SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934. For the Period Ended March 31, 1996. [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934. 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 of (I.R.S. Employer incorporation or organization) Identification No.) P.O. BOX 39802 MINNEAPOLIS, MN 55439 (Address of principal executive offices including zip code) (612) 820-6696 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES __X__ NO _____ At April 30, 1996, 19,144,552 shares of common stock were outstanding. This Form 10-Q consists of 13 pages (including Exhibits). The Index to Exhibits is set forth on page 9. PART I - FINANCIAL INFORMATION CNS, INC. CONDENSED BALANCE SHEETS (unaudited) March 31, December 31, 1996 1995 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $10,631,100 $ 8,551,919 Marketable securities 6,827,732 1,950,354 Accounts receivable, net 9,845,241 7,830,793 Inventories 7,634,652 11,100,909 Prepaid expenses and other current assets 1,150,397 997,674 Deferred income taxes 563,000 879,000 ----------- ----------- Total current assets 36,652,122 31,310,649 Property and equipment, net 664,297 558,999 Patents and trademarks, net 121,454 126,887 Certificate of deposit, restricted 320,000 320,000 Deferred income taxes 24,000 24,000 ----------- ----------- $37,781,873 $32,340,535 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses 5,641,445 4,947,193 Accrued income taxes 1,385,000 508,000 ----------- ----------- Total current liabilities 7,026,445 5,455,193 ----------- ----------- Stockholders' equity: Common stock - $.01 par value: Authorized 50,000,000 shares; issued and outstanding, 17,515,552 shares at March 31, 1996 and 17,387,852 shares at December 31, 1995 175,156 173,878 Additional paid-in capital 26,596,305 25,828,434 Retained earnings 3,983,967 883,030 ----------- ----------- Total stockholders' equity 30,755,428 26,885,342 ----------- ----------- $37,781,873 $32,340,535 =========== =========== The accompanying notes are an integral part of the condensed financial statements. CNS, INC. CONDENSED STATEMENTS OF OPERATIONS (unaudited) Three Months Ended March 31, --------------------------- 1996 1995 ------------ ------------ Net sales $ 20,820,761 $ 7,459,238 Cost of goods sold 7,651,631 2,850,285 ------------ ------------ Gross profit 13,169,130 4,608,953 ------------ ------------ Operating expenses: Marketing and selling 7,430,097 2,139,359 General and administrative 737,660 254,032 Product development 157,261 46,571 ------------ ------------ Total operating expenses 8,325,018 2,439,962 ------------ ------------ Operating income 4,844,112 2,168,991 Interest income 154,825 84,175 ------------ ------------ Income from continuing operations before income taxes 4,998,937 2,253,166 Income tax provision 1,898,000 -- ------------ ------------ Income from continuing operations 3,100,937 2,253,166 Loss from operations of discontinued sleep division -- 450,404 ------------ ------------ Net income $ 3,100,937 $ 1,802,762 ============ ============ Net income per common and common equivalent share: From continuing operations $ .17 $ .12 From discontinued operations -- (.02) ------------ ------------ Net income per share $ .17 $ .10 ============ ============ Weighted average number of common and common equivalent shares outstanding 18,706,000 18,174,000 ============ ============ The accompanying notes are an integral part of the condensed financial statements. CNS, INC. CONDENSED STATEMENTS OF CASH FLOWS (unaudited) Three Months Ended March 31, ---------------------------- 1996 1995 ------------ ------------ Operating activities: Net income $ 3,100,937 $ 1,802,762 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 54,617 54,797 Deferred income taxes 316,000 -- Changes in operating assets and liabilities: Accounts receivable (2,014,448) (3,028,570) Inventories 3,466,257 415,086 Prepaid expenses and other current assets (152,723) 122,893 Net assets of discontinued operations -- 49,653 Accounts payable and accrued expenses 1,571,252 2,241,245 ------------ ------------ Net cash from operating activities 6,341,892 1,657,866 ------------ ------------ Investing activities: Change in marketable securities (4,877,378) 1,040,533 Payments for purchases of property and equipment (141,210) (58,757) Payments for patents and trademarks (13,272) (19,671) ------------ ------------ Net cash from investing activities (5,031,860) 962,105 ------------ ------------ Financing activities: Proceeds from the exercise of stock options 769,149 41,824 ------------ ------------ Net cash from financing activities 769,149 41,824 ------------ ------------ Net change in cash and cash