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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 MARCH 31, 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 May 9, 2000, 14,552,167 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
March 31, 2000 and December 31,1999............................................. 3
Condensed Consolidated Statements of Operations for the
Three month periods ended March 31, 2000 and 1999............................... 4
Condensed Consolidated Statements of Cash Flows for the
Three month periods ended March 31, 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 6. Exhibits and Reports on Form 8-K................................................ 17
Signatures............................................................................... 18
</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, 2000 December 31, 1999
(Unaudited) (*)
-------------- -----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 16,649 $ 14,888
Short-term investments - 4,972
Accounts receivable, net 1,859 1,906
Inventories 572 1,181
Other current assets 78 164
-------- --------
Total current assets 19,158 23,111
Property and equipment, net 1,688 1,603
Other assets 84 84
-------- --------
$ 20,930 $ 24,798
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,264 $ 1,623
Accrued liabilities 1,128 1,442
Accrued compensation 1,791 2,167
Accrued warranty 877 907
Accrued clinical costs 600 547
Deferred revenue 1,085 1,287
-------- --------
Total current liabilities 6,745 7,973
Stockholders' equity:
Common stock 16 14
Additional paid-in capital 65,483 65,332
Deferred stock compensation (172) (189)
Accumulated deficit (51,142) (48,332)
-------- --------
Total stockholders' equity 14,185 16,825
-------- --------
$ 20,930 $ 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
Ended
----------------------------
March 31, March 31,
2000 1999
-------------- -------------
<S> <C> <C>
Product revenues $ 3,201 $ 2,342
Cost of sales 1,879 1,506
-------------- -------------
Gross Margin 1,322 836
Operating expenses:
Research and development 1,508 1,871
Selling, general and administrative 2,889 3,596
-------------- -------------
Total operating expenses 4,397 5,467
-------------- -------------
Loss from operations (3,075) (4,631)
Interest and other income 265 492
-------------- -------------
Net Loss $(2,810) $ (4,139)
Net loss per share, basic and diluted $ (0.19) $ (0.29)
============== =============
Shares used in computing net loss per share, basic and diluted 14,420 14,077
============== =============
</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, March 31,
2000 1999
---------------------- ---------------------
<S> <C> <C>
Cash flows used in operating activities
Net loss $(2,810) $(4,139)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of deferred compensation 17 103
Depreciation 196 243
Changes in operating assets and liabilities:
Other current assets 86 106
Accounts receivable 47 (218)
Inventories 609 (320)
Other noncurrent assets - (6)
Accounts payable, accrued liabilities and accrued warranty (703) 524
Accrued compensation (376) 727
Accrued clinical costs 53 84
Deferred revenue (202) 463
---------------------- ---------------------
Net cash used in operating activities (3,083) (2,433)
Cash flows used in investing activities
Capital expenditures (281) (114)
Maturity of short-term investments 4,972 -
Repurchase of common stock - (196)
---------------------- ---------------------
Net cash provided by (used in) investing activities 4,691 (310)
Cash flows provided by financing activities
Net proceeds from issuance of common stock 153 60
---------------------- ---------------------
Net increase (decrease) in cash and cash equivalents 1,761 (2,682)
Cash and cash equivalents, beginning of period 14,888 32,280
---------------------- ---------------------
Cash and cash equivalents at end of period $16,649 $29,598
====================== =====================
</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 March 31, 2000, the
condensed consolidated statements of operations for the three month periods
ended March 31, 2000 and 1999, and the condensed consolidated statements of cash
flows for the three month periods ended March 31, 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 March 31, 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 month periods
ended March 31, 2000 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending March
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 is recognized upon shipment to the final customer.
Allowances for product returns are provided for at the time of revenue
recognition.
Comprehensive Loss
We have no material components of other comprehensive loss and,
accordingly, the comprehensive loss is the same as the net loss for all periods
presented.
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Net Loss Per Share
Basic and diluted 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.
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 March 31,
2000 we have derived our revenue primarily from our operations in the United
States.
NOTE 2 - Inventories
- --------------------
<TABLE>
<CAPTION>
(in thousands) March 31, December 31,
2000 1999
<S> <C> <C>
Raw Materials $ 342 $ 406
Work in Process 61 214
Finished Goods 169 561
--------------------------------
$ 572 $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 hypertropy in December 1997 and OSAS/UARS in November 1998. During the
third quarter of fiscal 1998, we established a European headquarters in The
Netherlands.
