FINANCIAL HIGHLIGHTS
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
Results of Operations(1)(2):
Net sales:
Domestic net sales ................... $ 60,601,757 $ 60,098,235 $ 47,196,414 $ 2,798,174 $ 93,352
International net sales .............. 6,355,377 25,768,290 1,435,441 0 0
-----------------------------------------------------------------------------
Total net sales .................... 66,957,134 85,866,525 48,631,855 2,798,174 93,352
-----------------------------------------------------------------------------
Gross profit ........................... 45,664,139 52,519,647 31,077,442 1,008,629 44,840
Operating income (loss) ................ 9,644,195 21,742,602 12,398,086 (2,757,636) (395,554)
Income (loss) from continuing operations
before income taxes .................. 12,620,316 24,022,484 12,969,505 (2,558,101) (298,753)
Income (loss) from continuing operations 8,770,316 15,522,484 13,310,505 (2,558,101) (298,753)
Net income (loss) ...................... 8,770,316 15,522,484 14,076,494 (2,867,415) (1,430,773)
Diluted net income (loss) per share:
From continuing operations ........... $ .44 $ .78 $ .72 $ (.16) $ (.02)
From discontinued operations ......... .00 .00 .04 (.02) (.09)
-----------------------------------------------------------------------------
Diluted net income (loss) per share $ .44 $ .78 $ .76 $ (.18) $ (.11)
==============================================================================
Weighted average number of common and
assumed conversion shares outstanding 19,802,000 19,807,000 18,376,000 15,755,000 13,145,000
DECEMBER 31,
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
Financial Position(1):
Working capital ........................ $ 76,919,076 $ 78,402,795 $ 25,855,456 $ 10,790,457 $ 3,716,040
Total assets ........................... 88,494,973 89,409,067 32,340,535 11,612,871 3,871,506
Stockholders' equity ................... 80,644,501 79,774,907 26,885,342 11,206,535 3,871,506
(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.
(2) Results of operations prior to 1996 included no income tax expense due to
net operating loss and credit carryforwards.
1
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 Annual Report. 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.
OVERVIEW
The Company was founded in 1982. From 1987 until 1995, the Company designed,
manufactured and marketed computer-based diagnostic devices for sleep disorders.
Beginning in 1995, the Company focused on the Breathe Right(R) 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 primarily from the manufacture and sale of the Breathe
Right nasal strip. Revenue from sales is recognized when earned, 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 that 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.
During 1995, the Company continued its marketing efforts and also focused
on expanding its distribution network both domestically and internationally.
In the first quarter of 1995, a rapid increase in domestic 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. The Company eliminated the back orders and began building
inventory by the end of the second quarter of 1995.
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 most
domestic drug stores, mass merchants and warehouse clubs and a majority of
grocery stores. 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. In June 1996, the Company received FDA clearance
to market the Breathe Right nasal strip for the temporary relief of breathing
difficulties due to a deviated nasal septum. In July 1996, U.S. Utility Patents
were issued covering the basic invention of the Breathe Right nasal strip and
additional elements incorporated in the product. By the end of 1996, the
Company's international distributor, 3M, had introduced the Breathe Right nasal
strip in more than 30 foreign countries.
During 1997, the Company increased the level of domestic marketing
expenditures, primarily through national television advertising, in order to
increase the level of new trial and repeat usage of Breathe Right nasal strips.
While usage of the product increased, the overall results of the increased level
of marketing, especially in the first quarter of 1997, did not meet
expectations. In order to improve the effectiveness of advertising and promotion
programs, the Company hired a new advertising agency on April 1, 1997. The new
advertising campaign developed for the fourth quarter of 1997 focused on the
benefits of improved sleep resulting from better nasal breathing, with the
slogan "Breathe Right. Sleep Tight.(TM)"
As discussed in more detail below, the Company's international sales
decreased during 1997. The Company believes that a higher level of advertising
and promotion is needed in international markets and is working with 3M to amend
the distribution agreement to permit the Company to take a more active role in
advertising and promoting the product in certain countries in the future.
In January 1997, the Company was sued for patent infringement. The Company
believes it has good and sufficient defenses to the claim of patent
infringement. Cross motions for summary judgment with respect to the lawsuit are
pending. In February 1998, the company that brought the patent infringement suit
against the Company was issued a patent entitled "Transparent Nasal Dilator" and
commenced another patent infringement lawsuit against the Company. The Company
intends to defend this action vigorously.
Also, during 1997 the Company became aware of a foreign reference to a
nasal dilator, not commercially available, that will result in narrower
protection in the future from the patents licensed for Breathe Right nasal
strips.
8
OPERATING RESULTS
The tables below set forth certain selected financial information of the Company
and the percentage of net sales represented by certain items included in the
Company's statements of income for the periods indicated.
THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------
(In thousands)
Domestic net sales ............. $16,909 $12,623 $12,352 $18,718 $60,602
International net sales ........ 2,486 970 291 2,608 6,355
---------------------------------------------------
Net sales .................... 19,395 13,593 12,643 21,326 66,957
Cost of goods sold ............. 6,245 4,456 3,897 6,695 21,293
---------------------------------------------------
Gross profit ................. 13,150 9,137 8,746 14,631 45,664
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 11,124 4,900 4,582 11,033 31,639
General and administrative ... 762 812 933 768 3,275
Product development .......... 202 289 246 369 1,106
---------------------------------------------------
Total operating expenses .... 12,088 6,001 5,761 12,170 36,020
---------------------------------------------------
Operating income ............ 1,062 3,136 2,985 2,461 9,644
Interest income ................ 710 777 773 716 2,976
---------------------------------------------------
Income from continuing
operations before income taxes $ 1,772 $ 3,913 $ 3,758 $ 3,177 $12,620
===================================================
THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1996 1996 1996 1996 1996
- ---------------------------------------------------------------------------------------
(In thousands)
Domestic net sales ............. $17,986 $12,611 $11,582 $17,919 $60,098
International net sales ........ 2,835 8,508 7,793 6,632 25,768
---------------------------------------------------
Net sales .................... 20,821 21,119 19,375 24,551 85,866
Cost of goods sold ............. 7,652 9,147 8,000 8,548 33,347
---------------------------------------------------
Gross profit ................. 13,169 11,972 11,375 16,003 52,520
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 7,430 6,917 4,862 7,589 26,798
General and administrative ... 738 645 760 727 2,870
Product development .......... 157 340 336 275 1,109
---------------------------------------------------
Total operating expenses .... 8,325 7,902 5,958 8,591 30,777
---------------------------------------------------
Operating income ............ 4,844 4,070 5,417 7,412 21,743
Interest income ................ 155 685 696 743 2,279
---------------------------------------------------
Income from continuing
operations before income taxes $ 4,999 $ 4,755 $ 6,113 $ 8,155 $24,022
===================================================
THREE MONTHS ENDED (UNAUDITED) YEAR
- --------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
- --------------------------------------------------------------------------------------
(In thousands)
Domestic net sales ............. $7,151 $18,540 $10,180 $11,324 $47,196
International net sales ........ 308 278 108 742 1,436
--------------------------------------------------
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 ... 254 377 639 657 1,927
Product development .......... 46 7 3 0 57
--------------------------------------------------
Total operating expenses .... 2,440 4,172 5,478 6,588 18,679
--------------------------------------------------
Operating income ............ 2,169 7,574 1,297 1,359 12,398
Interest income ................ 84 124 214 149 572
--------------------------------------------------
Income from continuing
operations before income taxes $2,253 $ 7,698 $ 1,511 $ 1,508 $12,970
==================================================
THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------
Net sales ...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............. 32.2 32.8 30.8 31.4 31.8
---------------------------------------------------
Gross profit ................. 67.8 67.2 69.2 68.6 68.2
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 57.4 36.0 36.2 51.8 47.3
General and administrative ... 3.9 6.0 7.4 3.6 4.9
Product development .......... 1.0 2.1 2.0 1.7 1.6
---------------------------------------------------
Total operating expenses .... 62.3 44.1 45.6 57.1 53.8
---------------------------------------------------
Operating income ............ 5.5 23.1 23.6 11.5 14.4
Interest income ................ 3.6 5.7 6.1 3.4 4.4
---------------------------------------------------
Income from continuing
operations before income taxes 9.1% 28.8% 29.7% 14.9% 18.8%
===================================================
THREE MONTHS ENDED (UNAUDITED) YEAR
- ---------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1996 1996 1996 1996 1996
- ---------------------------------------------------------------------------------------
Net sales ...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............. 36.7 43.3 41.3 34.8 38.8
---------------------------------------------------
Gross profit ................. 63.3 56.7 58.7 65.2 61.2
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 35.7 32.8 25.1 30.9 31.2
General and administrative ... 3.5 3.0 3.9 3.0 3.3
Product development .......... .8 1.6 1.7 1.1 1.3
---------------------------------------------------
Total operating expenses .... 40.0 37.4 30.7 35.0 35.8
---------------------------------------------------
Operating income ............ 23.3 19.3 28.0 30.2 25.3
Interest income ................ .7 3.2 3.6 3.0 2.7
---------------------------------------------------
Income from continuing
operations before income taxes 24.0% 22.5% 31.6% 33.2% 28.0%
===================================================
THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
- ---------------------------------------------------------------------------------------
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 ... 3.4 2.0 6.2 5.4 4.0
Product development .......... .6 .1 .0 .0 .1
---------------------------------------------------
Total operating expenses .... 32.7 22.2 53.2 54.6 38.4
---------------------------------------------------
Operating income ............ 29.1 40.2 12.6 11.3 25.5
Interest income ................ 1.1 .7 2.1 1.2 1.2
---------------------------------------------------
Income from continuing
operations before income taxes 30.2% 40.9% 14.7% 12.5% 26.7%
===================================================
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1997 COMPARED TO 1996
NET SALES. Net sales were $67.0 million for 1997 compared to $85.9 million for
1996. Breathe Right nasal strip sales decreased in 1997 as a result of a
decrease in international sales. The Company has experienced in the past, and
expects that it will continue to experience in the future, quarterly
fluctuations in both domestic and international sales and earnings. These
fluctuations are due in part to seasonality of sales as described below, as well
as increases and decreases in purchases by distributors and retailers in
anticipation of future demand by consumers.
For the year 1997, domestic sales increased to $60.6 million from $60.1
million for 1996. While our domestic sales dollars were relatively flat in 1997
compared to 1996, both retail sell-through and our strip sales, measured in
units, increased by approximately ten percent. This is primarily due to a higher
percentage of sales in 30 and 24 count boxes compared to ten count boxes.
