SOMNUS MEDICAL TECHNOLOGIES INC, S-1/A, 1997-10-29

SOMNUS MEDICAL TECHNOLOGIES INC
S-1/A, 1997-10-29
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 29, 1997

REGISTRATION NO. 333-35401
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

---------------

AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

---------------

SOMNUS MEDICAL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

---------------

DELAWARE 3841 77-0423465
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
INCORPORATION OR
ORGANIZATION)

285 N. WOLFE ROAD
SUNNYVALE, CALIFORNIA 94086
(408) 773-9121
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

---------------

STUART D. EDWARDS
CHIEF EXECUTIVE OFFICER
SOMNUS MEDICAL TECHNOLOGIES, INC.
285 N. WOLFE ROAD
SUNNYVALE, CALIFORNIA 94086
(408) 773-9121
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

---------------

COPIES TO:
J. CASEY MCGLYNN, ESQ. GERALD S. TANENBAUM, ESQ.
JOHN T. SHERIDAN, ESQ. CAHILL GORDON & REINDEL
WILSON SONSINI GOODRICH & ROSATI EIGHTY PINE STREET
PROFESSIONAL CORPORATION NEW YORK, NY 10005-1702
650 PAGE MILL ROAD (212) 701-3000
PALO ALTO, CA 94304
(650) 493-9300

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration
Statement.

---------------

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE
REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.

================================================================================
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++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY JURISDICTION IN WHICH SUCH OFFER, SOLICITATION OR SALE +
+WOULD BE UNLAWFUL PRIOR TO THE REGISTRATION OR QUALIFICATION UNDER THE +
+SECURITIES LAWS OF ANY SUCH JURISDICTION. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion

PROSPECTUS October 29, 1997
4,000,000 Shares
LOGO

SOMNUS MEDICAL TECHNOLOGIES, INC.
Common Stock
(par value $0.001 per share)

All of the shares of Common Stock (the "Common Stock") offered hereby (the "Of-
fering") are being offered by Somnus Medical Technologies, Inc., a Delaware
corporation ("Somnus" or the "Company").

Prior to the Offering, there has been no public market for the Common Stock. It
is currently anticipated that the initial public offering price of the Common
Stock will be between $9.00 and $11.00 per share. See "Under-writing" for
information relating to the factors to be considered in determining the initial
public offering price of the Common Stock. Application has been made to have
the Common Stock quoted on the Nasdaq National Market under the symbol "SOMN."

SEE "RISK FACTORS" COMMENCING ON PAGE 7 FOR CERTAIN INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.

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PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT (1) COMPANY (2)
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<S> <C> <C> <C>
Per Share $ $ $
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Total (3) $ $ $
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(1) The Company has agreed to indemnify the Underwriters against certain lia-
bilities, including liabilities under the Securities Act of 1933, as amended.
See "Underwriting."
(2) Before deducting expenses of the Offering payable by the Company estimated
at $800,000.
(3) The Company has granted to the Underwriters an option, exercisable within
30 days after the date of this Prospectus, to purchase up to an additional
600,000 shares of Common Stock on the same terms as set forth above, solely to
cover over-allotments, if any. If such option is exercised in full, the total
Price to Public, Under writing Discount and Proceeds to Company will be $ ,
$ and $ , respectively. See "Underwriting."

The shares of Common Stock offered by this Prospectus are being offered by the
Underwriters, subject to prior sale, when, as and if delivered to and accepted
by the Underwriters, and subject to approval of certain legal matters by Cahill
Gordon & Reindel, counsel for the Underwriters. It is expected that delivery of
the shares of Common Stock offered hereby will be made against payment therefor
on or about , 1997 at the offices of J.P. Morgan Securities Inc., 60 Wall
Street, New York, New York.

J.P. MORGAN & CO.
UBS SECURITIES
SMITH BARNEY INC.

, 1997
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[Illustration of the Somnoplasty System,
including the models 615, 115 and 215
Radiofrequency Generators, and the
SP 1000, SP 1100, SP 3000 and SP 2000
Somnoplasty electrodes.]

The disposable devices and generators depicted above, except for the Model
115 Radiofrequency Generator, have been cleared by the FDA. The Somnoplasty
System has been cleared by the FDA for the treatment of snoring, but not for
other indications. There can be no assurance that the Model 115
Radiofrequency Generator will receive clearance from the FDA, or that the
Somnoplasty System will be cleared for any additional indications.

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFI-
CALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING AND MAY
BID FOR, AND PURCHASE, THE COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION
OF THESE ACTIVITIES, SEE "UNDERWRITING."
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[Illustration of unobstructed upper airway anatomy]

[Illustration of obstructed upper airway anatomy]

Somnus Medical Technologies, Inc. designs, develops, manufactures and markets
innovative medical devices to treat obstructions in the upper airway.
Obstructed breathing can result from enlarged tissues in the turbinates, soft
palate, uvula, tonsils and base of the tongue. The Somnoplasty System is cur-
rently cleared by the FDA for tissue volume reduction of the soft palate and
uvula for the treatment of snoring. Devices to treat other upper airway indica-
tions are in clinical trials and in development.

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THE SOMNOPLASTY PROCEDURE FOR THE TREATMENT OF SNORING

Somnoplasty is an outpatient, office-based
procedure. The physician first applies a local
anesthetic to the uvula and soft palate. After a
few minutes, the Somnus disposable device, which
is connected to a radiofrequency generator, is
placed into the mouth. A small electrode located
at the end of the device is inserted into the
soft palate.
[PICTURE #1]

Radiofrequency energy is applied through the
electrode. Energy is delivered for 1 1/2 to 5
minutes, heating the tissue in a limited area
around the electrode. Part of the electrode is
insulated to protect the delicate surface of the
tissue. The patient experiences only minimal
discomfort during the procedure.
[PICTURE #2]

The Somnoplasty procedure creates a submucosal
lesion in the soft palate. The patient may
experience some minor swelling and may have a
mild sore throat. Following the Somnoplasty
procedure, most patients take an over the
counter analgesic for one to three days.
[PICTURE #3]

Over a period of three to six weeks, the lesion
is naturally resorbed by the body, leading to
tissue volume reduction. By reducing and tight-
ening the obstructive tissue, the procedure is
designed to reduce snoring.
[PICTURE #4]
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No person has been authorized to give any information or to make any represen-
tations not contained in this Prospectus and, if given or made, such informa-
tion or representations must not be relied upon as having been authorized by
the Company or any Underwriter. This Prospectus does not constitute an offer to
sell, or a solicitation of an offer to buy, the Common Stock in any jurisdic-
tion to any person to whom it is unlawful to make such offer or solicitation.
Neither the delivery of this Prospectus nor any sale made hereunder shall under
any circumstances create any implication that there has been no change in the
affairs of the Company subsequent to the date hereof.

No action has been or will be taken in any jurisdiction by the Company or by
any Underwriter that would permit a public offering of the Common Stock or pos-
session or distribution of this Prospectus in any jurisdiction where action for
the purpose is required, other than in the United States. Persons into whose
possession this Prospectus comes are required by the Company and the Under-
writers to inform themselves about and to observe any restrictions as to the
offering of the Common Stock and the distribution of this Prospectus.

TABLE OF CONTENTS

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Page
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Prospectus Summary................................................ 4
Risk Factors...................................................... 7
The Company....................................................... 17
Use of Proceeds................................................... 17
Dividend Policy................................................... 17
Capitalization.................................................... 18
Dilution.......................................................... 19
Selected Consolidated Financial Data.............................. 20
Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 21

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Page
<S> <C>
Business.......................................................... 25
Management........................................................ 38
Certain Transactions.............................................. 46
Principal Stockholders............................................ 47
Description of Capital Stock...................................... 48
Shares Eligible for Future Sale................................... 50
Underwriting...................................................... 51
Legal Matters..................................................... 53
Experts........................................................... 53
Additional Information............................................ 53
Index to Consolidated Financial Statements........................ F-1
</TABLE>

UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION
TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDER-
WRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.

The Company intends to furnish its stockholders with annual reports containing
audited financial statements examined by its independent auditors and quarterly
reports containing interim unaudited financial statements for each of the first
three quarters of each fiscal year.

Somnus and Somnoplasty are a trademark and a servicemark, respectively, of the
Company. This Prospectus also contains trademarks and tradenames of other com-
panies.

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this Prospectus. The discussion in this Prospectus
contains forward looking statements that involve risks and uncertainties
including, but not limited to, those specifically identified herein. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in "Risk Factors," "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business," as
well as those discussed elsewhere in this Prospectus. Unless otherwise
indicated, all information in this Prospectus assumes (i) the conversion on a
one-for-one basis of all outstanding shares of Preferred Stock into shares of
Common Stock to be effected upon the consummation of the Offering (the
"Preferred Stock Conversion") and (ii) no exercise of the Underwriters' over-
allotment option. Selected data presented in this Prospectus is based on
interviews conducted by the Company with various industry sources.

THE COMPANY

Somnus Medical Technologies, Inc. ("Somnus" or the "Company") designs,
develops, manufactures and markets innovative medical devices that utilize its
proprietary radiofrequency ("RF") technology for the treatment of upper airway
disorders. The Company's Somnoplasty System provides physicians with a suite of
products designed to offer minimally-invasive, curative treatment alternatives
for disorders of the upper airway, including snoring, obstructive sleep apnea
("OSA") and enlarged turbinates. The Somnoplasty System shrinks tissue in the
upper airway by utilizing automated RF generators and a suite of disposable,
single-use, needle electrode devices which deliver controlled thermal energy to
obstructed areas, while protecting the delicate mucosal lining of the tissue.
The Company received U.S. Food and Drug Administration ("FDA") 510(k) premarket
clearance ("510(k) clearance") in July 1997 for the use of the Somnoplasty
System in the treatment of snoring and officially launched the marketing of the
Somnoplasty System at the American Academy of Otolaryngology--Head and Neck
Surgery Foundation, Inc. conference in September 1997. See "Business--
Government Regulation." The Company has also received the European Union
CE Mark (the "CE Mark") for use of the Somnoplasty System in the treatment of
upper airway disorders. In September 1997, the Company submitted a premarket
notification seeking 510(k) clearance for the treatment of enlarged turbinates
associated with chronic rhinitis. The Company believes that the clinical and
patient benefits of the Somnoplasty System include its effectiveness, quick
procedure time, outpatient setting, use of local anesthesia and low post-
procedural pain. These benefits represent a significant advancement to
physicians and patients over existing treatment options, which, depending upon
the disorder, are highly-invasive, non-curative and/or expensive. To date, the
Somnoplasty procedure has been performed for the treatment of snoring on over
125 patients in clinical centers in the United States and internationally.

The Company is developing a direct sales force to market its products in the
United States and Canada. The Company intends to market the Somnoplasty System
primarily to ear, nose and throat physicians, oral and maxillofacial surgeons,
pulmonologists, sleep medicine specialists and other physicians who treat upper
airway disorders. There are approximately 9,000 ear, nose and throat
physicians, 5,000 oral and maxillofacial surgeons, 5,200 pulmonologists and,
the Company believes, 3,100 sleep disorder medical centers in the United
States. As of September 30, 1997, the Company has shipped 14 Model 215 RF
Generators in the United States, including six in the month of September. In
April 1997, the Company entered into a three-year distribution arrangement with
Medtronic, Inc. ("Medtronic") for the exclusive distribution of the Somnoplasty
System in the European Union, Australia, Southeast Asia and certain other
areas. The Company will seek to enter into additional agreements for product
distribution in Japan and other international markets. The Company also intends
to establish a marketing program directed at consumers to further establish
awareness of the Somnoplasty procedure. As of September 30, 1997, the Company
has shipped 29 Model 215 RF Generators to Medtronic, including seven in the
month of September.

Currently, Somnus has commercially available or in development three models of
RF generators and five disposable devices designed to treat a variety of upper
airway disorders. In the United States, the Company currently has four issued
patents, eight allowed patents and an additional 34 pending patent applica-
tions. The Company also has two issued foreign patents and 17 pending foreign
patent applications.

MARKET OPPORTUNITIES

Habitual snoring. The Company estimates that there are more than 40 million
habitual snorers in the United States. Traditional treatment alternatives for
habitual snoring range from laser surgery to the use of non-surgical devices
such as nasal tapes and oral appliances. The surgical alternatives, including
laser-assisted uvulopalatoplasty ("LAUP"), are invasive procedures which result
in significant post-operative pain, swelling and recovery periods. Despite
these

4
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drawbacks, the Company estimates that there were approximately 45,000 to 50,000
LAUP procedures performed in 1996 in the United States. In contrast to
traditional treatments, the Company's Somnoplasty System is designed to be a
minimally-invasive, curative outpatient procedure which can be performed in one
or more sessions of less than 30 minutes each, and causes minimal pain and
swelling and requires only a brief recovery period. The Company's treatment for
snoring uses the SP 1000 single needle electrode or SP 2000 dual needle
electrode to reduce tissue in the uvula and soft palate.

Obstructive sleep apnea. According to a 1993 report to Congress, the National
Commission on Sleep Disorders Research estimated that approximately 20 million
people in the United States were afflicted with OSA, of whom an estimated 6.4
million experienced the disorder at a moderate to severe level. OSA is a
serious disorder which occurs when enlarged anatomical structures block the
upper airway during sleep. Currently, the most common approach to the
management of OSA is Continuous Positive Airway Pressure ("CPAP"), which
requires the sleeping patient to wear a mask over the nose, and sometimes the
mouth, while pressure from a compressor forces air through the upper airway to
keep excess tissue from collapsing. While CPAP is successful in managing OSA,
it is not a cure and must be used on a nightly basis for life. CPAP can also
result in a variety of adverse side effects. These side effects and the
inconvenience of the device result in low patient compliance which was
estimated by the American Sleep Disorders Association ("ASDA") at only 46% in
1993. Despite these drawbacks, the Company estimates that the market for CPAP
will be approximately $140 million in 1997, representing an approximate 25%
growth rate from the previous year. Other existing treatments for OSA include
uvulopalatopharyngoplasty ("UPPP") (the surgical resection of the uvula, part
of the soft palate, tonsils and excess tissue in the throat), tracheostomies
(surgical openings in the neck which bypass the obstruction) and other highly-
invasive surgical procedures. In contrast, the Somnoplasty System is intended
to treat, in a minimally-invasive manner, the causes of OSA, not the symptoms,
by reducing the tissues which cause the obstruction. The Company's suite of
disposable devices, including the SP 1000, SP 1100, SP 2000 and SP 3000, are
designed to allow physicians to treat any combination of the uvula, soft
palate, turbinates and tongue to enlarge the upper airway passage.

Enlarged turbinates. Chronic nasal obstructions are most frequently caused by
enlarged turbinates. Turbinates, the soft tissue in the nasal cavity, can
become chronically enlarged as a reaction to diseases, such as chronic and
drug-induced rhinitis, and allergy-causing substances. Existing treatments
include prescription and over-the-counter drugs, as well as surgical procedures
which generally entail using a scalpel or an electrocautery or laser device to
resect the turbinates. These surgical procedures are generally effective, but
can lead to discomfort in the form of occasional post- operative bleeding and
frequent crusting. In 1995, there were an estimated 129,000 turbinate resection
procedures performed in the United States, nearly all of which were performed
in an outpatient setting. The Company's SP 1100 single needle electrode device
is intended to offer a minimally-invasive, curative treatment for sufferers of
enlarged turbinates.

BUSINESS STRATEGY

The Company's strategy is to establish the Somnoplasty System, which utilizes
its proprietary RF technology, as the standard of care for the treatment of a
variety of upper airway disorders. Key elements of the Company's strategy
include: (i) providing physicians with a suite of products designed to offer
minimally-invasive, curative treatment alternatives for upper airway disorders;
(ii) pursuing clearance or approval for additional indications to achieve the
broadest possible application of the Somnoplasty System; (iii) creating global
distribution through a direct sales force in the United States and strategic
and distributor relationships internationally; and (iv) acquiring and licensing
complementary technologies and products to broaden the Company's product line,
leverage its distribution network and help accelerate the market acceptance and
penetration of the Somnoplasty System.

RISK FACTORS

An investment in the shares of Common Stock offered hereby is speculative and
involves a high degree of risk. The principal risks of the Offering include
uncertainties related to the Company's early stage of development and the
limited revenues that the Company has generated from the sale of the
Somnoplasty System, a system comprised of recently developed products, not yet
proven to result in a long-term curative treatment for snoring and other upper
airway disorders, as well as the lack of clinical and market acceptance for the
Somnoplasty System. The Company believes that its future success will depend
largely on the receipt of regulatory clearances and/or approvals for the use of
the Somnoplasty System to treat OSA and the successful commercialization and
market acceptance thereof. See "Risk Factors."

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THE OFFERING

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COMMON STOCK OFFERED............. 4,000,000 shares
COMMON STOCK OUTSTANDING AFTER
THE OFFERING.................... 12,816,214 shares(1)
USE OF PROCEEDS.................. Research and development, clinical trials,
regulatory matters, development of sales and
marketing capabilities and other general
corporate purposes. See "Use of Proceeds."
PROPOSED NASDAQ NATIONAL MARKET
SYMBOL.......................... "SOMN"
</TABLE>

SUMMARY CONSOLIDATED FINANCIAL DATA

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AS OF
SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED(3)
In thousands -------- --------------
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents............................ $ 7,013 $ 43,413
Working capital...................................... 4,741 41,141
Total assets......................................... 9,883 46,283
Long-term obligations under lease line of credit..... 2,147 2,147
Accumulated deficit.................................. (12,168) (12,168)
Total stockholders' equity .......................... 4,956 41,356
</TABLE>
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(1) Based upon shares outstanding as of September 30, 1997. Excludes as of
September 30, 1997: (i) 2,507,754 shares of Common Stock issuable upon exercise
of outstanding stock options at a weighted average exercise price of $1.95 per
share, (ii) 789,478 shares of Common Stock reserved for future issuance under
the Company's stock plans and (iii) 62,500 shares of Common Stock issuable upon
exercise of outstanding warrants at a weighted average exercise price of $1.80
per share. See "Management--Stock Plans," "Description of Capital Stock" and
Note 8 of Notes to Consolidated Financial Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
(3) As adjusted to reflect the sale of 4,000,000 shares of Common Stock offered
by the Company hereby at an assumed initial public offering price of $10.00 per
share and the receipt of the estimated net proceeds therefrom. See "Use of Pro-
ceeds" and "Capitalization."

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RISK FACTORS

An investment in the shares of Common Stock offered hereby is speculative and
involves a high degree of risk. Prospective investors should carefully con-
sider, in addition to the other information contained in this Prospectus, the
following risk factors in evaluating the Company and the Common Stock offered
hereby. This Prospectus contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward looking statements as a result of certain
factors, including those set forth in the following risk factors and elsewhere
in this Prospectus.

LIMITED OPERATING HISTORY; ABSENCE OF PROFITABILITY

The Company was incorporated in January 1996 and has a limited history of
operations that, to date, has consisted primarily of research and development,
product engineering, seeking clearance of its products from the FDA, initial
development of a direct sales force in the United States and training Medtronic
employees for distribution of the Somnoplasty System in the European Union,
Australia, Southeast Asia and certain other areas. The Company commercially
introduced the Somnoplasty System internationally, through Medtronic, beginning
in June 1997. One month later, after receiving 510(k) clearance for the use of
the Somnoplasty System to treat snoring, the Company began direct sales of the
Somnoplasty System in the United States. The Company has generated only limited
revenues from sales of the Somnoplasty System and does not have experience in
manufacturing, selling or marketing its products in large, commercial
quantities. There can be no assurance that the Somnoplasty System will be
successfully commercialized or that the Company will achieve significant
revenues. From its inception in 1996 through September 30, 1997, the Company
had total revenues of approximately $1.1 million and incurred cumulative losses
of approximately $12.2 million. The Company expects to significantly increase
its spending over the next several years with respect to research and
development efforts, clinical trials, manufacturing and sales and marketing and
expects to incur significant additional losses for the foreseeable future.
Whether the Company can successfully manage the transition to a larger-scale
commercial enterprise will depend upon a number of factors, including obtaining
additional regulatory approvals and increasing its commercial manufacturing,
sales and marketing capabilities, as well as establishing relationships with
international distributors. The Company's inability to establish such
capabilities and relationships would have a material adverse effect on its
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE

The Company has expended and will continue to expend substantial funds for
research and development, clinical testing, planned clinical investigations,
capital expenditures, manufacturing and marketing of its products. The timing
and amount of spending of such capital resources is difficult to predict
accurately and will depend upon several factors, including the progress of its
research and development efforts and planned clinical investigations, competing
technological and market developments, the receipt of regulatory clearances or
approvals, commercialization of products currently under development and market
acceptance and demand for the Company's products. To the extent required, the
Company may seek to obtain additional funds through equity or debt financing,
through collaborative or other arrangements with other companies and from other
sources. If additional funds are raised by issuing equity securities, further
dilution to stockholders could occur. There can be no assurance that additional
financing will be available when needed or on terms acceptable to the Company.
If adequate funds are not available, the Company could be required to delay
development or commercialization of the Somnoplasty System for certain
indications, to license to third parties the rights to commercialize certain
products or technologies that the Company would otherwise seek to commercialize
for itself or to reduce the marketing, customer support or other resources
devoted to certain of its products, each of which could have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Use of Proceeds," "Dilution" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."

NEED TO MANAGE GROWTH AND EXPAND FINANCIAL CAPABILITIES

Significant future growth in the Company's sales and expansion in the scope of
its operations, should they occur, may place considerable strain on the
Company's management, financial, manufacturing and other capabilities,
procedures and controls. In particular, the Company will be required in the
near term to improve and expand its financial capabilities through the addition
of qualified personnel and the enhancement of its financial reporting systems.
The Company hired a Chief Financial Officer in August 1997 and expects to hire
additional financial, accounting and other personnel in 1997. There can be no
assurance that any existing or additional capabilities, procedures or controls
will be adequate to support the Company's operations or that its capabilities,
procedures or controls will be designed, implemented or improved in a

7
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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 the Company's business, financial condition and
results of operations.

LIMITED REGULATORY CLEARANCE; DEPENDENCE UPON AND LIMITED HISTORY OF
THE SOMNOPLASTY SYSTEM

The Company's future success will depend upon the successful commercialization
and market acceptance of the Somnoplasty System for the treatment of snoring
and the successful development, regulatory clearances and/or approvals, commer-
cialization and market acceptance of the Somnoplasty System for additional
anticipated indications. In the United States, the Company has begun producing
and selling the Somnoplasty System for use in the reduction of tissue in the
uvula and soft palate to treat snoring, but the Company has not received FDA
clearance or approval to market its products for other indications, such as
reduction of tissue in the turbinates, base of the tongue or tonsils, or for
use in the treatment of OSA, which may require reduction of tissue in several
upper airway locations. The Company believes that its future success will
depend upon the ability of physicians to use one or more of the Company's
devices to treat individual or multiple indications, depending upon the
patient's needs. Consequently, if regulatory clearance or approval is not
obtained for the Somnoplasty System with respect to any one of these indica-
tions, it could materially adversely affect the Company's business, financial
condition and results of operations. Internationally, the Company received a CE
Mark in June 1997 and the Therapeutic Goods Administration ("TGA") of Australia
listing in July 1997, permitting the Company to commercialize the Somnoplasty
System in those markets for the treatment of upper airway disorders. Although
such approvals permit the Company to market its products for the treatment of
snoring, enlarged turbinates, enlarged tonsils and OSA, the Company must con-
tinue to pass annual ISO 9001/EN 46001 quality system audits ("ISO 9001") in
order to retain these international approvals. Failure to retain these
approvals could have a material adverse effect on the Company's business,
financial condition and results of operations. Other international markets,
such as Japan, have their own regulatory approval processes, and there can be
no assurance that these approvals will be obtained. Failure to obtain regula-
tory approval in other international markets could have a material adverse
effect on the Company's business, financial condition and results of opera-
tions.

The Somnoplasty System is in the early stage of commercialization and the Com-
pany has only a limited history of its use in the treatment of snoring. There
can be no assurance that the procedure, which involves the RF ablation of
tissue in the upper airways, 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 the Company's
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 the
Company's business, financial condition and results of operations.

UNCERTAINTY OF FDA OR OTHER REGULATORY CLEARANCES OR APPROVALS; GOVERNMENT
REGULATION

The preclinical and clinical testing, manufacturing, labeling, distribution and
promotion of the Company's products are subject to extensive and rigorous gov-
ernment regulation in the United States and other countries. Noncompliance with
applicable requirements can result in enforcement action by the FDA or compa-
rable foreign regulatory bodies including, among other things, fines, injunc-
tions, civil penalties, recall or seizure of products, refusal to grant
premarket clearances or approvals, withdrawal of marketing approvals and crim-
inal prosecution.

United States

The Company is prohibited from marketing its products in the United States
unless it obtains 510(k) clearance or premarket application ("PMA") approval
from the FDA. The Company believes that it usually takes from four to 12 months
from submission to obtain 510(k) clearance, but can take longer. The process of
obtaining PMA approval is much more costly, lengthy and uncertain. In any
event, there can be no assurance that 510(k) clearance or PMA approval will
ever be obtained.

The Somnoplasty System received 510(k) clearance on July 17, 1997 for the
intended use of coagulation (thermal ablation, tissue volume reduction) of soft
tissue, including the uvula and soft palate, and reduction in the severity of
snoring in some individuals. In September 1997, the Company submitted a
premarket notification seeking 510(k) clearance for the treatment of enlarged
turbinates associated with chronic rhinitis. The Company intends to seek 510(k)
clearance of the Somnoplasty System for other indications, including treatment
of OSA associated with blockage caused by the tongue and treatment of other
upper airway obstructions, some of which are associated with OSA. These future
submissions likely will need to include clinical trial data. There can be no
assurance, however, that these new indications, including the

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Company's recent submission for the treatment of enlarged turbinates, will
receive 510(k) clearance in a timely fashion, or at all. Delays in market
introduction resulting from the 510(k) clearance process could materially
adversely effect the Company's business, financial condition and results of
operations. If the FDA determines that any of the new indications is not eli-
gible for 510(k) clearance, the Company will need to seek PMA approval, which
is a much more complex, expensive and lengthy process. There can be no assur-
ance that the Company will submit a PMA application for any such indications or
that, once submitted, the PMA application will be accepted for filing, found
approvable or, if found approvable, will not include unfavorable restrictions.

A clinical trial in support of a 510(k) submission or PMA application generally
requires an Investigational Device Exemption ("IDE") application approved in
advance by the FDA for a limited number of patients. If a device presents a
"nonsignificant risk" to the patient, a sponsor may begin the clinical trial
after obtaining approval for the study by one or more appropriate institutional
review boards ("IRBs") without the need for FDA approval. The Company is
sponsoring several clinical trials which have been determined by the IRBs at
the participating institutions to be nonsignificant risk studies. There can be
no assurance, however, that the FDA would agree with these determinations and
not require the Company to obtain FDA approval of IDEs before continuing the
studies. Submission of an IDE application does not give assurance that the FDA
will approve the IDE application and, if it is approved, there can be no
assurance that the FDA will determine that the data derived from these studies
support the substantial equivalence or the safety and efficacy of the device or
warrant the continuation of clinical studies. The Company's failure to adhere
to regulatory requirements generally applicable to clinical trials could have a
material adverse effect on the Company's business, financial condition and
results of operations, including an inability to obtain marketing clearance or
approval for its products.

The Company has made modifications to its cleared devices which the Company
believes do not require the submission of new 510(k) notices. There can be no
assurance, however, that the FDA would agree with any of the Company's determi-
nations not to submit a new 510(k) notice for any of these changes or would not
require the Company to submit a new 510(k) notice for any of the changes made
to the device. If the FDA requires the Company to submit a new 510(k) notice
for any device modification, the Company may be prohibited from marketing the
modified device until the 510(k) notice is cleared by the FDA.