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 short-term expenditures 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 ever increasing percentage of our sales
from disposable handpieces as opposed to from the sale of control units.
8
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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 significant 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 March 31, 2000, we have incurred cumulative losses from inception of
approximately $51,142,000. 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 months ended March 31, 2000 and
March 31, 1999 were derived primarily from sales of our Somnoplasty system,
consisting of the control units and disposable devices to private practices,
hospitals, clinics, and sleep clinics. Net
9
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revenues for the three months ended March 31, 2000 were $3,201,000 compared to
$2,342,000 for the prior year quarter, an increase of approximately $859,000 or
37 percent. The increase is attributable to increased sales of disposable
handpieces driven off the higher installed base and an increased use of
disposable devices per control unit. For the three months ended March 31, 2000
and March 31, 1999 respectively, 88 percent of our revenues were derived from
sales to customers in the United States. As sales have grown, the dollar volume
of products shipped has shifted from a mix of about 51 percent control units and
49 percent disposable handpieces during 1999 to a mix of about 28 percent
control units and 72 percent disposable handpieces during the first quarter of
2000. We expect disposable handpieces to increase 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 quarter increased to $1,322,000 or 41 percent of sales,
from $836,000 or 36 percent of sales in the first quarter of 1999. The increase
in manufacturing volume and corresponding economies of scale resulted in the
increase in gross margin as a percentage of sales from the prior year quarter.
We believe that in the future as sales increase cost of sales will increase in
absolute dollars but may fluctuate as a percentage of revenues 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 first quarter of 2000 were
$1,508,000, compared to $1,871,000 for the prior year quarter, a decrease of
approximately $363,000 or 19 percent. This decrease 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 lower clinical trial costs.
The decrease was partially offset by increased spending on research and
development to develop new products.
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 first quarter of 2000 were
$2,889,000 compared to $3,596,000 for first quarter of 1999, a decrease of
approximately $707,000 or 20 percent. Factors in this decrease include lower
marketing spending as we redirect marketing effort from outside agencies to in-
house direction. Marketing spending is planned to increase in future quarters.*
In addition our general and administrative expenses were lower in the first
quarter of 2000, than the prior year quarter due to reduced bad debt, legal, and
personnel related costs. In addition, the prior year quarter included a one time
charge of $214,000 for severance for a former officer of the Company.
Interest and other income. Interest and other income for the first
quarter of 2000 was $265,000, compared to $492,000 for the prior year quarter.
The decrease is attributable to both the reduction in interest income earned on
a decreasing balance of cash, cash equivalents, and short-term investments, and
by nonrecurring technology and documentation fees received from a related party
in the prior year quarter which was not received in the first quarter of 2000.
Liquidity and Capital Resources
Since inception through March 31, 2000, Somnus has financed its operations
primarily through the private placement of equity securities, bank loans, lease
lines of credit, stockholder
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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 March 31, 2000 were
$16,649,000 compared to $19,860,000 at December 31, 1999.
Net cash used in operating activities was approximately $3,083,000 for the
three months ended March 31, 2000, compared to $2,433,000 for the prior year
quarter. 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 three months
ended March 31, 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 as inventory levels were reduced after the Y2K build up.
Net cash provided in investing activities was approximately $4,691,000 for
the three months ended March 31, 2000, compared to net cash used in investing
activities of $310,000 for the prior year quarter. The increase from the prior
year quarter 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 $153,000 for
the three months ended March 31, 2000 as compared to $60,000 for the prior year
quarter. The increase from the prior year quarter is attributable to an
increase in stock option exercises during the three months ended March 31, 2000
as compared to the prior year quarter.
We recorded deferred stock compensation expense for the difference between
the exercise price and the deemed fair value for financial statement
presentation purposes of our Common Stock, as determined by the Board of
Directors, for certain options granted. The total unamortized deferred stock
compensation at March 31, 2000 is $172,000. Our amortized deferred compensation
expenses were approximately $17,000 in the three months ended March 31, 2000
compared to $103,000 for the prior year quarter. The remainder of the deferred
stock compensation will be amortized over the corresponding vesting period of
each respective option, which is generally four years from date of original
issuance.*
At March 31, 2000, our principal sources of liquidity consisted of
$16,649,000 in cash and cash equivalents. There were no other material unused
sources of liquid assets at March 31, 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 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 at least through the next twelve months.*
However, there can be no assurance that we will not require additional funding
prior to such time. Our future capital requirements will depend on many factors,
including the ability of Somnus to establish and maintain strategic distributor
relationships, the time and cost in obtaining regulatory clearances, 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,
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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 March 31, 2000, we have had total
revenues of approximately $24.8 million and incurred cumulative losses of
approximately $51.1 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 OSAS/UARS, chronic turbinate hypertrophy and habitual snoring.
