UNITED STATES
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
For the fiscal year ended December 31, 1997
OR
[ ] 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 (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
Preferred stock purchase rights
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 3, 1998, assuming as market value the price of $6.3125 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
approximately $103,643,000.
As of March 3, 1998, the Company had outstanding 18,393,059 shares of Common
Stock of $.01 par value per share.
Documents Incorporated by Reference: The Company's (i) Annual Report to
Stockholders for the year ended December 31, 1997, and (ii) Proxy Statement for
its Annual Meeting of Stockholders to be held on April 22, 1998, are
incorporated by reference into Parts II and III of this Form 10-K.
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 14
Item 3. Legal Proceedings........................................................................ 15
Item 4. Submission of Matters to a Vote of Security Holders...................................... 15
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 16
Item 6. Selected Financial Data.................................................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition.............................. 16
and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................... 16
Item 8. Financial Statements and Supplementary Data.............................................. 16
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................................. 16
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 17
Item 11. Executive Compensation................................................................... 17
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 17
Item 13. Certain Relationships and Related Transactions........................................... 17
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K................................................................... 18
SIGNATURES ......................................................................................... 19
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements
under the Private Securities Litigation Reform Act of 1995 that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those presently anticipated or projected. Such forward-looking
statements can be identified by the use of terminology such as "may," "will,"
"expect," "plan," "intend," "anticipate," "estimate," or "continue" or
comparable terminology. Factors that could cause actual results to differ from
the results discussed in the forward-looking statements include, but are not
limited to the following factors: (i) the Company's revenue and profitability is
currently reliant on sales of a single product, Breath Right nasal strips; (ii)
the Company's success will depend, to a large extent, on the enforceability and
comprehensiveness of the patents on the Breathe Right(R) nasal strip technology,
which have been, and in the future may be, the subject of litigation (see Item
3, Legal Proceedings); (iii) the markets in which the Company competes are
highly competitive; (iv) the Company will face challenges in successfully
introducing any new products; (v) the fact that the Company is dependant upon
contract manufacturers for the production of substantially all of its products;
(vi) the fact that the Company is partially dependent upon 3M Company for sale
of its products internationally, and (vii) the fact that the Company's products
are generally subject to government regulation.
PART I
ITEM 1. BUSINESS
GENERAL
CNS, Inc. (the "Company") develops and markets consumer products,
including the Breathe Right nasal strip. The Breathe Right strip improves
breathing by reducing nasal airflow resistance. It can be effective in
eliminating or reducing snoring, for the temporary relief of nasal congestion
and for the temporary relief of breathing difficulties due to a deviated nasal
septum. The Company recently launched BANISH (TM), a personal smoke deodorizer
that removes same-day tobacco smoke odor trapped in clothing and hair. The
Company also has entered into or is exploring a number of agreements to market
or license other new consumer products, including a chewable dietary fiber
tablet. These new products are in various stages of evaluation and testing.
PRODUCTS
BREATHE RIGHT NASAL STRIPS. The Breathe Right nasal strip is a
nonprescription single-use disposable device that improves breathing by reducing
nasal airflow resistance. The Company received 510(k) clearances from the United
States Food and Drug Administration ("FDA") to market the Breathe Right nasal
strip for improvement of nasal breathing (October 1993), reduction or
elimination of snoring (November 1995), temporary relief of nasal congestion
(February 1996) and temporary relief of breathing difficulties due to a deviated
nasal septum (May 1996). The Breathe Right nasal strip comes both in tan and a
nearly transparent product, the Breathe Right Near Clear(TM) nasal strip.
The Breathe Right nasal strip includes 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 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 consumer market in quantities of 10, 24 or 30 strips per box.
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 and $11.99 for a box of 30. The Company
introduced its new Breathe Right Near Clear nasal strips at a suggested retail
price of $11.99 for a box of 24.
The Company has begun its expansion of the Breathe Right product line
with the introduction of Breathe Right Near Clear nasal strips, a nearly
transparent product that the Company believes may help reduce the vanity issues
associated with daytime use of the Breathe Right product. The Company introduced
Breathe Right Near Clear nasal strips in the second half of 1997 and the strips
became available in stores in November.