Any devices manufactured or distributed by the Company pursuant to FDA
clearances or approvals will be subject to pervasive and continuing regulation
by the FDA and certain state agencies. The Company will be subject to routine
inspection by the FDA and the California Department of Health Services ("CDHS")
and will have to comply with the host of regulatory requirements that usually
apply to medical devices marketed in the United States, including labeling
regulations, the Quality System Regulation ("QS Reg.") (which includes
elaborate testing, control, documentation and other quality assurance
procedures), the Medical Device Reporting ("MDR") regulation (which requires a
manufacturer to report to the FDA certain types of adverse events involving its
products) and the FDA's prohibitions against promoting products for unapproved
or "off-label" uses. The Company's failure to comply with applicable regulatory
requirements could result in enforcement action by the FDA, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.

Unanticipated changes in existing regulatory requirements, failure of the
Company to comply with such requirements or adoption of new requirements could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company also is subject to numerous federal,
state and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
hazardous substance disposal. There can be no assurance the Company will not be
required to incur significant costs to comply with such laws and regulations in
the future or that such laws or regulations will not have a material adverse
effect upon the Company's business, financial condition and results of
operations.

European Union

The Company will be required to comply with the applicable quality system stan-
dards and directives in order to produce its products for sale in the European
Union. The Company's future success will depend in part on its ability to manu-
facture its products in a timely, cost-effective manner and in compliance with
ISO 9001 and other regulatory requirements. The Company's manufacturing facili-
ties are subject to ongoing periodic inspection by regulatory authorities.

Sales of medical device products outside the United States are subject to for-
eign regulatory requirements that vary widely from country to country. The time
required to obtain approvals required by foreign countries may be longer or
shorter than that required for FDA approval, and requirements for licensing may
differ from FDA requirements. Failure to comply with foreign regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business--Government Regu-
lation."

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NO ASSURANCE OF MARKET ACCEPTANCE

The Somnoplasty System utilizes the Company's proprietary RF ablation
technology for the treatment of upper airway disorders. RF ablation in the
upper airway is a new and novel development. Although the Company has received
510(k) clearance for use of the Somnoplasty System to treat snoring, as well as
a CE Mark and TGA listing for treatment of upper airway obstructions, market
acceptance for these indications could be adversely affected by numerous
factors, including the lack of availability of third-party reimbursement, cost
of the procedure, clinical acceptance or effective physician training. The
Company does not anticipate that patients will receive third-party
reimbursement for use of the Somnoplasty System in the treatment of snoring. In
addition, should the Company receive regulatory clearance or approval for use
of the Somnoplasty System to treat additional indications, market acceptance
will depend, in large part, upon the availability of third-party reimbursement
for each of those indications, which is not assured. Market acceptance will
also depend upon the Company's 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. There can be no assurance that these products will adequately
demonstrate these characteristics or that they will receive market acceptance
among physicians. The Company believes that recommendations and endorsements by
influential physicians will be essential to market acceptance of its products.
There can be no assurance that such recommendations or endorsements will be
obtained. 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 the Company's products
and delay or preclude commercial sales and market acceptance. If the Company is
unable to achieve broad market acceptance of the Somnoplasty System for its
current and anticipated indications, the Company's business, financial
condition and results of operations would be materially adversely affected.

Patient acceptance may be affected by numerous factors, including the
possibility that the Somnoplasty procedure will require treatments on multiple
occasions. The clinical data submitted by the Company to the FDA with its
510(k) notification for the uvula and soft palate indicated that patients may
require anywhere from one to six treatments to significantly reduce snoring.
While the Company anticipates that most patients will only require one to three
treatments, factors such as poor training of the treating physician or improper
use of the Somnoplasty System by the treating physician could require more
treatments. The need for multiple treatments and the associated increased cost
of the procedure could have a significant adverse effect on patient acceptance
and on the Company's business, financial condition and results of operations.
Patient acceptance of the Somnoplasty System for the treatment of snoring 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 system will be
sufficient to allow the Company 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 the
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 the Company's business,
financial condition and results of operations.

DEPENDENCE ON STRATEGIC AND DISTRIBUTOR RELATIONSHIPS

The Company's future success will depend, in part, on its ability to enter into
and successfully develop strategic and distributor relationships with other
parties with respect to the marketing and distribution of its products. For
instance, in April 1997, the Company and Medtronic entered into a three-year
agreement pursuant to which the Somnoplasty System will be distributed
exclusively by Medtronic in the European Union, Australia, Southeast Asia and
certain other areas. The Company is currently seeking to enter into strategic
or distributor relationships in other markets, such as Japan. The success of
the Company's current relationship with Medtronic, and prospects for future
strategic or distributor relationships, will depend on the other parties'
interests in the specific products involved and their willingness and ability
to perform the role contemplated by the Company. The Company may have limited
or no control over the resources that any particular strategic party or
distributor devotes to its relationship with the Company. To date, the Company
has not generated material revenue from its relationship with Medtronic, and
there can be no assurance that its relationship with Medtronic will be
successful. Moreover, there can be no assurance that the Company will be
successful in locating 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 the Company. In the event the
Company is not successful in developing such additional relationships, or if
such relationships or the Medtronic relationship were not to prove successful,
the Company's business, financial condition and results of operations would be
materially adversely affected. See "Business--Sales, Marketing and
Distribution."

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LIMITED SALES AND MARKETING EXPERIENCE; RELIANCE ON INTERNATIONAL SALES

The Company has only limited experience selling and marketing the Somnoplasty
System for the treatment of snoring and does not have any experience selling
and marketing its products in commercial quantities. The Company intends to
sell the Somnoplasty System in the United States to private practices, clinics,
hospitals and sleep centers through a direct sales force. The Company currently
has a small direct sales force that covers certain regions of the United States
and intends to increase its 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 the Company will be successful in
building an effective sales and marketing force, that it will be cost-effective
or that it will ultimately prove successful in selling the Somnoplasty System
on a direct basis in the United States. Market acceptance of the Somnoplasty
Systems will also require the Company to demonstrate that the cost of its
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 an RF generator. There can be no assurance that the
Company will successfully generate sufficient demand for the Somnoplasty System
at the prices at which it currently offers its generators and disposable
devices. In the event the required investment were to preclude the Company from
placing sufficient quantities of generators, the Company's ability to sell
disposable devices would be limited, which would have a material adverse effect
on the Company's business, financial condition and results of operations.

The Company anticipates that a significant portion of its future revenues will
relate to international sales of the Somnoplasty System through strategic and
distributor relationships. 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, 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 the Company's products and the risk of financial
instability of distributors. Additionally, the Company's business, financial
condition and results of operations may be adversely effected by fluctuations
in overseas economic conditions and international currency exchange rates, as
well as by increases in duty rates, difficulty in obtaining export licenses,
constraints on its ability to maintain or increase prices and competition.
There can be no assurance that the Company will be able to successfully
commercialize the Somnoplasty System or any of its future products in any
international market, which would have a material adverse effect on the
Company's business, financial condition and results of operations. See "--
Uncertainty of FDA or Other Regulatory Clearances or Approvals; Government
Regulation" and "Business--Sales, Marketing and Distribution."

UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT AND RELATED MATTERS

The Company believes that its products will generally be purchased by private
practices, clinics, hospitals and sleep centers. In the United States, the
purchasers of medical devices generally rely on Medicare, Medicaid, private
health insurance plans, health maintenance organizations and other sources of
reimbursement for health care costs ("Third-Party Payors") to reimburse all or
part of the cost of the procedure in which the medical device is being used.
Certain Third Party Payors are moving toward a managed-care system in which
they contract to provide comprehensive health care for a fixed cost per person.
The fixed cost per person established by these Third-Party Payors may be
independent of the practice's cost incurred for the specific case and the
specific devices used. Medicare and other Third-Party Payors are increasingly
scrutinizing whether to cover new products and the level of reimbursement for
covered products.

In the United States, the Company does not anticipate that the Somnoplasty
System will be subject to reimbursement for the treatment of snoring. Tradi-
tionally, sufferers of snoring have paid for surgical and non-surgical treat-
ment and devices directly. However, the treatment of OSA and outpatient sur-
gical procedures for the uvula, soft palate and turbinates are commonly reim-
bursed by most carriers and resection of the tongue is reimbursed as an inpa-
tient procedure.

The Company's strategy is to pursue reimbursement for the Somnoplasty System
for treatment of enlarged turbinates, tonsils and base of the tongue and OSA,
if it is cleared for such indications by the FDA, based on physician endorse-
ment and the demonstration of improved quality of life for specific patient
groups. Quality of life issues will be included in the Company's clinical
trials to provide data in support of this reimbursement strategy. There can be
no assurance that the Company will be able to demonstrate improvement in
quality of life or that reimbursement will ever be available for the Company's
products. The Company's clinical sites do not reimburse the Company for
Somnoplasty System generators or disposable devices.

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<PAGE>

the availability of third-party reimbursement for procedures that would use the
Company's devices for such purposes. Failure by private practices, clinics,
hospitals, sleep centers and other potential users of the Company's devices to
obtain sufficient reimbursement from Third-Party Payors for the procedures in
which the Company's devices are intended to be used could have a material
adverse effect on the Company's business, financial condition and results of
operations.

International market acceptance of the Company's products currently being
commercialized and those under development may be dependent, in part, upon the
availability of reimbursement within prevailing health care payment systems.
Reimbursement and health care payment systems in international markets vary
significantly by country, and include both government sponsored health care and
private insurance. The Company does not anticipate that use of the Somnoplasty
System for treatment of snoring may be a reimbursable expense. The Company does
believe that various levels of reimbursement will be available in international
markets for treatment of enlarged turbinates, tonsils and the base of the
tongue and OSA; however, there can be no assurance that any international
reimbursement approvals will be obtained in a timely manner, if at all. Failure
to receive international reimbursement approvals could have a material adverse
effect on market acceptance of the Company's products in the international
markets in which such approvals are sought.

The Company believes that in the future, reimbursement will be subject to
increased restrictions both in the United States and in international markets.
The Company believes that the overall escalating cost of medical products and
services will continue to lead to increased pressures on the health care
industry, both domestic and international, to reduce the cost of products and
services, including the Company's existing products and products currently
under development by it. There can be no assurance that third-party
reimbursement and coverage will be available or adequate in either the United
States or international markets or that future legislation, regulation or
reimbursement policies of Third-Party Payors will not otherwise adversely
affect the demand for the Company's existing products or products currently
under development by it or its ability to sell its products on a profitable
basis. The unavailability of Third-Party Payor coverage or the inadequacy of
reimbursement could have a material adverse effect on the Company's business,
financial condition and results of operations.

HIGHLY COMPETITIVE MARKET; RISK OF COMPETING TREATMENT APPROACHES

The medical device industry is subject to intense competition. The market for
products designed to treat upper airway disorders is highly competitive, and
the Company expects competition to increase. Accordingly, the Company's future
success will depend in part on its ability to respond quickly to medical and
technological change and user preference through the development and introduc-
tion of new products that are of high quality and that address patient and sur-
geon requirements. In the treatment of snoring, the Somnoplasty System is sub-
ject to intense competition from existing products, such as nasal dilators and
oral appliances, and surgical procedures, such as LAUP. The U.S. market for the
treatment of enlarged turbinates, a market which the Company intends to enter
in the near future, is dominated by pharmacological treatments, such as nasal
sprays, and surgical procedures, such as turbinectomies. The U.S. market for
products for the treatment of OSA, a market which the Company hopes to enter in
the future, is currently dominated by CPAP products produced by Healthdyne
Technologies Inc., Nellcor Puritan Bennett, Inc., a wholly owned subsidiary of
Mallinckrodt Inc., ResMed Inc. and Respironics, Inc. There can be no assurance
that the Somnoplasty System will successfully compete with or replace any
existing products for these or other indications. Most of the Company's compet-
itors and potential competitors have greater financial, research and develop-
ment, manufacturing and sales and marketing resources than the Company. In
addition, some of the Company's competitors and potential competitors sell
additional lines of products, and therefore can bundle products to offer higher
discounts or offer rebates or other incentive programs to gain a competitive
advantage. The Company's inability to compete effectively against existing or
future competitors would have a material adverse effect on its business, finan-
cial condition and results of operations. See "Business--Competition."

RAPID TECHNOLOGICAL CHANGE AND RISK OF TECHNOLOGICAL OBSOLESCENCE

The medical device industry is characterized by rapid and significant
technological change. The Company's future success will depend in large part on
the Company's ability to continue to respond to such changes. There can be no
assurance that the Company will be able to respond to such changes or that new
or improved competing products will not be developed that render the
Somnoplasty System non-competitive. Product research and development will
require substantial expenditures and will be subject to inherent risks, and
there can be no assurance that the Company will be successful in developing or
improving products that have the characteristics necessary to effectively treat
particular upper airway obstructions or that any new products introduced will
receive regulatory clearance or approval or will be successfully
commercialized. See "Business--Research and Development."

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LIMITED MANUFACTURING EXPERIENCE; DEPENDENCE ON KEY SUPPLIERS

The Company currently manufactures its devices in limited quantities for sales
and clinical trials. Each device is assembled and tested by the Company prior
to sterilization. The manufacturing process consists primarily of assembly of
internally manufactured and purchased components and subassemblies, and certain
processes are performed in a clean room environment. The Company has no
experience manufacturing its products in the volumes or with the yields that
will be necessary for the Company to achieve significant commercial sales, and
there can be no assurance that the Company can establish high-volume
manufacturing capacity or, if established, that the Company will be able to
manufacture its products in high volumes with commercially acceptable yields.
While the Company believes that its current facility will be adequate to
support its commercial manufacturing activities in the near term, the Company
may be required to expand its manufacturing facilities to commence large-scale
manufacturing. The Company's inability to successfully manufacture or
commercialize its devices in a timely matter could have a material adverse
effect on the Company's business, financial condition and results of
operations.

Raw materials, components and subassemblies are purchased from various
qualified suppliers and are subject to stringent quality specifications and
inspections. The Company conducts quality audits of its key suppliers, several
of which are experienced in the supply of components to manufacturers of
medical devices. None of the Company's suppliers of components for its
disposable devices is contractually obligated to continue to supply the
Company, nor is the Company contractually obligated to purchase such devices
from a particular supplier. For certain of these components and subassemblies,
there are relatively few alternative sources of supply, and establishing
additional or replacement suppliers for such components and subassemblies could
not be accomplished quickly.

The Company has created manufacturing policies and procedures to accommodate
United States and international inspection requirements. The Company is
required to comply with QS Reg. standards in order to produce products for sale
in the United States. The QS Reg. requires, among other things, pre-production
design controls, purchasing controls and maintenance of service records for
medical device companies. The QS Reg. is expected to increase the cost of
complying with GMP and related requirements. The Company anticipates an
inspection by the CDHS in the near future, and if the Company fails to pass
such inspection, the Company may not receive a Device Manufacturing License
from the CDHS. Somnus has been certified under the ISO 9001 by TUV Essen, a
German Notified Body, which requires that the Company pass annual inspections
to maintain such certification and produce products for sale within the
European Union. Any failure of the Company to comply with applicable
regulations, standards and directives may result in the Company being required
to take corrective actions, such as modification of its policies and
procedures. Pending such corrective actions, the Company could be unable to
manufacture or ship any products, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
See "Business--Facilities."

DEPENDENCE ON SINGLE-SOURCE SUPPLIER

The Company purchases its 215 RF Generator, currently its only commercially
available generator, as a finished assembly from a single-source supplier. The
Company is in the process of developing two additional generators, one of which
will be assembled by the Company, with the same single-source supplier acting
as the vendor for the RF subassembly, and the other of which will be
manufactured entirely by the Company. However, the Company expects to continue
to purchase the 215 RF Generator from the single-source supplier through at
least mid-1998. There can be no assurance that the generator obtained from the
single-source supplier will continue to be available in adequate quantities or,
if required, that the Company will be able to locate alternative sources of
generators on a timely and cost-effective basis. To date, the Company has not
experienced significant adverse effects resulting from any shortage of
generators. However, there can be no assurance that the single-source supplier
will meet the Company's future requirements for timely delivery of generators
of sufficient quality and in sufficient quantity. The 215 RF Generator
currently takes several months to procure, and a significant increase of orders
could lead to significant delays and generator shortages. Such delays or
shortages, particularly as the Company scales up its manufacturing activities
in support of direct U.S. sales and international distributor orders, would
have a material adverse effect on its business, financial condition and results
of operations. See "Business--Manufacturing."

DEPENDENCE UPON PATENTS AND PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT

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its intellectual property portfolio, although it has not done so to date. The
Company's strategy has been to actively pursue patent protection in the United
States and foreign jurisdictions for all upper airway disorders that can ben-
efit from use of the Somnoplasty System.

The patent and trade secret positions of medical device companies, including
those of the Company, are uncertain and involve complex and evolving legal and
factual questions. The coverage sought in a patent application either can be
denied or significantly reduced before or after the patent is issued.
Consequently, there can be no assurance that any patents from pending
applications or from any future patent application will be issued, that the
scope of the patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents will be held valid
if subsequently challenged or that others will not claim rights in or ownership
of the patents and other proprietary rights held by the Company. Since patent
applications are secret until patents are issued in the United States, or
corresponding applications are published in other countries, and since
publication of discoveries in the scientific or patent literature often lags
behind actual discoveries, the Company cannot be certain that it was the first
to file patent applications for such inventions. In addition, there can be no
assurance that competitors, many of which have substantial resources, will not
seek to apply for and obtain patents that will prevent, limit or interfere with
the Company's ability to make, use or sell its products either in the United
States or in international markets. Further, the laws of certain foreign
countries do not protect the Company's intellectual property rights to the same
extent as do the laws of the United States. Litigation or regulatory
proceedings, which could result in substantial cost and uncertainty to the
Company, may also be necessary to enforce patent or other intellectual property
rights of the Company or to determine the scope and validity of other parties'
proprietary rights. There can be no assurance that the Company will have the
financial resources to defend its patents from infringement or claims of
invalidity.

The Company also relies upon unpatented proprietary technology, and no
assurance can be given that others will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
or disclose the Company's proprietary technology or that the Company can
meaningfully protect its rights in such unpatented proprietary technology. The
Company's policy is to require each of its employees, consultants,
investigators and advisors to execute a confidentiality agreement upon the
commencement of an employment or consulting relationship with the Company.
These agreements generally provide that all inventions conceived by the
individual during the term of the relationship shall be the exclusive property
of the Company and shall be kept confidential and not be disclosed to third
parties except in specified circumstances. There can be no assurance, however,
that these agreements will provide meaningful protection for the Company's
proprietary information in the event of unauthorized use or disclosure of such
information.

Recently, Public Law 104-208 was signed into law in the United States and
limits the enforcement of patents relating to the performance of surgical or
medical procedures on a body. This law precludes medical practitioners and
health care entities, who practice these procedures, from being sued for patent
infringement. Therefore, depending upon how these limitations are interpreted
by the courts, they could have a material adverse effect on the Company's
ability to enforce any of its proprietary methods or procedures deemed to be
surgical or medical procedures on a body.

In addition, patent applications in the United States and foreign jurisdictions
are maintained in secrecy for a period after filing. Publication of discoveries
in the scientific or patent literature tends to lag behind actual discoveries
and the filing of related patent applications. Although the Company has
conducted searches of certain patents issued to other companies, research and
academic institutions and others, patents issued and patent applications filed
in the United States or internationally relating to medical devices are
numerous, and there can be no assurance that current and potential competitors
and other third parties have not filed, or in the future will not file
applications for, or have not received or in the future will not receive,
patents or obtain additional proprietary rights relating to products or
processes used or proposed to be used by the Company. In the event any pending
applications provide proprietary rights to third parties relating to products
or processes used or proposed to be used by the Company, the Company may be
required to obtain licenses to patents or proprietary rights of others.

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<PAGE>

successful in any attempt to redesign its products or processes to avoid such
infringement or in obtaining licenses on terms acceptable to the Company, if at
all. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure by the Company to redesign its products or processes or
to obtain necessary licenses could prevent the Company from manufacturing and
selling the Somnoplasty System, which would have a material adverse effect on
the Company's business, financial condition and results of operations.
Although, to date, the Company has not been involved in any litigation, in the
future, costly and time-consuming litigation brought by the Company may be
necessary to enforce patents issued to the Company, to protect trade secrets or
know-how owned by the Company or to determine the enforceability, scope and
validity of the proprietary rights of others.

PRODUCT LIABILITY RISK; POSSIBLE INSUFFICIENCY OF INSURANCE

The Company's business involves the risk of product liability claims. Although
the Company has not experienced any product liability claims to date, any such
claims could have a material adverse effect on the Company. The Company
maintains product liability insurance at coverage levels which it deems
commercially reasonable; however, there can be no assurance that product
liability or other claims will not exceed such insurance coverage limits or
that such insurance will continue to be available on commercially acceptable
terms, or at all. The Company intends to periodically evaluate, depending on
changing circumstances, whether or not to obtain any additional product
liability insurance coverage prior to the time that the Company engages in any
extensive marketing of the Somnoplasty System. Even if the Company obtains
additional product liability insurance, there can be no assurance that it would
prove adequate or that a product liability claim, insured or uninsured, would
not have a material adverse effect on the Company's business, financial
condition and results of operations. Even if a product liability claim is not
successful, the time and expense of defending against such a claim may
adversely affect the Company's business, financial condition and results of
operations. See "Business--Product Liability Exposure and Availability of
Insurance."

DEPENDENCE UPON KEY PERSONNEL

The Company's future success depends in significant part upon the continued
service of certain key scientific, technical and management personnel and its
continuing 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 the Company can retain its key scientific, technical
and managerial personnel or that it can attract, assimilate or retain other
highly qualified scientific, technical and managerial personnel in the future.
Key employees of the Company include Stuart D. Edwards, its Chief Executive
Officer and Robert E. McNamara, its Chief Financial Officer. The Company has
taken steps to retain its key employees, including the granting of stock
options that vest over time. 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 the Company's business, financial condition
and results of operations.

CONTROL BY EXISTING STOCKHOLDERS

After the consummation of the Offering, current stockholders, including certain
executive officers and directors of the Company and their affiliates, will own
approximately 68.8% of the Company's outstanding Common Stock. As a result,
these stockholders will, to the extent they act together, continue to have the
ability to control matters requiring the approval of the Company's stockhold-
ers, including the election of the Company's Board of Directors. See "Principal
Stockholders."

BROAD DISCRETION AS TO USE OF PROCEEDS

Of the approximately $36.4 million net proceeds from the Offering (based upon
an assumed initial public offering price of $10.00 per share), approximately
$14.4 million, or 39.6%, has not currently been allocated for specific uses by
the Company. In addition, the amounts allocated for specific uses may vary sig-
nificantly depending on numerous factors, including the progress of the
Company's clinical trials and actions relating to regulatory matters, and the
costs and timing of expansion of sales and marketing and manufacturing activi-
ties, and hence the Company's management will retain broad discretion in the
allocation of the net proceeds. See "Use of Proceeds."

EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS

Upon consummation of the Offering, certain provisions of the Company's Amended
and Restated Certificate of Incorporation and Bylaws may have the effect of
making it difficult for a third party to acquire, or of discouraging a third
party from attempting to acquire, control of the Company. Such provisions could
limit the price that certain investors might be willing to pay in the future
for shares of the Company's Common Stock. Certain of these provisions will
allow the Company to issue Preferred Stock without any vote or further action
by the stockholders, provide for a classified board of directors, eliminate the
right of stockholders to call special meetings of stockholders or to act by
written consent without a meeting and eliminate cumulative voting in the
election of directors. These provisions may make it difficult for

15
<PAGE>

stockholders to take certain corporate actions and could have the effect of
delaying or preventing a change in control of the Company. See "Management" and
"Description of Capital Stock."

POTENTIAL ADVERSE IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE

Sales of a substantial number of shares of Common Stock (including shares
issuable upon the exercise of outstanding options or warrants) in the public
market after the Offering could materially and adversely affect the market
price of the Common Stock. Such sales might also make it more difficult for the
Company to sell equity securities or equity-related securities in the future at
a time and price that the Company deems appropriate. Of the 12,816,214 shares
of Common Stock the Company will have outstanding upon the consummation of the
Offering, the 4,000,000 shares offered hereby will be freely tradeable as of
the date of this Prospectus by persons other than "affiliates" of the Company
without restriction or further registration under the Securities Act of 1933,
as amended (the "Securities Act"). The remaining 8,816,214 shares (the
"Restricted Shares") of Common Stock are "restricted securities" within the
meaning of the Securities Act. The holders of the Restricted Shares have
entered into lock-up agreements (the "Lock-up Agreements") under which such
holders have agreed not to sell, directly or indirectly, or otherwise dispose
of any of their shares for a period of 180 days after the date of this
Prospectus without the prior written consent of J.P. Morgan Securities Inc.
J.P. Morgan Securities Inc. may, in its sole discretion and at any time without
notice, release all or any portion of the shares subject to the Lock-up
Agreements. As a result of the Lock-up Agreements and the provisions of Rules
144 and 701 promulgated under the Securities Act, upon consummation of the
Offering, the Restricted Shares will be available for sale in the public market
as follows: (i) no Restricted Shares will be eligible for immediate sale on the
date of this Prospectus, (ii) 8,739,054 Restricted Shares will be eligible for
sale 180 days after the date of the Prospectus upon expiration of the Lock-up
Agreements and (iii) the remaining 77,160 Restricted Shares will be eligible
for sale at various times over a period less than one year following the
completion of the Offering, subject to volume limitations pursuant to Rule 144.
As of September 30, 1997, 2,507,754 shares were issuable upon exercise of
currently outstanding options, all of which are subject to 180 day lock-up
agreements. Of these shares, 700,897 will be vested 180 days after the date of
the Prospectus. As of September 30, 1997, 62,500 shares were issuable upon
exercise of currently outstanding warrants, all of which are subject to the
Lock-up Agreements. All of these shares will become eligible for sale in the
public market 180 days after the date of this Prospectus upon expiration of the
Lock-up Agreements. After the Offering, the holders of approximately 5,937,358
shares of Common Stock (including up to 62,500 shares of Common Stock issuable
upon exercise of outstanding warrants as of the date of this Prospectus) will
be entitled to certain demand and piggyback rights with respect to registration
of such shares under the Securities Act upon termination of the Lock-up
Agreements. If such holders, by exercising their demand registration rights,
cause a large number of securities to be registered and sold in the public
market, such sales could have an adverse effect on the market price for the
Company's Common Stock. In addition, the Company intends to file a Registration
Statement on Form S-8 to register shares of Common Stock issuable upon exercise
of options granted under the 1996 Stock Plan and 1997 Director Option Plan and
sold pursuant to the 1997 Employee Stock Purchase Plan. Following the filing of
the Form S-8, shares of Common Stock issued under such plans will be available
for sale in the public market, subject to the Rule 144 volume limitations as
applicable to affiliates. See "Description of Capital Stock--Registration
Rights of Certain Holders," "Shares Eligible for Future Sale" and
"Underwriting."

NO PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK; DILUTION

Prior to the Offering, there has been no public market for the Common Stock.
There can be no assurance that an active trading market will develop and be
sustained upon the completion of the Offering, or that the market price of the
Common Stock will not decline below the initial public offering price. The
initial public offering price of the Common Stock has been determined by
negotiations between the Company and the Underwriters. As such, the initial
public offering price is not necessarily related to the Company's net worth or
any other established criteria of value and may not bear any relationship to
the market price of the Common Stock following the completion of the Offering.
The market prices for securities of medical device companies have historically
been highly volatile. Announcements of technological innovations or new
products by the Company or its competitors, developments concerning proprietary
rights, including patents and litigation matters, publicity regarding actual or
potential results with respect to products under development by the Company or
others, regulatory developments in both the United States and foreign countries
and public concern as to the safety of new technologies, changes in financial
estimates by securities analysts or failure of the Company to meet such
estimates and other factors may have a significant impact on the market price
of the Common Stock. In addition, the Company believes that fluctuations in its
operating results may cause the market price of its Common Stock to fluctuate,
perhaps substantially. Purchasers of shares of Common Stock offered hereby will
experience an immediate dilution of $6.77 in the net tangible book value per
share of their Common Stock from the assumed initial public offering price of
$10.00 per share. See "Dilution" and "Underwriting."

