<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998.
OR
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________.
TO ______________.
COMMISSION FILE NO. 000-23275
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0423465
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
285 N. WOLFE ROAD
SUNNYVALE, CALIFORNIA 94086
(Address of principal executive offices, including zip code)
(408) 773-9121
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- ---
As of March 31, 1998, 13,496,021 shares of the Registrant's Common Stock were
outstanding.
<PAGE>
EXPLANATORY NOTE
On May 5, 1998, Somnus Medical Technologies, Inc. (the "Company") filed its
Report on Form 10-Q for the fiscal quarter ended March 31, 1998, with the
Securities and Exchange Commission (the "Commission").
The Company is now filing with the Commission its first amended Report on
Form 10-Q/A. The sole purpose for filing this first amended Report on Form 10-Q
is to amend Part II to include Item 2, "Changes in Securities and Use of
Proceeds," in order to reflect the Company's use of proceeds from its initial
public offering.
For ease of reference, this first amended Report on Form 10-Q contains all
of the information required to be set forth in a Report on Form 10-Q.
<PAGE>
SOMNUS MEDICAL TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
- ------------------------------ ----
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
March 31, 1998 and December 31,1997.........................................3
Condensed Consolidated Statements of Operations
Three months ended March 31, 1998 and 1997..................................4
Condensed Consolidated Statements of Cash Flows
Three months ended March 31, 1998 and 1997..................................5
Notes to Interim Condensed Consolidated Financial
Statements..................................................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...............................8
PART II. OTHER INFORMATION
---------------------------
Item 6. Exhibits and Reports on Form 8-K..............................................18
Signature.................................................................19
</TABLE>
2
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PART I - FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
SOMNUS MEDICAL TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
MARCH 31, 1998
(UNAUDITED) DECEMBER 31, 1997(*)
--------------------- ---------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 41,680 $ 45,145
Accounts receivable, net of allowance for doubtful accounts of
$145 and $70 at March 31, 1998 and December 31,
1997 respectively 1,305 662
Inventories, net 242 236
Other current assets 369 300
-------------------- --------------------
Total current assets 43,596 46,343
Property and equipment, net 1,779 1,822
Other assets 109 62
-------------------- --------------------
$ 45,484 $ 48,227
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 926 $ 1,112
Accrued compensation 759 509
Other accrued liabilities 1,655 986
-------------------- --------------------
Total current liabilities 3,340 2,607
Stockholders' equity:
Common stock 14 13
Additional paid-in capital 64,808 64,782
Deferred stock compensation (2,751) (3,321)
Accumulated deficit (19,927) (15,854)
-------------------- --------------------
Total stockholders' equity 42,144 45,620
-------------------- --------------------
$ 45,484 $ 48,227
==================== ====================
</TABLE>
(*) Derived from audited financial statements.
See accompanying notes
3
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SOMNUS MEDICAL TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
--------------------------------------------
MARCH 31, 1998 MARCH 31, 1997
------------------- -------------------
<S> <C> <C>
Total revenues $ 1,685 $ --
Costs and expenses:
Manufacturing start-up costs and costs of revenues 1,324 273
Research and development 2,382 916
Selling, general and administrative 2,594 734
------------------- -------------------
Total costs and expenses 6,300 1,923
------------------- -------------------
Loss from operations (4,615) (1,923)
Interest and other income 543 102
Interest expense (1) (25)
------------------- -------------------
Net loss $(4,073) $(1,846)
=================== ===================
Net loss per share:
Basic and Diluted $(0.30) $(0.75)
=================== ===================
Shares used in computing per share amounts:
Basic and Diluted 13,479 2,463
=================== ===================
</TABLE>
See accompanying notes
4
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SOMNUS MEDICAL TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, In thousands)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
--------------------------------------------
MARCH 31, 1998 MARCH 31, 1997
------------------- -------------------
<S> <C> <C>
CASH FLOWS USED IN OPERATING ACTIVITIES
Net loss $(4,073) $(1,846)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of deferred compensation 570 --
Depreciation and amortization 161 119
Net book value of property, plant and equipment retirements 57 --
Issuance of stock for noncash consideration
Changes in operating assets and liabilities:
Other current assets (69) (112)
Accounts receivable (643) --
Inventories (6) --
Other assets noncurrent (47) (49)
Accounts payable and accrued liabilities 483 129
Accrued employee benefits 250 35
------------------- -----------------
Net cash used in operating activities (3,317) (1,724)
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures (175) (776)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Net proceeds from issuance of common stock 27 --
Repayment of shareholder loan -- 3
Proceeds from borrowings under lease line of credit -- 564
Repayment of lease line of credit -- (30)
------------------- -----------------
Net cash provided by financing activities 27 537
------------------- -----------------
Net increase (decrease) in cash and cash equivalents (3,465) (1,963)
Cash and cash equivalents, beginning of period 45,145 8,829
------------------- -----------------
Cash and cash equivalents at end of period $41,680 $ 6,866
=================== =================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 1 $ 26
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Property and equipment acquired under lease line of credit $ -- $ 564
</TABLE>
See accompanying notes
5
<PAGE>
SOMNUS MEDICAL TECHNOLOGIES, INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
- ------------------------------
The condensed consolidated balance sheet as of March 31, 1998, the
condensed consolidated statements of operations for the three months ended March
31, 1998 and 1997, and the condensed consolidated statements of cash flows for
the three months ended March 31, 1998 and 1997, have been prepared by the
Company, without audit. In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
financial position, results of operations and cash flows at March 31, 1998 and
for all periods presented have been made. The condensed consolidated balance
sheet at December 31, 1997 has been derived from the audited financial
statements at that date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.