The Company also intends to introduce additional non-nasal strip
products that carry the Breathe Right name and extend the Breathe Right product
line. Potential new products include a saline nasal spray and allergen barrier
pillow covers.
BANISH PERSONAL SMOKE DEODORIZER. Late in 1997, the Company began
introduction of the BANISH personal smoke deodorizer, a water based nontoxic
odorless spray that removes same day odor from clothes and hair. This product
does not cover up the tobacco smoke odor, it neutralizes it. The product is
available in 2 and 3 fl. oz. bottles and a 12 fl. oz. refill bottle. The Company
intends to begin national advertising of BANISH in the second quarter of 1998.
MARKETS
BREATHE RIGHT PRODUCT LINE. The Breathe Right nasal strip is sold
primarily in the consumer market, and to a lesser extent in the athletic market
and the professional medical market. A substantial number of potential users may
be included in more than one market.
CONSUMER MARKET. Air impedance in 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 are likely to use the Breathe
Right nasal strip as needed. People with these medical conditions are currently
the primary users of the product and are the primary targets of the Company's
advertising.
In November 1997, the Company began a focused campaign to increase
Breathe Right product sales in the consumer market, using a Breathe Right. SLEEP
TIGHT (TM). advertising campaign. The new campaign, with its emphasis on better
night time breathing and better sleep, provides an umbrella to point out the
benefits of Breathe Right strips for a variety of large consumer markets.
* Sleep quality can be enhanced by improving nasal breathing at
night with a Breath Right strip. Nearly 88% of all households
in the United States report nightly sleep disruptions, many of
which are related to poor breathing.
* Breathe Right nasal strips were effective in reducing snoring
loudness or eliminating snoring in 75% of the participants in
a clinical study. The Company believes that 78% of all
households have at least one snorer, and that approximately 37
million people snore regularly while another 50 million people
snore occasionally.
* Nasal congestion as a result of allergies affects
approximately 35 million Americans while substantially all
Americans suffer some nasal congestion annually as a result of
the common cold. 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).
* Approximately 12 million people in the United States suffer
from a deviated septum, a bend in the cartilage or bone that
divides the nostrils. Breathe Right strips were cleared by the
Food and Drug Administration in 1996 to provide temporary
relief from breathing difficulties associated with a deviated
septum.
ATHLETIC MARKET. 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. An exercise physiology study published
in peer-reviewed medical literature in 1997 concluded that the Breathe Right
nasal strip provided physiologic advantages in ventilation and heart rate during
mid-level exercise. Other exercise physiology studies are being conducted and
are expected to add to substantiation of the positive effects of the Breathe
Right nasal strips during exercise. The Breathe Right nasal strip has been used
by professional and collegiate athletes in sports such as football and hockey,
by race car drivers and horse racing jockeys and by recreational athletes,
including runners and bikers. 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.
PROFESSIONAL MEDICAL MARKET. The Company also sells Breathe Right nasal
strips to the professional medical market. Sales into this market have been
limited to date and the Company is reevaluating the best way to penetrate this
market.
BANISH PERSONAL SMOKE DEODORIZER. The Company believes there are
approximately 50 million adult smokers in the United States, 16 million of whom
are in positions that involve high interaction with others who could be offended
by smoke odor. There are also a significant number of additional Americans that
do not smoke, but are exposed to smoke in environments such as bars,
restaurants, offices, or factories. The Company believes BANISH has potential
use both for smokers and non-smokers who wish to eliminate tobacco smoke odor.
BUSINESS STRATEGY
The Company's business strategy includes increasing sales of its
Breathe Right nasal strip, expanding its Breathe Right product line and
successfully introducing new products such as BANISH personal smoke deodorizer.
INCREASING NEW CONSUMER PRODUCT TRIAL AND INCREASING PRODUCT USAGE. 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 consumer trial of the product. During the fourth quarter of
1997, the Company introduced a new advertising campaign Breathe Right. SLEEP
TIGHT., which promotes better sleep through use of Breathe Right nasal strips.
The campaign provides an umbrella to point out the benefits of Breathe Right
strips for a variety of large consumer markets including sleep, snoring, nasal
congestion and a deviated septum. By the end of 1997, household trial of the
Breathe Right nasal strip was approximately 13.5%.