16
<PAGE>

THE COMPANY

The Company was incorporated in Delaware in January 1996. References in this
Prospectus to "Somnus" and the "Company" refer to Somnus Medical Technologies,
Inc., a Delaware corporation. The Company's principal executive offices are
located at 285 N. Wolfe Road, Sunnyvale, California 94086, and its telephone
number at that address is (408) 773-9121.

USE OF PROCEEDS

The net proceeds to the Company from the Offering, after deducting the under-
writing discount and offering expenses payable by the Company, are estimated to
be approximately $36.4 million ($42.0 million if the Underwriters'
over-allotment option is exercised in full), based upon an assumed initial
public offering price of $10.00 per share.

The Company anticipates that it will use approximately $10.0 million of the net
proceeds for research and development, clinical trials and regulatory matters,
approximately $5.0 million to develop the Company's sales and marketing
capabilities, approximately $5.0 million to develop manufacturing expertise and
to establish large-scale manufacturing capabilities and approximately $2.0
million to improve and expand its financial capabilities through the addition
of qualified personnel, including programers, to enhance its financial
reporting systems. The Company intends to use the balance of the net proceeds,
approximately $14.4 million ($20.0 million if the Underwriters' over-allotment
option is exercised in full), for other general corporate purposes, including
for acquisitions or licenses of technologies or products that complement the
business of the Company. As of the date of this Prospectus, the Company has no
agreements, arrangements or understandings with any third parties for any such
acquisitions or licenses. Pending such uses, the Company intends to invest the
net proceeds of the Offering in interest bearing, investment grade financial
instruments.

The foregoing represents the Company's best estimate of its allocation of the
net proceeds of the Offering based upon the current state of its business oper-
ations, its current plans and current economic and industry conditions and is
subject to reallocation among the categories listed above or to new categories.
The amounts actually expended for each purpose may vary significantly depending
upon numerous factors, including the progress of the Company's clinical trials
and actions relating to regulatory matters, and the costs and timing of expan-
sion of sales, marketing and manufacturing activities, and hence the Company's
management will retain broad discretion in the allocation of the net proceeds.

DIVIDEND POLICY

The Company has not declared or paid any cash dividends since its inception.
The Company intends to retain any earnings to fund development of its business
and does not intend to pay any cash dividends in the foreseeable future.

17
<PAGE>

CAPITALIZATION

The following table sets forth the capitalization of the Company as of
September 30, 1997, (i) on an actual basis, (ii) on a pro forma basis, after
giving effect to the Preferred Stock Conversion and the amendment of the
Company's Restated Certificate of Incorporation to provide for authorized
capital stock consisting of 50,000,000 shares of Common Stock and 5,000,000
shares of undesignated Preferred Stock, and (iii) on an as adjusted basis to
give effect to the receipt by the Company of the estimated net proceeds from
the sale of 4,000,000 shares of Common Stock offered hereby at an assumed
initial public offering price of $10.00 per share, after deducting the
underwriting discount and estimated offering expenses payable by the Company:

<TABLE>
<CAPTION>
--------------------------------
AS OF SEPTEMBER 30, 1997
--------------------------------
ACTUAL PRO FORMA AS ADJUSTED
In thousands, except share data -------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current obligations under lease line of
credit........................................ $ 501 $ 501 $ 501
======== ======== ========
Long-term obligations under lease line of
credit........................................ $ 2,147 $ 2,147 $ 2,147
-------- -------- --------
Stockholders' equity:
Preferred Stock, $0.001 par value; 6,196,000
shares authorized, 5,998,446 shares issued
and outstanding actual; 5,000,000 shares
authorized; none issued and outstanding, pro
forma and as adjusted....................... 6 -- --
Common Stock, $0.001 par value; 20,000,000
shares authorized, 2,817,768 shares issued
and outstanding actual; 50,000,000 shares
authorized; 8,816,214 shares issued and
outstanding, pro forma; 12,816,214 shares
issued and outstanding, as adjusted(1)...... 3 9 13
Additional paid-in capital..................... 21,011 21,011 57,407
Deferred stock compensation.................... (3,895) (3,895) (3,895)
Accumulated deficit............................ (12,169) (12,169) (12,169)
-------- -------- --------
Total stockholders' equity................. 4,956 4,956 41,356
-------- -------- --------
Total capitalization..................... $ 7,103 $ 7,103 $ 43,503
======== ======== ========
</TABLE>
- -------
(1) Excludes as of September 30, 1997: (i) 2,507,754 shares of Common Stock
issuable upon exercise of outstanding stock options at a weighted average exer-
cise price of $1.95 per share, (ii) 789,478 shares of Common Stock available
for future issuance under the Company's stock plans and (iii) 62,500 shares of
Common Stock issuable upon exercise of outstanding warrants at a weighted
average exercise price of $1.80 per share. See "Management--Stock Plans," "De-
scription of Capital Stock" and Note 8 of Notes to Consolidated Financial
Statements.

18
<PAGE>

DILUTION

The pro forma net tangible book value of the Company as of September 30, 1997
was approximately $4,956,000 or $0.56 per share of Common Stock. Pro forma net
tangible book value per share represents the Company's total tangible assets
less total liabilities, divided by the pro forma number of outstanding shares
of Common Stock (after giving effect to the Preferred Stock Conversion).
Dilution per share represents the difference between the amount per share paid
by investors in the Offering and the pro forma net tangible book value per
share after the Offering. After giving effect to the sale of 4,000,000 shares
in the Offering at an assumed initial public offering price of $10.00 per share
and after deducting the underwriting discount and estimated offering expenses,
the pro forma net tangible book value of the Company as of September 30, 1997
would have been $41,356,000 or $3.23 per share. This represents an immediate
increase in net tangible book value of $2.67 per share to existing stockholders
and an immediate dilution in net tangible book value of $6.77 per share to new
investors purchasing shares at the assumed initial public offering price. The
following table illustrates this per share dilution:

<TABLE>
<CAPTION>
------------
<S> <C> <C>
Assumed initial public offering price.......................... $10.00
Pro forma net tangible book value before the Offering.......... $0.56
Increase attributable to new investors......................... 2.67
-----
Pro forma net tangible book value after the Offering........... 3.23
------
Dilution to new investors...................................... $ 6.77
======
</TABLE>

The following table summarizes, on a pro forma basis as of September 30, 1997,
the difference between existing stockholders and new investors with respect to
the number of shares of Common Stock purchased from the Company, the total con-
sideration paid and the average price per share paid:

<TABLE>
<CAPTION>
--------------------------------------------------
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------ ------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders........ 8,816,214 68.8% $17,395,000 30.3% $ 1.97
New investors................ 4,000,000 31.2 40,000,000 69.7 10.00
---------- ----- ----------- -----
Total...................... 12,816,214 100.0% $57,395,000 100.0%
========== ===== =========== =====
</TABLE>

The foregoing computations assume no exercise of outstanding stock options or
warrants. Such computations exclude as of September 30, 1997: (i) 2,507,754
shares of Common Stock issuable upon exercise of outstanding stock options at a
weighted average exercise price of $1.95 per share and (ii) 62,500 shares of
Common Stock issuable upon exercise of outstanding warrants at a weighted
average exercise price of $1.80 per share. To the extent outstanding options
and warrants are exercised, there will be further dilution to new investors.
See "Management--Stock Plans."

19
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data set forth below for, and as of the end
of, the period ended December 31, 1996 are derived from the consolidated
financial statements of Somnus Medical Technologies, Inc. and its subsidiary,
which financial statements have been audited by Ernst & Young LLP, independent
auditors. These consolidated financial statements, and the report thereon, are
included elsewhere in this Prospectus. The selected consolidated financial data
set forth below as of September 30, 1997 and for the periods ended September
30, 1996 and 1997 were derived from unaudited consolidated financial statements
of the Company, which are included elsewhere in this Prospectus, and include,
in the opinion of the Company, all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the Company's
financial position at that date and results of operations for those periods.
The results for the nine months ended September 30, 1997 are not necessarily
indicative of the results for any future period. The selected consolidated
financial data set forth below is qualified in its entirety by, and should be
read in conjunction with, the consolidated financial statements and notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
---------------------------
AS OF AS OF
DECEMBER 31, SEPTEMBER 30,
1996 1997
In thousands ------------ -------------
(UNAUDITED)
<S> <C> <C>
CONSOLIDATED BALANCE
SHEET DATA:
Cash and cash
equivalents............ $ 8,829 $ 7,013
Working capital......... 7,982 4,741
Total assets............ 10,031 9,883
Long-term obligations
under lease line of
credit................. 773 2,147
Accumulated deficit..... (3,097) (12,168)
Total stockholders'
equity(2).............. 8,353 4,956
</TABLE>
- -------
(1) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the computation of pro forma net loss per share.
(2) No cash dividends have been declared with respect to the Company's Common
or Preferred Stock.

20
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including those set forth under "Risk Factors" and elsewhere in this
Prospectus.

OVERVIEW

The Company has a limited history of operations that, to date, has consisted
primarily of research and development, product engineering, seeking clearance
of its products from the FDA, initial development of a direct sales force in
the United States and training Medtronic employees for distribution of the
Somnoplasty System in the European Union, Australia, Southeast Asia and certain
other areas. The Company commercially introduced the Somnoplasty System
internationally, through Medtronic, beginning in June 1997. One month later,
after receiving 510(k) clearance for the use of the Somnoplasty System to treat
snoring, the Company began direct sales of the Somnoplasty System in the United
States.

The Company has recently hired a Chief Financial Officer, a Corporate
Controller, a Director of Medical Affairs and Corporate Counsel to strengthen
the Company's management capability. In addition, the Company anticipates
hiring additional financial accounting personnel to meet increasing demands of
its business. The Company also plans to hire additional management and
engineering personnel to support and develop manufacturing expertise and large
scale manufacturing capacity expansion as required to support the anticipated
growth of the Company. Additionally, the Company will invest in further
production equipment, vertical integration and facility expansion to reduce
manufacturing costs, reduce manufacturing cycle time and increase production
capacity. These hires and capital expenditures will require operating capital
on an ongoing basis. The Company will continue to expand its internal reporting
and implement appropriate systems to properly manage its business.

This current and anticipated significant growth of the Company's personnel,
sales and scope of operations may place considerable strain on the Company's
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 the Company's
operations or that its 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 the Company's
business, financial condition and results of operations. See "Risk Factors--
Need to Manage Growth and Expand Financial Capabilities," "--Limited
Manufacturing Experience; Dependence on Key Suppliers" and "Use of Proceeds."

The Company is in the initial stages of building a direct sales force to cover
the United States and Canada. Presently the sales force consists of a Vice
President, Worldwide Sales, three regional sales managers and four sales
representatives. The Company anticipates significant short-term expenditures in
the development of its direct sales infrastructure. In addition to its
agreement with Medtronic, the Company will seek to enter into agreements for
product distribution in Japan and other international markets.

As of September 30, 1997, the Company has incurred cumulative losses from
inception of approximately $12.2 million. Moreover, the Company expects to
incur significant additional operating losses over the next couple of years due
to expanded research and development efforts, preclinical studies and clinical
trials and the development of its manufacturing and sales and marketing capa-
bilities. The Company's 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 timing of regulatory clearances or approvals, the extent to which
the Company's products gain market acceptance, the scale-up of manufacturing
capabilities, the expansion of sales and marketing activities, competition, the
timing and success of new product introductions by the Company or its
competitors and the

21
<PAGE>

ability of the Company and its agents to market its products in the United
States and internationally. Accordingly, interim period comparisons of the
Company's operating results are not necessarily meaningful and should not be
relied upon as indicators of likely future performance or annual operating
results.

In the near term, a large portion of the Company's revenues is anticipated to
come from international sales to Medtronic. The Company's business and
financial results could be materially adversely affected in the event that
Medtronic was unable to market the Somnoplasty System effectively, anticipate
customer demand accurately or effectively manage international pricing and cost
containment pressures in health care. The Company's 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

Total revenues. The Company's revenues are currently derived from sales of its
Somnoplasty System, consisting of the 215 RF Generator and SP 1000 and SP 2000
disposable devices, to private practices, hospitals, clinics and sleep centers.
No revenues were recorded for the period from inception (January 19, 1996) to
December 31, 1996 ("fiscal 1996"). For the nine months ended September 30,
1997, revenues, totaling $668,000, were attributable to sales to Medtronic and
$432,000 to other customers principally in the United States. The Company
expects that the sale of generators will constitute a significant percentage of
the Company's total revenues in the near term as it builds an installed base of
users.

Manufacturing start-up costs and costs of revenues. Manufacturing start-up
costs and costs of revenues were $403,000 in fiscal 1996 and $174,000 and $2.0
million for the periods ended September 30, 1996 and 1997, respectively. Manu-
facturing start-up costs and costs of revenues consists of raw materials, sub-
assemblies and completed electronics, quality assurance and warranty costs. The
cost of purchased materials and the costs of prototypes in the period ended
September 30, 1997 were approximately $888,000 and $684,000, respectively, rep-
resenting the principal increase between the comparison periods. The Company
believes that manufacturing start-up costs and costs of revenues will increase
in absolute dollars but may fluctuate as a percentage of revenues.

Research and development expenses. Research and development expenses were $1.3
million in fiscal 1996 and $663,000 and $4.1 million for the periods ended Sep-
tember 30, 1996 and 1997, respectively. Research and development expenses are
comprised of salaries, prototype development costs and clinical trial and regu-
latory approval expenses. The increases between the comparison periods reflect
the increased expenditures incurred in the development of the Somnoplasty Sys-
tem, new development efforts for the generators and the disposable devices,
initiation and expansion of clinical trials and expenses associated with regu-
latory approvals in the United States, the European Union and Australia. Clin-
ical trial costs in the period ended September 30, 1997, were approximately
$1.1 million as compared to approximately $90,000 in the period ended September
30, 1996. Salaries of research and development personnel represented $124,000,
$322,000 and $724,000 in fiscal 1996 and the periods ended September 30, 1996
and 1997, respectively. The 1997 expenses also include approximately $347,000
of non-cash stock compensation charges resulting from stock option grants.

Sales and marketing expenses. Sales and marketing expenses were $237,000 in
fiscal 1996 and $170,000 and $1.5 million for the periods ended September 30,
1996 and 1997, respectively. Sales and marketing expenses consist of salaries,
commissions, product training courses, advertising, promotional and sales
events expenses. The increase between the comparison periods reflects the
hiring of additional personnel, development of marketing literature and
campaigns, an extensive public relations effort to promote the Somnoplasty
System in conjunction with the product launch in June 1997 and additional
market research into new product areas. The costs of public relations and
advertising for the nine months ended September 30, 1997 were approximately
$729,000. This accounted for the majority of the increase from 1996. The 1997
expenses also include $170,000 of non-cash stock compensation charges resulting
from stock option grants.

General and administrative expenses. General and administrative expenses were
$1.3 million for fiscal 1996 and $730,000 and $2.8 million for the periods
ended September 30, 1996 and 1997, respectively. General and administrative
expenses include executive salaries, professional fees, facilities overhead,
accounting and human resources and general office administration expenses such
as rent and facility costs. General and administrative costs for the nine
months ended September 30, 1997 included legal and accounting costs of approxi-
mately $420,000 and professional recruitment costs and other consultant fees of
$583,000. The 1997 expenses also include $162,000 of non-cash stock compensa-
tion charges resulting from non-cash stock option grants.

Other income, net. Other income, net was $98,000 in fiscal 1996 and $11,000 and
$232,000 for the periods ended September 30, 1996 and 1997, respectively. The
increases were attributable to interest income earned by the Company on

22
<PAGE>

its outstanding balance of cash and cash equivalents, invested from the
proceeds of the issuance of Preferred Stock, net of interest expense on the
Company's lease line of credit obligations.

Net loss. The net loss was $3.1 million for fiscal 1996 and $1.7 million and
$9.1 million for the periods ended September 30, 1996 and 1997, respectively.
The Company expects that its operating losses will continue for at least the
next couple of years, as the Company continues to invest substantial resources
in product development, manufacturing and sales and marketing.

INCOME TAXES

As of December 31, 1996, the Company had federal and state net operating loss
carryforwards of approximately $3.0 million and $1.6 million, respectively. The
net operating loss carryforwards will expire in 2004, if not utilized.
Utilization of the net operating loss carryforwards may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986, as amended (the "Code"), and similar
state provisions. The annual limitation may result in the expiration of the net
operating loss carryforwards before becoming available to reduce the Company's
federal income tax liabilities. As of December 31, 1996, the Company had
deferred tax assets of approximately $1.2 million, which have been fully offset
by a valuation allowance. Deferred tax assets relate primarily to the net
operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

Since inception through September 30, 1997, the Company has financed its
operations primarily through the private placement of equity securities, bank
loans, lease lines of credit and stockholder loans. From inception, the Company
has raised approximately $16.4 million in net proceeds from private equity
financings.

Cash and cash equivalents at December 31, 1996 were $8.8 million compared to
$7.0 million at September 30, 1997. The decrease was due to net cash used by
operations in the period, which was partially offset by the proceeds raised
from the Company's issuance of Preferred Stock in April 1997.

Net cash used in operating activities was approximately $2.3 million for fiscal
1996 and $1.3 million and $7.2 million for the periods ended September 30, 1996
and 1997, respectively. Net cash used in operating activities is less than the
Company's net loss for these comparison periods primarily due to noncash
charges associated with the amortization of deferred compensation and the
depreciation of property and equipment. Net cash used in investing activities
was approximately $1.3 million for fiscal 1996 and $808,000 and $1.2 million
for the periods ended September 30, 1996 and 1997, respectively, and was
attributable to capital expenditures during these periods. Net cash provided by
financing activities was approximately $12.4 million for fiscal 1996 and $11.1
million and $6.7 million for the periods ended September 30, 1996 and 1997,
respectively, attributable primarily to the sale of equity securities in pri-
vate placement transactions and drawings under the lease line of credit.

The Company has recorded deferred stock compensation expense for the difference
between the exercise price and the deemed fair value for financial statement
presentation purposes of the Company's Common Stock, as determined by the Board
of Directors, for certain options granted during 1996 and 1997. The total
recorded deferred stock compensation through September 30, 1997 is $4.6 mil-
lion. The Company amortized deferred compensation expenses of approximately
$22,000 for fiscal 1996 and $679,000 for the nine months ended September 30,
1997. The remainder of the deferred stock compensation will be amortized over
the corresponding vesting period of each respective option, which is generally
four years.

At September 30, 1997, the Company's principal sources of liquidity consisted
of $7.0 million in cash and cash equivalents and remaining unused borrowings of
$284,000 under an equipment lease line of credit. There were no other material
unused sources of liquid assets at September 30, 1997. The lease line agreement
contains certain financial covenants including maximum quarterly net losses,
minimum ratios for liquidity and debt to tangible net worth and a minimum tan-
gible net worth requirement. In the quarter ended September 30, 1997, the Com-
pany exceeded the maximum permitted under the net loss covenant, but has subse-
quently received a written waiver of the quarterly loss limitation for that
period from the lender and is currently renegotiating the terms of the finan-
cial covenant affecting maximum net losses on a prospective basis. Although
there can be no assurance that the Company will not be in violation of covenant
terms in the future, based upon the anticipated re-negotiated terms, the Com-
pany currently expects to be in compliance with the covenant terms for at least
the next 12 months. The borrowings bear interest at a weighted average rate of
approximately 10% as of September 30, 1997 and are secured by substantially all
of the assets of the Company.

23
<PAGE>

The Company currently anticipates that its capital expenditure requirements
will be approximately $250,000 for the remainder of fiscal 1997 and $2.0 mil-
lion for fiscal 1998. These requirements relate primarily to the acquisition of
computer hardware and software and for additional leasehold improvements to
handle the anticipated headcount additions. A portion of these capital expendi-
tures may be funded by amounts currently available under the Company's lease
line.

The Company anticipates that its existing resources, including the net proceeds
of the Offering, will enable the Company to maintain its current and planned
operations through at least fiscal 1999. However, there can be no assurance
that the Company will not require additional funding prior to such time. The
Company's future capital requirements will depend on many factors, including
the ability of the Company to establish and maintain strategic and distributor
relationships, the time and cost in obtaining regulatory approvals, competing
technological and market developments, the cost of manufacturing and other fac-
tors. There can be no assurance that additional financing to meet the Company's
funding requirements will be available as needed. If additional funds are
raised by issuing equity securities, substantial dilution to existing stock-
holders may result. Insufficient funds may require the Company to delay, scale
back or eliminate some or all of its research or development programs or to
relinquish rights to products at an earlier stage of development or on less
favorable terms than the Company would otherwise seek to obtain. The failure of
the Company to raise capital when needed would have a material adverse effect
on the Company's business, financial condition and results of operations.

24
<PAGE>

BUSINESS

COMPANY OVERVIEW

Somnus designs, develops, manufactures and markets innovative medical devices
that utilize its proprietary RF technology for the treatment of upper airway
disorders. The Company's Somnoplasty System provides physicians with a suite of
products designed to offer minimally-invasive, curative treatment alternatives
for disorders of the upper airway, including snoring, OSA and enlarged
turbinates. The Somnoplasty System shrinks tissue in the upper airway by
utilizing automated RF generators and a suite of disposable, single-use, needle
electrode devices which deliver controlled thermal energy to obstructed areas,
while protecting the delicate mucosal lining of the tissue. The Company
received 510(k) clearance in July 1997 for the use of the Somnoplasty System in
the treatment of snoring and officially launched the marketing of the
Somnoplasty System at the American Academy of Otolaryngology-Head and Neck
Surgery Foundation, Inc. conference in September 1997. The Company has also
received the CE Mark for use of the Somnoplasty System in the treatment of
upper airway disorders. In September 1997, the Company submitted a premarket
notification seeking 510(k) clearance for the treatment of enlarged turbinates
associated with chronic rhinitis. The Company believes that the clinical and
patient benefits of the Somnoplasty System include its effectiveness, quick
procedure time, outpatient setting, use of local anesthesia and low post-
procedural pain. These benefits represent a significant advancement to
physicians and patients over existing treatment options, which, depending upon
the disorder, are highly-invasive, non-curative and/or expensive. To date, the
Somnoplasty procedure has been performed for the treatment of snoring on over
125 patients in clinical centers in the United States and internationally.

The Company is developing a direct sales force to market its products in the
United States and Canada. The Company intends to market the Somnoplasty System
primarily to ear, nose and throat physicians, oral and maxillofacial surgeons,
pulmonologists, sleep medicine specialists and other physicians who treat upper
airway disorders. There are approximately 9,000 ear, nose and throat
physicians, 5,000 oral and maxillofacial surgeons, 5,200 pulmonologists and,
the Company believes, 3,100 sleep disorder medical centers in the United
States. As of September 30, 1997 the Company has shipped 14 Model 215 RF
Generators in the United States, including six in the month of September. In
April 1997, the Company entered into a three-year distribution arrangement with
Medtronic for the exclusive distribution of the Somnoplasty System in the
European Union, Australia, Southeast Asia and certain other areas. The Company
will seek to enter into additional agreements for product distribution in Japan
and other international markets. The Company also intends to establish a
marketing program directed at consumers to further establish awareness of the
Somnoplasty procedure. As of September 30, 1997, the Company has shipped 29
Model 215 RF Generators to Medtronic, including seven in the month of
September.

BUSINESS STRATEGY

Provide Minimally-Invasive, Curative Treatments for Upper Airway Disorders. The
Somnoplasty System provides physicians with a suite of products designed to
offer minimally-invasive, curative treatment alternatives for a number of upper
airway disorders. The Company believes that the clinical and patient benefits
of the Somnoplasty System include its effectiveness, quick procedure time, out-
patient setting, use of local anesthesia and low post-procedural pain. These
benefits represent a significant advancement to physicians and patients over
existing treatment options, which, depending upon the disorder, are highly-
invasive, non-curative and/or expensive.

Pursue Additional Indications for the Somnoplasty System. Somnus received
510(k) clearance in July 1997 for the use of the Somnoplasty System for reduc-
tion of soft tissue, including the uvula and soft palate, for the treatment of
snoring. The Company received the CE Mark for treatment of upper airway disor-
ders in June 1997. In September 1997, the Company submitted a premarket notifi-
cation seeking 510(k) clearance for the treatment of enlarged turbinates asso-
ciated with chronic rhinitis, and the Company intends to seek 510(k) clearance
of the Somnoplasty System for other new indications, including the treatment of
OSA associated with blockage caused by the tongue and the treatment of other
upper airway obstructions, some of which are associated with OSA. The Company
has recently begun clinical trials for use of the Somnoplasty System in the
treatment of blockage caused by the tongue.

25
<PAGE>

Create Global Distribution through Direct Sales Force and Collaborative
Relationships. Somnus intends to create a direct sales and distribution capa-
bility in the United States, initially targeting the estimated 9,000 ear, nose
and throat physicians and 5,000 oral and maxillofacial surgeons. In markets
outside the United States, the Company initially intends to establish relation-
ships with leading medical device distributors that can provide the Company
with access to an established network for the marketing and distribution of the
Somnoplasty System. As part of this strategy, Somnus has an agreement with
Medtronic to distribute its products in the European Union, Southeast Asia,
Australia and certain other areas and will seek to enter into additional agree-
ments for product distribution in Japan and other international markets.

Acquire and License Complementary Technologies and Products. Somnus intends to
pursue the acquisition and license of technologies and products in an effort to
complement its core business and technological platform. The Company believes
acquisitions may allow it to broaden its product line, leverage its distribu-
tion network and help accelerate the market acceptance and penetration of the
Somnoplasty System.

UPPER AIRWAY DISORDERS

The upper airway comprises the passages in the back of the mouth, the nose and
the throat and allows breathing, swallowing and speech vocalization. The
breathing function requires the upper airway tissue and musculature to be stiff
enough to prevent collapse during respiration, while swallowing and speech
require compliance and flexibility. The upper airway is susceptible to a
variety of ailments, including tissue obstructions. A common cause of
obstruction found in the upper airway is excess tissue in one or more
locations, including the uvula (the small conical fleshy tissue hanging from
the center of the soft palate), soft palate, base of the tongue, turbinates
(soft tissue in the nasal cavity) and tonsils. Obstructed breathing impedes the
normal flow of air to the respiratory system.

Certain upper airway disorders, such as snoring and OSA, are present only
during sleep, when normal neurologic stimulation and upper airway muscle tone
are diminished. Such upper airway disorders are classified as sleep disorders
and can have an adverse impact on a person's everyday life. The consequences of
sleep disorders and sleep deprivation include reduced productivity, decreased
quality of life and increased risk of serious illness. Other disorders, such as
nasal congestion due to enlarged turbinates (for instance, as a consequence of
allergies, such as hay fever) or enlarged tonsils, are independent of the
wake/sleep cycle and affect people throughout the day as well as during sleep.

Snoring

Snoring occurs when throat muscles relax during sleep and tissues in the back
of the mouth and in the throat, unsupported by nearby bone structure, collapse
and partially block the upper airway. This partial obstruction causes the
sleeping person to inhale more deeply, creating a vacuum in the collapsible
part of the airway and pulling floppy tissue into the airway. Snoring is the
sound of these structures vibrating during breathing.

Habitual snorers are individuals who snore almost every night at a noise level
that would be considered disturbing to others in the same room. The Company
estimates that there are more than 40 million habitual snorers in the United
States. Factors contributing to habitual snoring include male gender, obesity,
alcohol consumption, use of tranquilizers or muscle relaxants and smoking.
Research has shown that the frequent arousals from sleep caused by snoring may
affect a person's health and productivity during the day. The disruption of
normal sleep can lead to excessive daytime sleepiness, fatigue and loss of
memory and concentration in both the individual suffering from snoring and in
his or her companion. Moreover, snoring is often associated with, and may be a
precursor to, OSA.

