<PAGE>
 
              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, 1998


                                     OR


[ ]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________.
     TO ______________.


                       COMMISSION FILE NO.  000-23275


                      SOMNUS MEDICAL TECHNOLOGIES, INC.
           (Exact name of registrant as specified in its charter)


            DELAWARE                                   77-0423465
  (State or other jurisdiction of                   (I.R.S. Employer 
   incorporation or organization)                  Identification No.)

                              285 N. WOLFE ROAD
                         SUNNYVALE, CALIFORNIA 94086
        (Address of principal executive offices, including zip code)

                               (408) 773-9121
            (Registrant's telephone number, including area code)



Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes[X]   No[_]
                                      

As of July 31, 1998, 13,784,024 shares of the Registrant's Common Stock were
outstanding.
<PAGE>
 
                      SOMNUS MEDICAL TECHNOLOGIES, INC.
                                    INDEX

PART I.  FINANCIAL INFORMATION                                      Page
------------------------------                                      ----     


Item 1.  Financial Statements

         Condensed Consolidated Balance Sheets as of
         June 30, 1998 (unaudited) and December 31,1997...............3

         Condensed Consolidated Statements of Operations
         for the Three and Six month periods ended 
         June 30, 1998 and 1997 (unaudited)...........................4

         Condensed Consolidated Statements of Cash
         Flows for the Six month periods ended
         June 30, 1998 and 1997 (unaudited)...........................5

         Notes to Interim Condensed Consolidated
         Financial Statements (unaudited).............................6

Item 2.  Management's Discussion and Analysis of
         Financial Condition and Results of Operations................8


PART II.  OTHER INFORMATION
---------------------------


Item 2.  Changes in Securities and Use of Proceeds...................19

Item 4.  Submission of Matters to a Vote of Security Holders........ 19

Item 6.  Exhibits and Reports on Form 8-K............................19


Signatures...........................................................20
                                        

                                       2
<PAGE>
 
PART I - FINANCIAL INFORMATION
------------------------------

Item 1.  Financial Statements

                            SOMNUS MEDICAL TECHNOLOGIES, INC.
                          Condensed Consolidated Balance Sheets
                                     (In thousands)


<TABLE>
<CAPTION>
                                                 June 30, 1998           December 31, 1997
                                                  (Unaudited)                   (*)
                                              --------------------      --------------------
Assets
Current assets:
<S>                                         <C>                       <C>
  Cash and cash equivalents                          $ 37,961                  $ 45,145
  Accounts receivable, net                              1,960                       662
  Inventories, net                                        346                       236
  Other current assets                                    357                       300
                                                   ----------                ----------
Total current assets                                   40,624                    46,343
Property and equipment, net                             1,772                     1,822
Other assets                                              112                        62
                                                   ----------                ----------
                                                     $ 42,508                  $ 48,227
                                                   ==========                ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                   $    584                  $  1,112
  Accrued compensation                                    905                       509
  Other accrued liabilities                             2,043                       986
                                                   ----------                ----------
Total current liabilities                               3,532                     2,607

Stockholders' equity:
  Common stock                                             14                        13
  Additional paid-in capital                           65,459                    64,782
  Deferred stock compensation                          (2,767)                   (3,321)
  Accumulated deficit                                 (23,730)                  (15,854)
                                                   ----------                ----------

Total stockholders' equity                             38,976                    45,620
                                                   ----------                ----------
                                                     $ 42,508                  $ 48,227
                                                   ==========                ========== 
</TABLE>

  (*)  Derived from audited financial statements.




                             See accompanying notes

                                       3
<PAGE>
 
<TABLE>
<CAPTION>

                                                 SOMNUS MEDICAL TECHNOLOGIES, INC.
                                          CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                         (Unaudited, in thousands, except per share data)



                                                 For the Three Months                  For the Six Months
                                                         Ended                                  Ended
                                           ---------------------------------     --------------------------------

                                               June 30,           June 30,           June 30,           June 30,
                                                 1998               1997               1998               1997
                                           --------------     --------------     --------------     --------------

<S>        <C>                               <C>                <C>                <C>                <C>
Total revenues                                    $ 2,015            $   231            $ 3,700            $   231

Cost and expenses:
    Manufacturing start-up costs
     and costs of revenues                          1,300                684              2,624                957
    Research and development                        1,647              1,134              4,029              2,050
    Selling, general and administrative             3,399              1,208              5,993              1,942
                                           --------------     --------------     --------------     --------------
Total costs and expenses                            6,346              3,026             12,646              4,949
                                           --------------     --------------     --------------     --------------
Loss from operations                               (4,331)            (2,795)            (8,946)            (4,718)

Interest and other income                             529                137              1,072                239
Interest expense                                       (1)               (43)                (2)               (68)
                                           --------------     --------------     --------------     --------------

Net Loss                                          $(3,803)           $(2,701)           $(7,876)           $(4,547)
                                           ==============     ==============     ==============     ==============
Net loss per share:
    Basic and Diluted                             $ (0.28)           $ (1.07)           $ (0.58)           $ (1.82)
                                           ==============     ==============     ==============     ==============
Shares used in computing per share amounts:
    Basic and Diluted                              13,644              2,534             13,562              2,499
                                           ==============     ==============     ==============     ==============
</TABLE>
                                                                                