equivalents 2,079,181 2,661,795 Cash and cash equivalents: Beginning of period 8,551,919 2,051,957 ------------ ------------ End of period $ 10,631,100 $ 4,713,752 ============ ============ The accompanying notes are an integral part of the condensed financial statements. NOTES TO CONDENSED FINANCIAL STATEMENTS The accompanying condensed financial statements as of March 31, 1996 and 1995 are unaudited but, in the opinion of management, include all adjustments (consisting only of normal, recurring accruals) necessary for a fair presentation of results for the interim periods presented. The accounting principles followed in the preparation of the financial information contained herein are the same as those described in the Form 10-K report for the year ended December 31, 1995, and reference is hereby made to that report for detailed information on accounting policies. 1. The Company has a $1.25 million bank line of credit. Borrowings are due on demand, bear interest at 1% over a defined base, are secured by substantially all assets of the Company and are subject to certain restrictive covenants. Borrowings are limited to 80% of eligible accounts receivable. There were no borrowings against this line of credit as of March 31, 1996. The line of credit expires on June 30, 1996. 2. During April 1996, the Company completed a public offering of 1,725,000 shares of common stock. Of these shares, 1,525,000 shares were sold by the Company and 200,000 shares by selling shareholders. Net proceeds to the Company were approximately $35 million. The primary use of the net proceeds will be to provide working capital for marketing , advertising and promotion expenses; to finance the purchase and construction of equipment, plant and machinery to develop certain supplementary in-house manufacturing capability; to expand and upgrade management information systems; and for other general corporate purposes. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The Company's current revenues are derived from the manufacture and sale of the Breathe Right nasal strip, which is a nonprescription disposable device that can reduce or eliminate snoring by improving nasal breathing and temporarily relieve nasal congestion. The Company also has entered into several agreements to market or license certain new medical consumer products that are in various stages of evaluation and testing. In 1995, the Company divested itself of all the assets of its sleep disorder diagnostic products division. Unless otherwise noted, the following discussion of financial condition and results of operations relates only to continuing operations of the Company. Results of Operations: Net sales increased to $20.8 million for the first quarter of 1996 from $7.5 million for the same quarter of 1995. Breathe Right sales increased in part as a result of increased advertising, particularly national television and radio. Unlike sales for the first quarter of 1995, which reflected an increase in inventory levels at existing and new retail outlets, sales during the first quarter of 1996 paralleled off the shelf movement at retail due to increased consumer demand. International sales were $2.8 million for the first quarter of 1996, which represented primarily initial inventory purchases by 3M, the Company's international distributor and initial stocking of inventory at international retail outlets in certain countries. Gross profit was $13.2 million for the first quarter of 1996 compared to $4.6 million for the same quarter of 1995. Gross profit as a percentage of net sales, improved to 63.2% for the first quarter of 1996 compared to 61.8% for the same quarter of 1995 as a result of the efficiencies realized from the higher level of Breathe Right nasal strip sales. Gross profit as a percentage of net sales was lower than the fourth quarter of 1995 level of 65.9% due to the higher level of international sales in the first quarter of 1996. International sales to 3M are at a lower gross profit margin than domestic sales, because 3M is responsible for substantially all of the operating expenses and a portion of the packaging costs of the product. Marketing and selling expenses were $7.4 million for the first quarter of 1996 compared to $2.1 million for the same quarter of 1995. This increase resulted primarily from marketing expenses associated with national television and radio advertising. General and administrative expenses were $738,000 for the first quarter of 1996 compared to $254,000 for the same quarter of 1995. This increase resulted from additional personnel and systems required to support growth of the Breathe Right nasal strip business. Product