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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1995
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition period from _________ to __________
COMMISSION FILE NUMBER: 0-16612
CNS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 41-1580270
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
P.O. BOX 39802
MINNEAPOLIS, MN 55439
(Address of principal executive offices and zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (612) 820-6696
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK, PAR VALUE OF $.01 PER SHARE
SERIES A JUNIOR PARTICIPATING PREFERRED STOCK, PAR VALUE OF
$.01 PER SHARE
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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 5, 1996, assuming as market value the price of $20.75 per share, the
closing sale price of the Company's Common Stock on the Nasdaq National Market,
the aggregate market value of shares held by non-affiliates was $317,598,587.
As of March 5, 1996, the Company had outstanding 17,436,052 shares of Common
Stock of $.01 par value per share.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be held in April 1996, a definitive copy of
which will be filed with the Commission within 120 days of December 31, 1995, is
incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Page
PART I
Item 1. Business........................................................................................3
Item 2. Properties.......................................................................................
Item 3. Legal Proceedings................................................................................
Item 4. Submission of Matters to a Vote of Security Holders..............................................
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................
Item 6. Selected Financial Data..........................................................................
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................................
Item 8. Financial Statements and Supplementary Data......................................................
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...........................................................................
PART III
Item 10. Directors and Executive Officers of the Registrant...............................................
Item 11. Executive Compensation...........................................................................
Item 12. Security Ownership of Certain Beneficial Owners and Management...................................
Item 13. Certain Relationships and Related Transactions...................................................
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K............................................................................
SIGNATURES...................................................................................................
FINANCIAL STATEMENTS.........................................................................................F-1
FINANCIAL STATEMENT SCHEDULES................................................................................S-1
This Form 10-K contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ significantly from those projected in the
forward-looking statements as a result, in part, of the risk factors set forth
in the Company's Registration Statement on Form S-3 filed with the Commission on
March 8, 1996 (the "Form S-3"). In connection with the forward-looking
statements which appear in these disclosures, investors should carefully review
the factors set forth in the Form S-3 under "Risk Factors."
PART I
ITEM 1. BUSINESS
BREATHE RIGHT NASAL STRIPS
CNS, Inc., (the "Company") manufactures and markets the Breathe Right nasal
strip, which is a nonprescription single-use disposable device that can reduce
or eliminate snoring by improving nasal breathing and temporarily relieve nasal
congestion. Broad consumer marketing of the Breathe Right nasal strip began in
September 1994. Net sales of the Breathe Right nasal strip grew from $2.8
million in 1994 with a pre-tax loss of $2.6 million, to $48.6 million in 1995
with pre-tax income of $13.3 million. According to data collected by Information
Resources, Inc., Breathe Right nasal strips became a leading sales volume
producer during 1995 in the OTC cough, cold and allergy section of drug, grocery
and mass merchant stores nationwide.
The Breathe Right nasal strip has two embedded plastic strips. When folded down
onto the sides of the nose, the Breathe Right nasal strip lifts the side walls
of the nose outward to open the nasal passages. The product improves nasal
breathing upon application and does not include any medication, thereby avoiding
any medicinal side effects. The Company has received 510(k) clearances from the
FDA to market the Breathe Right nasal strip for improvement of nasal breathing
(October 1993), reduction or elimination of snoring (November 1995) and
temporary relief of nasal congestion (February 1996). The Company believes that
the Breathe Right nasal strip is the only non-prescription product in wide
retail distribution that the FDA has cleared to market for the reduction or
elimination of snoring.
The Breathe Right nasal strip is offered in three sizes (junior/small,
small/medium and medium/large) to accommodate the range of nose sizes from a
child's nose to an adult's nose. The Breathe Right nasal strip is packaged
for the OTC market in quantities of 10 or 30 strips per box and for sporting
goods retailers in quantities of eight strips per box. Product is sold to
retailers or wholesalers in cases of 24 or 96 boxes per size or in a variety
of display configurations ranging from 12 to 60 boxes each. The Company
believes that the Breathe Right nasal strip is priced comparably to medicinal
decongestants on a daily or nightly dosage basis at suggested retail prices
of $4.99 for a box of ten, $11.99 for a box of 30 and $4.99 for an eight
count sports pack that includes a plastic case to protect the strips.
MARKETS
The Company currently sells the Breathe Right nasal strip in the consumer OTC
market, the professional medical market and the athletic market. Because a
substantial number of people may be included in more than one market, the
number of potential customers for the Breathe Right nasal strip does not
equal the aggregate population of these markets.
CONSUMER OTC MARKET. The nose accounts for half of the total airway
resistance involved in the respiratory system (i.e., half of the energy
required for breathing). If the effort to breathe through the nose during
sleep is excessive, the person will resort to mouth breathing, promoting
snoring, dry mouth, sore throat and mini-awakenings which disrupt sleep. In
addition, nasal breathing difficulties during sleep are often caused by nasal
congestion found in people with allergies, sinusitis and the common cold and
by nasal obstruction due to a deviated nasal septum. The Company believes
that people with deviated septa or other structural problems or chronic
conditions such as snoring may be more predisposed to use the Breathe Right
nasal strip on a regular or daily basis while seasonal sufferers would use
the Breathe Right nasal strip as needed. People with the aforementioned
conditions are currently the primary users of the product and are the primary
targets of the Company's advertising.
SNORING. The Company is currently concentrating the majority of its
marketing efforts on the snoring market. In November 1995, the FDA
cleared the Breathe Right nasal strip for marketing for the reduction
or elimination of snoring. The Breathe Right nasal strip reduces nasal
airflow resistance and therefore can reduce or eliminate snoring.
Market research commissioned by the Company indicates that, in the
U.S., approximately 78% of all households have at least one snorer,
approximately 37 million people snore regularly (every night) and 50
million people snore occasionally. In a clinical study conducted at the
Sleep Disorders Center in Cincinnati, Ohio, Breathe Right nasal strips
were effective in reducing snoring loudness or eliminating snoring in
75% of the participants in the study. Additional clinical studies show
that Breathe Right nasal strips may improve the quality of sleep. The
Company believes that the Breathe Right nasal strip is the only
non-prescription product in wide retail distribution that the FDA has
cleared to market for the reduction or elimination of snoring.
NASAL CONGESTION/OBSTRUCTION. The Company is also focusing its
marketing efforts on the nasal congestion market. In February 1996, the
FDA cleared the Breathe Right nasal strip for marketing for the
temporary relief from the symptoms of nasal congestion. The Company
believes the Breathe Right nasal strip can in many cases benefit those
people who suffer from nasal congestion, stuffy nose and nasal
obstruction resulting from the following conditions: (i) the common
cold; (ii) allergies and sinus disease -- 35 million people in the
U.S.; and (iii) deviated nasal septum and other nasal structural
deficiencies -- 12 million people in the U.S. Clinical studies at the
Oklahoma Allergy Clinic in Oklahoma City, Oklahoma and at Park Nicollet
Clinic in Minneapolis, Minnesota have shown that the product relieves
some of the symptoms associated with nasal congestion caused by
allergies, and a clinical study at Mount Sinai Hospital, Toronto,
Ontario has shown that the product relieves some of the symptoms of
nasal obstruction due to septal deviation. The Company has submitted
applications to the FDA to obtain clearance to market the product as a
treatment for nasal obstruction associated with a deviated septum. For
nasal congestion applications, the Company believes that the Breathe
Right nasal strip is often used as either an alternative or adjunct to
decongestant drugs (including nasal sprays and oral decongestants).
PROFESSIONAL MEDICAL MARKET. In 1996, the Company plans to increase its
marketing efforts in the professional medical market. The Company will
continue its program to educate physicians such as pulmonologists,
otolaryngologists and allergists on the advantages of using the Breathe Right
nasal strip for patients receiving various treatments for sleep apnea and
chronic lung disease. The Company believes that these patients may become
regular users of the product if it is recommended to them by their
physicians. The Company believes that there are over one million sleep apnea
and chronic lung disease patients receiving treatments and an additional 15
million chronic lung disease sufferers that may benefit from use of the
Breathe Right nasal strip. The Company also believes that awareness of the
product by physicians will increase their recommendations of the product for
other applications. The Company is currently evaluating special packaging
requirements to reach the hospital and home health care markets and is
exploring how to reach these markets through OEM sales arrangements with
medical products companies. As an alternative, the Company may establish an
independent representative sales force to penetrate these markets.
ATHLETIC MARKET. The Company has begun to market the Breathe Right nasal strip
for use during athletic activity. The Company believes that the product may make
nasal breathing more comfortable and may improve endurance during athletic
activity, particularly when a mouth guard is used. Clinical studies are being
conducted to establish the benefit of use during athletic activity. The use of
the Breathe Right nasal strip has been increasingly observed in football, and to
a lesser extent in hockey, baseball and basketball, at the professional and
collegiate levels. In addition, many recreational athletes, including runners
and bikers have begun using the product regularly during their sports
activities. The Company believes the use of the Breathe Right nasal strip will
grow in recreational sports and has initially targeted the running market
(approximately 9.6 million Americans are frequent runners according to Runners
World magazine) and biking market (approximately 3.3 million cyclists in the
U.S. ride at least 80 miles per month according to Bicycling magazine). Since
the introduction of the product in October 1993, the Company has received
publicity as a result of professional athletes wearing the Breathe Right nasal
strip. The Company uses athletes to endorse the Breathe Right nasal strip to
increase the visibility of the product, which thereby leads to awareness of the
product for not only its athletic applications, but also for snoring, nasal
congestion and other applications.
BUSINESS STRATEGY
The Company's strategy for increasing sales of its Breathe Right nasal strip
and expanding its product line consists of:
INCREASING NEW CONSUMER PRODUCT TRIAL. The Company uses a combination of
advertising, promotions and celebrity endorsements to increase consumer
awareness of the Breathe Right nasal strip and its benefits and to encourage
initial consumer trial of the product. The Company has implemented an
advertising campaign which utilizes widely distributed magazines, nationally
syndicated radio programs and network and cable television to establish the
Breathe Right nasal strip as a leading OTC branded product for the relief of
snoring and nasal congestion. A research study commissioned by the Company
indicates that, of the persons surveyed in March 1995 and January 1996, total
consumer awareness of a device used over the nose to improve nasal breathing
and reduce snoring increased from 32% to 53% and household trial of the
product increased from 1% to 5%.
INCREASING REPEAT USAGE. According to research data collected by an
independent, nationally recognized consumer market research firm,
approximately 28% of those who try Breathe Right nasal strips in the U.S.
purchase additional product. To encourage repeat usage, the Company
introduced a 30 count box, which carries a suggested retail price that is 20%
less per strip than the 10 count box. At the end of 1995, the 30 count box
was in 30% of the stores that carried the 10 count box, however the 30 count
box accounted for approximately 25% of the Company's retail sales volume. The
Company plans to increase the retail distribution of the 30 count box in 1996
and emphasize the 30 count box using in-box promotions and couponing programs
to help encourage repeat usage.
EXPANDING PRESENCE IN INTERNATIONAL MARKETS. In August 1995, the Company
signed an exclusive international distribution agreement with 3M to market
the Breathe Right nasal strip outside the U.S. and Canada. 3M has begun the
product introduction in several countries and expects the product to be
available at retail in more than 12 international markets by the end of 1996.