                             See accompanying notes

                                       4
<PAGE>
 
                       SOMNUS MEDICAL TECHNOLOGIES, INC.
                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (Unaudited, In thousands)


<TABLE>
<CAPTION>
                                                                                      FOR THE SIX MONTHS ENDED
                                                                                JUNE 30,                    JUNE 30,
                                                                                  1998                        1997
                                                                         ---------------------       --------------------
<S>                                                                        <C>                         <C>
CASH FLOWS USED IN OPERATING ACTIVITIES                                             (7,876)                  $(4,547)
Net loss
Adjustments to reconcile net loss to net cash used in operating
activities:
  Amortization of deferred compensation                                              1,137                       205
  Depreciation and amortization                                                        382                       263
  Net book value of property, plant and equipment retirements                          115                        -
  Changes in operating assets and liabilities:
    Other current assets                                                               (57)                     (119)
    Accounts receivable                                                             (1,298)                     (233)
    Inventories                                                                       (110)                       -
    Other assets noncurrent                                                            (50)                      (57)
    Accounts payable and accrued liabilities                                           528                       195
    Accrued employee benefits                                                          396                         5
                                                                         ---------------------       --------------------
Net cash used in operating activities                                               (6,833)                   (4,288)
                                                                         ---------------------       --------------------
CASH FLOWS USED IN INVESTING ACTIVITIES
Capital expenditures                                                                  (446)                   (1,415)
                                                                         ---------------------       --------------------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Net proceeds from issuance of preferred stock                                           -                      4,940
Net proceeds from issuance of common stock                                              95                         8
Repayment of shareholder loan                                                           -                          3
Proceeds from borrowings under lease line of credit                                     -                      1,165
Repayment of lease line of credit                                                       -                        (31)
                                                                         ---------------------       --------------------
Net cash provided by financing activities                                               95                     6,085
                                                                         ---------------------       --------------------
Net increase (decrease) in cash and cash equivalents                                (7,184)                      382
Cash and cash equivalents, beginning of period                                      45,145                     8,829
                                                                         ---------------------       --------------------
Cash and cash equivalents at end of period                                         $37,961                   $ 9,211
                                                                         =====================       ====================
                                                                     
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest                                                             $     2                   $    68

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES                      -                     1,165
Property and equipment acquired under lease line of credit                               -                     4,940
</TABLE> 

                             See accompanying notes

                                       5
<PAGE>
 
                       SOMNUS MEDICAL TECHNOLOGIES, INC.
         NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                                        

NOTE 1 - BASIS OF PRESENTATION
------------------------------

     The condensed consolidated balance sheet as of June 30, 1998, the condensed
consolidated statements of operations for the three and six month periods ended
June 30, 1998 and 1997, and the condensed consolidated statements of cash flows
for the three and six month periods ended June 30, 1998 and 1997, have been
prepared by the Company, 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, results of operations and
cash flows at June 30, 1998 and for all periods presented have been made.  The
condensed consolidated balance sheet at December 31, 1997 has been derived from
the audited financial statements at that date.

     Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations.

     These condensed financial statements should be read in conjunction with the
Company's audited consolidated financial statements as included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997, as filed with
the Securities and Exchange Commission.  The results of operations for the three
and six month periods ended June 30, 1998 are not necessarily indicative of the
results to be expected for any subsequent quarter or for the entire fiscal year
ending December 31, 1998.

NOTE 2 - REVENUE RECOGNITION
----------------------------

     The Company generally recognizes revenue at the time products are shipped.
To date, no customers have been given stock rotation privileges.  Product
returns and sales allowances are estimated and provided for at the time of sale.

NOTE 3 - NET LOSS PER SHARE
---------------------------

     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.

     The Company has securities outstanding that could dilute basic earnings per
share in the future that were not included in the computation of net loss per
share in the periods presented as their effect is antidilutive.


NOTE 4 - INITIAL PUBLIC OFFERING
--------------------------------

     During the quarter ended December 31, 1997, the Company successfully
completed its initial public offering (the "Offering"). The Offering generated
net proceeds of approximately $37.9 million from the sale of 4,000,000 shares of
Common Stock.  Subsequent to the end of

                                       6
<PAGE>
 
the quarter, the Company's underwriters exercised the over-allotment option,
generating additional net proceeds of approximately $5.9 million from the sale
of 600,000 shares of Common Stock. The proceeds from the Offering and over-
allotment option have been used to fund operating activities.

     Concurrent with the closing of the Offering, the then holders of all of the
Series A, B and C Preferred Stock (5,998,446 shares in total) converted their
shares into the Company's Common Stock.

NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS
--------------------------------------

     As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income",
issued by the FASB in June 1997.  SFAS No.130 establishes new rules for the
reporting and display of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net loss or
stockholders' equity.  SFAS No.130 requires unrealized gains or losses on the
Company's available-for-sale securities and foreign currency translation
adjustments, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income.  Comprehensive income is
equal to net income as of June 30, 1998 and 1997.