development expenses were $157,000 for the first quarter of 1996 compared to $47,000 for the same quarter of 1995. This increase resulted from costs related to evaluation and testing of potential new products. Interest income was $155,000 for the first quarter of 1996 compared to $84,000 for the same quarter of 1995, reflecting increased funds available for investment. Income before income taxes for the first quarter of 1996 increased to $5.0 million compared to $2.3 million for the same quarter of 1995. Income before income taxes as a percentage of net sales was 24.0% for the first quarter of 1996 compared to 30.2% for the same quarter of 1995, due to increased marketing expenses in the first quarter of 1996. Income tax expense for the first quarter of 1996 was $1.9 million or 38.0% of income before income taxes. There was no income tax expense in the first quarter of 1995 due to the utilization of net operating loss carry forwards. There are no net operating loss carry forwards available for 1996 or future years. Net income per share for the first quarter of 1996 was $.17 compared to $.12 per share from continuing operations for the same period of 1995. Net income per share from continuing operations would have been $.08 for the same quarter of 1995 on a fully taxed basis. 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, it is difficult to ascertain what, if any, impact seasonality has had on sales of the Breathe Right nasal strip. 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. Accordingly, the Company is unable to predict the extent to which its business will be affected by seasonality. Liquidity and Capital Resources: At March 31, 1996, the Company had cash and cash equivalents and marketable securities of $17.5 million, working capital of $29.6 million and a $1.25 million line of credit with a bank, subject to certain borrowing base restrictions The Company provided cash from operations of $6.3 million for the first quarter of 1996 compared with $1.7 million for the same quarter of 1995. The improved cash flow was primarily from an increase in net income, a decrease in inventories and an increase in accounts payable and accrued expenses, offset by an increase in accounts receivable. The Company purchased $4.9 million of marketable securities in the first quarter of 1996 and property and equipment of $141,000. The Company received $769,000 during the first quarter of 1996 from the exercise of stock options. At March 31, 1996, the Company had a $1.25 million bank line of credit. There were no borrowings against this line of credit as of March 31, 1996. The line of credit expires on June 30, 1996. During April 1996, the Company completed a public offering of 1,725,000 shares of common stock. Of these shares, 1,525,000 shares were sold by the Company and 200,000 shares by selling shareholders. Net proceeds to the Company were approximately $35 million. The primary use of the net proceeds will be to provide working capital for marketing, advertising and promotion expenses; to finance the purchase and construction of equipment, plant and machinery to develop certain supplementary in-house manufacturing capability; to expand and upgrade management information systems; and for other general corporate purposes. The Company believes that its existing funds and funds generated from operations will be sufficient to support its planned operations for the foreseeable future. PART II - OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information On January 11, 1996, the Company issued a press release (attached hereto as Exhibit 99.1) reporting that the Company had entered into an agreement with LecTec Corporation under which the Company will private-label and market LecTec's analgesic pain patch in the U.S. and Canada On March 5, 1996, the Company issued a press release (attached hereto as Exhibit 99.2) reporting that the U.S. Food and Drug Administration has cleared the Company's Breathe Right nasal strip for marketing with a new indication for use of the strip for the temporary relief of nasal congestion and stuffy nose. Item 6. Exhibits and Reports on Form 8-K Page -------------------------------- ---- (a) Exhibits: Exhibit No. 11, Calculation of Net Income Per Share 11 Exhibit No. 99.1, Press Release - LecTec Agreement 12 Exhibit No. 99.2, Press Release - FDA 13 Exhibit No. 27, Financial Data Schedule (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CNS, Inc. Registrant Date: May 10, 1996 By: /s/ Richard E. Jahnke Richard E. Jahnke President & Chief Operating Officer Date: May 10, 1996 By: /s/ David J. Byrd David J. Byrd Vice President of Finance and Chief Financial Officer