These condensed financial statements should be read in conjunction with the
Company's audited consolidated financial statements as included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997, as filed with
the Securities and Exchange Commission. The results of operations for the three
months ended March 31, 1998 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
December 31, 1998.
NOTE 2 - REVENUE RECOGNITION
- ----------------------------
The Company generally recognizes revenue at the time products are shipped.
To date, no customers have been given stock rotation privileges. Product
returns and sales allowances are estimated and provided for at the time of sale.
NOTE 3 - NET LOSS PER SHARE
- ---------------------------
In 1997, the FASB issued Statement No. 128, Earnings per Share. Statement
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share.
The Company has adopted SAB98, Earnings per Share which was issued on
February 3, 1998. In accordance with SAB98, 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 Company's initial public offering price are excluded from the calculation
of basic and diluted earnings per share.
The Company has securities outstanding that could dilute basic earnings per
share in the future that were not included in the computation of net loss per
share in the periods presented as their effect is antidilutive.
6
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NOTE 4 - INITIAL PUBLIC OFFERING
- --------------------------------
During the quarter ended December 31, 1997, the Company successfully
completed its initial public offering (the "Offering"). The Offering generated
net proceeds of approximately $37.9 million from the sale of 4,000,000 shares of
Common Stock. Subsequent to the end of the quarter, the Company's underwriters
exercised the over-allotment option, generating net proceeds of approximately
$5.9 million from the sale of 600,000 shares of Common Stock. The proceeds from
the Offering have been used to fund operating activities.
Concurrent with the closing of the Offering, the holders of all of the
Series A, B and C Preferred Stock (5,998,446 shares in total) converted their
shares into the Company's Common Stock.
NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS
- --------------------------------------
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement had no impact on the
Company's net loss or stockholders' equity. SFAS 130 requires unrealized gains
or losses on the Company's available-for-sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately in
stockholders' equity, to be included in other comprehensive income.
Comprehensive income is equal to net income as of March 31, 1998 and 1997.
Effective January 1, 1998, the Company adopted the Financial Accounting
Standard Board's Statement of Financial Accounting Standards No. 131 (SFAS
131), "Disclosures about Segments of an Enterprise and Related Information".
SFAS 131 superseded SFAS 14, "Financial Reporting for Segments of a Business
Enterprise". SFAS 131 establishes standards for the way that public business
enterprises report selected information about operating segments in interim
financial reports. SFAS 131 also establishes standards for related disclosures
about products and services, geographic areas, and major customers. The
adoption of SFAS 131 had no impact on the Company's results of operations,
financial position, or disclosure of segment information at March 31, 1998 or
1997.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the fiscal year
ended December 31, 1997.
The information set forth below contains forward-looking statements
(designated by an *), and 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 below under "Factors That May Affect
Future Results" and those set forth under "Item One" in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.
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 SomnoplastySM System provides physicians with a
suite of products designed to offer minimally-invasive, curative treatment
alternatives for disorders of the upper airway, including snoring and enlarged
turbinates.
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 ("EU"), 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 anticipates hiring additional financial accounting personnel to
meet increasing demands of its business and to strengthen the Company's
management capability.* 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 capabilities 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.
8
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The Company is building a direct sales force to cover the United States and
Canada. Presently the sales force consists of a Vice President, Worldwide Sales,
a Director of Sales, two regional sales managers and nine 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 March 31, 1998, the Company has incurred cumulative losses from
inception of approximately $19,900,000. Moreover, the Company expects to incur
significant additional operating losses over the next couple of years due to
expanded research and development efforts, including expenses associated with
the Company's patent portfolio, preclinical studies and clinical trials and the
development of its manufacturing and sales and marketing capabilities.* 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 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.