     Effective January 1, 1998, the Company adopted  FASB SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information".  SFAS
No.131 superseded SFAS 14, "Financial Reporting for Segments of a Business
Enterprise".  SFAS No.131 establishes standards for the way that public business
enterprises report selected information about operating segments in interim
financial reports.  SFAS No.131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The adoption of SFAS No.131 had no impact on the Company's results of
operations, financial position, or disclosure of segment information at June 30,
1998 or 1997.

                                       7
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto, and with the
Company's audited financial statements and notes thereto for the fiscal year
ended December 31, 1997.

     The information set forth below contains forward-looking statements
(designated by an *), and the Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth below under "Factors That May Affect
Future Results" and those set forth under "Item One" in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.

OVERVIEW

     Somnus designs, develops, manufactures and markets innovative medical
devices that utilize its proprietary RF technology for the treatment of upper
airway disorders.  The Company's SomnoplastySM System provides physicians with a
suite of products designed to offer minimally-invasive, curative treatment
alternatives for disorders of the upper airway, including snoring and enlarged
turbinates.

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

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

     This current and anticipated significant growth of the Company's personnel,
sales and scope of operations may place considerable strain on the Company's
management, financial, manufacturing and other capabilities, procedures and
controls.  There can be no assurance that any existing or additional
capabilities, procedures or controls will be adequate to support the Company's
operations or that its capabilities, procedures or controls will be designed,
implemented or improved in a timely and cost-effective manner.  Failure to
implement, improve and expand such capabilities, procedures and controls in an
efficient manner could have a material adverse effect on the Company's business,
financial condition and results of operations.

                                       8
<PAGE>
 
     The Company is building a direct sales force to cover the United States,
Europe and Canada. Presently the sales force consists of a Senior Vice President
of Sales & Marketing, a Vice President of North American Sales, and a Vice
President and General Manager of European Sales & Marketing, two regional sales
managers and twelve sales representatives. The Company anticipates significant
short-term expenditures in the development of its direct sales infrastructure.*
The Company plans to hire direct sales representatives, in France, Germany, the
UK and Italy, and to establish a network of distributors in other European
countries.* Medtronic previously distributed the Company's products in Europe.
Currently the Company and Medtronic are working cooperatively to transition
product distribution rights back to Somnus.  Additionally, the Company plans to
enter into agreements for product distribution in Japan and other international
markets.*

     As of June 30, 1998, the Company has incurred cumulative losses from
inception of approximately $23,700,000. Moreover, the Company expects to incur
significant additional operating losses over the next couple of years due to
expanded research and development efforts, including expenses associated with
the Company's patent portfolio, preclinical studies and clinical trials and the
development of its manufacturing and sales and marketing capabilities.* The
Company's limited operating history makes accurate prediction of future
operating results difficult or impossible.

     Future revenues and results of operations may fluctuate significantly from
quarter to quarter or year to year and will depend upon numerous factors,
including the timing of regulatory clearances or approvals, the extent to which
the Company's products gain market acceptance, the scale-up of manufacturing
capabilities, the expansion of sales and marketing activities, competition, the
timing and success of new product introductions by the Company or its
competitors and the ability of the Company and its agents to market its products
in the United States and internationally.  Accordingly, interim period
comparisons of the Company's operating results are not necessarily meaningful
and should not be relied upon as indicators of likely future performance or
annual operating results.

     The Company's business and financial results could be materially adversely
affected in the event that the Company is unable to market the Somnoplasty
System effectively, anticipate customer demand accurately or effectively manage
new product launches, pricing and cost containment pressures in health care.
The Company's operations and financial results could also be significantly
affected by international factors, including oversight by numerous regulatory
agencies, changes in foreign currency exchange rates and foreign economic and
political conditions.

RESULTS OF OPERATIONS

     Total revenues. The Company's revenues for the three and six months ended
June 30, 1998 (second quarter) are derived from sales of its Somnoplasty System,
consisting of the 215 RF Generator, the S2 Generator, the SP 1000, SP 1010 and
SP 1100 disposable devices, to private practices, hospitals, clinics and sleep
centers. The Company's revenues for the three months ended June 30, 1998 and six
months ended June 30, 1998 were approximately $2,015,000 and $3,700,000,
respectively. Revenues of $231,000 were recorded for the three months ended June
30, 1997 and for the period from inception (January 19, 1996) to June 30, 1997
(prior-year period). During the three and six months ended June 30, 1998, net
revenues were attributable to sales to customers principally in the United
States. No shipments were made to Medtronic during the second quarter or six
months ended June 30, 1998.  The

                                       9
<PAGE>
 
Company expects that the sale of generators will constitute a significant
percentage of the Company's total revenues in the near term as it builds an
installed base of users.*

     Manufacturing start-up costs and costs of revenues.  Manufacturing start-up
costs and costs of revenues were $1,300,000 in the three months ended June 30,
1998 compared to $684,000, for the prior year period.  For the six month period
ended June 30, 1998, manufacturing start up costs were $2,624,000, compared to
$957,000 for the prior-year period.  Manufacturing start-up costs and costs of
revenues consist of raw materials, subassemblies and completed electronics,
quality assurance and warranty costs. The cost of product, salaries and employee
related expenses, and the costs of establishing manufacturing capabilities
account for the majority of the increase from 1997 to 1998. The Company believes
that manufacturing start-up costs and costs of revenues will increase in
absolute dollars but may fluctuate as a percentage of revenues.*

