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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2000
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 August 2, 2000 14,574,463 shares of the Registrant's Common Stock were
outstanding.
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SOMNUS MEDICAL TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page
------------------------------ ----
<S> <C>
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
June 30, 2000 and December 31, 1999......................... 3
Condensed Consolidated Statements of Operations for the
Three and six month periods ended June 30, 2000 and 1999.... 4
Condensed Consolidated Statements of Cash Flows for the
Six month periods ended June 30, 2000 and 1999.............. 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 8
Item 3. Quantitative and Qualitative Disclosures of
Market Risk................................................ 17
PART II. OTHER INFORMATION
---------------------------
Item 4. Submission of Matters to a Vote of Security
Holders.................................................... 17
Item 6. Exhibits and Reports on Form 8-K........................... 18
Signatures.......................................................... 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>
June 30, 2000 December 31, 1999
(Unaudited) (*)
--------------------- ---------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 13,020 $ 14,888
Short-term investments - 4,972
Accounts receivable, net 1,855 1,906
Inventories 780 1,181
Other current assets 144 164
--------------------- ---------------------------
Total current assets 15,799 23,111
Property and equipment, net 1,754 1,603
Other assets 91 84
--------------------- ---------------------------
$ 17,644 $ 24,798
===================== ===========================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,329 $ 1,623
Accrued liabilities 1,079 1,442
Accrued compensation 1,608 2,167
Accrued warranty 877 907
Accrued clinical costs 609 547
Deferred revenue 803 1,287
--------------------- ---------------------------
Total current liabilities 6,305 7,973
Stockholders' equity:
Common stock 16 14
Additional paid-in capital 65,539 65,332
Deferred stock compensation (37) (189)
Accumulated deficit (54,179) (48,332)
--------------------- ---------------------------
Total stockholders' equity 11,339 16,825
--------------------- ---------------------------
$ 17,644 $ 24,798
===================== ===========================
</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 For the Six Months
Ended Ended
------------------------------------ -----------------------------------
June 30, June 30, June 30, June 30,
2000 1999 2000 1999
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Product revenue * $ 3,003 $ 2,967 $ 6,204 $ 5,309
Cost of sales 1,800 1,666 3,679 3,172
--------------- -------------- -------------- --------------
Gross margin 1,203 1,301 2,525 2,137
Operating expenses:
Research and development 1,410 1,499 2,918 3,370
Selling, general and administrative 3,019 3,576 5,908 7,172
--------------- -------------- -------------- --------------
Total operating expenses 4,429 5,075 8,826 10,542
--------------- -------------- -------------- --------------
Loss from operations (3,226) (3,774) (6,301) (8,405)
Interest and other income, net * 189 330 454 822
--------------- -------------- -------------- --------------
Net loss $(3,037) $(3,444) $(5,847) $(7,583)
Net loss per share, basic and diluted $ (.21) $ (0.24) $ (.40) $ (0.54)
=============== ============== ============== ==============
Shares used in computing net loss per
share, basic and diluted 14,522 14,211 14,472 14,144
=============== ============== ============== ==============
</TABLE>
* Revenue for the three and six months ended June 30, 1999 included related
party revenue of $191,000 and $350,000, respectively. Interest and other
income, net for the three and six months ended June 30, 1999, includes
nonrecurring technology and documentation fees from a related party of $133,000.
