October 26, 1998 between
the Company and ChaseMellon Shareholder Services, L.L.C. (the "Rights
Agent" successor to Chemical
25
<PAGE>
CYGNUS, INC.
March 31, 1999
Trust), incorporated by reference to Exhibit 99.1 of the Registrant's
Form 8-A/A filed on December 14, 1998, Registration No. 0-18962.
4.10 Amended and Restated Rights Agreement dated October 27, 1998 between
the Company and ChaseMellon Shareholder Services, L.L.C. (the "Rights
Agent" successor to Chemical Trust), which includes the Certificate of
Determination for the Series A Junior Participating Preferred Stock as
Exhibit A, the form of Right Certificate as Exhibit B and the Summary
of Rights to purchase Preferred Shares as Exhibit C, incorporated by
reference to Exhibit 99.2 of the Registrant's Form 8A/A filed on
December 14, 1998, Registration No. 0-19962.
10.39 Sublease Agreement dated February 19, 1999 between the Registrant and
The 3DO Company.
27.1 Financial Data Schedule
b) REPORTS ON FORM 8-K
The Company filed two Reports on Form 8-K during the quarter ended
March 31, 1999.
On February 5, 1999, the Company filed a Current Report on Form 8-K,
reporting under Item 5 its earnings for the quarter ended December 31,
1998. The Company also announced that there will be no reverse stock
split of the Company's Common Stock.
On February 5, 1999, the Company filed a Current Report on Form 8-K,
reporting under Item 5 the submission to the United States Food and
Drug Administration ("FDA") of the first part of the pre-market
approval application ("PMA") for the GlucoWatch-R- monitor and the
completion of the first of two additional small clinical studies for
the GlucoWatch-R- monitor.
26
<PAGE>
CYGNUS, INC.
March 31, 1999
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CYGNUS, INC.
Date: APRIL 27, 1999 By: /s/ JOHN C. HODGMAN
----------------------- ------------------------------------
John C. Hodgman
President and Chief Executive Officer
(Principal Executive Officer)
Date: APRIL 27, 1999 By: /s/ CRAIG W. CARLSON
----------------------- -------------------------------------
Craig W. Carlson
Chief Financial Officer
(Principal Accounting Officer)
27
<PAGE>
CYGNUS, INC.
March 31, 1999
INDEX OF EXHIBITS
The following exhibits are included herein:
Exhibit 27 Financial Data Schedule
Exhibit 10.39 Sublease Agreement dated February 19, 1999 between the
Registrant and The 3DO Company.
<PAGE>
Exhibit 10.39
SUBLEASE
THIS SUBLEASE ("Sublease") is entered into as of the 19th day of
February, 1999 between CYGNUS, INC., a Delaware corporation ("Sublandlord"), and
THE 3DO COMPANY, a California corporation ("Subtenant"), with reference to the
following facts:
A. Pursuant to that certain Ten-Year Industrial Net Lease Agreement
dated September 27, 1998 ("Lease"), between Seaport Centre Venture Phase I, a
California general partnership, as landlord ("Seaport"), and Cygnus, as tenant,
as amended by the First Amendment to Ten-Year Industrial Net Lease Agreement
dated May 15, 1992 ("First Amendment"), the Second Amendment to Ten-Year
Industrial Net Lease Agreement dated August 8, 1992 ("Second Amendment"), and
the Third Amendment to Ten-Year Industrial Net Lease Agreement dated June 9,
1998 ("Third Amendment") (collectively, the "Master Lease"), a copy of which is
attached hereto as EXHIBIT A and made a part hereof, Sublandlord leases from
Landlord (as defined below) and Landlord leases to Sublandlord approximately
32,038 rentable square feet of space consisting of two (2) buildings located at
701 Galveston Street and 501 Chesapeake Drive, Redwood City, California ("Master
Lease Premises"). Metropolitan Life Insurance Company, a New York corporation
("Landlord"), is the successor-in-interest to Seaport as landlord under the
Master Lease.
B. Subtenant desires to sublet from Sublandlord the portion of the
Master Lease Premises commonly known as 501 Chesapeake Drive, Redwood City,
California, consisting of approximately 11,158 rentable square feet, as more
particularly set forth in EXHIBIT B attached hereto and made a part hereof
("Subleased Premises"), and Sublandlord does hereby sublet the same to
Subtenant, upon the terms, covenants and conditions hereinafter set forth.
NOW, THEREFORE, in consideration of the covenants herein contained, and
for other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, the parties do hereby agree as follows:
1. SUBLEASE. Sublandlord does hereby sublease and demise to Subtenant,
and Subtenant does hereby hire and take from Sublandlord, all of the Subleased
Premises subject to: (i) the covenants, agreements, terms, provisions and
conditions of this Sublease for the term hereinafter stated; and (ii) the
applicable covenants, agreements, terms, provisions and conditions of the Master
Lease. Subtenant hereby acknowledges receipt of the copy of the Master Lease
attached hereto as EXHIBIT A. Capitalized terms not otherwise defined herein
shall have the meaning ascribed to them in the Master Lease.
2. TERM.
A. The term of this Sublease ("Term") shall commence on the date (the
"Commencement Date") which is the earlier to occur of (i) the date on which
Sublandlord delivers possession of the Subleased Premises to Subtenant in the
condition set forth in Paragraph 8.A of this Sublease or (ii) May 1, 1999, and
shall end on December 10, 2003, unless sooner terminated pursuant to this
Sublease, the Master Lease, or pursuant to law. Sublandlord and Subtenant expect
that the Commencement Date will be May 1, 1999. If for any reason Sublandlord
cannot deliver possession of the Subleased Premises to Subtenant on or before
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<PAGE>
May 1, 1999, Sublandlord shall not be subject to any liability therefor, nor
shall such failure affect the validity of this Sublease, or the obligations of
Subtenant hereunder, or extend the Term, but in such case, Subtenant shall not
be obligated to pay Rent (as defined in Paragraph 4.B of this Sublease) or
perform any other obligation of Subtenant under the terms of this Sublease until
Sublandlord delivers possession of the Subleased Premises to Subtenant. If
possession of the Subleased Premises is not delivered to Subtenant on or before
May 10, 1999, Subtenant may, at its option, cancel this Sublease by delivering
to Sublandlord written notice of such election by 5:00 p.m. (California time) on
May 20, 1999, in which event Sublandlord shall promptly return to Subtenant all
amounts previously paid by Subtenant to Sublandlord hereunder and the parties
shall be discharged from all obligations hereunder. Sublandlord's failure to
receive Subtenant's written notice canceling this Sublease by 5:00 p.m.