     Research and development expenses.  Research and development costs for the
three months ended June 30, 1998 were $1,647,000, compared to $1,134,000 for the
prior-year period.  For the Six months period ended June 30, 1998, research and
development costs were $4,029,000, compared to $2,050,000 for the prior-year
period. Research and development expenses are comprised of salaries, prototype
development costs, costs associated with intellectual property, and clinical
trial and regulatory approval expenses.  The increases between the comparative
periods reflects the increased expenditures incurred in the development of the
Somnoplasty System, new development efforts for the generators and the
disposable devices, initiation and expansion of clinical trials and expenses
associated with regulatory approvals in the United States, the EU and Australia.
Clinical trial and prototype costs for the second quarter and six months ended
June 30, 1998 were approximately $350,000 and $1,350,000 as compared to
approximately $450,000 and $900,000 in the prior-year periods, respectively.
Patent legal expenses increased to approximately $170,000 and $422,000 in the
three and six months ended June 30, 1998,  compared to $80,000 and $126,000 in
the prior year period, respectively.  In addition, salaries and employee related
expenses increased to $1,650,000 and $4,030,000 for the three and six months
ended June 30, 1998, compared to $1,130,000 and $2,050,000 for the prior year
periods, respectively.  The 1998 expenses also include approximately $190,000
and $400,000 for the three and six month periods, respectively of non-cash stock
compensation charges resulting from stock option grants, compared to $150,000
for each of the respective prior year periods.

     Selling, general and administrative. Selling, general and administrative
("SG&A") expenses for the three months ended June 30, 1998 were $3,399,000,
compared to $1,208,000 for the prior-year period.  For the six month period
ended June 30, 1998, SG&A was $5,993,000, compared to $1,942,000 for the prior-
year period. SG&A expenses consist of executive salaries, professional fees,
facilities overhead, accounting and human resources, general office
administration expenses such as rent and facility costs. The increases in SG&A
are primarily due to increased salaries and employee expenses of $970,000 and
$1.8 million, due to increased headcount, increased travel costs of $290,000 and
$680,000 incurred, costs of development of marketing literature and campaigns,
an extensive ongoing public relations effort to promote the Somnoplasty System
and additional market research into new product areas of approximately $290,000
and $450,000 for the three and six month periods, respectively.  The three and
six months ended June 30, 1998 also include expenses of $370,000 and $740,000
relating to non-cash stock compensation charges resulting from stock option
grants and related to a change in the employment status of a company executive.

     Interest and other income, net. Interest and other income, net for the
three months ended June 30, 1998 was $529,000, compared to $137,000 for the
prior-year period. For the six month period ended June 30, 1998, interest and
other income was $1,072,000, compared to

                                       10
<PAGE>
 
$239,000 for the prior-year period. The increases were attributable to interest
income earned by the Company on an increased outstanding balance of cash and
cash equivalents, invested from the proceeds of the IPO. Interest expense was
$1,000 and $2,000 in the three and six months ended June 30, 1998, compared to
$43,000 and $68,000 in the prior-year period, respectively. The decrease was due
to the repayment of borrowings under the equipment lease line of credit.

     Net loss.  The net loss for the three months ended June 30, 1998 was
$3,803,000, compared to $2,701,000 for the prior-year period.  For the six-month
period ended June 30, 1998, the net loss was $7,876,000, compared to $4,547,000
for the prior-year period.  The Company expects that its operating losses will
continue for at least the next couple of years and may increase in the short
term, as the Company continues to invest substantial resources in product
development, manufacturing, sales and marketing and its infrastructure.*

NEW ACCOUNTING PRONOUNCEMENTS

     As of January 1, 1998, the Company adopted SFAS No.130, "Reporting
Comprehensive Income."  SFAS No.130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
SFAS No.130 had no impact on the Company's net loss or stockholders' equity.
SFAS No.130 requires unrealized gains or losses on the Company's available-for-
sale securities and foreign currency translation adjustments, which before
adoption were reported separately in stockholders' equity, to be included in
other comprehensive income.  Comprehensive income is equal to net income as of
June 30, 1998 and 1997.

     Effective January 1, 1998, the Company adopted  FASB SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information".  SFAS
No.131 superseded SFAS 14, "Financial Reporting for Segments of a Business
Enterprise".  SFAS No.131 establishes standards for the way that public business
enterprises report selected information about operating segments in interim
financial reports.  SFAS No.131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The adoption of SFAS No.131 had no impact on the Company's results of
operations, financial position, or disclosure of segment information at June 30,
1998 or 1997.