See accompanying notes
4
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SOMNUS MEDICAL TECHNOLOGIES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, In thousands)
<TABLE>
<CAPTION>
For the Six Months Ended
June 30, 2000 June 30, 1999
--------------------- --------------------
<S> <C> <C>
Cash flows used in operating activities
Net loss $(5,847) $(7,583)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of deferred compensation 33 420
Depreciation 387 482
Changes in operating assets and liabilities:
Accounts receivable 51 (354)
Inventories 401 5
Other current assets 20 123
Other noncurrent assets (7) (21)
Accounts payable, accrued liabilities, and accrued warranty (687) 854
Accrued compensation (559) 453
Accrued clinical costs 62 101
Deferred revenue (484) 665
--------------------- --------------------
Net cash used in operating activities (6,630) (4,855)
--------------------- --------------------
Cash flows used in investing activities
Capital expenditures (538) (323)
Repurchase of common stock - (285)
Maturity of Short-term investments 4,972 -
--------------------- --------------------
Net cash provided by (used in) investing activities 4,434 (608)
--------------------- --------------------
Cash flows provided by financing activities
Net proceeds from issuance of common stock 328 195
--------------------- --------------------
Net decrease in cash and cash equivalents (1,868) (5,268)
Cash and cash equivalents at beginning of period 14,888 32,280
--------------------- --------------------
Cash and cash equivalents at end of period $13,020 $27,012
===================== ====================
</TABLE>
See accompanying notes
5
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SOMNUS MEDICAL TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - Summary of Significant Accounting Policies
---------------------------------------------------
Basis of Presentation
The condensed consolidated balance sheet as of June 30, 2000, the condensed
consolidated statements of operations for the three and six month periods ended
June 30, 2000 and 1999, and the condensed consolidated statements of cash flows
for the six month periods ended June 30, 2000 and 1999, have been prepared by
management, without audit, in accordance with generally accepted accounting
principles, for interim financial information and pursuant to instructions to
Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position at June 30, 2000 and results of operations
and cash flows for all periods presented have been made. The condensed
consolidated balance sheet at December 31, 1999 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
audited consolidated financial statements as included in our Annual Report on
Form 10-K for the year ended December 31, 1999, as filed with the Securities and
Exchange Commission. The results of operations for the three and six month
periods ended June 30, 2000 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
December 31, 2000.
Revenue Recognition
We recognize revenue at the time products are shipped or, for sales which
are financed through third parties, upon acceptance from a third party leasing
company of a customer lease and the related equipment. For shipments to
distributors made under agreements that do not provide for right of return or
price protection, revenue for control units is recognized upon shipment to the
final customer. Allowances for product returns are provided for at the time of
revenue recognition. In December 1999, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101, "Revenue recognition in financial
statements" (SAB 101). SAB 101 provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements. The Company
does not anticipate that SAB 101 will have a material impact on its results of
operations, financial position, and cash flows. The Company is required to
adopt SAB 101 in the fourth quarter of fiscal year 2000.
Comprehensive Loss
We have no material components of other comprehensive loss and,
accordingly, the comprehensive loss is the same as the net loss for all periods
presented.
Net Loss Per Share
Basic and diluted earnings per share have been calculated using the
weighted average common shares outstanding during the periods in accordance with
Statement No. 128 "Earnings Per Share" issued by the Financial Accounting
Standards Board and Securities and Exchange Commission Staff Accounting Bulletin
(SAB) No. 98.
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We have securities outstanding that could dilute basic earnings per share
in the future that were not included in the computation of net loss per share in
the periods presented as their effect is antidilutive.
Segment Information
We have organized the business in one operating segment which includes
activities relating to development, manufacturing and marketing of medical
devices that utilize proprietary temperature controlled radiofrequency
technology for the management and treatment of upper airway disorders.
Substantially all of our assets are in the United States and through June 30,
2000 we have derived our revenue primarily from our operations in the United
States.
NOTE 2 - Inventories
--------------------
<TABLE>
<CAPTION>
(in thousands) June 30, 2000 December 31, 1999
<S> <C> <C>
Raw Materials $418 $ 406
Work in Process 90 214
Finished Goods 272 561
-------------------------------------------------
$780 $1,181
=================================================
</TABLE>
7
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with our
audited financial statements and notes thereto for the fiscal year ended
December 31, 1999.
The information set forth below contains forward-looking statements
(designated by an *), and our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth below under "Factors That May Affect Future Results"
and those set forth under "Item 1" in our Annual Report on Form 10-K for the
fiscal year ended December 31, 1999.
Overview
We design, develop, manufacture and market innovative medical devices that
utilize our proprietary temperature controlled radiofrequency technology for the
treatment of upper airway disorders. Our Somnoplasty(R) System provides
physicians with a suite of products designed to offer minimally invasive,
curative treatment alternatives for disorders of the upper airway, including
obstructive sleep apnea syndrome, (OSAS), upper airway resistance syndrome,
(UARS), chronic turbinate hypertrophy, and habitual snoring.
Our operations in 1996 and 1997 consisted largely of research and
development, product engineering, seeking clearance of our products from the
Food & Drug Administration (FDA), development of a direct sales force in the
United States and distribution network, and training international distributor
employees for distribution of the Somnoplasty System in the European Union (EU),
Australia, Southeast Asia and certain other areas. We commercially introduced
the Somnoplasty System internationally, beginning in June 1997. One month later,
after receiving 510(k) clearance from the FDA for the use of the Somnoplasty
System to treat habitual snoring, we began direct sales of the Somnoplasty
System in the United States. We received FDA clearance to treat chronic
turbinate hypertrophy in December 1997 and OSAS/UARS in November 1998. During
the third quarter of fiscal 1998, we established a European headquarters in The
Netherlands. In June 2000, we received clearance from the FDA for a new device
designed to significantly reduce enlarged tonsils. In addition, in June 2000, we
secured regulatory "shonin" approval to market the Somnoplasty System in Japan.