(California time) on May 20, 1999 shall be conclusively deemed Subtenant's
waiver of such cancelation right and its election to keep this Sublease in full
force. Promptly after the Commencement Date, the parties shall execute a
memorandum confirming the Commencement Date; provided, however, failure to
execute such memorandum shall not affect the validity of this Sublease.
B. Subtenant shall have the right of access to the Subleased Premises,
subject to all of the provisions of this Sublease, other than payment of base
rent and Additional Rent (as defined in Paragraph 4.B below) other than
utilities, at any time between the date of Landlord's consent to this Sublease
and the Commencement Date solely for the purposes of performing measurements and
space planning, but not for any construction of Alterations (as defined in
Paragraph 8.B below), provided that Subtenant shall give Sublandlord reasonable
prior notice in advance of accessing the Subleased Premises and shall use best
efforts not to unreasonably interfere with the activities of Sublandlord within
the Subleased Premises.
3. USE. Subtenant shall use the Subleased Premises in strict conformance
with allowable uses under the Master Lease and for no other purpose without the
prior written consent of Sublandlord and Landlord. Subtenant hereby represents
and warrants that it shall not use any Hazardous Materials or Permitted
Hazardous Materials (as each such term is described or defined in Paragraph 9
of the Master Lease and Rider No. 1) within the Subleased Premises; provided,
however, as between Sublandlord and Subtenant only, Sublandlord agrees that
Subtenant may use and store office supplies and products typically found in an
office use which may contain Hazardous Materials. Unless Landlord agrees in
writing to the contrary, Subtenant shall strictly comply with all of the
applicable terms and conditions of Paragraph 9 and Rider No. 1 of the Master
Lease.
4. RENT.
A. Subtenant shall pay Sublandlord as monthly base rent for the
Subleased Premises on the first (1st) day of each calendar month during the Term
of this Sublease according to the following schedule:
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<PAGE>
<TABLE>
<CAPTION>
MONTHS AMOUNT
<S> <C>
1 Free
2 - 12 $25,663.40
(plus partial month at Term
commencement)
13 - 24 $26,332.88
25 - 36 $27,002.36
37 - 48 $27,671.84
49-end of Term $28,341.32
</TABLE>
The base rent for second full calendar month of the Term shall be due and
payable on the mutual execution of this Sublease. The base rent for any partial
month at the commencement of the Term shall be paid within five (5) days after
the Commencement Date. All Rent shall be payable, in advance, without any
offset, deduction, or abatement (except as otherwise expressly provided herein),
and without prior notice or demand. The base rent shall be a triple net rent,
and Subtenant shall also be fully responsible for Additional Rent applicable to
the Subleased Premises pursuant to Paragraph 4.B below. Base rent and Additional
Rent for any partial calendar month shall be prorated based on the actual number
of days in such month.
B. Except for the first full calendar month of the Term, during which
time Subtenant shall only reimburse Sublandlord for its utility expenses,
Subtenant shall also pay to Sublandlord all Additional Rent applicable to the
Subleased Premises for each calendar month of the Term. If Landlord bills
Subtenant for any such Additional Rent, Subtenant shall pay the same to Landlord
in accordance with the Master Lease, which payment shall satisfy Subtenant's
obligation to pay such Additional Rent hereunder. If Sublandlord bills Subtenant
for any such Additional Rent, Subtenant shall pay the same to Sublandlord within
ten (10) days thereafter. If Subtenant fails to reimburse Sublandlord for
Additional Rent within such ten (10) day period, Subtenant shall also pay
interest on such amount at ten percent (10%) per annum from the date due until
paid. As used in this Sublease, the term "Additional Rent" shall mean all
payments which Subtenant is required to pay under this Sublease other than
monthly base rent, together with all payments which Sublandlord is required to
pay to Landlord with respect to the Subleased Premises during the Term pursuant
to the Master Lease other than monthly base rent; provided, however, "Additional
Rent" shall not include any amounts that are imposed or incurred because of (i)
Sublandlord's failure to pay or perform its obligations under the Master Lease
through no fault of Subtenant, (ii) the violation by Sublandlord or its
employees, agents or contractors of any applicable laws, codes, rules,
regulations or other governmental directives or (iii) the negligence or willful
misconduct of Sublandlord or its employees, agents or contractors. Subtenant
shall, at its own expense, contract for and pay directly for its telephone
service for the Subleased Premises and shall pay for all utilities as set forth
in Paragraph 8 of the Master Lease, Paragraph 6(c) of the Second Amendment and
Paragraph 7 of the Third Amendment. For purposes herein, "Rent" shall mean all
monthly base rent and Additional Rent.
5. INCORPORATION OF MASTER LEASE. Except to the extent that they are
inapplicable to, or modified by, or excluded by, the terms of this Sublease, all
of the covenants, agreements, terms, provisions and conditions of the Master
Lease are hereby incorporated into and made a part of this Sublease. Except to
the extent that they are inapplicable to, or modified by, the terms
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<PAGE>
of this Sublease, the rights and obligations contained in the Master Lease are
hereby imposed upon the respective parties hereto, Sublandlord being substituted
for "Lessor" named in the Master Lease, Subtenant being substituted for "Lessee"
named in the Master Lease, and "Subleased Premises" being substituted for the
"Premises" named in the Master Lease, except for Paragraphs 1, 2, 3, 4, 5, and
6, Paragraph 26(g), the last sentence of the first paragraph of Paragraph 28,
Paragraph 30, Paragraph 34(b), Paragraph 35, Paragraph 38, Paragraph 39,
Paragraph 41, Exhibits A, A1, B and C of the Lease; the First Amendment in its
entirely; Paragraphs 2, 4, 5, 6 and 7, the first two (2) grammatical paragraphs
of Paragraph 3, and all references to Buildings 5 and 8 in Paragraph 8 of the
Second Amendment; all references to Buildings 5 and 8 in the Third Amendment;
and Section 2, Section 4(b)(iii), 4(b)(iv), Section 4(c), Section 5, Section
6(i), Section 8, Section 9, Section 10, Section 13, Section 14 and Section 16 of
the Third Amendment, which are hereby deleted from this Sublease.