YEAR 2000 COMPLIANCE

     The Company is aware of the issues associated with the programming code in
existing computer systems as the year 2000 approaches.  The "year 2000 problem"
is pervasive and complex as virtually every computer operation will be affected
in some way by the rollover of the two digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000.  Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. Management
is in the process of working with its software vendors to ensure that the
Company's internal systems are prepared for the year 2000.  Management does not
anticipate that the Company will incur significant operating expenses or be
required to invest heavily in computer systems improvements to be year 2000
compliant.*  However, significant uncertainty exists concerning the potential
costs and effects associated with any year 2000 compliance. The Company will
implement an upgrade in 1999 to its management information system that the
Company believes will be year 2000 compliant.*  Any year 2000 compliance problem
of either the Company or its suppliers, partners or customers, could materially
adversely affect the Company's business, results of operations, cash flows,
financial condition and prospects.

                                       11
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES

     Since inception through June 30, 1998, the Company has financed its
operations primarily through the private placement of equity securities, bank
loans, lease lines of credit, stockholder loans and its November 1997 IPO. From
inception, the Company raised approximately $16,400,000 in net proceeds from
private equity financings.  The Company raised an additional $43,756,000 from
its IPO, net of costs of $4,540,000.

     Cash and cash equivalents at June 30, 1998 were $37,961,000 compared to
$45,145,000 at December 31, 1997.

     Net cash used in operating activities was approximately $6,833,000 for the
six months ended June 30, 1998, compared to $4,288,000 for the prior-year
period.  Net cash used in operating activities differs from the Company's net
loss for these comparison periods primarily due to non-cash charges associated
with the amortization of deferred compensation and the depreciation of property
and equipment offset partially by an increase in accounts receivable as the
Company commenced sales of its products.  Net cash used in investing activities
was approximately $446,000 for the six months ended June 30, 1998, compared to
$1,415,000 for the prior-year periods. The net cash used in investing activities
was primarily attributable to capital expenditures during these periods.  Net
cash provided by financing activities was approximately $95,000 for the six
months ended June 30, 1998 and  $6,085,000 for the prior-year periods,
respectively, net cash provided by financing activities is attributable
primarily to the exercise of options, and borrowings under a lease line of
credit.

     The Company has recorded deferred stock compensation expense for the
difference between the exercise price and the deemed fair value for financial
statement presentation purposes of the Company's Common Stock, as determined by
the Board of Directors, for certain options granted and related to the change in
employment status of a company executive. The total unamortized deferred stock
compensation at June 30, 1998 is $2,767,000. The Company amortized deferred
compensation expenses of approximately $1,137,000 in the six months ended June
30, 1998 compared to $205,000 for the respective 1997 period. The remainder of
the deferred stock compensation will be amortized over the corresponding vesting
period of each respective option, which is generally four years from date of
original issuance.

     At June 30, 1998, the Company's principal sources of liquidity consisted of
$37,961,000 in cash and cash equivalents. There were no other material unused
sources of liquid assets at June 30, 1998.

     The Company currently anticipates that its capital expenditure requirements
will be approximately $2.0 million for the next twelve months.* These
requirements relate primarily to the acquisition of computer hardware and
software and for additional leasehold improvements to handle anticipated
headcount additions.*

     The Company anticipates that its existing resources will enable the Company
to maintain its current and planned operations through the next twelve months.*
However, there can be no assurance that the Company will not require additional
funding prior to such time. The Company's future capital requirements will
depend on many factors, including the ability of the Company to establish and
maintain strategic distributor relationships, the time and cost in obtaining
regulatory approvals, competing technological and market developments, the cost
of manufacturing and other factors. There can be no assurance that additional
financing to meet the Company's funding requirements will be available as
needed. If additional funds are raised by issuing equity securities, substantial
dilution to existing stockholders may result. Insufficient funds may require the
Company to delay, scale back or eliminate some or all of its research or

                                       12
<PAGE>
 
development programs or to relinquish rights to products at an earlier stage of
development or on less favorable terms than the Company would otherwise seek to
obtain. The failure of the Company to raise capital when needed would have a
material adverse effect on the Company's business, financial condition and
results of operations.

FACTORS THAT MAY AFFECT FUTURE RESULTS

     The Company's operating results may vary significantly depending on certain
factors, including the effect of delays in its research and development program,
adverse results in its clinical studies, delay in the introduction or shipment
of new products, increased competition, litigation costs should the Company be
involved in litigation, adverse changes in the economic conditions in any of the
several countries in which the Company does business, a slower growth rate in
the Company's target markets, order deferrals in anticipation of new product
releases, lack of market acceptance of new products, the uncertainty of FDA or
other domestic and international regulatory clearances or approvals, and the
factors set forth under the Company's annual report on form 10-K for the fiscal
year ended December 31, 1997.