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.
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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 OSAS, enlarged turbinates and habitual snoring 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
of OSAS/UARS and chronic turbinate hypertrophy will depend, in large part, upon
the availability and receipt of and acceptable level of third-party
reimbursement for each of those indications, neither of which is 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. We believe our temperature controlled radiofrequency
technology provides more predictable and consistent tissue volume reduction than
competing radiofrequency products. There can be no assurance that we will be
able to successfully differentiate our technology from competing products.
Physician training. Broad use of the Somnoplasty System will require
training for physicians on how to perform the Somnoplasty procedure and
educating physicians regarding the advantages of the Somnoplasty System over
currently available surgical and non-surgical approaches.* The time required to
complete such training and education could extend the sales cycle for our
products and delay or preclude commercial sales and market acceptance. If we are
unable to achieve broad market acceptance of the Somnoplasty System for our
current and anticipated indications, our business, financial condition and
results of operations would be materially adversely affected.
Patient acceptance. Patient acceptance may be affected by numerous
factors, including the possibility that the Somnoplasty procedure will require
treatments on multiple occasions, which would be not only inconvenient for the
patient, but also more costly.* Patients may require anywhere from one to six
treatments to significantly reduce snoring; however, we anticipate that most
patients will only require one to three treatments to significantly reduce
snoring.* We anticipate that most patients will require fewer treatments to
reduce enlarged turbinates than required to reduce snoring and more to treat
OSAS/UARS than snoring which can require from one to nine treatments.* 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 habitual snoring, turbinate reduction, OSAS/UARS, and other potential
indications will also
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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 OSAS/UARS, chronic turbinate hypertrophy and
habitual snoring. 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.
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 10 representatives and one
sales representative group is supported by three clinical specialists whose role
is to support the physicians in the use of the system for increased sales and
patient satisfaction. In Europe our distributors are managed from the European
headquarters in The Netherlands. Our sales 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
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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.
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. The Company has
undertaken a comprehensive review and intends to respond to the FDA. However,
there can be no assurance that the FDA will deem our corrective actions to be
adequate or that additional corrective actions will not be required. Failure
to achieve and maintain compliance with Quality Systems 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.
15
<PAGE>
We may experience manufacturing problems with regard to our product.
The S2 control unit and devices are manufactured entirely by Somnus. There
can be no assurance that we will not experience design or production issues as
Somnus manufactures these units. In addition, certain parts may be discontinued
or placed on allocation by their manufacturers. We may have to have such parts
specifically manufactured, redesign the product to use other available parts, or
qualify altenative vendors. There can be no assurance that we will be able to
have such parts specifically manufactured, redesign the product to use other
available parts, qualify alternative vendors, or that such manufacturer,
redesign, or qualification of new vendors will be performed 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 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.
If our current vendors are unable to supply us with adequate quantities of
components, we will 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 would require significant
time and could 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.
We are dependent on single-source suppliers for components.
We purchase certain key components of our products from single-source
suppliers. There can be no assurance that the components obtained from the
single-source suppliers will continue to be available in adequate quantities or,
if required, that we will be able to locate alternative sources of such
components on a timely and cost-effective basis. To date, we have not
experienced significant adverse effects resulting from any shortage of
components. However, there can be no assurance that the single-source suppliers
will meet our future requirements for timely delivery of components of
sufficient quality and in sufficient quantity.* The components may take several
months to procure, and a significant increase of orders could lead to
significant delays and control unit or device shortages. Such delays or
shortages, particularly as we scale up our manufacturing activities in support
of sales and distributor 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
16
<PAGE>
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 6: Exhibits and Reports on Form 8-K
(a) There were no reports on Form 8-K during the quarter ended March 31, 2000.
Exhibit 27.1 - Financial Data Schedule
17
<PAGE>
SOMNUS MEDICAL TECHNOLOGIES, INC.
---------------------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SOMNUS MEDICAL TECHNOLOGIES, INC.
(Registrant)
Date: May 15, 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)
18
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