MARKETING NEW PRODUCTS THAT LEVERAGE DISTRIBUTION CHANNELS. The Company
plans to leverage its marketing and distribution strengths by acquiring or
licensing the rights to products that it believes have merit and by attempting
to bring them to market. In late 1997, the Company introduced BANISH personal
smoke deodorizer and plans to begin national advertising in the second quarter
of 1998. Among other products currently being evaluated is a unique, chewable
dietary fiber tablet. Current plans are to introduce this product later in 1998.
There can be no assurance that the Company will ever successfully market any of
the Company's new products.
EXPANDING COMPANY PRESENCE IN INTERNATIONAL MARKET. The Company sells
its Breathe Right nasal strip outside the United States pursuant to an
international distribution agreement under which 3M Company agreed to act as
exclusive distributor for the Breathe Right nasal strip in all counties outside
of the United States and Canada. The Company believes international markets
require an increased level of advertising and promotion to reach their
potential. Under a new arrangement with 3M, the Company and 3M will jointly
undertake a more aggressive advertising and promotional campaign in the United
Kingdom early in 1998. A similar approach is anticipated over the next two to
three years in a number of other countries where both companies believe the
approach could enhance Breathe Right nasal strip sales. This will also allow the
Company to build its international marketing and distribution capacity in
preparation for other Company products.
MARKETING NEW PRODUCTS THAT LEVERAGE THE BREATHE RIGHT BRAND NAME. The
Company believes that the Breathe Right brand name is one of its most valuable
assets. The Company is in the process of evaluating new products that leverage
off the Breathe Right name. Potential products include a saline nasal spray and
allergen barrier pillow covers.
MARKETING STRATEGY
BREATHE RIGHT NASAL STRIPS. 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. In 1997, the Breathe Right brand was the number one ranking brand
in annual dollar sales in the nasal products category, with sales exceeding
those of familiar brand names such as Afrin(R), Vicks Sinex(R) and Dristan(R).
The Company's marketing efforts are primarily directed to the consumer
market. The Company's advertising focuses on the snoring and nasal congestion
applications for the product using the campaign Breathe Right. SLEEP TIGHT. The
campaign, with its emphasis on better night time breathing and better sleep,
provides an umbrella for the Company to point out the benefits of Breathe Right
nasal strips for a variety of large consumer markets. 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 paid advertising programs have been enhanced by media
coverage of use of Breathe Right nasal strips by professional athletes. In
addition, a number of radio and television personalties have provided
unsolicited endorsements of the product on national radio and television
programs. The Company has also entered into endorsement agreements pursuant to
which athletes will provide the Company with endorsement services. 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). In 1997, the Company
undertook joint promotions with two of the nations best-known brand names
KLEENEX (R) tissues, and TYLENOL(R) PM pain reliever. The Company intends to
seek additional joint promotion opportunities in the future. 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.
Because the Breathe Right nasal strip is sold as a consumer 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. The most recent research data
collected by a nationally recognized consumer market research firm indicated
that approximately 32% of those in the U.S. who had purchased Breathe Right
nasal strips have purchased additional product.
BANISH PERSONAL SMOKE DEODORIZER. The Company intends to market its
BANISH personal smoke deodorizer to the consumer market. Similar to its
marketing of Breathe Right nasal strips, the Company intends to use public
relations to launch the BANISH personal smoke deodorizer by making consumers
aware of the product's benefits. Beginning in the second quarter of 1998 the
Company anticipates using a mix of consumer and trade promotions and radio and
magazine advertising to market the product.
DOMESTIC DISTRIBUTION
The Breathe Right nasal strip is sold primarily as a consumer product
in drug stores, grocery stores, mass merchant chain stores, warehouse clubs,
military base stores and convenience stores in the U.S. The Company sells
product to retailers through a network of independent sales representatives
referred to in the
industry as non-food general merchandise brokers. The Company uses broker groups
who call on the chain drug, grocery, mass merchant and warehouse club accounts
and the wholesalers who serve primarily the independent drug stores and many of
the grocery stores in the U.S.