EXPANDING PRESENCE IN OTHER MARKETS. The Company seeks to increase its
presence in the professional medical market, which includes patients
receiving various treatments for sleep apnea and chronic lung disease. The
Company will educate physicians and pharmacists as to the efficacy and
various applications of the Breathe Right nasal strip to gain their
recommendations of the product for treatment of patients in this market as
well as for relief from snoring and nasal congestion. In addition, largely as
a result of NFL exposure, many sporting goods retailers have expressed an
interest in carrying the product. The Company has developed special packaging
for the sports market and plans to continue to leverage its high profile
athletic endorsers to increase sales in the athletic market.
MARKETING NEW PRODUCTS THAT LEVERAGE DISTRIBUTION CHANNELS. The Company has
established a strong brand identity for the Breathe Right name and strong
distribution channels. As a result of its visibility and success to date, the
Company is regularly presented with and evaluates new products. The Company
plans to leverage its marketing and distribution strengths by acquiring or
licensing the rights to those products that it believes have merit and
attempt to bring them to market. There can be no assurance that any of these
products will ever be marketed by the Company.
MARKETING STRATEGY
The Company began broad consumer marketing of the Breathe Right nasal strip in
September 1994. According to data collected by Information Resources, Inc.
("IRI"), the Breathe Right nasal strip became a leading sales volume producer
during 1995 in the cough, cold and allergy section of drug, grocery and mass
merchant stores nationwide. In September 1995, the Company received two REX
(retail excellence) awards from Drug Stores News magazine. The first award named
the Breathe Right nasal strip as the best new product in the cough, cold and
allergy section in U.S. drug stores. The second award named the product the
"market maker of the year," the single most important product which
disproportionately increased traffic and profits in U.S. drug stores.
The Company's marketing efforts are primarily directed to the OTC market.
After receiving FDA clearance in November 1995 to market the Breathe Right
nasal strip for the reduction or elimination of snoring, the Company's
advertising focused on the snoring application for the product. The Company
currently plans to begin advertising for the treatment of nasal congestion in
the fall of 1996 coincident with the cold season.
The Company primarily uses a mix of consumer and trade promotions and
magazine, radio and television advertising to market the Breathe Right nasal
strip. Marketing communications are generally designed to promote trial of
the Breathe Right nasal strip by increasing consumer awareness of the
product's benefits.
The Company's print ads have featured full face photos of familiar faces
(Jerry Rice, the Statue of Liberty, the Mona Lisa) wearing a Breathe Right
nasal strip as well as a photo of the box and a description of the benefits
of the product. The Company's radio campaign includes advertising on the
nationally syndicated radio programs of Rush Limbaugh, Paul Harvey and Dr.
Dean Edell. The Company recently launched its national cable television
advertising program and advertised on network television during Super Bowl
XXX.
The Company's paid advertising programs have been enhanced by media coverage
of unsolicited use of Breathe Right nasal strips by professional athletes,
including Herschel Walker of the New York Giants and Kirby Puckett of the
Minnesota Twins. In addition, a number of radio and television personalties,
including Rush Limbaugh, have provided unsolicited endorsements of the
product on national radio and television programs.
The Company has also entered into endorsement agreements pursuant to which
the following athletes will provide the Company with endorsement services:
NAME TEAM/SPORT
---- ----------
Jerry Rice San Francisco 49ers football team
Peter Bondra Washington Capitals hockey team
Michael Andretti Race car driver
Luke and Murphy Jensen Tennis players
Ann Marie Lauck U.S. Olympic marathon runner
The Volvo/Cannondale Mountain bike racers
Mountain Bike Team
Manuel Lagos Minnesota Thunder soccer team
Eddy Matzger In-line speed skater
The Company believes that use by professional athletes increases the
visibility of the product, which thereby leads to greater awareness of the
product for not only its athletic applications but also for snoring, nasal
congestion and other applications, and also makes it more acceptable for
consumers to wear the highly visible product.
The Company also uses product promotion programs, such as coupons, and public
relations activities to encourage product trial and repeat purchases.
Typically, coupons for the Breathe Right nasal strip appear three to four
times each year in free standing inserts (FSIs) that are included in Sunday
newspapers and are often tied to a holiday or special event theme such as
Super Bowl, Fathers Day, or the Christmas holidays (stocking stuffer). To
increase consumer product awareness, the Company also uses public relations
programs associated with "special events," such as sponsoring marathons,
providing product to certain professional athletic teams and sponsoring radio
station contests in conjunction with certain holidays.
The Company also has a program aimed at educating pharmacists and physicians
as to the efficacy of the product for various applications and the drug free
nature of the product in order to gain their recommendations of the product.
The Company believes that educating the professional medical market will lead
to both recommendations for use of the product in that market and for other
applications, such as for snoring and nasal congestion.
Because the Breathe Right nasal strip is sold as an OTC product, sales of the
product will depend in part upon the degree to which the consumer is aware of
the product and is satisfied with its use, which also influences repeat usage
and word of mouth referrals. A research study commissioned by the Company
indicates that approximately 5% of households in the U.S. include a person
that has tried Breathe Right nasal strips, and research data collected by a
nationally recognized consumer market research firm indicates that
approximately 28% of those who have tried Breathe Right nasal strips
purchased additional product.
The Company conducted consumer awareness surveys in March 1995, September
1995 and January 1996 in which 1,000 consumers over the age of 18 were
surveyed by telephone. Unaided product awareness, where respondents
identified a nasal strip as a product designed to help people breathe more
easily or provide relief from snoring, increased from 6% in March 1995 to 16%
in January 1996. Aided product awareness, where the respondents were asked if
they were aware of a product worn across the nose which is designed to help
people breathe and can also be used to reduce snoring, increased from 26% in
March 1995 to 37% in January 1996. Therefore, as of January 1996, 53% of the
consumers surveyed had some level of awareness of a nasal strip product.
Unaided awareness of the Breathe Right brand name increased from 2% in March
1995 to 7% in January 1996.
DOMESTIC DISTRIBUTION
OTC MARKET. The Breathe Right nasal strip is sold as an OTC product in
drug stores, grocery stores and mass merchant chain stores. In addition,
product distribution has recently begun to military base stores and
convenience stores in the U.S. The Company sells product to these retailers
through a network of independent sales representatives referred to in the
industry as non-food general merchandise brokers. Presently, the Company uses
eight broker groups who call on the chain drug, grocery and mass merchant
accounts and the wholesalers who serve primarily the independent drug stores
and many of the grocery stores in the U.S. Another broker calls on U.S.
military base commissaries and post exchanges, and the Company has a master
broker to market to the convenience store market.
The Company regularly uses IRI InfoScan data to determine market penetration of
Breathe Right nasal strips. IRI measures the all commodity volume ("ACV")
distribution of the Breathe Right nasal strip, which is the total sales volume
of stores in which the Breathe Right nasal strip is sold as a percentage of
total sales volume of all stores in that category. The following table shows ACV
distribution of the Breathe Right nasal strip for the four-week periods ended:
1/1/95 3/26/95 7/16/95 10/8/95 12/31/95
Drug store ACV 65% 86% 94% 98% 98%
Grocery store ACV 20% 33% 53% 61% 71%
Mass merchant ACV 10% 85% 94% 97% 99%
While the Company believes that it has widespread distribution, the 30 count
box that was first distributed to retailers in August 1995 was only available
in stores which accounted for approximately 40% of the total drug store sales
volume, 5% of the total grocery store sales volume and 60% of the total mass
merchant sales volume by the end of 1995. The Company intends to emphasize
increasing the distribution (and availability to the consumer) of the 30
count box during 1996. Since the 30 count box carries a suggested retail
price that is 20% lower per strip than the strips in the 10 count box, the
Company believes that increased availability of the 30 count box will help
encourage repeat usage.
Although the Company's advertising currently focuses on the snoring
application, the Breathe Right nasal strip is typically positioned in the
cough, cold and allergy section of the store because Breathe Right nasal
strips provide benefits similar to those obtained with decongestant products.
There is typically no section in stores for snoring relief products. Due to
the strong sales levels of the Breathe Right nasal strip and its rapid sales
growth, many store managers have also placed the product in secondary
locations, such as on the pharmacy counter or in special sections located at
the end of an aisle reserved for better selling products. The Company
believes that the Breathe Right nasal strip is priced competitively with
decongestant drugs (including nasal sprays and oral decongestants) on a per
dose basis.
The Company's OTC customers for the Breathe Right nasal strip include national
drug store, grocery store and mass merchant chains such as Walgreens, Eckerd,
REVCO, Kroger, Safeway, Wal-Mart, Kmart and Target, as well as regional and
independent stores in the same store categories. In 1995, no OTC customer
represented more than 3% of the retail stores that carried the product, and one
retailer accounted for approximately 13% of Breathe Right nasal strip sales. The
loss of this customer or any other large retailer would require the Company to
replace the lost sales through other retail outlets and could temporarily
disrupt distribution of the Breathe Right nasal strip.
PROFESSIONAL MEDICAL MARKET. The Company believes that establishing a strong
presence in the professional medical market will not only increase sales to
this market, but will also result in physicians recommending the product for
other applications. The Company has sold the product to this market in small
quantities either directly or through a few small respiratory specialty
distributors. The Company is currently evaluating special packaging
requirements to reach the hospital and home health care markets and is
exploring how to reach these markets through OEM sales arrangements with
medical products companies. As an alternative, the Company may establish an
independent representative sales force to penetrate these markets.
ATHLETIC MARKET. Largely as a result of the exposure that the Breathe Right
nasal strips received when NFL football players began wearing them, many
sporting goods retailers expressed an interest in carrying the product. A
special package has been developed for this market and the Company has
contracted with E-Z Gard, Inc. (a mouth guard manufacturer) to act as master
broker to provide sales and distribution to the sporting goods retailer
market in the U.S. and Canada. The Breathe Right nasal strips sports package
was first available in September 1995 and is distributed to sporting goods
stores and mass merchant sports departments. In addition, many drug stores
carry the sports package in their sports medicine section.
INTERNATIONAL DISTRIBUTION
The Company executed an international distributor agreement with 3M in August
1995 pursuant to which 3M has the exclusive right to distribute the Breathe
Right nasal strip outside of the U.S. and Canada. 3M has operations in over
60 foreign countries. The product is marketed internationally under the
co-brand of "3M Breathe Right nasal strips" in order to benefit from both
3M's brand name and the publicity that the Breathe Right brand name has
received. Under the terms of the agreement, 3M buys product from the Company
either in finished form in 3M boxes or in bulk quantities to be packaged by
3M's international subsidiaries. All sales to 3M are denominated in U.S.
dollars. 3M is responsible for obtaining all necessary regulatory approvals
outside of the U.S. and for all marketing and selling expenses. The agreement
contains certain minimum performance objectives and breakup provisions.
3M began training its international sales force on the Breathe Right nasal
strip product line in October 1995. Package designs for several countries
were completed and initial product orders were placed by the end of 1995. The
Company expects that product will be on retail shelves in Japan and several
European countries by March 31, 1996 and in a total of at least 12 foreign
countries by the end of 1996.