Notwithstanding the foregoing, the references to "Lessor" in the following
sections and paragraphs of the Master Lease shall mean Landlord and not
Sublandlord: the last sentence of the second grammatical paragraph of Paragraph
4 of the Lease; Paragraph 7 of the Lease; the fourth sentence of the second
grammatical paragraph of Paragraph 9 of the Lease; Paragraph 12(b) of the Lease;
Paragraph 17 of the Lease; Paragraph 32 of the Lease; Paragraph 37 of the Lease;
Paragraph 42(x) of the Lease; Sections 1.4.2 and 1.7 of Rider No. 1 to the
Lease; and Section 11 of the Third Amendment. Except as so excluded,
inapplicable or modified, all acts and obligations to be performed and all of
the terms and conditions to be observed by Sublandlord as Lessee under the
Master Lease with respect to the Master Lease Premises shall be performed and
observed by Subtenant with respect to the Subleased Premises.
6. SUBORDINATION TO THE MASTER LEASE. This Sublease and Subtenant's
rights under this Sublease shall at all times be subject and subordinate to the
Master Lease. If any conflict between the Master Lease and the Sublease occurs,
as between Sublandlord and Subtenant this Sublease will control. Unless Landlord
agrees in writing to the contrary pursuant to Paragraph 14 below, termination of
the Master Lease shall extinguish the Sublease at Landlord's discretion, without
liability to Sublandlord provided that such termination is not due to the
default of Sublandlord under the Master Lease or to the voluntary surrender by
Sublandlord of its rights under the Master Lease. Subtenant shall have no right
to assign this Sublease or further sublet the Subleased Premises without the
prior written consent of Sublandlord and Landlord in strict conformance with the
terms of Paragraph 15 of the Master Lease.
7. MODIFICATIONS TO INCORPORATED TERMS OF MASTER LEASE. Subtenant
agrees that, notwithstanding anything to the contrary in this Sublease and the
Master Lease, Sublandlord shall not be required to provide any of the services,
make any of the repairs (including, without limitation, maintenance and repairs
required pursuant to Paragraph 12(b), Paragraph 24, and Paragraph 25 of the
Master Lease), improvements or restorations, or perform any of the other
obligations that the Landlord has agreed to provide or make or cause to be
provided or made under the provisions of the Master Lease, including, without
limitation, repairs, utilities, insurance and indemnification obligations, and
Subtenant shall look to Landlord for the provision or making thereof.
Notwithstanding the foregoing, Sublandlord agrees: (i) to maintain the insurance
required under Paragraph 20 of the Master Lease as applicable to the Master
Lease Premises and Sublandlord's personal property; and (ii) that the provisions
of Paragraph 19 of the Master Lease shall apply as between Sublandlord and
Subtenant. Sublandlord, upon request of Subtenant, agrees to use reasonable
efforts to cause Landlord to observe and/or perform any such obligations;
provided, however, without limiting the generality of the foregoing, the
obligation of
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<PAGE>
Sublandlord to use "reasonable efforts" shall be construed as requiring
Sublandlord, if necessary, to institute or prosecute any legal action or
proceeding if Landlord shall default in the performance of any such
obligations under the terms of the Master Lease. Sublandlord's obligations in
respect thereto shall be to use its diligent efforts to assist Subtenant
hereunder in any claims or proceedings against Landlord (including assigning
Sublandlord's rights under the Master Lease to the extent necessary to permit
Subtenant to institute legal proceedings to obtain Landlord's performance) as
long as Subtenant agrees to reimburse Sublandlord for all costs associated
with such actions or proceedings under the Master Lease; provided, however,
that Sublandlord and Subtenant shall equitably share such costs to the extent
the actions or proceedings affect the Subleased Premises and other portions
of the Premises.
8. CONDITION OF SUBLEASED PREMISES.
A. Sublandlord shall deliver the Subleased Premises to
Subtenant on the Commencement Date in its present "as-is" condition, and
Subtenant shall rely solely on Subtenant's own inspection of the Subleased
Premises and the physical condition thereof, including, without limitation,
accessibility and location of utilities, the condition of improvements and the
existence of Hazardous Materials, and not on any representations or warranties
of Sublandlord or its agents, employees or contractors, whether express or
implied, except as set forth in the next sentence. Notwithstanding the
foregoing, Sublandlord shall, at its own cost, deliver the Subleased Premises in
broom clean condition, with all furniture in place, all building systems
servicing the Subleased Premises operating satisfactorily, and will patch and
provide touch up paint where Sublandlord deems necessary.
B. Subtenant shall not make or suffer to be made any
alterations, additions or improvements (collectively, "Alterations") in, on or
to the Subleased Premises without the prior written consent of Sublandlord and
Landlord, which consent shall be given or withheld by each of them in accordance
with Paragraph 11 of the Master Lease. All Alterations shall be performed in
strict compliance with Paragraph 11 of the Master Lease. In the event
Sublandlord and Landlord consent to the making of any such Alterations by
Subtenant, the same shall be made by Subtenant at Subtenant's sole cost and
expense, and any contractor or person selected by Subtenant to make the same
shall first be approved in writing by Sublandlord and Landlord. Subject to
Sublandlord's right to approve plans, specifications and permits in accordance
with Paragraph 11 of the Master Lease, and subject to Landlord's rights under
Paragraph 11 of the Master Lease, Sublandlord hereby consents to the proposed
Alterations described on attached EXHIBIT C. Upon the expiration or sooner
termination of this Sublease, Subtenant shall, upon demand by Sublandlord or
Landlord, at Subtenant's sole cost and expense, forthwith and with all due
diligence, remove any Alterations made or paid for by Subtenant, and repair and
restore the Subleased Premises to their original condition on the Commencement
Date, ordinary wear and tear excepted. Without limiting the foregoing, Subtenant
acknowledges and agrees that its obligations to surrender and restore the
Subleased Premises may include construction of improvements in existence on the
Commencement Date which are subsequently removed by Subtenant, and Subtenant
agrees to construct the same notwithstanding Landlord's and Sublandlord's
consent to removal of such improvements during the Term; provided, however, at
the expiration of the Term or upon the earlier termination thereof as a result
of Sublandlord's default which terminates the Master Lease (but not the earlier
termination thereof as a result of any other default or event), if Landlord does
not require such construction of improvements, then Sublandlord shall not
require such construction of improvements. Finally, Sublandlord will
-5-
<PAGE>
cooperate with Subtenant to acquire Landlord's consent to any Alterations,
but Subtenant acknowledges that Sublandlord makes no representation as to
Landlord's willingness to consent to such Alterations and shall have no
liability for Landlord's failure to provide such consent.
