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UNITED STATES 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 JUNE 30, 1999
OR
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________.
TO ______________.
COMMISSION FILE NO. 000-23275
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0423465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
285 N. Wolfe Road
Sunnyvale, California 94086
(Address of principal executive offices, including zip code)
(408) 773-9121
(Registrant's telephone number, including area code)
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
--- ---
As of July 30, 1999, 14,319,616 shares of the Registrant's Common Stock were
outstanding.
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SOMNUS MEDICAL TECHNOLOGIES, INC.
INDEX
PART I. FINANCIAL INFORMATION
- ------------------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
June 30, 1999 and December 31, 1998................ 3
Condensed Consolidated Statements of Operations
for the Three and six month periods ended
June 30, 1999 and 1998............................. 4
Condensed Consolidated Statements of Cash Flows
for the Three and six month periods ended
June 30, 1999 and 1998............................. 5
Notes to Condensed Consolidated Financial
Statements......................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...... 8
Item 3. Quantitative and Qualitative Disclosures of
Market Risk........................................ 19
PART II. OTHER INFORMATION
- ---------------------------
Item 2. Changes in Securities and Use of Proceeds.......... 20
Item 4. Submission of Matters to a Vote of Security
Holders............................................ 20
Item 6. Exhibits and Reports on Form 8-K................... 20
Signatures.................................................. 21
</TABLE>
2
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PART I - FINANCIAL INFORMATION
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Item 1. Financial Statements
SOMNUS MEDICAL TECHNOLOGIES, INC.
Condensed Consolidated Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
(Unaudited) (*)
--------------------- --------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents.................. $ 27,012 $ 32,280
Accounts receivable, net................... 1,683 1,329
Inventories................................ 801 806
Other current assets....................... 287 411
--------------------- --------------------
Total current assets......................... 29,783 34,826
Property and equipment, net.................. 1,443 1,601
Other assets................................. 106 85
--------------------- --------------------
$ 31,332 $ 36,512
===================== ====================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable........................... $ 1,854 $ 1,521
Accrued liabilities........................ 2,695 2,174
Accrued compensation....................... 2,311 1,858
Accrued clinical costs..................... 776 675
Deferred revenue and related allowances.... 1,521 856
--------------------- --------------------
Total current liabilities.................... 9,157 7,084
Stockholders' equity:
Common stock............................... 14 14
Additional paid-in capital................. 65193 65,046
Deferred stock compensation................ (267) (450)
Accumulated deficit........................ (42,765) (35,182)
--------------------- --------------------
Total stockholders' equity................... 22,175 29,428
--------------------- --------------------
$ 31,332 $ 36,512
===================== ====================
</TABLE>
(*) Derived from audited financial statements.
See accompanying notes
3
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SOMNUS MEDICAL TECHNOLOGIES, INC.
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the Three Months Ended For the Six Months Ended
---------------------------- ----------------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue * $ 2,967 $ 2,015 5,309 $ 3,700
Cost of sales 1,666 1,300 3,172 2,624
------------ ------------ ------------ ------------
Gross margin 1,301 715 2,137 1,076
Operating expenses:
Research and development 1,499 1,647 3,370 4,029
Selling, general and administrative 3,576 3,399 7,172 5,993
------------ ------------ ------------ ------------
Total operating expenses 5,075 5,046 10,542 10,022
------------ ------------ ------------ ------------
Loss from operations (3,774) (4,331) (8,405) (8,946)
Interest and other income, net * 330 528 822 1,070
------------ ------------ ------------ ------------
Net loss $(3,444) $(3,803) $(7,583) $(7,876)
Net loss per share:
Basic and diluted $(0.24) $(0.28) $(0.54) $(0.58)
============ ============ ============ ============
Shares used in computing per share amounts:
Basic and diluted 14,211 13,644 14,144 13,562
============ ============ ============ ============
</TABLE>
* Revenue for the three and six months ended June 30, 1999 includes related
party revenue of $191,000 and $350,000, respectively. Interest and other
income, net for the three and six months ended June 30, 1999 includes
nonrecurring technology and documentation fees from a related party of
$133,000.
See accompanying notes
4
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SOMNUS MEDICAL TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, In thousands)
<TABLE>
<CAPTION>
For the Six Months Ended
June 30, June 30,
1999 1998
--------------------- --------------------
<S> <C> <C>
Cash flows used in operating activities
Net loss $ (7,583) $ (7,876)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of deferred compensation 420 1,137
Depreciation and amortization 482 382
Net book value in property, plant and equipment retirements -- 115
Changes in operating assets and liabilities:
Accounts receivable (354) (1,923)
Inventories 5 (110)
Other current assets 123 (57)
Other assets noncurrent (21) (50)
Accounts payable and other accrued liabilities 854 116
Accrued compensation 453 396
Accrued clinical costs 101 412
Deferred revenue and related allowances 665 625
-------------- -------------
Net cash used in operating activities (4,855) (6,833)
-------------- -------------
Cash flows used in investing activities
Capital expenditures (323) (446)
Repurchase of common stock (285) -
-------------- -------------
Net cash used in investing activities (608) (446)
-------------- -------------
Cash flows provided by financing activities
Net proceeds from issuance of common stock 195 95
-------------- -------------
Net decrease in cash and cash equivalents (5,268) (7,184)
Cash and cash equivalents at beginning of period 32,280 45,145
============== =============
Cash and cash equivalents at end of period $27,012 $37,961
============== =============
Supplemental disclosure of cash flow information
Cash paid for interest $ 2 $ 2
</TABLE>
See accompanying notes
5
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SOMNUS MEDICAL TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - Summary of Significant Accounting Policies
- ---------------------------------------------------
Basis of Presentation
The condensed consolidated balance sheet as of June 30, 1999, the condensed
consolidated statements of operations for the three and six month periods ended
June 30, 1999 and 1998, and the condensed consolidated statements of cash flows
for the three and six month periods ended June 30, 1999 and 1998, have been
prepared by management, without audit, in accordance with generally accepted
accounting principles, for interim financial information and pursuant to
instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of
management, all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position at June 30, 1999 and results
of operations and cash flows for all periods presented have been made. The
condensed consolidated balance sheet at December 31, 1998 has been derived from
the audited financial statements at that date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.
These condensed financial statements should be read in conjunction with our
audited consolidated financial statements as included in our Annual Report on
Form 10-K for the year ended December 31, 1998, as filed with the Securities and
Exchange Commission. The results of operations for the three and six month
periods ended June 30, 1999 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
December 31, 1999.
Revenue Recognition
-------------------
We generally recognize revenue at the time products are shipped or, for
sales which are financed through third parties, upon acceptance from a third
party leasing company of a customer lease and the related equipment. For
shipments to distributors made under agreements, revenue is generally recognized
upon sell through by the distributor. Allowances for product returns are
provided for at the time of revenue recognition.
Comprehensive Loss
We have no material components of other comprehensive loss and,
accordingly, the comprehensive loss is the same as the net loss for all periods
presented.
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Net Loss Per Share
------------------
Basic and diluted loss per share has been calculated using the weighted
average common shares outstanding during the periods in accordance with
Statement No. 128 "Earnings Per share" issued by the Financial Accounting
Standards Board and Securities and Exchange Commission Staff Accounting Bulletin
(SAB) No. 98.
We have securities outstanding that could dilute basic earnings per share
in the future that were not included in the computation of net loss per share in
the periods presented as their effect is antidilutive.
Segment Information
We have organized the business in one operating segment which includes
activities relating to development, manufacturing and marketing of medical
devices and utilization of proprietary radiofrequency technology for the
treatment of upper airway disorders. Substantially all of our assets are in the
United States and through June 30, 1999 we have derived our revenue primarily
from our operations in the United States.
NOTE 2 - Inventories
- --------------------
<TABLE>
<CAPTION>
(in thousands) June 30, 1999 December 31,
(Unaudited) 1998
<S> <C> <C>
Raw Materials $251 $399
Work in Process 164 111
Finished Goods 386 296
------------------------------------
$801 $806
====================================
</TABLE>
NOTE 3 - Stock Repurchase Program
- ---------------------------------
In October 1998, we announced that our board of directors had authorized a
stock repurchase program permitting the purchase of up to 1,000,000 shares, at
up to $5.00 per share, of our common stock in the open market. The stock
repurchase program was implemented during the first quarter of fiscal 1999 and
100,000 shares have been repurchased under the program as of June 30, 1999 for a
net cash outflow of approximately $285,000.
7
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with our
audited financial statements and notes thereto for the fiscal year ended
December 31, 1998.
The information set forth below contains forward-looking statements
(designated by an *), and our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth below under "Factors That May Affect Future Results"
and those set forth under "Item One" in our Annual Report on Form 10-K for the
fiscal year ended December 31, 1998.
Overview
Somnus Medical Technologies, Inc. designs, develops, manufactures and
markets innovative medical devices that utilize our proprietary RF technology
for the treatment of upper airway disorders. Our Somnoplasty(SM) System provides
physicians with a suite of products designed to offer minimally invasive,
curative treatment alternatives for disorders of the upper airway, including
obstructive sleep apnea (OSA), enlarged turbinates and snoring.
We have a limited history of operations that, to date, has consisted
primarily of:
. Initiation and expansion of commercial operations,
. development of a direct sales force in the United States and internationally,
. training international distributor employees for distribution of the
Somnoplasty System in the European Union (EU) and Asia/Pacific,
. research and development,
. product engineering and
. seeking clearance of our products from the Food & Drug Administration (FDA).
We commercially introduced the Somnoplasty System internationally, through
a distributor, beginning in June 1997. One month later, after receiving 510(k)
clearance from the FDA for the use of the Somnoplasty System to treat snoring,
we began direct sales of the Somnoplasty System in the United States. We
subsequently received FDA clearance to treat enlarged turbinates, in December
1997, and OSA in November 1998. During the third quarter of fiscal 1998 we
established a European headquarters in The Netherlands. This headquarters is
responsible for:
. establishing and managing relationships with key distributors throughout
Europe,
. marketing the Somnoplasty System throughout Europe and
. providing clinical support.
We ship product from our Sunnyvale, California facility to end user
customers within the United States. Additionally, we have entered into
independent distribution agreements, several of which were executed during the
six months ended June 30, 1999, for distribution of our products within Europe,
Canada and Asia/Pacific. We expect to continue to invest in our sales and
marketing organization and to identify future qualified distribution partners.*
8
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We plan to continue to hire personnel as required to support the current
and anticipated growth, including senior management for:
. product development and enhancement,
. manufacturing expertise and large scale manufacturing capacity expansion,
. total quality management and
. continued clinical, regulatory and reimbursement efforts.*
Additionally, we intend to invest in further production equipment, test
equipment, vertical integration and facility expansion to reduce manufacturing
costs, reduce manufacturing cycle time and increase production capacity and
product quality.*
During the first quarter of fiscal 1999, we completed certain manufacturing
facility expansion and improved layout for increased capacity, process
improvement and quality control to support such growth. During the second
quarter of fiscal 1999, we commenced implementation of a reporting tool to
extract data from our core enterprise resource planning system for enhanced
reporting and analysis across the company. We believe this implementation will
involve an ongoing effort subsequent to the initial implementation.* Personnel
hires and capital expenditures will continue to require operating capital on an
ongoing basis.* We intend to continue to strengthen our management team,
improve processes, expand our internal reporting capabilities and further
strengthen systems to manage our expanding business, all of which will require
continued investment in personnel and capital equipment.*
This current and anticipated significant growth of our sales and scope of
operations may place considerable strain on our management, financial,
manufacturing and other capabilities, procedures and controls. There can be no
assurance that any existing or additional capabilities, procedures or controls
will be adequate to support our operations or that our capabilities, procedures
or controls will be designed, implemented or improved in a timely and cost-
effective manner. Failure to implement, improve and expand such capabilities,
procedures and controls in an efficient manner could have a material adverse
effect on our business, financial condition and results of operations.