During 1999, we continued to build our direct sales force in the United
States. Presently, the sales force consists of a Vice President of Sales and
Marketing, two domestic regional sales managers, ten domestic sales
representatives, one independent representative group and three clinical
specialists. During 1998, we hired a Vice President and General Manager of
European Sales and Marketing to manage distributors in European countries.
During the fourth quarter of 1999, we hired a Director of International Sales to
manage our distributors in countries other than the United States and Europe.
We anticipate significant investments will be continued in the development of
our direct and indirect sales infrastructure.*
Product shipments of control units and disposable devices are made directly
from our facility in Sunnyvale, California to domestic customers and
international distributors. As the Company's installed base of control units has
grown we have continued to receive an increasing percentage of our sales from
disposable handpieces as opposed to from the sale of
8
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control units.
We plan to continue to hire additional management and engineering personnel
to support and develop manufacturing expertise and larger scale manufacturing
capacity as required to support the current and anticipated growth.*
Additionally, we will invest in further production equipment, vertical
integration and facility expansion to reduce manufacturing costs, reduce
manufacturing cycle time and increase production capacity.* Personnel hires and
capital expenditures will require operating capital on an ongoing basis.* We
will also continue to expand our internal reporting capabilities and further
strengthen systems to manage our expanding business.*
This current and anticipated growth of our personnel, sales and scope of
operations may place considerable strain on our management, financial,
manufacturing and other capabilities, procedures and controls. There can be no
assurance that any existing or additional capabilities, procedures or controls
will be adequate to support our operations or that our capabilities, procedures
or controls will be designed, implemented or improved in a timely and cost-
effective manner. Failure to implement, improve and expand such capabilities,
procedures and controls in an efficient manner could have a material adverse
effect on our business, financial condition and results of operations.
As of June 30, 2000, we have incurred cumulative losses from inception of
approximately $54,179,000. Moreover, we expect to incur significant additional
operating losses over the next couple of years primarily due to the development
of our manufacturing and sales and marketing capabilities along with ongoing
research and development efforts, including clinical studies and expenses
associated with our patent portfolio, as well as costs associated with the
implementation of the appropriate infrastructure to support and grow the
business operations.* Our limited operating history makes accurate prediction of
future operating results difficult or impossible.
Future revenues and results of operations may fluctuate significantly from
quarter to quarter or year to year and will depend upon numerous factors,
including the extent to which our products gain market acceptance, the scale-up
of manufacturing capabilities, the expansion of sales and marketing activities,
competition, the timing and success of new product introductions by us or our
competitors, the timing of regulatory clearances or approvals of those new
products and our ability to market our products in the United States and
internationally. Accordingly, interim period comparisons of our operating
results are not necessarily meaningful and should not be relied upon as
indicators of likely future performance or annual operating results.
Our business and financial results could be materially adversely affected
in the event that we are unable to market the Somnoplasty System effectively,
anticipate customer demand, meet customer demand or effectively manage new
product launches, pricing and cost containment pressures in health care. Our
operations and financial results could also be significantly affected by
international factors, including oversight by numerous regulatory agencies,
changes in foreign currency exchange rates and foreign economic and political
conditions.
Results of Operations
Net revenue. Our revenues for the three and six months ended June 30, 2000
were
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derived primarily from sales of our Somnoplasty system, consisting of control
units and disposable devices to private practices, hospitals, clinics, and sleep
clinics. Net revenues for the three and six months periods ended June 30, 2000
were $3,003,000 and $6,204,000 respectively, an increase over the prior year
periods of $36,000, or 1.2 percent, and $895,000, or 16.9 percent, respectively.
The increase for both the three and six month period ended June 30, 2000 as
compared to the prior year periods is attributable to increased sales of
disposable handpieces driven off the higher installed base offset by a decrease
in the average selling price of our control unit. During the three and six month
periods ended June 30, 2000, 83 percent and 86 percent of our revenues
respectively were derived from sales to customers in the United States. During
the three and six month periods ended June 30, 1999, approximately 90% of our
revenues were derived from sales to customer in the United States. As we
implement sales programs that reduce the price of control units, the dollar
volume of products shipped has shifted from a mix of approximately 56 percent
control units and 44 percent disposable handpieces for the three and six month
periods ended June 30, 1999 to a mix of about 28 percent control units and 72
percent disposable handpieces and 24 percent control units and 76 percent
disposable handpieces, respectively for the three and six month periods ended
June 30, 2000. We expect disposable handpieces to fluctuate as a percentage of
total revenue, quarter over prior year quarter and year over year, as we
implement sales programs that reduce the price of control units.