     Limited Operating History; Absence of Profitability.  The Company was
incorporated in January 1996 and has a limited history of operations that, to
date, has consisted primarily of research and development, product engineering,
seeking clearance of its products from the FDA, initial development of a direct
sales force in the United States and training Medtronic employees for
distribution of the Somnoplasty System in the EU, Australia, Southeast Asia and
certain other areas. Currently, the Company and Medtronic are working
cooperatively to transition European product distributor rights back to the
Company, and the Company is in the process of establishing a direct European
sales force.  The Company commercially introduced the Somnoplasty System
internationally, through Medtronic, beginning in June 1997. One month later,
after receiving 510(k) clearance for the use of the Somnoplasty System to treat
snoring, the Company began direct sales of the Somnoplasty System in the United
States. In December 1997, the Company received 510(k) clearance to use the
Somnoplasty System for the treatment of enlarged turbinates associated with
chronic rhinitis.  The Company began direct sales of the device for treating
enlarged turbinates in the first quarter of 1998.  The Company has generated
only limited revenues from sales of the Somnoplasty System and does not have
experience in manufacturing, selling or marketing its products in large,
commercial quantities. There can be no assurance that the Somnoplasty System
will be successfully commercialized or that the Company will achieve significant
revenues. From its inception in 1996 through June 30, 1998, the Company had
total revenues of approximately $6.3 million and incurred cumulative losses of
approximately $23.7 million.  The Company expects to significantly increase its
spending over the next several years with respect to research and development
efforts, clinical trials, manufacturing and sales and marketing and expects to
incur significant additional losses for the foreseeable future.*  Whether the
Company can successfully manage the transition to a larger-scale commercial
enterprise will depend upon a number of factors, including obtaining additional
regulatory approvals and increasing its commercial manufacturing, sales and
marketing capabilities, as well as establishing relationships with international
distributors.  The Company's inability to establish such capabilities and
relationships would have a material adverse effect on its business, financial
condition and results of operations.

     Additional Capital Requirements; No Assurance Future Capital Will Be
Available. The Company has expended and will continue to expend substantial
funds for research and development, clinical testing, planned clinical
investigations, capital expenditures, manufacturing and marketing of its
products.* The timing and amount of spending of such capital resources is
difficult to predict accurately and will depend upon several factors, including

                                       13
<PAGE>
 
the progress of its research and development efforts and planned clinical
investigations, competing technological and market developments, the receipt of
regulatory clearances or approvals, commercialization of products currently
under development and market acceptance and demand for the Company's products.*
To the extent required, the Company may seek to obtain additional funds through
equity or debt financing, through collaborative or other arrangements with other
companies and from other sources.* If additional funds are raised by issuing
equity securities, dilution to stockholders could occur. There can be no
assurance that additional financing will be available when needed or on terms
acceptable to the Company. If adequate funds are not available, the Company
could be required to delay development or commercialization of the Somnoplasty
System for certain indications, to license to third parties the rights to
commercialize certain products or technologies that the Company would otherwise
seek to commercialize for itself or to reduce the marketing, customer support or
other resources devoted to certain of its products, each of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.

     Need to Manage Growth and Expand Financial Capabilities.  Significant
future growth in the Company's sales and expansion in the scope of its
operations, should they occur, may place considerable strain on the Company's
management, financial, manufacturing and other capabilities, procedures and
controls. In particular, the Company will be required in the near term to
improve and expand its financial capabilities through the addition of qualified
personnel and the enhancement of its financial reporting systems.*  There can be
no assurance that any existing or additional capabilities, procedures or
controls will be adequate to support the Company's operations or that its
capabilities, procedures or controls will be designed, implemented or improved
in a timely and cost-effective manner. Failure to implement, improve and expand
such capabilities, procedures and controls in an efficient manner could have a
material adverse effect on the Company's business, financial condition and
results of operations.

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

                                       14
<PAGE>
 
obtain regulatory approval in other international markets could have a material
adverse effect on the Company's business, financial condition and results of
operations.

     The Somnoplasty System is in the early stage of commercialization and the
Company has only a limited history of its use in the treatment of snoring and
enlarged turbinates.  There can be no assurance that the procedure, which
involves the RF ablation of tissue in the upper airways, will provide a
permanent, curative treatment for patients. Independent factors, such as aging
and weight gain, may, over time, lead to the enlargement of tissue in areas
previously treated by the Company's procedure.  Such regrowth of tissue could
require further treatments, making the procedure a potentially less attractive
alternative to existing surgical and non-surgical procedures, which could have a
material adverse effect upon the Company's business, financial condition and
results of operations.

     No Assurance of Market Acceptance.  The Somnoplasty System utilizes the
Company's proprietary RF ablation technology for the treatment of upper airway
disorders. RF ablation in the upper airway is a new and novel development.
Although the Company has received 510(k) clearance for use of the Somnoplasty
System to treat snoring and enlarged turbinates, as well as a CE Mark and TGA
listing for treatment of upper airway obstructions, market acceptance for these
indications could be adversely affected by numerous factors, including the lack
of availability of third-party reimbursement, cost of the procedure, clinical
acceptance or effective physician training.  The Company does not anticipate
that patients will receive third-party reimbursement for use of the Somnoplasty
System in the treatment of snoring.*  In addition, should the Company receive
regulatory clearance or approval for use of the Somnoplasty System to treat
additional indications, market acceptance will depend, in large part, upon the
availability of third-party reimbursement for each of those indications, which
is not assured.* Market acceptance will also depend upon the Company's ability
to demonstrate that the Somnoplasty System is an attractive alternative to
existing procedures, which will depend upon physicians' evaluations of the
clinical safety and efficacy, ease of use, reliability and cost-effectiveness of
the Somnoplasty System in a clinical setting.*  There can be no assurance that
these products will adequately demonstrate these characteristics or that they
will receive market acceptance among physicians.  The Company believes that
recommendations and endorsements by influential physicians will be essential to
market acceptance of its products.* There can be no assurance that such
recommendations or endorsements will be obtained. Broad use of the Somnoplasty
System will require training for physicians on how to perform the Somnoplasty
procedure and educating physicians regarding the advantages of the Somnoplasty
System over currently available surgical and non-surgical approaches.  The time
required to complete such training and education could extend the sales cycle
for the Company's products and delay or preclude commercial sales and market
acceptance. If the Company is unable to achieve broad market acceptance of the
Somnoplasty System for its current and anticipated indications, the Company's
business, financial condition and results of operations would be materially
adversely affected.