As of June 30, 1999, we have incurred cumulative losses from inception of
approximately $42.8 million. Moreover, we expect to incur significant
additional operating losses beyond the next 12 months primarily due to the
development of our manufacturing and sales and marketing capabilities along with
ongoing research and development efforts, including clinical studies and
expenses associated with our patent portfolio.* Our limited operating history
makes accurate prediction of future operating results difficult or impossible.
Future revenues and results of operations may fluctuate significantly from
quarter to quarter or year to year and will depend upon numerous factors,
including the extent to which our products gain market acceptance, our ability
to increase the rate of sale of control units and handpiece consumption per
control unit, the scale-up of manufacturing capabilities, the expansion of sales
and marketing activities, our ability to attract and retain key personnel,
competition, the timing and success of new product introductions by us or our
competitors, the timing of regulatory clearances or approvals of those new
products and our ability to market our products in the United States and
internationally. Accordingly, interim period comparisons of our operating
results are not necessarily meaningful and should not be relied upon as
indicators of likely future performance or annual operating results.
9
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Our business and financial results could be materially adversely affected
in the event that we are unable to market the Somnoplasty System effectively,
anticipate customer demand accurately or effectively manage new product
launches, pricing and cost containment pressures in health care. Our operations
and financial results could also be significantly affected by international
factors, including oversight by numerous regulatory agencies, changes in foreign
currency exchange rates and foreign economic and political conditions.
Results of Operations
Net revenue. Our revenues for the three and six months ended June 30,
1999 (first and second quarter) are derived primarily from sales of our
Somnoplasty System, consisting of the S2 control unit and disposable handpieces,
to private practices, hospitals, clinics and sleep centers. During the second
quarter of 1998 the control unit commercially available was the 215 RF, the S2
control unit was introduced in June 1998. Net revenues for the second quarter
and the six months ended June 30, 1999 were approximately $3.0 million and $5.3
million respectively, an increase over the prior year periods of $952,000, or
47%, and $1.6 million, or 44%, respectively. These increases are primarily due
to increased sales of control units and increased handpiece shipments driven by
a higher installed base, increased intensity of consumption by that installed
base, plus additional indications treatable with the Somnoplasty System. During
the six month periods ended June 30, 1999 and 1998, net revenues were
attributable to sales to customers principally in the United States.
International markets accounted for approximately 10% of net revenues in fiscal
1999 and an immaterial amount in fiscal 1998. We expect that the sale of
control units will constitute a significant percentage of our total revenues in
the near term as we build an installed base of users.* However, we expect
disposable handpieces to continue to increase as a percentage of total revenue,
year over year.*
Cost of sales. Cost of sales increased by approximately $366,000, or 28%,
to $1.7 million and by $548,000, or 21%, to $3.2 million, for the second quarter
and six months ended June 30, 1999, respectively, compared to the prior year
periods. However, cost of sales reduced as a percentage to approximately 56.2%
of net revenue for the second quarter of fiscal 1999, an improvement of 13% from
the prior year period percentage of 64.5% and to approximately 59.7% of net
revenue for the six months ended June 30, 1999, an improvement of 16% from the
prior year period percentage of 70.9%. Cost of sales consists primarily of
salaries and wages, raw materials, subassemblies and completed electronics,
quality assurance and warranty costs. In fiscal 1998 cost of sales also
included manufacturing start-up costs.
The increase in cost of sales expenses for the second quarter and six
months ended June 30, 1999 are primarily direct labor and material costs related
to higher volumes of product produced. The reduction of cost of sales as a
percentage of net revenues included the effect of certain fixed costs being
absorbed over these higher volumes, a change in product mix to a higher
proportion of higher margin handpieces and process improvements, partially
offset by the effect of lower average selling prices in North America and
especially in international markets. We believe that cost of sales will
continue to increase in absolute dollars with increased volumes but may
fluctuate as a percentage of revenues.*
Research and development expenses. Research and development (R&D) costs
for the second quarter and six months ended June 30, 1999 were approximately
$1.5 million and $3.4 million, respectively, a decrease over the prior year
periods of $148,000, or 9%, and $659,000,
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or 16%, respectively. Research and development expenses are primarily comprised
of salaries and related expenses, prototype development costs, costs associated
with intellectual property, and clinical trial and regulatory approval expenses.
The decrease in expenses for the second quarter and six months is primarily
due to a decrease in salaries and employee related expenses due to lower
headcount including two open vice president and various open engineering
positions and lower costs associated with intellectual property. These were
partially offset by increased consulting costs, in part due to the open
positions and also due to intensive clinical activity substantiating the
efficacy and safety of the Somnoplasty System. Additionally a one-time charge
of $214,000, being fifty percent of the severance costs of a certain officer,
were recorded in the first quarter of fiscal 1999. The six month decrease also
included lower outside design and equipment costs associated with the intensive
development efforts in the first half of fiscal 1998. Non-cash stock
compensation charges resulting from stock option grants for the second quarter
and six months ended June 30, 1999 verses the same periods of 1998 are
approximately $40,000 and $186,000, respectively, verses $194,000 and $400,000,
respectively.
Selling, general and administrative. Selling, general and administrative
("SG&A") expenses for the second quarter and six months ended June 30, 1999 were
approximately $3.6 million and $7.2 million, respectively, an increase over the
prior year periods of $177,000, or 5%, and $1.2 million, or 20%, respectively.
SG&A expenses primarily consist of executive salaries, professional fees,
facilities overhead, accounting, information systems and human resources,
general office administration expenses such as rent and facility costs.
The increase in SG&A for the second quarter and six months is primarily
due to increased infrastructure costs, including our overseas offices,
information systems, human resources and the facility remodeling in the first
quarter of fiscal 1999. Additionally, higher commissions and travel and
entertainment costs are associated with the higher volume of sales in North
America. A one-time charge of $214,000, being fifty percent of the severance
costs of a certain officer, was recorded in the first quarter of fiscal 1999.
These increases were partially offset by a one-time charge of $300,000 being the
severance costs of a certain officer in the second quarter of fiscal 1998. Non-
cash stock compensation charges resulting from stock option grants for the
second quarter and six months ended June 30, 1999 verses the same periods of
1998 are approximately $41,000 and $189,000, respectively, verses $248,000 and
$612,000, respectively.
Interest and other income, net. Interest and other income, net for the
second quarter and six months ended June 30, 1999 was approximately $331,000 and
$822,000, respectively, compared to $528,000 and $1.1 million, respectively, for
the prior-year periods. The decreases are largely attributable to the reduction
in interest income earned on a decreasing balance of cash and cash equivalents.
The six month decrease is reduced by nonrecurring technology and documentation
fees received from a related party in the first quarter of fiscal 1999.
Interest expense for each of the second quarters is approximately $1,000 and for
each of the six month periods is approximately $2,000.
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. As a result, software
that records only the last two
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digits of the calendar year may not be able to distinguish whether "00" means
1900 or 2000. This may result in software failures or the creation of erroneous
results.
We believe, based on our assessment process, upgrades and testing, vendor
assurances and contingency plan that we are substantially Year 2000 compliant.
Such compliance is defined as ensuring that mission critical operations
experience no interruption, or if there is an interruption, that we will be able
to continue to ship product and service customers for a period of three weeks.
Prolonged interruptions to business are not planned for and could have a
material adverse affect.
We believe that our networking systems are Year 2000 compliant and our
enterprise resource planning (ERP) systems and telecommunications systems will
be Year 2000 compliant by the end of the third quarter of fiscal 1999.* We have
contacted the manufacturer of our ERP system and received written assurance that
the operating system, our implementation of the operating system and the
database will be Year 2000 compliant after a minor upgrade scheduled for the
third quarter of fiscal 1999.* We have upgraded our Microsoft operating system
and office suite to a version that Microsoft claims is Year 2000 compliant. We
do not employ any other mission critical software systems. We have identified a
Year 2000 compliant upgrade available for our current telephone system and will
be installing this upgrade during the third quarter of fiscal 1999.* We are
primarily relying upon assurances provided by vendors and will be performing
minimal testing to supplement those assurances.* We have not and do not plan to
perform substantial independent testing to validate these manufacturer's claims.
Our product is not date dependant and is therefore Year 2000 compliant.
However, while we believe we have made significant progress in resolving known
Year 2000 issues, we will perform ongoing testing and upgrades during the
remainder of fiscal 1999 to reasonably ensure Year 2000 compliance for our
operations.*
We have identified critical suppliers of products and services. Our
reliance on our key suppliers, and therefore on the proper functioning of their
information systems and software, is increasing. We have written to existing
critical suppliers to gain assurance from them of their Year 2000 readiness.
However, to date, we have not received responses from all suppliers contacted
and are in the process of following up on confirmations of our suppliers Year
2000 readiness.* There can be no assurance that we will obtain all such
responses, and that all of these suppliers or future suppliers will be Year 2000
compliant. Their failure to address Year 2000 issues could have a material
adverse effect on us.
Although it is difficult to estimate the total Year 2000 project costs, our
estimate is that such costs will total between approximately $100,000 and
$200,000, * which is not material to our business operations or financial
condition. We estimate we have incurred approximately $65,000 through June 30,
1999 on this project. The expenses of the Year 2000 project are being funded
from existing cash reserves and through operating cash flows.
Our contingency plan to address situations that may result if we are unable
to achieve Year 2000 readiness of our operations is for certain mission critical
operations for the three-week period immediately subsequent to January 1, 2000.
Mission critical operations have been identified by management as including:
. Somnus product,
- our product is not date dependant and is not dependent upon power
supplies to our facility to store in inventory. Therefore we plan to
build safety levels of raw materials and manufacture finished goods
to ensure we have inventory on hand
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to support a three week interruption in production. There can be no
assurance however, that we can build the necessary safety levels of
inventory in the period remaining prior to December 31, 1999.*
- suppliers of energy and other utility companies may not be Year 2000
compliant and may experience service interruptions. A prolonged
interruption in utility services could have a material adverse
affect.*
. Information systems, hardware and software,
- we are relying upon assurances from the manufacturers of our ERP,
networking and telecommunications systems, *
. Critical vendors,
- we have written to suppliers to gain assurances from them of their
Year 2000 readiness and will rely on their assurances,*
- we have implemented safety time into materials sourcing, *
- where practicable we have identified alternate suppliers for critical
materials*
. Critical service providers,
- our cash and cash equivalents are held between three different
financial institutions, we will therefore have access to cash for a
limited period unless all three institutions are not Year 2000
ready,*
- we have arrangements with and utilize alternate freight carriers,*
- we are relying upon utilities companies being compliant, however,
there can be no assurance that utility companies will be Year 2000
compliant*
There can be no assurance that our contingency plan will adequately address
issues that may arise in the Year 2000. Finally, we are also vulnerable to
external forces that might generally affect industry and commerce, such as
utility or transportation Year 2000 compliance failures and related service
interruptions.