In 1995, the Company arranged with LOCIN Industries, a Canadian dental floss
company, to establish distribution in the Canadian market. During 1995, LOCIN
distributed the product to drug stores in Canada. During 1996, LOCIN may
purchase product in bulk and package it at its facility and assume
responsibility for cooperative advertising programs.
POTENTIAL LINE EXTENSIONS AND NEW PRODUCTS
BREATHE RIGHT NASAL STRIP ENHANCEMENTS AND LINE EXTENSIONS. The Company is
currently evaluating a number of enhancements to the existing Breathe Right
nasal strip product line. These enhancements include a modification that
would increase the dilating force of the strip without diminishing the
strip's ability to stay in place, an enhancement that would reduce the
potential for irritation over the top of the nose and production of nasal
strips with different colors, insignias and cartoon or other characters, and
scented nasal strips.
NEW PRODUCTS. As a result of the Company's established distribution channels
and highly visible success with the Breathe Right nasal strip, the Company is
frequently approached by individuals and smaller companies to explore the
possibility of partnering with the Company to manufacture and market new
product ideas. The Company routinely evaluates the merit of these products,
and from time to time may acquire or license the rights to innovative
products which it believes could successfully be sold through the Company's
established distribution channels.
The Company has entered into contractual arrangements for a number of
products which are in various stages of evaluation and testing prior to
potential market launch. The Company plans to incur costs of approximately
$1.0 million relating to evaluation and test marketing of these products in
1996 and expects to launch one product, the TheraPatch in 1996. Most, if not
all, of these products are regulated to varying degrees by the FDA and some
will require extensive clinical studies and regulatory approvals prior to
marketing. There can be no assurance that any required regulatory approvals
will be obtained or, other than the TheraPatch, that the Company will market
any of these products. Products currently being evaluated by the Company
include:
THERAPATCH EXTERNAL ANALGESIC PATCH. The TheraPatch is a 2" by 3" external
analgesic patch designed for temporary relief of pain from arthritis, simple
backaches and muscular aches and strains. The patch is coated with a
proprietary hydrogel formulation which, when placed on the skin, creates a
cutaneous sensation that interferes with the sensation of pain. The Company
believes that the TheraPatch design allows it to provide longer lasting
relief (four to six hours) than similar patches or external analgesic creams
(60 to 90 minutes) currently on the market. The Company, however, will not be
able to make any claims as to duration without FDA approval. The Company is
planning to test market the patch in late spring and summer 1996, with broad
scale product marketing dependent upon favorable test market results and
compliance with applicable FDA requirements.
The FDA has issued a deferment letter to the product's manufacturer which
allows the product to be marketed and defers the product's regulatory status
until the FDA publishes a Final Monograph on External Analgesics. After the
Final Monograph is published, the Company will have one year to comply with
the FDA's requirements listed in the Final Monograph.
POLLEN-GUARD GEL. The Company has the right to enter into an exclusive,
worldwide license agreement covering the patent and pending patent
applications on the Pollen-Guard Gel, which is an ionized gel product that
can be applied around the nostrils. The gel dries clear, colorless and
odorless and creates a local electrostatic field. The product has been the
subject of favorable preliminary laboratory and clinical tests, and a
Company-sponsored clinical study is currently in progress.
The Company believes that this product reduces the inhalation of airborne
contaminants such as pollen, mold spores and dust, which will thereby reduce
allergic symptoms. The Company is not aware of similar competitive products.
SMOKING CESSATION AND APPETITE SUPPRESSANT PRODUCTS. The Company plans to
perform clinical tests on two products that utilize a chemical compound that
is used as a common food additive found in cereals, milk, dairy products and
other common foods and is listed on the Flavor and Extract Manufacturers
Generally Regarded As Safe List. The compound is naturally found in the
Virginia tobacco leaf and is used as an additive in the manufacture of
cigarettes. The Company believes that the compound, when inhaled, may be
effective as an adjunct to assist in stopping smoking or as a smoking
substitute product, and may also be useful in suppressing appetite, resulting
in weight loss, but the Company has not completed any clinical studies on
these products to date. The licensor of the product obtained a patent on the
appetite suppressant product in 1985 and on the smoking cessation product in
1994 and the Company has licensed the rights to the patents.
The Company intends to proceed with formal clinical studies, and if they are
successful the Company will attempt to gain FDA clearance to market both
products. FDA clearance of such products will require filing a new drug
application and completion of extensive clinical studies, the protocols and
results of which must be satisfactory to the FDA. The Company is aware of one
competitive product for smoking cessation that is currently being distributed
in Europe.
LARYNGOSCOPE DENTAL WARNING SYSTEM. A laryngoscope is a medical device used in
the process of intubation, which involves insertion of a breathing tube into a
patient's trachea by passing it through the mouth and throat. During the process
of intubation, the laryngoscope's blade has a tendency to be pressed against the
patient's top teeth, at times causing damage to those teeth or to adjacent
bridge work. The laryngoscope dental warning system uses a disposable warning
circuit embedded into a thin plastic strip placed on the bottom of the
laryngoscope's blade to warn the user when the blade makes contact with the
teeth, allowing the physician to avoid damaging the patient's teeth.
Approximately 19 million surgeries are performed each year in the U.S., which
are preceded by intubations. The reported incidence of dental damage is
approximately one per 1,000 cases.
The licensor of the product has a patent application pending with the U.S.
Patent Office. The Company intends to finalize the design of the product,
manufacture and test the product and submit an application with the FDA to
obtain regulatory clearance to market the product by the fall of 1996. The
Company is not aware of any similar devices on the market.
MANUFACTURING AND OPERATIONS
The Company currently sub-contracts with five manufacturers (and has
qualified two additional manufacturers), known as converters, to produce the
Breathe Right nasal strip and does no in-house fabrication. Three of the
converters are capable of providing full turnkey service and ship product to
the Company that is completely packaged ready to be sold to retailers. The
others provide semi-finished goods to the Company that require final
packaging. To complete these products, the Company has the ability to wrap
individual strips in the paper sleeve in-house and subcontracts the final
packaging out to one of seven qualified packaging subcontractors.
Each of these converters builds the product to the Company's specifications
using materials specified by the Company and, for the major materials, places
orders against a supply agreement negotiated by the Company with the material
manufacturer. The converters have all entered into confidentiality agreements
with the Company to protect the Company's intellectual property rights.
Company quality control and operations personnel periodically visit the
converters to observe processes and procedures. Finished goods are inspected
at the Company to insure that they meet quality requirements. The Company
inspects its converters on a regular basis and is not aware of any material
violation of FDA Good Manufacturing Practice Standards. The Company works
closely with its material vendors and converters to reduce scrap and waste,
improve efficiency, and improve yields to reduce the manufacturing costs of
the product. These efforts, combined with volume efficiencies, have resulted
in higher gross margins. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
To ensure consistent quality and favorable pricing, the Company has entered
into a multi-year material supply agreement with 3M for the major components
of the Breathe Right nasal strip. Although similar materials are currently
available from other suppliers, the Company believes that 3M's materials are
of superior quality. Although the Company believes that this relationship
will not be disrupted or terminated, the inability to obtain sufficient
quantities of these components or the need to develop alternative sources in
a timely and cost effective manner, if and as required in the future, could
adversely affect the Company's operations until new sources of these
components become available, if at all. In addition, while the Company does
not expect 3M to do so, 3M has the right to discontinue its production or
sale of these products at any time with 90 days notice to the Company.
In the first quarter of 1995, a rapid increase in demand for the product
resulted in the Company being unable to secure delivery of sufficient raw
materials to avoid large back orders and out of stock situations at the
retail level. It took until the end of the second quarter of 1995 for the
Company to eliminate the back orders and to begin building inventory. The
Company believes that its converters can produce sufficient quantities of
product to meet the Company's current and projected requirements.
The Company plans to use a portion of the net proceeds of this offering to
supplement the manufacturing capacity of its packaging subcontractors and
converters with its own manufacturing capabilities. The Company believes that
this will allow it to be more flexible and responsive to changes in the mix
of final packaging requirements while managing both product costs and
inventory levels.
COMPETITION
The Company believes that the market for decongestant products is highly
competitive while the market for products for the reduction or elimination of
snoring may become more competitive in the future. The Company's competition in
the OTC market for decongestant products and other cold, allergy and sinus
relief products consist primarily of pharmaceutical products and products
similar to the Breathe Right nasal strip. Products that compete with the Breathe
Right nasal strip in the OTC market for snoring remedies consist primarily of
internal nasal dilators and products similar to the Breathe Right nasal strip.
Many of the manufacturers of the pharmaceutical products that compete with the
Breathe Right nasal strip have significantly greater financial and operating
resources than the Company. In addition, these competitors may develop products
which are able to circumvent the Company's patents.
GOVERNMENT REGULATION
As a manufacturer and marketer of medical devices, the Company is subject to
regulation by, among other governmental entities, the FDA and the
corresponding agencies of the states and foreign countries in which the
Company sells its products. The Company must comply with a variety of
regulations, including the FDA's Good Manufacturing Practice regulations, and
is subject to periodic inspections by the FDA and applicable state and
foreign agencies. If the FDA believes that its regulations have not been
fulfilled, it may implement extensive enforcement powers, including the
ability to ban products from the market, prohibit the operation of
manufacturing facilities and effect recalls of products from customer
locations. The Company believes that it is currently in compliance with
applicable FDA regulations.
FDA regulations classify medical devices into three classes that determine
the degree of regulatory control to which the manufacturer of the device is
subject. In general, Class I devices involve compliance with labeling and
record keeping requirements and are subject to other general controls. Class
II devices are subject to performance standards in addition to general
controls. Class III devices are those devices, usually invasive, for which
pre-market approval (as distinct from pre-market notification) is required
before commercial marketing to assure the products' safety and effectiveness.
The Breathe Right nasal strip has not yet been classified.
Before a new medical device can be introduced into the market, the
manufacturer generally must obtain FDA clearance through either a 510(k)
pre-market notification or a pre-market approval application ("PMA"). A
510(k) clearance will be granted if the submitted data establish that the
proposed device is "substantially equivalent" to a legally marketed Class I
or II medical device, or to a Class III medical device for which the FDA has
not called for PMAs. The PMA process can be expensive, uncertain and lengthy,
frequently requiring from one to several years from the date the PMA is
accepted. In addition to requiring clearance for new products, FDA rules may
require a filing and waiting period prior to marketing modifications of
existing products. The Company has received 510(k) approvals to market the
Breathe Right nasal strip as a device that can (i) reduce or eliminate
snoring, (ii) temporarily relieve the symptoms of nasal congestion and stuffy
nose and (iii) improve nasal breathing by reducing nasal airflow resistance.
In addition to the Company's medical device products, the Company has entered
into an agreement to manufacture and market a smoking substitute and appetite
suppressant product that the FDA may classify as a "New Drug." The FDA must
approve safety and effectiveness for each labeled use before a New Drug can
be sold. As part of the requirements for obtaining approval of a New Drug,
the Company will be required to conduct extensive preclinical studies to
determine the safety and efficacy of the drug. Upon completion of these
studies, the Company will submit an Investigational New Drug application
("IND") to the FDA, which permits the Company to begin clinical trials.