International sales decreased to $6.4 million for 1997 from $25.8 million
for 1996. International sales in 1996 represented primarily initial inventory
purchases by 3M, the Company's international distributor, and initial stocking
of inventory at international retail outlets in certain countries. The lower
level of international sales in 1997 reflects continued high inventory levels at
3M. As a result, the quarterly international sales patterns for 1997 are not
comparable to the quarters of 1996 and may not be comparable to the quarters of
1998. The Company believes a higher level of advertising and promotion is needed
in international markets and is working with 3M to amend the distribution
agreement to permit the Company to take a more active role in advertising and
promoting the product in certain countries in the future.
GROSS PROFIT. Gross profit was $45.7 million for 1997 compared to $52.5
million for 1996. Gross profit as a percentage of net sales was 68.2% for 1997
compared to 61.2% for 1996. The higher gross profit as a percentage of net sales
in 1997 was due to the lower level of international 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. Domestic
gross profit as a percentage of domestic net sales for 1997 was approximately
1.5 percentage points higher than 1996, due to a combination of lower
manufacturing costs obtained from sub contractors, an increase in the selling
price of certain products and changes in the mix of products sold. The Company
is continuing efforts to reduce the manufacturing costs of the product and
improve gross profit margins on sales.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $31.6
million for 1997 compared to $26.8 million for 1996. This increase resulted
primarily from heavier levels of advertising primarily associated with domestic
national television advertising. Marketing and selling expenses as a percentage
of net sales increased to 47.3% in 1997 from 31.2% in 1996 as a result of the
increase in expenses and lower level of international sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $3.3 million for 1997 compared to $2.9 million for 1996. This increase
resulted primarily from expenses associated with patent litigation. General and
administrative expenses as a percentage of net sales increased to 4.9% in 1997
from 3.3% in 1996 primarily as a result of the lower level of international
sales.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses were $1.1
million for 1997 and 1996. Product development expenses as a percentage of net
sales increased to 1.6% in 1997 from 1.3% in 1996 primarily as a result of the
lower level of international sales.
INTEREST INCOME. Interest income was $3.0 million for 1997 compared to $2.3
million for 1996. This increase resulted primarily from investment of net
proceeds from the public offering of common stock completed in the second
quarter of 1996.
INCOME TAX EXPENSE. Income tax expense for 1997 was $3.9 million or 30.5%
of income before income taxes compared to $8.5 million or 35.4% for 1996. The
lower effective income tax rate was due primarily to the higher level of tax
exempt interest income as a percentage of income before income taxes.
1996 COMPARED TO 1995
NET SALES. Net sales increased to $85.9 million for 1996 from $48.6 million for
1995. Breathe Right nasal strip sales increased in 1996 in part as a result of
increased consumer advertising, particularly national television and radio, and
the commencement of international sales.
Unlike domestic sales in the first nine months of 1995, which reflected an
increase in inventory levels at existing and new retail outlets, domestic sales
during 1996 approximated off the shelf movement at retail due to increased
consumer demand for the product. As a result, the quarterly domestic sales
patterns for the first three quarters of 1996 are not directly comparable to the
first three quarters of 1995. During the fourth quarter of 1996, domestic retail
10
sell-through of Breathe Right nasal strips was estimated to be approximately 50
percent higher than the fourth quarter of 1995. For the year 1996, domestic
retail sell-through approximately doubled from the 1995 level.
International sales increased to $25.8 million for 1996 from $1.4 million
for 1995. International sales in 1996 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. Gross profit was $52.5 million for 1996 compared to $31.1
million for 1995. Gross profit as a percentage of net sales was 61.2% for 1996
compared to 63.9% for 1995. The lower gross profit in 1996 was due to the higher
level of international sales. Domestic gross profit as a percentage of domestic
net sales for 1996 was approximately 4 percentage points higher than 1995,
primarily due to lower manufacturing costs resulting from the Company bringing a
portion of the packaging operation in-house and increased production levels.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $26.8
million for 1996 compared to $16.7 million for 1995. This increase resulted
primarily from expenses associated with national television and radio
advertising. Marketing and selling expenses as a percentage of net sales
decreased to 31.2% in 1996 from 34.3% in 1995 as a result of the higher level of
sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $2.9 million for 1996 compared to $1.9 million for 1995. This increase
resulted from the additional personnel and systems required to support growth of
the Breathe Right nasal strip business. General and administrative expenses as a
percentage of net sales decreased to 3.3% in 1996 from 4.0% in 1995 as a result
of the higher level of sales.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses were $1.1
million for 1996 compared to $57,000 for 1995. This increase resulted from
expenses associated with the development of potential new products and
enhancements to the Breathe Right nasal strip. Product development expenses as a
percentage of net sales increased to 1.3% in 1996 from .1% in 1995 primarily as
a result of increased expenditures.
INTEREST INCOME. Interest income was $2.3 million for 1996 compared to
$572,000 for 1995. This increase resulted primarily from investment of net
proceeds from the public offering of common stock completed in the second
quarter of 1996.
INCOME TAX BENEFIT (EXPENSE). Income tax expense for 1996 was $8.5 million
or 35.4% of income before income taxes. 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 by the elimination of the valuation
allowance on deferred tax assets due to the Company's expected future taxable
income. There were no net operating loss carry forwards available for 1996 or
future years.