We believe that we are unlikely to experience a material adverse impact on
our financial condition or results of operations due to Year 2000 compliance
issues within our operations.* However, since the assessment process is
ongoing, we believe Year 2000 compliance complications can not be fully known,
critical suppliers of components, services and others including utility
companies are outside our control, and potential liability issues are not clear,
the full potential impact of the Year 2000 on us is not known at this time. If
management and our suppliers fail to remedy any Year 2000 issues, the most
likely worst case scenario would include one or a combination of the following
events occurring: interruption of electricity which would prevent the
manufacturing and testing of products; collapse of financial and communications
networks which would hinder the payment and collection of invoices as well as
basic business transactions conducted over the telephone or the internet;
shortages of supplies and parts resulting from "panic" buying or hoarding which
would adversely affect the manufacturing of products as well as ongoing research
and development; interruption in freight service which would prevent us from
delivering product.* Any of these occurrences could result in material costs
and loss of revenue. At this time, we are not able to estimate the extent or
duration of the events discussed above or to quantify the effect it would have
on our future revenues and results from operations.
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Liquidity and Capital Resources
Since inception through June 30, 1999, we have financed our operations
primarily through the private placement of equity securities, bank loans, lease
lines of credit, stockholder loans and our November 1997 IPO. From inception, we
raised approximately $16.4 million in net proceeds from private equity
financings. We raised an additional $43.8 million from our IPO, net of costs of
$4.5 million.
Cash and cash equivalents at June 30, 1999 were $27.0 million compared to
$32.3 million at December 31, 1998.
Net cash used in operating activities was approximately $5.1 million for
the six months ended June 30, 1999, compared to $6.8 million for the prior-year
period. Net cash used in operating activities differs from our net loss for
these comparison periods primarily due to non-cash charges associated with the
amortization of deferred compensation, the depreciation of property and
equipment, the reduction in other current assets and the increase in accounts
payable and other accruals and deferrals. These sources of funds were offset by
an increase in accounts receivable, as we have increased sales of our products.
Net cash used in investing activities was approximately $323,000 for the six
months ended June 30, 1999, compared to $446,000 for the prior-year period, the
net cash used in investing activities was primarily attributable to capital
expenditures during these periods and additionally the stock repurchase program
in 1999. Net cash provided by financing activities was approximately $147,000
for the six months ended June 30, 1999 and for the prior year period was
$95,000. Net cash provided by financing activities in these six month periods
is primarily attributable to the exercise of options.
We recorded deferred stock compensation expense for the difference between
the exercise price and the deemed fair value for financial statement
presentation purposes of our Common Stock, as determined by the Board of
Directors, for certain options granted. The total unamortized deferred stock
compensation at June 30, 1999 is $267,000. Our amortized deferred compensation
expenses were approximately $183,000 in the six months ended June 30, 1999,
compared to $1.1 million for the respective 1998 period. The remainder of the
deferred stock compensation will be amortized over the corresponding vesting
period of each respective option, which is generally four years from date of
original issuance.*
At June 30, 1999, our principal sources of liquidity consisted of $27.0
million in cash and cash equivalents. There were no other material unused
sources of liquid assets at June 30, 1999.
We currently anticipate that our capital expenditure requirements will be
approximately $1 million for the next twelve months.* These requirements relate
primarily to the acquisition of computer hardware and software, manufacturing
and test equipment and for additional leasehold improvements to handle
anticipated headcount additions.*
We anticipate that our existing resources will enable the us to maintain
our current and planned operations at least through the next twelve months.*
However, there can be no assurance that we will not require additional funding
prior to such time. Our future capital requirements will depend on many
factors, including the ability of management to establish and maintain strategic
distributor relationships, our ability to attract and retain key employees, the
time and cost in obtaining regulatory approvals, competing technological and
market developments, the cost of manufacturing, market penetration and other
factors. There can be
14
<PAGE>
no assurance that additional financing to meet our funding requirements will be
available as needed. If additional funds are raised by issuing equity
securities, substantial dilution to existing stockholders may result.
Insufficient funds may require us to delay, scale back or eliminate some or all
of our research or development programs or to relinquish rights to products at
an earlier stage of development or on less favorable terms than we would
otherwise seek to obtain. The failure of management to raise capital when needed
would have a material adverse effect on our business, financial condition and
results of operations.
Factors That May Affect Future Results
Our operating results may vary significantly depending on certain factors,
including the effect of lack of market acceptance of products, maintained rate
of increase of our installed base or the rate of consumption of handpieces by
that installed base, delays in the introduction or shipment of new products,
inability to attract and retain key personnel, increased competition, delays in
ongoing research and development programs, litigation costs should we be
involved in litigation, adverse changes in the economic conditions in any of the
several countries in which we do business, a slower growth rate in our target
markets, the uncertainty of international regulatory clearances or approvals,
and the factors set forth in our annual report on form 10-K for the fiscal year
ended December 31, 1998.
Several factors will impact our ability to achieve market acceptance.
RF tissue volume reduction in the upper airway is a new and novel
development. Market acceptance of this procedure for the treatment of OSA,
enlarged turbinates and snoring could be adversely affected by numerous factors,
including:
. the lack of availability of third-party reimbursement,
. cost of the procedure,
. clinical acceptance,
. long-term effectiveness of tissue volume reduction ,
. effective physician training and
. patient acceptance.
Third party reimbursement. We do not anticipate that patients will receive
third-party reimbursement for use of the Somnoplasty System in the treatment of
snoring.* Market acceptance of the Somnoplasty System for the treatment of OSA
and enlarged turbinates will depend, in large part, upon the availability of
third-party reimbursement for each of those indications, which is not assured.*
Cost of the procedure and clinical acceptance. Market acceptance will also
depend upon our ability to demonstrate that the Somnoplasty System is an
attractive alternative to existing procedures, which will depend upon
physicians' evaluations of the clinical safety and efficacy, ease of use,
reliability and cost-effectiveness of the Somnoplasty System in a clinical
setting.* We believe that recommendations and endorsements by influential
physicians will be essential to market acceptance.* There can be no assurance
that such recommendations or endorsements will be obtained.
Long-term effectiveness. Market acceptance will depend, in large part, upon
the effectiveness of the Somnoplasty System over time.* There can be no
assurance that the
15
<PAGE>
procedure will provide a permanent, curative treatment for patients. Independent
factors, such as aging and weight gain, may, over time, lead to the enlargement
of tissue in areas previously treated by our procedure.* Such regrowth of tissue
could require further treatments, making the procedure a potentially less
attractive alternative to existing surgical and non-surgical procedures, which
could have a material adverse effect upon our business, financial condition and
results of operations.
Physician training. Broad use of the Somnoplasty System will require
training for physicians on how to perform the Somnoplasty procedure and
educating physicians regarding the advantages of the Somnoplasty System over
currently available surgical and non-surgical approaches.* The time required to
complete such training and education could extend the sales cycle for our
products and delay or preclude commercial sales and market acceptance. If we are
unable to achieve broad market acceptance of the Somnoplasty System for our
current and anticipated indications, our business, financial condition and
results of operations would be materially adversely affected.
Patient acceptance. Patient acceptance may be affected by numerous
factors, including the possibility that the Somnoplasty procedure will require
treatments on multiple occasions, which would be not only inconvenient for the
patient, but also more costly.* Patients may require anywhere from one to six
treatments to significantly reduce snoring; however, we anticipate that most
patients will only require one to three treatments to significantly reduce
snoring.* We anticipate that most patients will require fewer treatments to
reduce enlarged turbinates than required to reduce snoring and more to treat OSA
than snoring.* Factors such as poor training of the treating physician or
improper use of the Somnoplasty System by the treating physician could lead to a
patient requiring more treatments. Patient acceptance of the Somnoplasty System
for the treatment of snoring, turbinate reduction, OSA, and other potential
indications will also depend in part upon physician recommendations as well as
other factors, including the effectiveness and reliability of the procedure as
compared to existing surgical and non-surgical procedures.* There can be no
assurance that the Somnoplasty System will be accepted by the patient community
or that market demand for such a system will be sufficient to allow us to
achieve profitable operations. In addition, publicity arising from any adverse
outcome or other problem occurring in the treatment of a Somnoplasty patient for
any reason, particularly during this early phase of the commercialization of the
Somnoplasty System, could materially adversely affect patient demand for the
procedure. Failure of the Somnoplasty System, for whatever reason, to achieve
significant patient acceptance would have a material adverse effect on our
business, financial condition and results of operations.
We have limited direct sales and marketing experience.
We have only limited experience selling and marketing the Somnoplasty
System for the treatment of OSA, enlarged turbinates and snoring. We are
directing our sales effort in the United States on private practices, clinics,
hospitals and sleep clinics through a direct sales force. We currently have a
small direct sales force that covers certain regions of the United States and
intend to increase our sales and marketing force in the near future to
accelerate commercialization of the Somnoplasty System throughout the United
States.* There can be no assurance that we will be successful in building an
effective sales and marketing force, that we will be cost-effective or that we
will ultimately prove successful in selling the Somnoplasty System on a direct
basis in the United States in sufficient quantities for us to become profitable.
Market acceptance of the Somnoplasty System will also require us to demonstrate
that the cost of our products and procedures are competitive with currently
available alternatives.* The use of the Somnoplasty System requires the
healthcare provider to make an up-front investment in
16
<PAGE>
an RF control unit. There can be no assurance that we will successfully generate
sufficient demand for the Somnoplasty System at the prices at which we currently
offer our control units and disposable devices. In the event the required
investment were to preclude us from placing sufficient quantities of control
units, our ability to sell disposable devices would be limited, which would have
a material adverse effect on our business, financial condition and results of
operations.
We need to develop successful distributor relationships for international
sales.
Our future success will depend, in part, on our ability to enter into and
successfully develop strategic and distributor relationships with other parties
with respect to the marketing and distribution of our products.*
In September 1998, we established a European Headquarters in The
Netherlands. This headquarters is responsible for:
. establishing and managing relationships with key distributors throughout
Europe,
. marketing the Somnoplasty System throughout Europe and
. providing clinical support
We ship product from our facility to end user customers within the United
States. Additionally, we have entered into independent distribution agreements,
several of which were executed during the six months ended June 30, 1999, for
distribution of our products within Europe, Canada and Asia/Pacific. We expect
to continue to invest in our sales and marketing organization and to identify
future qualified distribution partners.*
The success of our future strategic or distributor relationships, will
depend on the other parties' ability to perform the role contemplated by us.*
We may have limited or no control over the resources that any particular
strategic party or distributor devotes to our relationship with us. There can
be no assurance that we will be successful in locating or finalizing agreements
with further qualified parties with whom to enter into additional strategic or
distributor relationships or that any such relationships can be maintained or
will ultimately prove beneficial to us. In the event we are not successful in
developing such additional relationships, or if such relationships do not prove
to be successful, our business, financial condition and results of operations
would be materially adversely affected.
International sales of the Somnoplasty System are subject to numerous
risks. Distribution, pricing and marketing structures, as well as regulatory
requirements, vary significantly from country to country. Additionally, such
sales can be adversely affected by:
. limitations or disruptions caused by the imposition of government controls,
. difficulty in obtaining export licenses,
. political instability,
. trade restrictions,
. changes in foreign tax laws or tariffs or other trade regulations,
. difficulties coordinating communications among and managing international
operations,
. the risk that distributors will fail to effectively promote our products,
. the risk of financial instability of distributors,
. fluctuations in overseas economic conditions and international currency
exchange rates,
. increases in duty rates and
17
<PAGE>
. competition.
There can be no assurance that we will be able to successfully
commercialize the Somnoplasty System or any of our future products in any
international market, which would have a material adverse effect on our
business, financial condition and results of operations.
We have a limited operating history and are not profitable.