These clinical trials of the products must be conducted and the results
submitted to the FDA as part of a New Drug Application ("NDA"). The FDA must
approve the NDA before pharmaceutical products may be sold in the U.S. The
grant of regulatory approvals often takes a number of years and may involve
the expenditure of substantial resources. There is no assurance that NDAs
will be approved for the Company's products if any are required. Even after
initial FDA approval has been granted, further studies may be conducted to
provide additional data on safety or efficacy or to obtain approval for
marketing the drug as a treatment for disease indications in addition to
those originally approved. In addition, the FDA can revoke its approval even
after it has initially been given.
Sales of the Company's products outside the U.S. are subject to regulatory
requirements governing human clinical trials and marketing approval for
drugs, and such requirements vary widely from country to country. Under its
agreement with the Company, 3M is responsible for obtaining all necessary
regulatory approvals outside the U.S. The Company believes it has provided 3M
with the necessary documentation to enable 3M to obtain the "CE" mark, an
international symbol of quality and compliance with applicable European
medical device directives, and 3M is affixing the CE mark on the Company's
products in Europe.
No assurance can be given that the FDA or state or foreign regulatory
agencies will give on a timely basis, if at all, the requisite approvals or
clearances for additional applications for the Breathe Right nasal strip or
for any of the Company's products which are under development. Moreover,
after clearance is given, the Company is required to advise the FDA and these
other regulatory agencies of modifications to its products. These agencies
have the power to withdraw the clearance or require the Company to change the
device or its manufacturing process or labeling, to supply additional proof
of its safety and effectiveness or to recall, repair, replace or refund the
cost of the medical device if it is shown to be hazardous or defective. The
process of obtaining clearance to market products is costly and
time-consuming and can delay the marketing and sale of the Company's
products. Furthermore, federal, state and foreign regulations regarding the
manufacture and sale of medical devices are subject to future change. The
Company cannot predict what impact, if any, such changes might have on its
business.
The Company is also subject to substantial federal, state and local
regulation regarding occupational health and safety, environmental
protection, hazardous substance control and waste management and disposal,
among others.
PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS
The Company entered into a license agreement in 1992 (the "License
Agreement") pursuant to which the Company acquired from the licensor (the
"Licensor") the exclusive rights to manufacture and sell the Breathe Right
nasal strip. Pursuant to the License Agreement, the Company has the exclusive
right to manufacture, sell and otherwise practice any invention, including
the Breathe Right nasal strip, claimed in the Licensor's patent applications
related thereto and all patents issued in any country which correspond to
those applications. The Company must pay royalties to the Licensor based on
sales of the Breathe Right nasal strip including certain minimum royalty
amounts to maintain its exclusivity. The Company is also responsible for all
costs and expenses incurred in obtaining and maintaining patents related to
the Breathe Right nasal strip.
The Licensor has filed patent applications with the U.S. Patent and Trademark
Office seeking patent protection for different aspects of the Breathe Right
nasal strip technology. The Licensor has received notice of allowance from
the U.S. Patent and Trademark Office in two of its patent applications
covering the Breathe Right nasal strip, including one with claims that cover
the single-body construction of the Breathe Right nasal strip. A third patent
application has issued as a patent, and a fourth application has received
notice of allowance covering structural changes to the product. A fifth
application pending has just recently been filed and remains pending. The
Licensor has also obtained patent protection on the Breathe Right nasal strip
in two foreign countries and has applications pending which seek patent
protection in 23 additional countries. In addition to its patent position,
the Company believes that its position as the first entrant in the market and
the design knowledge, which the Company has protected as trade secrets, will
provide the Company with advantages over possible competition.
If the Licensor obtains additional patents covering the Breathe Right nasal
strip, there can be no assurance that they, or the patent already issued,
will effectively foreclose the development of competitive products or that
the Company will have sufficient resources to pursue enforcement of any
patents issued. The Company intends to aggressively enforce the patents
covering the Breathe Right nasal strip, when and if they are issued. In order
to enforce any patents issued covering the Breathe Right nasal strip, the
Company may have to engage in litigation, which may result in substantial
cost to the Company and counterclaims against the Company. Any adverse
outcome of such litigation could have a negative impact on the Company's
business.
The Company believes its trademarks are important as protection for the
Company's names and advertising. The Company has initiated opposition
proceedings in the U.S. Patent and Trademark Office against two competitors
that are attempting to register trademarks that are substantially similar to
"Breathe Right" and has filed a trademark infringement suit against one of
them.
There can be no assurance that the Company's technology will not be
challenged on the grounds that the Company's products infringe on patents,
copyrights or other proprietary information owned or claimed by others or
that others will not successfully utilize part or all of the Company's
technology without compensation to the Company. The Company will attempt to
protect its technologies and proprietary information as trade secrets.
EMPLOYEES
At March 1, 1996, the Company had 37 full-time employees, of whom 13 were
engaged in operations, 12 in general administration, 10 in marketing and
sales and two in new products and business development. There are no unions
representing Company employees. Relations with its employees are believed to
be good and there are no pending or threatened labor employment disputes or
work interruptions.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth the names and ages of the Company's
Executive Officers together with all positions and offices held with the Company
by such Executive Officers. Officers are appointed to serve until the meeting of
the Board of Directors following the next Annual Meeting of Shareholders and
until their successors have been elected and have qualified.
Name and Age Office
------------ ------
Daniel E. Cohen, M.D. (43) Chairman of the Board, Chief Executive
Officer, Treasurer and Director
Richard E. Jahnke (47) President, Chief Operating Officer and
Director
M. W. Anderson, Ph.D. (45) Vice President of Clinical and
Regulatory Affairs
David J. Byrd (42) Vice President of Finance and Chief
Financial Officer
William Doubek (40) Vice President of Operations
Rihab FitzGerald (44) Vice President of Consumer Sales
Kirk P. Hodgdon (36) Vice President of Consumer Marketing
Gerhard Tschautscher (39) Vice President of International and
Professional Medical Marketing
Daniel E. Cohen, M.D. has served as the Company's Chairman of the Board
since 1993, its Chief Executive Officer since 1989 and a director and the
Treasurer since 1982 . Dr. Cohen was a founder of the Company and is a
board-certified neurologist.
Richard E. Jahnke has served as the Company's President and Chief
Operating Officer and as a director since 1993. From 1991 to 1993, he was
Executive Vice President and Chief Operating Officer of Lemna Corporation, which
manufactures and sells waste water treatment systems. From 1986 to 1991, Mr.
Jahnke was general manager of the government operations division of ADC
Telecommunications, an electronic communications systems manufacturer. From 1982
to 1986, he was Director of Marketing and Business and Technical Development at
BMC Industries, Inc. From 1972 to 1982, he held various positions of increasing
responsibility in engineering, sales and marketing management at 3M Company.
M. W. Anderson, Ph.D. has served as the Company's Vice President of
Clinical and Regulatory Affairs and Vice President of Research and Development
since 1990. He has served in various capacities since joining the Company in
1984, including Director of Applications Research and Director of Research and
Development. Prior to joining the Company in 1984, Dr. Anderson was an Assistant
Professor at the University of Minnesota's College of Pharmacy.
David J. Byrd has served as the Company's Vice President of Finance and
Chief Financial Officer since February 1996. Prior to joining the Company, Mr.
Byrd was Chief Financial Officer and Treasurer of Medisys, Inc., a health care
services company, since 1991. From 1975 to 1991, Mr. Byrd was employed by
Coopers & Lybrand, where he was a partner from 1986 to 1991. Mr. Byrd is a
certified public accountant.
William Doubek has served as the Company's Vice President of Operations
since 1990, Director of Operations from 1986 to 1990 and was the Company's
Senior Engineer from 1982 to 1986. Prior to joining the Company in 1982, Mr.
Doubek served as Senior Project Engineer at Medtronic, Inc., a manufacturer of
medical devices, Senior Engineer at Micro Control Company, a manufacturer of
computer testing equipment, and Electrical Engineer at Palico Instrument
Company, a manufacturer of computer testing equipment.
Rihab Fitzgerald has served as the Company's Vice President of Consumer
Sales since August 1993, Vice President of Sales and Marketing from 1990 to
August 1993 and Director of Marketing from 1985 to 1990. Prior to joining the
Company in 1984, Ms. Fitzgerald was employed in sales and marketing with Nicolet
Instrument Corporation, a medical devices manufacturer.
Kirk P. Hodgdon has been the Company's Vice President of Marketing
since February 1994. Prior to joining the Company, Mr. Hodgdon served as: Vice
President-Management Supervisor at Gage Marketing Communications, a marketing
services company, from 1993 to February 1994; Vice President - Account
Supervisor at U.S. Communications, a marketing agency, from 1989 to 1993; and
Marketing Manager at Land O'Lakes, Inc., a consumer foods cooperative, from 1988
to 1989.
Gerhard Tschautscher has served as the Company's Vice President of
International and Professional Medical Marketing since January 1994 and as a
Company Product Director and as the International Sales Marketing and Sales
Director between 1988 and December 1993.
ITEM 2. PROPERTIES
The Company leases approximately 80,000 square feet of office,
manufacturing and warehouse space in Bloomington, Minnesota. The lease expires
in December 2000.
ITEM 3. LEGAL PROCEEDINGS
Except as otherwise disclosed in this Form 10-K, no material legal proceedings
are pending or known to be contemplated to which the Company is a party or to
which any of its property is subject, and the Company knows of no material legal
proceedings pending or threatened, or judgments against any director or officer
of the Company in his or her capacity as such.
In October 1995, an individual commenced a lawsuit against the Company in
U.S. District Court for the Northern District of Ohio claiming that the
Breathe Right nasal strip infringes the plaintiff's patents relating to a
facial cleanser. The plaintiff is seeking an undefined amount of monetary
damages from the Company and an order enjoining the Company from infringing
on his patents. The plaintiff's patents cover a facial cleanser for a
person's nose. The facial cleanser consists of an elongated strip which can
be bent and which is formed of material suitable for scraping one's skin. The
facial cleanser has gripping means in the form of indentations at the ends of
the strips and an absorbent pad which is impregnated with a topically
effective agent for application to the surface of the skin being cleansed.
The Company believes that the suit is completely without merit and has denied
all material allegations in the complaint and is vigorously defending itself
based upon what it considers meritorious defenses.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Common Stock of the Company has been traded under the symbol "CNXS"
on the Nasdaq National Market since April 8, 1994 and was traded on the Nasdaq
SmallCap Market prior to April 8, 1994. The following table sets forth the high
and low bid prices of the Company's Common Stock for the periods for which it
was traded on the SmallCap Market and sets forth the high and low last sale
prices for the periods for which it has been traded on the National Market. The
Nasdaq SmallCap Market bid quotations represent interdealer prices, without
retail mark-ups, mark-downs or commissions, and may not necessarily represent
actual transactions. The prices prior to June 23, 1995 have been adjusted to
reflect the Company's two-for-one stock split.