SEASONALITY
The Company believes that approximately 50% of Breathe Right nasal strip users
currently use the product for the temporary relief of nasal congestion and
congestion-related snoring. Sales of nasal congestion remedies are higher during
the fall and winter seasons because of increased use during the cold season. For
this reason the Company's domestic net sales were relatively higher in the first
and fourth quarters.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had cash, cash equivalents and marketable
securities of $59.7 million and working capital of $76.9 million.
OPERATING ACTIVITIES. The Company generated cash from operations of
approximately $8.0 million for 1997 compared to $16.4 million for 1996. The
reduced cash flow was primarily due to a decrease in net income.
INVESTING ACTIVITIES. The Company purchased, net of sales and maturities,
marketable securities of $9.1 million in 1997 compared to $42.4 million in 1996
which included net proceeds from the 1996 public offering of common stock.
Marketable securities purchased consisted of cash equivalents, commercial paper,
corporate bonds, U.S. Government obligations and municipal bonds.
The Company purchased $1.2 million of property and equipment in 1997,
primarily associated with the upgrade of management information systems,
compared to $465,000 in 1996. Capitalized product rights were $1.6 million in
1997 compared to $141,000 in 1996. The Company currently expects to spend up to
an aggregate of $7.0 million on capital expenditures in 1998 and 1999 in order
to among other things supplement its in-house manufacturing capability and to
complete the expansion and upgrade of management information systems. The actual
amount of the expenditures as well as the timing of the expenditures may be
subject to change.
The Company has reviewed the ability of its computer systems to process
transactions relating to the year 2000 and beyond and believes that all
significant systems are compliant.
FINANCING ACTIVITIES. In 1997, the Company's Board of Directors authorized
and the Company purchased one million shares of its common stock for
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
$8.3 million. These treasury shares are to be used to meet the Company's
obligations under its employee stock ownership plan and stock option plans, and
for possible future acquisitions. The Company received $362,000 in 1997 from the
exercise of stock options.
In 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 $35.5
million. The Company also received $686,000 in 1996 from the exercise of stock
options.
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.
The Company believes that its existing funds and funds generated from
operations will be sufficient to support its planned operations for the
foreseeable future, including capital expenditures noted above and possible
future acquisitions of products that would complement existing operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement No.
128, Earnings Per Share. The Company adopted the provisions of this Statement in
1997. The FASB also issued Statement No. 130, Reporting Comprehensive Income and
Statement No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Company intends to adopt these standards in 1998 by making the
required disclosures. Therefore, the adoption of these standards is not expected
to have an effect on the Company's financial position or results of operations.
FORWARD LOOKING STATEMENTS
This Annual Report 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: (i) the
Company's revenue and profitability is currently reliant on sales of a single
product; (ii) the Company's success will depend, to a large extent, on the
enforceability and comprehensiveness of the patents on the Breathe Right nasal
strip technology, and the Company has been sued for patent infringement (see
Item 3, Legal Proceedings in the Company's Form 10-K for the year ended December
31, 1997); (iii) the markets in which the Company competes are highly
competitive; and (iv) the risk factors included in the Company's Prospectus
dated March 29, 1996.
12
STATEMENTS OF INCOME CNS, Inc.
YEARS ENDED DECEMBER 31,
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
Net sales ................................................. $ 66,957,134 $ 85,866,525 $ 48,631,855
Cost of goods sold ........................................ 21,292,995 33,346,878 17,554,413
----------------------------------------------
Gross profit ............................................ 45,664,139 52,519,647 31,077,442
----------------------------------------------
Operating expenses:
Marketing and selling ................................... 31,638,518 26,798,820 16,695,428
General and administrative .............................. 3,275,636 2,869,163 1,926,988
Product development ..................................... 1,105,790 1,109,062 56,940
----------------------------------------------
Total operating expenses ............................... 36,019,944 30,777,045 18,679,356
----------------------------------------------
Operating income ....................................... 9,644,195 21,742,602 12,398,086
Interest income ........................................... 2,976,121 2,279,882 571,419
----------------------------------------------
Income from continuing operations before income taxes .. 12,620,316 24,022,484 12,969,505
Income tax benefit (expense) .............................. (3,850,000) (8,500,000) 341,000
----------------------------------------------
Income from continuing operations ...................... 8,770,316 15,522,484 13,310,505
Loss from operations of discontinued sleep division
(less applicable income tax benefit of $259,000 in 1995) 0 0 (459,901)
Gain on sale of sleep division (less applicable
income taxes of $690,000 in 1995) ....................... 0 0 1,225,890
----------------------------------------------
Net income ............................................. $ 8,770,316 $ 15,522,484 $ 14,076,494
==============================================
Basic net income per share:
From continuing operations .............................. $ .46 $ .83 $ .77
From discontinued operations ............................ .00 .00 .05
----------------------------------------------
Basic net income per share ............................. $ .46 $ .83 $ .82
----------------------------------------------
Weighted average number of common shares outstanding ...... 19,119,000 18,704,000 17,221,000
==============================================
Diluted net income per share:
From continuing operations .............................. $ .44 $ .78 $ .72
From discontinued operations ............................ .00 .00 .04
----------------------------------------------
Diluted net income per share ........................... $ .44 $ .78 $ .76
==============================================
Weighted average number of common and
assumed conversion shares outstanding ................... 19,802,000 19,807,000 18,376,000
==============================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
13
BALANCE SHEETS CNS, Inc.