C. Subtenant shall, at its sole cost, make all modifications,
alterations and improvements to the Subleased Premises and Building that are
required by any applicable city, state or federal rule, law, regulation or order
because of: (i) Subtenant's particular use of the Subleased Premises or
Building; (ii) Subtenant's application for any permit or governmental approval;
or (iii) Subtenant's making of any Alteration to or within the Subleased
Premises. All other improvements or capital expenditures relating to
modifications, alterations or improvements to the Subleased Premises or Building
shall be governed by the terms and conditions of Paragraphs 10 and 11 of the
Master Lease.
9. INSURANCE. Subtenant, at its sole cost and expense, shall obtain and
keep in full force and effect during the entire term of this Sublease such
insurance, and in such amounts, as are required under Paragraph 20 of the Master
Lease. Sublandlord and the Landlord shall be named as additional insured parties
under any such liability policy of insurance. Subtenant and Sublandlord shall
each obtain from their respective insurers hereof a waiver of all rights of
subrogation as set forth in Paragraph 19 of the Master Lease and the other
waivers contained in Paragraph 19 shall apply as between the Subtenant and
Sublandlord. Notwithstanding any contrary provision of this Sublease, as between
Sublandlord and Subtenant, the foregoing waiver of subrogation shall control.
10. SECURITY DEPOSIT. Upon execution hereof, Subtenant shall deposit
with Sublandlord Twenty-Eight Thousand Three Hundred Forty-One and 32/100
Dollars ($28,341.32) in cash, as security for the performance by Subtenant of
the terms and conditions of this Sublease. If Subtenant fails to pay Rent or
otherwise defaults with respect to any provision of this Sublease,
Sublandlord may draw upon, use, apply or retain all or any portion of the
security deposit for the payment of any Rent, other expenses arising out of
any such default, for the payment of any other sum which Sublandlord has
become obligated to pay by reason of Subtenant's default, or to compensate
Sublandlord for any out-of-pocket expenses which Sublandlord has suffered
thereby. If Sublandlord so uses or applies all or any portion of the security
deposit, then Subtenant shall, within ten (10) days after demand therefor,
deposit cash with Sublandlord in the amount required to restore the security
deposit. At the end of the Sublease Term, Sublandlord shall return to
Subtenant that portion of the security deposit which has not been applied by
Sublandlord pursuant to this Paragraph 10, or which is not otherwise required
to cure Subtenant's defaults, without interest. Sublandlord may hold such
security deposit together with Sublandlord's other funds.
11. TIME LIMITS. The time limits provided in the Master Lease for the
giving of notices, making demands, performance of any act, condition, or
covenant, or the exercise of any right or remedy (excluding the payment of
Rent), are changed solely for the purpose of incorporation as the terms of this
Sublease by lengthening or shortening the same in each instance by three (3)
days (or two (2) days for any three (3) day period), as appropriate; so that
notices may be given, demands made, or any act, condition, or covenant
performed, or any right or remedy exercised, by Sublandlord or Subtenant, as the
case may be, within the time limit relating thereto contained in the Master
Lease.
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<PAGE>
12. NOTICES. All notices and other communications under this Sublease
shall be properly given only if made in writing and either (i) sent via
facsimile to the party at the facsimile number set forth in this Paragraph 12
(or such other facsimile number as such party may designate by ten (10) days'
prior notice to the other party) with a copy of such notice mailed to the party
by first class mail on the same day, or (ii) mailed by certified mail, return
receipt requested, postage prepaid, or delivered by hand (including messenger or
recognized delivery, courier or air express service) to the party at the address
set forth in this Paragraph 12 (or such other address as such party may
designate by ten (10) days' prior notice to the other party). Such notices and
other communications shall be effective on the date of receipt (evidenced by a
facsimile machine-generated confirmation of receipt or the certified mail
receipt) if sent via facsimile or if mailed, or on the date of hand delivery if
hand delivered; provided, however, if any such notice or other communication is
received on a Saturday, Sunday or federal holiday, then such notice or other
communication shall be effective on the immediately following business day. If
any such notice or communication is not received or cannot be delivered due to a
change in the facsimile number or the address of the receiving party of which
notice was not previously given to the sending party or due to a refusal to
accept by the receiving party, such notice or other communication shall be
effective on the date delivery is attempted.
Notices and communications to Sublandlord shall be sent to:
Cygnus, Inc.
400 Penobscot Drive
Redwood City, CA 94063
Attn: President and Chief Executive Officer
Telephone: (650) 369-4300
Facsimile: (650) 369-5318
Notices and communications to Subtenant shall be sent to:
The 3DO Company
600 Galveston Drive
Redwood City, CA 94063
Attn: Chief Financial Officer
Telephone: (650) 261-3000
Facsimile: (650) 261-3151
13. AMENDMENTS. Sublandlord and Subtenant shall not amend in any
respect this Sublease unless such is in writing and signed by both parties.
14. CONSENT. This Sublease shall be subject to and conditioned upon the
following: (i) Subtenant and Landlord agreeing to Subtenant's nondisturbance
language attached hereto as EXHIBIT D, or similar commercially reasonable
language, within ten (10) business days after the commencement of Landlord's
thirty (30) day review period of this Sublease pursuant to the Master Lease;
(ii) consent by Landlord to the terms and conditions of this Sublease, and this
Sublease shall not become effective unless and until such consent is executed
and delivered by Landlord; and (iii) the execution of a binding lease assignment
agreement (the "Assignment") between Subtenant and Heartport, Inc. with respect
to Heartport's lease of the adjacent premises located at 525 Chesapeake Drive,
Redwood City, California, and the written approval of same by
-7-
<PAGE>
Landlord. If Subtenant provides written notice by the tenth (10th) business day
that Subtenant elects to terminate the Sublease for the failure to agree to
acceptable nondisturbance language with Landlord, the Sublease shall terminate.
If Subtenant fails to provide such written notice of its termination election by
such date, this Sublease shall remain in full force and effect, and Subtenant's
termination right shall be null and void. In addition, if (a) Landlord fails to
consent to this Sublease within thirty (30) days of the date of this Sublease,
or (b) Subtenant and Heartport, Inc. have not executed the Assignment, which has
been approved by Landlord, all within thirty (30) days of the date of this
Sublease, then Sublease shall automatically terminate and neither party shall
have any continuing rights against or obligations to the other with respect to
the Subleased Premises or this Sublease, except that Sublandlord shall thereupon
return to Subtenant all advance rents and security deposits paid by Subtenant to
Sublandlord.