Although the Company's advertising focuses on both the snoring and
nasal congestion applications, 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 and there is typically no section in stores for snoring relief
products. 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's retail customers for the Breathe Right nasal strip
include national chains of drug stores, grocery stores and mass merchants such
as Eckerd, Walgreens, RiteAid, CVS, Albertson's, Kroger, Wal-Mart and Kmart and
warehouse clubs such as Sam's Club and Price Costco, as well as regional and
independent stores in the same store categories. In 1997, one retailer accounted
for approximately 18% of domestic 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.
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. The product was on retail
shelves in over 40 countries by the end of 1997. The Company is in the process
of negotiating modifications to certain minimum purchase and pricing provisions
of the 3M agreement to enable the Company to take a more active role in sales
and marketing in certain countries.
In 1995, the Company arranged with LOCIN Industries, a Canadian dental
floss company, to establish distribution in the Canadian market. LOCIN
distributes the product to drug stores in Canada. During 1996, LOCIN began
purchasing product in bulk and packaging it at its facility and assumed
responsibility for cooperative advertising programs.
BANISH PERSONAL SMOKE DEODORIZER DISTRIBUTION .
The BANISH personal smoke deodorizer is being sold as a consumer
product with distribution planned initially for drug stores, grocery stores,
mass merchant chain stores and convenience stores. The Company sells product to
retailers through its network of independent sales representatives. The planned
primary location for the product in stores is tobacco accessories.
THERAPATCH (TM) EXTERNAL ANALGESIC PATCH.
In 1996, the Company began national distribution of the TheraPatch
(TM), an external analgesic patch designed for temporary relief of pain from
arthritis, simple backaches and muscular aches and strains. The Company is not
actively pursuing distribution of the product at the current time and does not
expect to do so in the near future.
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 products which it believes
could successfully be sold through the Company's established distribution
channels. The Company has entered into contractual arrangements for several
products which are in various stages of evaluation and testing prior to
potential market launch. The Company is currently evaluating a unique, chewable
dietary fiber tablet with plans to introduce this product later in 1998. The
Company plans to incur costs of approximately $1.5 million relating to
evaluation and test marketing of these products in 1998. 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
that the Company will market any of these products.
MANUFACTURING AND OPERATIONS
The Company currently sub-contracts with multiple manufacturers, known
as converters, to produce the Breathe Right nasal strip and does no in-house
product production itself. The converters are capable of providing full turnkey
service and shipping product to the Company that is completely packaged ready to
be sold to retailers or providing 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 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 ensure 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. In 1997, the Company received certification
that it has established and maintains a quality system which meets the
requirements of ISO 9002/EN 46002.
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 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.
The Company has contracted with a third party for the production of the
BANISH personal smoke deodorizer.
COMPETITION
The Company believes that the market for decongestant products is
highly competitive while there is currently somewhat less competition in the
market for products for the reduction or elimination of snoring. In the U.S.,
the Company's competition in the consumer market for decongestant products and
other cold, allergy and sinus relief products consists primarily of
pharmaceutical products while competition in the snoring remedies market consist
primarily of internal nasal dilators. Although the Company believes that the
patents on the Breathe Right nasal strip will somewhat limit the ability of
others to introduce competitive external nasal dilator products in the United
States, the Company announced in 1997 that it had become aware of a foreign
reference to a nasal dilator that will result in narrower protection in the
future for the patents licensed by the Company with respect to Breathe Right
nasal strips. External nasal dilator products also compete in the consumer
markets with decongestant and sinus relief products and snoring remedies in
international markets where the Company does not have patent protection on the
Breathe Right nasal strip. See "Patents, Trademarks and Proprietary Rights"
below. 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, 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 categories 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, (iii)
improve nasal breathing by reducing nasal airflow resistance and (iv)
temporarily relieve breathing difficulties due to a deviated nasal septum.
BANISH personal smoke deodorizer is not a medical product and does not
fall under the regulatory authority of the FDA. It does, however fall under the
purview of the Federal Trade Commission (FTC) as a consumer product. In this
context, the claims that are made concerning BANISH (express or implied) must
have a reasonable basis before they are disseminated. The Company believes that
it has a reasonable basis for all claims it is making with respect to BANISH.