December 31,
1997 1996
- ----------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 229,647 $12,109,150
Marketable securities ...................................... 59,458,236 50,339,193
Accounts receivable, net of allowance for doubtful accounts
of $210,000 in 1997 and 1996 .............................. 11,392,001 14,665,731
Inventories ................................................ 8,624,663 8,314,826
Prepaid expenses and other current assets .................. 3,295,001 1,647,055
Deferred income taxes ...................................... 1,770,000 961,000
----------------------------
Total current assets .................................... 84,769,548 88,036,955
Property and equipment, net .................................. 1,863,007 839,415
Product rights, net .......................................... 1,502,520 192,633
Certificate of deposit, restricted ........................... 359,898 340,064
----------------------------
$ 88,494,973 $89,409,067
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ........................................... $ 3,130,660 $ 5,134,683
Accrued expenses ........................................... 3,561,279 3,179,944
Accrued income taxes ....................................... 1,158,533 1,319,533
----------------------------
Total current liabilities ................................ 7,850,472 9,634,160
----------------------------
Stockholders' equity:
Preferred stock -- authorized 8,483,589 shares;
none issued or outstanding ................................ 0 0
Common stock-- $.01 par value; authorized 50,000,000 shares;
issued and outstanding 19,294,570 shares in 1997
and 19,145,445 shares in 1996 ............................. 192,946 191,454
Additional paid-in capital ................................. 63,495,718 63,177,939
Treasury shares-- at cost; 961,511 shares in 1997 .......... (8,219,993) 0
Retained earnings .......................................... 25,175,830 16,405,514
----------------------------
Total stockholders' equity .............................. 80,644,501 79,774,907
Commitments (notes 9 and 10)
----------------------------
$ 88,494,973 $89,409,067
============================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
14
STATEMENTS OF STOCKHOLDERS' EQUITY CNS, Inc.
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
COMMON STOCK TREASURY SHARES
-------------------- ADDITIONAL ------------------------ TOTAL
NUMBER PAR PAID-IN NUMBER RETAINED STOCKHOLDERS'
OF SHARES VALUE CAPITAL OF SHARES COST EARNINGS EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 ....... 17,041,656 $170,416 $ 24,229,583 0 $ 0 $(13,193,464) $ 11,206,535
Stock issued in connection
with Employee Stock
Purchase Plan ................. 5,365 54 22,377 0 0 0 22,431
Stock options exercised ......... 129,870 1,299 379,034 0 0 0 380,333
Tax benefit from stock
options exercised ............. 0 0 485,000 0 0 0 485,000
Warrants exercised, less issuance
costs of $35,000 .............. 210,961 2,109 712,440 0 0 0 714,549
Net income for the year ......... 0 0 0 0 0 14,076,494 14,076,494
--------------------------------------------------------------------------------------------
Balance at December 31, 1995 ....... 17,387,852 173,878 25,828,434 0 0 883,030 26,885,342
Proceeds from public stock
offering less issuance
costs of $2,469,000 ........... 1,525,000 15,250 35,449,926 0 0 0 35,465,176
Stock issued in connection
with Employee Stock
Purchase Plan ................. 893 9 11,048 0 0 0 11,057
Stock options exercised ......... 231,700 2,317 683,531 0 0 0 685,848
Tax benefit from stock
options exercised ............. 0 0 1,205,000 0 0 0 1,205,000
Net income for the year ......... 0 0 0 0 0 15,522,484 15,522,484
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 ....... 19,145,445 191,454 63,177,939 0 0 16,405,514 79,774,907
Stock issued in connection
with Employee Stock
Purchase Plan ................. 927 10 7,180 (1,489) 8,464 0 15,654
Stock options exercised ......... 77,300 773 241,308 (37,000) 50,062 0 292,143
Tax benefit from stock
options exercised ............. 0 0 70,000 0 0 0 70,000
Warrants exercised .............. 70,898 709 (709) 0 0 0 0
Treasury shares purchased ....... 0 0 0 1,000,000 (8,278,519) 0 (8,278,519)
Net income for the year ......... 0 0 0 0 0 8,770,316 8,770,316
--------------------------------------------------------------------------------------------
Balance at December 31, 1997 ....... 19,294,570 $192,946 $ 63,495,718 961,511 $(8,219,993) $ 25,175,830 $ 80,644,501
============================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
15
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
Operating activities:
Net income .......................................................... $ 8,770,316 $ 15,522,484 $ 14,076,494
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net gain on sale of assets of discontinued operations ............. 0 0 (1,915,890)
Depreciation and amortization ..................................... 460,044 259,822 187,428
Deferred income taxes ............................................. (809,000) (58,000) (418,000)
Changes in operating assets and liabilities:
Accounts receivable .............................................. 3,273,730 (6,834,938) (6,894,514)
Inventories ...................................................... (309,837) 2,786,083 (9,975,900)
Prepaid expenses and other current assets ........................ (1,647,946) (649,381) (752,055)
Net assets of discontinued operations ............................ 0 0 (814,201)
Accounts payable and accrued expenses ............................ (1,783,688) 5,383,967 5,048,857
-----------------------------------------------
Net cash provided by (used in) operating activities ............. 7,953,619 16,410,037 (1,457,781)
-----------------------------------------------
Investing activities:
Purchases of marketable securities .................................. (99,045,360) (177,630,971) (42,709,438)
Sales and maturities of marketable securities ....................... 89,926,317 135,200,938 39,768,835
Payments for purchases of property and equipment .................... (1,239,918) (464,675) (383,810)
Payments for product rights ......................................... (1,553,605) (141,309) (73,426)
Purchase of certificate of deposit, restricted ...................... (19,834) (20,064) (320,000)