15. INDEMNIFICATION.
A. Subtenant shall indemnify, defend, protect and hold
harmless Sublandlord and Sublandlord's officers, directors, shareholders, agents
and employees (collectively, "Sublandlord's Parties") from and against all
claims, liability, cost, damage and expense (including, without limitation,
reasonable attorneys' fees) arising from either: (i) the negligence, willful
misconduct, or breach of this Sublease by Subtenant or Subtenant's officers,
directors, shareholders, agents or employees (collectively "Subtenant's
Parties"), (ii) the use of the Subleased Premises by Subtenant or Subtenant's
Parties; (iii) the construction of any Alterations or any claims for work or
labor performed, or for materials or supplies furnished to or at the request of
Subtenant in relation thereto; or (iv) the use, release or disposal of Hazardous
Materials by Subtenant or Subtenant's Parties; provided, however, that the
indemnification provided in this Paragraph 15.A shall not apply to the extent
that any claim, liability, cost, damage or expense arises from the negligence,
willful misconduct or breach of this Sublease by Sublandlord or Sublandlord's
Parties.
B. Sublandlord shall indemnify, defend, protect and hold
harmless Subtenant's Parties from and against all claims, liability, cost,
damage and expense (including, without limitation, reasonable attorneys' fees)
arising from either (i) the negligence, willful misconduct, or breach of this
Sublease by Sublandlord or Sublandlord's Parties; (ii) the use of the Master
Lease Premises by Sublandlord or Sublandlord's Parties; or (iii) the use,
release or disposal of Hazardous Materials by Sublandlord or Sublandlord's
Parties in the Building; provided, however, that the indemnification provided in
this Paragraph 15.B shall not apply to the extent that any claim, liability,
cost, damage or expense arises from the negligence, willful misconduct or breach
of this Sublease by Subtenant or Subtenant's Parties.
C. The terms of this Paragraph 15 shall survive the expiration
or termination of this Sublease and, as between Sublandlord and Subtenant, shall
supersede the terms of Paragraph 17 of the Master Lease and Paragraph 1.7 of
Rider No. 1.
16. MISCELLANEOUS.
A. Subtenant shall be entitled to use, on a nonexclusive basis
and free of charge, all of the parking stalls available for use by Sublandlord
for the Subleased Premises at the ratio set forth in the Master Lease.
-8-
<PAGE>
B. Subtenant shall be responsible and shall pay to Sublandlord
promptly upon demand, any late charges owed arising out of Subtenant's late
payment of Rent hereunder.
C. This Sublease may be executed in counterparts each of which
when executed shall constitute but one original, and all of which together shall
constitute a single agreement.
D. Subtenant shall have the right, at its sole cost and
expense, to install door signage at the entrance to the Premises. All signage
shall be subject to the terms of the Master Lease and the consent of
Sublandlord, Landlord, and the City of Redwood City.
E. Sublandlord and Subtenant each represents and warrants to
the other that they have negotiated this Sublease directly with CPS and Tory
Corporate Real Estate Advisors, Inc. (dba The Staubach Company) (collectively
"Brokers"). Sublandlord shall pay the Brokers a commission pursuant to a
separate written agreement with The Staubach Company. Subtenant has not
authorized or employed, or acted by implication to authorize or to employ, any
other real estate broker or salesman to act for Subtenant in connection with
this Sublease. Each party shall hold the other harmless from and indemnify and
defend the other against any and all claims by any real estate broker or
salesman other than the Brokers identified above claiming to represent that
party for a commission, finder's fee or other compensation as a result of each
party entering into this Sublease.
F. Should Subtenant, or any of its successors in interest,
holdover the Subleased Premises, or any part thereof, after the expiration of
the Term of this Sublease, unless otherwise agreed to in writing, such holding
over shall constitute and be construed as tenancy from month-to-month only at a
monthly rent equal to one hundred fifty percent (150%) of the monthly base rent
owed during the final year of the Term of this Sublease as the same may be
extended from time to time. This inclusion of the preceding sentence shall not
be construed as Sublandlord's permission for Subtenant to holdover.
G. Sublandlord represents to Subtenant that: (i) the Master
Lease is in full force and effect; (ii) Sublandlord has received no written
notice asserting any default by Sublandlord under the Master Lease; and (iii) to
the actual knowledge of Sublandlord's employees who are responsible for
administering the Master Lease, without duty of inquiry, (A) no default exists
on the part of Landlord, and (B) there exists no event that, with the passing of
time or the giving of notice or both, would constitute a default on the part of
Sublandlord or Landlord. Sublandlord agrees to maintain the Master Lease in full
force and effect except to the extent its failure to maintain the Master Lease
is due to the failure of Subtenant to comply with its obligations under this
Sublease provided Subtenant receives prior written notice from Sublandlord as
required by the Master Lease (as modified by Paragraph 11 above). Except to the
extent that Subtenant is obligated to perform the obligations of the lessee
named in the Master Lease, Sublandlord agrees to perform its obligations under
the Master Lease. During the Term, Sublandlord shall not enter into any
amendment of the Master Lease that would diminish Subtenant's rights or increase
Subtenant's obligations.
H. The undersigned representative of Sublandlord and Subtenant
affirms that he/she is duly authorized to execute this Sublease on behalf of
his/her company and that this
-9-
<PAGE>
Sublease is entered into with the consent of the Board of Directors of his/her
company, if so required.
I. In the event of any damage, casualty or condemnation
affecting the Subleased Premises, Rent payable by Subtenant shall be abated in
the same proportion that Sublandord is entitled to abate rent under the Master
Lease.
J. If either party brings any action or legal proceeding with
respect to this Sublease, the prevailing party shall be entitled to recover
reasonable attorneys' fees, experts' fees and court costs.
IN WITNESS WHEREOF, the parties hereto have executed this Sublease as
of this date first above written.
"SUBLANDLORD" "SUBTENANT"
CYGNUS, INC., THE 3DO COMPANY,
a Delaware corporation a Californiacorporation
By: /s/ Barbara G. McClung By: /s/ John Adams
------------------------------------ ----------------------------
Its: Vice President and General Counsel Its: CFO
----------------------------------- ----------------------------
-10-
<PAGE>
EXHIBIT A TO SUBLEASE
MASTER LEASE
Ten -Year Industrial Net Lease Agreement (Building No. 8), dated September 27,
1988 between the Registrant and Seaport Centre Venture Phase I, incorporated by
reference to Exhibit 10.27 of the Registrant's Form S-1 Registration Statement
No. 33-38363.
First Amendment to Ten-Year Industrial Net Lease Agreement, dated May 15, 1992
1988 between the Registrant and Seaport Centre Venture Phase I (expired).