We have generated only limited revenues from sales of the Somnoplasty
System and have limited experience in manufacturing, selling and marketing our
products in commercial quantities. There can be no assurance that the
Somnoplasty System will be sufficiently successful for us to achieve significant
revenues. From inception in 1996 through June 30, 1999, we have had total
revenues of approximately $15.2 million and incurred cumulative losses of
approximately $42.8 million. We expect to significantly increase spending over
the next several years with respect to sales and marketing, manufacturing and to
a lesser extent, ongoing research and development efforts and clinical trials,
and expect to incur significant additional losses beyond the next 12 months.*
Whether we can successfully manage the transition to a larger-scale enterprise
will depend upon a number of factors, including our ability to increase our
commercial manufacturing and sales and marketing capabilities. Our inability to
establish such capabilities would have a material adverse effect on our
business, financial condition and results of operations.
We may experience manufacturing problems with regard to our control unit.
In the past we purchased our 215 RF control unit as a finished assembly
from a single-source supplier. We discontinued selling the 215 RF control unit
model during fiscal 1998. The S-2 control unit is manufactured largely by us in
our Sunnyvale, California facility. There can be no assurance that we will not
experience design or production issues as we develop and expand such
manufacturing activities.
We launched the S-2 during the second quarter of fiscal 1998. The S-2
control unit is more expensive than the 215 RF control unit. There can be no
assurance that we will be able to successfully market and sell the S-2 control
unit. Further, there can be no assurance that we will not experience increased
levels of returns of the 215 RF control unit as a result of the launch of the S-
2 control unit or that we will continue to be able to support the 215 RF control
unit. We may experience increased levels of warranty costs associated with the
new product. Further, we expect that we will continuously bring new generation
products to market that may compliment or replace current products.* There can
be no assurance that we can successfully manage these product transitions.
We are dependent on single-source suppliers for components.
We purchase certain key components of our products from single-source
suppliers. There can be no assurance that the components obtained from the
single-source suppliers will continue to be available in adequate quantities or,
if required, that we will be able to locate alternative sources of such
components on a timely and cost-effective basis. To date, we have not
experienced significant adverse effects resulting from any shortage of
components. However, there can be no assurance that the single-source suppliers
will meet our future requirements for timely delivery of components of
sufficient quality and in sufficient quantity.* The components may take several
months to procure, and a significant increase of orders could lead to
significant delays and control unit or device shortages. Such delays or
shortages, particularly as we scale up our manufacturing activities in support
of sales and distributor
18
<PAGE>
orders, would have a material adverse effect on our business, financial
condition and results of operations.
We are dependent upon key personnel.
Our future success depends in significant part upon the continued service
of certain key scientific, technical and management personnel and our ability to
attract and retain highly qualified scientific, technical and managerial
personnel.* Competition for such personnel is intense, and there can be no
assurance that we can retain our key scientific, technical and managerial
personnel or that we can attract, assimilate or retain other highly qualified
scientific, technical and managerial personnel in the future. We have taken
steps to retain our key employees, including the granting of stock options that
vest over time. However, we continue to have open positions, including key
positions in R&D, clinical and manufacturing, including all three vice president
positions. The loss of key personnel, especially if without advanced notice, or
the inability to hire or retain qualified personnel could have a material
adverse effect upon our business, financial condition and results of operations.
Due to the factors noted above, our future earnings and stock price may be
subject to significant volatility, particularly on a quarterly basis. Any
shortfall in revenues or earnings from levels expected by security analysts
could have an immediate and significant adverse effect on the trading price of
our common stock.
Item 3. Quantitative and Qualitative Disclosures of Market Risk
There have been no material changes in the reported market risks since
December 31, 1998.
19
<PAGE>
PART II - OTHER INFORMATION
- -----------------------------
Item 2. Changes in Securities and Use of Proceeds
From the date of the sale of securities under our Registration Statement on
Form S-1 (File No. 333-35401), which was declared effective on November 5, 1997
(the "Offering"), through June 30, 1999, the approximate amount of net proceeds
used from the Offering were $9.4 million for research and development, clinical
trials and regulatory matters, $7.8 million to manufacture product and further
develop manufacturing expertise and capabilities, $17.4 million to improve and
expand financial capabilities, to enhance financial reporting systems, to expand
sales and marketing efforts, and for other general corporate purposes and $1.1
for the acquisition of fixed assets. The remaining net proceeds from the IPO
continue to be held in cash and cash equivalent investments.
All amounts represent estimates of direct or indirect payments of amounts
to third parties. No amounts were paid directly or indirectly for the above
purposes to directors of officers of the Company, to persons owning ten percent
or more of any class of equity securities of the Company, or to affiliates of
the Company. The use of proceeds described above do not represent a material
change in the use of proceeds describe in the Offering prospectus.
Item 4: Submission of Matters to a Vote of Security Holders
We solicited proxies for an annual meeting of stockholders on May 13, 1999
to all of our stockholders.
The election of all directors was conducted and the following nominees were
elected: Gary R. Bang, John G. Schulte and Abhi Acharya, PH.D.
<TABLE>
<CAPTION>
Votes Votes
Name For Withheld
---- --- --------
<S> <C> <C>
Gary R. Bang 9,976,910 42,800
John G.Schulte 9,976,910 42,800
Abhi Acharya, PH.D. 9,976,910 42,800
</TABLE>
Our 1996 Stock Plan was amended and the number of shares of Common Stock
reserved for issuance under the plan was increased by 500,000 to 4,350,000 with
8,702,195 votes in favor, 1,311,850 votes against and 5,665 abstentions.
Ernst & Young, LLP was ratified as the independent auditors of the Company
for the fiscal year ending December 31, 1999 with 9,979,392 votes in favor and
40,318 votes withheld.
Item 6: Exhibits and Reports on Form 8-K
(a) There were no reports on Form 8-K during the quarter ended June 30,
1999.
Exhibit 10.5 - Development and Supply Agreement+
Exhibit 27.1 - Financial Data Schedule
+ Confidential treatment requested
20
<PAGE>
SOMNUS MEDICAL TECHNOLOGIES, INC.
---------------------------------
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.
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Registrant)
Date: August 16, 1999 By: /s/ John G. Schulte
----------------------------
John G. Schulte
President and
Chief Executive Officer
By: /s/ Robert D. McCulloch
------------------------------
Robert D. McCulloch
Vice President of Finance
Chief Financial Officer and Chief Information
Officer (principal financial and accounting
officer)
21
<PAGE>
EXHIBIT 10.5
DEVELOPMENT AND SUPPLY AGREEMENT
This DEVELOPMENT AND SUPPLY AGREEMENT ("Agreement"), effective as of July
__, 1996, (the "Effective Date"), by and between Somnus Medical Technologies,
Inc., having a principal place of business at 995 Benecia Avenue, Sunnyvale,
California 94086 ("Somnus"), and Apical Instruments, Inc., having a principal
place of business at 967 North Shoreline Boulevard, Mountain View, California
94043 ("Apical").
WHEREAS, Somnus and Apical desire that Apical perform development work on
behalf of Somnus with respect to radio frequency generators for use in ear,
nose, and throat applications, on the terms and conditions set forth herein; and
WHEREAS, Apical desires to manufacture and sell Products (as defined
herein) exclusively for and to Somnus, and Somnus is willing to purchase such
Products from Apical.
NOW, THEREFORE, Somnus and Apical agree as follows:
1. DEFINITIONS
The following terms shall have the following meanings herein:
1.1 "Affiliate" shall mean: (a) any entity owning, controlling, or
---------
controlled by, directly or indirectly, at least fifty percent (50%) of the stock
normally entitled to use for election of directors as a party; or (b) any entity
of at least fifty percent (50%) of whose stock normally entitled to vote for
election of directors is owned, controlling, or controlled by, directly or
indirectly, a party, or if such level of ownership or control exceeds that
which, is otherwise permissible in the country of residence of such entity, the
maximum ownership or control right permitted in such country.
1.2 "Generator(s)" shall mean a radio frequency (RF) generator meeting the
------------
specifications set forth in Exhibit A hereto.
1.3 "Deliverables" shall mean the items to be delivered by Apical to
------------
Somnus upon completion of the Development Tasks, as set forth in Article 2
below.
1.4 "Product" shall mean a Generator sold by Somnus, its Affiliates,
-------
sublicensees, and/or distributors, exclusive of a computer, monitor and an
enclosure for the Generator.
1.5 "Specifications" shall mean the technical and other specifications for
--------------
the Deliverables and Development Tasks, as set forth in Exhibit A.
1.6 "Technology" shall mean all tangible and intangible results and items
----------
arising out of, developed in connection with or constituting the results of the
Development Program, including all
- --------------------------------------------------------------------------------
Confidential treatment has been requested for portions of this exhibit. The
copy filed herewith omits the information subject to the confidentiality
request. Omissions are designated as *****. A complete version of this
exhibit has been filed separately with the Securities and Exchange
Commission.
- --------------------------------------------------------------------------------
<PAGE>
Deliverables, Generators, Products, ideas, inventions, discoveries, designs,
know-how, notes, memoranda, documentation, and copyrighted materials, and all
intellectual property rights constituting, embodied in, or pertaining to any of
the foregoing. It is understood that Technology shall not include know-how,
designs, or other information developed or acquired by Apical outside of the
Development Program.
1.7 "Term Sheet" shall mean that certain Memorandum of Terms executed by
----------
the parties on April 24, 1996, a copy of which is appended hereto as Exhibit B.
1.8 Rules of Construction. As used in this Agreement, all defined terms
---------------------
used in the singular shall include the plural, and vice versa, as the context
may require. The words "hereof," "herein," and "hereunder" and other words of
similar import refer to this Agreement as a whole. The word "including" when
used herein is to intended to be exclusive and instead shall mean "including,
without limitation," unless otherwise indicated. The descriptive Article,
Section and Paragraph numbers and headings are used for convenience and
reference only and do not constitute a part of and shall not be utilized in
interpreting this Agreement. This Agreement has been negotiated and drafted by
the parties and their respective counsel and shall be fairly interpreted in
accordance with its terms and without any rules of construction relating to
which party drafted the Agreement being applied in favor or against either
party.
2. PRODUCT DEVELOPMENT
2.1 Development Tasks.
-----------------
2.1.1 Performance. Apical shall use its best efforts to complete
-----------
development of a commercially marketable Product by October 1, 1996 (the
"Development Program"), and shall complete the following development tasks
("Development Tasks") and deliver to Somnus the Deliverables in accordance with
the Development Task Schedule below.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Development Task Schedule
- -------------------------------------------------------------------------------------------------------------
Development Task Completion Date Deliverable
---------------- --------------- -----------
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------------
1. Complete full specifications and block July 3, 1996 Full specifications and block diagram
diagram schematic for a Generator schematic for a Generator
- -------------------------------------------------------------------------------------------------------------
2. Complete engineering drawings and detailed July 8, 1996 Engineering drawings and detailed
electrical schematics for a Generator electrical schematics for a Generator
- -------------------------------------------------------------------------------------------------------------
3. Complete PC board design for a Generator August 22, 1996 Generator PC board design
- -------------------------------------------------------------------------------------------------------------
4. Complete first Generator prototype September 15, 1996 Generator prototype
- -------------------------------------------------------------------------------------------------------------
5. Complete first product October 1, 1996 First product
- -------------------------------------------------------------------------------------------------------------
</TABLE>
Apical agrees to conduct the Development Program in a prudent and
skillful manner with employees with proper training and skills, and in
accordance will all applicable U.S., state and local laws, rules, regulations,
and other requirements now or later in effect.
-2-
<PAGE>
2.1.2 No Subcontractors. Apical shall not subcontract any aspect of
-----------------
its obligations under this Agreement in respect of the Development Tasks or
manufacturing of Generators without Somnus' prior written consent.