High Low
1994
First Quarter.................................. 4-3/4 2-15/16
Second Quarter................................. 4 2-5/8
Third Quarter.................................. 4-1/16 2-1/4
Fourth Quarter................................. 4-13/16 2-7/8
1995
First Quarter.................................. 9-5/8 4-7/16
Second Quarter ................................ 19 9-15/16
Third Quarter.................................. 24-1/4 13-1/8
Fourth Quarter................................. 17-3/8 9-1/2
On March 1, 1996, the last sale price of the Common Stock as reported
on the Nasdaq National Market was $18.875. As of March 1, 1996, there were
approximately 2,000 owners of record of Common Stock.
DIVIDEND POLICY
The Company has never paid any dividends on its Common Stock. The
Company currently intends to retain any earnings for use in its operations and
does not anticipate paying any cash dividends in the foreseeable future. The
payment of dividends, if any, in the future will be at the discretion of the
Board of Directors and will depend upon, among other things, future earnings,
capital requirements, restrictions in future financing agreements, the general
financial condition of the Company and general business considerations.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
(Dollars in thousands, except per share data)
YEAR ENDED DECEMBER 31,
1991 1992 1993 1994 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENTS OF OPERATIONS DATA (1):
Net sales $ -- $ -- $ 93 $ 2,798 $48,632
Cost of goods sold -- -- 49 1,790 17,555
Gross profit -- -- 44 1,008 31,077
Operating expenses:
Marketing and selling -- -- -- 3,100 16,695
General and administrative -- -- 440 666 1,984
Total operating expenses -- -- 440 3,766 18,679
Operating income (loss) -- -- (396) (2,758) 12,398
Other income, net -- -- 97 200 572
Income (loss) from continuing -- -- (299) (2,558) 12,970
operations before income taxes
Income tax benefit -- -- -- -- 341
Income (loss) from continuing -- -- (299) (2,558) 13,311
operations
Loss from operations of (840) (808) (1,132) (309) (460)
discontinued sleep division
Gain on sale of sleep division -- -- -- -- 1,226
Net income (loss) $ (840) $ (808) $(1,431) $(2,867) $14,077
Net income (loss) per common and
common equivalent share:
From continuing operations -- -- (.02) (.16) .72
From discontinued operations (.08) (.07) (.09) (.02) .04
Net income (loss) $ (.08) $ (.07) $ (.11) $ (.18) $ .76
Weighted average number of common
and common equivalent shares
outstanding 10,065 12,276 13,145 15,755 18,376
DECEMBER 31,
1991 1992 1993 1994 1995
(IN THOUSANDS)
BALANCE SHEET DATA
(1):
Working capital $3,233 $5,201 $3,717 $10,790 $25,855
Total assets 3,233 5,201 3,872 11,613 32,341
Stockholders' equity 3,233 5,201 3,872 11,207 26,885
(1) Until June 1995, the Company manufactured and marketed diagnostic devices
for sleep disorders. This line of business was sold in June 1995 and is
reported as discontinued operations.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations should be read in conjunction with the Company's audited financial
statements and notes thereto appearing elsewhere in this Form 10-K. In the
opinion of the Company's management, the quarterly unaudited information set
forth below has been prepared on the same basis as the audited financial
information, and includes all adjustments (consisting only of normal, recurring
adjustments) necessary to present this information fairly when read in
conjunction with the Company's Financial Statements and Notes thereto contained
elsewhere in this Form 10- K.
OVERVIEW
The Company was founded in 1982. From 1987 until 1995, the Company designed,
manufactured and marketed computer-based diagnostic devices for sleep
disorders. In 1995, the Company focused on the Breathe Right nasal strip and
divested itself of the assets related to its sleep disorders business. Unless
otherwise noted, the following discussion of financial condition and results
of operations relate only to continuing operations of the Company.
The Company's revenues are derived from the manufacture and sale of the
Breathe Right nasal strip. Revenue from sales is recognized when earned,
generally at the time products are shipped. The Company obtained the license
to manufacture and sell the Breathe Right nasal strip in 1992 and received
FDA clearance in October 1993 to market the Breathe Right nasal strip as a
product which improves nasal breathing.
In September 1994, the Company launched its consumer marketing program which
was enhanced by broad media coverage of the use of Breathe Right nasal strips
by professional football players. At the same time, a number of radio and
television personalities provided unsolicited endorsements of the product on
national radio and television.
In the first quarter of 1995, a rapid increase in demand for the product
resulted in the Company being unable to secure delivery of sufficient raw
materials to avoid large back orders and out of stock situations at the
retail level. It took until the end of the second quarter of 1995 for the
Company to eliminate the back orders and to begin building inventory.
During 1995, the Company continued its marketing efforts and also focused on
expanding its distribution network both domestically and internationally. In
August 1995, the Company signed an exclusive international distribution
agreement with 3M to market Breathe Right nasal strips outside the U.S. and
Canada. At the end of 1995, Breathe Right nasal strips were available in
stores which account for approximately 98% of total drug store sales volume,
99% of total mass merchant sales volume and 71% of total grocery store sales
volume in the U.S.
In November 1995, the Company received FDA clearance to market the Breathe
Right nasal strip for the reduction or elimination of snoring and began
marketing programs emphasizing the snoring benefits of the product. In
February 1996, the Company received FDA clearance to market the Breathe Right
nasal strip for the temporary relief of nasal congestion and thereafter
launched a media program to increase consumer awareness of the benefits of
the product for this application.
OPERATING RESULTS
The table below sets forth certain selected financial information of the
Company for the periods indicated.
THREE MONTHS ENDED YEAR ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1994 1994 1994 1994 1994
(IN THOUSANDS)
STATEMENTS OF OPERATIONS DATA:
Net sales $ 344 $ 529 $ 682 $ 1,243 $ 2,798
Cost of goods sold 248 364 368 809 1,790
Gross profit 96 165 314 434 1,008
Operating expenses:
Marketing and selling 387 517 839 1,357 3,100
General and administrative 140 182 184 160 666
Total operating expenses 527 699 1,023 1,517 3,766
Operating income (loss) (431) (534) (709) (1,083) (2,758)
Other income, net (3) 60 78 64 200
Income (loss) from continuing
operations before income taxes $(434) $(474) $ (631) $(1,019) $(2,558)
THREE MONTHS ENDED YEAR ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
STATEMENTS OF OPERATIONS DATA:
Net sales $7,459 $18,818 $10,288 $12,066 $48,632
Cost of goods sold 2,850 7,072 3,513 4,119 17,555
Gross profit 4,609 11,746 6,775 7,947 31,077
Operating expenses:
Marketing and selling 2,140 3,788 4,836 5,931 16,695
General and administrative 300 384 642 657 1,984
Total operating expenses 2,440 4,172 5,478 6,588 18,679
Operating income (loss) 2,169 7,574 1,297 1,359 12,398
Other income, net 84 124 214 149 572
Income (loss) from continuing
operations before income taxes $2,253 $ 7,698 $ 1,511 $ 1,508 $12,970
The table below sets forth the percentage of net sales represented by certain
items included in the Company's statement of operations for the periods
indicated.
THREE MONTHS ENDED YEAR ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1994 1994 1994 1994 1994
STATEMENTS OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 72.1 68.8 54.0 65.1 63.9
Gross profit 27.9 31.2 46.0 34.9 36.1
Operating expenses:
Marketing and selling 112.5 97.7 123.0 109.1 110.8
General and administrative 40.7 34.4 27.0 12.9 23.8
Total operating expenses 153.2 132.1 150.0 122.0 134.6
Operating income (loss) (125.3) (100.9) (104.0) (87.1) (98.5)
Other income, net (0.9) 11.3 11.5 5.1 7.1
Income (loss) from continuing
operations before income taxes (126.2)% (89.6)% (92.5)% (82.0)% (91.4)%
THREE MONTHS ENDED YEAR ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
STATEMENTS OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 38.2 37.6 34.2 34.1 36.1
Gross profit 61.8 62.4 65.8 65.9 63.9
Operating expenses:
Marketing and selling 28.7 20.1 47.0 49.2 34.3
General and administrative 4.0 2.1 6.2 5.4 4.1
Total operating expenses 32.7 22.2 53.2 54.6 38.4
Operating income (loss) 29.1 40.2 12.6 11.3 25.5
Other income, net 1.1 0.7 2.1 1.2 1.2
Income (loss) from continuing
operations before income taxes 30.2% 40.9% 14.7% 12.5% 26.7%
1995 COMPARED TO 1994
NET SALES. Net sales increased to $48.6 million for 1995 from $2.8 million
for 1994. Breathe Right nasal strip sales increased as a result of expanded
consumer advertising and an increase in the number of retail outlets selling
the product. In the first quarter of 1995, a rapid increase in demand for the
product resulted in the Company being unable to avoid large back orders and
out of stock situations. As a result, net sales for the three months ended
June 30, 1995 included approximately $7 million of back orders received in
the prior quarter. The Company believes that much of the product sold during
the nine months ended September 30, 1995 represented an increase in inventory
levels at existing and new retail outlets and initial stocking of inventory
of additional box and size configurations of the product. As a result, the
Company does not expect that the quarterly sales patterns for the first three
quarters of 1996 will be directly comparable to the first three quarters of
1995.
GROSS PROFIT. Gross profit was $31.1 million for 1995 compared to $1.0
million for 1994. Gross profit as a percentage of net sales improved to 63.9%
for 1995 and 65.9% for the three months ended December 31, 1995 compared to
36.1% for 1994, primarily as a result of efficiencies realized from the
higher level of Breathe Right nasal strip sales and cost reduction programs
initiated by the Company. The Company is continuing efforts to reduce the
manufacturing costs of the product and improve gross profit margins on
domestic sales. The Company obtains lower gross profit margins on
international sales because the Company sells product to 3M at a price lower
than its sales price in domestic markets. In connection with these
international sales, 3M is responsible for substantially all of the operating
expenses and a portion of the packaging costs.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $16.7
million for 1995 compared to $3.1 million for 1994. This increase resulted
primarily from the marketing expenses associated with a full year of consumer
advertising for the Breathe Right nasal strip. The Company anticipates that
the total dollar amount spent on marketing and selling will increase in 1996,
in part as a result of increased television advertising. Marketing and
selling expenses as a percentage of net sales decreased to 34.3% in 1995 from
110.8% in 1994 as a result of the higher level of sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$2.0 million for 1995 compared to $666,000 for 1994. This increase resulted
from the additional personnel and systems required to support growth of the
Breathe Right nasal strip business. The Company intends to increase
expenditures for the development of new products and on information systems
personnel during 1996. General and administrative expenses as a percentage of
net sales decreased to 4.1% in 1995 from 23.8% in 1994 primarily as a result
of the higher level of sales.
OTHER INCOME, NET. Other income, net was $572,000 for 1995 compared to
$200,000 for 1994, resulting from investment of funds from the sale of the
Company's sleep disorder diagnostic products business.
INCOME TAX BENEFIT. The income tax benefit for 1995 of $341,000 resulted from
the recognition of the benefit of net operating losses and credit carry
forwards from prior years and the elimination of the valuation allowance on
reinstatement of deferred tax assets due to the Company's expected future
taxable income. There are no net operating loss carry forwards available for
future years.
1994 COMPARED TO 1993
NET SALES. Net sales for 1994 were $2.8 million compared to $93,000 for 1993.
During the fourth quarter of 1994, sales of the Breathe Right nasal strip
increased significantly due to an increase in consumer awareness of the
product from its use by professional athletes in several sports. In addition,
the Company commenced national consumer advertising in newspapers and
magazines and expanded its distribution network.