Second Amendment to Ten-Year Industrial Net Lease Agreement, dated August 8,
1992 1988 between the Registrant and Seaport Centre Venture Phase I (expired).
Third Amendment to Ten-Year Industrial Lease Agreement (Building No. 8), dated
June 9, 1998 between the Registrant and Metropolitan Life Insurance Company, a
New York corporation (predecessor in interest to Seaport Centre Venture Phase
I), incorporated by reference to Exhibit 10.30 of the Registrant's Form 10-K for
the fiscal year ended December 31, 1998.
-11-
<PAGE>
EXHIBIT B TO SUBLEASE
DEPICTION OF SUBLEASED PREMISES
-12-
<PAGE>
EXHIBIT C TO SUBLEASE
DESCRIPTION OF PROPOSED ALTERATIONS
All of the alterations and improvements to the Subleased Premises described on
the drawings prepared by Holey Associates, dated 1/19/99, entitled "Issued for
Permit/Construction.
-13-
<PAGE>
EXHIBIT D TO SUBLEASE
NON-DISTURBANCE PROVISIONS
[See attached]
-14-
<PAGE>
CONSENT TO SUBLEASE
February 25, 1999
TO PRIME TENANT:
Cygnus, Inc.
400 Penobscot Drive
Redwood City, CA 94063
Attention: Barbara McClung, Senior Vice President
TO SUBTENANT:
THE 3DO COMPANY,
a Delaware corporation
&
THE 3DO COMPANY,
a California corporation
both at
600 Galveston Drive
Redwood City, CA 94063
Re: Seaport Centre, 501 Chesapeake Drive, Redwood City, California
Sublease by Cygnus, Inc. to The 3DO Company
Ladies and Gentlemen:
Reference is made to the written lease dated as of September 27, 1988,
between Seaport Centre Venture Phase I, a California general partnership,
predecessor in interest to Metropolitan Life Insurance Company, a New York
corporation ("Landlord"), and Cygnus Research Corporation, a California
corporation, predecessor in interest to Cygnus, Inc., a Delaware corporation, as
lessee ("Prime Tenant"), as amended by the First Amendment to Ten-Year
Industrial Net Lease Agreement dated May 15, 1992, the Second Amendment to
Ten-Year Industrial Net Lease Agreement dated August 8, 1992 and the Third
Amendment to Ten-Year Industrial Net Lease Agreement dated June 9, 1998
(collectively, as amended, the "Prime Lease"), covering the premises ("Prime
Lease Premises") described in the Prime Lease. Pursuant to the terms of the
Prime Lease, Prime Tenant has requested our consent to a written sublease dated
as of February 19, 1999 (the "Sublease") to and by The 3DO Company, a Delaware
corporation ("Subtenant" or "The 3DO Company") of that space ("Sublet Premises")
known as 501 Chesapeake Drive, Redwood City, California and more particularly
described in the Sublease, a copy of which Sublease is appended hereto as
EXHIBIT A and made a part hereof. Except as set forth above, the Prime Lease has
not been amended or modified.
We hereby grant our consent to the Sublease upon the following express
terms and conditions of this letter (the "Consent Letter"):
1. The Sublease is subject and subordinate to the Prime Lease and to
all of its terms, covenants, conditions, provisions and agreements. Except to
the extent otherwise defined in this Consent Letter, capitalized terms shall
have the respective meanings set forth in the Prime Lease.
2. Except for monthly rent payable by Prime Tenant under the Prime
Lease, the Subtenant shall perform faithfully and be bound by all of the terms,
covenants, conditions, provisions and agreements of the Prime Lease to the
extent applicable to the Sublet Premises, applicable to the period covered by
the Sublease, except that liability survives expiration or termination of the
Sublease as to obligations which are intended to survive the expiration or
termination of the Prime Lease.
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 2
3. Neither the Sublease nor this consent thereto shall:
(a) release or discharge Prime Tenant from any liability,
whether past, present or future, under the Prime Lease;
(b) operate as an approval by us to or for any of the specific
terms, covenants, conditions, provisions or agreements of the Sublease
and we shall not be bound thereby;
(c) be construed to modify, waive or affect any of the terms,
covenants, conditions, provisions or agreements of the Prime Lease, or
to waive any breach thereof, or to waive, reduce or derogate from any
of our rights as Landlord thereunder, or to enlarge or increase our
obligations as Landlord thereunder; or
(d) be construed as a consent by us to any further subletting
either by Prime Tenant or by the subtenant or to any assignment by
Prime Tenant of the Prime Lease or assignment by the Subtenant of the
Sublease, whether or not the Sublease purports to permit the same and
both Prime Tenant and the Subtenant agree that: the Subtenant has no
right whatsoever to assign, mortgage or encumber the Sublease nor to
sublet any portion of the Sublet Premises or permit any portion of the
Sublet Premises to be used or occupied by any other party.
Notwithstanding any provision of the foregoing to the contrary,
provided that Subtenant has first obtained the consent of the Prime
Tenant, Landlord agrees that one (and only one) further assignment of
the Sublease or sublet of all or any portion of the Subleased Premises
shall be subject to Landlord's prior written approval in accordance
with the assignment and subletting provisions stated in the Prime
Lease. Any such further assignment or sublet, or Landlord's consent
thereto, shall not release Prime Tenant of its obligations and
liability under the Prime Lease or release Subtenant of its obligations
and liability hereunder. Prime Tenant, Subtenant and Landlord agree
that Landlord shall be entitled to one-half (1/2 ) of any excess rent
payable with respect to any such further assignment of the Sublease or
sublet of all or any portion of the Subleased Premises in the same
manner as if Subtenant was the Lessee under paragraph 15(d) of the
Prime Lease.
4. Prime Tenant shall not be released from any liability under the
Prime Lease because of our failure to give notice of default under or in respect
of any of the terms, covenants, conditions, provisions or agreements of the
Prime Lease.
5. Prime Tenant immediately and irrevocably assigns to Landlord all
rent and other payments due from Subtenant under the Sublease, provided however,
that Prime Tenant shall have a license to collect such rent and other payments
until the occurrence of an event of default under any of the provisions of the
Prime Lease, regardless of whether or not notice of such event of default has
been given. At any time at our option, we shall have the right to give notice to
the Subtenant of such assignment. We shall credit Prime Tenant with any rent
received by us under such assignment but the acceptance of any payment on
account of rent from the Subtenant as the result of any such default shall in no
manner whatsoever serve to release Prime Tenant from any liability under the
terms, covenants, conditions, provisions or agreement under the Prime Lease. No
such payment of rent or any other payment by the Subtenant directly to Landlord
and/or acceptance of such payment(s) by Landlord, regardless of the
circumstances or reasons therefor, shall in any manner whatsoever be deemed an
attornment by the Subtenant to Landlord in the absence of either a specific
written agreement signed by us to such an effect or written notice from Landlord
to Subtenant pursuant to paragraph 7 below or be deemed a breach of the Sublease
by Subtenant.