Net proceeds from promissory note ................................... 0 0 595,611
-----------------------------------------------
Net cash used in investing activities ........................... (11,932,400) (43,056,081) (3,122,228)
-----------------------------------------------
Financing activities:
Net proceeds from sale of discontinued operations ................... 0 0 5,000,000
Net proceeds from public stock offering ............................. 0 35,465,176 0
Proceeds from the issuance of common stock
under Employee Stock Purchase Plan ................................. 15,654 11,057 22,431
Proceeds from the exercise of stock options ......................... 362,143 685,848 380,333
Proceeds from exercise of common stock warrants ..................... 0 0 714,549
Purchase of treasury shares ......................................... (8,278,519) 0 0
-----------------------------------------------
Net cash (used in) provided by financing activities ............. (7,900,722) 36,162,081 6,117,313
-----------------------------------------------
Net (decrease) increase in cash and cash equivalents ............ (11,879,503) 9,516,037 1,537,304
Cash and cash equivalents:
Beginning of year ................................................... 12,109,150 2,593,113 1,055,809
-----------------------------------------------
End of year ......................................................... $ 229,647 $ 12,109,150 $ 2,593,113
-----------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest .............................. $ 0 $ 0 $ 12,500
Cash paid during the year for income taxes .......................... 4,750,000 6,541,467 0
===============================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
16
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
NOTE 1 SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
BUSINESS CNS, Inc. ("the Company"), designs, manufactures and markets consumer
products, primarily the Breathe Right(R) 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 relieving nasal
congestion. The Breathe Right nasal strip is sold over-the-counter in retail
outlets, including drug, grocery and mass merchant stores. The Company has 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 All financial instruments are carried at
amounts that approximate fair value.
CASH EQUIVALENTS Cash equivalents consist primarily of money market funds.
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 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.
PRODUCT RIGHTS Product rights, consisting of patents, trademarks and other
product rights, are stated at cost and are amortized over three to seven years
using the straight-line method.
STOCK BASED COMPENSATION The Company follows the disclosure requirements for
stock based compensation plans and, accordingly, no compensation expense has
been recognized.
FOREIGN SALES Foreign sales are made in U.S. dollars only. There are no currency
conversions.
ADVERTISING The Company expenses the production costs of advertising the first
time the advertising runs.
INCOME TAXES Deferred tax assets and liabilities 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 Per Share In 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings
Per Share, which simplifies the standards for computing earnings per share. SFAS
No. 128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share, which excludes dilution. The Company
adopted SFAS No. 128 during 1997 and replaced previously reported primary net
income per share with basic net income per share.
Basic net income per share has been computed based upon the weighted
average number of common shares outstanding during the year. Diluted net income
per share has been computed based upon the weighted average number of common and
assumed conversion shares outstanding during the year.
NEW ACCOUNTING STANDARDS In 1997, the FASB issued SFAS No. 130, Reporting
Comprehensive Income and No. 131, Disclosures about Segments of an Enterprise
and Related Information. The Company intends to adopt these standards in 1998 by
making the required disclosures. Therefore, the adoption of these standards is
not expected to have an effect on the Company's financial position or results of
operations.
NOTE 2 SALE OF DIVISION
On June 1, 1995 the Company completed the sale of all the assets of its sleep
disorder diagnostic products division. Net sale proceeds of $5,000,000 cash and
a note receivable of $596,000 resulted in a gain on the sale of discontinued
operations of $1,916,000. The net loss of this operation is shown on the
statement of income as the loss from discontinued operations.
NOTE 3 MARKETABLE SECURITIES
Marketable securities, including estimated fair value based on quoted market
prices or valuation models, are summarized as follows (in thousands):
17
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31,
1997 1996
- ------------------------------------------------------------------------
COST FAIR VALUE COST FAIR VALUE
- ------------------------------------------------------------------------
Cash equivalents .......... $ 805 $ 805 $ 497 $ 497
Commercial paper .......... 0 0 2,486 2,486
Corporate bonds ........... 3,772 3,772 6,045 6,045
U.S. Government obligations 3,994 3,994 1,998 1,998
Municipal bonds ........... 50,887 50,887 39,313 39,313
- ------------------------------------------------------------------------
Total marketable securities $59,458 $59,458 $50,339 $50,339
========================================================================
Maturities of marketable securities at December 31, 1997 are as follows (in
thousands):
COST FAIR VALUE
- -------------------------------------------------------------
Due within one year .................. $22,566 $22,566
Due after one year through three years 36,892 36,892
- -------------------------------------------------------------
Total marketable securities .......... $59,458 $59,458
=============================================================
There were no realized gains or losses during 1997, 1996 or 1995.
NOTE 4 ADVERTISING
At December 31, 1997 and 1996 $1,337,000 and $212,000, respectively, of
advertising costs were reported as assets. Advertising expense was $21,160,000
in 1997, $16,215,000 in 1996, and $11,839,000 in 1995.