2.1.3 No Conflicts. During the term of this Agreement, Apical agrees
------------
not to conduct any work or services on its own behalf or for any other party
which is competitive with its obligations to Somnus hereunder. For purposes of
this paragraph, "competitive" work or services shall mean any activity relating
to the development or manufacture of RF products or technology for use in mouth,
nose or throat applications.
2.2 Compensation.
------------
2.2.1 Payments. In consideration for the activities of Apical
--------
hereunder, and subject to any applicable withholdings, Somnus shall pay to
Apical the amount specified below, in each case within fifteen (15) days of the
date Apical completes the corresponding Development Task:
<TABLE>
<CAPTION>
Development Task and Payment Schedule
-------------------------------------
Payment
--------
<S> <C>
1. Execution of the Term Sheet by the parties $ 35,000
2. Somnus approves Product specifications and block diagram schematic 15,000
3. Somnus approves engineering drawings and electrical schematics for a Product 15,000
4. Somnus approves PC board design for a Product 15,000
5. Somnus approves first Product prototype 0
6. Somnus approves the first Product 60,000
_______
Total: $140,000
</TABLE>
2.2.2 Acknowledgment. The parties acknowledge that as of the
--------------
Effective Date, Somnus has paid, and Apical has received, Thirty-Five Thousand
Dollars ($35,000), corresponding to that payment specified above in respect of
execution of the Term Sheet by the parties.
2.3 Delivery and Acceptance.
-----------------------
2.3.1 Delivery. Upon completion of each Development Task specified
--------
in Paragraph 2.1.1, Apical shall provide to Somnus the related Deliverables,
including documentation, within five (5) days of the completion date for the
corresponding Development Task, for evaluation by Somnus pursuant to Paragraph
2.3.2 below.
2.3.2 Acceptance. Upon delivery to Somnus of each Deliverable,
----------
including related documentation, Somnus shall evaluate such Deliverable for
conformity to its corresponding Specifications. Within thirty (30) days after
delivery of a Deliverable, Somnus shall provide Apical with written acceptance
thereof, or a statement of defects to be corrected. Apical shall promptly
correct such defects and return the corrected Deliverable(s) for retesting
and/or reevaluation, and Somnus shall within thirty (30) days after such
redelivery provide Apical with written acceptance or a statement of defects
relating thereto. Failure by Somnus to deliver a statement of defects within
the
-3-
<PAGE>
thirty (30) day period shall constitute acceptance of the Deliverable. If Somnus
has not accepted any Deliverable by September 15, 1996, then Somnus may, with
written notice to Apical, elect to terminate this Agreement immediately for
default by Apical, without further opportunity to cure; provided, however, that
until Somnus notifies Apical of its election to terminate, Apical shall continue
to attempt to correct any stated defect(s) and provide conforming Deliverables.
2.4 Changes. Somnus shall have the right to request reasonable changes in
-------
or modifications ("Changes") to the Specifications during the Development
Program. If Changes will result in an increase in the cost of the Development
Tasks or Deliverables, the parties shall agree in writing upon an estimate of
additional time and material costs for the accomplishment of any Changes.
Apical shall not incur or expend costs in excess of the estimate in connection
with the Changes without Somnus's prior written consent. Apical shall provide
Somnus semi-monthly written reports regarding the progress and time and
materials costs associated with the Changes, and from time to time and at
Somnus's request, the parties shall meet to discuss Apical's progress, time, and
materials costs associated with such Changes. If Changes will effect the
projected completion date of the Development Program (i.e., September 15, 1996),
Apical shall promptly notify Somnus of the effect that such Changes would have
on the completion of the Development Tasks and Deliverables.
2.5 Development Task Reports. Apical shall provide Somnus with written
------------------------
monthly progress reports during the term of the Development Program. Such
reports shall be provided to Somnus within ten (10) days following the end of
each calendar month and shall summarize the progress with respect to the
Development Tasks during such month. On or before October 15, 1996, Apical
shall deliver to Somnus a draft written report summarizing in a form reasonably
acceptable to Somnus the performance of the Development Tasks. All such reports
shall be owned exclusively by Somnus and be Confidential Information, subject to
Article 11 herein.
2.6 Right of Access. Representatives of Somnus shall have the right to
---------------
visit Apical's facilities during normal working hours to observe the performance
of the Development Program, discuss the Development Program with representatives
of Apical, and inspect and copy all documents relevant to the Development
Program.
2.7 Warranty of Deliverables. Apical warrants that any Deliverable will
------------------------
perform in accordance and comply with its corresponding Specifications for a
period of twelve (12) months after its completion and final acceptance by
Somnus. Apical shall, at its expense, make all corrections and modifications
requested by Somnus to correct any failures to comply with this warranty which
may be discovered in the Technology and reported to Apical during such warranty
period, and Apical shall promptly deliver corrected versions to Somnus as soon
as practicable after such notice. EXCEPT FOR THE EXPRESS WARRANTIES ABOVE,
APICAL MAKES NO ADDITIONAL WARRANTIES, EXPRESS, IMPLIED, STATUTORY OR OTHERWISE,
WITH RESPECT TO THE DELIVERABLES, INCLUDING ANY WARRANTIES OF MERCHANTABILITY OR
FITNESS FOR A PARTICULAR PURPOSE.
-4-
<PAGE>
2.8 Technical Assistance. During the term of this Agreement, Apical shall
--------------------
make available to Somnus, at Somnus's request, ongoing technical assistance with
respect to the Technology provided by Apical to Somnus in connection with the
Development Program. This technical assistance will be provided to Somnus at
Apical's standard, reasonable charges therefor, including reimbursement of
travel and other expenses in connection therewith.
2.9 Ownership. Somnus shall own all right, title, and interest in the
---------
Technology, and Apical agrees to deliver all Technology, including a detailed
written description of any intangible aspect thereof to Somnus, by the end of
the Development Program. Apical hereby irrevocably transfers, conveys and
assigns to Somnus its entire right, title, and interest in the Technology, and
any intellectual property thereafter conceived, reduced to practice or otherwise
developed during the term of this Agreement which relates to a Generator,
Product or Technology. Apical shall require each of its employees who will be
involved in the Development Program hereunder to enter into a confidentiality
and proprietary rights agreement, in a form acceptable to Somnus, irrevocably
assigning any and all interest such employees might have in any Technology to
Apical. Apical shall promptly and fully disclose to Somnus in writing any
Technology, and shall treat all such Technology as the Confidential Information
of Somnus, pursuant to Article 9 below. Somnus shall have the exclusive right
to apply for or register patents, copyrights, and such other proprietary
protection(s) as it deems appropriate. Apical agrees to execute such documents,
render such assistance, and take such other action as Somnus may reasonably
request, at Somnus's expense, to apply for, register, perfect, enforce, and
defend Somnus's rights in the Technology. Somnus shall have the exclusive right
to commercialize, prepare and sell products based upon Technology, and to
sublicense, prepare derivative works from, or otherwise use or exploit the
Technology. It is understood and agreed that in the event Apical incorporates
any know-how, designs, or other information other than Technology (the "Other
Technology") into a Product, it shall so notify Somnus, and Apical agrees to
grant, and hereby grants to Somnus a fully paid up, perpetual, irrevocable,
royalty-free, non-exclusive license, including the right to grant and authorize
sublicenses, to make, have made, use, sell, and otherwise exploit such Other
Technology as it relates to Products.
3. PRODUCT MANUFACTURE AND SALE
3.1 Manufacturing License. Subject to the terms and conditions herein,
---------------------
Somnus hereby grants to Apical, and Apical hereby accepts, a non-exclusive, non-
transferable manufacturing license under the Technology solely for the purpose
of making and selling Products to Somnus pursuant to this Agreement. This
restricted license shall terminate upon termination of this Agreement.
3.2 Purchase and Sale. Apical agrees to manufacture and sell to Somnus,
-----------------
and Somnus agrees to purchase from Apical, Somnus's requirements for Products
during the term of this Agreement. The parties agree that during the term of
this Agreement, Somnus shall submit purchase orders to Apical for at least one
hundred (100) Products in accordance with the terms hereof, and if such purchase
orders are accepted by Apical during the term hereof and this Agreement is not
terminated pursuant to Section 13.2 or 13.3, Somnus shall purchase and Apical
shall supply any
-5-
<PAGE>
Product so ordered. Unless otherwise agreed by the parties in writing, Apical
shall sell Products exclusively to Somnus.
3.3 Initial Manufacturing Schedule. Without Somnus being required to
------------------------------
submit purchase orders therefor, but otherwise subject to the terms and
conditions herein, Apical shall manufacture and deliver Products to Somnus
according to the following Schedule:
<TABLE>
<CAPTION>
Delivery Date Number of Products
------------- ------------------
<S> <C>
On or before October 1, 1996 2
On or before October 15, 1996 2
On or before October 30, 1996 2
On or before November 15, 1996 2
On or before November 31, 1996 2
</TABLE>
3.4 Forecasts. Following the successful completion of the Development
---------
Program and before November 1, 1996, and quarterly thereafter, Somnus shall
provide Apical with a rolling forecast of Somnus's anticipated quarterly
requirements of Products for the following twelve (12) month period commencing
on the date of such forecast. Such forecast shall create a firm commitment on
Somnus to purchase the Products forecast for the first three (3) calendar months
of such forecast, but shall not create a binding obligation on Somnus for the
remainder of such twelve (12) month period. It is understood that Somnus shall
use reasonable efforts to make each forecast as accurate as possible.
3.5 Orders. Somnus may initiate purchases under this Agreement by
------
telephone contact, telex, fax or by submitting written purchase orders to Apical
at the address above. Any purchase order initiated by telephone, fax or telex
must be confirmed within ten (10) working days by a written purchase order. All
purchase orders shall contain: (a) a purchase order number and date; (b)
quantity of Product(s) to be purchased; (c) shipping instructions; (d) a
specified delivery date; (e) a destination and billing address (if different
from Somnus's address listed above); (f) the net unit price for the Product(s);
and (g) a signature made by an authorized Somnus representative.
3.6 Acceptance. Purchase orders shall be binding when accepted by Apical.
----------
Apical shall acknowledge each purchase order in writing within ten (10) business
days of receipt. Within such ten (10) day period, Apical may reject an order
which does not conform with the terms and conditions of this Agreement, or if
such order is for quantities substantially larger than prior orders which
Apical, using commercially reasonable efforts, cannot fulfill. Notice of
rejection must be sent to Somnus by telex or fax, followed by notification in
writing. If an order is neither confirmed nor rejected by Apical within ten
(10) business days of receipt, it shall be deemed to have been accepted.
3.7 Delivery Date. Unless otherwise agreed in writing by the parties,
-------------
Apical shall deliver Products to Somnus at the specified destination, as
provided in Section 3.8, no later than five (5) days after the date specified in
an accepted purchase order.
-6-
<PAGE>
3.8 Shipping. All Products subject to this Agreement shall be suitably
--------
packed for shipment in containers adequate to insure safe arrival of the goods
at Somnus's designated delivery destination, marked for shipment to the address
specified in Somnus's purchase order or such other address as Somnus may specify
in writing, and delivered to a carrier or forwarding agent chosen by Somnus.
Apical shall mark all containers with necessary lifting, handling and shipping
information, purchase order numbers, and date of shipment. An itemized packing
list must accompany each shipment. Somnus shall bear all costs for
transportation, shipping and insurance expenses, and in the event that Somnus
requests special packaging or finishing for any order, Somnus shall pay the
incremental cost for such special packaging or finishing; provided, however,
that Apical agrees to include any special documentation regarding the Products
requested by Somnus at no additional charge. Shipment will be F.O.B. Somnus's
designated facility, Sunnyvale, California. All shipping papers and/or invoices
shall include the purchase order number and serial numbers of Products shipped.