6. Both Prime Tenant and the Subtenant shall be and continue to be
liable for the payment of (a) all bills rendered by us for charges incurred by
the Subtenant for services and materials supplied to the Sublet Premises,
including without limitation, any services and materials supplied beyond that
which is required by the terms of the Prime Lease and (b) any additional costs
incurred by Landlord for maintenance and repair of the Sublet Premises as the
result of Subtenant (rather than Prime Tenant) occupying the
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 3
Sublet Premises (including but not limited to any excess cost to Landlord of
services furnished to or for the Sublet Premises resulting from the extent to
which Subtenant uses them for purposes other than as set forth in the Prime
Lease).
7. The term of the Sublease shall expire and come to an end, regardless
of any provision of the Sublease to the contrary, upon the earlier of (i) its
natural expiration date or any premature termination date thereof or (ii)
concurrently with any premature termination or natural expiration of the Prime
Lease (whether by consent or other right, now or hereafter agreed to by Landlord
or Prime Tenant, or by operation of law or at Landlord's option in the event of
default by Prime Tenant). Notwithstanding the foregoing, in the event that the
Term (as defined in the Prime Lease) of the Prime Lease should be terminated,
for any reason other than as a result of Landlord's right to terminate the Prime
Lease for casualty or condemnation as provided in the Prime Lease, prior to the
expiration of the term of the Sublease, it is agreed that Landlord will
recognize Subtenant's right to possession of the Sublet Premises, and Subtenant
and Landlord shall be bound to each other under the terms, covenants and
conditions of the Sublease and as otherwise provided in paragraph 8 below, for
the remaining balance of the natural term of the Sublease (as opposed to early
termination) thereof, with the same force and effect as if Landlord were the
sublessor under such Sublease, and Subtenant does hereby agree to attorn to
Landlord as its landlord, such attornment to be effective and self-operative
without the execution of any further instruments on the part of any of the
parties to this Agreement.
8. In the event of a recognition and attornment as provided in
paragraph 7 above, Subtenant shall observe and perform: (i) each of the terms,
covenants and conditions of the Sublease except those designated on Exhibit B
hereto, which terms, covenants and conditions shall be of no force or effect
between Landlord and Subtenant, and (ii) those other terms, covenants and
conditions to which the parties have agreed as set forth in Exhibit C. It is
further agreed that Landlord shall not be:
(a) liable for any act or omission of Prime Tenant; or
(b) obligated to cure any defaults of Prime Tenant which
occurred prior to the time that Landlord succeeded to the interest of
landlord under the Sublease; or
(c) subject to any offsets or defenses which Subtenant may be
entitled to assert against any prior landlord (including Prime Tenant);
or
(d) bound by any payment of any kind, including without
limitation, rent or additional rent, by Subtenant to any prior landlord
(including Prime Tenant) for more than one month in advance except to
the extent Landlord has actually received for its own account such
rent; or
(e) bound by any amendment or modification of the Sublease
made without the written consent of Landlord; or
(f) liable or responsible for or with respect to the
retention, application and/or return to Subtenant of any security
deposit or other refundable amounts paid to any prior landlord
(including Prime Tenant), whether or not still held by such prior
landlord, except to the extent Landlord has actually received for its
own account as landlord such security deposit or other refundable
amounts.
9. This consent is not assignable, nor shall this consent be a consent
to any amendment, modification, extension or renewal of the Sublease, without
Landlord's prior written consent (which consent shall not be unreasonably
withheld) and provided that Prime Tenant has timely and validly exercised its
option to extend the term of the Prime Lease.
10. Prime Tenant covenants and agrees that under no circumstances shall
we be liable for any brokerage commission or other charge or expense in
connection with the Sublease and Prime Tenant hereby indemnifies and agrees to
protect, defend and hold us harmless against same and against all
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 4
liability, loss, damage, cost or expense (including but not limited to counsel
fees) in connection with any claim for such brokerage commission. Further, each
of Prime Tenant and Subtenant represents and warrants that it has dealt with no
brokers other than those brokers whose fees are to be paid by Prime Tenant.
Subtenant hereby indemnifies and agrees to protect, defend and hold us harmless
against any liability, loss, damage, cost or expense (including but not limited
to counsel fees) in connection with any claim for any brokerage commission by
any person acting for Subtenant or claiming any commission on the basis of
contracts or dealings with Subtenant.
11. Neither Landlord nor Landlord's representatives have made any
representations or promises with respect to the Sublet Premises, including
without limitation, whether or not the Sublet Premises is subject to another
sublease. Without limiting the generality of the foregoing, Subtenant
acknowledges and agrees (a) that Subtenant has been afforded ample opportunity
to inspect the Sublet Premises and has investigated its condition to the extent
Subtenant desires to do so, and (b) that Landlord has no obligation to remodel
or to make any alterations or improvements to the Sublet Premises. The taking of
possession of the Sublet Premises by Subtenant pursuant to the Sublease shall be
conclusive evidence, as between Subtenant and Landlord, that Subtenant has
accepted the same in its then "as is" condition, subject to Landlord's repair
and maintenance obligations under the Prime Lease.
12. Prime Tenant and Subtenant understand and acknowledge that
Landlord's consent hereto is not a consent to any improvement or alteration work
being performed in the Sublet Premises, and that Landlord's consent must be
separately sought in accordance with the provisions of the Prime Lease.
13. In the event of any action at law or in equity between or among
Landlord and Prime Tenant and Subtenant to enforce any of the provisions hereof,
any unsuccessful party to such litigation shall pay to the successful party all
costs and expenses, including actual attorneys' fees (including costs and
expenses incurred in connection with all appeals) incurred therein by such
successful party, and such costs, expenses and attorneys' fees may be included
in and as part of such judgment. A successful party shall be any party who is
entitled to recover his costs of suit, whether or not the suit proceeds to final
judgment.