To date, a large portion of the Company's revenues has come from
international sales to Medtronic. The Company's business and financial results
could be materially adversely affected in the event that Medtronic is 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 for the three months ended March
31, 1998 (first quarter) are derived from sales of its Somnoplasty System,
consisting of the 215 RF Generator, the SP 1000 and the SP 1100 disposable
devices, to private practices, hospitals, clinics and sleep centers. No revenues
were recorded for the period from inception (January 19, 1996) to March 31, 1997
(prior-year period). During the first quarter, net revenues, totaling
$1,685,000, were attributable to sales to customers principally in the United
States. No shipments were made to Medtronic during the first quarter. 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 $1,324,000 in the first quarter and $273,000 in
the prior-year period. Manufacturing start-up costs and costs of revenues
consist of raw materials, subassemblies and completed electronics, quality
assurance and warranty costs. The cost of purchased materials, the costs of
prototypes, and the costs of establishing manufacturing capabilities account for
the majority of the increase from 1996 to 1997. The Company believes that
9
<PAGE>
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
$2,382,000 in the first quarter and $916,000 in the prior-year period. Research
and development expenses are comprised of salaries, prototype development costs,
costs associated with intellectual property, and clinical trial and regulatory
approval expenses. The increases between the comparison periods reflect the
increased expenditures incurred in the development of the Somnoplasty System,
new development efforts for the generators and the disposable devices,
initiation and expansion of clinical trials and expenses associated with
regulatory approvals in the United States, the EU and Australia. Clinical trial
and prototype costs for the first quarter were approximately $1,000,000 as
compared to approximately $450,000 in the prior-year period. Patent legal
expenses increased to approximately $250,000 in the first quarter, as compared
to $0 in the prior-year period, respectively. The 1998 expenses also include
approximately $206,000 of non-cash stock compensation charges resulting from
stock option grants and increased infrastructure costs of approximately
$200,000.
Selling, general and administrative. Selling, general and administrative
("SG&A") expenses were $2,594,000 in the first quarter and $734,000 in the
prior-year period, respectively. SG&A expenses consist of executive salaries,
professional fees, facilities overhead, accounting and human resources, general
office administration expenses such as rent and facility costs. The increase in
SG&A is primarily due to increased salaries and employee expenses of $800,000,
due to increased headcount and increased travel costs, costs of development of
marketing literature and campaigns, an extensive ongoing public relations effort
to promote the Somnoplasty System and additional market research into new
product areas of approximately $460,000. The first quarter expenses also
include $364,000 of non-cash stock compensation charges resulting from stock
option grants.
Interest and other income, net. Interest and other income, net was
$542,000 in the first quarter and $77,000 for the prior-year period. The
increases were attributable to interest income earned by the Company on an
increased outstanding balance of cash and cash equivalents, invested from the
proceeds of the IPO. Interest expense was $1,000 in the first quarter and
$25,000 in the prior-year period. The decrease was due to the repayment of
borrowings under the equipment lease line of credit.
Net loss. The net loss for the first quarter of 1998 was $4,073,000 and
$1,846,000 for the same quarter in the prior year. The Company expects that its
operating losses will continue for at least the next couple of years and may
increase in the short term, as the Company continues to invest substantial
resources in product development, manufacturing, sales and marketing and its
infrastructure.*
NEW ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of SFAS 130 had no impact on the
Company's net loss or stockholders' equity. SFAS 130 requires unrealized gains
or losses on the Company's available-for-sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately in
stockholders' equity, to be included in other comprehensive income.
Comprehensive income is equal to net income as of March 31, 1998 and 1997.
Effective January 1, 1998, the Company adopted the Financial Accounting
Standard Board's Statement of Financial Accounting Standards No. 131 (SFAS 131),
"Disclosures about Segments of an Enterprise and Related Information". SFAS 131
superseded SFAS 14, "Financial Reporting for Segments of a Business Enterprise".
SFAS 131 establishes standards for the way that public business enterprises
report selected information about operating segments in interim financial
reports. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The adoption of
SFAS 131 had no impact on the Company's results of operations, financial
position, or disclosure of segment information at March 31, 1998 or 1997.