Obstructive Sleep Apnea

OSA occurs when tissues in the back of the mouth and in the throat completely
block the upper airway, resulting in an inability to breathe. The brain,
sensing that the body is suffocating from a lack of oxygen, arouses the person
to a light sleep, causing the throat muscles to contract, thus allowing a small
passage of air and producing a gasping sound. The person falls back into deeper
sleep until the muscles relax again, blocking the upper airway and repeating
the cycle of arousal.

The cycle of complete or partial upper airway closure with subconscious arousal
to lighter levels of sleep can be repeated as many as several hundred times
during six to eight hours of sleep. Sufferers of OSA typically experience ten
or more such cycles per hour and experience two or more clinical symptoms of
OSA, such as excessive daytime sleepiness, reduced cognitive function (in-
cluding memory loss and lack of concentration) and irritability. Several
reports indicate that the oxygen desaturation, increased heart rate and ele-
vated blood pressure caused by OSA may be associated with increased risk of
cardiovascular morbidity and mortality due to angina, stroke and heart attack.

According to a 1993 report to Congress, the National Commission on Sleep
Disorders Research estimated that approximately 20 million people in the United
States were afflicted with OSA, of whom an estimated 6.4 million

26
<PAGE>

experienced the disorder at a moderate to severe level. The Company believes
that only a small percentage of those persons afflicted by OSA are aware that
they suffer from this condition and that it is the cause of their fatigue or
other symptoms of OSA.

Enlarged Turbinates

Chronic obstruction of the nasal cavity can impact a person's health and
quality of life. Chronic nasal obstructions are most frequently caused by
enlarged turbinates. Turbinates can become chronically enlarged as a reaction
to diseases, such as chronic and drug-induced rhinitis, and allergy-causing
substances. Enlarged turbinates can partially obstruct or completely block the
nasal passages, resulting in an inefficient or non-existent nasal function.
During the day, enlarged turbinates can cause breathing through the nose to be
difficult and uncomfortable, and at night can contribute to snoring and OSA.

CURRENT TREATMENTS FOR UPPER AIRWAY DISORDERS

Currently, no standard modality dominates the treatment of upper airway
disorders. Traditional treatment methods for upper airway disorders range from
behavioral changes to highly invasive surgery. More recently, treatments such
as Continuous Positive Airway Pressure and laser surgery have emerged for OSA
and snoring, respectively. Current treatments often result in lengthy recovery
periods, significant patient discomfort, poor compliance by the user and/or
high medical expenses.

Treatment of Snoring

There are both nonsurgical and surgical methods for treating snoring.
Nonsurgical devices and appliances used to treat snoring include nasal dila-
tors, such as adhesive nasal tapes which widen the nostrils to create a larger
passage and improve airflow, and oral appliances, which adjust the position of
a patient's jaw or tongue during sleep to prevent collapse of the upper airway.

Surgical treatment for snoring is available today with LAUP. Published studies
indicate a success rate for this procedure in the treatment of snoring of 75%
and greater. LAUP is the surgical resection of the uvula and soft palate
through the use of a surgical laser that operates at temperatures in excess of
700(degrees)C (1,292(degrees)F). A LAUP procedure does not require an overnight
stay in the hospital; however, it does present a risk of significant swelling,
scarring and post-operative pain, requiring a short period of close monitoring.

Third-party reimbursement is not available for the treatment of snoring.
Snoring sufferers most often seek treatment for quality of life rather than
medical reasons. Despite the lack of reimbursement and the significant post-
operative discomfort associated with LAUP procedures, the Company estimates
that in 1996 there were an estimated 45,000 to 50,000 LAUP procedures performed
in the United States. The Company believes that the average cost of a laser
required to perform a LAUP procedure is in excess of $60,000. LAUP, which typi-
cally requires two procedures to be effective, is typically charged at $1,200
to $2,000 for a full course of treatment.

Treatment of OSA

The most common treatment for OSA is CPAP. In CPAP, the sleeping patient wears
a mask over the nose, and sometimes the mouth, while pressure from a compressor
forces air through the upper airway to keep excess tissues from collapsing and
obstructing the airway. CPAP machines range from compressors which deliver an
unchanging, steady flow of air, to compressors which adjust pressure during
inspiration and expiration and even more sophisticated systems. Third-party
reimbursement is generally available for CPAP.

While CPAP is successful in addressing the symptoms of OSA, its use has a
number of disadvantages, including facial skin irritation, abdominal bloating,
mask leaks, sore eyes and headaches. Additionally, CPAP is not a cure for OSA
and, therefore, must be used on a nightly basis for life. The discomfort of the
mask, the inconvenience of use and the unsightly nature of the application
cause many patients to stop using CPAP machines. The ASDA estimated CPAP com-
pliance at only 46% in 1993. The cost for a basic CPAP machine is approximately
$500. Additional CPAP costs include costs for certain disposable components and
titration studies. Despite the discomfort to patients, an industry source esti-
mates that the market for CPAP machines will be approximately $140 million in
1997, representing an approximate 25% increase over the prior year.

For patients with severe OSA, surgical treatments exist such as UPPP, the sur-
gical resection of the uvula, part of the soft palate, tonsils and excess
tissue in the throat; maxillofacial surgery, a highly invasive procedure
requiring the resection of the tongue or reconstruction of the jaw bones; and
tracheostomies, surgical openings through the neck which bypass the obstruc-
tion.

27
<PAGE>

UPPP and the other surgical alternatives have been successful in treating OSA
in certain patients. However, possibly due to the fact that UPPP does not
address obstructions at the base of tongue or in the turbinates, it has proven
effective in only about half the patients treated. The most significant draw-
backs of UPPP, maxillofacial surgery and tracheostomies are that they are
highly-invasive, involve significant post-operative morbidity, including a
painful and lengthy recovery, and are expensive. The estimated cost of the
existing surgical procedures for OSA range from $6,000 for UPPP to $40,000 or
more for maxillofacial reconstruction.

Treatment of Enlarged Turbinates

Enlarged turbinates are associated with a variety of forms of rhinitis, and
optimal treatment varies accordingly. The first line of treatment typically
involves the use of a variety of drugs. While antihistamines, corticosteroids
and sympathomimetic drugs are often effective for acute presentations of
enlarged turbinates, this method of treatment suffers from side-effects on
other physiologic functions such as decreased effectiveness over time, rebound
congestion and even drug-induced rhinitis.

Various surgical techniques exist to treat enlarged turbinates, with different
instrumentation and degrees of invasiveness. Scalpels and electrocautery and
laser devices are the more common instruments. Resection can be limited to the
soft tissue of the turbinate or extend to part of the underlying bone
structure. These procedures are generally effective, but lead to significant
discomfort in the form of occasional post-operative bleeding and frequent
crusting. This requires time consuming post-operative management of the patient
on the part of the physician. In 1995, there were an estimated 129,000
turbinate resection procedures in the United States, nearly all of which were
performed in an outpatient setting. Surgical treatment of the turbinates is
generally reimbursed by Third-Party Payors. Median physician charges for this
procedure averaged $856 in 1995.

THE SOMNUS SOLUTION: SOMNOPLASTY

Somnus' proprietary Somnoplasty System is designed to use RF energy to provide
a minimally-invasive, curative and relatively painless treatment of upper
airway disorders. The Somnoplasty System includes an automated RF generator
with temperature monitoring and a suite of proprietary, single-use, disposable
needle electrode devices which deliver controlled thermal energy into the
uvula, soft palate, tongue and turbinates to reduce tissue volume and stiffen
overly-compliant soft tissue. The Somnoplasty System allows physicians to per-
form a safe, minimally-invasive surgical procedure in less than 30 minutes in
an outpatient setting. The use of RF energy to reduce tissue volume treats the
causes of upper airway disorders enlarging the airway passages and eliminates
the need for treatments such as CPAP, thereby obviating patient compliance
issues. The Somnoplasty System received 510(k) clearance in July 1997 for the
reduction of tissue, including the uvula and soft palate, for the treatment of
snoring. In June 1997, the Company received the CE Mark for use of the
Somnoplasty System for tissue reduction in the upper airway.

The procedure creates finely controlled coagulative lesions at precise loca-
tions underneath the mucosal layer of tissue in the upper airway. An insulating
sleeve at the base of the needle electrode protects the mucosa from thermal
damage which prevents tissue sloughing, mucosal scarring, swelling, bleeding
and excessive post-operative pain. Thermocouples in the insulation and at the
tip of the needle electrode assist in the accurate monitoring of tissue temper-
ature, which reaches only approximately 85(degrees)C (185(degrees)F), ensuring
optimal ablation and protecting the mucosa. The lesions created by the proce-
dure are naturally resorbed in approximately three to six weeks, reducing
excess tissue volume.

The Company believes that the primary advantages of the Somnoplasty System
include:

Minimal Discomfort and Reduced Recovery Time. The use of RF energy causes
significantly less swelling and post procedural pain than traditional and
laser-assisted surgery. Patients who undergo the Somnoplasty procedure
typically require only over-the-counter pain medication to treat the post-
operative pain and typically can return to work and resume their normal
activities the same day.

Clinical Effectiveness. Unlike treatments such as CPAP for OSA and over-the-
counter remedies for snoring, the Somnoplasty System is designed to be a cura-
tive treatment directly addressing the obstructive tissues in the upper airway.
The Company believes the treatment outcomes from the Somnoplasty System will be
equivalent to traditional surgical procedures without the deleterious side
effects of standard and laser-assisted operations.

Rapid Procedure Time. The Somnoplasty System, including patient preparation
and administration of local anesthesia, takes less than 30 minutes, with typi-
cally less than five minutes necessary for the RF ablation itself. Treatment
requires, on average, one to three visits to a trained physician and can be
performed in an outpatient setting using local anesthesia.

Ease of Use. The Somnoplasty System is designed to be easy for physicians to
use, thereby minimizing physician training requirements. The Somnoplasty proce-
dure is less complicated than many minor surgical procedures performed by den-
tists in their offices.

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<PAGE>

PRODUCT DESCRIPTION

The Company has developed devices for treatment of the soft palate and uvula,
the turbinates, the tongue and the tonsils.

SOMNOPLASTY PRODUCT LINE

<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
PRODUCT NAME DESCRIPTION STATUS
- ------------------- --------------------------------------- ---------------------------------------
<S> <C> <C>
Disposable Devices:
SP 1000 Single needle deployable electrode Commercially available; 510(k)
designed for the soft palate and uvula clearance and CE Mark approval
SP 2000 Dual needle deployable electrode Commercially available; 510(k)
designed for the soft palate and uvula clearance and CE Mark approval
SP 1100 Single needle electrode designed for In development; filed 510(k) submission
the turbinates for turbinate indication in September
1997; CE Mark approval
SP 3000 Multiple needle deployable electrode In clinical trials; anticipated 510(k)
designed for the tongue submission in 1998; CE Mark approval
SP 1900 Single needle electrode designed for In development; clinical trials
the tonsils expected to commence in 1998
Generators:
215 RF Dual channel generator Commercially available; 510(k)
clearance and CE Mark approval
615 RF Two, four or six channel generator with 510(k) clearance; commercial
data collection availability expected in the first half
of 1998
115 RF Single channel generator In development
</TABLE>

Disposable Devices

SP 1000. The SP 1000 is a single needle deployable electrode device designed
for the delivery of controlled RF energy into tissue in the soft palate and
uvula. The device delivers the RF energy through a coagulating needle electrode
which can be positioned using direct vision. The angle of deployment may be
adjusted prior to the procedure, allowing the physician to adapt the instrument
to individual patient requirements. The SP 1000 is commercially available and
the United States list price is $425.

SP 2000. The SP 2000 is a dual needle deployable electrode device for use in
the soft palate and uvula. By using two needles simultaneously, the physician
creates a wider lesion, reducing the amount of time required to reach the
appropriate level of energy. Like the SP 1000, the SP 2000 may be adjusted to
deploy both needles at different angles to accommodate individual anatomies.
The electrodes may be placed using direct vision or a light source. The SP 2000
is commercially available and the United States list price is $500.

SP 1100. The SP 1100 is a single needle electrode device designed for use in
enlarged turbinates. It delivers the RF energy through a coagulating single
needle electrode which can be positioned using direct vision. The angle of
deployment is fixed.

SP 3000. The SP 3000 is a multiple needle deployable electrode device designed
for the application of controlled thermal energy for patients suffering from
base of tongue airway obstruction. The SP 3000 delivers the RF energy through
one, two or three coagulating needle electrodes which are positioned using
direct vision.

SP 1900. The SP 1900 is a single needle electrode device designed for use in
enlarged tonsils.

Generators

The Company's RF generators are intended to be used for the treatment of tissue
obstructions in the upper airway by allowing the physician to efficiently con-
trol and monitor the delivery of energy needed for the RF ablation of tissue.
In automatic mode, the physician determines the maximum amount of power to
deliver, the length of time for the ablation and the target temperature to
maintain at the center of the lesion or, in the 615 and 115 RF Generators, the
total energy applied. The user interface of each generator is designed to
require minimal interaction, allowing the surgeon to focus on

29
<PAGE>

the patient. Each generator contains proprietary software that modulates the
delivery of power based on information transmitted from the disposable needle
electrode devices.

215 RF Generator. The 215 RF Generator is designed for use with the SP 1000, SP
1100, SP 2000 and SP 1900 needle electrode devices. The real-time display
allows the physician to monitor delivered power, energy and temperatures in up
to two independent channels for as many as six thermocouples. The Company has
obtained 510(k) clearance and the CE Mark for the 215 RF Generator for use with
all of the Company's single and dual needle electrode devices. The 215 RF Gen-
erator is commercially available and the United States list price is $25,000.

615 RF Generator. The 615 RF Generator is being designed to be compatible with
all of the Company's needle electrode devices while being incompatible with
needle electrode devices supplied by other companies. A high-quality color
screen displays delivered power, energy and temperatures in up to six indepen-
dent channels for up to sixteen thermocouples. An integral disk drive captures
procedure data and is also used for software upgrades as new products are
introduced. The Company has obtained 510(k) clearance for the 615 RF Generator
for use with all of the Company's needle electrode devices.

115 RF Generator. The 115 RF Generator is being developed for use with the SP
1000, SP 1100 and SP 1900 needle electrode devices. An LCD display will show
real-time display of all relevant settings. Like the 615 RF Generator, the 115
RF Generator is being designed to be compatible with only those needle elec-
trode devices supplied by the Company.

CLINICAL AND REGULATORY STATUS

United States. In July 1997, the Company received 510(k) clearance for use of
the Somnoplasty System for coagulation of soft tissue, including the uvula and
soft palate, which may reduce the severity of snoring in some individuals. The
510(k) clearance was based on the results of a 24 patient, single-center clin-
ical trial completed in June 1997. The data from this trial indicated that
patients may require anywhere from one to six treatments to significantly
reduce snoring. While the Company anticipates that most patients will only
require one to three treatments, factors such as the severity of the patient's
upper airway obstruction or improper use of the Somnoplasty System by the
treating physician could require more treatments. To date, over 125 patients
have been treated with the Somnoplasty System for this indication in clinical
centers in the United States and internationally.

The Company is conducting a trial for use of the Somnoplasty System in the
reduction of enlarged turbinates typically associated with chronic rhinitis. In
September 1997, the Company submitted a 510(k) premarket notification with the
FDA for turbinates, based on the results of 38 patients from the first two cen-
ters involved in this clinical trial.

In addition, the Company plans to conduct a three-center trial with a total of
45 patients for use of the Somnoplasty System in the treatment of OSA associ-
ated with an airway obstruction at the base of the tongue. A safety trial with
five patients was successfully completed in July 1997. The Company expects to
submit a 510(k) premarket notification with the FDA for this indication in
1998.

Following the clinical evaluation of the turbinate and tongue indications men-
tioned above, the Company intends to pursue FDA clearance for the treatment of
additional upper airway obstructions, some of which may strengthen the claim
for the treatment of OSA. The Company expects its 510(k) submissions for these
supplemental indications will require additional clinical trials.

The Company has obtained 510(k) clearance from the FDA for the use of the SP
1000 and SP 2000 disposable electrodes for the reduction of severity of snoring
in some individuals. The 215 and 615 RF Generators and SP 3000 disposable elec-
trode have received 510(k) clearance for a general claim of tissue coagulation.
Other clearances are being pursued for various product enhancements. All Somnus
products cleared are Class II products.

International. In June 1997, the Company received authorization from the Euro-
pean Union (through a duly appointed Notified Body) to affix the CE Mark to its
commercially available products for treatment of upper airway obstructions. The
Company has been certified under the ISO 9001 QS Reg. by TUV Essen, a German
Notified Body. The Company has also received a TGA listing for Australia.

RESEARCH AND DEVELOPMENT

Somnus believes that it has a strong base of proprietary design, engineering,
manufacturing and prototype development capabilities. The Company has
particular expertise in the core research and development areas relevant to the
production of new disposable needle electrode devices for use in conjunction
with its current RF generators. Primarily through internal research and
development efforts, the Company plans to continue to develop new proprietary
products, often in

30
<PAGE>

collaboration with leading surgeons and sleep medicine professionals, that
allow surgeons to perform their current or future procedures in a less-
traumatic manner with more precision, less surgical time and greater
simplicity. Specifically, the Company is developing new disposable devices
which are intended to address additional upper airway obstructions such as
enlarged tonsils and bronchial growths. The Company believes that its
experience in designing, developing and manufacturing its current suite of
disposable needle electrode devices gives it a competitive advantage in
implementing this strategy. The Company also from time to time may evaluate
acquisitions and licensing of third-party technology and products to further
expand and enhance its product line.

The Company's research and development expenditures for the period from
inception to December 31, 1996 and for the nine months ended September 30, 1997
were approximately $1,303,000 and $4,095,000, respectively. As of September 30,
1997, the Company's research and development staff consisted of 14 persons. The
Company performs its research and development activities at its offices in
Sunnyvale, California. No assurance can be given that the Company will be able
to complete the development of or successfully introduce any or all of its
devices under development or contemplated for future development on a timely
basis, if at all.

SALES, MARKETING AND DISTRIBUTION

In the United States, the Company is building a direct sales force to target
ear, nose and throat surgeons, oral and maxillofacial surgeons, sleep centers
and other physicians who treat sleep disorders. To date the Company has hired
three regional sales managers with medical device sales experience and four
sales representatives to implement its direct sales strategy in the United
States. The Company intends to add approximately 30 additional sales represent-
atives by the end of 1998.

The primary customers in the United States for the Somnoplasty System are
expected to be the approximately 9,000 ear, nose and throat physicians and the
approximately 5,000 oral and maxillofacial surgeons. The Company also intends
to market to the approximately 5,200 pulmonologists, as well as sleep medicine
specialists. Certain products, such as the SP 1100 for the treatment of the
enlarged turbinates, are expected to appeal to a larger target market,
including allergists and primary care physicians. An important additional
target for the Company's sales efforts will be the approximately 3,100 sleep
centers which the Company believes exist in the United States. These sleep cen-
ters are multi-specialty practices dedicated to sleep disorders, include spe-
cialists such as ear, nose and throat and oral and maxillofacial surgeons,
pulmonologists and psychiatrists and are typically chaired by physicians who
are board certified in sleep medicine. The centers include facilities for over-
night monitoring and have access to sophisticated diagnostic equipment to
determine the type and characteristics of sleep apnea. To date, over 350 of
these centers have been accredited by the ASDA. Sleep centers are important not
only as potential customers, but also for their role in referring diagnosed
patients for treatment.

For physicians not served by the Company's direct sales organization, such as
allergists and primary care physicians treating the enlarged turbinates in
patients suffering from chronic allergies, the Company will consider other dis-
tribution channels, such as partnerships with established medical device compa-
nies.

The Company intends to initially assign, on an exclusive basis, international
distribution rights for therapeutic products to distributors. In April 1997,
the Company entered into a three-year distribution agreement with Medtronic for
the European Union, Australia, Southeast Asia and certain other areas.
Medtronic commenced distribution of the Company's products in June 1997 when
the Company was awarded the CE Mark, the principal regulatory requirement for
medical device sales in Europe. As of September 30, 1997, the Company has
shipped 29 Model 215 RF Generators to Medtronic, including seven in the month
of September.

The Company's marketing and education efforts are currently focused on early
adopters with emphasis on leading surgeons and sleep centers. As its products
mature, the Company's marketing and education will focus increasingly on the
mainstream medical market and, ultimately, on consumers so as to create patient
demand for the Somnoplasty procedure.

MANUFACTURING

The Company currently manufactures its devices in limited quantities for its
United States, European and Australian sales and clinical trials. Each device
is assembled and tested by the Company prior to sterilization. The manufac-
turing process consists primarily of assembly of internally manufactured and
purchased components and subassemblies, and certain processes are performed in
a clean room environment. The Company has no experience manufacturing its prod-
ucts in the volumes or with the yields that will be necessary for the Company
to achieve significant commercial sales, and there can be no assurance that the
Company can establish high-volume manufacturing capacity or, if established,
that the Company will be able to manufacture its products in high volumes with
commercially acceptable yields. The Company intends to use a portion of the
proceeds from the Offering to develop manufacturing expertise and to establish
large-scale manufacturing capabilities.

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<PAGE>

Raw materials, components and subassemblies are purchased from various
qualified suppliers and are subject to stringent quality specifications and
inspections. The Company conducts quality audits of its key suppliers, several
of whom are experienced in the supply of components to manufacturers of medical
devices. None of the Company's suppliers of components for its disposable
devices is contractually obligated to continue to supply the Company nor is the
Company contractually obligated to purchase such devices from a particular
supplier. For certain of these components and subassemblies, there are
relatively few alternative sources of supply, and establishing additional or
replacement suppliers for such components and subassemblies could not be
accomplished quickly.

The Company has designed its 215 RF Generator in concert with a single-source
supplier, Apical Instruments, a developer of RF medical devices. The generator
is purchased as a finished assembly from Apical. The Company is in the process
of developing the 615 RF Generator which will be assembled at the Company's
facility, with Apical Instruments acting as a supplier for the RF subassembly.
The 115 RF Generator currently in development will be manufactured entirely by
the Company. The Company has not experienced any significant adverse effects
resulting from shortages of components. Delays associated with any future part
shortages, particularly as the Company scales up its manufacturing activities
in support of international distributor orders and commercial introduction in
the United States, would have a material adverse effect on its business, finan-
cial condition and results of operations.

The Company's manufacturing facilities are subject to periodic inspection by
regulatory authorities, and its operations must undergo compliance inspections
conducted by the FDA and corresponding state agencies.

DEPENDENCE UPON PATENTS AND PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT

In the United States, the Company has four issued patents, eight allowed pat-
ents and an additional 34 pending patent applications. The Company also has two
issued foreign patents and 17 pending foreign patent applications. These pat-
ents and patent applications relate to the Company's RF devices and methods for
reduction of tissue in the uvula, soft palate, tongue and tonsils, and design
of its generators and disposable devices. In addition, the Company may also
selectively license patents owned by others which it believes will complement
the technology and increase the value and strength of its intellectual property
portfolio, although it has not done so to date. The Company's strategy has been
to actively pursue patent protection in the United States and foreign jurisdic-
tions for all upper airway disorders that can benefit from use of the
Somnoplasty System.

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<PAGE>

The medical device industry in general has been characterized by substantial
litigation. Litigation regarding patent and other intellectual property rights,
whether with or without merit, could be time-consuming and expensive and could
divert the Company's technical and management personnel. The Company may be
involved in litigation to defend against claims of infringement by the Company,
to enforce patents issued to the Company or to protect trade secrets of the
Company. If any relevant claims of third-party patents are held as infringed
and not invalid in any litigation or administrative proceeding, the Company
could be prevented from practicing the subject matter claimed in such patents
or would be required to obtain licenses from the patent owners of each such
patent or to redesign its products or processes to avoid infringement. In
addition, in the event of any possible infringement, there can be no assurance
that the Company would be successful in any attempt to redesign its products or
processes to avoid such infringement or in obtaining licenses on terms
acceptable to the Company, if at all. Accordingly, an adverse determination in
a judicial or administrative proceeding or failure by the Company to redesign
its products or processes or to obtain necessary licenses could prevent the
Company from manufacturing and selling the Somnoplasty System, which would have
a material adverse effect on the Company's business, financial condition and
results of operations. Although, to date, the Company has not been involved in
any litigation, in the future, costly and time-consuming litigation brought by
the Company may be necessary to enforce patents issued to the Company, to
protect trade secrets or know-how owned by the Company or to determine the
enforceability, scope and validity of the proprietary rights of others.

COMPETITION

The Company believes that the primary competitive factors in the market for
treatment of upper airway disorders include regulatory approvals, clinical and
patient acceptance, post-operative discomfort, ease of use, product perfor-
mance, product price, product supply, marketing and sales capability and the
enforceability of patent and other proprietary rights. The Company believes
that it is or will be competitive with respect to these factors. Nonetheless,
because the Company's

33
<PAGE>

products have recently been introduced or are still under development, the rel-
ative competitive position of the Company in the future is difficult to pre-
dict.

GOVERNMENT REGULATION

The preclinical and clinical testing, manufacturing, labeling, distribution and
promotion of the Company's products are subject to extensive and rigorous gov-
ernment regulation in the United States and other countries. Noncompliance with
applicable requirements can result in enforcement action by the FDA or compa-
rable foreign regulatory bodies including, among other things, fines, injunc-
tions, civil penalties, recall or seizures of products, refusal to grant
premarket clearances or approvals, withdrawal of marketing approvals and crim-
inal prosecution.

United States

A medical device may be marketed in the United States only with the FDA's prior
authorization. Devices classified by the FDA as posing less risk are placed in
either in Class I or II and require the manufacturer to seek 510(k) clearance
from the FDA. Such clearance generally is granted when submitted information
establishes that a proposed device is "substantially equivalent" in intended
use and safety and effectiveness to a "predicate device," which is either a
Class I or II device already legally on the market or a "preamendment" Class
III device (i.e., one that has been in commercial distribution since before May
28, 1976) for which the FDA has not called for PMA applications. The Company
believes that it usually takes from four to 12 months from the date of
submission to obtain 510(k) clearance, but it may take longer, and there can be
no assurance that 510(k) clearance will ever be obtained. During this process,
the FDA may determine that it needs additional information or that a proposed
device is precluded from receiving clearance because it is not substantially
equivalent to a predicate device. After a device receives clearance, any
modification that could significantly affect its safety or effectiveness, or
would constitute a major change in the intended use of the device, will require
a new 510(k) submission.

The Company has made modifications to its cleared devices which the Company
believes do not require the submission of new 510(k) notices. There can be no
assurance, however, that the FDA would agree with any of the Company's determi-
nations not to submit a new 510(k) notice for any of these changes or would not
require the Company to submit a new 510(k) notice for any of the changes made
to the devices. If the FDA requires the Company to submit a new 510(k) notice
for any device modification, the Company may be prohibited from marketing the
modified device until the 510(k) notice is cleared by the FDA.

A device that does not qualify for 510(k) clearance is placed in Class III,
which is reserved for devices classified by FDA as posing the greatest risk
(e.g., life-sustaining, life-supporting or implantable devices, or devices that
are not substantially equivalent to a predicate device). A Class III device
generally must obtain PMA approval, which requires the manufacturer to
establish the safety and effectiveness of the device to the FDA's satisfaction.
A PMA application must provide extensive preclinical and clinical trial data
and also information about the device and its components regarding, among other
things, manufacturing, labeling and promotion. As part of the PMA review, the
FDA will inspect the manufacturer's facilities for compliance with the QS Reg.,
which includes elaborate testing, control, documentation and other quality
assurance procedures.

Upon submission, the FDA determines if the PMA application is sufficiently com-
plete to permit a substantive review, and if so, the application is accepted
for filing. The FDA then commences an in-depth review of the PMA application,
which the Company believes typically takes one to three years, but may take
longer. The review time is often significantly extended as a result of the FDA
asking for more information or clarification of information already provided.
The FDA also may respond with a "not approvable" determination based on defi-
ciencies in the application and require additional clinical trials that are
often expensive and time consuming and can delay approval for months or even
years. During the review period, an FDA advisory committee, typically a panel
of clinicians, likely will be convened to review the application and recommend
to the FDA whether, or upon what conditions, the device should be approved.
Although the FDA is not bound by the advisory panel decision, the panel's rec-
ommendation is important to the FDA's overall decision making process.