Cost of sales and gross margin. Cost of sales consists of raw materials,
subassemblies and completed electronics, quality assurance and warranty costs.
Gross margin for the three and six months periods ended June 30, 2000 decreased
by 4% to 40 percent of sales and increased by 1% to 41 percent of sales,
compared to the prior year periods. The decrease in gross margin as a
percentage of sales for the three months ended June 30, 2000 as compared to
prior year period is due primarily to a decrease in the average selling price of
our control units. The slight increase in gross margin as a percentage of sales
for the six months ended June 30, 2000 as compared to the prior year period is
due to an increase in manufacturing volume and the corresponding economy of
scale offset by the lower average selling price of our control units. We
believe that in the future as sales increase cost of sales will increase in
absolute dollars but may fluctuate as a percentage of sales depending on volume
and product mix.*
Research and development expenses. Research and development expenses are
comprised of salaries, prototype development costs, costs associated with
intellectual property, and clinical trial and regulatory approval costs.
Research and development (R&D) costs for the three and six months ended June 30,
2000 were $1,410,000 and $2,918,000, a decrease over the prior year periods
of $89,000 or 5.9 percent and $452,000 or 13.4 percent, respectively. The
decrease for the three months ended June 30, 2000 as compared to the prior year
period was primarily attributable to the timing of clinical trial costs. The
decrease for the six months ended June 30, 2000 as compared to the prior year
period was primarily attributable to a one-time charge of $214,000 for
severance for a former officer of the Company during the first quarter of 1999
as well as the timing of clinical trials.
Selling, general and administrative. Selling, general and administrative
("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. SG&A expenses for the three and six months
ended June 30, 2000 were $3,019,000 and $5,908,000, a decrease over the prior
year periods of $557,000 or 15.6 percent and $1,264,000 or 17.6 percent,
respectively. The decrease in the three month period ended June 30, 2000 as
compared to the prior year period is primarily attributable to reduced bad debt,
legal, and
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personnel related costs. The decrease in the six month period ended June 30,
2000 as compared to the prior year period is primarily attributable to reduced
bad debt, legal, and personnel related costs as well as a one time charge of
$214,000 for severance for a former officer of the Company included in the prior
year period.
Interest and other income. Interest and other income for the three and six
months ended June 30, 2000 was $189,000 and $454,000, a decrease over the prior
year periods of $141,000 or 42.7 percent and $368,000 or 44.8 percent,
respectively. The decrease in the three month period ended June 30, 2000 as
compared to the prior year period is attributable to the reduction in interest
income earned on a decreasing balance of cash, cash equivalents, and short-term
investments. The decrease in the six month period ended June 30, 2000 as
compared to the prior year period is attributable to both the reduction in
interest income earned on a decreasing balance of cash, cash equivalents, and
short-term investments as well as by nonrecurring technology and documentation
fees received from a related party during the prior year period not received
during the six month period ended June 30, 2000.
Liquidity and Capital Resources
Since inception through June 30, 2000, Somnus has financed its operations
primarily through the private placement of equity securities, bank loans, lease
lines of credit, stockholder loans and our November, 1997 IPO. From inception,
we raised approximately $16,400,000 in net proceeds from private equity
financing. We raised an additional $43,800,000 from our IPO, net of costs of
$4,500,000.
Cash and cash equivalents and short-term investments at June 30, 2000 were
$13,020,000 compared to $19,860,000 at December 31, 1999.
Net cash used in operating activities was approximately $6,630,000 for the
six months ended June 30, 2000, compared to $4,855,000 million for the prior
year period. The increase in cash used in operating activities from the prior
year quarter is primarily attributable to the decrease in accounts payable,
accrued liabilities, accrued warranty, and accrued compensation during the six
months ended June 30, 2000. This was partially offset by the decrease in net
loss from the prior year quarter and a reduction in inventory levels from
December 31, 1999.