NOTE 5 DETAILS OF SELECTED BALANCE SHEET ACCOUNTS
Details of selected balance sheet accounts are as follows (in thousands):
1997 1996 1995
- ---------------------------------------------------------------
Allowance for doubtful accounts:
Balance beginning of year .......... $210 $201 $ 55
Plus provision for doubtful accounts 5 123 154
Less charge offs ................... 5 114 8
- ---------------------------------------------------------------
Balance end of year ............... $210 $210 $201
===============================================================
DECEMBER 31,
1997 1996
- ---------------------------------------------------------------------
Inventories:
Finished goods ............................... $6,475 $6,254
Work in process .............................. 468 462
Raw materials and component parts ............ 1,682 1,599
- ---------------------------------------------------------------------
Total inventories ........................... $8,625 $8,315
- ---------------------------------------------------------------------
Property and equipment:
Production equipment ......................... $ 928 $ 789
Office equipment and information systems 1,477 376
- ---------------------------------------------------------------------
2,405 1,165
Less accumulated depreciation ................ 542 326
- ---------------------------------------------------------------------
Property and equipment, net ................. $1,863 $ 839
- ---------------------------------------------------------------------
Product rights:
Product rights ............................... $1,920 $ 366
Less accumulated amortization ................ 417 173
- ---------------------------------------------------------------------
Product rights, net ......................... $1,503 $ 193
- ---------------------------------------------------------------------
Accrued expenses:
Promotions and allowances .................... $1,926 $1,305
Royalties and commissions .................... 1,214 1,284
Salaries, incentives and paid time off ....... 273 392
Other ........................................ 148 199
- ---------------------------------------------------------------------
Total accrued expenses ...................... $3,561 $3,180
=====================================================================
NOTE 6 STOCKHOLDERS' EQUITY
Stock Options The Company's stock option plans allow for the grant of options to
officers, directors, and employees to purchase up to 2,950,000 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 and vest in increments
over 1 to 5 years from the grant date. The plans allow for the grant of shares
of restricted common stock. No shares of restricted common stock have been
granted under these plans as of December 31, 1997.
Stock option activity under these plans is summarized as follows:
WEIGHTED-AVERAGE SHARES
EXERCISE PRICE SHARES AVAILABLE
PER SHARE OUTSTANDING FOR GRANT
- ------------------------------------------------------------------------
Balance at December 31, 1994 $ 2.50 1,047,600 832,622
Granted .................. 5.80 698,000 (698,000)
Exercised ................ 2.93 (129,870) 0
Canceled ................. 4.88 (107,430) 107,430
- ------------------------------------------------------------------------
Balance at December 31, 1995 3.85 1,508,300 242,052
Granted .................. 17.61 175,000 (175,000)
Exercised ................ 2.96 (231,700) 0
- ------------------------------------------------------------------------
Balance at December 31, 1996 5.65 1,451,600 67,052
Granted .................. 7.13 110,000 (110,000)
Exercised ................ 2.56 (114,300) 0
Canceled ................. 16.79 (90,000) 90,000
Unused 1987 expired ...... -- 0 (31,702)
Amend 1994 Plan .......... -- 0 750,000
- ------------------------------------------------------------------------
Balance at December 31, 1997 $ 5.29 1,357,300 765,350
========================================================================
At December 31, 1997, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $1.31 - $18.13 and 6.8
years, respectively. At December 31, 1997, 1996 and 1995, currently exercisable
options aggregated 958,100, 775,700 and 653,000 shares of common stock,
respectively and the weighted-average exercise price of those options was $4.00,
$3.87 and $3.10, respectively.
The per share weighted-average fair value of stock options granted during
1997, 1996 and 1995 is estimated as $2.38, $11.00 and $3.48, respectively on the
date of grant using the Black-Scholes option pricing model with the following
assumptions: volatility of 65%; risk-free interest rate of 6.25% in 1997 and
5.4% in 1996 and 1995; and an expected life of 6 years.
The Company applies APB No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for its plans. Accordingly, no
compensation expense has been recognized for its stock-based compensation plans.
Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net income and diluted earnings per share would have
been reduced by approximately $350,000, or $.02 per share in 1997, $900,000, or
$.05 per share in 1996 and $1.5 million, or $.08 per share in 1995.
Pro forma net income reflects only options granted in 1997, 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the
18
pro forma net income amounts presented because compensation cost is reflected
over the options' vesting period and compensation cost for options granted prior
to January 1, 1995 is not considered.
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 138,802 shares have been purchased by employees
as of December 31, 1997.
WARRANTS During 1997 and 1995 warrants to purchase a total of 100,000 shares at
$2.75 were exercised. The warrants had been issued in connection with an
agreement to license a product to be marketed as the Breathe Right device.
During 1995 warrants to purchase 200,000 shares at $3.75 were exercised. The
warrants had been issued to the underwriter of the Company's 1994 public stock
offering.
In connection with an agreement to license a potential product, the
licenser was issued a warrant during 1997 to purchase 25,000 shares of the
Company's common stock exercisable at a price of $8.00 per share which expires
November 2002.
PREFERRED STOCK At December 31, 1997, 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.