If the FDA's evaluation of the PMA application is favorable, the FDA typically
issues an "approvable letter" requiring the applicant's agreement to specific
conditions (e.g., changes in labeling) or specific additional information
(e.g., submission of final labeling) in order to secure final approval of the
PMA application. Once the approvable letter is satisfied, the FDA

34
<PAGE>

will issue a PMA for approved indications, which can be more limited than those
originally sought by the manufacturer. The PMA can include postapproval condi-
tions that the FDA believes necessary to ensure the safety and effectiveness of
the device including, among other things restrictions on labeling, promotion,
sale and distribution. Failure to comply with the conditions of approval can
result in material adverse enforcement action, including the loss or withdrawal
of the approval. The PMA process can be expensive and lengthy, and no assurance
can be given that any PMA application will ever be approved for marketing. Even
after approval of a PMA, a new PMA or PMA supplement is required in the event
of a modification to the device, its labeling or its manufacturing process.

In September 1997, the Company submitted a premarket notification seeking
510(k) clearance for the treatment of enlarged turbinates associated with
chronic rhinitis. The Company intends to seek 510(k) clearance of the
Somnoplasty System for new indications, including treatment of OSA associated
with blockage caused by the tongue, and the treatment of other upper airway
obstructions, some of which are associated with OSA. These future submissions
likely will need to include supporting clinical trial data. There can be no
assurance, however, that these new indications, including the Company's recent
submission for the treatment of enlarged turbinates, will receive 510(k) clear-
ance in a timely fashion, or at all. Delays in market introduction resulting
from the 510(k) clearance process could have a material adverse effect on the
Company's business, financial condition and results of operations. If the FDA
determines that any of the new indications are not eligible for 510(k) clear-
ance, the Company will need to seek PMA approval. There can be no assurance
that the Company will submit a PMA application for any such indications or that
once submitted, the PMA application will be accepted for filing, found approv-
able or, if found approvable, will not include unfavorable restrictions.

A clinical trial in support of a 510(k) submission or PMA application generally
requires an IDE application approved in advance by the FDA for a limited number
of patients. The IDE application must be supported by appropriate data, such as
animal and laboratory testing results. Clinical trials may begin if the IDE
application is approved by the FDA and the appropriate IRBs at the clinical
trial sites. Submission of an IDE application does not give assurance that the
FDA will approve the IDE application and, if it is approved, there can be no
assurance that the FDA will determine that the data derived from these studies
support the safety and efficacy of the device or warrant the continuation of
clinical studies. If the device presents a "nonsignificant risk" to the
patient, a sponsor may begin the clinical trial after obtaining approval for
the study by one or more appropriate IRBs without the need for FDA approval.
The Company is sponsoring several clinical trials which have been determined by
the IRBs at the participating institutions to be nonsignificant risk studies.
There can be no assurance however, that the FDA would agree with these determi-
nations and not require the Company to obtain IDE approval before continuing
the studies. During a clinical trial, the Company is permitted to sell products
used for the study for an amount that does not exceed recovery of the costs of
manufacture, research, development and handling. The Company's failure to
adhere to regulatory requirements generally applicable to clinical trials or to
the conditions of an IDE approval could have a material adverse effect on the
Company's business, financial conditions and results of operations, including
an inability to obtain marketing clearance or approval for its products.

Any devices manufactured or distributed by the Company pursuant to FDA clear-
ances or approvals will be subject to pervasive and continuing regulation by
the FDA and certain state agencies. The Company will be subject to routine
inspection by the FDA and the CDHS and will have to comply with the host of
regulatory requirements that usually apply to medical devices marketed in the
United States, including labeling regulations, the QS Reg., the MDR regulation
and the FDA's prohibitions against promoting products for unapproved or "off-
label" uses. In addition, Class II devices, such as the Company's Somnoplasty
System, can be subject to additional special controls (e.g., performance stan-
dards, postmarket surveillance, patient registries, and FDA guidelines) that do
not apply to Class I devices. The Company's failure to comply with applicable
regulatory requirements could result in enforcement action by the FDA, which
could have a material adverse effect on the Company's business, financial con-
dition and results of operations.

35
<PAGE>

European Union

The primary regulatory environment in Europe is that of the European Union
which consists of 15 countries encompassing most of the major countries in
Europe. Certain other countries, such as Switzerland, have voluntarily adopted
laws and regulations that mirror those of the European Union with respect to
medical devices. The European Union has adopted numerous directives and stan-
dards regulating the design, manufacture, clinical trial, labeling, and adverse
event reporting for medical devices. The principal directives prescribing the
laws and regulations pertaining to medical devices in the EU are the Medical
Devices Directive, 93/42/EEC.

Devices that comply with the requirements of a relevant directive will be
entitled to bear CE conformity marking, indicating that the device conforms
with the essential requirements of the applicable directive and, accordingly,
can be commercially distributed throughout the European Union. The method of
assessing conformity varies depending on the class of the product, but normally
involves a combination of self-assessment by the manufacturer and a third-party
assessment by a Notified Body. This third-party assessment may consist of an
audit of the manufacturer's quality system and specific testing of the
manufacturer's product. An assessment by a Notified Body in one country within
the European Union is required in order for a manufacturer to commercially
distribute the product throughout the European Union. The Company's Somnoplasty
System received the CE Mark in June 1997.

While no additional premarket approvals or individual EU countries are
required, prior to the marketing of a device bearing the CE Mark, practical
complications with respect to market introduction may occur. For example, dif-
ferences among countries have arisen with regard to labeling requirements.

THIRD-PARTY REIMBURSEMENT

The Company believes that its products will generally be purchased by private
practices, clinics, hospitals and sleep centers. In the United States, the pur-
chasers of medical devices generally rely on Third-Party Payors to reimburse
all or part of the cost of the procedure in which the medical device is being
used. Certain Third-Party Payors are moving toward a managed-care system in
which they contract to provide comprehensive health care for a fixed cost per
person. The fixed cost per person established by these Third-Party Payors may
be independent of the practice's cost incurred for the specific case and the
specific devices used. Medicare and other Third-Party Payors are increasingly
scrutinizing whether to cover new products and the level of reimbursement for
covered products.

Because the Company's devices are currently under development for treatment of
enlarged turbinates, tonsils and base of the tongue and OSA and have not
received FDA clearance or approval for such indications, uncertainty exists
regarding the availability of third-party reimbursement for procedures that
would use the Company's devices for such purposes. Failure by private prac-
tices, clinics, hospitals, sleep centers and other potential users of the
Company's devices to obtain sufficient reimbursement from Third-Party Payors
for the procedures in which the Company's devices are intended to be used could
have a material adverse effect on the Company's business, financial condition
and results of operations.

36
<PAGE>

The Company believes that in the future, reimbursement will be subject to
increased restrictions both in the United States and in international markets.
The Company believes that the overall escalating cost of medical products and
services will continue to lead to increased pressures on the health care indus-
try, both domestic and international, to reduce the cost of products and serv-
ices, including the Company's existing products and products currently under
development by it. There can be no assurance that third-party reimbursement and
coverage will be available or adequate in either the United States or interna-
tional markets or that future legislation, regulation or reimbursement policies
of Third-Party Payors will not otherwise adversely affect the demand for the
Company's existing products or products currently under development by it or
its ability to sell its products on a profitable basis. The unavailability of
Third-Party Payor coverage or the inadequacy of reimbursement could have a
material adverse effect on the Company's business, financial condition and
results of operations.

PRODUCT LIABILITY EXPOSURE AND AVAILABILITY OF INSURANCE

The Company's business involves the risk of product liability claims. Although
the Company has not experienced any product liability claims to date, any such
claims could have a material adverse impact on the Company. Although the Com-
pany maintains product liability insurance with coverage limits of $2.0 million
per occurence and an annual aggregate maximum of $2.0 million, coverage levels
which the Company believes to be commercially reasonable and adequate given the
Company's current operations, there can be no assurance that product liability
or other claims will not exceed such insurance coverage limits or that such
insurance will continue to be available on commercially acceptable terms, or at
all. The Company intends to periodically evaluate, depending on changing cir-
cumstances, and in connection with the introduction of products currently under
development, whether or not to obtain any additional product liability insur-
ance coverage prior to the time that the Company engages in any extensive mar-
keting of the Somnoplasty System or new products. Even if the Company obtains
additional product liability insurance, there can be no assurance that it would
prove adequate or that a product liability claim, insured or uninsured, would
not have a material adverse effect on the Company's business, financial condi-
tion and results of operations. Even if a product liability claim is not suc-
cessful, the time and expense of defending against such a claim may adversely
affect the Company's business, financial condition and results of operations.

EMPLOYEES

As of September 30, 1997, the Company employed 58 individuals full time. Of the
Company's total work force, 20 employees are engaged in manufacturing, 14
employees are engaged in research and development activities, 11 employees are
engaged in sales and marketing activities and 13 employees are engaged in
finance and administrative activities. The Company's employees are not repre-
sented by a collective bargaining agreement. The Company believes its relations
with its employees are good.

FACILITIES

The Company leases an approximately 20,000 square foot light industrial
facility in Sunnyvale, California, under a lease which terminates in 2002, with
an option to extend to 2007. The Company believes that its facility is adequate
to meet its current and reasonably anticipated future requirements.

37
<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information as of September 30, 1997
with respect to the executive officers and directors of the Company:

<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
NAME AGE POSITION
- ------------------------ --- ----------------------------------------------------
<S> <C> <C>
Stuart D. 52 Chairman of the Board of Directors, Chief Executive
Edwards(1)(2).......... Officer and President
Robert E. McNamara...... 40 Executive Vice President, Chief Financial Officer
Eric N. Doelling........ 39 Executive Vice President, Chief Operating Officer
and Director
Stephen M. Rudy......... 40 Senior Vice President, Marketing and Business
Development
Donald R. Bruce......... 47 Vice President, Worldwide Sales
Eve A. Conner, Ph.D. ... 52 Vice President, Clinical and Regulatory Affairs
Kirti P. Kamdar......... 36 Vice President, Research and Development
David L. Douglass(2).... 45 Director
David Illingworth(1).... 43 Director
Ronald G. Lax........... 64 Director
David B. Musket (1)..... 39 Director
Woodrow A. Myers(2)..... 43 Director
</TABLE>
- -------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.

STUART D. EDWARDS is the founder of the Company and has served as Chairman of
the Board, Chief Executive Officer and President of the Company since its
founding in January 1996. From July 1992 to May 1995, Mr. Edwards served as
President, Chief Executive Officer and Chairman of the Board of VidaMed, Inc.,
a medical device company co-founded by Mr. Edwards which develops minimally-
invasive surgical systems. He continued to serve as President and Chief
Executive Officer of VidaMed, Inc. until December 1995 and continues to serve
as a board member of such company. From December 1989 until October 1992, Mr.
Edwards was Vice President and Chief Technical Officer of EP Technologies,
Inc., a developer and manufacturer of electrophysiology catheters. Mr. Edwards
previously held positions with Applied Immune Sciences, Inc., a subsidiary of
Rhone-Poulenc Rorer Inc., Control Data Systems, Inc., AVI Corporation, UFE
Corporation, Abbott Laboratories, Ideal Toy Corporation and Baxter Healthcare
Corporation. Mr. Edwards holds a Certificate in Mechanical Engineering from the
Union of Educational Institutions in England.

ROBERT E. MCNAMARA has served as Chief Financial Officer of the Company since
August 1997. From April 1995 until August 1997, Mr. McNamara served as Vice
President of Finance and Administration and Chief Financial Officer of Target
Therapeutics, Inc., a medical device manufacturer. From August 1994 until April
1995, Mr. McNamara served as Chief Financial Officer of Guittard Chocolate Co.
From 1987 until August 1994, Mr. McNamara held various financial management
positions at Tandem Computers, Inc. He holds a B.S. from the University of San
Francisco and an M.B.A. from the University of Pennsylvania's Wharton School.

ERIC N. DOELLING has served as Executive Vice President, Chief Operating
Officer of the Company since July 1996 and as a Director since November 1996.
From April 1993 until July 1996, Mr. Doelling was Vice President, Manufacturing
of Cardiac Pathways Corporation, a medical device company. From January 1990 to
March 1993, he was Vice President of Operations for Spectranetics, Inc. Mr.
Doelling holds both a B.S. and an M.B.A. from Rensselaer Polytechnic Institute.

STEPHEN M. RUDY has served as Senior Vice President, Marketing and Business
Development of the Company since April 1996. From May 1995 until June 1996, Mr.
Rudy was a Principal for Cowper Consulting, a consulting firm specializing in
business development and marketing for medical device companies. From September
1992 until May 1995, he served as Vice President of Marketing and Sales for
VidaMed, Inc. Mr. Rudy holds a B.A. in Political Science from Johns Hopkins
University and an M.B.A. from Stanford University.

DONALD R. BRUCE has served as Vice President, Worldwide Sales of the Company
since March 1997. From June 1996 until March 1997, he was a Principal of Orb
International, a sales consulting firm to medical device companies. From 1977
until June 1996, Mr. Bruce worked for Xomed, Inc., an otolaryngology device
company, in several capacities, including,

38
<PAGE>

most recently, Vice President of International Sales and Marketing. Mr. Bruce
holds a B.S. in Biology from the University of Minnesota where he served as the
manager of the ear, nose and throat research laboratory.

EVE A. CONNER, PH.D. has served as Vice President, Clinical and Regulatory
Affairs of the Company since August 1996. From October 1991 to June 1996, she
served as Vice President, Regulatory/Clinical Affairs and Quality Assurance for
Baxter Healthcare Corporation's Novacor Division. Dr. Conner holds a B.A. in
Biology and Chemistry from Keuka College and a Ph.D. in Pharmacology/Toxicology
from the University of Minnesota.

KIRTI P. KAMDAR has served as Vice President, Research and Development of the
Company since August 1997 and previously served as Vice President,
Manufacturing from August 1996 to July 1997. From May 1995 until August 1996,
he was Vice President of Research and Development, developing new
cardiovascular devices, at Guided Medical Systems, a medical device company.
From October 1994 until May 1995, he was a Project Manager in Research and
Development with Cardiac Pathways Corporation. From April 1991 to October 1994,
Mr. Kamdar held several engineering and managerial positions for Mallinckrodt
Inc. Mr. Kamdar holds a B.S. from Gujarat University (India), a M.S. from New
Jersey Institute of Technology and an M.B.A. from the University of Houston.

DAVID L. DOUGLASS has served as a director of the Company since March 1996.
Since June 1990, Mr. Douglass has been a General Partner of Delphi Ventures, a
venture capital firm. Since February 1986, he has also been a General Partner
of Matrix Partners II, L.P., a venture capital firm. Mr. Douglass serves on the
board of several private medical technology companies and VidaMed, Inc., a
public company. He holds a B.A. in Political Science from Amherst College and
an M.A. in Administration and Policy Analysis and an M.B.A. from Stanford Uni-
versity.

DAVID ILLINGWORTH has served as a Director of the Company since February 1997.
Since January 1993, Mr. Illingworth has held positions with Nellcor Puritan
Bennett, Inc., a wholly owned subsidiary of Mallinckrodt Inc., most recently
serving as Executive Vice President and President, Alternative Care Business.
From September 1991 until December 1992, he served as General Manager of G.E.
Medical Systems. He holds a B.S. in Engineering from Texas A&M University.

RONALD G. LAX has served as a Director of the Company since March 1996 and as a
Consultant for the Company since June 1996. Mr. Lax has experience with several
medical device companies. Since January 1996, he has served as President of
Prodesearch Corp. From 1975 to December 1995, Mr. Lax served as founder and
President of Gant Western, Inc. From June 1994 to April 1995, Mr. Lax served as
Vice President Engineering and Development of RITA Medical Systems, Inc.
(formerly ZoMed, Inc.). From July 1992 until June 1994, he served as a
consultant to VidaMed, Inc.

DAVID B. MUSKET has served as a Director of the Company since November 1996 as
a designated representative of INVESCO Trust Company, an investor in the Com-
pany. Since August 1991, he has been President of Musket Research Associates,
Inc., an investment banking firm specializing in healthcare, and of DBM Corpo-
rate Consulting Group. Since June 1996, he has also been a managing Member of
ProMed Management, LLC, a money management company focusing on both public and
private healthcare companies.

WOODROW A. MYERS, JR., M.D. has served as a Director of the Company since
August 1997. Since November 1995, Dr. Myers has served as the Director,
Healthcare Management, of Ford Motor Company. From August 1991 to October 1995,
Dr. Myers served as Senior Vice President and Corporate Medical Director of The
Associated Group. From January 1990 to July 1991, he served as the Commissioner
of Health of New York City and as an Assistant Professor of Medicine at Cornell
Medical College. Dr. Myers holds a B.S. in Biological Science from Stanford
University, an M.D. from Harvard Medical School and an M.B.A. from Stanford
University.

EMPLOYMENT AGREEMENTS

The Company has entered into an agreement relating to the employment of Robert
E. McNamara whereby the Company has agreed to provide Mr. McNamara with
severance benefits during the first two years of employment in the event of
termination without cause consisting of 12 months continued salary, insurance
benefits, bonus and option vesting. The agreement also provides that, upon an
acquisition, merger or sale of a majority of the Company's assets, Mr. McNamara
will receive six months continued salary, insurance benefits and bonus, and all
of his outstanding stock options will fully and immediately vest. Mr.
McNamara's current annual salary is $175,000 and he holds 225,000 options to
purchase shares of Common Stock which vest over four years from the date of
hire.

The Company has entered into an agreement relating to the employment of Eric N.
Doelling whereby the Company has agreed to provide Mr. Doelling with severance
benefits in the event of termination consisting of six months salary, insurance
benefits and vesting of stock options which would otherwise have vested in the
year following his termination. The agreement also provides that, upon an
acquisition, merger or sale of a majority of the Company's assets, all of
Mr. Doelling's outstanding stock options will fully and immediately vest. Mr.
Doelling's current annual salary is $160,000 and he holds 300,000 options to
purchase shares of Common Stock which vest over four years from the date of
hire.

39
<PAGE>

The Company has entered into an agreement relating to the employment of Stephen
M. Rudy which provides for, in the event of termination, the vesting of all
stock options which would otherwise have vested in the year of his termination.
The agreement also provides that, upon an acquisition, merger or sale of a
majority of the Company's assets. Mr. Rudy's outstanding options will fully and
immediately vest. Mr. Rudy's current annual salary is $160,000 and he holds
200,000 options to purchase shares of Common Stock which vest over four years
from the date of hire and 25,000 options to purchase shares of Common Stock
which vest over four years from August 1997.

BOARD COMPOSITION

The Company currently has authorized seven directors. In accordance with the
terms of the Company's Restated Certificate of Incorporation, effective upon
the consummation of the Offering, the terms of office of the Board of Directors
will be divided into three classes: Class I, whose term will expire at the
annual meeting of stockholders to be held in 1998; Class II, whose term will
expire at the annual meeting of stockholders to be held in 1999; and Class III,
whose term will expire at the annual meeting of stockholders to be held in
2000. The Class I directors are David L. Douglass and David B. Musket, the
Class II directors are Eric N. Doelling, David Illingworth and Ronald G. Lax,
and the Class III directors are Stuart D. Edwards and Woodrow A. Myers. At each
annual meeting of stockholders after the initial classification, the successors
to directors whose term will then expire will be elected to serve from the time
of election and qualification until the third annual meeting following
election. In addition, the Company's Restated Certificate of Incorporation
provides that the authorized number of directors may be changed only by
resolution of the Board of Directors. Any additional directorships resulting
from an increase in the number of directors will be distributed among the three
classes so that, as nearly as possible, each class will consist of one-third of
the authorized number of directors. This classification of the Board of
Directors may have the effect of delaying or preventing changes in control or
management of the Company.

Each officer of the Company is elected by and serves at the discretion of the
Board of Directors. Each of the Company's officers and directors, other than
nonemployee directors, devotes substantially full time to the affairs of the
Company. The Company's nonemployee directors devote such time to the affairs of
the Company as is necessary to discharge their duties. There are no family
relationships among any of the directors or executive officers of the Company.

Pursuant to a voting agreement dated September 11, 1996 between the Company and
certain stockholders of the Company, INVESCO Trust Company, an investor in the
Company, was granted the right to designate a representative to serve as
director of the Company. David B. Musket serves on the Board as the designated
representative of INVESCO Trust Company. Upon the consummation of the Offering,
this voting agreement will terminate by its terms.

BOARD COMMITTEES

The Audit Committee of the Board of Directors reviews the internal accounting
procedures of the Company and consults with and reviews the services provided
by the Company's independent accountants. The members of the Audit Committee
are Messrs. Edwards, Illingworth and Musket. The Compensation Committee of the
Board of Directors reviews and recommends to the Board the compensation and
benefits of all officers, employees and consultants of the Company and
establishes and reviews general policies relating to compensation and benefits
of employees of the Company. The members of the Compensation Committee are
Messrs. Edwards, Douglass and Myers.

DIRECTOR COMPENSATION

The Company's directors do not receive cash compensation for services on the
Board of Directors or any committee thereof, but directors may be reimbursed
for reasonable expenses in connection with attendance at Board and committee
meetings. Following consummation of the Offering, non-employee directors may
receive stock option grants pursuant to the Company's 1997 Director Option
Plan. See "Stock Plans--1997 Director Option Plan."

40
<PAGE>

EXECUTIVE COMPENSATION

The following table sets forth the information for the year ended December 31,
1996 regarding the compensation of the Company's Chief Executive Officer. None
of the Company's executive officers received total compensation for such fiscal
year in excess of $100,000. Additionally, the table sets forth 1997 annualized
information regarding the compensation of the Company's Chief Executive Officer
(footnoted) and the Company's four most highly compensated executive officers
(the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
----------------------------------------------------------------------
LONG TERM
COMPENSATION
AWARDS
------------
SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER
POSITION SALARY($) BONUS COMPENSATION($) OPTIONS COMPENSATION($)(1)
- ------------------ --------- ------ --------------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
Stuart D. Edwards $ 61,538(2) -- -- --(3) 1,846(4)
Chief Executive Officer
Robert E. McNamara(5) 175,000 10,000 -- 225,000 3,600
Chief Financial Officer
Eric N. Doelling 160,000 7,500 -- 300,000 3,600
Chief Operating Officer
Stephen M. Rudy 160,000 -- -- 225,000 3,600
Vice President,
Marketing and Business
Development
Donald R. Bruce(6) 140,000 42,000 -- 125,000 --
Vice President,
Worldwide Sales
</TABLE>
- -------
(1) Reflects amounts for automobile allowances.

(2) Reflects Mr. Edwards' 1996 salary which he began receiving from the Company
in September 1996. During 1997, Mr. Edward's annual salary was $225,000 until
August, when his annual salary was increased to $250,000.

(3) In August 1997, Mr. Edwards received an option to purchase 100,000 shares
of the Company's Common Stock, which option vests over four years.

(4) During 1997, Mr. Edwards has received an automobile allowance of $500 per
month.

(5) Mr. McNamara joined the Company in August 1997

(6) Mr. Bruce joined the Company in March 1997.

41
<PAGE>

OPTION GRANTS IN CURRENT FISCAL YEAR

The Company made no stock option grants to and there was no exercise of stock
options by its Chief Executive Officer during the year ended December 31, 1996.
The following table sets forth each grant of stock options made during the cur-
rent fiscal year for the period ended September 30, 1997 to each of the Named
Executive Officers who received a grant during such period:

<TABLE>
<CAPTION>
------------------------------------------------------------------
INDIVIDUAL GRANTS
-----------------------------------------------
POTENTIAL
REALIZABLE VALUE
AT ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED IN EXERCISE FOR OPTION TERM(3)
OPTIONS FISCAL YEAR PRICE EXPIRATION ------------------
NAME GRANTED(#) (%)(1) ($/SH)(2) DATE 5%($) 10%($)
- ---- ---------- ------------- --------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Stuart D. Edwards 100,000(4) 7.0 3.00 08/21/07 188,668 478,123
Robert E. McNamara(5) 225,000 15.7 3.00 08/21/07 424,504 1,075,776
Stephen M. Rudy 25,000(4) 1.7 3.00 08/21/07 47,167 119,531
Donald R. Bruce 100,000(4) 7.0 0.70 06/06/07 44,023 111,562
25,000(4) 1.7 3.00 08/21/07 47,167 119,531
</TABLE>
- -------
(1) Based on an aggregate of options to purchase 1,434,400 shares of the
Company's Common Stock granted to employees and directors of, and consultants
to, the Company, including the Named Executive Officers.

(2) The Company recorded deferred compensation with respect to the option
grants for the difference between the exercise price and the deemed fair value
of these options. See Note 5 of Notes to Consolidated Financial Statements.

(3) The potential realizable value is calculated based on the term of the
option at its time of grant (ten years). It is calculated assuming that the
fair market value of the Common Stock of the Company on the date of grant
appreciates at the annual rate shown (compounded annually) from the date of
grant until the expiration of the ten year option term. These numbers are cal-
culated based on the requirements promulgated by the Securities and Exchange
Commission and do not reflect the Company's estimate of future stock price
growth.

(4) Options become exercisable as to 25% of the option shares on the first
anniversary of the vesting commencement date and thereafter ratably on a
monthly basis, with full vesting occurring on the fourth anniversary of the
vesting commencement date.

(5) Mr. McNamara's options vest as to 56,250 shares in February 1998 and there-
after as to 4,018 shares monthly, until all shares are vested.

AGGREGATE OPTION EXERCISES IN FISCAL 1997 AND SEPTEMBER 30, 1997 OPTION VALUES

The following table sets forth for each of the Named Executive Officers certain
information with respect to stock option exercises during the period from Jan-
uary 1, 1997 to September 30, 1997 and the number and value of securities
underlying unexercised options held by the Named Executive Officers at Sep-
tember 30, 1997:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES SEPTEMBER 30, 1997(#) SEPTEMBER 30, 1997($)(1)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Stuart D. Edwards -- -- -- 100,000 -- 700,000
Robert E. McNamara -- -- -- 225,000 -- 1,575,000
Eric N. Doelling 87,500 66,250 6,250 206,250 61,875 2,041,875
Stephen M. Rudy 93,750 271,875 3,125 103,125 30,938 1,020,938
Stephen M. Rudy -- -- -- 25,000 -- 175,000
Donald R. Bruce -- -- -- 100,000 -- 930,000
Donald R. Bruce -- -- -- 25,000 -- 175,000
</TABLE>
- -------
(1) Based upon an assumed initial public offering price of $10.00 per share
minus the exercise price.

42
<PAGE>

STOCK PLANS

1996 Stock Plan

The Company's Amended and Restated 1996 Stock Plan (the "1996 Plan") was
approved by the Board of Directors in March 1996 and by the stockholders in
July 1996. The 1996 Plan was amended and restated in August 1997. A total of
3,350,000 shares of Common Stock have been reserved for issuance under the 1996
Plan. As of September 30, 1997, 452,768 shares had been issued upon exercise of
stock options granted, 2,507,754 shares were subject to outstanding options and
389,478 shares remained available for future issuance under the 1996 Plan.

The 1996 Plan provides for the grant of incentive stock options, within the
meaning of Section 422 of the Code, to employees (including officers and
employee directors) and for the grant of nonstatutory stock options and stock
purchase rights ("SPRs") to employees, directors and consultants. The 1996 Plan
provides for an increase, without further approval or ratification by the
stockholders, of 750,000 shares on the date of the stockholder's annual meeting
to be held in 1998 and additional increases, without further approval or rati-
fication by the stockholders, on the date of each subsequent stockholders'
annual meeting equal to the lesser of (i) 500,000 shares, (ii) 2.5% of the out-
standing shares or (iii) a lesser amount determined by the Board. Unless termi-
nated sooner, the 1996 Plan will terminate automatically in March 2006.