GROSS PROFIT. Gross profit for 1994 was $1.0 million compared to $44,000 for
1993. The increase in gross profit was due to increased sales of the Breathe
Right nasal strip in 1994.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses related to the
Breathe Right nasal strip were $3.1 million in 1994 compared to no expenses
in 1993. These expenses resulted from the marketing expenses associated with
establishing distribution channels, trade advertisements, consumer
advertisements, and other product roll-out items for the Breathe Right nasal
strip.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses for
1994 were $666,000 compared to $440,000 for 1993. This increase resulted from
additional personnel and systems required to support the Breathe Right nasal
strip.
OTHER INCOME, NET. Other income, net was $200,000 in 1994 compared to $97,000
in 1993 reflecting the increased cash available for investment and higher
interest rates during 1994.
SEASONALITY
The Company began marketing the Breathe Right nasal strip on a broad scale in
September 1994. Given the short time frame since introduction of the Breathe
Right nasal strip and the rapid revenue growth experienced by the Company in
1995, it is difficult to ascertain what, if any, impact seasonality has had
on sales of the Breathe Right nasal strip during 1995. The Company believes
that sales of the product for the temporary relief of nasal congestion may be
higher during the fall and winter seasons because of increased use during the
cold season. If such seasonality occurs, the Company expects its net sales
and operating income to be relatively higher in the first and fourth
quarters. In November 1995, the Company received FDA clearance to market the
Breathe Right nasal strip for the reduction or elimination of snoring. The
Company believes that sales of the product for the snoring application may be
marginally higher during the allergy seasons, which occur during the second
and third quarters. Accordingly, the Company is unable to predict the extent
to which its business will be affected by seasonality.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1995, the Company had cash, cash equivalents and marketable
securities of $10.5 million, working capital of $25.9 million and a $1.25
million line of credit with a bank, subject to certain borrowing base
restrictions.
OPERATING ACTIVITIES. The Company used cash for operations of approximately
$1.5 million for 1995 compared with a use of cash of $4.2 million for 1994.
The improved cash flow was due to an increase in income from continuing
operations offset by increases in accounts receivable and inventories
resulting from higher sales levels.
INVESTING ACTIVITIES. The Company purchased $384,000 of property and
equipment in 1995 compared to $229,000 in 1994 to support increases in sales
of the Breathe Right nasal strip. Capitalized patent and trademark costs were
approximately $73,000 in 1995 compared to $91,000 in 1994.
The Company currently expects to spend up to an aggregate of $7.5 million on
capital expenditures in 1996 and 1997 in order to among other things supplement
its in-house manufacturing capability and to expand and upgrade management
information systems. The Company has not yet finalized its plans for these
expenditures or received bids on these projects. The final amount of the
expenditures as well as the timing of the expenditures may be subject to change.
FINANCING ACTIVITIES. In June 1995, the Company sold all the assets of its
sleep disorder diagnostic products business. Proceeds from the sale included
$5.0 million cash and a note receivable of $596,000 that was collected later
in 1995. The Company also received $1.1 million in 1995 from the exercise of
stock options and warrants. In 1994 the Company completed a public offering
of common stock for $9.7 million and received $507,000 from the exercise of
stock options and warrants.
At December 31, 1995, the Company had a $1.25 million bank line of credit.
Borrowings are due on demand, bear interest at 1% over a defined base rate
(8.5% at December 31, 1995), are secured by substantially all assets of the
Company and are subject to certain restrictive covenants. Borrowings are
limited to the lesser of $1.25 million or 75% of eligible accounts
receivable. There were no borrowings against this line of credit as of
December 31, 1995. The credit line expires on March 31, 1996.
The Company believes that its existing funds and funds generated from
operations, together with any proceeds received in its pending public offering
of Common Stock, will be sufficient to support its planned operations for the
foreseeable future.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1995, the Financial Accounting Standards Board issued Statement No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of (SFAS No. 121). SFAS No. 121 prescribes accounting
and reporting standards when circumstances indicate that the carrying amount
of an asset may not be recoverable. The Company adopted SFAS No. 121 during
1995 and it had no impact on the Company's financial statements.
In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, Accounting for Stock-Based Compensation. In 1996, the Company
intends to adopt the disclosure provisions of this Statement while continuing
to account for options and other stock-based compensation using the intrinsic
value based method.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 for a listing of the financial information filed with this
Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information required under this Item with respect to directors
is contained in the Section "Election of Directors" in the Company's Proxy
Statement for the Annual Meeting of Shareholders to be held in April 1996 (the
"1996 Proxy Statement"), a definitive copy of which will be filed with the
Commission within 120 days of the close of the past fiscal year, and is
incorporated herein by reference.
Information concerning executive officers is set forth in the Section
entitled "Executive Officers of the Company" in Part I of this Form 10-K
pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the section
entitled "Executive Compensation" in the 1996 Proxy Statement and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information required under this item is contained in the section
entitled "Security Ownership of Principal Shareholders and Management" in the
Company's 1996 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
a. Documents filed as part of this Report:
1. Financial Statements. At page F-1, see Index to Financial
Statements which are attached hereto beginning at page F-2.
2. Financial Statement Schedules. At page S-1, see Index to
Financial Statement Schedules which are attached hereto
beginning on page S-2.
3. Exhibits. See "Exhibit Index" on the page following the
Financial Statement Schedules.
b. Reports on Form 8-K. The Company did not file a report on Form 8-K
during the fourth quarter ended December 31, 1995.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CNS, INC.
("Registrant")
Dated: March 8, 1996 By /s/ Daniel E. Cohen, M.D.
--------------------------
Daniel E. Cohen, M.D.
Chairman of the Board, Chief
Executive Officer, Treasurer and
Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on March 8, 1996 on behalf
of the Registrant in the capacities indicated.
(Power of Attorney)
Each person whose signature appears below constitutes and appoints
DANIEL E. COHEN, M.D. and PATRICK DELANEY as his true and lawful
attorneys-in-fact and agents, each acting alone, with the full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any or all amendments to this Annual Report on
Form 10-K and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, each acting alone, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all said
attorneys-in-fact and agents, each acting alone, or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.
/s/ Daniel E. Cohen, M.D.
Daniel E. Cohen, M.D.
Chairman of the Board and Chief Executive
Officer, Treasurer and Director
(Principal Executive Officer)
/s/ Richard E. Jahnke
Richard E. Jahnke
Director, President and
Chief Operating Officer
/s/ David J. Byrd
David J. Byrd
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer)
/s/ Patrick Delaney
Patrick Delaney
Director
/s/ R. Hunt Greene
R. Hunt Greene
Director
/s/ Andrew J. Greenshields
Andrew J. Greenshields
Director
/s/ Richard W. Perkins
Richard W. Perkins
Director
CNS, INC.
INDEX TO FINANCIAL STATEMENTS
PAGE
Independent Auditors' Report F-2
Balance Sheets as of December 31, 1994 and 1995 F-3
Statements of Operations for the Years Ended December 31, 1993, 1994, and 1995 F-4
Statements of Stockholders' Equity for the Years Ended December 31, 1993, 1994, and 1995 F-5
Statements of Cash Flows for the Years Ended December 31, 1993, 1994, and 1995 F-6
Notes to Financial Statements F-7
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
CNS, Inc.:
We have audited the accompanying balance sheets of CNS, Inc. as of December
31, 1994 and 1995 and the related statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1995. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CNS, Inc. as of December 31,
1994 and 1995 and the results of its operations and its cash flows for each
of the years in the three-year period ended December 31, 1995 in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
Minneapolis, Minnesota
January 26, 1996
CNS, INC.
BALANCE SHEETS
DECEMBER 31, 1994 AND 1995
ASSETS
1994 1995
Current assets:
Cash and cash equivalents $ 783,704 $ 8,551,919
Marketable securities 5,240,662 1,950,354
Accounts receivable, net of allowance for doubtful accounts 936,279 7,830,793
of $55,000 in 1994 and $201,000 in 1995
Inventories 1,125,009 11,100,909
Prepaid expenses and other current assets 245,619 997,674
Deferred income taxes 0 879,000
Net assets of discontinued operations 2,865,520 0
Total current assets 11,196,793 31,310,649
Property and equipment, net 303,574 558,999
Patents and trademarks, net 112,504 126,887
Certificate of deposit, restricted 0 320,000
Deferred income taxes 0 24,000
$ 11,612,871 $32,340,535
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 272,039 $ 3,778,077
Accrued expenses 134,297 1,169,116
Accrued income taxes 0 508,000
Total current liabilities 406,336 5,455,193
Stockholders' equity:
Common stock--$.01 par value:
Authorized 50,000,000 shares; issued and outstanding 170,416 173,878
17,041,656 shares in 1994 and 17,387,852 shares in 1995
Additional paid-in capital 24,229,583 25,828,434
Retained earnings (deficit) (13,193,464) 883,030
Total stockholders' equity 11,206,535 26,885,342
Commitments (notes 10 and 11) $ 11,612,871 $32,340,535
The accompanying notes are an integral part of the financial statements.
CNS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 1993, 1994, AND 1995
1993 1994 1995
Net sales $ 93,352 $ 2,798,174 $48,631,855
Cost of goods sold 48,512 1,789,545 17,554,413
Gross profit 44,840 1,008,629 31,077,442
Operating expenses:
Marketing and selling 0 3,099,806 16,695,428
General and administrative 440,394 666,459 1,983,928
Total operating expenses 440,394 3,766,265 18,679,356
Operating income (loss) (395,554) (2,757,636) 12,398,086
Other income (expense):
Interest income 21,801 207,480 583,919
Interest expense (15,000) (7,945) (12,500)
Other income 90,000 0 0
Other income, net 96,801 199,535 571,419
Income (loss) from continuing operations (298,753) (2,558,101) 12,969,505
before income taxes
Income tax benefit 0 0 341,000
Income (loss) from continuing operations (298,753) (2,558,101) 13,310,505
Loss from operations of discontinued sleep division (1,132,020) (309,314) (459,901)
(less applicable income tax benefit of $0, $0, and
$259,000 in 1993, 1994, and 1995, respectively)
Gain on sale of sleep division (less applicable 0 0 1,225,890
income taxes of $0, $0, and $690,000 in 1993, 1994,
and 1995, respectively)
Net income (loss) $(1,430,773) $(2,867,415) $14,076,494
Net income (loss) per common and common equivalent
share:
From continuing operations $ (0.02) $ (0.16) $ 0.72
From discontinued operations (0.09) (0.02) 0.04
Net income (loss) per share $ (0.11) $ (0.18) $ 0.76
Weighted average number of common and common
equivalent shares outstanding 13,145,276 15,754,586 18,375,525
The accompanying notes are an integral part of the financial statements.