The Company's proposed dietary fiber product is considered to be a
dietary supplement and is regulated under the Federal Food, Drug, and Cosmetic
Act (the Act) as amended by the Dietary Supplement Health and Education Act
"DSHEA" of 1994, and under the Fair Packaging and Labeling Act. There is
generally no requirement that a firm obtain a license or approval from FDA
before marketing dietary supplements in the U.S. The FDA is developing
implementing regulations for certain provisions of the DSHEA which will be
published as final rules in the Federal Register.
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 either a "New Drug" or
as a dietary supplement. 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
current agreement with the Company, which is as noted above under "International
Distribution" in the process of being renegotiated, 3M is responsible for
obtaining all necessary regulatory approvals outside the U.S. for Breathe Right
nasal strips. 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. Specifically, the Company has the exclusive right pursuant to the License
Agreement 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. Six of these patent applications have resulted in
issued patents, including one with claims that cover the single-body
construction of the Breathe Right nasal strip. The Company has one patent
application pending. The Licensor has also obtained patent protection on the
Breathe Right nasal strip in three foreign countries and has various
applications pending which seek patent protection in a number of additional
countries.
There can be no assurance that the Licensor's patents on the Breathe
Right nasal strip, or any additional patents issued, if any, will effectively
foreclose the development of competitive products or that the Company will have
sufficient resources to pursue enforcement of any patents issued. See Item 3,
Legal Proceedings. The Company intends to aggressively enforce the patents
covering the Breathe Right nasal strip. 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. In 1997, the Company became
aware of a foreign reference to a nasal dilator that will result in narrower
protection than originally expected from the patents being licensed by the
Company with respect to Breathe Right nasal strips. In addition, in February
1998, the Company was notified by Acutek Adhesive Specialities, Inc. ("Acutek")
that Acutek or one or its affiliates will make or sell nasal dilators in the
United States and certain other markets. Acutek and the Company are engaged in
patent litigation on which settlement discussions are pending. See Item 3, Legal
Proceedings.
The Company has registered its Breathe Right trademark in the United
States and in several foreign countries and is seeking registration of its other
trademarks. The Company believes its trademarks are important as protection for
the Company's names and advertising, and intends to take such steps as are
necessary to protect these trademarks.
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. In addition to seeking patent protection
for its products, the Company intends to also protect its technologies and
proprietary information as trade secrets.
EMPLOYEES
At March 3, 1998, the Company had 50 full-time and two part-time
employees, of whom 14 were engaged in operations, 19 in general administration,
17 in marketing and sales and two in product development. There are no unions
representing Company employees. Relations with its employees are believed to be
positive 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.(45) Chairman of the Board, Chief Executive Officer,
Treasurer and Director
Marti Morfitt(40) President, Chief Operating Officer and Director
M. W. Anderson, Ph.D.(47) Vice President of Clinical and Regulatory Affairs
David J. Byrd(44) Vice President of Finance and Chief Financial Officer
William Doubek(42) Vice President of Operations
Rihab FitzGerald(46) Vice President of Consumer Sales
Kirk P. Hodgdon(38) Vice President of Consumer Marketing
Gerhard Tschautscher(41) 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.
MARTI MORFITT, has agreed to serve as the Company's President and Chief
Operating Officer and a director beginning March 30, 1998. From September 1982
through February 1998, Ms. Morfitt served in a series of positions of increasing
responsibility with the Pillsbury Company, a Minneapolis-based manufacturer and
distributor of food products, most recently serving from May 1997, to February
1998, as Vice-President, Meals, and from February 1994, to May 1997, as
Vice-President, Green Giant Brands. She also serves as a director of Graco,
Inc., a Minneapolis-based manufacturer of fluid handling systems.
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. The Company also leases approximately 32,000 square feet of
warehouse space on a month to month basis.