10
<PAGE>
YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "year 2000 problem"
is pervasive and complex as virtually every computer operation will be affected
in some way by the rollover of the two digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. Management
is in the process of working with its software vendors to ensure that the
Company's internal systems are prepared for the year 2000. Management does not
anticipate that the Company will incur significant operating expenses or be
required to invest heavily in computer systems improvements to be year 2000
compliant.* However, significant uncertainty exists concerning the potential
costs and effects associated with any year 2000 compliance. The Company will
implement an upgrade to its management information system that the Company
believes is year 2000 compliant.* Any year 2000 compliance problem of either
the Company or its suppliers, partners or customers, including Medtronic, could
materially adversely affect the Company's business, results of operations, cash
flows, financial condition and prospects.
LIQUIDITY AND CAPITAL RESOURCES
Since inception through March 31, 1997, the Company has financed its
operations primarily through the private placement of equity securities, bank
loans, lease lines of credit, stockholder loans and its November 1997 IPO. From
inception, the Company raised approximately $16,400,000 in net proceeds from
private equity financings. The Company raised an additional $43,756,000 from
its IPO, net of costs of $4,540,000.
Cash and cash equivalents at March 31, 1998 were $41,680,000 compared to
$45,145,000 at December 31, 1997.
Net cash used in operating activities was approximately $3,317,000 for the
first quarter and $1,724,000 for the prior-year period. Net cash used in
operating activities is larger than the Company's net loss for these comparison
periods primarily due to non-cash charges associated with the amortization of
deferred compensation and the depreciation of property and equipment. Net cash
used in investing activities was approximately $175,000 for the first quarter
and $776,000 for the prior-year period, and was attributable to capital
expenditures during these periods. Net cash provided by financing activities
was approximately $27,000 for the first quarter and $537,000 for the prior-year
period, attributable primarily to the exercise of options, and private placement
transactions.
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. The total unamortized
deferred stock compensation at March 31, 1998 is $2,751,000. The Company
amortized deferred compensation expenses of approximately $570,000 in the first
quarter of 1998 compared to $0 in the same quarter in the prior year. The
remainder of the deferred stock compensation will be amortized over the
corresponding vesting period of each respective option, which is generally four
years from date of original issuance.
11
<PAGE>
At March 31, 1998, the Company's principal sources of liquidity consisted
of $41,680,000 in cash and cash equivalents. There were no other material unused
sources of liquid assets at March 31, 1998.
The Company currently anticipates that its capital expenditure requirements
will be approximately $2.0 million for the next twelve months.* These
requirements relate primarily to the acquisition of computer hardware and
software and for additional leasehold improvements to handle anticipated
headcount additions.*
The Company anticipates that its existing resources will enable the Company
to maintain its current and planned operations through the next twelve months.*
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 factors. 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 stockholders 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.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's operating results may vary significantly depending on certain
factors, including the effect of delays in its research and development program,
adverse results in its clinical studies, delay in the introduction or shipment
of new products, increased competition, litigation costs should the Company be
involved in litigation, adverse changes in the economic conditions in any of the
several countries in which the Company does business, a slower growth rate in
the Company's target markets, order deferrals in anticipation of new product
releases, lack of market acceptance of new products, the uncertainty of FDA or
other domestic and international regulatory clearances or approvals, and the
factors set forth under the Company's annual report on form 10-K for the fiscal
year ended December 31, 1997.
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 EU, 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. In December 1997, the Company received 510(k) clearance to use the
Somnoplasty System for the treatment of enlarged turbinates associated with
chronic rhinitis. The Company began direct sales of the device for treating
enlarged turbinates in the first quarter of 1998. 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 March 31, 1998,
12
<PAGE>
the Company had total revenues of approximately $4.6 million and incurred
cumulative losses of approximately $19.9 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.
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, 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.
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 1997 and is in the process of hiring
additional financial, accounting and other personnel in 1998.* 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.
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 enlarged turbinates, and the successful
development, regulatory clearances and/or approvals, commercialization 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, and the reduction of tissue in the turbinates, but the
Company has not received FDA
13
<PAGE>
clearance or approval to market its products for other indications, such as
reduction of tissue in the 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 indications, 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
continue 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 regulatory approval in other
international markets could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Somnoplasty System is in the early stage of commercialization and the
Company has only a limited history of its use in the treatment of snoring and
enlarged turbinates. 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.
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 and enlarged turbinates, 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
14
<PAGE>
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. The
Company anticipates that most patients will require less treatments to reduce
enlarged turbinates than required to reduce snoring.* The Company anticipates
that most patients will only require one to three treatments to significantly
reduce snoring.* 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, turbinate reduction, 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.