3.9 Terms and Conditions. This Agreement contains the exclusive terms and
--------------------
conditions which shall apply to all purchases of Products by Somnus. In
ordering and delivering Products, Somnus and Apical may use their standard
forms, but nothing in such forms shall amend or modify the terms of this
Agreement. In case of conflict between such forms and this Agreement, the terms
of this Agreement shall control.
3.10 Second Source. In the event Apical is unable to or fails to meet any
-------------
of Somnus's Product reasonable requirements in any quarter at any time during
the term of this Agreement, Somnus shall, at its sole discretion, have the
right, but not the obligation, to (i) select a second source to manufacture
Products for all or part of Somnus's Product requirements, and/or (ii) itself
undertake the manufacture of part or all of its Product requirements. In the
event Somnus either selects a second manufacturing source or itself undertakes
the manufacture of Products, Apical shall actively cooperate with and use its
best efforts to enable the second source and/or Somnus, as the case may be, to
begin and continue such manufacture as soon as is commercially practicable, and
to provide such assistance to such party as may be required or helpful in
manufacturing Products. In this regard, in the event Somnus requests in writing
that Apical provide manufacturing assistance in respect of the manufacture of
Products, Apical shall use its best efforts to promptly after receipt of such
request dispatch to the second source or Somnus, as the case may be, one or more
mutually agreed technical personnel to assist in establishing a Product
manufacturing operation. The parties agree that to effectuate the purpose of
this Agreement in the event that Apical fails to meet its supply obligations
hereunder, after Apical begins commercial manufacture of Products, personnel
designated by Somnus shall be given adequate opportunity to study and observe
the manufacture of Products by Apical at Apical's Product production facility
and other appropriate locations, at such reasonable times and for such
reasonable periods as may be reasonably requested by Somnus.
4. CANCELLATION AND RESCHEDULING
4.1 Changes. Somnus may reschedule for up to sixty (60) days, adjust the
-------
number of Product units ordered, or cancel all or a portion of a purchase order
previously accepted by Apical,
-7-
<PAGE>
provided Somnus provides Apical notice of such rescheduling, adjustment, or
cancellation at least forty five (45) days in advance of the delivery date
specified in the corresponding purchase order. Apical shall use its best efforts
to comply with all rescheduled delivery dates. Requests for rescheduling,
adjustment or cancellation made by Somnus less than ten (10) days prior to the
specified delivery date may be accepted or rejected at Apical's discretion. In
the event that Somnus requests rescheduling, adjustment or cancellation of an
order for delivery less than twenty (20) days before the specified delivery
date, Apical may request that Somnus pay an inventory deposit with respect to
any materials which have been received or for which noncancellable orders have
been placed by Apical prior to Apical's receipt of the notice of rescheduling,
adjustment or cancellation.
4.2 Delayed Delivery. Apical shall promptly notify Somnus if any
----------------
circumstance arises which could result in delivery of a Product after the
specified delivery date in an accepted purchase order. If Somnus has not
received Products for which Apical accepted a purchase order more than twenty
(20) days following the specified delivery date, and the cause of such delay was
within the reasonable control of Apical, Somnus shall, in addition to other
remedies provided herein with respect to a failure by Apical to meet its supply
obligations, be entitled to cancel such order, in whole or part, with such
cancellation to be effective immediately upon Apical's receipt of notice to such
effect from Somnus. Somnus will reimburse Apical for all raw materials, work in
process and finished products effected by such cancellation, and Somnus will be
the owner of all such materials.
5. PRICING AND PAYMENT
5.1 Product Prices. Somnus shall pay to Apical [*] for each Product
--------------
ordered and delivered, in accordance with Sections 5.3 and 5.4.
5.2 Taxes. All prices described herein are exclusive of federal, state
-----
and local excise, sales, use and similar taxes. Somnus shall be liable for and
shall pay all applicable taxes invoiced by Apical, unless Somnus provides Apical
with a properly executed tax exemption certificate prior to delivery of an
invoice setting forth any such taxes.
5.3 Payment. Apical shall issue Somnus individual invoices for each
-------
Product shipment. Each such invoice shall separately list the number of Product
units, the individual and total prices therefor, taxes, transportation, shipping
and insurance charges, and any special packaging or finishing charges. Somnus
shall pay each invoice within thirty (30) days of the date of such invoice or
the delivery date, whichever is later. Payment of an invoice shall not
constitute implied acceptance of Products listed thereon.
5.4 Payment Method. Somnus shall, at its discretion, make payment to
--------------
Apical for Products by check or by wire transfer to an account specified by
Apical. Accounts outstanding over thirty (30) days will be subject to a charge
of one and one-half percent (1.5%) per month, or the maximum interest allowed by
law, whichever is less.
- --------------------------------------------------------------------------------
****** Certain information on this page has been omitted and filed separately
with the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.
- --------------------------------------------------------------------------------
-8-
<PAGE>
6. PRODUCT QUALITY
6.1 Quality Assurance. Apical agrees to assure the quality level of
-----------------
Products through the use of a formal quality assurance program reasonably
acceptable to Somnus. Such program shall require Apical to prepare and maintain
written records sufficient to enable Somnus to trace the history of each Product
unit. Pursuant to such program, Apical shall place serial numbers on all
Products to enable the identification and tracing of individual Product units.
During the term of the Agreement, Somnus shall have the right to audit such
quality assurance program, at its expense, during regular business hours.
6.2 Inspection. Apical shall conduct a final inspection and quality
----------
control test on each Product prior to shipment to verify that such Product meets
and conforms with the Specifications. Each shipment of Products shall be
accompanied by a quality assurance analytical data sheet (the "Q.A. Data
Sheet").
6.3 Inspection and Acceptance. Somnus shall have the right and Apical
-------------------------
shall cooperate to the fullest extent practicable in giving Somnus an
opportunity to inspect the Products at all times and places, including during
the period of manufacture. However, no inspection or test made prior to final
inspection and acceptance at Somnus's facility shall relieve Apical from
responsibility for defects or other failure to supply conforming Products.
Final inspection and acceptance of Products shall be at Somnus's facility, and
shall be performed within ten (10) working days after Somnus receives the
Products.
6.4 Latent Defects. It is understood that Products may have defects
--------------
("defects" meaning that such Products fail to conform to the applicable
Specifications or otherwise fail to conform to the warranties given by Apical
herein) which would not be discoverable upon reasonable physical inspection or
testing (the "Latent Defects"). As soon as either Somnus or Apical becomes
aware of a Latent Defect in any Product, it shall immediately notify the other
party and, during the warranty period, at Somnus's election, such Products shall
be deemed nonconforming to the Specifications and rejected as of the date of
such notice, and the provisions of Article 8 shall apply to such Products.
6.5 Presence at Facility. During the term of this Agreement, Somnus shall
--------------------
have the right upon reasonable notice and during normal business hours to have
its representatives visit the facilities at which Products are being
manufactured, and to inspect such facilities and the records relating to the
manufacture of Products to verify Apical's compliance with the terms of this
Agreement and the warranties in Article 10 below, including Apical's manufacture
of Products in compliance with Good Manufacturing Practices ("GMP"), ISO 9000
requirements or other applicable rules and regulations.
7. PRODUCT CHANGES
7.1 Requested Modifications. Somnus may request or Apical may suggest
-----------------------
changes in the design or operation of the Products relating to improvements, or
the reliability or serviceability of the
-9-
<PAGE>
Products. The parties shall promptly discuss such modifications in good faith
and Apical shall make any modifications requested by Somnus, provided Somnus
agrees to pay the reasonable costs of implementing such changes.
7.2 Mandatory Modifications. In the event any changes must be made in the
-----------------------
Products to comply with official requirements (including governmental regulation
or industrial standards), Apical shall make any such changes to Products. It is
understood that this may result in schedule changes, non-recurring expenses or
Product price adjustments which will be negotiated by the parties in good faith
at such time. With respect to Products changed to comply with such requirements
that have been ordered but not yet delivered, an appropriate adjustment of the
delivery date shall be agreed by the parties.
7.3 Validation Units. In the event any change effecting form, fit,
----------------
function, safety, reliability or performance of a Product is made, at Somnus's
request, Apical shall ship to Somnus one or more validation units incorporating
such changes. Within thirty (30) days after receipt of such validation unit(s),
Somnus shall notify Apical of whether it approves or disapproves of the proposed
changes. Apical shall not make any proposed change(s) until the end of such
thirty (30) day period, or until Somnus provides notice of its approval of such
change(s), whichever occurs earlier. At Somnus's request, Apical shall stop all
further manufacture of Products until such approval is given by Somnus.
8. PRODUCT WARRANTY
8.1 Limited Warranty. Apical hereby warrants to Somnus that:
----------------
8.1.1 on the date of shipment, all Products sold by Apical to Somnus
hereunder are new, will comply with the Specifications for such Products and any
further specifications, standards and/or criteria agreed upon by the parties,
and conform fully with the Q.A. Data Sheet provided for the particular Product
according to Section 6.2 hereof;
8.1.2 Products purchased hereunder shall be free from defects in
material and workmanship for a period of twelve (12) months from the date of
shipment to Somnus;
8.1.3 all of the Products sold hereunder shall have been
manufactured, packaged, stored and shipped in conformance with all applicable
GMP, ISO 9000 requirements or other applicable rules and regulations which are
in force or hereinafter adopted by the U.S. Food and Drug Administration or any
successor agency thereto, or any corresponding foreign regulatory body
(individually and collectively referred to hereinafter as "FDA"), as set forth
in the Specifications;
8.1.4 title to all Products sold hereunder shall pass to Somnus as
provided herein free and clear of any security interest, lien, or other
encumbrance;
-10-
<PAGE>
8.1.5 Apical shall meet Somnus's required shipment and/or delivery
schedule(s) as provided in purchase orders submitted in accordance with the
terms herein; and
8.1.6 the Products sold to Somnus hereunder shall have been
manufactured, packaged and stored in facilities which are approved by the FDA at
the time of such manufacture, packaging and storage, to the extent such approval
is required by law.
8.2 Effect of Warranty.
------------------
8.2.1 Options. If any Product purchased hereunder does not meet the
-------
warranties specified herein or otherwise applicable, Somnus may, at its option
(i) require Apical to replace or correct at no cost to Somnus any defective or
nonconforming Product(s), (ii) return any nonconforming Product(s) to Apical at
Apical's expense and recover from Apical the full market price thereof, or (iii)
replace or correct the defective or nonconforming Product(s) itself and charge
Apical with the reasonable cost of such correction. The foregoing remedies are
in addition to all other remedies at law or in equity or under this Agreement
and shall not be deemed to be exclusive thereof. All warranties and remedies
available hereunder to Somnus shall also be available to Somnus's Affiliates,
licensees, distributors and customers.
8.2.2 No Waiver. No inspection or acceptance, approval or
---------
acquiescence by Somnus with respect to nonconforming Products shall relieve
Apical from any portion of its warranty obligation, nor shall waiver by Somnus
of any Specification requirement for one or more Products constitute a waiver of
such requirements for remaining Products unless expressly agreed by Somnus in
writing.
8.3 Warranty Procedures. Subject to Section 8.2 above, Somnus may send
-------------------
Products with defects covered by the foregoing warranties to Apical's repair
center at an address specified by Apical from time to time. Somnus shall
request authorization from Apical prior to the return of each defective Product
for repair or replacement by Apical. Upon such request, Apical shall provide
Somnus with a Material Return Authorization (MRA) tracer number to be
prominently displayed on the shipping container for the defective Product. Once
Somnus receives an MRA number for any defective Product, Somnus may ship such
Product to Apical's designated repair facility, at Apical's expense, in its
original shipping container or in a container of equivalent protective
constitution. If such defective Product is received by Apical during the
applicable warranty period, Apical shall, at its sole option and expense, repair
or replace such Product, employing at its option, new or used parts or Products,
and shall ship the repaired or replaced Product to Somnus, freight prepaid.