NOTE 7 INCOME TAXES
Income tax expense (benefit), from continuing operations, for the three years
ended December 31, 1997, excluding tax on discontinued operations, is as follows
(in thousands):
CURRENT DEFERRED TOTAL
- ---------------------------------------------------------------
1997:
Federal ..................... $4,154 $(728) $ 3,426
State ....................... 505 (81) 424
- ---------------------------------------------------------------
Income tax expense (benefit) $4,659 $(809) $ 3,850
- ---------------------------------------------------------------
1996:
Federal ..................... $8,164 $ (52) $ 8,112
State ....................... 394 (6) 388
- ---------------------------------------------------------------
Income tax expense (benefit) $8,558 $ (58) $ 8,500
- ---------------------------------------------------------------
1995:
Federal ..................... $ 532 $(853) $ (321)
State ....................... 30 (50) (20)
- ---------------------------------------------------------------
Income tax expense (benefit) $ 562 $(903) $ (341)
===============================================================
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):
1997 1996 1995
- -------------------------------------------------------------------------------------
Computed tax expense ........................... $ 4,417 $ 8,408 $ 4,539
State taxes, net of federal benefit ............ 331 452 389
Tax exempt interest ............................ (765) (185) 0
Benefit of foreign sales corporation ........... (127) (417) 0
Change in deferred tax asset valuation allowance 0 0 (5,439)
Other .......................................... (6) 242 170
- -------------------------------------------------------------------------------------
Actual tax expense (benefit) ................. $ 3,850 $ 8,500 $ (341)
=====================================================================================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities for 1997 and
1996 are presented below (in thousands):
DECEMBER 31,
1997 1996
- -------------------------------------------------------
Deferred tax assets:
Inventory items ............. $ 363 $ 294
Accounts receivable allowance 78 78
Product rights .............. 55 55
Accrued expenses ............ 1,328 574
Tax credits ................. 0 24
- -------------------------------------------------------
1,824 1,025
Deferred tax liabilities:
Property and equipment ...... (54) (64)
- -------------------------------------------------------
Net deferred tax assets .... $ 1,770 $ 961
=======================================================
NOTE 8 SALES
The Company had two significant customers, including 3M Company, who accounted
for approximately 28% of total sales in 1997 and 42% of total sales in 1996, and
had one significant customer who accounted for approximately 13% of total sales
in 1995. Accounts receivable from these customers as of December 31, 1997 and
1996 were $5,082,000 and $6,762,000, respectively. Foreign sales by geographic
area are as follows (in thousands):
1997 1996 1995
- ------------------------------------------------------
Europe ............... $4,319 $12,617 $ 162
Asia ................. 730 10,616 370
Other ................ 1,306 2,535 904
- ------------------------------------------------------
Total foreign sales $6,355 $25,768 $1,436
======================================================
NOTE 9 LICENSE AGREEMENT
The Company has an agreement to exclusively license the Breathe Right nasal
strip. Royalties due under this agreement are 3% of net sales. To maintain the
Company's license, it must make minimum royalty payments of $450,000 each year
until patents for the product expire. Royalty expense was $1,995,000 in 1997,
$2,647,000 in 1996 and $1,458,000 in 1995.
NOTE 10 OPERATING LEASES
The Company leases equipment and office space under noncancelable operating
leases which expire over the next three years. Future minimum lease payments due
in accordance with these leases as of December 31, 1997 are as follows (in
thousands):
YEAR ENDING DECEMBER 31, AMOUNT
- -------------------------------------------------
1998 ................................ $ 455
1999 ................................ 455
2000 ................................ 412
- -------------------------------------------------
Future minimum lease payments $1,322
=================================================
19
NOTES TO FINANCIAL STATEMENTS
Total rental expense for operating leases was $471,000 in 1997, $473,000 in
1996, and $377,000 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 $360,000
certificate of deposit.
NOTE 11 EARNINGS PER SHARE
A reconciliation of basic and diluted average common shares outstanding are as
follows (in thousands):
1997 1996 1995
- ---------------------------------------------------------------------------
Average common shares outstanding .......... 19,119 18,704 17,221
Assumed conversion of stock options ........ 682 1,028 1,083
Assumed conversion of warrants ............. 1 75 72
- ---------------------------------------------------------------------------
Average common and assumed conversion shares 19,802 19,807 18,376
===========================================================================
Options to purchase 108,000 shares of common stock at $11.375 to $18.125 per
share were outstanding during 1997 but were not included in the computation of
diluted earnings per share because the exercise prices of the options were
greater than the average market price of the common shares. The options expire
in 2005 and 2006.
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,
1997 and 1996 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. 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,
1997 and 1996 and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 1997 in conformity with
generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
January 21, 1998
COMMON STOCK INFORMATION
PRICE RANGE The Common Stock of the Company is traded under the symbol "CNXS"on
the Nasdaq National Market. The following table sets forth the high and low last
sale prices of the Company's stock for the periods indicated.
1997 HIGH LOW
- -----------------------------------------------------------
First Quarter $16 3/4 $ 8
Second Quarter 12 3/8 8 1/8
Third Quarter 9 1/2 6 5/8
Fourth Quarter 8 3/4 5 11/16
1996 HIGH LOW
- -----------------------------------------------------------
First Quarter $25 7/8 $14 5/8
Second Quarter 25 1/8 19
Third Quarter 25 3/8 15 3/8
Fourth Quarter 20 1/2 13 1/2
SHAREHOLDERS As of March 3, 1998, there were approximately 850 owners of record
of the Common Stock and an estimated 17,000 beneficial holders whose shares were
registered in the names of nominees.
DIVIDEND POLICY The Company has never paid any cash 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.