The 1996 Plan may be administered by the Board of Directors or a committee of
the Board (as applicable, the "Administrator"). The Administrator has the power
to determine the terms of the options or SPRs granted, including the exercise
price of the option or SPR, the number of shares subject to each option or SPR,
the exercisability thereof, and the form of consideration payable upon such
exercise. In addition, the Administrator has the authority to amend, suspend or
terminate the 1996 Plan, provided that no such action may affect any share of
Common Stock previously issued and sold or any option previously granted under
the 1996 Plan.

Options and SPRs granted under the 1996 Plan are not generally transferable by
the optionee, and each option and SPR is exercisable during the lifetime of the
optionee only by such optionee. Options granted under the 1996 Plan must gener-
ally be exercised within 90 days after the end of optionee's status as an
employee, director or consultant of the Company, or within 12 months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option's ten year term.

In the case of SPRs, unless the Administrator determines otherwise, the
Restricted Stock Purchase Agreement shall grant the Company a repurchase option
exercisable upon the voluntary or involuntary termination of the purchaser's
employment with the Company for any reason (including death or disability). The
purchase price for shares repurchased pursuant to the Restricted Stock Purchase
Agreement shall be the original price paid by the purchaser and may be paid by
cancellation of any indebtedness of the purchaser to the Company. The repur-
chase option shall lapse at a rate determined by the Administrator.

The exercise price of all incentive stock options granted under the 1996 Plan
must be at least equal to the fair market value of the Common Stock on the date
of grant. The exercise price of nonstatutory stock options and SPRs granted
under the 1996 Plan is determined by the Administrator, but with respect to
nonstatutory stock options intended to qualify as "performance-based compensa-
tion" within the meaning of Section 162(m) of the Code, the exercise price must
at least be equal to the fair market value of the Common Stock on the date of
grant. With respect to any participant who owns stock possessing more than 10%
of the voting power of all classes of the Company's outstanding capital stock,
the exercise price of any incentive stock option granted must equal at least
110% of the fair market value on the grant date and the term of such incentive
stock option must not exceed five years. The term of all other options granted
under the 1996 Plan may not exceed ten years.

The 1996 Plan provides that in the event of a merger of the Company with or
into another corporation, or a sale of substantially all of the Company's
assets, each option shall be assumed or an equivalent option substituted for by
the successor corporation. If the outstanding options are not assumed or sub-
stituted for by the successor corporation, the Administrator shall provide for
the optionee to have the right to exercise the option or SPR as to all of the
optioned stock, including shares as to which it would not otherwise be exercis-
able. If the Administrator makes an option or SPR exercisable in full in the
event of a merger or sale of assets, the Administrator shall notify the
optionee that the option or SPR shall be fully exercisable for a period of 15
days from the date of such notice, and the option or SPR will terminate upon
the expiration of such period.

43
<PAGE>

1997 Employee Stock Purchase Plan

The Company's 1997 Employee Stock Purchase Plan (the "1997 Purchase Plan") was
adopted by the Board of Directors in September 1997 and approved by the stock-
holders in September 1997, subject to the closing of the Offering. A total of
50,000 shares of Common Stock has been reserved for issuance under the 1997
Purchase Plan, plus annual increases equal to the lesser of (i) 175,000 shares,
(ii) 1% of the outstanding shares on such date or (iii) a lesser amount deter-
mined by the Board.

The 1997 Purchase Plan, which is intended to qualify under Section 423 of the
Code, contains consecutive, overlapping, 24 month offering periods. Each
offering period includes four six-month purchase periods. The offering periods
generally start on the first trading day on or after May 1 and November 1 of
each year, except for the first such offering period which commences on the
first trading day on or after the effective date of the Offering and ends on
the last trading day on or before October 31, 1999.

Employees are eligible to participate if they are customarily employed by the
Company or any participating subsidiary for at least 20 hours per week and more
than five months in any calendar year. However, any employee who (i) immedi-
ately after grant owns stock possessing 5% or more of the total combined voting
power or value of all classes of the capital stock of the Company, or (ii)
whose rights to purchase stock under all employee stock purchase plans of the
Company accrues at a rate which exceeds $25,000 worth of stock for each cal-
endar year may be not be granted an option to purchase stock under the 1997
Purchase Plan. The 1997 Purchase Plan permits participants to purchase Common
Stock through payroll deductions of up to 10% of the participant's "compensa-
tion." Compensation is defined as the participant's base straight time gross
earnings, overtime and commissions but excludes payments for shift premium,
incentive compensation, incentive payments, bonuses and other compensation. The
maximum number of shares a participant may purchase during a single purchase
period is 2,500 shares.

Amounts deducted and accumulated by the participant are used to purchase shares
of Common Stock at the end of each purchase period. The price of stock pur-
chased under the 1997 Purchase Plan is 85% of the lower of the fair market
value of the Common Stock at the beginning of the offering period or at the end
of the purchase period. In the event the fair market value at the end of a pur-
chase period is less than the fair market value at the beginning of the
offering period, the participants will be withdrawn from the current offering
period following exercise and automatically re-enrolled in a new offering
period. The new offering period will use the lower fair market value as of the
first date of the new offering period to determine the purchase price for
future purchase periods. Participants may end their participation at any time
during an offering period, and they will be paid their payroll deductions to
date. Participation ends automatically upon termination of employment with the
Company.

Rights granted under the 1997 Purchase Plan are not transferable by a partici-
pant other than by will, the laws of descent and distribution, or as otherwise
provided under the 1997 Purchase Plan. The 1997 Purchase Plan provides that, in
the event of a merger of the Company with or into another corporation or a sale
of substantially all of the Company's assets, each outstanding option may be
assumed or substituted for by the successor corporation. If the successor cor-
poration refuses to assume or substitute for the outstanding options, the
offering period then in progress will be shortened and a new exercise date will
be set. The 1997 Purchase Plan will terminate in August 2007. The Board of
Directors has the authority to amend or terminate the 1997 Purchase Plan,
except that no such action may adversely affect any outstanding rights to pur-
chase stock under the 1997 Purchase Plan.

1997 Director Option Plan

The 1997 Director Option Plan (the "Director Plan") was adopted by the Board of
Directors in September 1997 and approved by the stockholders in September 1997,
subject to the closing of the Offering. The Director Plan provides for the
grant of nonstatutory stock options to non-employee directors. The Director
Plan has a term of ten years, unless terminated sooner by the Board. A total of
350,000 shares of Common Stock has been reserved for issuance under the
Director Plan, plus annual increases equal to (i) the optioned stock underlying
options granted in the immediately preceding year, or (ii) a lesser amount
determined by the Board.

The Director Plan provides that each non-employee director shall automatically
be granted an option to purchase 20,000 shares of Common Stock (the "Initial
Option") on the date which such person first becomes a non-employee director,
unless immediately prior to becoming a non-employee director, such person was
an employee director of the Company. In addition to the Initial Option, each
non-employee director shall automatically be granted an option to purchase
5,000 shares (a "Subsequent Option") on the date of the Company's annual
meeting of stockholders, if on such date he or she shall have served on the
Board for at least six months. Each Initial Option and each Subsequent Option
shall have a term of ten years.

44
<PAGE>

The shares subject to the Initial Option shall vest as to 25% of the optioned
stock one year from the date of grant, and 1/48 of the optioned stock shall
vest each month thereafter, provided the person continues to serve as a
Director on such dates. The exercise price of each Initial Option and each Sub-
sequent Option shall be 100% of the fair market value per share of the Common
Stock, generally determined with reference to the closing price of the Common
Stock as reported on the Nasdaq National Market on the last trading day prior
to date of grant.

In the event of a merger of the Company or the sale of substantially all of the
assets of the Company, each option may be assumed or an equivalent option sub-
stituted for by the successor corporation. If an option is assumed or substi-
tuted for by the successor corporation, it shall continue to vest as provided
in the Director Plan. However, if a non-employee director's status as a
director of the Company or the successor corporation, as applicable, is termi-
nated other than upon a voluntary resignation by the non-employee director,
each option granted to such non-employee director shall become fully vested and
exercisable. If the successor corporation does not agree to assume or substi-
tute for the option, each option shall become fully vested and exercisable for
a period of 15 days from the date the Board notifies the optionee of the
option's full exercisability, after which period the option shall terminate.
Options granted under the Director Plan must be exercised within three months
of the end of the optionee's tenure as a director of the Company, or within 12
months after such director's termination by death or disability, but in no
event later than the expiration of the option's ten year term. No option
granted under the Director Plan is transferable by the optionee other than by
will or the laws of descent and distribution, and each option is exercisable,
during the lifetime of the optionee, only by such optionee.

EMPLOYEE RETIREMENT PLANS

The Company has a 401(k) Plan which stipulates that all full-time employees
with at least 60 days of employment can elect to contribute to the 401(k) Plan,
subject to certain limitations, up to 15% of salary on a pretax basis. The Com-
pany has the option to provide matching contributions but has not done so to
date.

45
<PAGE>

CERTAIN TRANSACTIONS

The Company's operations, prior to incorporation and until its April 1996
issuance of Series A Preferred Stock, were funded by VidaCare International,
Inc. ("VidaCare"), a private holding company of Stuart D. Edwards, the Chairman
of the Board, Chief Executive Officer and President of the Company. The
expenses incurred prior to incorporation consisted primarily of payroll,
consultant and legal costs incurred in the establishment of the Company,
intellectual property protection and initial research and development efforts.
Of the $213,660 invested by VidaCare, $63,660 was converted into 63,660 shares
of Series A Preferred Stock in May 1996 and $150,000 was repaid in cash in
April 1996. Since the beginning of the Company's last fiscal year, Mr. Edwards
was indebted to the Company for short-term loans totalling, in the aggregate,
$142,813. The loans carried no interest and the total amount was repaid in
August 1997.

In March 1996, in connection with its formation, the Company issued and sold an
aggregate of 2,365,000 shares of Common Stock to a total of 16 investors at a
purchase price of $0.001 per share. The officers, directors and five percent
stockholders who purchased shares of Common Stock are (i) Stuart D. Edwards,
1,000,000 shares, (ii) Stephen M. Rudy, 5,000 shares, (iii) Ronald G. Lax,
150,000 shares, and (iv) David L. Douglass, 500,000 shares.

In April and May 1996, the Company issued and sold an aggregate of 1,784,160
shares of Series A Preferred Stock to a total of 36 investors at a purchase
price of $1.00 per share. The directors who purchased shares of Series A Pre-
ferred Stock were (i) Ronald G. Lax, 50,000 shares, (ii) David B. Musket,
25,000 shares and (iii) Eric N. Doelling, 15,000 shares.

In September and October 1996, the Company issued and sold an aggregate of
3,500,000 shares of Series B Preferred Stock to a total of 30 investors at a
purchase price of $3.00 per share. The officers, directors and five percent
stockholders who purchased shares of Series B Preferred Stock were (i) persons
and entities affiliated with David B. Musket, 177,700 shares, (ii) Global
Health Sciences Fund, a mutual fund company advised by INVESCO Trust Company,
1,000,000 shares, (iii) entities affiliated with The Travelers Companies,
1,000,000 shares, and (iv) HPB Associates, L.P., 666,667 shares. Pursuant to
the terms of the Series B Preferred Stock Purchase Agreement, a finder's fee
was paid to an entity affiliated with Mr. Musket, Musket Research Associates
("MRA") totaling 7% of the aggregate proceeds received by the Company from the
sale of Series B Preferred Stock. The total finder's fee to MRA of $710,223 was
paid by the issuance of 60,000 shares of Series B Preferred Stock and the
payment of $530,233. Additionally, in connection with the Series B Preferred
Stock financing, MRA and the Company entered into an agreement whereby for each
1% of the shares actually sold in the Company's initial public offering that
are purchased by investors or parties directly affiliated with the investors
identified by MRA in the Series B Preferred Stock financing, MRA will be
granted options or warrants to purchase 1,000 shares of Common Stock at a price
equivalent to the initial public offering price. Such options or warrants if
issued, will have a five year term and be entitled to antidilution and
piggyback registration rights.

During the year ended December 31, 1996, RGL Leasing, a company affiliated with
Ronald G. Lax, a stockholder and Director of the Company, leased equipment with
a value of $78,000 to the Company. The lease agreement provides terms compa-
rable to other lease agreements entered into by the Company.

In April 1997, the Company issued and sold 714,286 shares of Series C Preferred
Stock to Medtronic Asset Management, Inc., an investment entity of Medtronic,
at a purchase price of $7.00 per share. In connection with this transaction,
the Company granted to Medtronic exclusive distribution rights over certain of
the Company's products and devices in the European Union, Australia, Southeast
Asia and certain other areas until April 21, 2000.

In June 1997, the Company granted options to purchase 100,000 shares of the
Company's Common Stock to Donald Bruce at an exercise price of $0.70 per share.
One-fourth of the shares subject to the option shall become exercisable at the
end of one year and 1/48 of such shares shall become exercisable at the end of
each month thereafter.

In August 1997, the Company granted options to Stephen M. Rudy, Donald Bruce
and Stuart D. Edwards to purchase 25,000, 25,000 and 100,000 shares of the
Company's Common Stock, respectively, each at an exercise price of $3.00 per
share. In each case, one-fourth of the shares subject to the option shall
become exercisable at the end of one year and 1/48 of such shares shall become
exercisable at the end of each month thereafter.

In August 1997, the Company granted options to purchase 225,000 shares of the
Company's Common Stock to Robert E. McNamara at an exercise price of $3.00 per
share. One-fourth of the shares subject to the option shall become exercisable
at the end of six months and 1/42 of the remaining shares shall become exercis-
able at the end of each month thereafter.

46
<PAGE>

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information known to the Company with
respect to the beneficial ownership of the Common Stock as of September 30,
1997, giving effect to the Preferred Stock Conversion, and as adjusted to
reflect the sale of Common Stock offered by the Company hereby for (i) each
person who is known by the Company to own beneficially more than five percent
of the Common Stock, (ii) each of the Company's directors, (iii) the Company's
Chief Executive Officer and (iv) all of the Company's directors and executive
officers as a group.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED(1)
----------------------------------
PERCENT PERCENT
BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER OFFERING OFFERING
- ------------------------------------ ------------ ---------- ----------
<S> <C> <C> <C>
INVESCO Trust Company(2) 1,000,000 11.3% 7.8%
Attn: Buck Phillips
7800 East Union Avenue, Suite 1100
Denver, CO 80237
Entities affiliated with The Travelers 1,000,000 11.3% 7.8%
Companies(3)
Attn: Don Scudder
The Travelers Companies
One Tower Square
Hartford, CT 06183
Stuart D. Edwards 808,500 9.2% 6.3%
Somnus Medical Technologies, Inc.
285 N. Wolfe Road
Sunnyvale, CA 94086
Medtronic Asset Management, Inc.(4) 714,286 8.1% 5.6%
7000 Central Avenue, NE
Minneapolis, MN 55432-3576
HPB Associates, L.P. 666,667 7.6% 5.2%
Attn: Howard Berkowitz
888 Seventh Avenue
New York, NY 10106
David L. Douglass 500,000 5.7% 3.9%
Delphi Ventures
3000 Sand Hill Road
Building 1, Suite 135
Menlo Park, CA 94025
Ronald G. Lax 300,000 3.4% 2.3%
Somnus Medical Technologies, Inc.
285 N. Wolfe Road
Sunnyvale, CA 94086
David B. Musket(5) 222,533 2.5% 1.7%
Musket Research Associates
125 Cambridgepark Drive
Cambridge, MA 02140
Eric N. Doelling(6) 106,500 1.2% *
David Illingworth(7) 10,833 * *
Woodrow A. Myers, Jr., M.D.(8) 2,500 * *
All directors and executive officers as a 2,125,866 23.8% 16.5%
group (12 persons)(4)(5)(6)(7)(9)
</TABLE>
- -------
* Represents beneficial ownership of less than one percent.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or invest-
ment power with respect to securities. Beneficial ownership also includes
shares of stock subject to options or warrants currently exercisable or
convertible, or exercisable or convertible within 60 days after the date of
this table. Except as indicated by footnote, and subject to community prop-
erty laws where applicable, to the knowledge of the Company, all persons
named in the table above have sole voting and investment power with respect
to all shares of Common Stock shown as beneficially owned by them. Per-
centage of beneficial ownership is based on 8,816,214 shares of Common
Stock outstanding as of September 30, 1997 and 12,816,214 shares of Common
Stock outstanding upon consummation of the Offering.
(2) These shares are owned by the Global Health Sciences Fund, a mutual fund
company advised by INVESCO Trust Company. INVESCO Trust Company has full
voting and investment authority for these shares and is therefore the bene-
ficial owner.
(3) Consists of 450,000 shares held by The Travelers Insurance Company, 440,000
shares held by The Travelers Indemnity Company, 60,000 shares held by The
Phoenix Insurance Company and 50,000 shares held by The Travelers Life and
Annuity Company.
(4) Does not include shares of Common Stock that Medtronic may purchase in the
Offering. Medtronic has indicated a non-binding intention to purchase up to
$5,000,000 of Common Stock in the Offering (up to 500,000 shares at an
assumed initial public offering price of $10.00 per share). If Medtronic
purchases 500,000 shares in the Offering, it will beneficially own 9.5% of
the Common Stock outstanding after the Offering. See "Underwriting."
(5) Includes 85,600 shares held by MedCap I Corp. and 41,100 shares held by
ProMed Partners, L.P. Mr. Musket is a managing Member of ProMed Management,
LLC which manages both MedCap I Corp. and ProMed Partners, L.P. and dis-
claims beneficial ownership of the shares held by such entities except to
the extent of his proportionate ownership interest therein. Also includes
options to purchase up to 10,833 shares exercisable within 60 days after
September 30, 1997.
(6) Includes options to purchase up to 25,000 shares exercisable within 60 days
after September 30, 1997.
(7) Consists of options to purchase up to 10,833 shares exercisable within 60
days after September 30, 1997.
(8) Consists of options to purchase up to 2,500 shares exercisable within 60
days after September 30, 1997.
(9) Includes options to purchase up to 51,250 shares exercisable within 60 days
after September 30, 1997.

47
<PAGE>

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company will consist of 50,000,000 shares
of Common Stock and 5,000,000 shares of Preferred Stock after giving effect to
the amendment of the Company's Restated Certificate of Incorporation upon the
consummation of the Offering.

The following summary of certain provisions of the Common Stock and Preferred
Stock does not purport to be complete and is subject to, and qualified in its
entirety by, the provisions of the Company's Restated Certificate of Incorpora-
tion which is included as an exhibit to the Registration Statement of which
this Prospectus is a part, and by the provisions of applicable law.

COMMON STOCK

As of September 30, 1997, there were 8,816,214 shares of Common Stock out-
standing (assuming the Preferred Stock Conversion on a one-for-one basis) which
were held of record by 108 stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from
time to time by the Board of Directors out of funds legally available for that
purpose. See "Dividend Policy." In the event of a liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, subject to prior
distribution rights of Preferred Stock, if any, then outstanding. The Common
Stock has no preemptive or conversion rights or other subscription rights.
There are no redemption or sinking fund provisions applicable to the Common
Stock.

PREFERRED STOCK

Effective upon the consummation of the Offering, the Company will be authorized
to issue 5,000,000 shares of undesignated Preferred Stock, none of which will
be outstanding. The Board of Directors will have the authority, subject to any
limitations prescribed by law, without further action by the stockholders, to
issue the undesignated Preferred Stock in one or more series, to fix the
rights, preferences, privileges and restrictions granted to or imposed upon any
wholly unissued shares of undesignated Preferred Stock and to fix the number of
shares constituting any series and the designation of such series.

The issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
stockholders, may discourage bids for the Company's Common Stock at a premium
over the market price of the Common Stock and may adversely affect the market
price of, and the voting and other rights of the holders of, Common Stock. At
present, the Company has no plans to issue any of the Preferred Stock.

WARRANTS

As of September 30, 1997, the Company had outstanding warrants to purchase
37,500 shares of Preferred Stock at $1.00 per share, expiring in June 2006, and
25,000 shares of Preferred Stock at $3.00 per share, expiring in October 2001.
Each warrant is exercisable immediately and contains provisions for the adjust-
ment of the exercise price and the aggregate number of shares issuable upon the
exercise of the warrant under certain circumstances, including stock dividends,
stock splits, reorganizations and reclassifications. Each warrant may be exer-
cised, without the payment of cash, for a number of shares of Preferred Stock
determined pursuant to a net issue exercise formula contained in the warrant.
Each warrant holder has certain registration rights. In addition, the terms of
the warrants provide that upon the consummation of the Offering, the warrants
will become exercisable for shares of Common Stock. See "Registration Rights of
Certain Holders."

REGISTRATION RIGHTS OF CERTAIN HOLDERS

The holders of 5,937,358 shares (the "Registrable Securities") of Common Stock
(including up to 62,500 shares of Common Stock issuable upon exercise of out-
standing warrants) or their transferees are entitled to certain rights with
respect to the registration of such shares under the Securities Act. These
rights are provided under the terms of agreements between the Company and the
holders of the Registrable Securities. Subject to certain limitations in such
agreements and to the Lock-up Agreements, the holders of at least a majority of
the Registrable Securities may require, on two occasions beginning three months
after the date of this Prospectus, that the Company use its best efforts to
register the Registrable Securities for public resale. In addition, if the Com-
pany registers any of its Common Stock either for its own account or for the
account of other security holders, the holders of Registrable Securities are
entitled to include their shares of Common Stock in the registration, subject
to the ability of the underwriters to limit the number of shares included in
such offering. The holders of at least five percent of the Registrable Securi-
ties may also require the Company to register all or a portion of

48
<PAGE>

their Registrable Securities on Form S-3 when use of such form becomes avail-
able to the Company, provided, among other limitations, that the proposed
aggregate selling price (net of any underwriters' discounts or commissions) is
at least $1 million. All registration expenses must be borne by the Company and
all selling expenses relating to Registrable Securities must be borne by the
holders of the securities being registered.

DELAWARE LAW AND CERTAIN CHARTER PROVISIONS

The Company is subject to the provisions of Section 203 of the Delaware Law, an
anti-takeover law. In general, the statute prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business combina-
tion is approved in a prescribed manner. For purposes of Section 203, a "busi-
ness combination" includes a merger, asset sale or other transaction resulting
in a financial benefit to the interested stockholder, and an "interested stock-
holder" is a person who, together with affiliates and associates, owns (or
within three years prior, did own) 15% or more of the corporation's voting
stock.

The Company's Amended and Restated Certificate of Incorporation and Bylaws also
require that, effective upon the consummation of the Offering, any action
required or permitted to be taken by stockholders of the Company must be
effected at a duly called annual or special meeting of the stockholders and may
not be effected by a consent in writing. In addition, special meetings of the
stockholders of the Company may be called only by the Board of Directors, the
Chairman of the Board or the Chief Executive Officer. The Company's Amended and
Restated Certificate of Incorporation will also provide for a classified Board
which will be instituted at such time as the Company is no longer subject to
Section 2115 of the California Corporations Code and specifies that the
authorized number of directors may be changed only by an amendment to the
Bylaws, duly adopted by the Board of Directors or the stockholders, or by a
duly adopted amendment to the Certificate of Incorporation. These provisions
may have the effect of deterring hostile takeovers or delaying changes in
control or management of the Company. See "Management--Board Composition."

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is American Securities
Transfer, Incorporated.

49
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Prior to the Offering, there has been no market for the Common Stock of the
Company. Future sales of substantial amounts of Common Stock of the Company in
the public market could materially and adversely affect the prevailing market
price of the Common Stock and the ability of the Company to raise equity cap-
ital in the future.

Upon consummation of the Offering, the Company will have 12,816,214 shares of
Common Stock outstanding, assuming no exercise of options after September 30,
1997. Of these shares, the 4,000,000 shares sold in the Offering will be freely
tradable without restriction under the Securities Act, unless held by "affili-
ates" of the Company, as that term is defined in Rule 144 under the Securities
Act. The remaining 8,816,214 shares of Common Stock held by existing stock-
holders are "restricted securities" within the meaning of the Securities Act.
The holders of the Restricted Shares have entered into Lock-up Agreements under
which such holders have agreed not to sell, directly or indirectly, or other-
wise dispose of any of their shares for a period of 180 days after the date of
this Prospectus without the prior written consent of J.P. Morgan Securities
Inc. J.P. Morgan Securities Inc. may, in its sole discretion and at any time
without notice, release all or any portion of the shares subject to the Lock-up
Agreements. As a result of the Lock-up Agreements and the provisions of Rules
144 and 701 promulgated under the Securities Act upon consummation of the
Offering, the Restricted Shares will be available for sale in the public market
as follows: (i) no Restricted Shares will be eligible for immediate sale on the
date of this Prospectus, (ii) 8,739,054 Restricted Shares will be eligible for
sale 180 days after the date of the Prospectus upon expiration of the Lock-up
Agreements and (iii) the remaining 77,160 Restricted Shares will be eligible
for sale at various times over a period less than one year following the com-
pletion of the Offering, subject to volume limitations pursuant to Rule 144. As
of September 30, 1997, 2,507,754 shares were issuable upon exercise of cur-
rently outstanding options, all of which are subject to 180 day lock-up agree-
ments. Of these shares, 700,897 will be vested 180 days after the date of the
Prospectus. As of September 30, 1997, 62,500 shares were issuable upon exercise
of currently outstanding warrants, all of which are subject to the Lock-up
Agreements. All of these shares will become eligible for sale in the public
market 180 days after the date of this Prospectus upon expiration of the Lock-
up Agreements.

After the Offering, the holders of approximately 5,937,358 shares of Common
Stock (including up to 62,500 shares of Common Stock issuable upon exercise of
outstanding warrants) will be entitled to certain demand and piggyback rights
with respect to registration of such shares under the Securities Act upon ter-
mination of the Lock-up Agreements. If such holders, by exercising their demand
registration rights, cause a large number of securities to be registered and
sold in the public market, such sales could have an adverse effect on the
market price for the Company's Common Stock. In addition, the Company intends
to file a Registration Statement on Form S-8 to register shares of Common Stock
issuable upon exercise of options granted under the 1996 Plan and Director Plan
and sold pursuant to the 1997 Purchase Plan. Following the filing of the Form
S-8, shares of Common Stock issued under such plans will be available for sale
in the public market, subject to the Rule 144 volume limitations as applicable
to affiliates.

In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated) who has beneficially owned shares for at least one year
(including the holding period of any prior owner, except an affiliate) is enti-
tled to sell in "broker's transactions" or to market makers, within any three-
month period commencing 90 days after the date of this Prospectus, a number of
shares that does not exceed the greater of (i) one percent of the number of
shares of Common Stock then outstanding (approximately 128,000 shares immedi-
ately after the Offering) or (ii) the average weekly trading volume of the
Common Stock during the four calendar weeks preceding the required filing of a
Form 144 with respect to such sale. Sales under Rule 144 are generally subject
to certain manner of sale provisions and notice requirements and to the avail-
ability of current public information about the Company. Under Rule 144(k), a
person who is not deemed to have been an affiliate of the Company at any time
during the 90 days preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years (including the holding period of any
prior owner, except an affiliate), is entitled to sell such shares without
having to comply with the manner of sale, public information, volume limitation
or notice provisions of Rule 144. Under Rule 701 under the Securities Act, per-
sons who purchase shares upon exercise of options granted prior to the effec-
tive date of the Offering are entitled to sell such shares 90 days after the
effective date of the Offering in reliance on Rule 144, without having to
comply with the holding period requirements of Rule 144 and, in the case of
non-affiliates, without having to comply with the public information, volume
limitation or notice provisions of Rule 144.

50
<PAGE>

UNDERWRITING

The Underwriters named below (the "Underwriters"), for whom J.P. Morgan
Securities Inc., UBS Securities LLC and Smith Barney Inc. are acting as
representatives (the "Representatives"), have severally agreed, subject to the
terms and conditions set forth in the underwriting agreement between the
Company and the representatives (the "Underwriting Agreement"), to purchase
from the Company, and the Company has agreed to sell to the Underwriters, the
respective number of shares of Common Stock set forth opposite their names
below:

<TABLE>
<CAPTION>
---------
NUMBER
UNDERWRITERS OF SHARES
- ------------ ---------
<S> <C>
J.P. Morgan Securities Inc. ..........................................
UBS Securities LLC....................................................
Smith Barney Inc. ....................................................
---------
Total............................................................... 4,000,000
=========
</TABLE>

The nature of the Underwriters' obligations under the Underwriting Agreement is
such that all of the Common Stock being offered, excluding shares covered by
the over-allotment option granted to the Underwriters, must be purchased if any
are purchased.