Net cash provided by investing activities was approximately $4,434,000 for
the six months ended June 30, 2000, compared to net cash used in investing
activities of $608,000 for the prior year period. The increase from the prior
year period is attributable to the sale of short-term investments partially
offset by an increase in capital expenditures.
Net cash provided by financing activities was approximately $328,000 for
the six months ended June 30, 2000 as compared to $195,000 for the prior year
period. The increase from the prior year period is attributable to an increase
in stock option exercises during the six months ended June 30, 2000 as compared
to the prior year period.
At June 30, 2000, our principal sources of liquidity consisted of in cash and
cash equivalents. There were no other material unused sources of liquid assets
at June 30, 2000.
We currently anticipate that our capital expenditure requirements will be
approximately $1.0 million for the next twelve months.* These requirements
relate primarily to the acquisition
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of additional leasehold improvements, manufacturing equipment, computer hardware
and software to handle anticipated manufacturing expansion and headcount
additions.
We anticipate that our existing resources will enable us to maintain our
current and planned operations through the next twelve months.* However, there
can be no assurance that we will not require additional funding prior to such
time. Our future capital requirements will depend on many factors, including the
ability of Somnus to establish and maintain strategic distributor relationships,
the rate of market adoption of our products, competing technological and market
developments, the cost of manufacturing and other factors. There can be no
assurance that additional financing to meet our funding requirements will be
available as needed. If additional funds are raised by issuing equity
securities, substantial dilution to existing stockholders may result.
Insufficient funds may require Somnus to delay, scale back or eliminate some or
all of our research or development programs or to relinquish rights to products
at an earlier stage of development or on less favorable terms than we would
otherwise seek to obtain or to scale back and eliminate certain sales and
marketing initiatives. The failure of Somnus to raise capital when needed would
have a material adverse effect on our business, financial condition and results
of operations.
Factors That May Affect Future Results
Our operating results may vary significantly depending on certain factors,
including the effect of lack of market acceptance of products, the ability to
anticipate and meet customer demand, delays in the introduction or shipment of
new products, increased competition, delays in ongoing research and development
programs, litigation costs should we be involved in litigation, adverse changes
in the economic conditions in any of the several countries in which we do
business, a slower growth rate in our target markets, the uncertainty of
international regulatory clearances or approvals, and the factors set forth in
our annual report on form 10-K for the fiscal year ended December 31, 1999.
Limited Operating History; Absence of Profitability.
Somnus has generated only limited revenues from sales of the Somnoplasty
System and has limited experience in manufacturing, selling and marketing our
products in commercial quantities. There can be no assurance that the
Somnoplasty System will be sufficiently successful for us to achieve significant
revenues. From inception in 1996 through June 30, 2000, we have had total
revenues of approximately $27.8 million and incurred cumulative losses of
approximately $54.2 million. We expect to significantly increase spending over
the next several years with respect to sales and marketing, manufacturing and to
a lesser extent, ongoing research and development efforts and clinical trials,
and expect to incur significant additional losses for the foreseeable future.*
Whether we can successfully manage the transition to a larger-scale enterprise
will depend upon a number of factors, including our ability to increase our
commercial manufacturing and sales and marketing capabilities. Our inability to
establish such capabilities would have a material adverse effect on our
business, financial condition and results of operations.
We are dependent upon the Somnoplasty System, which has not been available for
sufficient time for us to know if it is effective on a long term basis.
Our success depends upon the market acceptance of the Somnoplasty System
for the treatment of turbinate hypertrophy (chronic nasal obstruction), soft
palate/uvula (habitual
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snoring), hypertrophic tonsils and base of tongue (obstructive sleep apnea
syndrome/upper airway resistance syndrome). Market acceptance will depend, in
large part, upon the effectiveness of the Somnoplasty System over time.* There
can be no assurance that the procedure will provide a permanent, curative
treatment for patients. Independent factors, such as aging and weight gain, may,
over time, lead to the enlargement of tissue in areas previously treated by our
procedure.* This could result in the need for further treatments, making the
procedure a potentially less attractive alternative to existing surgical and
non-surgical procedures, which could have a material adverse effect upon our
business, financial condition and results of operations.
Several factors will impact our ability to achieve market acceptance.
Temperature Controlled Radiofrequency tissue volume reduction in the upper
airway is a new and novel development. Market acceptance of this procedure for
the treatment of turbinate hypertrophy (chronic nasal obstruction), soft
palate/uvula (habitual snoring), hypertrophic tonsils and base of tongue
(obstructive sleep apnea syndrome/upper airway resistance syndrome) could be
adversely affected by numerous factors, including:
. the lack of availability of third-party reimbursement,
. cost of the procedure,
. clinical acceptance,
. differentiation of our temperature control feature,
. effective physician training and
. patient acceptance.