CNS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995
COMMON STOCK
ADDITIONAL RETAINED TOTAL
NUMBER PAR PAID-IN EARNINGS STOCKHOLDERS'
OF SHARES VALUE CAPITAL (DEFICIT) EQUITY
Balance at December 31, 1992 13,124,202 $131,242 $13,964,561 $ (8,895,276) $ 5,200,527
Stock issued in connection with 21,502 216 32,165 0 32,381
Employee Stock Purchase Plan
Stock options exercised 57,400 574 68,797 0 69,371
Net loss for the year 0 0 0 (1,430,773) (1,430,773)
Balance at December 31, 1993 13,203,104 132,032 14,065,523 (10,326,049) 3,871,506
Proceeds from public stock 3,450,000 34,500 9,627,382 0 9,661,882
offering less issuance costs of
$1,119,368
Stock issued in connection with 15,552 154 33,676 0 33,830
Employee Stock Purchase Plan
Stock options exercised 133,000 1,330 163,352 0 164,682
Warrants exercised 240,000 2,400 339,600 0 342,000
Warrants issued 0 0 50 0 50
Net loss for the year 0 0 0 (2,867,415) (2,867,415)
Balance at December 31, 1994 17,041,656 170,416 24,229,583 (13,193,464) 11,206,535
Stock issued in connection with 5,365 54 22,377 0 22,431
Employee Stock Purchase Plan
Stock options exercised 129,870 1,299 379,034 0 380,333
Tax benefit from stock options 0 0 485,000 0 485,000
exercised
Warrants exercised, less 210,961 2,109 712,440 0 714,549
issuance costs of $35,438
Net income for the year 0 0 0 14,076,494 14,076,494
Balance at December 31, 1995 17,387,852 $173,878 $25,828,434 $ 883,030 $26,885,342
The accompanying notes are an integral part of the financial statements.
CNS, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
1993 1994 1995
Operating activities:
Net income (loss) $(1,430,773) $(2,867,415) $14,076,494
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Net gain on sale of assets of discontinued 0 0 (1,915,890)
operations
Depreciation and amortization 3,886 59,707 184,135
Deferred income taxes 0 0 (418,000)
Loss on sale of fixed assets 0 0 3,293
Changes in operating assets and liabilities:
Accounts receivable (191,727) (744,552) (6,894,514)
Inventories (407,383) (717,626) (9,975,900)
Prepaid expenses and other current assets (50,135) (195,484) (752,055)
Net assets of discontinued operations 890,745 205,433 (814,201)
Accounts payable 235,879 36,160 3,506,038
Accrued expenses 115,502 18,795 1,034,819
Accrued income taxes 0 0 508,000
Net cash used in operating activities (834,006) (4,204,982) (1,457,781)
Investing activities:
Change in marketable securities 0 (5,240,662) 3,290,308
Payments for purchases of property and equipment (99,215) (229,414) (383,810)
Payments for patents and trademarks (60,136) (90,906) (73,426)
Purchase of certificate of deposit, restricted 0 0 (320,000)
Net proceeds from promissory note 0 0 595,611
Net cash provided by (used in) investing activities (159,351) (5,560,982) 3,108,683
Financing activities:
Net proceeds from sale of discontinued operations 0 0 5,000,000
Net proceeds from public stock offering 0 9,661,932 0
Proceeds from the issuance of common stock 32,381 33,830 22,431
under Employee Stock Purchase Plan
Proceeds from the exercise of stock options 69,371 164,682 380,333
Proceeds from exercise of common stock warrants 0 342,000 714,549
Net cash provided by financing activities 101,752 10,202,444 6,117,313
Net (decrease) increase in cash and (891,605) 436,480 7,768,215
cash equivalents
Cash and cash equivalents:
Beginning of year 1,238,829 347,224 783,704
End of year $ 347,224 $ 783,704 $ 8,551,919
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 10,000 $ 12,945 $ 12,500
Supplemental schedule of noncash operating and investing activities:
A note receivable of $595,611 was obtained in 1995 as a result of the sale
of the Sleep Products
Disorder Diagnostic Division.
The accompanying notes are an integral part of the financial statements.
CNS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
CNS, Inc. (the "Company"), designs, manufactures and markets consumer
products, primarily the Breathe Right nasal strip. The Breathe Right nasal
strip is a nonprescription, single use, disposable device that can reduce or
eliminate snoring by improving nasal breathing and temporarily relieve nasal
congestion. The Breathe Right nasal strip is sold over-the-counter in retail
outlets, including drug, grocery and mass merchant stores, primarily in the
U.S. During 1995, the Company signed an international distribution agreement
with 3M Company to market Breathe Right nasal strips outside the U.S. and
Canada.
REVENUE RECOGNITION
Revenue from sales is recognized at the time products are shipped.
ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments requires disclosure of the fair value of all
financial instruments to which the company is a party. All financial
instruments are carried at amounts that approximate estimated fair value.
CASH EQUIVALENTS
Cash equivalents at December 31, 1995 consist primarily of U.S. Treasury
bills.
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or
less to be cash equivalents.
MARKETABLE SECURITIES
The Company classifies its marketable debt securities as available-for-sale
and records these securities at fair market value. Net realized and
unrealized gains and losses are determined on the specific identification
cost basis. Any unrealized gains and losses are reflected as a separate
component of stockholders' equity. A decline in the market value of any
available-for-sale or held-to-maturity security below cost that is deemed
other than temporary, results in a charge to operations resulting in the
establishment of a new cost basis for the security.
INVENTORIES
Inventories are valued at the lower of cost (determined on a first-in,
first-out basis) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment is depreciated using the
straight-line method over five years. Leasehold improvements are amortized
over the lesser of the estimated useful life of the improvement or the term
of the lease.
PATENTS AND TRADEMARKS
Patents and trademarks are stated at cost and are amortized over three years
using the straight-line method.
FOREIGN SALES
Foreign sales are made in U.S. dollars only. There are no currency
conversions.
ADVERTISING
The Company adopted Statement of Position No. 93-7, Reporting on Advertising
Costs, January 1, 1995. This SOP requires that all advertising costs be
expensed as incurred or the first time the advertising takes place, except
for direct response advertising, which can be capitalized and written off
over the period during which the benefits are expected. The adoption did not
have a material effect on the financial statements of the Company.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes. Under
this method, deferred tax liabilities and assets and the resultant provision
for income taxes are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse.
NET INCOME (LOSS) PER SHARE
Net income per share has been computed based upon the weighted average number
of common and common equivalent shares outstanding during the year. Net loss
per common share has been computed using the weighted average number of
common shares outstanding during the year.
All share and per share amounts in the accompanying financial statements have
been retroactively adjusted to reflect a two-for-one stock split to
stockholders of record on June 1, 1995, which was distributed on June 22,
1995. The par value remained at $.01 per share.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1995 the Financial Accounting Standards Board issued Statement No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of (SFAS No. 121). SFAS No. 121 prescribes accounting
and reporting standards when circumstances indicate that the carrying amount
of an asset may not be recoverable. The Company adopted SFAS No. 121 during
1995, which had no impact on the financial statements.
In October 1995 the Financial Accounting Standards Board issued Statement No.
123, Accounting for Stock-Based Compensation. In 1996 the Company intends to
adopt the disclosure provisions of the statement while continuing to account
for options and other stock-based compensation using the intrinsic
value-based method.
2. SALE OF DIVISION
On June 1, 1995 the Company completed the sale of all the assets of its Sleep
Disorder Diagnostic Products Division ("Sleep"). Net sale proceeds of
$5,000,000 cash and a note receivable of $595,611 resulted in a gain on the
sale of discontinued operations of $1,915,890. The net loss of this operation
is shown on the statement of operations as the loss from discontinued
operations. The net assets of Sleep were $2,865,520 at December 31, 1994.
3. MARKETABLE SECURITIES
Marketable securities consist of U.S. Treasury bills and a U.S. Government
money market fund. Investments are recorded at cost plus accrued interest
earned. Due to the short-term maturity of the Company's marketable
securities, the market value approximates their carrying value.
4. ADVERTISING
The Company expenses the production costs of advertising the first time the
advertising takes place.
At December 31, 1994 and 1995 $226,969 and $561,493, respectively, of
advertising costs were reported as assets. Advertising expense was $0,
$2,429,205, and $11,839,033 in 1993, 1994, and 1995, respectively.
5. DETAILS OF SELECTED BALANCE SHEET ACCOUNTS
DECEMBER 31,
1994 1995
Inventories:
Finished goods $ 932,407 $ 9,364,102
Work in process 171 199,765
Raw materials and component parts 192,431 1,537,042
Total inventories $1,125,009 $11,100,909
Property and equipment:
Production equipment $ 248,368 $ 526,717
Office equipment 68,135 127,491
Leasehold improvements 12,126 46,105
328,629 700,313
Less accumulated depreciation and 25,055 141,314
amortization
Property and equipment, net $ 303,574 $ 558,999
Patents and trademarks:
Patents and trademarks $ 151,042 $ 224,468
Less accumulated amortization (38,538) (97,581)
Patents and trademarks, net $ 112,504 $ 126,887
Accrued expenses:
Royalty and commissions (draws) $ (10,901) $ 643,008
Promotions 29,950 385,657
Vacations 61,692 102,221
Other 53,556 38,230
Total accrued expenses $ 134,297 $ 1,169,116
6. LINE OF CREDIT
The Company has a $1.25 million bank line of credit. Borrowings are due on
demand, bear interest at 1% over a defined base rate (8.5% at December 31,
1995), are secured by substantially all assets of the Company, and are
subject to certain restrictive covenants. Borrowings are limited to
$1,250,000 or 75% of eligible accounts receivable. There were no borrowings
against this line of credit as of December 31, 1995. The line of credit
expires on March 31, 1996.
7. STOCKHOLDERS' EQUITY
STOCK OPTIONS
The Company's stock option plans allow for grant of options to officers,
directors, and employees to purchase up to 2,200,000 shares of common stock
at exercise prices not less than 100% of fair market value on the dates of
grant. The term of the options may not exceed ten years.
Stock option activity under these plans is summarized as follows:
OPTION PRICE AVAILABLE
PER SHARE OUTSTANDING FOR GRANT
Balance at December 31, 1992 $ 1.155 - 2.125 353,400 717,222
Granted 1.3125 - 2.3125 386,000 (386,000)
Exercised 1.155 - 2.125 (57,400) 0
Balance at December 31, 1993 1.155 - 2.3125 682,000 331,222
1994 plan - 0 1,000,000
Granted 3.095 - 4.125 530,000 (530,000)
Exercised 1.155 - 2.3125 (133,000) 0
Canceled 1.47 - 2.3125 (31,400) 31,400
Balance at December 31, 1994 1.155 - 3.50 1,047,600 832,622
Granted 4.50 - 16.125 698,000 (698,000)
Exercised 1.155 - 11.375 (129,870) 0
Canceled 2.125 - 5.50 (107,430) 107,430
Balance at December 31, 1995 $ 1.155 - 16.125 1,508,300 242,052
Currently exercisable options aggregated 263,040 shares and 653,000 shares of
common stock at December 31, 1994 and 1995, respectively.
The 1990 stock option plan allows for the grant of shares of restricted
common stock. No shares of restricted common stock have been granted under
this plan as of December 31, 1995.
EMPLOYEE STOCK PURCHASE PLAN
The Employee Stock Purchase Plan allows eligible employees to purchase shares
of the Company's common stock through payroll deductions. The purchase price
is the lower of 85% of the fair market value of the stock on the first or
last day of each six-month period during which an employee participated in
the plan. The Company has reserved 200,000 shares under the plan of which
135,493 shares have been purchased by employees as of December 31, 1995.