The Representatives have advised the Company that the several Underwriters pro-
pose to offer the Common Stock to the public initially at the public offering
price set forth on the cover page of this Prospectus and may offer the Common
Stock to selected dealers at such price less a concession not to exceed $
per share. The Underwriters may allow, and such dealers may reallow, a conces-
sion to other dealers not to exceed $ per share. After the public offering
of the Common stock, the public offering price and other selling terms may be
changed by the Representatives.

The Company has granted the Underwriters an option, exercisable within 30 days
after the date of this Prospectus, to purchase up to 600,000 additional shares
of Common Stock from the Company at the same price per share to be paid by the
Underwriters for the other shares offered hereby. If the Underwriters purchase
any such additional shares pursuant to the option, each of the Underwriters
will be committed to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may exercise the
option only to cover over-allotments, if any, made in connection with the
distribution of the Common Stock offered hereby.

Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price will be determined by negotiations between
the Company and the Representatives. Among the factors to be considered in
determining the initial public offering price are prevailing market conditions,
the market valuations of certain publicly traded companies, the Company's past
and present financial performance and revenues and earnings of comparable
companies in recent periods, estimates of the business potential and prospects
of the Company, the experience of the Company's management and the position of
the Company in its industry.

The Representatives have informed the Company that the Underwriters will not
confirm, without prior specific written approval, sales to their customer
accounts as to which they have discretionary trading power.

The Company and current stockholders, who in the aggregate hold 100% of the
Common Stock outstanding immediately prior to the consummation of the Offering,
have agreed not to offer, sell or otherwise dispose of any Common Stock or any
securities convertible into Common Stock or register for sale under the Securi-
ties Act any Common Stock for a period of 180 days after date of this Pro-
spectus without the prior written consent of J.P. Morgan Securities Inc.,
except that the Company may, without such consent, issue Common Stock and grant
options pursuant to the Stock Plans and issue Common Stock pursuant to the
exercise of outstanding warrants. See "Shares Eligible for Future Sale."

The Company has agreed to indemnify the Underwriters against certain liabili-
ties, including liabilities under the Securities Act, or to contribute to pay-
ments the Underwriters may be required to make in respect thereof.

51
<PAGE>

The Underwriters have represented and agreed that (i) they have not offered or
sold and, prior to the expiry of the period of six months from the closing of
the Offering, will not offer or sell, any shares of Common Stock to persons in
the United Kingdom, except persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or
agent) for the purposes of their businesses or otherwise in circumstances which
have not resulted and will not result in an offer to the public within the
meaning of the Public Offers of Securities Regulations 1995, (ii) they have
complied and will comply with all applicable provisions of the Financial
Services Act 1986 with respect to anything done by them in relation to the
Offering in, from or otherwise involving the United Kingdom and (iii) they have
only issued or passed on, and will only issue and pass on, in the United
Kingdom any document received by them in connection with the Offering to a
person who is of a kind described in Article 11(3) of the Financial Services
Act 1986 (Investment Advertisement) (Exemptions) Order 1995 or is a person to
whom such document may otherwise lawfully be issued or passed on.

Application has been made to have the Common Stock quoted on The Nasdaq
National Market under the trading symbol "SOMN."

At the Company's request, the Underwriters have reserved up to 5% of the Common
Stock offered for sale at the initial public offering price to the Company's
employees, their relatives and other persons having business relationships with
the Company. The number of shares of Common Stock available for sale to other
members of the public will be reduced to the extent that these persons purchase
such reserved shares. Any reserved shares not purchased will be offered by the
Underwriters on the same basis as the other shares offered hereby.

Medtronic has indicated its non-binding intention to purchase up to $5,000,000
of Common Stock in the Offering (up to 500,000 shares at an assumed initial
public offering price of $10.00 per share). However, the number of shares allo-
cated to Medtronic is subject to the discretion of the Underwriters and,
accordingly, such allocation may be below the amount Medtronic may request to
purchase in the Offering.

In connection with the Offering, the Underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the Common Stock
offered hereby. Specifically, the Underwriters may overallot in connection with
the Offering, creating a syndicate short position. In addition, the Under-
writers may bid for, and purchase, Common Stock in the open market to cover
syndicate short positions created in connection with the Offering or to stabi-
lize the price of the Common Stock. Finally, the underwriting syndicate may
reclaim selling concessions allowed for distributing Common Stock in the Offer-
ing, if the syndicate repurchases previously distributed Common Stock in the
market to cover overallotments or to stabilize the price of the Common Stock.
Any of these activities may stabilize or maintain the market price of the
Common Stock above independent market levels. The Underwriters are not required
to engage in any of these activities, and may end any of them at any time.

In view of the fact that persons affiliated or associated with Smith Barney
beneficially own more than 10% of the common equity of the Company, the
Offering is being conducted in accordance with the NASD's Conduct Rule 2720
which provides that the offering price to the public may not be higher than
that recommended by a "qualified independent underwriter" who has participated
in the preparation of the registration statement and prospectus and has exer-
cised the usual standards of "due diligence" with respect thereto. J.P. Morgan
Securities, Inc., has agreed to serve as "qualified independent underwriter"
and the offering price to the public will not be higher than the price recom-
mended by J.P. Morgan Securities, Inc.

52
<PAGE>

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo
Alto, California. Cahill Gordon & Reindel, a partnership including a profes-
sional corporation, is acting as counsel for the Underwriters in connection
with certain legal matters relating to the shares of Common Stock offered
hereby. As of the date of this Prospectus, certain members, associates and
investment partnerships of Wilson Sonsini Goodrich & Rosati, Professional Cor-
poration, beneficially own 138,333 shares of the Common Stock of the Company.

EXPERTS

The consolidated financial statements of Somnus Medical Technologies, Inc. at
December 31, 1996 and for the period from inception (January 19, 1996) to
December 31, 1996 appearing in this Prospectus and Registration Statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of such firm as experts in accounting and
auditing.

The statements in this Prospectus under the captions "Risk Factors--Dependence
Upon Patents and Proprietary Technology; Risk of Infringement" and "Business--
Dependence upon Patents and Propriety Technology; Risk of Infringement" have
been reviewed and approved by Wilson Sonsini Goodrich & Rosati, Professional
Corporation, as experts in such matters, and are included herein in reliance
upon such review and approval.

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission"), in Washington, D.C. 20549, a Registration Statement on Form S-1
under the Securities Act with respect to the shares of Common Stock offered
hereby. This Prospectus, which is part of the Registration Statement, does not
contain all the information set forth in the Registration Statement and the
exhibits and schedules thereto. For further information with respect to the
Company and Common Stock offered hereby, reference is made to the Registration
Statement and such exhibits and schedules filed therewith, which may be
inspected without charge at, or copies of such material may be obtained at
prescribed rates from the Public Reference Section of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. The
Registration Statement and such exhibits and schedules are also available on
the Commission's Web site (http://www.sec.gov). Statements contained in this
Prospectus as to the contents of any contract or other document referred to are
not necessarily complete, and in each instance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference.

53
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Consolidated Balance Sheets................................................. F-3
Consolidated Statements of Operations....................................... F-4
Consolidated Statement of Stockholders' Equity.............................. F-5
Consolidated Statements of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements.................................. F-7
</TABLE>

F-1
<PAGE>

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Somnus Medical Technologies, Inc.

We have audited the accompanying consolidated balance sheet of Somnus Medical
Technologies, Inc. as of December 31, 1996, and the related consolidated state-
ment of operations, stockholders' equity, and cash flows for the period from
inception (January 19, 1996) to December 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing stan-
dards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of mate-
rial misstatement. An audit includes examining, on a test basis, evidence sup-
porting the amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement pre-
sentation. We believe that our audit provides a reasonable basis for our opin-
ion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Somnus Medical
Technologies, Inc. at December 31, 1996, and the consolidated results of its
operations and its cash flows for the period from inception (January 19, 1996)
to December 31, 1996, in conformity with generally accepted accounting
principles.

/s/ ERNST & YOUNG LLP

Palo Alto, California
March 7, 1997
except for Note 8,
as to which the date is
September 4, 1997

F-2
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<S> <C> <C> <C>
-----------------------------------------
<CAPTION>
PRO FORMA
STOCKHOLDERS'
AS OF AS OF EQUITY AT
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1996 1997 1997
------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,828,708 $ 7,012,900
Accounts receivable, net of allow-
ance for doubtful accounts of
$50,000 at September 30, 1997 -- 346,257
Accounts receivable from officer 12,359 6,959
Inventories -- 116,882
Other current assets 45,790 37,683
----------- ------------
Total current assets 8,886,857 7,520,681
Property and equipment, net 1,140,168 1,998,562
Other assets 3,840 364,090
----------- ------------
$10,030,865 $ 9,883,333
=========== ============
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Accounts payable and accrued lia-
bilities $ 632,183 $ 1,973,694
Accrued employee benefits 69,169 305,124
Current obligations under lease
line of credit 203,137 500,594
----------- ------------
Total current liabilities 904,489 2,779,412
Long-term obligations under lease
line of credit 773,482 2,147,499
Commitments
Stockholders' equity:
Convertible preferred stock, par
value $0.001 per share, 5,371,660
shares authorized at December 31,
1996 and 6,196,660 shares at
September 30, 1997 (unaudited);
pro forma unaudited: 5,000,000
shares authorized, no shares
outstanding, issuable in series:
Series A: 1,871,660 shares
designated, 1,784,160 shares
issued and outstanding at
December 31, 1996 and September
30, 1997 (unaudited); aggregate
liquidation preference of
$1,784,160; pro forma unaudited:
no shares outstanding 1,784 1,784 $ --
Series B: 3,500,000 and 3,525,000
shares designated at December 31,
1996 and September 30, 1997
(unaudited), respectively;
3,500,000 shares issued and
outstanding at December 31, 1996
and September 30, 1997
(unaudited); aggregate
liquidation preference of
$10,500,000; pro forma unaudited:
no shares outstanding 3,500 3,500 --
Series C: 800,000 shares
designated, 714,286 shares issued
and outstanding at September 30,
1997 (unaudited); aggregate
liquidation preference of
$5,000,002; pro forma unaudited:
no shares outstanding -- 714 --
Common stock, 20,000,000 shares
authorized, par value $0.001 per
share, shares issued and
outstanding: 2,463,125 and
2,817,768 shares at December 31,
1996 and September 30, 1997
(unaudited), respectively; pro
forma unaudited: 50,000,000
shares authorized, 8,816,214
shares issued and outstanding 2,463 2,818 8,816
Additional paid-in capital 11,969,044 21,010,954 21,010,954
Receivable from stockholder (2,500) -- --
Deferred stock compensation (524,280) (3,894,944) (3,894,944)
Accumulated deficit (3,097,117) (12,168,404) (12,168,404)
----------- ------------ ------------
Total stockholders' equity 8,352,894 4,956,422 $ 4,956,422
----------- ------------ ============
$10,030,865 $ 9,883,333
=========== ============
</TABLE>
See accompanying notes.

F-3
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

F-4
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30, 1997

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------

CONVERTIBLE PREFERRED STOCK
------------------------------------------------
SERIES A SERIES B SERIES C COMMON STOCK ADDITIONAL RECEIVABLE
---------------- ---------------- -------------- ---------------- PAID-IN FROM
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDER
--------- ------ --------- ------ ------- ------ --------- ------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of
common stock to
founders at
$0.001 per
share in
exchange for
cash and
technology -- $ -- -- $ -- -- $ -- 2,335,000 $2,335 $ -- $ --
Issuance of
common stock at
$0.10 per share
for services -- -- -- -- -- -- 30,000 30 2,970 --
Issuance of
Series A
convertible
preferred stock
at $1.00 per
share in
exchange for
cash, net of
issuance costs
of $16,328 1,784,160 1,784 -- -- -- -- -- -- 1,766,048 --
Issuance of
Series B
convertible
preferred stock
at $3.00 per
share in
exchange for
cash, net of
issuance costs
of $845,468 -- -- 3,500,000 3,500 -- -- -- -- 9,651,032 --
Issuance of
common stock
upon exercise
of stock
options for
cash,
receivable and
associated
compensation
related to 1996
stock option
grants -- -- -- -- -- -- 98,125 98 548,994 (2,500)
Net loss -- -- -- -- -- -- -- -- -- --
--------- ------ --------- ------ ------- ---- --------- ------ ----------- ------
Balances at
December 31,
1996 1,784,160 1,784 3,500,000 3,500 -- -- 2,463,125 2,463 11,969,044 (2,500)
Issuance of
Series C
convertible
preferred stock
at $7.00 per
share in
exchange for
cash, net of
issuance costs
of $60,926
(unaudited) -- -- -- -- 714,286 714 -- -- 4,939,362 --
Issuance of
common stock
upon exercise
of stock
options for
cash
(unaudited) -- -- -- -- -- -- 354,643 355 53,323 --
Repayment of
receivable from
stockholder
(unaudited) -- -- -- -- -- -- -- -- -- 2,500
Deferred
compensation
related to
grant of stock
options
(unaudited) -- -- -- -- -- -- -- -- 4,049,225 --
Amortization of
deferred
compensation
(unaudited) -- -- -- -- -- -- -- -- -- --
Net loss
(unaudited) -- -- -- -- -- -- -- -- -- --
--------- ------ --------- ------ ------- ---- --------- ------ ----------- ------
Balances at
September 30,
1997
(unaudited) 1,784,160 $1,784 3,500,000 $3,500 714,286 $714 2,817,768 $2,818 $21,010,954 $ --
========= ====== ========= ====== ======= ==== ========= ====== =========== ======

DEFERRED TOTAL
STOCK ACCUMULATED STOCKHOLDERS'
COMPENSATION DEFICIT EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
Issuance of
common stock to
founders at
$0.001 per
share in
exchange for
cash and
technology $ -- $ -- $ 2,335
Issuance of
common stock at
$0.10 per share
for services -- -- 3,000
Issuance of
Series A
convertible
preferred stock
at $1.00 per
share in
exchange for
cash, net of
issuance costs
of $16,328 -- -- 1,767,832
Issuance of
Series B
convertible
preferred stock
at $3.00 per
share in
exchange for
cash, net of
issuance costs
of $845,468 -- -- 9,654,532
Issuance of
common stock
upon exercise
of stock
options for
cash,
receivable and
associated
compensation
related to 1996
stock option
grants (524,280) -- 22,312
Net loss -- (3,097,117) (3,097,117)
----------- ------------ ------------
Balances at
December 31,
1996 (524,280) (3,097,117) 8,352,894
Issuance of
Series C
convertible
preferred stock
at $7.00 per
share in
exchange for
cash, net of
issuance costs
of $60,926
(unaudited) -- -- 4,940,076
Issuance of
common stock
upon exercise
of stock
options for
cash
(unaudited) -- -- 53,678
Repayment of
receivable from
stockholder
(unaudited) -- -- 2,500
Deferred
compensation
related to
grant of stock
options
(unaudited) (4,049,225) -- --
Amortization of
deferred
compensation
(unaudited) 678,561 -- 678,561
Net loss
(unaudited) -- $ (9,071,287) $ (9,071,287)
----------- ------------ ------------
Balances at
September 30,
1997
(unaudited) $(3,894,944) $(12,168,404) $ 4,956,422
=========== ============ ============
</TABLE>

See accompanying notes.

F-5
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
------------------------------------------
PERIOD FROM PERIOD FROM
INCEPTION INCEPTION
(JANUARY 19, (JANUARY 19, NINE MONTHS
1996) TO 1996) TO ENDED
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1996 1996 1997
------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
CASH FLOWS USED IN OPERATING
ACTIVITIES
Net loss $(3,097,117) $(1,726,488) $(9,071,287)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Amortization of deferred
compensation -- -- 678,561
Depreciation and amortization 142,662 41,202 381,180
Issuance of stock for noncash
consideration 25,350 -- --
Changes in operating assets and
liabilities:
Other current assets (45,790) (70,934) 13,507
Accounts receivable (12,359) (17,986) (346,257)
Inventories -- -- (116,882)
Other assets--noncurrent (3,840) (3,069) (360,250)
Accounts payable and accrued
liabilities 632,183 396,156 1,341,511
Accrued employee benefits 69,169 72,660 235,955
----------- ----------- -----------
Net cash used in operating
activities (2,289,742) (1,308,459) (7,243,962)
CASH FLOWS USED IN INVESTING
ACTIVITIES
Capital expenditures (1,282,830) (808,204) (1,239,574)
CASH FLOWS PROVIDED BY FINANCING
ACTIVITIES
Proceeds from issuance of
preferred stock 11,422,364 10,566,699 4,940,076
Proceeds from issuance of common
stock 2,297 1,985 53,678
Repayment of shareholder loan -- -- 2,500
Proceeds from borrowings under
lease line of credit, net of
repayments 976,619 499,850 1,671,474
----------- ----------- -----------
Net cash provided by financing
activities 12,401,280 11,068,534 6,667,728
----------- ----------- -----------
Net increase (decrease) in cash
and cash equivalents 8,828,708 8,951,871 (1,815,808)
Cash and cash equivalents,
beginning of period -- -- 8,828,708
----------- ----------- -----------
Cash and cash equivalents at end
of period $ 8,828,708 $ 8,951,871 $ 7,012,900
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH
FLOW INFORMATION
Cash paid for interest $ 23,918 $ -- $ 329,684
=========== =========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING
ACTIVITIES
Property and equipment acquired
under lease line of credit $ 976,619 $ 499,850 $ 2,215,995
=========== =========== ===========
Issuance of Series B preferred
stock in exchange for services $ 179,990 $ -- $ --
=========== =========== ===========
</TABLE>

See accompanying notes.

F-6
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization, Ownership and Business

Somnus Medical Technologies, Inc. (the "Company"), originally Sleep
Technologies, Inc., was incorporated in Delaware on January 19, 1996. The
Company designs, develops, manufactures and markets medical devices that
utilize proprietary radiofrequency technology for the treatment of upper
airway disorders. The Company's Somnoplasty System is intended to offer
minimally-invasive, curative treatment alternatives for disorders of the
upper airway, including snoring, obstructive sleep apnea, enlarged
turbinates and enlarged tonsils. In 1996, the Company established Somnus
Medical Technologies Pty. Ltd. in Australia for purposes of conducting
clinical research studies on behalf of the Company. Collectively, the
entities are referred to as the Company.

Since inception, the Company's principal activities have been recruiting
personnel, raising capital and performing research and development. Subse-
quent to December 31, 1996, the Company received approval for the sale of
its first product which generated $1,100,164 of revenue for the nine months
ended September 30, 1997. Accordingly, the Company is no longer considered
to be in the development stage.

From incorporation through September 30, 1997 the Company has incurred an
accumulated deficit of $12,168,404. Company activities have been financed
through the private placement of equity securities and loans from a Company
stockholder and founder who also serves as the Company's Chairman of the
Board of Directors, Chief Executive Officer and President.

In the long term, the Company plans to finance operations with revenues
from product sales. The Company's ability to continue as a going concern is
dependent upon additional financing and ultimately upon achieving
profitable operations. In the event it is necessary, the management of the
Company has the intent and believes it has the ability to delay or reduce
expenditures so as not to require additional financial resources if such
resources were not available.

Basis of Presentation

The consolidated financial statements include the accounts of Somnus
Medical Technologies, Inc. and Somnus Medical Technologies Pty. Ltd. All
significant intercompany accounts and transactions have been eliminated.

Interim Financial Information

The financial information at September 30, 1997 and for the period from
inception (January 19, 1996) to September 30, 1996 and for the nine months
ended September 30, 1997 is unaudited but includes all adjustments
(consisting only of normal recurring adjustments) which the Company
considers necessary for a fair presentation of the financial position at
such date and the operating results and cash flows for those periods.
Results of the September 30, 1997 period are not necessarily indicative of
the results that may be expected for the entire year.

Revenue Recognition

The Company recognizes revenue at the time products are shipped. To date,
no customers have been given contractual right of return or stock rotation
privileges. Product returns and sales allowances (which were not signifi-
cant through September 30, 1997) are estimated and provided for at the time
of sale.

Dependence on Sole Distributor and Suppliers

All sales recorded to date have been made to the Company's sole distribu-
tor, Medtronic, Inc. ("Medtronic"). The Distribution Agreement with
Medtronic, entered into on April 21, 1997, is for a period of three years
with defined minimum annual purchase requirements. The Agreement grants
Medtronic exclusive distribution rights of certain of the Company's prod-
ucts in the European Union, Australia, Southeast Asia and certain other
areas until April 21, 2000 (see Note 8). Sales of approximately $668,000
were made to Medtronic's European operations and approximately $432,000 to
customers primarily in the United States.

F-7
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The Company purchases what is currently its only commercially available
radiofrequency ("RF") generator from a single-source supplier. Establishing
additional or replacement suppliers for such generator or certain of the
components used in the Company's products, if required, may not be
accomplished quickly and could involve significant additional costs. Any
supply interruption from suppliers or failure of the Company to obtain
alternative suppliers for the generator or such components would limit the
Company's ability to manufacture and sell its products and would have a
material adverse effect on the Company's business, financial condition and
results of operations.

Net Loss Per Share

Except as noted below, net loss per share is computed using the weighted-
average number of common shares outstanding. Common equivalent shares from
stock options and warrants are excluded from the computation as their
effect is antidilutive, except that, pursuant to the Securities and
Exchange Commission ("SEC") Staff Accounting Bulletins, common and common
equivalent shares (stock options, warrants and convertible preferred stock)
issued during the 12-month period prior to the initial filing of the
registration statement relating to the proposed public offering at prices
below the assumed public offering price have been included in the
calculation as if they were outstanding for all periods presented (using
the treasury stock method for stock options and warrants).

Historical net loss per share information is as follows:

<TABLE>
<CAPTION>
----------------------------------------
PERIOD FROM PERIOD FROM
INCEPTION INCEPTION
(JANUARY 19, (JANUARY 19, NINE MONTHS
1996) TO 1996) TO ENDED
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1996 1996 1997
------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Net loss per share $ (0.40) $ (0.23) $ (1.09)
========= ========= =========
Shares used in computing histor-
ical net loss per share 7,805,075 7,643,571 8,289,588
========= ========= =========
</TABLE>

Pro forma net loss per share has been computed as described above and also
gives effect, pursuant to SEC staff policy, to common equivalent shares
from convertible preferred shares issued more than 12 months prior to the
proposed initial public offering that will be converted upon completion of
the Company's initial public offering (using the if-converted method) from
the original date of issuance.

In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings Per Share" ("Statement 128"), which is required to be
adopted on December 31, 1997. At that time, the Company will be required to
change the method currently used to compute earnings per share and to
restate all prior periods. Under the new requirements for calculating
primary earnings per share, the dilutive effect of stock options will be
excluded. The impact of Statement 128 is expected to result in no change to
the Company's historical net loss per share as stock options are
antidilutive and therefore have been excluded from the current computation.

Stock-Based Compensation

The Company accounts for stock-based awards to employees and directors in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB Opinion No. 25") and has adopted the dis-
closure-only alternative of Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("FAS 123").

F-8
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounting Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported results of operations during
the reporting period. Actual results could differ from these estimates.

Research and Development

Research and development costs, which include clinical and regulatory
costs, are charged to expense as incurred.

Inventory

Inventories are stated at the lower of cost, determined on an average cost
basis, and market value. During the nine months ended September 30, 1997,
the Company acquired inventory for the first time. Inventory at September
30, 1997 is stated net of reserves of $366,000 and primarily consists of
finished goods.

Property and Equipment

Property and equipment are stated at cost, net of accumulated amortization
and depreciation. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets. Equipment purchased
under the Company's lease line of credit is amortized over the lesser of
the lease term or the estimated useful lives of the related assets, which-
ever is shorter.

The Company adopted Statement of Financial Accounting Standard No. 121,
"Accounting for the Impairment of Long-Lived Assets to Be Disposed of,"
effective January 19, 1996. The adoption did not have a material impact on
the Company's financial statements.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity from
date of purchase of three months or less to be cash equivalents. The Com-
pany maintains deposits with a financial institution in the United States
and invests its excess cash in U.S. government obligations and U.S. corpo-
rate securities which bear minimal risk. The Company had no short-term
investments at December 31, 1996 or September 30, 1997.

Management determines the appropriate classification of debt securities in
accordance with Statement No. 115, ("Accounting for Certain Investments in
Debt and Equity Securities") at the time of purchase and reevaluates such
designation as of each balance sheet date. At December 31, 1996 and
September 30, 1997, all debt securities are designated as available-for-
sale. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses reported in stockholders' equity. At December
31, 1996 and September 30, 1997, the fair value of investments approximates
cost. The amortized cost of debt securities in this category is adjusted
for amortization of premiums and accretion of discounts to maturity. Such
amortization is included in interest income. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in interest income and have been immaterial in all
periods presented. The cost of securities sold is based on the specific
identification method. Interest and dividends on securities classified as
available-for-sale are included in interest income.

Concentration of Credit Risk

The Company invests cash which is not required for immediate operating
needs principally in a diversified portfolio of financial instruments
issued by institutions with strong credit ratings. By policy, the amount of
credit exposure to any one institution, with the exception of U.S.
government-backed securities, is limited. These investments are not
collateralized and mature within two years. The Company has not experienced
significant losses on these investments.

The Company's revenues and trade accounts receivable consist of shipments
to one large, multinational distributor (see Note 8). The Company has not
incurred any credit losses to date.

F-9
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996 AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

2 PROPERTY AND EQUIPMENT

Property and equipment consists of the following:
<TABLE>
<CAPTION>
--------------------------
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Machinery and equipment $ 632,690 $1,039,663
Computer equipment 397,196 671,077
Furniture and fixtures 78,597 527,243
Purchased software 174,347 284,421
---------- ----------
1,282,830 2,522,404
Less accumulated depreciation and amortization (142,662) (523,842)
---------- ----------
Property and equipment, net $1,140,168 $1,998,562
========== ==========
</TABLE>

3 COMMITMENTS

Long-term obligations consist of capital lease arrangements and secured
borrowings used to acquire capital equipment. In 1996, the Company entered
into $2 million equipment lease lines of credit, of which $1,023,381
remains available at December 31, 1996. The borrowings bear interest at
Prime plus 1.5% to 2% (9.75% to 10.25% at December 31, 1996) and are
secured by substantially all of the assets of the Company. The carrying
value of these lease obligations approximate their fair value. The fair
value was estimated using discounted cash flow analyses, based on the
Company's estimate of what the borrowing rate for a similar type of
borrowing arrangement would be.

Included in computer equipment and office equipment, furniture and fixtures
are assets with a cost and accumulated depreciation of approximately
$976,619 and $122,701 respectively, acquired pursuant to these obligations.

The lease line agreement contains certain financial covenants including
maximum quarterly net losses, minimum ratios for liquidity and debt to tan-
gible net worth and a minimum tangible net worth requirement. At December
31, 1996 the Company was in compliance with these covenants. In the quarter
ended September 30, 1997, the Company exceeded the maximum permitted net
loss under the covenant terms but has subsequently received a written
waiver of the quarterly loss limitation for this period and expects to re-
negotiate the terms of the financial covenant affecting maximum net losses
on a prospective basis.

In conjunction with equipment term loans, which were repaid prior to
December 31, 1996, the Company issued warrants to purchase preferred stock
(see Note 5).