Third party reimbursement. We do not anticipate that patients will receive
third-party reimbursement for use of the Somnoplasty System in the treatment of
habitual snoring.* Market acceptance of the Somnoplasty System for the treatment
turbinate hypertrophy (chronic nasal obstruction), hypertrophic tonsils and base
of tongue (obstructive sleep apnea syndrome/upper airway resistance syndrome)
will depend, in large part, upon the availability and receipt of and acceptable
level of third-party reimbursement for each of those indications, which cannot
be assured.*
Cost of the procedure and clinical acceptance. Market acceptance will also
depend upon our ability to demonstrate that the Somnoplasty System is an
attractive alternative to existing procedures, which will depend upon
physicians' evaluations of the clinical safety and efficacy, ease of use,
reliability and cost-effectiveness of the Somnoplasty System in a clinical
setting.* We believe that recommendations and endorsements by influential
physicians will be essential to market acceptance.* There can be no assurance
that such recommendations or endorsements will be obtained.
Differentiation. There can be no assurance that we will be able to
successfully differentiate our technology from competing products.
Physician training. Broad adoption of the Somnoplasty System will require
us to train physicians on how to perform the Somnoplasty procedure and
educating physicians regarding the advantages of the Somnoplasty System over
currently available surgical and non-surgical approaches.* The time required to
complete such training and education could extend the sales cycle for our
products and delay or preclude commercial sales and market acceptance. If we are
unable to achieve broad market acceptance of the Somnoplasty System for our
current and
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anticipated indications, our business, financial condition and results of
operations would be materially adversely affected.
Patient acceptance. Patient acceptance may be affected by numerous factors,
including the possibility that the Somnoplasty procedure will require multiple
treatments, which would be not only inconvenient for the patient, but also more
costly.* Patients may require anywhere from one to six treatments to
significantly reduce snoring; however, we now know that most patients will
require one to three treatments to significantly reduce snoring and typically
one treatment for chronic nasal obstruction and one to nine treatments for
obstructive sleep apnea syndrome/upper airway resistance syndrome. Factors such
as poor training of the treating physician or improper use of the Somnoplasty
System by the treating physician could lead to a patient requiring more
treatments. Patient acceptance of the Somnoplasty System for the treatment of
turbinate hypertrophy (chronic nasal obstruction), soft palate/uvula (habitual
snoring), hypertrophic tonsils and base of tongue (obstructive sleep apnea
syndrome/upper airway resistance syndrome) 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 us to achieve profitable operations. In addition,
publicity arising from any adverse outcome or other problem occurring in the
treatment of a Somnoplasty patient for any reason, particularly during this
early phase of the commercialization of the Somnoplasty System, could materially
adversely affect patient demand for the procedure. Failure of the Somnoplasty
System, for whatever reason, to achieve significant patient acceptance would
have a material adverse effect on our business, financial condition and results
of operations.
We have limited direct sales and marketing experience.
We have only limited experience selling and marketing the Somnoplasty
System for the treatment of turbinate hypertrophy (chronic nasal obstruction),
soft palate/uvula (habitual snoring), hypertrophic tonsils and base of tongue
(obstructive sleep apnea syndrome/upper airway resistance syndrome). We are
directing our sales effort in the United States on private practices, clinics,
hospitals and sleep clinics through a direct sales force and a manufacturers
representative group. We currently have a small direct sales force that covers
certain regions of the United States and intend to increase our sales and
marketing force in the near future to accelerate commercialization of the
Somnoplasty System throughout the United States.* There can be no assurance that
we will be successful in building an effective sales and marketing force, that
we will be cost-effective or that we will ultimately prove successful in selling
the Somnoplasty System on a direct basis in the United States in sufficient
quantities for us to become profitable. Market acceptance of the Somnoplasty
System will also require us to demonstrate that the cost of our products and
procedures are competitive with currently available alternatives.* The use of
the Somnoplasty System may require the healthcare provider to make an up-front
investment in an RF control unit or make the commitment to purchase a definitive
number of handpieces over a defined period of time. There can be no assurance
that we will successfully generate sufficient demand for the Somnoplasty System
at the prices at which we currently offer our control units and disposable
devices. In the event the required investment were to preclude us from placing
sufficient quantities of control units, our ability to sell disposable devices
would be limited, which would have a material adverse effect on our business,
financial condition and results of operations.