14. Without limiting the generality of paragraph 3 above, Landlord
shall have no responsibility to provide (or liability for not providing) any
additional space for which Subtenant has any option or right under the Sublease
unless Landlord at its option elects to provide the same and Subtenant hereby
releases Landlord from any obligation it may otherwise have to provide same, and
agrees that Subtenant shall have no right to cancel the Sublease, abate rent or
assert any claim against Landlord if any such additional space is not provided.
15. All notices hereunder to Landlord, Prime Tenant or Subtenant shall
be deemed to have been duly given if mailed by United States registered or
certified mail, with return receipt requested, postage prepaid, or by United
States Express Mail or nationally recognized courier service to the parties at
the following addresses (or at such other addresses as shall be given in writing
by any party to the others in the manner provided in this paragraph) and shall
be deemed complete upon receipt or refusal to accept delivery as indicated in
the return receipt or in the receipt of such Express Mail or courier service:
LANDLORD'S ADDRESS:
As provided pursuant to the Prime Lease
PRIME TENANT'S ADDRESS:
As provided pursuant to the Prime Lease
SUBTENANT'S ADDRESS:
3DO Company
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 5
600 Galveston Drive
Redwood City, CA 94063
Attention: Chief Financial Officer
In the event of any strike or occurrence of another similar event which
interrupts mail service or nationally recognized courier service, notices may be
served personally upon an individual, partner, or an officer or director of a
corporation which is or is part of the party being served hereunder.
16. This Consent Letter may be executed in duplicates or counterparts,
or both, and such duplicates or counterparts together shall constitute but one
original of the Consent Letter. Each duplicate and counterpart shall be equally
admissible in evidence, and each original shall fully bind each party who has
executed it.
17. This Consent Letter shall be of no force or effect unless, within
thirty (30) days from the date hereof, Prime Tenant (as Prime Tenant) and
Subtenant execute and deliver to Landlord a copy of this consent, which
execution and delivery shall indicate Prime Tenant and Subtenant's
acknowledgment of and agreement to the foregoing terms and conditions and shall
constitute Subtenant's acknowledgment that it has received a copy of the Prime
Lease from Prime Tenant.
18. In connection with this consent, Landlord is contemporaneously
providing a separate letter of consent to Heartport, Inc., a Delaware
corporation ("Heartport") in connection with the assignment of lease by
Heartport to The 3DO Company of certain space located at 525 Chesapeake Drive,
Redwood City, California.
19. Notwithstanding any provision to the contrary herein or in the
Prime Lease, with respect to the Sublet Premises, Prime Tenant and Subtenant
shall be allowed to use any hazardous substance or Hazardous Material (as
defined in the Rider to the Prime Lease) in insignificant amounts typically
found or used in general office applications, without being required to comply
with the reporting obligations set forth in Section 1.4 of the Rider to the
Prime Lease, so long as (i) such substances are maintained only in such
quantities as are reasonably necessary for Prime Tenant's and Subtenant's
operations in the Sublet Premises, (ii) such substances are used strictly in
accordance with the manufacturers' instructions therefor and all applicable
laws, (iii) such substances are not disposed of in or about the Building or the
Project in a manner which would constitute a release or discharge thereof, and
(iv) all such substances are removed from the Building and the Project by
Subtenant or Prime Tenant upon the expiration or earlier termination of the
Sublease. NOTWITHSTANDING ANY PROVISION OF THE PRECEDING SENTENCE TO THE
CONTRARY, UNDER NO CIRCUMSTANCES SHALL PRIME TENANT OR SUBTENANT EVER DEPOSIT
ANY ESTERS OR KETONES (USUALLY FOUND IN SOLVENTS TO CLEAN UP PETROLEUM PRODUCTS)
IN THE DRAINS AT THE PREMISES OR BUILDING, AND ALL PROVISIONS OF THE THIRD
PARAGRAPH OF PARAGRAPH 9 OF THE PRIME LEASE APPLY TO PRIME TENANT AND SUBTENANT
WITH RESPECT TO THE SUBLET PREMISES. Prime Tenant or Subtenant shall, within
thirty (30) days after demand therefor, provide to Landlord a written list
identifying any Hazardous Material then maintained by the occupant of the Sublet
Premises, the use of each such Hazardous Material so maintained together with
written certification stating, in substance, that neither Prime Tenant,
Subtenant nor any person for whom the certifying party is responsible has
released or discharged any Hazardous Material in or about the Building or the
Project. Landlord's right of entry under the Prime Lease shall include the right
to enter and inspect the Premises for violations of Prime Tenant's and
Subtenant's covenants herein.
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 6
20. Landlord, Prime Tenant and Subtenant agree that the release and
waiver of subrogation provisions stated in Section 19 of the Prime Lease shall
be deemed a three party agreement binding among and inuring to the benefit of
Landlord, Prime Tenant and Subtenant in connection with the Subleased Premises.
Very truly yours,
Landlord:
METROPOLITAN LIFE INSURANCE COMPANY,
a New York corporation
By: /s/ Edward J. Hayes
-----------------------------------
Its: Assistant Vice President
-----------------------------------
ACKNOWLEDGED AND AGREED:
Cygnus, Inc.,
a Delaware corporation
By: /s/ Barbara G. McClung
-----------------------------------
Its: Vice President & General Counsel
-----------------------------------
SUBTENANT:
The 3DO Company,
a Delaware corporation
By: /s/ John Adams
-----------------------------------
Its: CFO
-----------------------------------
The 3DO Company,
a California corporation
By: /s/ John Adams
-----------------------------------
Its: CFO
-----------------------------------
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 7
EXHIBIT A
[ATTACH FULL COPY OF SUBLEASE AS EXHIBIT A]
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 8
EXHIBIT B
None
<PAGE>
Cygnus, Inc.
February 25, 1999
Page 9
EXHIBIT C
None
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<PAGE>
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<PERIOD-START> MAR-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 8,480
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<PP&E> 20,873
<DEPRECIATION> 13,549
<TOTAL-ASSETS> 36,864
<CURRENT-LIABILITIES> 19,319
<BONDS> 50,269
0
0
<COMMON> 22
<OTHER-SE> (33,269)
<TOTAL-LIABILITY-AND-EQUITY> 36,864
<SALES> 0
<TOTAL-REVENUES> 2,921
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,355
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 140
<INCOME-PRETAX> (6,818)
<INCOME-TAX> (2)
<INCOME-CONTINUING> (6,816)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,816)
<EPS-PRIMARY> (0.31)
<EPS-DILUTED> (0.31)
<FN>
<F1>THIS AMOUNT REPRESENTS SHORT-TERM INVESTMENTS HELD BY THE COMPANY 3/31/99
</FN>
</TABLE>