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 January 1997, the Company was sued for patent infringement in the
United States District Court for the Central District of California by Acutek
Adhesive Specialties, Inc. ("Acutek"). Acutek claims to be an exclusive licensee
in the United States Reissue Patent RE. 35,408. The plaintiff seeks compensatory
damages, interest, costs and fees. The Company has counterclaimed for a
declaration of invalidity of the patents asserted by Acutek and for a
declaration that the Company does not infringe the Reissue Patent. Cross-motions
for summary judgment with respect to the lawsuit are pending. In February 1998,
Acutek was issued a patent entitled "Transparent Nasal Dilator" and commenced an
additional patent infringement lawsuit against the Company in the United States
District Court for the Central District of California. The Company believes that
it does not infringe any valid patent claims and has vigorously defended the
lawsuits brought against it by Acutek. The Company is engaged in settlement
negotiations, however, that may resolve all pending matters between the parties.
The Company is currently unable to determine if these discussions will
ultimately result in a settlement.
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
Information as to the principal market on which the Company's common
stock is traded and market price information for the common stock of the Company
is incorporated herein by reference from page 20 of the 1997 Annual Report to
Shareholders (the "1997 Annual Report").
On March 3, 1998, the last sale price of the Common Stock as reported
on the NASDAQ National Market was $6.3125. As of March 3, 1998, there were
approximately 850 owners of record of Common Stock.
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 information is presented on page 1 of the Company's
1997 Annual Report and is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and
Results of Operations appears on pages 8 through 12 of the Company's 1997 Annual
Report and is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Balance Sheets of the Company as of December 31, 1996 and 1997,
and the related Statements of Income, Stockholders' Equity and Cash Flows for
each of the years in the three-year period ended December 31, 1997, the Notes to
the Financial Statements and the Report of KPMG Peat Marwick LLP, independent
auditors, is contained in the Company's 1997 Annual Report on pages 13 through
20 and is incorporated herein by reference.
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" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for
the Annual Meeting of Shareholders to be held on April 22, 1998 (the "1998 Proxy
Statement"), a definitive copy of which will be filed with the Commission within
120 days of the close of the last 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 1998 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 Stockholders and Management" in the
Company's 1998 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. See Item 8, Financial Statements.
2. Financial Statement Schedules. Not Applicable.
3. Exhibits. See "Exhibit Index" on the page following the
Signature Page.
b. Reports on Form 8-K. The Company did not file a report on Form 8-K
during the fourth quarter ended December 31, 1997.
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 27, 1998 By/s/ Daniel E. Cohen
--------------------
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 27, 1998 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/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.
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.1 Company's Certificate of Incorporation as amended to date
(incorporated by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1995 (the "1995 Form 10-K").
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).
10.2 * 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).
10.3 * 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).
10.4 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).
10.5 * CNS, Inc. 1994 Amended Stock Plan.
10.6 Distribution Agreement dated August 2, 1995 between the
Company and Minnesota Mining and Manufacturing Company ("3M")
(incorporated by reference to Exhibit 10.11 to the 1995 Form
10-K).
10.7 Supply Agreement dated May 17, 1995 between the Company and
Minnesota Mining and Manufacturing Company ("3M") incorporated
by reference to Exhibit 10.12 to the 1995 Form 10-K).
10.8 License Agreement dated January 24, 1996 between the Company
and Ronald S. Nietupsky (incorporated by reference to Exhibit
10.15 to the 1995 Form 10-K).
10.9 License Agreement dated May 9, 1997 between the Company and
Cigone, Enterprises, SmokeBusters of Texas, Inc. and Odor
Pros, Inc. (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.)
10.10 * Employment Agreement between the Company and Dr. Daniel E.
Cohen dated April 15, 1996, (incorporated by reference to
Exhibit 10.15 to 1996 Form 10-K).
10.11 * Employment Agreement dated April 15, 1996 between the Company
and Kirk Hodgdon (incorporated by reference to Exhibit 10.17
to 1996 Form 10-K).
10.12 * Employment Agreement dated April 15, 1996 between the Company
and David J. Byrd (incorporated by reference to Exhibit 10.18
to 1996 Form 10-K).
11.1 Computation of Net Income Per Share of Common Stock.
13.1 Selected information from 1997 Annual Report to Stockholders
21.1 Subsidiaries of the Company
23.1 Consent of KPMG Peat Marwick LLP.
24.1 Powers of Attorney (included on the signature page hereof).
27.1 Financial Data Schedule.
27.2 Financial Data Schedule.
27.3 Financial Data Schedule.
- ---------------
* Indicates Compensatory Agreement