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We need to develop successful distributor relationships for international sales.
Our future success will depend, in part, on our ability to enter into and
successfully develop strategic and distributor relationships with other parties
with respect to the marketing and distribution of our products.*
In the United States, our direct sales force of supports the physicians in
the use of the Somnoplasty System for increased sales and patient satisfaction.
In Europe our distributors are managed from the European headquarters in The
Netherlands. Our distributors in the rest of the world are coordinated by the
Director of International Sales, hired in 1999 and based in Sunnyvale. We may
add additional sales personnel, representative groups, and distributors as
necessary to further penetrate markets in the United States and around the
world.
The success of our future strategic or distributor relationships, will
depend on the other parties' ability to perform the role contemplated by us.* We
may have limited or no control over the resources that any particular strategic
party or distributor devotes to our relationship with us. There can be no
assurance that we will be successful in locating or finalizing agreements with
further qualified parties with whom to enter into additional strategic or
distributor relationships or that any such relationships can be maintained or
will ultimately prove beneficial to us. In the event we are not successful in
developing such additional relationships, or if such relationships do not prove
to be successful, our business, financial condition and results of operations
would be materially adversely affected.
International sales of the Somnoplasty System are subject to numerous
risks. Distribution, pricing and marketing structures, as well as regulatory
requirements, vary significantly from country to country. Additionally, such
sales can be adversely affected by:
. limitations or disruptions caused by the imposition of government
controls,
. difficulty in obtaining export licenses,
. political instability,
. trade restrictions,
. changes in foreign tax laws or tariffs or other trade regulations,
. difficulties coordinating communications among and managing
international operations,
. the risk that distributors will fail to effectively promote our
products,
. the risk of financial instability of distributors,
. fluctuations in overseas economic conditions and international
currency exchange rates,
. increase in duty rates and
. competition.
There can be no assurance that we will be able to successfully
commercialize the Somnoplasty System or any of our future products in any
international market, which would have a material adverse effect on our
business, financial condition and results of operations.
Compliance with Quality System regulations is costly and time consuming and our
failure to comply could lead to delays in filling product orders and loss of
sales revenues.
15
<PAGE>
Our facilities are subject to inspection by regulatory authorities,
including the FDA, for compliance with Quality System regulations. The FDA
completed such an inspection of our manufacturing facility in April 2000 and
provided a list of observations that its inspector believed were not in full
compliance with applicable Quality System regulations. In addition, in July
2000, the FDA issued us a formal warning letter which stated that the methods
used in, or the facilities or controls used for the manufacture, packaging,
storage, or installation of our devices are not in conformance with applicable
Quality System regulations. When a formal warning letter is issued, federal
agencies are advised of the issuance of all warning letters about devices so
that they may take this information into account when considering the award of
contracts. Additionally, no pre-market submission for devices to which Quality
System violations are reasonably related will be cleared until the violations
have been corrected. Also, no request for Certificates for Products to Export
will be approved until the violations have been corrected. At the current time,
we have no pending submissions for either clearance to market new or modified
products or to export to new foreign markets. Accordingly, the Company has
undertaken a comprehensive plan to take corrective actions to address the FDA's
observations and submitted a written response to the Warning Letter. FDA will
likely initiate a reinspection to verify we have corrected the deficiencies. The
scope of any reinspection could be more comprehensive than the initial
inspection. Failure to achieve and maintain compliance with Quality System
regulations could have a significant adverse effect on our ability to continue
to manufacture and sell our products, and in the most serious cases could result
in the seizure or recall of products, and injunction and/or civil fines.
We may experience manufacturing problems with regard to our product.
The S2 control unit and devices are manufactured entirely by Somnus. We
have in the past experienced and we may in the future experience design or
production problems and delays as we manufacture these units. In addition,
certain parts may be discontinued or placed on allocation by their
manufacturers. We have had to qualify alternative vendors when parts could no
longer be obtained by the vendor we had been using. We have also had to redesign
our products to use alternative parts when we have switched vendors. These
transfers to new vendors can cause delays in our manufacturing operations.
Additionally, there can be no assurance that in the future we will be able to
have parts specifically manufactured, redesign our products to use other
available parts or, qualify alternative vendors, at all or without interrupting
our ability to meet customer demand. The inability to react to design or
production issues through the manufacturing of special parts, redesign of the
our products, and the qualification of new vendors could have a material adverse
effect on, financial condition and results of operations.