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

                                       15
<PAGE>
 
Patient acceptance of the Somnoplasty System for the treatment of snoring,
turbinate reduction, and other potential indications will also depend in part
upon physician recommendations as well as other factors, including the
effectiveness and reliability of the procedure as compared to existing surgical
and non-surgical procedures.* There can be no assurance that the Somnoplasty
System will be accepted by the patient community or that market demand for such
system will be sufficient to allow the Company to achieve profitable operations.
In addition, publicity arising from any adverse outcome or other problem
occurring in the treatment of a Somnoplasty patient for any reason, particularly
during the early phase of the commercialization of the Somnoplasty System, could
materially adversely affect patient demand for the procedure. Failure of the
Somnoplasty System, for whatever reason, to achieve significant patient
acceptance would have a material adverse effect on the Company's business,
financial condition and results of operations.

     Strategic and Distributor Relationships.  The Company's future success will
depend, in part, on its ability to enter into and successfully develop strategic
and distributor relationships with other parties with respect to the marketing
and distribution of its products.*  The Company is currently seeking to enter
into strategic or distributor relationships with other markets, such as Japan.*
The success of the Company's future strategic or distributor relationships, will
depend on the other parties' interests in the specific products involved and
their willingness and ability to perform the role contemplated by the Company.
The Company may have limited or no control over the resources that any
particular strategic party or distributor devotes to its relationship with the
Company.  Currently the Company and Medtronic are working cooperatively to
transition European product distribution rights back to the Company, and the
Company is in the process of establishing a direct European sales force. To
date, the Company has generated approximately $800,000 of net revenue from its
relationship with Medtronic.  No shipments were made to Medtronic during the six
months ended June 30, 1998.  Moreover, there can be no assurance that the
Company will be successful in locating qualified parties with whom to enter into
additional strategic or distributor relationships or that any such relationships
can be maintained or will ultimately prove beneficial to the Company. In the
event, the Company is not successful in developing such additional
relationships, or if such relationships do not prove to be successful, the
Company's business, financial condition and results of operations would be
materially adversely affected.

     Limited Sales and Marketing Experience; Reliance on International Sales.
The Company has only limited experience selling and marketing the Somnoplasty
System for the treatment of snoring and enlarged turbinates, and selling and
marketing its products in commercial quantities. The Company intends to sell the
Somnoplasty System in the United States to private practices, clinics, hospitals
and sleep centers through a direct sales force.* The Company currently has a
small direct sales force that covers certain regions of the United States and
intends to increase its sales and marketing force in the near future to
accelerate commercialization of the Somnoplasty System throughout the United
States.* There can be no assurance that the Company will be successful in
building an effective sales and marketing force, that it will be cost-effective
or that it will ultimately prove successful in selling the Somnoplasty System on
a direct basis in the United States. Market acceptance of the Somnoplasty System
will also require the Company to demonstrate that the cost of its products and
procedures are competitive with currently available alternatives.* The use of
the Somnoplasty System requires the healthcare provider to make an up-front
investment in an RF generator. There can be no assurance that the Company will
successfully generate sufficient demand for the Somnoplasty System at the prices
at which it currently offers its generators and disposable devices. In the event
the required investment were to preclude the Company from placing sufficient
quantities of generators, the Company's ability to sell disposable devices would
be limited, which would have a material adverse effect on the Company's
business, financial condition and results of operations.

                                       16
<PAGE>
 
     The Company anticipates that a significant portion of its future revenues
will relate to international sales of the Somnoplasty System through strategic
and distributor relationships.* International sales of the Somnoplasty System
are subject to numerous risks.  Distribution, pricing and marketing structures,
as well as regulatory requirements, vary significantly from country to country.
Additionally, such sales can be adversely affected by limitations or disruptions
caused by the imposition of government controls, export licenses, political
instability, trade restrictions, changes in foreign tax laws or tariffs or other
trade regulations, difficulties coordinating communications among and managing
international operations, the risk that distributors will fail to effectively
promote the Company's products and the risk of financial instability of
distributors.  Additionally, the Company's business, financial condition and
results of operations may be adversely effected by fluctuations in overseas
economic conditions and international currency exchange rates, as well as by
increases in duty rates, difficulty in obtaining export licenses, constraints on
its ability to maintain or increase prices and competition.  There can be no
assurance that the Company will be able to successfully commercialize the
Somnoplasty System or any of its future products in any international market,
which would have a material adverse effect on the Company's business, financial
condition and results of operations.