Future payments under equipment financing arrangements at December 31, 1996
are as follows:

<TABLE>
<CAPTION>
---------------------
OPERATING CAPITAL
LEASES LEASES
---------- ----------
<S> <C> <C>
Years ending December 31:
1997 $ 348,000 $ 258,511
1998 405,000 388,034
1999 417,000 355,466
2000 429,000 124,993
2001 441,000 --
2002 and thereafter 111,000 --
---------- ----------
Total minimum payments $2,151,000 1,127,004
==========
Less amount representing interest (150,385)
----------
Present value of minimum payments 976,619
Less current portion (203,137)
----------
Long-term portion $ 773,482
==========
</TABLE>

During the nine months ended September 30, 1997, the Company entered into
an additional $1 million equipment lease line of credit. A total of
$284,005 remains available at September 30, 1997 from the various lease
lines of credit.

F-10
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

3 COMMITMENTS (CONTINUED)

At December 31, 1996, the Company leased its facility under an operating
lease agreement which expired on May 16, 1997. On February 12, 1997, the
Company entered into a lease for new premises which expires on March 31,
2002.

Rent expense was approximately $71,000 for the period from inception (Jan-
uary 19, 1996) to December 31, 1996 and approximately $252,000 for the nine
months ended September 30, 1997.

4 RELATED PARTY TRANSACTIONS

The Company's operations, until the April 1996 issuance of Series A
preferred stock, were funded by the Chief Executive Officer's private
holding company, VidaCare International, Inc. ("VidaCare"). The expenses
consisted primarily of payroll, consultant and legal costs incurred in the
establishment of the corporation and initial research and development
efforts. Of the $213,660 incurred by VidaCare, $63,660 was converted into
63,660 shares of Series A preferred stock in May 1996 and $150,000 was
repaid in cash in April 1996.

The Company's Series B preferred stock issuance in September 1996 included
a finder's fee to an entity associated with a member of the board of direc-
tors totaling 7% of the aggregate proceeds received by the Company from the
sale of Series B preferred stock. The agreement included a provision which
allowed the entity to receive not less than 25% of the fee owed by the Com-
pany in equity or debt instruments in the Company. Pursuant to this clause,
the total finder's fee owed of $710,233 was paid with 60,000 shares of
Series B preferred stock valued at $3.00 per share and $530,233 in cash.
This transaction has been included in the issuance costs of the Series B
offering. Additionally, in connection with the Series B preferred stock
financing, the entity associated with a director entered into an agreement
with the Company whereby for each 1% of the shares actually sold in the
Company's initial public offering that are purchased by investors or par-
ties directly affiliated with the investors placed by the entity in the
Series B preferred stock financing, the entity will be granted options or
warrants to purchase 1,000 shares of common stock at a price equivalent to
the initial public offering price. Such options or warrants, if issued,
will have a five-year term and be entitled to anti-dilution and piggyback
registration rights.

During fiscal 1996, a company affiliated with a stockholder and member of
the board of directors leased equipment with a value of $78,000 to the Com-
pany. The lease agreement provides terms comparable to other lease agree-
ments entered into by the Company.

5 STOCKHOLDERS' EQUITY

Preferred Stock

In April 1996, September 1996 and April 1997, the Company issued 1,784,160
Series A convertible preferred shares at a price of $1.00 per share,
3,500,000 Series B convertible preferred shares at a price of $3.00 per
share and 714,286 Series C convertible preferred shares at a price of $7.00
per share, respectively.

Each share of Series A, B and C convertible preferred stock is, at the
option of the holder, convertible into one share of common stock, subject
to certain adjustments for dilution, if any, resulting from future stock
issuances. The outstanding shares of convertible preferred stock
automatically convert into common stock immediately prior to the closing of
an underwritten public offering of common stock under the Securities Act of
1933 in which the Company receives at least $15,000,000 in gross proceeds
and the price per share is at least $6.00.

Series A, B and C convertible preferred stockholders are entitled to
noncumulative dividends of $0.08 per share. Dividends will be paid only
when declared by the board of directors out of legally available funds. No
dividends have been declared or paid as of December 31, 1996 or September
30, 1997.

The Series A, B and C convertible preferred stockholders are entitled to
receive, upon liquidation, an amount per share equal to the issuance price,
plus all declared but unpaid dividends. Thereafter, the remaining assets
and funds, if any, shall be distributed pro rata among the common stock-
holders.

F-11
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

5 STOCKHOLDERS' EQUITY (CONTINUED)

The Series A, B and C convertible preferred stockholders have voting rights
equal to the common shares issuable upon conversion.

Common Stock

The Company has sold 2,335,000 and 30,000 shares of common stock to
founders for $0.001 and $0.10 per share, respectively, which certain shares
are subject to repurchase rights which generally expire ratably over four
years. Upon termination of service, any unvested shares may be repurchased
by the Company at the issuance price. At September 30, 1997, 733,959 shares
were subject to these repurchase rights held by the Company.

The Company has reserved 5,998,446 shares of its common stock for issuance
upon conversion of its Series A, B and C preferred stock and 3,350,000
shares of common stock for issuance under its 1996 Stock Option Plan at
September 30, 1997.

1996 Stock Plan

Under the Company's 1996 Stock Plan (the "Plan"), which was adopted in
March 1996, options may be granted for common stock or common stock may be
issued, pursuant to actions by the board of directors, to eligible partici-
pants. Options granted are either incentive stock options or nonstatutory
stock options and are exercisable within the times or upon the events
determined by the board of directors as specified in each option agreement.
Incentive stock options granted under the Plan are at prices not less than
100% of the fair value at the date of grant, as determined by the board of
directors. Nonstatutory options granted under the plan are at prices not
less than 85% of the fair value on the date of the grant, as determined by
the board of directors. Stock options granted to a 10% stockholder shall
not be less than 110% of the fair value at the date of grant. Stock sold
under issuances is subject to repurchase by the Company upon termination of
the purchasers employment or services at the price paid upon issuance.
Options granted generally vest over a period of four years, with 25% of the
options vesting on the first anniversary of the grant. The term of the plan
is ten years.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.

The effect of applying the minimum value method of FASB Statement No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123") to the Company's
stock option grants did not result in pro forma net loss that is materially
different from historical amounts reported. Therefore, such pro forma
disclosure information is not separately presented herein. Future pro forma
net income and earnings/loss per share results may be materially different
from actual amounts reported.

The fair value of each option is estimated on the date of grant using the
minimum value method with the following weighted-average assumptions: no
dividends, an expected life of between three and four years, nominal vola-
tility and a risk-free interest rate of 5.3% for fiscal 1996.

F-12
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

5 STOCKHOLDERS' EQUITY (CONTINUED)

The following table summarizes stock option activity:

<TABLE>
<CAPTION>
----------------------------------------
OUTSTANDING STOCK OPTIONS
----------------------------
WEIGHTED-
AVERAGE
SHARES NUMBER OF EXERCISE PRICE
AVAILABLE SHARES PER SHARE
---------- ----------- ---------------
<S> <C> <C> <C>
Original authorization of shares 865,000 -- --
Additional shares authorized for
issuance 1,055,000 -- --
Options granted (1,751,550) 1,751,550 $ 0.17
Options exercised -- (98,125) $ 0.10
Options canceled 15,625 (15,625) $ 0.10
---------- ----------- -------------
Balance at December 31, 1996 184,075 1,637,800 $ 0.17
Additional shares authorized for
issuance (unaudited) 1,430,000 -- --
Options granted (unaudited) (1,434,400) 1,434,400 $ 3.32
Options exercised (unaudited) -- (354,643) $ 0.14
Options canceled (unaudited) 209,803 (209,803) $ 0.45
---------- ----------- -------------
Balance at September 30, 1997
(unaudited) 389,478 2,507,754 $ 1.95
========== =========== =============
Weighted-average fair value of
options granted during 1996 $ 0.03
=============
Weighted-average remaining con-
tractual life of options out-
standing at December 31, 1996 9.6 years
=============
Range of per share exercise price
of options outstanding at
December 31, 1996 $ 0.10-$0.30
=============
</TABLE>

At December 31, 1996, options to purchase 684,590 shares were exercisable.

Exercise prices per options outstanding as of September 30, 1997 ranged
from $0.10 to $7.50 per share. The weighted-average remaining contractual
use of those options is 9.41 years.

<TABLE>
<CAPTION>
EXERCISABLE
OPTIONS OUTSTANDING OPTIONS
------------------- WEIGHTED- -----------------
WEIGHTED- AVERAGE WEIGHTED-
EXERCISE AVERAGE REMAINING AVERAGE
PRICE EXERCISE CONTRACTUAL EXERCISE
RANGE NUMBER PRICE LIFE (IN YEARS) NUMBER PRICE
-------- ------ --------- --------------- ------ ---------
<S> <C> <C> <C> <C> <C>
$ 0.10 584,854 $ 0.10 8.79 120,337 $ 0.10
$ 0.30 638,650 0.30 9.10 117,397 0.30
$ 0.70 310,000 0.70 9.71 -- 0.70
$ 3.00 640,750 3.00 9.90 6,040 3.00
$ 7.50 333,500 7.50 9.98 2,083 7.50
--------- ------ ---- ------- ------
2,507,754 1.95 9.41 245,857 0.33
========= ====== ==== ======= ======
</TABLE>

F-13
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

5 STOCKHOLDERS' EQUITY (CONTINUED)

Warrants

In connection with equipment term loans in 1996, the Company issued war-
rants to purchase 37,500 shares of Series A preferred stock at $1.00 per
share and 25,000 shares of Series B preferred stock at $3.00 per share.
These warrants may be exercised at any time prior to June 24, 2006 and
October 1, 2001, respectively. The values of these warrants were determined
by the Company to be immaterial for financial statement purposes.

Warrants outstanding at September 30, 1997 were 62,500.

Stock Compensation

The Company recorded deferred compensation of approximately $546,000 and
$4,049,225 during the period from inception (January 19, 1996) to December
31, 1996 and the nine months ended September 30, 1997, respectively. These
amounts represent the difference between the exercise price and the deemed
fair value of certain of the Company's stock options granted in these peri-
ods. The Company recorded amortization expense of approximately $22,000 and
$679,000, respectively, during these periods.

At September 30, 1997, the Company has a total of $3,894,944 remaining to
be amortized over the corresponding vesting period of each respective
option, generally four years.

6 EMPLOYEE BENEFIT PLANS

The Company has a 401(k) Plan which stipulates that all full-time employees
with at least 60 days of employment can elect to contribute to the 401(k)
Plan, subject to certain limitations, up to 15% of salary on a pretax
basis. The Company has the option to provide matching contributions but has
not done so to date.

7 INCOME TAXES

As of December 31, 1996, the Company had federal and state net operating
loss carryforwards of approximately $3,000,000 and $1,600,000, respec-
tively. The net operating loss carryforwards will expire in 2004, if not
utilized.

Utilization of the net operating loss may be subject to a substantial
annual limitation due to the ownership change limitations provided by the
Internal Revenue Code of 1986 and similar state provisions. The annual lim-
itation may result in the expiration of the net operating losses before
utilization.

As of December 31, 1996, the Company had deferred tax assets of approxi-
mately $1,200,000 which have been fully offset by a valuation allowance.
Deferred tax assets relate primarily to the net operating loss
carryforward.

8 SUBSEQUENT EVENTS

In April 1997, the Company issued 714,286 shares of Series C convertible
preferred stock at $7.00 per share, resulting in cash proceeds of
$5,000,002, less issuance costs. The Holder of Series C preferred stock is
entitled to noncumulative dividends of $0.08 per share if and when declared
by the board of directors. Each share of Series C preferred stock is
convertible into one share of common stock at the option of the holder,
subject to certain adjustments. Each share of Series C will automatically
convert into common stock upon the closing of an initial public offering of
the Company's common stock in which the Company receives at least $15
million in gross proceeds and the price per share is at least $6.00 (see
Note 1).

F-14
<PAGE>

SOMNUS MEDICAL TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)

(INFORMATION FOR THE PERIOD FROM INCEPTION (JANUARY 19, 1996) TO SEPTEMBER 30,
1996
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)

8 SUBSEQUENT EVENTS (CONTINUED)

In April 1997, and as a condition to the Series C preferred stock agreement
referred to above, the Company entered into a Distribution Agreement with
Medtronic whereby Medtronic is appointed as the Company's exclusive
distributor with the right to sell and distribute certain of the Company's
products in the European Union, Australia, Southeast Asia and certain other
areas. The term of the Distribution Agreement is three years, and is
subject to defined minimum purchase quotas in each year.

On August 21, 1997, the board of directors adopted, and the stockholders
approved, an increase in the number of shares available for issuance under
the 1996 Plan from 2,600,000 to 3,350,000 shares of common stock.

F-15
<PAGE>

Somnus Medical Technologies, Inc.

Research and Manufacturing Facilities at its headquarters in Sunnyvale,
California

[Photos of Manufacturing and Research and Development Areas]

Clockwise from top left: Surgical device development, device assembly, rapid
device prototyping, computer-aided machining and instrument development
laboratory.
<PAGE>

[LOGO OF SOMNUS MEDICAL TECHNOLOGY APPEARS HERE]

<PAGE>

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than underwriting
discounts, commissions and certain accountable expenses, payable by the Company
in connection with the sale of Common Stock being registered. All amounts are
estimates except the SEC registration fee and the NASD filing fee.

<TABLE>
<S> <C>
SEC Registration Fee........................................... $ 15,333
NASD Filing Fee................................................ 6,250
Nasdaq National Market Listing Fee............................. 49,436
Printing Fees and Expenses..................................... 100,000
Legal Fees and Expenses........................................ 225,000
Accounting Fees and Expenses................................... 160,000
Blue Sky Fees and Expenses..................................... 15,000
Transfer Agent and Registrar Fees.............................. 8,000
Director and Officer Liability Insurance....................... 200,000
Miscellaneous.................................................. 20,981
--------
Total........................................................ $800,000
========
</TABLE>

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

(a) As permitted by the Delaware General Corporation Law, the Amended and
Restated Certificate of Incorporation of the Company (Exhibit 3.2 hereto) elim-
inates the liability of directors to the Company or its stockholders for mone-
tary damages for breach of fiduciary duty as a director, except to the extent
otherwise required by the Delaware General Corporation Law.

(b) The Amended and Restated Certificate of Incorporation provides that the
Company will indemnify each person who was or is made a party to any proceeding
by reason of the fact that such person is or was a director or officer of the
Company against all expense, liability and loss reasonably incurred or suffered
by such person in connection therewith to the fullest extent authorized by the
Delaware General Corporation Law. The Company's Bylaws (Exhibit 3.3 hereto)
provide for a similar indemnity to directors and officers of the Company to the
fullest extent authorized by the Delaware General Corporation Law.

(c) The Amended and Restated Certificate of Incorporation also gives the Com-
pany the ability to enter into indemnification agreements with each of its
directors and officers. The Company has entered into indemnification agreements
with each of its directors and officers, the form of which is attached hereto
as Exhibit 10.1, which provide for the indemnification of directors and offi-
cers of the Company against any and all expenses, judgments, fines, penalties
and amounts paid in settlement, to the fullest extent permitted by law.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Since January 1996, the Registrant has issued and sold the following unregis-
tered securities:

(1) In March 1996, the Registrant issued and sold 2,365,000 shares of
Common Stock to sixteen Founders of the Company at a price of $0.001 per
share for an aggregate cash purchase price of $2,365.00.

(2) In April 1996, the Registrant issued 1,784,160 shares of Series A
Preferred Stock to a total number of thirty-seven investors at a price of
$1.00 per share for an aggregate cash purchase price of $1,784,160.

(3) In June 1996, the Registrant issued a Warrant to purchase 37,500 shares
of Series A Preferred Stock to Venture Lending, a division of Cupertino
National Bank & Trust at an exercise price of $1.00 per share for an aggre-
gate cash purchase price of $37,500.00.

(4) Since July 1996, the Registrant has issued and sold 452,768 shares of
Common Stock to a total of 21 employees and consultants at prices ranging
from $0.10 per share to $3.00 per share, upon exercise of stock options,
pursuant to the Amended and Restated 1996 Stock Plan.

(5) In September and October 1996, the Registrant issued and sold 3,500,000
shares of Series B Preferred Stock to a total of twenty-nine investors for
an aggregate cash purchase price of $10,500,000. Under the terms of a
placement

II-1
<PAGE>

agent agreement with the Registrant, Musket Research Associates received a
placement fee equal to seven percent of the aggregate proceeds recorded by
the Registrant for the sales of shares of Series B Preferred Stock, which
fee was paid in cash and in 60,000 shares of Series B Preferred Stock
issued to David Musket.

(6) In October 1996, the Registrant issued a Warrant to purchase 25,000
shares of Series B Preferred Stock to Venture Lending, a division of
Cupertino National Bank & Trust at an exercise price of $3.00 per share for
an aggregate purchase price of $75,000.00.

(7) In April 1997, the Registrant issued and sold 714,286 shares of Series
C Preferred Stock to Medtronic Asset Management, Inc. for an aggregate cash
purchase price of $5,000,000.

The sales of the above securities were deemed to be exempt from registration
under the Securities Act in reliance on Section 4(2) of the Securities Act,
except in the case of items (1) and (4), above, which were deemed to be exempt
from such registration pursuant to Rule 701 promulgated thereunder and in the
case of item (5), above, on Regulation D promulgated thereunder, as
transactions by an issuer not involving a public offering. The recipients of
securities in each such transaction represented their intention to acquire the
securities for investment only and not with a view to or in connection with any
sale or distribution thereof and appropriate legends were affixed to the share
certificates and warrants issued in such transactions. All recipients had
adequate access, through their relationships with the Company, to information
about the Registrant.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) Exhibits

<TABLE>
<C> <S>
1.1* Form of Underwriting Agreement.
3.1* Restated Certificate of Incorporation, as amended as of April 18,
1997.
3.2* Form of Amended and Restated Certificate of Incorporation to be filed
after the closing of the Offering.
3.3* Form of Bylaws, to be effective upon the closing of the offering.
3.4* Bylaws of the Registrant.
4.1* Specimen Common Stock Certificate.
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional
Corporation.
10.1* Form of Indemnification Agreement for directors and officers.
10.2* Amended and Restated 1996 Stock Plan and form of agreement
thereunder.
10.3* Restated Investors' Rights Agreement between the Registrant and the
parties named therein dated as of April 21, 1997.
10.4*+ Distribution Agreement dated April 21, 1997 between the Registrant
and Medtronic, Inc.
10.5*+ Development and Supply Agreement dated July 15, 1996 between the
Registrant and Apical Instruments, Inc.
10.6* Letter Agreement dated June 6, 1996 between the Registrant and Musket
Research Associates.
10.7* Lease dated February 4, 1997 for the Registrant's headquarters in
Sunnyvale, California.
10.8* Amended and Restated Loan and Security Agreement dated April 2, 1997
between the Registrant and Venture Lending.
10.9* Employment Letter Agreement dated July 20, 1997 between the
Registrant and Robert McNamara.
10.10* Employment Letter Agreement dated May 8, 1996 between the Registrant
and Eric N. Doelling, and amendment thereto dated August 26, 1996.
10.11* Employment Letter Agreement dated June 1, 1996 between the Registrant
and Stephen M. Rudy, and amendment thereto dated October 14, 1996.
10.12* 1997 Employee Stock Purchase Plan.
10.13* 1997 Director Option Plan.
10.14* Lease Agreement dated July 1, 1996 between the Registrant and RGL
Leasing Co.
11.1* Statement Regarding the Computation of Per Share Loss.
21.1* List of Subsidiaries of the Registrant.
24.1 Consent of Independent Auditors
24.2 Consent of Counsel (included in Exhibit 5.1).
24.3* Consent of Counsel.
25.1* Power of Attorney (see page II-4).
27.1 Financial Data Schedule
</TABLE>
- -------
* Previously filed.

+ Confidential treatment is being sought for portions of this exhibit.

(b) Financial Statement Schedules

Consolidated Schedules not listed above have been omitted because the informa-
tion required to be set forth therein is not applicable or is shown in the
Financial Statements or Notes thereto.

II-2
<PAGE>

ITEM 17. UNDERTAKINGS

The undersigned Registrant hereby undertakes to provide to the Underwriters at
the closing specified in the Underwriting Agreement certificates in such denom-
inations and registered in such names as required by the Underwriters to permit
prompt delivery to each purchaser.

Insofar as indemnification by the Registrant for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the provisions referenced in Item 14 of this Reg-
istration Statement or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such lia-
bilities (other than the payment by the Registrant of expenses incurred or paid
by a director, officer, or controlling person of the Registrant in the suc-
cessful defense of any action, suit or proceeding) is asserted by such direc-
tor, officer or controlling person in connection with the securities being reg-
istered hereunder, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.

The undersigned Registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement (i) to include any
prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii)
to reflect in the Prospectus any facts or events arising after the
effective date of the Registration Statement (or the most recent post
effective amendment thereto which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
Registration Statement; and (iii) to include any material information with
respect to the plan of distribution not previously disclosed in the
Registration Statement or any material change to such information in the
Registration Statement.

(2) That, for the purpose of determining. any liability under the Securi-
ties Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.

(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination
of the Offering.

II-3
<PAGE>

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THE REGISTRANT HAS DULY
CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDER-
SIGNED, THEREUNTO DULY AUTHORIZED, IN SUNNYVALE, STATE OF CALIFORNIA, ON THE
29TH DAY OF OCTOBER, 1997.

Somnus Medical Technologies, Inc.

/s/ Stuart D. Edwards
By: __________________________________
STUART D. EDWARDSPRESIDENT AND
CHIEF EXECUTIVE OFFICER

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT, THIS REGISTRATION
STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED:

SIGNATURE TITLE DATE

<S> <C> <C>
President, Chief October 29, 1997
/s/ Stuart D. Edwards Executive Officer
- ---------------------------------- and Director
(STUART D. EDWARDS) (Principal
Executive
Officer)

Chief Financial October 29, 1997
/s/ Robert E. McNamara* Officer
- ---------------------------------- (Principal
(ROBERT E. MCNAMARA) Financial and
Accounting
Officer)

Director October 29, 1997
/s/ Eric N. Doelling*
- ----------------------------------
(ERIC N. DOELLING)

/s/ David L. Douglass* Director October 29, 1997
- ----------------------------------
(DAVID L. DOUGLASS)

Director October 29, 1997
/s/ David J. Illingworth*
- ----------------------------------
(DAVID J. ILLINGWORTH)

/s/ Ronald G. Lax* Director October 29, 1997
- ----------------------------------
(RONALD G. LAX)

/s/ David B. Musket* Director October 29, 1997
- ----------------------------------
(DAVID B. MUSKET)

/s/ Woodrow A. Myers, Jr.* Director October 29, 1997
- ----------------------------------
(WOODROW A. MYERS, JR.)

/s/ Stuart D. Edwards
*By:______________________________
STUART D. EDWARDS
ATTORNEY-IN-FACT

</TABLE>

II-4
<PAGE>

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
1.1* Form of Underwriting Agreement.
3.1* Restated Certificate of Incorporation, as amended as of April 18,
1997.
3.2* Form of Amended and Restated Certificate of Incorporation to be filed
after the closing of the Offering.
3.3* Form of Bylaws, to be effective upon the closing of the offering.
3.4* Bylaws of the Registrant.
4.1* Specimen Common Stock Certificate.
5.1 Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation.
10.1* Form of Indemnification Agreement for directors and officers.
10.2* Amended and Restated 1996 Stock Plan and form of agreement thereunder.
10.3* Restated Investors' Rights Agreement between the Registrant and the
parties named therein dated as of April 21, 1997.
10.4*+ Distribution Agreement dated April 21, 1997 between the Registrant and
Medtronic, Inc.
10.5*+ Development and Supply Agreement dated July 15, 1996 between the
Registrant and Apical Instruments, Inc.
10.6* Letter Agreement dated June 6, 1996 between the Registrant and Musket
Research Associates.
10.7* Lease dated February 4, 1997 for the Registrant's headquarters in
Sunnyvale, California.
10.8* Amended and Restated Loan and Security Agreement dated April 2, 1997
between the Registrant and Venture Lending.
10.9* Employment Letter Agreement dated July 20, 1997 between the Registrant
and Robert McNamara.
10.10* Employment Letter Agreement dated May 8, 1996 between the Registrant
and Eric N. Doelling, and amendment thereto dated August 26, 1996.
10.11* Employment Letter Agreement dated June 1, 1996 between the Registrant
and Stephen M. Rudy, and amendment thereto dated October 14, 1996.
10.12* 1997 Employee Stock Purchase Plan.
10.13* 1997 Director Option Plan.
10.14* Lease Agreement dated July 1, 1996 between the Registrant and RGL
Leasing Co.
11.1* Statement Regarding the Computation of Per Share Loss.
21.1* List of Subsidiaries of the Registrant.
24.1 Consent of Independent Auditors
24.2 Consent of Counsel (included in Exhibit 5.1).
24.3* Consent of Counsel.
25.1* Power of Attorney (see page II-4).
27.1 Financial Data Schedule.
</TABLE>
- -------
* Previously filed.

+ Confidential treatment is being sought for portions of this exhibit.

<PAGE>

EXHIBIT 5.1

[LETTERHEAD OF WILSON SONSINI GOODRICH & ROSATI]

October 29, 1997

Somnus Medical Technologies, Inc.
285 N. Wolfe Road
Sunnyvale, CA 94086

Re: Registration Statement on Form S-1

Ladies and Gentlemen:

We have examined the Registration Statement on Form S-1 (File No. 333-35401)
filed with the Securities and Exchange Commission on September 11, 1997 (as
amended by Amendment No. 1 thereto filed on October 16, 1997 and Amendment No.
2 thereto filed on October 29, 1997, as such may be amended or supplemented,
the "Registration Statement"), in connection with the registration under the
Securities Act of 1933, as amended, of 4,000,000 shares of Common Stock of
Somnus Medical Technologies, Inc. (the "Shares"). The Shares, which include up
to 600,000 shares of common stock issuable pursuant to an over-allotment option
granted to the underwriters, are to be sold to the underwriters as described in
such Registration Statement for the sale to the public or issued to the
Representatives of the underwriters. As your counsel in connection with this
transaction, we have examined the proceedings proposed to be taken in
connection with said sale and issuance of the Shares.

It is our opinion that, upon approval by the pricing committee duly autho-
rized by the Company's Board of Directors, the Shares when issued and sold in
the manner referred to in the Registration Statement will be legally and val-
idly issued, fully paid and nonassessable.

We consent to the use of this opinion as an exhibit to the Registration
Statement, and further consent to the use of our name wherever appearing in the
Registration Statement, including the prospectus constituting a part hereof,
and any amendment thereto.

Very truly yours,

WILSON SONSINI GOODRICH & ROSATI
Professional Corporation

/s/ Wilson Sonsini Goodrich & Rosati

<PAGE>

EXHIBIT 24.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the references to our firm under the captions "Selected
Consolidated Financial Data" and "Experts" and to the use of our report dated
March 7, 1997 (except for Note 8, as to which the date is September 4, 1997),
in Amendment No. 2 to the Registration Statement (Form S-1 No. 333-35401) and
related Prospectus of Somnus Medical Technologies, Inc. for the registration of
shares of its common stock.

/s/ ERNST & YOUNG LLP

Palo Alto, California

October 29, 1997

<PAGE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AMENDMENT
NO. 2 TO FORM S-1 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 7,012,900
<SECURITIES> 0
<RECEIVABLES> 396,257
<ALLOWANCES> 50,000
<INVENTORY> 116,882
<CURRENT-ASSETS> 7,520,681
<PP&E> 2,522,404
<DEPRECIATION> 523,842
<TOTAL-ASSETS> 9,883,333
<CURRENT-LIABILITIES> 2,779,412
<BONDS> 0
0
5,998
<COMMON> 2,818
<OTHER-SE> 4,947,606
<TOTAL-LIABILITY-AND-EQUITY> 9,883,333
<SALES> 1,100,164
<TOTAL-REVENUES> 1,100,164
<CGS> 1,968,775
<TOTAL-COSTS> 1,968,775
<OTHER-EXPENSES> 8,434,325
<LOSS-PROVISION> 50,000
<INTEREST-EXPENSE> 120,142
<INCOME-PRETAX> (9,071,287)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,071,287)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,071,287)
<EPS-PRIMARY> (0.90)
<EPS-DILUTED> (0.90)

</TABLE>