WARRANTS
During 1995 warrants to purchase 200,000 shares at $3.75 were exercised. The
warrants had been issued in 1994 to the underwriter of the Company's 1994
public stock offering.
In connection with an agreement to license a product to be marketed as the
Breathe Right device, the licenser was issued a warrant to purchase 100,000
shares of the Company's common stock exercisable at a price of $2.75 per
share which expires March 1997. During 1995 a total of 12,500 shares were
exercised.
During 1994 warrants to purchase 240,000 shares at $1.425 were exercised. The
warrants had been issued in 1992 to the underwriter of the Company's 1992
public stock offering.
PREFERRED STOCK
At December 31, 1995, the Company is authorized to issue 1,000,000 shares of
Series A Junior Participating Preferred Stock upon a triggering event under
the Company's stockholders' Rights Plan and 7,483,589 shares of undesignated
preferred stock.
8. INCOME TAXES
Income tax expense (benefit), from continuing operations, for the three years
ended December 31, 1995, excluding tax on discontinued operations, is as
follows (in thousands):
CURRENT DEFERRED TOTAL
1995:
Federal $532 $(853) $(321)
State 30 (50) (20)
$562 $(903) $(341)
There was no tax expense in 1994 and 1993.
Income tax expense (benefit) attributable to income from continuing
operations differed from the amounts computed by applying the U.S. federal
income tax rate of 35% as a result of the following (in thousands):
DECEMBER 31,
1993 1994 1995
Computed tax expense (benefit) $(105) $(895) $ 4,539
State taxes, net of federal benefit 0 0 389
Change in income tax benefit resulting from tax benefit of 105 895 0
net operating loss not recognized for financial statement
purposes
Change in deferred tax asset valuation allowance 0 0 (5,439)
Other 0 0 170
Actual tax expense (benefit) $ 0 $ 0 $ (341)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities calculated
using an effective tax rate of 40% and 37% for 1994 and 1995, respectively,
are presented below (in thousands):
DECEMBER 31,
1994 1995
Deferred tax assets:
Inventory items $ 214 $275
Accounts receivable allowance 53 74
Property and equipment 0 25
Accrued expenses 120 213
Deferred maintenance 113 0
contracts
Tax credits 312 316
Net operating loss 4,686 0
5,498 903
Less valuation allowance 5,439 0
59 903
Deferred tax liabilities:
Property and equipment (59) 0
Net deferred tax assets $ 0 $903
A valuation allowance is provided when there is some likelihood that all or a
portion of a deferred tax asset may not be realized. The Company has
determined that establishing a valuation allowance for the deferred tax
assets as of December 31, 1995 is not required since it is more likely than
not that the deferred tax assets will be realized principally through future
taxable income. Based on tax rates in effect at December 31, 1995
approximately $2,500,000 of future taxable income is required prior to
December 31, 2009 for full realization of the net deferred tax asset.
The Company has federal and state tax credit carryforwards of $316,000 at
December 31, 1995 which are available to reduce income taxes payable in
future years and expire between 1999 and 2009.
9. SALES
The Company had two significant customers who accounted for approximately 37%
of Breathe Right product sales for the year ended December 31, 1994 and had
one significant customer who accounted for approximately 13% of Breathe Right
product sales for the year ended December 31, 1995. Accounts receivable from
these customers as of December 31, 1994 and 1995 were $388,386 and
$1,319,137, respectively.
Foreign sales were not significant in 1993, 1994 or 1995.
10. LICENSE AGREEMENT
On January 30, 1992 the Company entered into an agreement to exclusively
license a product to be marketed as the Breathe Right device. Royalties due
under this agreement are based on a sliding percentage of sales beginning at
5% and declining to 3%. Future royalties will be at 3%. To maintain the
Company's license, it must make minimum royalty payments of $160,000 in 1996;
$300,000 in 1997; and $450,000 each year thereafter until the patent for the
product expires. Royalty expense in 1993, 1994, and 1995 was $20,000,
$110,844, and $1,458,473, respectively.
11. OPERATING LEASES
The Company leases equipment and office space under noncancelable operating
leases which expire over the next five years. Future minimum lease payments
due in accordance with these leases as of December 31, 1995 are as follows:
YEAR ENDING DECEMBER 31, AMOUNT
1996 $ 319,028
1997 402,410
1998 402,410
1999 402,410
2000 368,876
$1,895,134
Total rental expense for operating leases was $351,659 in 1993, $350,859 in
1994, and $376,873 in 1995.
The Company's office space lease requires a $320,000 letter of credit to
remain with the lessor. The letter of credit is secured by a $320,000
certificate of deposit which bears interest at 5.75% per annum and matures on
April 30, 1998.
CNS, INC.
INDEX TO FINANCIAL STATEMENT SCHEDULES
Schedule
Designation
(if applicable) Description Page
- --------------- ----------- ----
Independent Auditors' S-2
Report on Financial Statement
Schedules
II Valuation and Qualifying S-3
Accounts
All other schedules are omitted as the required information is inapplicable or
the information is presented in the financial statements or related notes.
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Stockholders
CNS, Inc.:
Under date of January 26, 1996, we reported on the balance sheets of CNS, Inc.
as of December 31, 1995 and 1994, and the related statements of operations,
stockholders' equity and cash flows, for each of the years in the three-year
period ended December 31, 1995, as contained in the 1995 annual report on Form
10-K to stockholders. These financial statements and our report thereon are
included in the 1995 annual report on Form 10-K. In connection with our audits
of the aforementioned financial statements, we also have audited the related
financial statement schedule as listed in the accompanying index. This financial
statement schedule is the responsiblity of the Company's management. Our
responsiblity is to express an opinion on this financial statement schedule
based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
KPMG Peat Marwick LLP
Minneapolis, Minnesota
January 26, 1996
Schedule II
CNS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Balance Balance
at the Additions at the
beginning charged to end
of period expense Deductions of period
--------- ------- ---------- ---------
Year ended December 31, 1993:
Allowance for doubtful accounts $ 0 0 0 $ 0
Year ended December 31, 1994:
Allowance for doubtful accounts $ 0 54,600 0 $ 54,600
Year ended December 31, 1995:
Allowance for doubtful accounts $54,600 154,502 8,113 $200,989
CNS, INC.
EXHIBIT INDEX
Exhibit No. Description
3.1 Company's Certificate of Incorporation as amended to date.
3.1.1 Certificate of Retirement for the Preferred Stock of the
Company which was redeemed and converted to Common Stock on
April 16, 1992 (incorporated by reference to Exhibit 3.1.1 to
the Company's Registration Statement on Form S-2 filed with
the Commission on March 2, 1994 (the "1994 Form S-2")).
3.1.2 Certificate of Designation, Preferences and Rights of Series A
Junior Participating Preferred Stock (incorporated by
reference to Exhibit 1 to the Company's Form 8-A dated July
21, 1995).
3.2 Company's Amended By-Laws (incorporated by reference to
Exhibit 3.2 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1991 (the "1991 Form 10-K")).
10.1 CNS, Inc. 1987 Employee Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-18, Commission File No.
33-14052C (the "Form S-18")).
10.2 Employment Agreement between the Company and Dr. Daniel E.
Cohen dated February 13, 1984 (incorporated by reference to
Exhibit 10.6 to the Form S-18.)
10.2.1 Memorandum dated February 7, 1991 amending Employment
Agreement between the Company and Dr. Daniel E. Cohen
(incorporated by reference to Exhibit 10.5.1 to the 1991 Form
10-K).
10.2.2 Amendment dated as of January 1, 1994 to Employment Agreement
between the Company and Dr. Daniel E. Cohen (incorporated by
reference to Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1995 (the "March 31,
1995 Form 10- Q)).
10.3 Loan Agreement with Riverside Bank dated March 31, 1995
(incorporated by reference to Exhibit 10.3 to the March 31,
1995 Form 10-Q).
10.4 CNS, Inc. 1989 Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.9 to the Company's Registration
Statement on Form S-8, Commission File No. 33-29454).
10.5 CNS, Inc. 1990 Stock Plan (incorporated by reference to
Exhibit 10.11 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1990).
10.6 Employment Agreement dated February 22, 1988 between the
Company and William Doubek (incorporated by reference to
Exhibit 10.9 to the Company's Registration Statement on Form
S-2, Commission File No. 33-46120 (the "1992 Form S-2")).
10.7 License Agreement dated January 30, 1992 between the Company
and Creative Integration and Design, Inc. (incorporated by
reference to Exhibit 10.11 to the 1992 Form S-2).
10.8 Employment Agreement dated March 8, 1993 between the Company
and Richard E. Jahnke (incorporated by reference to Exhibit
10.16 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1992).
10.8.1 Amendment dated as of January 1, 1994 to Employment Agreement
between the Company and Richard E. Jahnke (incorporated by
reference to Exhibit 10.1 to the March 31, 1995 Form 10- Q).
10.9 Employment Agreement dated February 21, 1994 between the
Company and Kirk Hodgdon (incorporated by reference to Exhibit
10.18 to the 1994 Form S-2).
10.10 CNS, Inc. 1994 Stock Plan (incorporated by reference to
Exhibit 10.14 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994).
10.11 Distribution Agreement dated August 2, 1995 between the
Company and Minnesota Mining and Manufacturing Company
(certain information has been omitted from this exhibit and
filed separately with the SEC pursuant to a request for
confidential treatment under Rule 24b-2).
10.12 Supply Agreement dated May 17, 1995 between the Company and
Minnesota Mining and Manufacturing Company (certain
information has been omitted from this exhibit and filed
separately with the SEC pursuant to a request for confidential
treatment under Rule 24b-2).
10.13 Asset Purchase Agreement dated May 8, 1995 between the Company
and Aequitron Medical, Inc. (incorporated by reference to
Exhibit 10.4 to the March 31, 1995 Form 10-Q).
10.14 Non-Exclusive Distributorship Agreement dated May 8, 1995
between the Company and Aequitron Medical, Inc. (incorporated
by reference to Exhibit 10.5 to the March 31, 1995 Form 10-Q).
10.15 License Agreement dated January 24, 1996 between the Company
and Ronald S. Nietupsky (certain information has been omitted
from this exhibit and filed separately with the SEC pursuant
to a request for confidential treatment under Rule 24b-2).
10.16 License Agreement dated February 26, 1996 between the Company
and Scott Dahlbeck, M.D. (certain information has been omitted
from this exhibit and filed separately with the SEC pursuant
to a request for confidential treatment under Rule 24b-2).
10.17 Option Agreement dated October 5, 1995 between the Company and
TruTek Corp. (certain information has been omitted from this
exhibit and filed separately with the SEC pursuant to a
request for confidential treatment under Rule 24b-2).
10.18 Marketing and Distribution Agreement dated as of January 11,
1996 between the Company, Natus Corporation and LecTec
Corporation (certain information has been omitted from this
exhibit and filed separately with the SEC pursuant to a
request for confidential treatment under Rule 24b-2).
11 Computation of Net Earnings (Loss) Per Share of Common Stock.
23.1 Consent of KPMG Peat Marwick LLP.
24 Powers of Attorney (included on the signature page hereof).
27 Financial Data Schedule.