8.4 Exclusions. The limited warranties set forth in Section 8.1 above
----------
shall not apply to defects to a Product which result from normal wear and tear
or improper, unqualified or unauthorized repair of Products.
8.5 Disclaimer. EXCEPT FOR THE ABOVE LIMITED WARRANTIES, APICAL MAKES NO
----------
WARRANTIES WITH RESPECT TO THE PRODUCTS, EXPRESS, IMPLIED, STATUTORY, OR
OTHERWISE IN ANY PROVISION OF THIS AGREEMENT, AND APICAL
-11-
<PAGE>
SPECIFICALLY DISCLAIMS ANY IMPLIED WARRANTY OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE.
8.6 Maintenance. Somnus shall be responsible for performing all
-----------
maintenance with respect to the Products.
9. CONFIDENTIALITY
9.1 Confidential Information. Pursuant to this Agreement, Somnus may
------------------------
disclose to Apical certain proprietary technical or business information or
materials ("Confidential Information"). Apical agrees that it will not use any
Confidential Information received from Somnus except for the purposes of this
Agreement. Apical agrees not to disclose any Confidential Information of Somnus
to third parties, and to maintain and to use its best efforts to prevent
unauthorized disclosure or use of the Confidential Information and to prevent
the same from falling into the public domain or the possession of unauthorized
persons. Apical agrees to disclose to its employees only such Somnus
Confidential Information as is necessary to each employee's responsibilities in
performing the acts allowed by this Agreement. Apical shall immediately advise
Somnus of any disclosure, loss or use of Confidential Information in violation
of this Agreement. Apical agrees that for a period of seven (7) years from the
Effective Date it will hold Somnus Confidential Information in strict confidence
and not disclose to any third party any such Confidential Information except as
expressly agreed upon in writing by Somnus.
9.2 Exclusions. Confidential Information shall not include information:
----------
9.2.1 that becomes lawfully known or available to Apical from a
source other than Somnus without breach of this Agreement;
9.2.2 that was already known to Apical, as evidenced by written
records, before its disclosure by Somnus to Apical;
9.2.3 that is within, or later falls within, the public domain
without breach of this Agreement by Apical;
9.2.4 publicly disclosed with the written approval of Somnus; or
9.2.5 disclosed pursuant to a requirement or demand of a lawful
governmental or judicial authority, but only to the extent required by operation
of law, regulation or court order.
10. TRADEMARKS
10. Somnus, in its sole discretion, may select the trademarks, trade names
and trade dresses to be used in connection with each Product, and all such
trademarks, trade names and trade
-12-
<PAGE>
dresses shall be and become the exclusive property of Somnus. Apical shall not
adopt any trademark, trade name or trade dress that may be confusingly similar
therewith. Apical shall acquire no interest or rights in and to any trademarks,
trade names and trade dresses selected or used by Somnus. Somnus shall have the
right to remove any Apical trademarks incorporated in, marked on, or fixed to
the Products.
11. REPRESENTATIONS AND WARRANTIES
11.1 Somnus. Somnus represents and warrants on an continuing basis that:
------
(i) it has the right to enter this Agreement, is a corporation duly organized,
validly existing, and in good standing under the laws of the state in which it
is incorporated, (ii) has the power and authority to execute and deliver this
Agreement and to perform its obligations hereunder, (iii) has by all necessary
corporate action duly and validly authorized the execution and delivery of this
Agreement and the performance of its obligations hereunder.
11.2 Apical. Apical represents and warrants on an continuing basis that:
------
(i) Apical has the right to enter this Agreement, is a corporation duly
organized, validly existing and in good standing under the laws of the state in
which it is incorporated; (ii) has the power and authority, to execute and
deliver this Agreement and to perform its obligations hereunder; (iii) it has by
all necessary corporate action duly and validly authorized the execution and
delivery of this Agreement and the performance of its obligations hereunder;
(iv) any employee or other personnel affiliated with Apical who will perform
Development Tasks or other work related to or in connection with Development
Program, have access to Technology, or manufacture Products has executed a
proprietary information and technology agreement in favor of Apical, pursuant to
which such employee or other personnel is obligated to assign his/her entire
right, title, and interest in and to any invention, discovery, technology, or
related intellectual property conceived of, reduced to practice or otherwise
developed in the course of their employment to Apical; and (v) it has not and
will not during the term of this Agreement enter into any agreement which
conflicts with or which will result in any breach of, or constitute a default
under, any note, security agreement, commitment, contract or other agreement,
instrument or undertaking to which Apical is a party.
12. INDEMNITY
12.1 Somnus Indemnity. Somnus shall defend, indemnify and hold Apical,
----------------
its officers, directors, employees and agents (each an "Apical Indemnitee")
harmless from any and all damages, liabilities, costs and expenses (including,
but not limited to, reasonable attorneys' fees) incurred by an Apical Indemnitee
as a result of any claim, action, suit on proceeding by a third party based on
any breach or alleged breach of any of Somnus's representations and warranties
in Section 11.1, from injury to or death of any person, or damage to property
arising out of or in connection with the distribution or use of any Product
manufactured by Somnus; provided, however, that Somnus shall have no obligation
to indemnify any Apical Indemnitee for any damage, liability, cost or expense to
the extent caused by any negligent or wilful act or omission by or on behalf of
Apical. Somnus shall
-13-
<PAGE>
defend, indemnify and hold any Apical Indemnitee harmless from any and all
damages, liabilities, costs and expenses (including, but not limited to,
reasonable attorneys' fees) that may be asserted against any such Indemnitee by
any Somnus customer or any other third party in respect of any Somnus act or
omission, or arising from compliance by Apical with Somnus designs,
specifications, instructions or requirements (but only to the extent that any
such claim or liability does not arise from a defect in workmanship or
components used by Apical), or from the incorporation of the Products into any
other device, provided that any such claim or other liability is not
attributable to the Product incorporated into such device.
12.2 Apical Indemnity. Apical shall defend, indemnify and hold Somnus,
----------------
its officers, directors, employees and agents (each a "Somnus Indemnitee")
harmless from any and all damages, liabilities, costs and expenses (including,
but not limited to, reasonable attorneys' fees) incurred by a Somnus Indemnitee
or any Somnus customer, representative, distributor, or dealer arising out of
any claim, action, suit or proceeding by a third party based on any breach or
alleged breach of any of Apical's representations and warranties in Section
11.2, any failure of the Products manufactured by Apical to meet the
Specifications, or arising out of or in connection with Apical's performance of
this Agreement; provided, however, that Apical shall have no obligation to
indemnify any Somnus Indemnitee or customer, distributor, dealer or
representative of Somnus for any damage, liabilities, costs or expenses to the
extent caused by any negligent or wilful act or omission by or on behalf of
Somnus.
12.3 Procedure. In the event that a party, or any of its Affiliates,
---------
directors, officers, employees or agents (each an "Indemnitee") intends to claim
indemnification under this Article 12, such Indemnitee shall notify the other
party (the "Indemnitor") in writing of any alleged loss, claim, damage,
liability or other action (individually or collectively, a "Liability") in
respect of which the Indemnitee intends to claim indemnification hereunder. The
failure by any Indemnitee to deliver written notice to the Indemnitor within a
reasonable time after becoming aware of any Liability for which indemnification
is later sought hereunder, if prejudicial to the Indemnitor's ability to defend
against such Liability, shall relieve Indemnitor of any obligation to such
Indemnitee under this Article 12. The Indemnitor shall have the right to
control the conduct of any action, defense, or other proceeding, including
settlement, in respect of indemnification sought hereunder for any Liability,
and the Indemnitee shall cooperate fully with the Indemnitor and its legal
representatives in the investigation and conduct of any action, defense,
settlement or other proceeding covered by this Article 12. An Indemnitee shall
not, except at its own cost, voluntarily make any payment or incur any expense
with respect to any Liability, or make any admission of liability or attempt to
settle any claim in respect of a Liability without the prior written consent of
the Indemnitor, which consent the Indemnitor shall not be required to give.
-14-
<PAGE>
13. TERM AND TERMINATION
13.1 Term. This Agreement shall commence on the Effective Date and shall
----
have a term of one (1) year from the first commercial distribution of a Product,
unless terminated earlier as provided herein. This Agreement may be extended by
written mutual agreement of the parties.
13.2 Termination for Cause. Either party may, without penalty, terminate
---------------------
this Agreement or cancel any purchase order or portion thereof effective upon
written notice to the other party in the event of one of the following events:
13.2.1 The other party materially breaches this Agreement, and such
breach remains uncured for thirty (30) days following written notice of breach
by the nonbreaching party, unless such breach is incurable, in which event
termination shall be immediate upon receipt of written notice;
13.2.2 Any cause as set forth in Section 15.5 delays the other
party's performance for more than sixty (60) days; or
13.2.3 A petition for relief under any bankruptcy statute is filed
by or against the other party, or the other party makes an assignment for the
benefit of creditors, or a receiver is appointed for all or a substantial part
of the other party's assets, and such petition, assignment or appointment is not
dismissed or vacated within sixty (60) days.
13.3 Permissive Termination. Somnus shall have the right to terminate the
----------------------
Development Program or this Agreement for any reason, or no reason, upon thirty
(30) days notice to Apical, and, after completion of the Development Program,
Apical may terminate this Agreement for any reason, or no reason, upon thirty
(30) days notice to Somnus.
13.4 Effect of Termination or Expiration.
-----------------------------------
13.4.1 Cessation of Development Program. If Somnus terminates the
--------------------------------
Agreement prior to the completion of the Development Program, Apical will
immediately cease making expenditures attributable to the Development Program
upon receipt of Somnus's notice of intent to terminate. Somnus shall reimburse
Apical for all services actually performed prior to its receipt of notice of
termination. Within thirty (30) days of the effective date of termination,
Apical shall provide Somnus a final written report of all costs incurred and
shall reimburse Somnus for any funds advanced in excess of total costs incurred.
13.4.2 Accrued Right and Obligations. In the event of expiration of
-----------------------------
this Agreement, the provisions hereof shall continue to apply to (i) all
purchase orders accepted by Apical prior to the effective date of expiration,
and (ii) Products ordered on such purchase orders. Except as provided herein,
termination or expiration of this Agreement shall not relieve or release either
party from making payments for obligations accrued prior to such termination.
In the event Apical terminates this Agreement for cause, such payments by Somnus
shall include costs of all raw materials
-15-
<PAGE>
purchased by Apical for use in manufacturing Products or for which
noncancellable orders were placed prior to the receipt of any notice of
termination by Apical, work in progress relating to Products, and finished
Products made by Apical. In the event Somnus terminates this Agreement for cause
other than for Apical's failure to meet its Product supply obligation hereunder,
Somnus will purchase from Apical at Apical's actual cost such raw materials,
work in progress relating to Products, and finished Products made by Apical
prior to the effective date of such termination. In the event Somnus terminates
this Agreement because of Apical's failure to meet its supply obligations
hereunder, Somnus shall be relieved of its obligation to pay Apical for Products
ordered by purchase orders accepted by Apical, and Somnus shall have no
obligation with respect to (i) raw materials ordered by Apical in respect of
such Products and (ii) work in progress relating to Products.