If our vendors are unable to satisfy our manufacturing requirements our business
will be materially harmed
We must purchase electronic components for our S2 control unit and our
disposable devices. The electronics industry is in a period of undersupply.
Our vendors supply the electronic components we require to much larger
customers, with whom we have to compete for the limited supply. If we are not
able to obtain such components in a timely manner or in quantities necessary to
meet our requirements, we may be unable to fulfill orders and may lose
customers.
We have in the past and may in the future have vendors who are unable to
supply us with adequate quantities of components. In such a situation, we have
to identify and qualify one or more substitute suppliers for these components
needs. Incorporating new components or transferring existing components needs to
new vendors requires significant time and can cause product shipment delays. In
addition, the costs associated with manufacturing our products may increase if
we are required to use new third party vendors. If we fail to satisfy our
manufacturing requirements, our business would be materially harmed.
16
<PAGE>
We are dependent on single-source suppliers for components.
We purchase certain key components of our products from single-source
suppliers. We have in the past and may in the future encounter shortages from
one of our single-source suppliers. In such a situation, we have had to identify
and qualify one or more substitute suppliers for these component needs. There
can be no assurance that in the future components obtained from the single-
source suppliers will continue to be available in adequate quantities or, if
required, that we will be able to locate alternative sources of such components
on a timely and cost-effective basis. To date, we have not experienced
significant adverse effects resulting from any shortage of components. However,
there can be no assurance that the single-source suppliers will meet our future
requirements for timely delivery of components of sufficient quality and in
sufficient quantity.* The components may take several months to procure, and a
significant increase of orders could lead to significant delays and control unit
or device shortages. Such delays or shortages, particularly as we scale up our
manufacturing activities in support of sales and distributor orders, would have
a material adverse effect on our business, financial condition and results of
operations.
We are dependent upon key personnel.
Our future success depends in significant part upon the continued service
of certain key scientific, technical and management personnel and our 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 we can retain our key scientific, technical and managerial
personnel or that we can attract, assimilate or retain other highly qualified
scientific, technical and managerial personnel in the future. We have taken
steps to retain our key employees, including the granting of stock options that
vest over time. The loss of key personnel, especially if without advanced
notice, or the inability to hire or retain qualified personnel could have a
material adverse effect upon our business, financial condition and results of
operations.
Due to the factors noted above, our future earnings and stock price may be
subject to significant volatility, particularly on a quarterly basis. Any
shortfall in revenues or earnings from levels expected by security analysts
could have an immediate and significant adverse effect on the trading price of
our common stock.
Item 3: Quantitative and Qualitative Disclosures of Market Risk
There have been no material changes in the reported market risks since
December 31, 1999.
PART II - OTHER INFORMATION
-----------------------------
Item 4: Submission of Matters to a Vote of Security Holders
We solicited proxies for an annual meeting of stockholders on May 11, 2000
to all of our stockholders.
The election of all directors was conducted and the following nominees were
elected: Stuart T Edwards, Woodrow A Meyers Jr, MD and Mark B Logan.
17
<PAGE>
<TABLE>
<CAPTION>
Votes Votes
Name For Withheld
----------------------------- ---------- --------
<S> <C> <C>
Stuart T. Edwards 11,274,376 36,916
Woodrow A Myers Jr, MD 11,304,376 6,916
Mark B. Logan 11,304,376 6,916
</TABLE>
The Company's 1997 option plan ("The Director Plan") was amended to
increase the option shares of common stock that each outside director shall be
granted automatically upon joining the board from 20,000 shares to 30,000
shares, and to increase the annual option grant issued to each outside director
from 5,000 shares to 7,500 shares with 10,528,733 votes in favor, 769,936
against and 12,623 abstentions.
Ernst & Young, LLP was ratified as the independent auditors of the Company
for the fiscal year ending December 31, 2000 with 11,299,024 votes in favor,
8,055 against and 4,213 abstentions.
Item 6: Exhibits and Reports on Form 8-K
(a) There were no reports on Form 8-K during the quarter ended June 30, 2000.
Exhibit 27.1 - Financial Data Schedule
18
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SOMNUS MEDICAL TECHNOLOGIES, INC.
---------------------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Registrant)
Date: August 2, 2000 By: /s/ John G. Schulte
----------------------------
John G. Schulte
President and
Chief Executive Officer
By: /s/ Robert D. McCulloch
------------------------------
Robert D. McCulloch
Vice President of Finance
Chief Financial Officer
(principal financial and accounting officer)
19