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 EU, 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 generated approximately $824,000 of net revenue from its
relationship with Medtronic. No shipments were made to Medtronic during the
first quarter. Management is currently working with Medtronic management to
establish a plan for execution in Europe.* However, there can be no assurance
that its relationship with Medtronic, or the plan, 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.
15
<PAGE>
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 enlarged turbinates, and 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 System
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.
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.
16
<PAGE>
Transition from 215 RF Generator to 615/S2 Generator. The Company currently
purchases its 215 RF Generator as a finished assembly from a single-source
supplier. The Company plans to discontinue selling the 215 RF Generator model
during 1998.* The Company is currently developing the 615/S2 (hereinafter the
"S2") Generator, which will be manufactured entirely by the Company with the
same single-source supplier acting as the vendor for the RF subassembly.* There
can be no assurance that the Company will not experience design or production
issues as the Company commences such manufacturing activities. Management
believes that the Company has procured adequate quantities of the 215 Generator
model from the supplier to ensure demand for generators is met as the Company
transitions from the 215 Generator. However, there can be no assurance that the
Company has procured adequate quantities of the 215 RF Generator. In addition,
there is no assurance that management would be able to procure additional 215 RF
Generators should demand exceed supply.
The Company plans to launch the S2 during the second quarter of 1998.*
There can be no assurance that the RF subassembly 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 RF
subassemblies on a timely and cost-effective basis. To date, the Company has
not experienced significant adverse effects resulting from any shortage of RF
subassemblies. However, there can be no assurance that the single-source
supplier will meet the Company's future requirements for timely delivery of RF
subassemblies of sufficient quality and in sufficient quantity. The RF
subassemblies currently take 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. Management anticipates that the
S2 Generator will be more expensive than the 215 Generator.* There can be no
assurance that the Company will be able to successfully market and sell the S2
Generator. Further, there can be no assurance that the level of sales of the
215 Generator will not decline or that the Company will not experience increased
levels of returns of the 215 Generator in anticipation of the launch of the S2
Generator.
Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenues or earnings from levels expected by security
analysts could have an immediate and significant adverse effect on the trading
price of the Company's common stock.
17
<PAGE>
PART II - OTHER INFORMATION
- -----------------------------
Item 2: Changes in Securities and Use of Proceeds
From the date of the sale of securities under the Company's
Registration Statement on Form S-1 (File No. 333-35401), which was declared
effective on November 5, 1997 (the "Offering"), through March 31, 1998, the
approximate amount of net proceeds used from the Offering were $2,200,000 for
research and development, clinical trials and regulatory matters, $1,900,000 to
manufacture product and further develop manufacturing expertise and
capabilities, $2,900,000 to improve and expand financial capabilities, to
enhance financial reporting systems, to expand sales and marketing efforts, and
for other general corporate purposes and $300,000 for the acquisition of fixed
assets. The Company has also made temporary investments in cash and cash
equivalents of $36,500,000 .
All amounts represent estimates of direct or indirect payments of
amounts to third parties. No amounts were paid directly or indirectly for the
above purposes to directors or officers of the Company, to persons owning ten
percent or more of any class of equity securities of the Company, or to
affiliates of the Company. The use of proceeds described above do not represent
a material change in the use of proceeds described in the Offering
prospectus.
Item 6: Exhibits and Reports on Form 8-K
(a) There were no reports on Form 8-K during the quarter ended March
31, 1998.
Exhibit 27.1 - Financial Data Schedule
18
<PAGE>
SOMNUS MEDICAL TECHNOLOGIES, INC.
---------------------------------
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Registrant)
Date: May 12, 1998 By: /s/ Stuart D. Edwards
-------------------------------
Stuart D. Edwards
Chief Executive Officer
19
<TABLE> <S> <C>
<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> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 SEP-30-1997
<CASH> 41,680,000 7,012,900
<SECURITIES> 0 0
<RECEIVABLES> 1,450,000 396,257
<ALLOWANCES> 145,000 50,000
<INVENTORY> 242,000 116,882
<CURRENT-ASSETS> 43,596,000 7,520,681
<PP&E> 2,731,000 2,522,404
<DEPRECIATION> 952,000 523,842
<TOTAL-ASSETS> 45,484,000 9,883,333
<CURRENT-LIABILITIES> 3,340,000 2,779,412
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0 5,998
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<OTHER-EXPENSES> 4,976,000 8,434,325
<LOSS-PROVISION> 145,000 50,000
<INTEREST-EXPENSE> 1,000 120,142
<INCOME-PRETAX> (4,073,000) (9,071,287)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (4,073,000) (9,071,287)
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<NET-INCOME> (4,073,000) (9,071,287)
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