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

     Transition from 215 RF Generator to 615/S2 Generator.  The Company has
purchased its 215 RF Generator as a finished assembly from a single-source
supplier.  The Company plans to discontinue selling the 215 RF Generator model
during 1998.* The  615/S2 (hereinafter the "S2") Generator, which is
manufactured entirely by the Company and has the same single-source supplier
acting as the vendor for the RF subassembly.*  There can be no assurance that
the Company will not experience design or production issues as the Company
commences such manufacturing activities.  Management believes that the Company
has procured adequate quantities of the 215 Generator model from the supplier to
ensure demand for generators is met as the Company transitions from the 215
Generator.  However, there can be no assurance that the Company has procured
adequate quantities of the 215 RF Generator. In addition, there is no assurance
that management would be able to procure additional 215 RF Generators should
demand exceed supply.

     The Company launched the S2 during the second quarter of 1998.* There can
be no assurance that the RF subassembly obtained from the single-source supplier
will continue to be available in adequate quantities or, if required, that the
Company will be able to locate alternative sources of RF subassemblies on a
timely and cost-effective basis. To date, the Company has not experienced
significant adverse effects resulting from any shortage of RF subassemblies.
However, there can be no assurance that the single-source supplier will meet the
Company's future requirements for timely delivery of RF subassemblies of
sufficient quality and in sufficient quantity. The RF subassemblies currently
take several months to procure, and

                                       17
<PAGE>
 
a significant increase of orders could lead to significant delays and generator
shortages. Such delays or shortages, particularly as the Company scales up its
manufacturing activities in support of direct U.S. sales and international
distributor orders, would have a material adverse effect on its business,
financial condition and results of operations. The S2 Generator is more
expensive than the 215 Generator. There can be no assurance that the Company
will be able to successfully market and sell the S2 Generator. Further, there
can be no assurance that the Company will not experience increased levels of
returns of the 215 Generator as a result of the launch of the S2 Generator.


     Due to the factors noted above, the Company's future earnings and stock
price may be subject to significant volatility, particularly on a quarterly
basis.  Any shortfall in revenues or earnings from levels expected by security
analysts could have an immediate and significant adverse effect on the trading
price of the Company's common stock.

                                       18
<PAGE>
 
PART II  -  OTHER INFORMATION
-----------------------------


ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     From the date of the sale of securities under the Company's Registration
Statement on Form S-1 (File No. 333-35401), which was declared effective on
November 5, 1997 (the "Offering"), through June 30, 1998, the approximate amount
of net proceeds used from the Offering were $3.4 million for research and
development, clinical trials and regulatory matters, $2.7 million to manufacture
product and further develop manufacturing expertise and capabilities, $5.6
million to improve and expand financial capabilities, to enhance financial
reporting systems, to expand sales and marketing efforts, and for other general
corporate purposes and $504,000 for the acquisition of fixed assets.  The
Company has also made temporary investments in cash and cash equivalents of
$31.6 million.

     All amounts represent estimates of direct or indirect payments of amounts
to third parties.  No amounts were paid directly or indirectly for the above
purposes to directors or officers of the Company other than in the ordinary
course of business (as reflected above in the amounts used for general corporate
purposes), to persons owning ten percent or more of any class of equity
securities of the Company, or to affiliates of the Company. The use of proceeds
described above do not represent a material change in the use of proceeds
describe in the Offering prospectus.

ITEM  4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     The Company solicited proxies for an annual meeting of stockholders on May
20, 1998 to all of the Company's stockholders.

     The election of all directors was conducted and the following nominees were
elected: David L. Douglass and David B. Musket.  The vote with respect to each
nominee was as follows:
 
                               Votes             Votes
     Name                       For             Withheld
-----------------          -------------      -------------
David L. Douglass            9,636,775           436,057
David B. Musket              9,736,975           335,551


     The Company's 1996 Stock Plan was amended and the number of shares of
Common Stock reserved for issuance under the plan was increased by 500,000 to
3,600,000 with 7,488,746 votes in favor, 2,574,847 votes against and 9,233
abstentions.

     Ernst & Young LLP was ratified as the independent auditors of the Company
for the fiscal year ending December 31, 1998 with 10,068,630 votes in favor,
2,040 votes against and 2,156 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,
        1998.

        Exhibit 27.1 - Financial Data Schedule

                                       19
<PAGE>
 
                       SOMNUS MEDICAL TECHNOLOGIES, INC.
                       ---------------------------------
                                        

                                  SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



                          SOMNUS MEDICAL TECHNOLOGIES, INC.
                                   (Registrant)




Date:  August 10, 1998             By:     /s/ Stuart D. Edwards
                                  -------------------------------
                                   Stuart D. Edwards
                                   Chief Executive Officer


                                   By:   /s/  Robert D. McCulloch
                                  --------------------------------
                                   Robert D. McCulloch
                                   Vice President of Finance
                                   Chief Financial Officer
                                   (principal financial and accounting officer)
 
  

                                       20