13.4.3 Return of Confidential Information. Upon any termination, but
----------------------------------
not expiration, of this Agreement, Apical shall promptly return to Somnus any
Confidential Information received from Somnus prior to such termination, and
Apical shall no longer be entitled to use any such Confidential Information for
any purpose.
13.4.4 Assistance by Apical. In the event of any termination of this
--------------------
Agreement during the term hereof, at Somnus's request and expense, Apical shall
use its best efforts to assist Somnus, as it may elect at its sole discretion,
to (i) locate and establish a second source for the manufacture of Products
meeting the Specifications, and/or (ii) initiate and thereafter continue to
itself manufacture all or a part of its Product requirements, as provided in
Section 3.10.
13.5 Survival. Sections 2.7, 2.9, 5.2, 13.4 and 13.5, and Articles 8, 9,
--------
11, 12, 14 and 15 shall survive the termination of this Agreement for any
reason.
14. ARBITRATION
If a dispute arises between the parties relating to the interpretation or
performance of this Agreement, or the grounds for the termination hereof,
representatives of the parties with decision-making authority shall meet to
attempt in good faith to negotiate a resolution of the dispute prior to pursuing
other available remedies. If within thirty (30) days after such meeting the
parties have not succeeded in negotiating a resolution of the dispute, and
unless otherwise mutually agreed, such dispute shall be submitted to final and
binding arbitration under the then current Commercial Arbitration Rules of the
American Arbitration Association ("AAA"), by one (1) arbitrator in Santa Clara
County, California. Such arbitrator shall be selected by the mutual agreement
of the parties or, failing such agreement, shall be selected according to the
aforesaid AAA rules. The arbitrator will be instructed to prepare and deliver a
written, reasoned opinion stating his decision within thirty (30) days of the
completion of the arbitration. Such arbitration shall be concluded within nine
(9) months following the filing of the initial request for arbitration. The
parties shall bear the costs of arbitration equally and shall bear their own
expenses, including attorneys' and other professional fees. The decision of the
arbitrator shall be final and non-appealable and may be enforced in any court of
competent jurisdiction.
-16-
<PAGE>
15. MISCELLANEOUS
15.1 Governing Law and Jurisdiction. This Agreement shall be governed by
------------------------------
the laws of the State of California, without reference to principles of
conflicts of laws.
15.2 Compliance with Laws. Apical shall perform this Agreement in
--------------------
compliance with all applicable U.S. and foreign national, state and local laws,
rules and regulations. Apical shall indemnify Somnus and its customers for loss
or damage sustained because of Apical's noncompliance with any such law, rule or
regulation. Apical shall furnish to Somnus any information requested or
required by Somnus during the term of this Agreement or any extensions hereof to
enable Somnus to comply with the requirements of any U.S. or foreign federal,
state and/or government agency.
15.3 Limitation of Liability. IN NO EVENT SHALL EITHER PARTY BE LIABLE
-----------------------
FOR INCIDENTAL, CONSEQUENTIAL, INDIRECT, OR SPECIAL DAMAGES OF THE OTHER PARTY
ARISING OUT OF THIS AGREEMENT, UNDER ANY THEORY OF LIABILITY.
15.4 Inspections by Government Agencies. With respect to any adverse
----------------------------------
findings affecting Products, Apical shall promptly notify Somnus of any
inspections by U.S. and foreign national, federal, state or local regulatory
representatives (including, without limitation, FDA, EPA, EEOC, OSHA, and
corresponding or similar foreign agencies or entities, state agencies or
building code inspectors) of any facility at which a Product is being or will be
manufactured and shall provide Somnus with the results of any such inspections,
including actions taken by Apical or any other entity to remedy conditions cited
in such inspections. Without limiting the generality of the foregoing, Apical
shall provide copies of any written inspection reports issued by such agencies
and all correspondence between Apical and the agency involved. Apical shall
permit such regulatory agencies to conduct whatever inspections of the
facilities at which Products are to be manufactured as such agencies may request
in connection with Somnus's obtaining approval to manufacture and market the
Products, and shall cooperate fully with any such regulatory entity, domestic or
foreign as the case may be, during any such inspections. Apical will give
Somnus prompt written notice of any inspection relating to Products and allow
representatives of Somnus to be present at such facilities during any such
inspection.
15.5 Force Majeure. Neither party shall be held responsible for any delay
-------------
or failure in performance hereunder caused by strikes, embargoes, unexpected
government requirements, civil or military authorities, acts of God, earthquake,
or by the public enemy or other causes reasonably beyond such party's control
and without such party's fault or negligence.
15.6 Independent Contractors. Apical shall perform its obligations
-----------------------
hereunder as an independent contractor and shall be solely responsible for its
own financial obligations. Nothing contained herein shall be construed to imply
a joint venture or principal and agent relationship between the parties, and
neither party shall have any right, power or authority to create any obligation,
express or implied, on behalf of the other in connection with the performance
hereunder.
-17-
<PAGE>
Apical will not act as an agent of Somnus and Apical's employees shall not be
deemed to be employees of Somnus for the purpose of any employee benefit
program, tax withholding, FICA taxes, unemployment benefits or otherwise.
15.7 Confidentiality of Agreement. Except as required by law, Apical
----------------------------
shall not disclose the contents or any term of this Agreement to any person or
entity without the prior written consent of Somnus.
15.8 Further Assurances. At any time or from time to time on and after
------------------
the date of this Agreement, Apical shall at the request of Somnus (i) deliver to
Somnus such records, data or other documents consistent with the provisions of
this Agreement, and (ii) execute, and deliver or cause to be delivered, all such
assignments, consents, documents or further instruments of transfer or license,
and (iii) take or cause to be taken all such other actions, as Somnus may
reasonably deem necessary or desirable in order for Somnus to obtain the full
benefits of this Agreement and the transactions contemplated hereby.
15.9 Notices. All notices or reports permitted or required under this
-------
Agreement shall be in writing and shall be delivered in person, mailed by first
class mail, postage prepaid, (registered or certified), or sent by telecopy, to
the party to receive the notice at the address or telecopy number listed below,
or such other address as either party may specify in writing. All such notices
shall be effective upon receipt.
If to Somnus: Somnus Medical Technologies, Inc.
21070 Homestead Road, Suite 205
Cupertino, California 95014
FAX: (408) 773-9137
Attention: President
If to Apical: Apical Instruments, Inc.
967 North Shoreline Boulevard
Mountain View, California 94043
FAX: (415) 967-3371
Attention: President
15.10 No Use of Names. Neither party will use the name of the other in
---------------
its advertising or promotional materials without the prior written consent of
such other party.
15.11 No Implied License. Except as expressly provided herein, nothing
------------------
contained in this Agreement shall be implied to grant Apical any license with
the respect to any Confidential Information, Deliverables, Products or
Technology.
15.12 Assignment. Apical shall not assign this Agreement or any rights
----------
hereunder without the prior written consent of Somnus. Somnus may assign this
Agreement without restriction.
-18-
<PAGE>
15.13 Severability. If any provision(s) of this Agreement shall be held
------------
invalid, illegal or unenforceable by a court of competent jurisdiction to the
maximum extent possible, this Agreement shall continue in full force and effect
without said provision.
15.14 Modification; Waiver. This Agreement may not be altered, amended or
--------------------
modified in any way except by a writing signed by both parties. The failure of
a party to enforce any provision of the Agreement shall not be construed to be a
waiver of the right of such party to thereafter enforce that provision or any
other provision or right.
15.15 Entire Agreement. This Agreement and the exhibits hereto represent
----------------
and constitute the entire agreement between the parties and supersede all prior
agreements and understandings with respect to the matters covered by this
Agreement.
IN WITNESS WHEREOF, the parties have caused this Agreement to be duly
executed by their authorized representatives and delivered in duplicate
originals as of the Effective Date.
SOMNUS MEDICAL TECHNOLOGIES, INC. APICAL INSTRUMENTS, INC.
By: By:
----------------------------- ------------------------------
Print Name: Print Name:
---------------------- ----------------------
Title: Title:
--------------------------- ---------------------------
-19-
<PAGE>
EXHIBIT A
---------
GENERATOR SPECIFICATIONS
Each Generator shall meet the following specifications:
[*]
- --------------------------------------------------------------------------------
****** Certain information on this page has been omitted and filed separately
with the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT B
---------
MEMORANDUM OF TERMS
<PAGE>
April 18, 1996
Bruno Strul
Re: Somnus Letter of Intent
Dear Bruno:
As you know, Somnus Medical Technology, Inc. (hereafter "Somnus") would
like to enter into a Development and Manufacturing Agreement with Apical
Instruments, Inc. (hereafter "Apical"), to have Apical develop and manufacture a
proprietary RF generator. The purpose of this Letter of Intent is to establish
a framework in order to proceed towards a definitive agreement between Somnus
and Apical.
1) The parties have initiated discussions regarding a Development and
Manufacturing Agreement (the "Proposed Transaction") and agree that they shall
proceed to negotiate a definitive agreement covering the Proposed Transaction
culminating in a final agreement (the "Agreement") with the intent to finalize
and execute the Agreement no later than April 23, 1996, or such later date as
the parties may mutually agree; provided, however, that either party may
discontinue such negotiations at any time by written notice for any reason
whatsoever. The parties agree that the Business Proposal dated April 4, 1996,
attached to this Letter of Intent, summarizes the current status of the
discussions between representatives of Somnus and Apical, and the business terms
for the Agreement. Although it is the intent of the parties that their
negotiations initially proceed based upon on the Business Proposal, the parties
acknowledge that the terms contained in the Business Proposal have not been
agreed to by the parties and are subject to change in the course of the planned
negotiations.
2) The parties further agree not to disclose at any time to any third
party, whether by way of press release, announcement or in any other matter,
without the prior written consent of the other party, the existence, intent or
terms of this Letter of Intent, or the occurrence or content of any discussions,
negotiations or investigations which have occurred or which may occur regarding
the Proposed Transaction.
3) Any provisions of the Proposed Transaction shall not be binding on
either party or be deemed to create any legal rights or obligations between
Somnus and Apical, but rather are only intended to facilitate negotiations and
preparations of the Agreement embodying the final understanding of the parties.
Neither party shall have any liability whatsoever to the other party where its
discontinuance of such negotiations by written statement at any time prior to
April 23, 1996 or its decisions for any reason not to enter into the Agreement.
The Agreement shall be subject to all required corporate approvals at Somnus and
Apical. Each party shall bear its own expenses in connection with the
negotiation and consummation of the Proposed Transaction and any actions taken
by either party in reliance on this Letter of Intent shall be at such parties so
risk an expense.
Please contact me directly at (408) 773-9121 should you have any questions
regarding the content of this letter. Otherwise, please indicate the concurrence
of Apical as the basis on which we will
<PAGE>
proceed to negotiate the Agreement as set forth below by executing both copies
of this letter in the space provided below and returning one copy to me at your
earliest convenience. I look forward to the successful completion of the
negotiations contemplated by this letter.
Very truly yours
Stuart Edwards
President & CEO
Somnus Medical Technology, Inc.
Agreed and Accepted:
APICAL INSTRUMENTS, INC.
Date:
- ------------------- -------------------------
Bruno Strul, President and CEO
-4-
<PAGE>
Business Proposal
April 4, 1996
1. Apical shall complete the development of a commercially deliverable RF
generator suitable for mass manufacturing (hereafter the "Commercial Generator")
shall be completed by __________________. The following milestones will be met:
A.
B.
C.
The Commercial Generator shall meet the following specification:
[*, pp3-5]
- --------------------------------------------------------------------------------
****** Certain information on this page has been omitted and filed separately
with the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.
- --------------------------------------------------------------------------------
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<PAGE>
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